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38–109 PDF 2007

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FEDERAL RESERVE’S FIRST MONETARY POLICY

REPORT FOR 2007

HEARING

BEFORE THE

COMMITTEE ON 

BANKING, HOUSING, AND URBAN AFFAIRS 

UNITED STATES SENATE

ONE HUNDRED TENTH CONGRESS

FIRST SESSION

ON

OVERSIGHT ON THE MONETARY POLICY REPORT TO CONGRESS PURSUANT TO THE FULL EMPLOYMENT AND BALANCED GROWTH ACT OF 1978

FEBRUARY 14, 2007

Printed for the use of the Committee on Banking, Housing, and Urban Affairs

(

Available at: http://www.access.gpo.gov/congress/senate/senate05sh.html 

COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS 

CHRISTOPHER J. DODD, Connecticut, Chairman

TIM JOHNSON, South Dakota 

JACK REED, Rhode Island 

CHARLES E. SCHUMER, New York 

EVAN BAYH, Indiana 

THOMAS R. CARPER, Delaware 

ROBERT MENENDEZ, New Jersey 

DANIEL K. AKAKA, Hawaii 

SHERROD BROWN, Ohio 

ROBERT P. CASEY, Pennsylvania 

JON TESTER, Montana 

RICHARD C. SHELBY, Alabama 

ROBERT F. BENNETT, Utah 

WAYNE ALLARD, Colorado 

MICHAEL B. ENZI, Wyoming 

CHUCK HAGEL, Nebraska 

JIM BUNNING, Kentucky 

MIKE CRAPO, Idaho 

JOHN E. SUNUNU, New Hampshire 

ELIZABETH DOLE, North Carolina 

MEL MARTINEZ, Florida

SHAWN MAHER, Staff Director 

WILLIAM D. DUHNKE, Republican Staff Director and Counsel 

AARON KLEIN, Chief Economist 

PEGGY R. KUHN, Republican Senior Financial Economist 

JOSEPH R. KOLINSKI, Chief Clerk and Computer Systems Administrator 

JIM CROWELL, Editor

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CONTENTS

WEDNESDAY, FEBRUARY 14, 2007

Page

Opening statement of Chairman Dodd .................................................................. 1

Opening statements, comments, or prepared statements of: 

Senator Shelby .................................................................................................. 4

Senator Casey ................................................................................................... 5

Senator Bunning ............................................................................................... 5

Senator Bayh .................................................................................................... 6

Senator Martinez .............................................................................................. 6

Senator Menendez ............................................................................................ 6

Senator Hagel ................................................................................................... 7

Senator Tester .................................................................................................. 8

Senator Bennett ................................................................................................ 8

Senator Brown .................................................................................................. 9

Senator Allard ................................................................................................... 10

Senator Reed ..................................................................................................... 10

Senator Sununu ................................................................................................ 11

WITNESS 

Ben S. Bernanke, Chairman, Board of Governors of the Federal Reserve 

System, Washington, DC ..................................................................................... 12

Prepared statement .......................................................................................... 60

Response to written questions of: 

Senator Shelby ........................................................................................... 64

Senator Sununu ......................................................................................... 66

ADDITIONAL MATERIAL SUPPLIED FOR THE RECORD

Monetary Policy Report to the Congress dated February 14, 2007 ..................... 68

Letter to Senator Christopher J. Dodd from Ben S. Bernanke, Chairman, 

Board of Governors of the Federal Reserve System dated February 26, 

2007 ....................................................................................................................... 98

Letter to Senator John E. Sununu from Ben S. Bernanke, Chairman, Board 

of Governors of the Federal Reserve System dated February 26, 2007 .......... 101

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(1)

FEDERAL RESERVE’S FIRST MONETARY 

POLICY REPORT TO CONGRESS FOR 2007

WEDNESDAY, FEBRUARY 14, 2007

U.S. SENATE, COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS, Washington, DC.

The Committee met at 10:07 a.m., in room SD–106, Dirksen Senate Office Building, Senator Christopher J. Dodd (Chairman of the 

Committee) presiding. 

OPENING STATEMENT OF CHAIRMAN CHRISTOPER J. DODD 

Chairman DODD. The hearing will come to order. 

Let me thank all of our colleagues and others who have made it 

in this morning to participate in this hearing on our first true winter morning this year. Mr. Chairman, we thank you for being with 

us as well, and we appreciate your testimony before the Committee. 

What I will do is open up with a brief opening statement. I will 

turn to my colleague, Senator Shelby, and then any of our other 

colleagues who would like to make some brief opening remarks. 

Your full statements, I will guarantee you, will be included in the 

record, as will yours and any supporting documentation, Mr. Chairman, you would like to be a part of this record this morning. We 

will try and move along so we can get to the question and answer 

period with you as quickly as possible. 

This morning, the Committee is pleased to welcome Federal Reserve Chairman Bernanke to deliver the Fed’s Semi-Annual Monetary Policy Report. I want to congratulate you, Mr. Chairman, for 

completing your first year as Chairman. Following in the footsteps 

of a very successful Chairman can be difficult, and it is something 

that I can certainly relate to, sitting in this chair and sitting next 

to my friend from Alabama. But I believe that you have done a 

very good job in gaining the respect and confidence of the markets 

and your colleagues on the Federal Reserve Board. 

The Fed’s monetary policy—most notably, its decision to stop rising interest rates in June—has played a very important role in 

some recent positive economic developments. During 2006, the 

economy grew at a sustainable rate and unemployment was kept 

to under 5 percent. While this is not quite as strong as it was in 

the late 1990’s—when growth was higher and unemployment fell 

below 4 percent, with much higher labor force participation—this 

economic news is welcome. Long-term interest rates have remained 

at modest levels, despite a large Federal budget deficit, a historic 

2

current account deficit, and the cumulative effect of the Fed’s 2-

year cycle raising the interest rates that ended in June. 

While these developments are, as I said, positive, there are other 

facts that, in my view, raise some very important questions about 

our Nation’s long-term ability to provide economic security, opportunity, and prosperity to the people of this country. 

As I travel around these days and talk to many people from all 

walks of life, I am confronted by people who are concerned about 

the future, whether or not we will have the kind of stability and 

long-term growth necessary for our success. What I am hearing 

from people is that they are concerned about many of the same 

things. 

Health care costs are rising at a rate that is unsustainable for 

businesses and employees. Over the past 6 years, health care costs 

have increased by 30 percent. More than 46 million Americans 

have no health insurance at all today, as we all know. That is an 

increase of 6 million people over the past 6 years. The price of gasoline, home heating oil, and other forms of energy has skyrocketed 

over the past years. This past summer, gasoline cost over $3 per 

gallon in many parts of the country. And while it is much lower 

today, it is still twice as high as it was 5 years ago. Families are 

concerned as well that they cannot afford to send their kids to college. My colleague from New York, Senator Schumer, has spent a 

lot of time on this issue. College tuition has risen by more than 

twice the rate of inflation over the past 20 years. Room, board, and 

tuition at many private universities now cost well over $50,000 a 

year. 

As these costs rise, working Americans are experiencing more 

and more uncertainty about their future. People are wondering 

whether their home is losing value as they see houses in their 

neighborhood sell for less today than they did a year ago. And millions of Americans are in exotic and subprime mortgages while the 

potential for sharp increases in monthly payments is right around 

the corner. Several credible reports say that we are facing a tidal 

wave of defaults and foreclosures, which could strip these families 

of their major, if not their only, source of wealth and long-term economic security. 

Despite some recent gains in household incomes, the real median 

family income, what a family right in the middle of the middle 

class earns in a year, is lower today than it was 6 years ago. People 

are working longer and harder, and many are not bringing home 

enough money to keep pace with what they need. And for those 

who lose their jobs, the prospect of falling out of the middle class 

is far greater today. Americans are more than twice as likely to experience a precipitous drop in income as Americans of a generation 

ago, according to a recent research study by Jacob Hacker at Yale 

University. 

As we worry about some Americans falling out of the middle 

class, we must also be concerned about those working hard to climb 

into the middle class. Over 10 million Americans today do not have 

access to mainstream financial institutions, such as a bank, a credit union, or a thrift. For these entrepreneurs and workers, affordable credit and capital services are scarce, if not impossible to find. 

And as a result, millions of our fellow citizens lack the financial 

3

tools that they need to build more secure and prosperous futures 

for themselves and their families. 

Finally, Mr. Chairman, our Nation finds itself with trade policies 

that are unsustainable, as well, in my view. We have learned this 

week that last year, we ran a record trade deficit of $763 billion. 

Our Nation’s current account deficit will approach 7 percent of our 

GDP. We are relying on over $2.4 billion a day from foreign investors, who are increasingly foreign governments, to finance our economic growth because of the lack of savings here at home. 

The Administration has an official trade policy that is, in key respects, out of touch with reality. For instance, it is widely believed 

that China manipulates its currency. We had a very good hearing, 

as you may know, with Hank Paulson before this Committee a 

week or so ago on the exchange rate issue. Yet, the Administration 

refuses to officially recognize that fact. When Chairman Bernanke 

was in China, as part of the Strategic Economic Dialogue, he gave 

a speech that pointed out, ‘‘effective subsidy that an undervalued 

currency provides for Chinese firms that focused on exporting.’’ 

While this subsidy is not the sole cause of either our record international trade deficit or our loss of over 3 million manufacturing 

jobs, including about 1 million of those jobs in critical national defense-related industries, the distortion of Chinese currency manipulation is having a very significant negative impact on American 

manufacturing jobs. 

As policymakers, I think we need to ask ourselves a very fundamental question: Are we satisfied with America’s place in the world 

at the beginning of this new century? I do not think that any one 

of us can look at all the facts and reach any conclusion other than 

that we can do a lot better than I think we are. And for the sake 

of the people we serve and generations coming after them, I think 

all of us would agree we have to do better. 

There are steps we can and should take, in my view, to build a 

stronger foundation for a more secure and prosperous future. Today’s hearing provides the Committee with an opportunity to discuss some of these steps. We can start by keeping interest rates at 

modest levels, and, again, I congratulate the Fed on doing that 

since last June. Certainly, monetary policy is obviously an important component of our economic future. The Fed’s dual mandate is 

to promote full employment and price stability. This is a vital and 

difficult mission, and we look forward to hearing from the Chairman about the steps the Fed has taken since its last report to fulfill that statutory mandate. 

In addition, we need our Federal financial regulatory agencies to 

be vigilant in assuring not only the safety and soundness of our financial institutions, but also that those institutions are serving, 

not thwarting, the aspirations of Americans to build a more secure 

and prosperous life for themselves and those families. 

I look forward to discussing the aspects of the Fed’s mission as 

well as with you today, Mr. Chairman, and I will turn to my colleague from Alabama for any opening comments he may have and 

then to my colleagues here as well for any brief statements they 

want to make as we start this hearing. 

Senator Shelby. 

4

STATEMENT OF SENATOR RICHARD C. SHELBY 

Senator SHELBY. Thank you, Chairman Dodd. 

Chairman Bernanke, we are pleased to have you before the Committee again to deliver the Federal Reserve’s Semi-Annual Monetary Policy Report. This hearing provides an important mechanism 

for assuring accountability over the Fed’s policies and operations. 

Chairman Bernanke, you have recently completed one year at 

the helm of the Federal Reserve System. When President Bush 

nominated you for this position, I noted at the hearing that you 

would have big shoes to fill, following in the footsteps of the distinguished Chairman Greenspan. I also noted my belief that the 

President made a superb choice in asking you to take on this responsibility. The Federal Reserve’s conduct of monetary policy thus 

far under your leadership has given me further reason to applaud 

your service. 

Chairman Bernanke, as 2006 began, there was much debate as 

to whether the Federal Reserve would prove successful in engineering a ‘‘soft landing,’’ after many successive increases in the Fed 

funds target rate. Certainly the economic data in recent weeks tells 

us that the debate maybe all but over. Analysts and other Fed 

watchers are now giving you high praise for the manner in which 

you have handled your responsibilities, and I join them. 

Real gross domestic product, GDP, increased at an annual rate 

of 3.5 in the fourth quarter of 2006. For all of 2006, GDP grew 3.4 

percent compared with the 3.2-percent increase in 2005. Both numbers topped the 20-year average of 3.1 percent. 

Along with this strong growth, we have seen positive news on the 

job front. The Labor Department reported that the economy created, Mr. Chairman, more than 2.2 million jobs last year, 400,000 

more than previously estimated. We continue to enjoy a low unemployment rate, both historically and relative to other industrialized 

nations. 

At its most recent meeting on January 31, Federal Open Market 

Committee kept the Federal funds target rate at 5.25 percent, the 

fifth consecutive meeting with no change. Fed watchers noted that 

the latest FOMC statement seemed more upbeat on growth prospects and keeping inflation in check. My colleagues and I, Mr. 

Chairman, will no doubt spend time this morning trying to figure 

out how long the FOMC intends to leave short-term rates unchanged. 

I am certain that today’s hearing will also include some discussions of the potential risks in the economy, such as the housing 

market slowdown, among others. 

Mr. Chairman, while it is our responsibility to continue to examine the horizon for such risks, we must also note the strong performance of this economy. I hope that we will also take time today 

to discuss the very strengths and how to maintain and build upon 

them. 

Chairman Bernanke, again, we welcome you back to the Committee, and we like the job you are doing. 

Chairman DODD. He is not here, but Senator Schumer was next 

on our list, but, Senator Casey, this early bird rule applies here. 

Senator Casey. 

5

STATEMENT OF SENATOR ROBERT P. CASEY 

Senator CASEY. Mr. Chairman, thank you very much for gathering us here. Chairman Bernanke, thank you for your time here 

today and for your service. 

I do not have a long statement, but I just wanted to highlight 

a couple of things I know that you have touched on before and that 

I am sure we will speak to today, some of the long-term fiscal challenges that you outlined here in your previous testimony, I guess 

a week or so ago, with regard to Medicare, Social Security, and 

other demands that are being placed on the Federal budget into 

the future. I appreciate the fact that you are thinking about and 

focusing on that and building that into the planning that you do. 

I think also the people that I represent in Pennsylvania are concerned about those costs. They are concerned about the deficit, 

which I guess last year was $248 billion. This year, the projection 

is for something less than that. But they are also concerned about 

the impact, as Chairman Dodd outlined, of the costs in their own 

lives, in their real lives, and you know the cost of health care and 

college tuition and housing and so many other areas. I hope that 

one of the things we have a chance to discuss today is the impact 

that those costs have, the impact not just on that family, the horrific impact it can sometimes have on their budgets, but also the 

impact that that has on overall long-term economic growth and stability. 

So, I look forward to discussing that today with you, and we appreciate the time you are spending with us, and we appreciate the 

report. 

Chairman DODD. Senator Bunning. 

STATEMENT OF SENATOR JIM BUNNING 

Senator BUNNING. Thank you, Mr. Chairman. 

Chairman Bernanke, thank you for being here today. To repeat 

what I told you at the Budget Committee hearing a few weeks ago, 

the Federal Open Market Committee did the right thing by stopping the increases in the Fed fund rates after the June 2006 Fed 

meeting. By holding rates constant, you have done the right thing 

ever since. After the latest increase, the stock markets took off and 

the cost of credit leveled off. If the Fed had chosen to continue hiking rates, mortgages and other forms of credit would have become 

less and less affordable to the average American. 

Over the last 2 years, the costs of credit, such as mortgages, student loans, and credit cards, have all increased. I am not sure how 

much more tightening consumers could have handled before serious 

harm was done to the economy. Higher interest rates accelerated 

the housing decline. We will not know the full extent of the damage 

for months, if not longer. If the Fed had not stopped when it did, 

we would have been in even more danger. 

You have been at the helm of the Fed for a year now. My initial 

fears were that you would be a carbon copy of your predecessor, yet 

you have done some things I have never seen your predecessor do: 

Embrace open and full debate. There is an old saying that there 

is a reason we have two ears and one mouth: It is often more important to listen than to talk. 

6

During your brief tenure at the Fed, you have made a serious effort to improve on how the Fed listens, but you know I am not 

going to let you off that easy, even though today is Valentine’s Day. 

The people of my State and I have real concerns about the dangers 

that lie ahead for our economy. As this Committee discussed with 

Secretary Paulson last month, our constituents are nervous when 

they see more and more manufacturing jobs going to the Chinese. 

They are concerned about the future of the housing market. They 

are particularly concerned about the effects that the potential repeal of the Bush tax cuts will have on our economic recovery. You 

inherited an economy that was approaching a tipping point, and so 

far you have managed not to push it over. I urge you to act with 

caution and deliberation in the coming year. 

Finally, soon there will be two vacancies on the Board of Governors. I hope the President moves quickly to fill these positions 

with people who have real experience in financial services and commercial banking, not just ivory tower academics. I look forward to 

your remarks. 

Thank you, Mr. Chairman. 

Chairman DODD. Thank you, Senator Bunning. 

Senator Bayh. 

COMMENTS OF SENATOR EVAN BAYH 

Senator BAYH. Thank you, Mr. Chairman. 

Chairman Bernanke, I suspect that most of the people here today 

have gathered to listen to you, not me, and I will, therefore, reserve 

my comments for the question period. 

Chairman DODD. Very good. 

Senator Martinez. 

STATEMENT OF SENATOR MEL MARTINEZ 

Senator MARTINEZ. I will almost resist the temptation. 

Chairman DODD. That was a standard Senator Bayh set there. 

Senator MARTINEZ. But I will be very brief, Mr. Chairman. 

Thank you very much. 

Chairman Bernanke, welcome, and I again join in the high 

praise that you have been receiving for your first year on the job. 

I will simply look forward to hearing your comments as it relates 

to the housing market, a great concern to me, housing affordability; 

also, the issue that we dealt with last week in this Committee, 

which is subprime lending and the rate of defaults in that area; 

and just in general the effect of the hurricanes in the Gulf Coast, 

which continue to be an impact on the economies of the Gulf 

States. 

So, I look forward to your comments, and thank you for being 

with us today. 

Chairman DODD. Thank you very much. 

Senator Menendez. 

STATEMENT OF SENATOR ROBERT MENENDEZ 

Senator MENENDEZ. Thank you, Mr. Chairman. 

Chairman Bernanke, welcome. It is great to welcome a fellow 

New Jerseyan back again to the Committee. 

7

Today, some people say the economy is solid due to some of the 

leading economic indicators appearing generally healthy, with unemployment below 5 percent, with moderate economic growth, with 

inflation stabilized, and I certainly want to commend you for the 

stewardship you have shown at the Fed in working on this economy. But at the same I also worry about who is benefitting from 

this economy and who is being left behind. 

Indeed, there are serious limitations, I think, in judging a situation solely through looking at the big-picture numbers, as this view 

often hides the details of a situation, and specifically I am talking 

about the burden being placed on our middle class. So while some 

in this country might believe that our economy is chugging along 

quite well because our gross domestic product continues to grow, 

there seems to be an increasing gap between the average citizen 

and those at the top of our economic ladder. And the disparity that 

continues to grow, in my mind, is widening at an alarming rate. 

When I am back in New Jersey, I hear more and more from New 

Jerseyans that our current economic policies are not working for 

them. The middle class continues to shrink, poverty is increasing, 

the gap between the rich and the poor is growing wider. We have 

a record-breaking national debt and a record-breaking trade deficit. 

The personal savings rate is now below zero, which has not happened since the Great Depression. Millions of Americans are seeing 

their wages stagnant and their pension and health care benefits 

slashed, while the wealthiest people in the country are doing better 

than ever. 

So ultimately my concern is that our economy is not working for 

the broadest scope of Americans that we would hope. The middle 

class is shrinking instead of growing, and we seem far more concerned about boosting the incomes of the wealthiest Americans 

while denying our responsibility to those struggling to make ends 

meet. I do not think we can sustain that position over the longterm. We are borrowing to pay for tax cuts and the war effort. It 

is an unfair burden we are placing on our children and grandchildren. 

So, I look forward to your testimony today and hearing your 

thoughts on some of these things I have mentioned, some of the 

other things I hope you will address, like the cooling off of the 

housing market, what that may mean; energy prices; the consequences of deficit and debt, from large budget deficits to record 

personal debt. And I understand that in your capacity as Chairman 

of the Federal Reserve, you are responsible for keeping inflation 

low and stable while maintaining economic growth, not economic 

equality. But I do hope either in your opening statement or subsequently in the questions that we will have an opportunity to ask 

to hear your views about how we get this economy working in a 

direction that it really helps middle-class families in this country. 

Thank you, Mr. Chairman. 

Chairman DODD. Thank you very much. 

Senator Hagel. 

STATEMENT OF SENATOR CHUCK HAGEL 

Senator HAGEL. Mr. Chairman, thank you. 

8

* Held in Committee files. 

Mr. Chairman, welcome. We are glad you are here. I want to personally thank you for you taking time to address the Greater 

Omaha Chamber of Commerce at their annual meeting 2 weeks 

ago. It was a rather significant event, as it always is, and your 

speech matched the expectations that many had, and I appreciate 

you very much taking a day of your time to come to my State and 

deliver that speech and spend some time with our leaders in Nebraska. And I look forward to your testimony. 

Thank you. 

Chairman DODD. Thank you very much. 

Senator Tester. 

COMMENTS OF SENATOR JON TESTER 

Senator TESTER. Thank you, Chairman Dodd. 

Chairman Bernanke, I want to also welcome you here. This is 

one of those odd occasions where I do not have another committee. 

Thank God for snow. So, I look forward to your comments, and I 

will have questions when you are done. 

Thank you. 

Chairman DODD. Thank you very much. 

Senator Bennett. 

STATEMENT OF SENATOR ROBERT F. BENNETT 

Senator BENNETT. Thank you, Mr. Chairman. I had planned to 

follow Senator Bayh’s standard, but I have heard so many things 

being said here that I think at least one voice should rise in defense, if you will, of where certain things have been going. 

Mr. Chairman, you know my personal affection for you, but it 

will not be a surprise that I disagree with your opening statement. 

Chairman DODD. I am shocked to hear that. 

[Laughter.] 

Senator BENNETT. And, by coincidence, I suppose the best rebuttal is in a piece that appeared in this morning’s paper by Brian 

Wesbury, who is the Chief Economist at First Trust Advisors, LP, 

in Illinois, ‘‘A Portrait of the Economy.’’ I would ask unanimous 

consent that the entire piece appear in the record.* 

Chairman DODD. Without objection. 

He starts out, ‘‘It is the best of times. It is the scariest of times. 

Last year, U.S. exports, industrial production, real hourly compensation, corporate profits, Federal tax revenues, retail sales, 

GDP, productivity, the number of people with jobs, the number of 

students in college, airline passenger traffic, and the Dow Jones Industrial Average all hit record levels. For the third consecutive 

year, global growth was strong, continuing to lift and hold millions 

of people out of poverty. From 30,000 feet—heck, from 1,000 feet, 

it sure looks like the best of times. In relative terms, the first 5 

years of the current recovery have been much better than the first 

5 years of the 1990’s recovery. But this has not softened the pessimism of many pundits and politicians who are either 

unimpressed or expect the whole thing to come crashing down any 

minute, unless the Government firmly grabs the rein of the global 

economy and steers it clear of disaster.’’

9

And then he goes on to outline the history of how badly things 

have gone every time the Government has tried to step in and 

steer it clear, starting with the 1930’s and then the 1970’s. He 

makes this comment about the 1970’s, which I responded to, and 

it says, ‘‘Forgotten in the rush to pass judgment on capitalism is 

the fact that the last two times the Government seriously tried to 

control the economies in the 1930’s and 1970’s and made a terrible 

mess of it’’—well, I will leave the rest of it for people to read, but 

the one thing I would say to you, Mr. Chairman, if he is right—

and I think he is—in the year of your stewardship, the last year, 

exports, industrial production, real hourly compensation, profits, 

tax revenues, retail sales, all are at record levels, you must have 

been doing a pretty good job. And if you were running for office, 

you would take full credit for absolutely all of it. 

Thank you, Mr. Chairman. 

Chairman DODD. Thank you, Senator Bennett. 

Senator Brown. 

STATEMENT OF SENATOR SHERROD BROWN 

Senator BROWN. Thank you, Mr. Chairman. 

Chairman Bernanke, I appreciate your joining us today to share 

your thoughts on the direction of monetary policy in the months 

ahead. I also appreciate the comments you have made in Nebraska 

and other places before other groups and the steps you have taken 

toward greater transparency. 

I am sure that you can appreciate for most of the families in my 

State of Ohio and elsewhere, many of the issues we discuss today 

are far removed from their day-to-day lives. As Senator Menendez 

said, the uncertainties that middle-class families face are not the 

uncertainties that the columnist that Senator Bennett mentioned 

and others and economists worry about as often perhaps as they 

should. 

I know and appreciate your acknowledging the widening gap of 

income in our society. I commend you for adding your voice to that 

discussion. I agree with you that we should look at ways to improve education and training of our citizens, but I do not think that 

is nearly enough. Globalization has had a tremendous impact on 

workers in this country, on communities, on teachers, on firefighters, on cities’ ability to deliver services to their constituents. 

There is no question that good-paying manufacturing jobs have 

gone offshore. Fourteen years ago, the trade deficit in this country 

was $38 billion. Today, announced just this week, it exceeds $760 

billion. George Bush the First said that a $1 billion trade deficit 

translates into 13,000 lost jobs. You do the math. 

Of course, we must trade with the world. The question is not if 

we will trade with other countries; rather, it is how we will trade 

with them and who will benefit. If the beneficiaries are limited to 

those with investment capital and the losers too often are workers 

and their communities across the country, we simply will not have 

a very sustainable trade policy. We devote substantial time and effort to protecting intellectual property in our trade negotiations 

and enforcement. We need to do this, but we exert almost no effort 

in protecting the rights of our workers and their counterparts overseas. That simply has to change. 

10

Many in the media and some in Government label those of us 

who advocate for labor and environmental standards as ‘‘protectionist.’’ Yet when our trade agreements protect the drug industry 

or Hollywood films, we call that simply ‘‘free trade.’’ If we can protect an Ohio inventor, if we can protect pharmaceuticals, if we can 

protect copyrights, as we should, we can do a much better job protecting workers and the environment. 

I thank you for your time. 

Chairman DODD. Thank you very much, Senator. 

Senator Allard. 

STATEMENT OF SENATOR WAYNE ALLARD 

Senator ALLARD. Thank you, Mr. Chairman. I would like to 

thank you and Senator Shelby for holding this important hearing. 

I always look forward to hearing from Chairman Bernanke. I think 

that you have started off very well in your tenure as Chairman of 

the Federal Reserve, and I want to congratulate you on that initial 

effort. I think you have gained the confidence of the markets, and 

I think you have gained the confidence of many Members of the 

Congress, although there are a few skeptics still among us. 

I would like to emphasize that the economy is doing well. If we 

look at economic growth, this last year it is 3.4 percent; the previous year it was 3.2 percent. The average over 20 years is 3.1 percent. So we are above the average in economic growth. I think a 

lot of that is attributable to the economic growth package that we 

put in place in 2003 and the tax cuts that we had in 2001. We have 

heard a lot of comments here in this Committee about how it is 

going to impact the family. In my view, the hardest-working American is the small businessman, and those economic growth packages were targeted to the small businessman. That is where economic growth occurs. There are Members in Congress that are 

pushing hard to do away with those temporary tax reductions that 

we put in place to stimulate the economy. 

My question to you is: I hope you will address this. If we let 

those temporary tax cuts go away, what kind of impact is it going 

to have on the average family? I think it is going to have a dramatic impact, particularly on the hard-working men and women of 

this country who are in business for themselves. And I hope that 

you can address that in your comments. 

Thank you very much. 

Chairman DODD. Thank you, Senator Allard. 

Senator Reed. 

STATEMENT OF SENATOR JACK REED 

Senator REED. Thank you, Mr. Chairman, and thank you, Chairman Bernanke, for joining us today. Your task in setting the right 

course of monetary policy is complicated by fiscal policy and international imbalances. We no longer have the fiscal discipline that 

we had in the 1990’s which allowed for a monetary policy that was 

more encouraging of robust investment and long-term growth. 

The present large and persistent budget deficits have led to an 

ever-widening trade deficit that forces us to borrow vast amounts 

from abroad and puts us at risk of a major financial collapse if foreign lenders suddenly stop accepting our IOU’s. Continued budget 

11

and trade deficits will be a drag on the growth of our standard of 

living and leave us ill prepared to deal with the effects of the retirement of the baby-boom generation. Strong investment, financed 

by our own national saving, not foreign borrowing, is the foundation of a strong and sustained economic growth and rising standards of living. 

One final issue that I would like to raise is the growing inequality of income earnings and wealth in the U.S. economy. Between 

2003 and 2005, GDP grew at a rate of 3.5 percent per year. However, after adjusting for inflation, the typical weekly earnings of 

full-time wage and salary workers at the median of the earnings 

distribution went up only 0.6 percent between the end of 2000 and 

the end of 2006. Obviously, these median workers are not sharing 

in that robust GDP. 

Data from the Federal Reserve Board Survey of Consumer Finances show that household wealth is very unevenly distributed. 

The wealthiest 1 percent of families held more of the country’s 

wealth than the bottom 90 percent of families combined. Even more 

disturbing is the large number of families, particularly AfricanAmerican and Hispanic communities, that have little or no net 

wealth. 

Chairman Bernanke, I was heartened to read you comments in 

Omaha last week emphasizing the importance of education and 

training in reducing this economic inequality. And I know you 

share the concern that widening inequality is not good for our democracy and the fabric of the country. So, I hope you will agree 

there is an inconsistency at best in the Administration’s pursuit of 

tax breaks for those who are already well off, including the permanent elimination of the estate tax, while continuing to propose cuts 

to elementary and secondary education, student aid and loan assistance for higher education, and job training for displaced workers. The challenges facing our economy are compounded by the disarray that characterizes our fiscal policy. We have been running 

unsustainable fiscal deficits, and in order to make the necessary investments in training and education, we must reverse this course. 

And I would be remiss if I did not note that the lead story today 

in most of the wire services is that Chrysler is cutting 13,000 jobs. 

I suspect that will probably raise the stock of Chrysler, make the 

investors happy, and investment bankers who are structuring the 

transformation of the company; it is necessary perhaps to do. But 

for 13,000 Americans who used to have good jobs with good health 

benefits, they are in a quandary, and our obligation is to them as 

well as it is to the shareholders of that company. 

So, I think we have to do a lot more, and I think you do sense 

that, and I think together, hopefully, we can make some progress. 

Chairman DODD. Thank you, Senator Reed. 

Senator Sununu. 

STATEMENT OF SENATOR JOHN E. SUNUNU 

Senator SUNUNU. Thank you very much, Mr. Chairman. 

Senator Bennett, I thought, was somewhat eloquent in talking 

about the very positive trends we have seen in the economy: Record 

job creation and above average recovery period, record homeownership, rising income levels. It is fair to say, though, for any Member 

12

who has spent a little time back home, there is a sense of insecurity that can be felt even in what are relatively strong economic 

times. And I think that is an issue or a set of issues dealing with 

their insecurity or uncertainty that we should deal with as policymakers and perhaps that at some level can even be addressed by 

the Fed. But I think it is important to understand that the role of 

the Fed is not to redistribute wealth, not to raise taxes, not to establish protectionist trade measures. And I think that is a good 

thing. I suspect maybe Chairman Bernanke thinks that is a good 

thing, because he has a tall enough order as it is. 

The areas where the Fed can have a very positive impact within 

their mission are to deal with the uncertainties of inflation, the uncertainties of establishing a sustainable and steady record of economic growth, the security that comes from the establishment of 

safe and sound financial markets. And those are all responsibilities 

of the Fed, I think responsibilities that Chairman Bernanke takes 

very seriously. You have spoken very well to those issues in the 

past, and I look forward to hearing your comments on those and 

other issues this morning. 

Thank you Mr. Chairman. 

Chairman DODD. Thank you very much, Senator Sununu. 

Mr. Chairman, we welcome you again to the Committee. We are 

anxious to hear your comments, and your full statement and supporting documents will, of course, be a part of the record. 

STATEMENT OF BEN S. BERNANKE, CHAIRMAN,

BOARD OF GOVERNORS, FEDERAL RESERVE SYSTEM 

Chairman BERNANKE. Thank you. Chairman Dodd, Senator Shelby, and other Members of the Committee, I am pleased to present 

the Federal Reserve’s Monetary Policy Report to the Congress. Real 

activity in the United States expanded at a solid pace in 2006, although the pattern of growth was uneven. After a first-quarter rebound from weakness associated with the effects of the hurricanes 

that ravaged the Gulf Coast the previous summer, output growth 

moderated somewhat on average over the remainder of 2006. Real 

gross domestic product is currently estimated to have increased at 

an annual rate of about 2.75 percent in the second half of the year. 

As we anticipated in our July report, the U.S. economy appears 

to be making a transition from the rapid rate of expansion experienced over the preceding several years to a more sustainable average pace of growth. The principal source of the ongoing moderation 

has been a substantial cooling of the housing market, which has 

led to a marked slowdown in the pace of residential construction. 

However, the weakness in housing market activity and the slower 

appreciation of house prices do not seem to have spilled over to any 

significant extent to other sectors of the economy. 

Consumer spending has continued to expand at a solid rate, and 

the demand for labor has remained strong. On average, about 

165,000 jobs per month have been added to nonfarm payrolls over 

the past 6 months, and the unemployment rate, at 4.6 percent in 

January, remains low. 

Inflation pressures appear to have abated somewhat following a 

run-up during the first half of 2006. Overall inflation has fallen in 

large part as a result of declines in the price of crude oil. Readings 

13

on core inflation—that is, inflation excluding the prices of food and 

energy—have improved modestly in recent months. Nevertheless, 

the core inflation rate remains somewhat elevated. 

In the five policy meetings since the July report, the Federal 

Open Market Committee, or FOMC, has maintained the Federal 

funds rate at 5.25 percent. So far the incoming data have supported the view that the current stance of policy is likely to foster 

sustainable economic growth and the gradual ebbing of core inflation. However, in the statement accompanying last month’s policy 

decision, the FOMC again indicated that its predominant policy 

concern is the risk that inflation will fail to ease as expected and 

that it is prepared to take action to address inflation risks if developments warrant. 

Let me now discuss the economic outlook in a little more detail, 

beginning with developments in the real economy and then turning 

to inflation. I will conclude with some brief comments on monetary 

policy. 

Consumer spending continues to be the mainstay of the current 

economic expansion. Personal consumption expenditures, which account of more than two-thirds of aggregate demand, increased at 

an annual rate of about 3.5 percent in real terms during the second 

half of last year, broadly matching the brisk pace of the previous 

3 years. Consumer outlays were supported by strong gains in personal income, reflecting both the ongoing increases in payrolled employment and a pick-up in the growth of real wages. Real hourly 

compensation, as measured by compensation per hour in the nonfarm business sector deflated by the personal consumption expenditures price index, rose at an annual rate of around 3 percent in the 

latter half of 2006. 

The resilience of consumer spending is all the more striking 

given the backdrop of the substantial correction in the housing 

market that became increasingly evident during the spring and 

summer of last year. By the middle of 2006, monthly sales of new 

and existing homes were about 15 percent lower than a year earlier, and the previously rapid rate of house price appreciation had 

slowed markedly. 

The fall in housing demand in turn prompted a sharp slowing in 

the pace of construction of new homes. Even so, the backlog of 

unsold homes rose from about 41⁄2 months’ supply in 2005 to nearly 

7 months’ supply by the third quarter of last year. Single-family 

housing starts have dropped more than 30 percent since the beginning of last year, and employment growth in the construction sector has slowed substantially. 

Some tentative signs of stabilization have recently appeared in 

the housing market. New and existing home sales have flattened 

out in recent months. Mortgage applications have picked up, and 

some surveys find that homebuyers’ sentiment has improved. However, even if housing demand falls no further, weakness in residential investment is likely to continue to weigh on economic growth 

over the next few quarters as homebuilders seek to reduce their inventories of unsold homes to more comfortable levels. 

Despite the ongoing adjustments in the housing sector, overall 

economic prospects for households remain good. Household finances 

appear generally solid, and delinquency rates on most types of conVerDate 0ct 09 2002 16:41 Nov 20, 2007 Jkt 000000 PO 00000 Frm 00017 Fmt 6633 Sfmt 6633 S:\DOCS\38109.TXT SBANK4 PsN: KEVIN
14

sumer loans and residential mortgages remain low. The exception 

is subprime mortgages with variable interest rates, for which delinquency rates have increased appreciably. 

The labor market is expected to stay healthy, and real incomes 

should continue to rise, although the pace of employment gains 

may be slower than that to which we have become accustomed in 

recent years. In part, slower average job growth may simply reflect 

the moderation of economic activity. Also, the impending retirement of the leading edge of the baby-boom generation and an apparent leveling out from women’s participation in the workforce, 

which had risen for several decades, will likely restrain the growth 

of the labor force in coming years. With fewer job seekers entering 

the labor force, the rate of job creation associated with the maintenance of stable conditions in the labor market will decline. 

All told, consumer expenditures appear likely to expand solidly 

in coming quarters, albeit a little less rapidly than the growth in 

personal incomes, if, as we expect, households respond to the slow 

pace of home equity appreciation by saving more out of current income. 

The business sector remains in excellent financial condition with 

strong growth and profits, liquid balance sheets, and corporate leverage near historical lows. Last year, those factors helped to support continued advances in business capital expenditures. Notably, 

investment in high-tech equipment rose 9 percent in 2006, and 

spending on nonresidential structures, such as office buildings, factories, and retail space, increased rapidly through much of the 

year, after several years of weakness. 

Growth in business spending slowed toward the end of last year, 

reflecting mainly a deceleration of spending on business structures, 

a drop in outlays in the transportation sector where spending is notably volatile, and some weakness in purchases of equipment related to construction and motor vehicle manufacturing. 

Over the coming year, capital spending is poised to expand at a 

moderate pace, supported by steady gains in business output and 

favorable financial conditions. Inventory levels in some sectors, 

most notably at motor vehicle dealers and in some construction-related manufacturing industries, rose over the course of last year, 

leaving some firms to cut production to better align inventories 

with sales. Remaining imbalances may continue to impose modest 

restraint on industrial production during the early part of this 

year. 

Outside the United States, economic activity in our major trading 

partners has continued to grow briskly. The strength of demand 

abroad helped stir a robust expansion in U.S. real exports, which 

grew about 9 percent last year. The pattern of real U.S. imports 

was somewhat uneven, partly because of fluctuations in oil imports 

over the course of the year. On balance, import growth slowed in 

2006 to 3 percent. 

Economic growth abroad should further support steady growth in 

U.S. exports this year. Despite the improvements in trade performance, the U.S. current account deficit remains large, averaging 

about 6.5 percent of nominal GDP during the first three quarters 

of 2006. 

15

Overall, the U.S. economy seems likely to expand at a moderate 

pace this year and next, with growth strengthening somewhat as 

the drag from housing diminishes. Such an outlook is reflected in 

the projections that the members of the Board of Governors and 

presidents of the Federal Reserve Banks made around the time of 

the FOMC meeting late last month. The central tendency of those 

forecasts, which are based on the information available at that 

time and on the assumption of appropriate monetary policy, is for 

real GDP to increase about 2.5 to 3 percent in 2007 and about 2.75 

to 3 percent in 2008. The projection for GDP growth in 2007 is 

slightly lower than our projection last July. The difference partly 

reflects an expectation of somewhat greater weakness in residential 

construction during the first part of this year than we anticipated 

last summer. The civilian unemployment rate is expected to finish 

both 2007 and 2008 around 4.5 to 4.75 percent. 

The risks to this outlook are significant. To the downside, the ultimate extent of the housing market correction is difficult to forecast and may prove greater than we anticipate. Similarly, spillover 

effects from developments in the housing market onto consumer 

spending and employment in housing-related industries may be 

more pronounced than expected. To the upside, output may expand 

more quickly than expected if consumer spending continues to increase at the brisk pace seen in the second half of 2006. 

I turn now to the inflation situation. As I noted earlier, there are 

some indications that inflation pressures are beginning to diminish. 

The monthly data are noisy, however, and it will consequently be 

some time before we can be confident that underlying inflation is 

moderating as anticipated. 

Recent declines in overall inflation have primarily reflected lower 

prices for crude oil, which have fed through to the prices of gasoline, heating oil, and other energy products used by consumers. 

After moving higher in the first half of 2006, core consumer price 

inflation has also edged lower recently, reflecting a relatively 

broad-based deceleration in the prices of core goods. That deceleration is probably also due to some extent to lower energy prices, 

which have reduced costs of production and thereby lessened one 

source of pressure on the prices of final goods and services. The 

ebbing of core inflation has likely been promoted as well by the stability of inflation expectations. 

A waning of the temporary factors that boosted inflation in recent years will probably help to foster a continued edging down of 

core inflation. In particular, futures quotes imply that oil prices are 

expected to remain well below last year’s peak. If actual prices follow the path currently indicated by futures prices, inflation pressures would be reduced further as the benefits of the decline in oil 

prices from last year’s high levels are passed through to a broader 

range of core goods and services. 

Non-fuel import prices may also put less pressure on core inflation, particularly if price increases for some other commodities, 

such as metals, slow from last year’s rapid rates. But as we have 

been reminded only too well in recent years, the prices of oil and 

other commodities are notoriously difficult to predict, and they remain a key source of uncertainty to the inflation outlook. 

16

The contribution from rents and shelter costs should also fall 

back following a step-up last year. The faster pace of rent increases 

last year may have been attributable in part to reduced affordability of owner-occupied housing, which led to a greater demand 

for rental housing. Rents should rise somewhat less quickly this 

year and next, reflecting recovering demand for owner-occupied 

housing as well as increases in the supply of rental units, but the 

extent and pace of that adjustment are not yet clear. 

Upward pressure on inflation could materialize if final demand 

were to exceed the underlying productive capacity of the economy 

for a sustained period. The rate of resource utilization is high, as 

can be seen in rates of capacity utilization above their long-term 

average, and most evidently in the tightness of the labor market. 

Indeed, anecdotal reports suggest that businesses are having difficulty recruiting well-qualified workers in certain occupations. 

Measures of labor compensation, though still growing at a moderate pace, have shown some signs of acceleration over the past 

year, likely in part the result of tight labor market conditions. 

The implications for inflation of faster growth in nominal labor 

compensation depend on several factors. Increases in compensation 

might be offset by higher labor productivity or absorbed by a narrowing of firms’ profit margins rather than passed on to consumers 

in the form of higher prices. In these circumstances, gains in nominal compensation would translate into gains in real compensation 

as well. 

Underlying productivity trends appear favorable, and the markup of prices over unit labor cost is high by historical standards, so 

such an outcome is certainly possible. Moreover, as activity expands over the next year or so at the moderate pace anticipated by 

the FOMC, pressures in both labor and product markets should 

ease modestly. That said, the possibility remains that tightness in 

product markets could allow firms to pass higher labor costs 

through their prices, adding to inflation and effectively nullifying 

the purchasing power of at least some portion of the increase in 

labor compensation. Thus, the high level of resource utilization remains an important upside risk to continued progress on inflation. 

Another significant factor influencing medium-term trends in inflation is the public’s expectations of inflation. These expectations 

have an important bearing on whether transitory influences on 

prices, such as those created by changes in energy costs, become 

embedded in wage and price decisions and so leave a lasting imprint on the rate of inflation. It is encouraging that inflation expectations appear to have remain contained. 

The projections of the members of the Board of Governors and 

the presidents of the Federal Reserve Banks are for inflation to 

continue to ebb over this year and next. In particular, the central 

tendency of those forecasts is for core inflation, as measured by the 

price index for personal consumption expenditures, excluding food 

and energy, to be 2 to 2.25 percent this year and to edge lower to 

1.75 to 2 percent next year. But as I noted earlier, the FOMC has 

continued to view the risk that inflation will not moderate as expected as the predominant policy concern. 

Monetary policy affects spending and inflation with long and 

variable lags. Consequently, policy decisions must be based on an 

17

assessment of medium-term economic prospects. At the same time, 

because economic forecasting is an uncertain enterprise, policymakers must be prepared to respond flexibly to developments in 

the economy when those developments lead to a reassessment of 

the outlook. The dependence of monetary policy actions on a broad 

range of incoming information complicates the public’s attempts to 

understand and anticipate policy decisions. 

Clear communication by the central bank about the economic 

outlook, the risks to that outlook, and its monetary policy strategy 

can help the public to understand the rationale that is behind policy decisions and to anticipate better the central bank’s reaction to 

new information. This understanding should in turn enhance the 

effectiveness of policy and lead to improved economic outcomes. By 

reducing uncertainty, central bank transparency may also help anchor the public’s longer-term expectations of inflation. 

Much experience has shown that while anchored inflation expectations tend to help stabilize inflation and promote maximum sustainable economic growth, good communication by the central bank 

is also vital for ensuring appropriate accountability for its policy 

actions, the full effects of which can be observed only after a 

lengthy period. A transparent policy process improves accountability by clarifying how a central bank expects to attain its policy 

objectives and by ensuring that policy is conducted in a manner 

that can be seen to be consistent with achieving those objectives. 

Over the past decade or so, the Federal Reserve has significantly 

improved its methods of communication, but further progress is 

possible. As you know, the FOMC last year, established a subcommittee to help the full committee evaluate the next steps in 

this continuing process. Our discussions are directed at examining 

all aspects of our communications and have been deliberate and 

thorough. These discussions are continuing, and no decisions have 

been reached. 

My colleagues and I remain firmly committed to an open and 

transparent monetary policy process that enhances our ability to 

achieve our dual objectives of stable prices and maximum sustainable employment. I will keep Committee Members apprised of the 

developments as our deliberations move forward. I look forward to 

continuing to work closely with the Members of the Committee and 

your colleagues in the Senate and the House on the important 

issues pertaining to monetary policy and the other responsibilities 

with which the Congress has charged the Federal Reserve. 

Thank you. I would be happy to take questions. 

Chairman DODD. Thank you very much, Mr. Chairman, for a 

very comprehensive statement. What I am going to do is we will 

have 7 minutes per Member. I will not hold to that so tightly. I 

would just ask Members to be conscious of the time, and you have 

the clocks in front of you here so we can make sure everybody has 

adequate time to ask questions and give you an adequate time to 

respond to them as well. 

Let me pick up, if I can, a number of my colleagues referred to 

your speech in Omaha. Senator Hagel talked about your reception 

there and the comments you made about income inequality, and I 

want to pick up on those comments, if I can as well. 

18

I think all of us recognize here, I would say to my friend from 

Utah, we are all very conscious the tremendous wealth that has 

been created in certain sectors of our economy, that there are good 

things that are happening. None of us is suggesting all is bad. 

There is a sense, as Senator Sununu has said, and others, of uncertainty that people are feeling across the country about the longterm economic growth and stability of the Nation. And I think 

those of us who are expressing those views to you here, Mr. Chairman, probably reflect your comments as well as I read them. Your 

quote in Omaha, ‘‘By many measures, inequality in economic outcomes has increased over time.’’

Your predecessor, Chairman Greenspan, was very concerned 

about the growth in income inequality as well. He testified, ‘‘I 

think the income distribution issue is very critical because we cannot have a significant inequality of income and expect to have support for the type of institutions that have been made this country 

great.’’

Do you share Chairman Greenspan’s concern, Mr. Chairman, 

that continued economic growth of inequality is a significant threat 

to our Nation’s fundamental promise of economic opportunity? Do 

you suggest by your comments here that we should have a balanced view? I just left a markup a few minutes ago before coming 

here, marking up a new Head Start bill that will hopefully deal 

with greater accountability, but serving about 900,000 to 1 million 

young people in this country in the past 41 or 42 years that has 

tried to give those children an opportunity to become active and 

successful members of our economy in the future. 

I am concerned as we look at this that the decisions we make 

here will lack that kind of balance, and your comments seem to 

suggest a similar train of thought. And I wonder if you might just 

take a few more minutes this morning to expound on those comments in Omaha, and just a general observation. I am not asking 

if you endorse a specific spending program here and there, but just 

your general observation about this inequality issue and your concern that you obviously expressed in Omaha. 

Chairman BERNANKE. Thank you, Mr. Chairman. The very important drivers of economic growth and prosperity in this country 

include free and open trade and technological progress. It is very 

important to allow those forces to continue to operate in our economy. However, we do have to recognize, as I discussed in Omaha, 

that the effects of these forces can be differential across the population. They may create greater income possibilities for some than 

others. They may create painful dislocations, for example, if the 

composition of industries changes or job skill requirements change. 

I agree with Chairman Greenspan’s general point that in order 

to support and retain support for policies of free trade, open borders, technological change, flexible labor markets, we need to make 

sure that the gains and benefits from these powerful, growth-producing forces are broadly shared and that people understand that 

these things are good for the American economy and good for people generally in the economy. 

How to do that is very difficult. It is easy enough to say let us 

promote economic opportunity. I certainly support that idea. Doing 

it is not necessarily easy. I discussed in my speech some general 

19

issues and approaches, including education, not only K–12 education but also training throughout the life span, from early childhood through adult retraining. We need to help people who are dislocated by these powerful dynamic forces to find new jobs, to find 

new opportunities. I think that is very important. 

I would just say, though, that I am glad you did not ask me to 

endorse specific policies, because making that work in practice is 

difficult. We have to find ways to achieve these objectives. For example, retraining workers in ways that are effective, and are effective in terms of the spending that we put into it. 

So it is a great challenge for us going forward to look among all 

the possible approaches and decide which types of programs, which 

types of initiatives will be most effective at achieving this objective. 

That being said, again, I do agree that we need to spread the 

benefits widely and make people understand that open trade and 

technological change are beneficial for not only the economy in the 

aggregate, but also for the great majority of people in the economy. 

Chairman DODD. Well, I do not know if you had the chance to 

read a report called ‘‘The Gathering Storm.’’ It was prepared by a 

number of senior retired corporate executives along with some of 

our leading academicians in the country about a year and a half 

ago who took a month off and examined where we were in K–12 

in science and math—again, without getting into the specifics of individual programs, but they were very cautious. In fact, they 

warned us, all of us, those of us who sit on this side of the dais, 

as well as others across the country, that if we did not make some 

investments in the quality of education, particularly in math and 

science, we could find abrupt changes occurring in our country very 

quickly in this century. 

I do not know if you have had an opportunity to look at that report or not, whether or not you agree with their conclusions about 

your concerns over whether or not this inequality could be exacerbated by the failure of us to have a level of education, investments 

in education from that earliest early childhood area through the 

higher educational opportunity. 

Chairman BERNANKE. Mr. Chairman, I did read that report. It 

had a lot of interesting things to say. I think if you look at it carefully, it suggests that the issues are different in different parts of 

the educational system. For example, our universities remain very 

strong. Our research universities lead the world. So in terms of research, development, innovation, and so on, the United States retains substantial leadership in the world. But in other parts of the 

educational system, perhaps in elementary school, for example, we 

are probably not doing what we should in terms of ensuring that 

all children have opportunities to learn math and science and the 

applications of those areas. 

Again, my wife is a teacher, and I have been in education for a 

long time. I was on the school board for many years, so I am very 

sensitive to these issues. But I also appreciate from those particular positions that we have been worrying about educational 

quality for a long time, and it is a difficult thing to achieve. I encourage continued thought and continued efforts to improve these 

vital components of our economy without having any delusions 

about how difficult that really is to accomplish effectively. 

20

Chairman DODD. I thank you for that. 

I am going to turn to my colleague from Alabama, but I will 

probably send this as a written question, unless one of my colleagues raises it with you here. 

Back in December, Senator Sarbanes, Senator Allard, Senator 

Reed, Senator Bunning, Senator Schumer, and myself sent you and 

other regulators a letter regarding these exotic mortgages. We had 

a hearing here the other day, and I have talked about this. I am 

a strong advocate of subprime lending. It has made a huge difference in accessibility to homeownership. I am also simultaneously 

very concerned about the predatory lending practices that go on. 

That concern about providing those subprime borrowers with the 

same kind of protections we do to the prime borrowers is a matter 

of concern to many of us here on this Committee. 

The letter we got back, frankly, Mr. Chairman, was a little inadequate. The notion, ‘‘We are thinking about it,’’ was nice to know, 

but I think many of us would like to know they are taking some 

additional steps. And, again, I will make this a written question to 

you, but I am very concerned about this issue, and some of the data 

we are receiving were as many as 2 million of our fellow citizens 

may be foreclosed out of their homes because of predatory practices. 

Again, I will not ask you here. I want to turn to Senator Shelby, 

but I want to raise that issue with you and ask you to be thinking 

about it because it is an important concern for many of us. 

Senator Shelby. 

Senator SHELBY. Thank you, Chairman Dodd. 

Chairman Bernanke, the Federal Open Market Committee has 

held the Federal funds rate target at 5.25 percent since June 2006. 

In the FOMC statement following your most recent meeting in January, the FOMC noted, ‘‘the high level of resource utilization has 

the potential to sustain inflation pressures. The Committee judges 

that some inflation risks remain.’’

Mr. Chairman, what data related to resource utilization will you 

be paying the closest attention to between now and the next FOMC 

meeting in March? 

Chairman BERNANKE. Senator, a flip answer is, ‘‘Everything.’’ I 

should be clear: Our concern is not about the labor market per se. 

Our concern is about the overall balance of spending and productive capacity. 

Senator SHELBY. The whole picture. 

Chairman BERNANKE. The whole picture. The Federal Reserve 

contributes to setting overall financial conditions, which in turn 

stimulates spending by consumers and businesses on the product 

of our companies. 

If spending is growing more quickly than the underlying productive capacity for a sustained period, we risk creating inflation 

which will then make it more difficult to sustain a healthy expansion over a longer period of time. 

So we are looking for evidence that consumption spending and 

other components of spending growth are exceeding the underlying 

capacity. In doing so, we look at a wide variety of indicators, including the strength of various spending components, measures of 

resource utilization, which include not only capacity utilization and 

21

unemployment, but also many indicators in labor markets and capital markets. 

We also look very much at prices because they are the canary in 

the coal mine. If prices begin to rise, that is indicative that there 

is too much demand given the amount of supply. 

We do not have any fixed speed limit in mind when we think 

about the economy going forward. We do not have any fixed number for the unemployment rate. But rather, we are looking at the 

overall balance of supply and demand, looking at the evolution of 

inflation, and trying to ensure that there is a reasonable balance 

between demand and supply so that our economy can continue to 

grow at a sustainable, moderate pace going forward. 

Senator SHELBY. Is your economic goal here basically price stability? 

Chairman BERNANKE. Price stability consistent with strong employment as well. 

Senator SHELBY. Productivity. The President’s economic report 

noted that between 2000 and 2005, productivity growth in the 

United States accelerated to about 3 percent, Mr. Chairman, the 

fastest growth of any G–7 country, which includes Canada, France, 

Germany, Italy, Japan, and the United Kingdom. Most other major 

industrialized countries suffered a slowdown in productivity 

growth. 

What factors do you believe explain the difference in productivity 

growth given that the other G–7 countries also have access to the 

same technological improvements and broad capital markets the 

United States has? And could you expand on these differences in 

productivity, what productivity implies for our standard of living 

and our long-term growth? 

Chairman BERNANKE. Senator, you are quite correct that productivity began to grow more quickly in the United States about a decade ago, and that has been a very important factor in the strength 

of our economy. 

In 1995, we saw a step-up in productivity growth from 1.5 to 2.5 

percent, which seems to have been driven primarily by improved 

and more efficient methods of producing high-tech equipment—

faster computers, stronger, better communications equipment, and 

the like. 

Over the succeeding few years—and, in fact, we saw productivity 

growth step up further around 2000—those technological innovations had been diffused through the economy and helping industries across the economy manage their production and distribute 

their output more efficiently, and reduce costs and increase productivity. So in some sense, the underlying factor is the technological 

change, the investment in information and communications technologies, and the diffusion of those technologies throughout the 

economy. 

Now, you ask, quite properly, why we have seen better results 

here in the United States than in some other countries, and I have 

given some speeches on that subject. I do believe that it is the 

interaction of the new technologies and our flexible dynamic economic system. That includes flexible labor markets that can adjust 

to changes in the market associated with technological change. 

That includes deep and liquid capital markets that can allocate 

22

capital toward new ventures, toward new technologies. And I believe that flexibility has been essential in helping us take technological advances and create from them economic benefits. This relates to my answer to Chairman Dodd that we need to maintain 

that flexibility in our economy and that providing broad opportunity and education is one way to support that going forward. 

Senator SHELBY. Mr. Chairman, I want to get to another part of 

your responsibilities, and that is, bank regulation. Regulation Z, 

Senator Dodd has already referred to this. The Banking Committee 

held a hearing on the credit card industry that was widely followed. Witnesses at the hearing highlighted a number of troubling 

industry practices, many of which are subject to Federal Reserve 

oversight. I understand that the Federal Reserve Board is currently reviewing its Regulation Z, which implements the Truth in 

Lending Act. 

What is the status of the Board’s Regulation Z review? And does 

the Board intend to use this review to address any of the questionable industry practices raised in the Committee’s hearing? 

Chairman BERNANKE. Senator, we have been putting a great 

deal of effort into our review of Regulation Z, with a particular 

focus on short-term revolving credit, like credit cards. One of the 

real challenges in improving disclosures for credit cards and other 

types of lending is to make the disclosures both compliant with 

legal requirements, but also sufficiently clear and understandable 

that people can understand what it is that they are getting into. 

In order to improve the understandability and the clarity of disclosures, the Federal Reserve has conducted extensive consumer 

testing. We have not just done it in the ivory tower, as somebody 

mentioned. We have gone out into the public and conducted focus 

groups. We have done psychological testing to try to figure out how 

to structure disclosures in a way that people will notice them, pay 

attention to them, and understand them. So that has been a big 

part of our effort. 

We are very close to the end of that effort. We expect to have a 

proposed rule out within a few months, by the middle of this year, 

and I believe and hope that it will address many of the appropriate 

concerns that people have had about disclosures and practices in 

the credit card industry and other short-term debt. 

Senator SHELBY. Chairman Dodd, I know my time is up, but 

could I just ask the Chairman a question for the record? I think 

it would take some time. 

We have been concerned for some time about the implementation 

of the Basel II Capital Accord and the impact that Basel II may 

have on safety and soundness of the U.S. banking system. I am 

worried that Basel II may lead to a sharp reduction in the amount 

of capital banks are required to hold, which would put U.S. taxpayers ultimately at risk of having to pay for expensive bank failures, if there are some. I believe that it is critical that Basel II be 

implemented with the utmost care and diligence. 

Mr. Chairman, would you for the record update the Committee 

on the status of Basel II Capital Accords, the current time frame 

for implementing Basel II, and also comment on whether there is 

another time for banking regulators, including yourself, to finalize 

the rules in implementing Basel II so that banks adopting Basel 

23

II can start the test run for Basel II presently scheduled to begin 

next year? If you care to, you can do it for the record. 

Chairman BERNANKE. Should I answer, Mr. Chairman? 

Chairman DODD. We will make that for the record, and let me 

add to that quickly before turning to Senator Schumer. Some of my 

bankers have raised the issue, too, about foreign acquisition of domestic banks and whether or not they are really meeting the capital requirements today. We have some real concerns raised by my 

bankers in Connecticut about this issue. They follow it very closely. 

And I would add that to the question that Senator Shelby has 

raised with you, whether or not that is something we should be 

looking more closely at. Are they actually meeting those criteria before those acquisitions occur? 

Senator Schumer. 

Senator SCHUMER. Thank you, Mr. Chairman, and it is your first 

year. You have completed a year. You are getting good grades everywhere, and I would concur. I think you are doing a fine job and 

have vindicated the support that you received almost unanimously 

from this Committee. 

My first question deals with the issues of income inequality in 

the speech you gave yesterday where you pointed out that this has 

just been an ideas, almost instantaneous, economy and wealth agglomerates to the top. You talked about Manny Ramirez. I would 

like to talk about Henry Ford, his great idea. He deserved to become rich from it, but he needed a million people to carry it out, 

and each of them made $10,000 a year to make the cars, distribute 

the cars. 

Bill Gates, maybe the Henry Ford of our generation, had another. He mass produced in a certain sense computer platforms, 

but he needed 10,000 people to carry it out, and they each made 

a couple million dollars. 

Given that this is happening—and it is not the Government’s 

doing. This is just the nature of our economy, as you pointed out 

in the speech. Doesn’t it make sense, if this goes too far, to have 

a more progressive tax code, even though Government did not 

cause it, to keep a middle-class base, to keep too much wealth from 

agglomerating at the top? I am not asking you any specific policy, 

but just a general view that wouldn’t progressivity, further progressivity in the tax code help be an antidote to the natural flow of 

money to the very top, to the few who create those new ideas and 

deserve to make money from that and not get in the way of doing 

that? 

Chairman BERNANKE. Senator, your comparison of Henry Ford 

and Bill Gates was very telling, actually. Henry Ford developed the 

assembly line, and it allowed relatively low-skilled workers to be 

very productive in that context and generated high wages for those 

workers. 

Bill Gates created a new model of operating systems in the hightech industry. The kinds of workers he needed were much more 

skilled workers. 

Senator SCHUMER. Exactly, and many fewer of them as well. 

Chairman BERNANKE. And fewer of them, certainly. So, I think 

that one very important lesson from that comparison is that those 

who are going to benefit the most from globalization and techVerDate 0ct 09 2002 16:41 Nov 20, 2007 Jkt 000000 PO 00000 Frm 00027 Fmt 6633 Sfmt 6633 S:\DOCS\38109.TXT SBANK4 PsN: KEVIN
24

nology are those who have the skills, who have the capabilities to 

benefit and to be productive in that context. 

So, I would say whatever we do with tax policy and transfer policy, I hope that we will try to address the issues of skills and individual productivity. 

Senator SCHUMER. I agree with you completely. But that is going 

to take a while. 

Chairman BERNANKE. Senator, on the issue of progressivity, you 

will be unsatisfied. As the head of the nonpartisan central bank, 

I think it is very important for me not to take sides on issues 

where values are very important. 

Senator SCHUMER. Talking about more money or more help for 

education is as much a policy decision as talking about the progressivity of the code. I am not asking you about a specific policy, and 

I think you should address it. 

Chairman BERNANKE. Senator, I am sorry, I decline, because 

there really is a value judgment involved in trading off—I talked 

about this in my inequality speech. I said, on the one hand, you 

have the importance of promoting incentives. Senator Bennett 

mentioned entrepreneurs, people who take risks. We have to give 

them incentives to take risks. On the other hand, as you point out, 

correctly the tax code has an important role to play in generating 

more equality. But I am not an elected official, so I cannot comment. 

Senator SCHUMER. Okay. I think you are ducking it, in all due 

respect, because you do talk about other policy issues, but let me 

move on. 

Trade deficit. Are you happy with the size of the trade deficit, at 

the rate of its growth? And do you think stronger policies, particularly against those who we have huge balance of trade deficits with 

to open their markets, not particularly to close ours, would be helpful in reducing the trade deficit? Obviously, my focus is on China, 

but I would ask a more general question. 

So, the first question, are you happy with the size of the deficit 

and its rate of growth? 

Chairman BERNANKE. No, I am not happy with it. 

Senator SCHUMER. Do you think policies that would not require, 

but importune other countries whose markets are not as open as 

ours to open theirs would be a salutary change and that we should 

emphasize that as a, if you will, pro-free trade way to deal with the 

trade deficit? 

Chairman BERNANKE. Senator, I am entirely in favor of trying to 

open markets. We have the World Trade Organization, and China 

is a signatory. We should aggressively pursue attempts to open 

markets to foreign investment and——

Senator SCHUMER. Do you think the Chinese have done enough 

on their currency? 

Chairman BERNANKE. They have moved in the right direction, 

but, no, I do not think they have done enough. 

With respect to trade, though, I would like to add that trade policies alone are not going to resolve the trade deficit. There is also 

the issue of saving and investment, which we do need to address 

as well. 

Senator SCHUMER. I think I agree with you on that. 

25

Senators Graham, Baucus, Grassley, and myself are going to try 

to do a WTO-friendly way or compliant way of getting the Chinese 

to do more on currency, and I hope you will look at that carefully 

and be supportive. 

A final question is on competitiveness of our financial institutions and industries. Coming from New York, I am obviously concerned, but so should my colleagues from many other States be. 

The Carolinas, South Dakota, New Jersey, so many other States 

have a stake here. And the problem we seem to be facing is this: 

That other regulatory and legal schemes—you know, regimens in 

other countries are looser than ours. And now that capital can flow 

quite freely, companies who are international and their loyalty to 

their stockholders means they are not going to be loyal to the 

United States or it will precede their loyalty to the United States 

may seek the lowest common denominator or a lower common denominator. And the pretty exquisite balance between regulation 

and entrepreneurialness that we have had over the last quarter of 

the last century seems to be in some trouble, that people are fleeing to go to less regulated places for their short-term gain, even if 

it creates problems in the system as a whole. 

Could you comment on that problem? Do you think it is a real 

one? Do you think it is only caused by simply knowledge spreading 

and the Internet or is caused by some of these regulatory differences? And do you think we should look at that in a policy way 

to do something about it? 

Chairman BERNANKE. Senator, to some extent, it is caused by 

the diffusion of knowledge and the growth of other markets, and 

to the extent that we are having a more competitive, deeper, broader capital market around the world, that is probably good for world 

growth. It is probably good for even our companies because they 

have more options for raising funds. 

There is, though, I think, an issue of regulation, as has been 

pointed out in the two reports that you are quite familiar with. 

There is a subtle distinction to make. If you take Sarbanes-Oxley 

as an example, to the extent that Sarbanes-Oxley appropriately 

balances disclosures and governance against the cost of achieving 

those disclosures and governance, I think it is worthwhile to keep. 

Even if there is some short-run tendency for firms to run away 

from that, because the investor wants that protection, ultimately 

the investor will reward firms that list on exchanges that have appropriate, adequate protections such as a well-designed SarbanesOxley. 

That being said, there are always concerns about SarbanesOxley, about Basel II, about the regulatory structure, about securities litigation, about CIFIUS, where legitimate questions can be 

raised whether the costs of those regulatory schemes exceed the actual benefits to investors and to others of implementing them. As 

a general matter, not just in the context of competitiveness of our 

exchanges, we should always be looking to restore that balance and 

make sure that the costs we are imposing from a regulatory side 

are justified in terms of the social benefits. 

So, for example, it is a good step that the Public Company Accounting Oversight Board and the SEC have taken some steps in 

revising the audit standard to reduce the burden of SOX 404 while 

26

maintaining, I believe, many of the benefits in terms of disclosure 

and controls that that law was intended to achieve. 

Senator SCHUMER. Thank you, Mr. Chairman. 

Chairman DODD. Thank you very much, Senator Schumer. 

Senator Bunning. 

Senator BUNNING. Thank you, Mr. Chairman. 

Two of your predecessors, Paul Volcker and Alan Greenspan, always expressed great concern. I happen to have served on the 

House Banking Committee when Mr. Volcker was the head of the 

Federal Reserve and then Chairman Greenspan, both House Banking and now Senate Banking. And yesterday in the Washington 

Post, there was an article about the inversion of the yield curve for 

8 straight months and how local banks and banking in general—

and since that is the Fed’s charge, to make sure that our banks are 

sound and secure—were having difficulty with the inverted yield 

curve. 

I have questioned you about this before, and you have always 

said it is not very important in this day and time. I am going to 

ask you again: How long can we stand to have—we have had it 8 

straight months now—an inverted yield curve, where short-term 

rates are higher than our 30-year bond rate? 

Chairman BERNANKE. Senator, the usual context of this question 

is: Does an inverted yield curve presage a recession or a slowdown 

in the economy? 

Senator BUNNING. Well, it also hurts our banks very badly. 

Chairman BERNANKE. I will address that, sir. Just very quickly, 

though, on the forecasting power of the yield curve: There has been 

a good bit of evidence that declines in the term premium and perhaps a great deal of saving chasing a relatively limited number of 

investment opportunities around the world have led to a somewhat 

permanent flattening—or even inversion—of the yield curve, and 

that pattern does not necessarily predict slowing in the economy or 

a recession. Indeed, if you look at other measures of financial markets such as corporate bond spreads, you do not see anything that 

suggests anticipations of future stress. 

The question you raise is a different one, of course, which is the 

effect on the banking system. Specifically, banks that do their traditional business of taking deposits and making loans are going to 

be put under pressure because the short-term deposit rates tend to 

be higher than the loan rates they can get. I recognize that is a 

problem for some banks. Other banks have been able to deal with 

it by hedging interest rate risk, by getting fees, and finding other 

ways of doing their business. 

So, overall, I do not see the banking sector as being under tremendous pressure in terms of its profits and asset quality at the 

moment. But I recognize—particularly for smaller banks, which 

have fewer options in terms of raising funds and earning fees and 

income—that the inverted yield curve does produce some pressure. 

From the Federal Reserve’s point of view, we are entirely cognizant of that and hear about it from bankers. We have to set monetary policy, of course, to achieve overall price stability and maximum sustainable employment growth. So we sometimes find that 

in the context of various industries policy creates some pressure in 

individual industries. But we only have this one tool, and we try 

27

to use it to achieve overall macroeconomic stability, while fully recognizing that it does create some problems for some sectors. 

Senator BUNNING. You are telling us today that an inverted yield 

curve down the road will not affect the economy. Did I misunderstand that, or is that accurate? 

Chairman BERNANKE. I think the yield curve could be inverted 

for a considerable period without significant implications for the 

economy as a whole, yes—possibly for some banks, but not for the 

economy as a whole. 

Senator BUNNING. How does this economic cycle that we are in, 

and recovery and expansion, compare to previous recoveries and expansions? In other words, when we hit the wall in 1992 and then 

also in 2002, how does this recovery that we are involved in now 

compare to those recoveries? 

Chairman BERNANKE. I would say that qualitatively it is fairly 

similar to the recovery that followed the 1991 recession, with many 

of the same features. There was weakness for some time after the 

recession ended, including a period of so-called ‘‘jobless growth.’’

Senator BUNNING. But we did not have a housing market 

that——

Chairman BERNANKE. Well, the housing market was actually 

quite weak during the recession itself. The decline in residential 

starts during 1991 was not quite as large, but in the same neighborhood, as what we have seen recently. During the recovery period, we did not have that particular pattern, but in many ways, 

it was a fairly similar expansion. 

Senator BUNNING. Could you estimate how close we are to a full 

employment in the United States? 

Chairman BERNANKE. It is very hard to say specifically, and I do 

not pretend to know an exact number or an exact estimate. But the 

economy has certainly been growing faster than potential for a 

number of years, and that can be seen in the tightening of labor 

markets and capacity utilization. So, clearly, we are much closer 

today, I think it is safe to say, to full employment, to the sustainable level of growth than we were a few years ago. 

Senator BUNNING. And in your opening statement, you made the 

remarks to the effect that you have not seen any new evidence of 

inflation since your last Fed meeting in January or February? 

Chairman BERNANKE. We have not had much information on inflation since just 2 weeks ago, but the recent readings on inflation 

have been encouraging. 

Senator BUNNING. Encouraging? 

Chairman BERNANKE. Yes. 

Senator BUNNING. Okay. 

Chairman BERNANKE. But as I indicated in my remarks, they are 

somewhat noisy, the data, and we do not want to draw a complete 

conclusion——

Senator BUNNING. Well, that is why we have Fed meetings, you 

know, every month or two. 

Chairman BERNANKE. That is correct, Senator. 

Senator BUNNING. Thank you very much, Mr. Chairman. 

Chairman DODD. Thank you very much, Senator Bunning. 

Senator Casey. 

28

Senator CASEY. Thank you, Mr. Chairman, and the other Chairman in the room, thank you for your time and for your service. I 

have two general questions, one on debt and one on children. 

With regard to debt, I was looking at the report that the Federal 

Reserve Board is submitting in connection with your appearance 

here today and your testimony. And, in particular, I wanted to direct your attention and the attention of others to the report. 

I note here that in the section which deals with the Federal Government and expenditures and outlays by the Federal Government, 

it says, ‘‘Net interest payments increased 23 percent in fiscal year 

2006 as interest rates rose and Federal debt continued to grow.’’

Then it goes on from there and talks about the outlays for Medicare Part D, Medicare itself up 10.5 percent. It talks about disaster 

relief, Medicaid spending, and then it gets to the next part of the 

paragraph. ‘‘Outlays for defense in fiscal year 2006 slowed to their 

lowest rate of increase since fiscal year 2001, although the rise was 

still about 6 percent.’’ That is the first predicate of my question. 

It goes on to talk about debt, the Federal debt subject to the stat- utory limit has increased, now we are at the $8.6 trillion level. 

I guess with that as a predicate, let me tell you what I think 

about this. I think that that is unsustainable, and as much as we 

have talked, as important as it is to talk about the good sound bite, 

reducing our dependence on foreign oil, I think we need a lot more 

effort in this Congress and in this town on reducing our dependence on foreign debt. I think it is making us less safe in the fight 

against terrorism. I think it is making us less safe in terms of our 

ability to spend money on defense, not to mention our inability to 

spend money on good investments in the economy, as you talked 

about, education, training, and the rest. 

So, I guess my basic question is: In light of that data, and any 

other data you want to factor into this question, are these numbers 

sustainable, an $8.6 trillion debt and a 23-percent increase in net 

interest payments? Is that sustainable over time? 

Chairman BERNANKE. I recently testified before the Senate Budget Committee, and I pointed out—and it is not exactly a secret—

that the long-term prospects for the U.S. fiscal situation are quite 

serious. In particular, we are going to start seeing—as the population ages—expanded costs of entitlements, Social Security and 

Medicare; those grow very quickly. And we will generate, if no action is taken, an increasing spiral of higher interest payments and 

debt. 

I quoted in that testimony several interesting, useful simulations 

by the Congressional Budget Office. The intermediate simulation 

suggests that by the year 2030 the deficit will be 9 percent of GDP, 

and the debt-to-GDP ratio, which is currently about 37 percent, 

will be closer to 100 percent of GDP—a number which we have not 

seen since World War II. 

So, obviously, there are a lot of issues that Congress will debate 

about short-term spending and tax proposals. But if you think 

about fiscal sustainability in a longer time frame, dealing with the 

fiscal implications of the aging population and rising health care 

costs are going to be dominant, and essentially there will not be 

any way to address fiscal sustainability without addressing that 

issue in some way. 

29

Senator CASEY. I wanted to pick up, in the remaining time I 

have, on the issue of how we invest in children, pick up on what 

Chairman Dodd spoke of earlier. 

There is a great organization out there that has as its moniker, 

as its message, ‘‘Fight crime, invest in kids.’’ It is a great sound 

bite. Sometimes we need sound bites to make the point. I would 

also assert—and I would ask for your sense of this and your reflections on this—that you could use the same construct for the impact 

on how we invest in children and how we grow our economy. Instead of saying, ‘‘Fight crime, invest in kids,’’ you could say, ‘‘Grow 

the gross national product’’ or ‘‘Grow GDP’’ or ‘‘Grow the economy, 

invest in kids.’’

Now, I ask you that because we are going to be making some 

critically important decisions in the next couple of months and certainly in this 110th Congress. Chairman Dodd talked about the 

issue of the Head Start program. There have been votes cast in the 

U.S. Senate in the last couple of years where the choice was clearly 

and unambiguously a choice between investing in Head Start or investing in education or investing in any other support for children 

and their economic future, not to mention our future, and tax cuts. 

Sometimes the votes have been that stark, and there are people 

here who voted for the tax cuts over Head Start and over some 

other priorities. 

So, I would ask you about your opinion—and this is a policy 

question, but I think you can answer this—your opinion on the 

level of investment in children, whether it is with regard to education or Head Start, early learning, all of these initiatives to give 

kids a healthy and smart start in life, how you see that in the context of economic growth and GDP growth, and whether or not you 

think the investment currently is adequate. 

Chairman BERNANKE. I think that investing in children is extremely important and has significant economic and social benefits. 

I hope that Congress will continue to look very carefully at that. 

What I do not know is precisely how best to do that, and I think 

you are going to have to bring real experts here to talk about different approaches—what works and what does not. But I urge you 

to continue to do that. 

In terms of priorities, to go back to Senator Schumer’s question, 

clearly, there are always priorities. But you can weigh these things 

against tax cuts, you can weigh them against other kinds of spending. Clearly, you have to have an overall picture of what is important. 

Again, I cannot speak to the overall combination of taxes and 

spending other than to say that they should be in balance. But I 

will go so far as to say that I think that there is a significant return to investing in young kids. 

In my remarks in Omaha, I even cited some Federal Reserve research from the Federal Reserve Bank of Minneapolis, which 

showed the very substantial economic returns associated with early 

childhood education, and I do think that that is certainly worth investigating. 

Senator CASEY. Thank you. 

Chairman DODD. Thank you, Senator Casey. Very good questions. I appreciate your focusing attention on that. 

30

I want to just mention, before turning to Senator Martinez, your 

response, Mr. Chairman, to Senator Schumer’s questions about 

Sarbanes-Oxley and competitiveness. I appreciated your answer 

very much to that question. There are some things clearly that 

could be done to try and show some balance and making sure we 

are not overburdening smaller public companies, but your thrust 

was that this is working pretty well. And, frankly, anecdotally, I 

suspect most of us here ask the question of every business we talk 

to: How is this working? And I must tell you, overall the response 

I get is a good one. 

I had one company the other day say to me that, ‘‘Even if Congress decided tomorrow to repeal Sarbanes-Oxley, we would decide 

to stay with all the things that have been required of us. We have 

found that it has been very worthwhile for our company.’’ So, I appreciate your comments about that. 

Senator Martinez. 

Senator MARTINEZ. Mr. Chairman, thank you very much. 

I hate to differ with the Chairman, but I must say that the experience that I hear on the competitiveness and Sarbanes-Oxley issue 

is far different from that. I hear a great deal of concern about the 

incredible cost and the burden of competitiveness that it has created. And, in fact, I will begin with this area because I intended 

to get into it, but our colleague from New York, Senator Schumer, 

and Mayor Bloomberg recently released a report that I found quite 

interesting detailing an analysis of market conditions in the United 

States and abroad and about the concern that there is about 

whether New York will continue to be the financial capital of the 

world or whether, in fact, there seems to be others competing for 

that title, which might include London. And there were some rather dramatic statistics of declines and increases in New York vis-a ́-

vis London. 

One of the things that was mentioned in the report was the U.S. 

regulatory framework being too complicated and the implementation of Sarbanes-Oxley having produced heavier costs than were expected at the beginning or when you initiated that effort. Also it 

was mentioned immigration policies which create problems for 

those abroad who might wish to come here to do business, to invest 

in America, and the difficulties that current immigration problems 

raise for that, and some of them coming to be educated, others coming just as business people and investors. 

In any event, I wondered if you had an opportunity to see that 

report and whether its finding cause the same concerns to you that 

they raised to me. 

Chairman BERNANKE. Senator, as I indicated, I do think that we 

should be trying to reduce regulatory burden, and in particular ensuring that the costs of the burden are commensurate with the 

benefits. 

With respect to Sarbanes-Oxley, my intent was to say that I do 

believe that there are benefits from that legislation, including improved controls, improved disclosures, improved governance of corporations. So there are certainly some benefits. 

It is important to decide whether we can reduce the costs and retain the benefits, and in that respect, I think that the proposed 

change in one audit standard being put forth by the SEC and the 

31

PCAOB is a step in the right direction because it attempts to focus 

on the most materially important issues, and it also makes allowance for the size and complexity of a firm in setting up the audit 

standard. 

So to try to summarize, Sarbanes-Oxley accomplishes some important objectives, but I do believe those objectives can be accomplished at lower cost, and I think the new audit standard moves 

in that direction. And in all other regulatory areas, including those 

the Federal Reserve is involved, we should continually be looking 

to find ways to accomplish the social or economic objectives of the 

regulation at a lower cost. 

Senator MARTINEZ. Well, I agree that there are many good features to Sarbanes-Oxley. What I was speaking of is some of the excesses, particularly in the auditing arena and some of the areas 

that have caused such an overburden of costs. So, I appreciate your 

comment on that. 

Shifting to the issue of home sales, I used to sit in that very 

chair when I was Housing Secretary before this Committee, and at 

times, I would be asked a question about a housing bubble and in 

the overheated housing market whether, in fact, we were headed 

for a collapse and a bubble that would burst. In fact, we have seen 

as significant decrease in housing starts. We have seen the market 

cool down significantly, but we have not seen a bursting bubble. I 

always said at the time that the fears of a bubble were misplaced 

and that the housing market is more regional than it is national, 

and there were many different features between that and a localized market. 

But do you feel that the fear of a bubble has receded given the 

fact that the market cooled off, that it has done so in a fairly modest way without any cataclysmic consequences? 

Chairman BERNANKE. Senator, as I indicated in my opening testimony, we think we see some tentative signs of stabilization in demand in the housing market, that nevertheless takes some time yet 

to work its way out because of the inventories of unsold homes that 

still exist on the market. I would emphasize that the signs of stabilization are tentative, and we do not want to jump to conclusions. 

It will be helpful to see what happens when the spring selling season begins and strong demand is at that time. 

But it is interesting that so far the economy has done a good job 

of withstanding the slowdown in construction, which, although substantial relative to the last couple of years, is still similar to the 

late 1990’s, for example. It is not that we have had a complete collapse in construction by any means. So the decline in construction, 

while it has slowed the economy, has obviously not thrown us into 

a much slower growth situation. And we have not seen substantial 

spillovers from the housing slowdown to consumer spending or to 

other parts of the economy. 

So it is early to say that this problem is over. I think we are 

going to have to continue to watch it very carefully, and as I indicated, I think it is a downside risk to the economy going forward. 

But so far, the economy has reasonably adapted to this adjustment 

in the housing market. 

Senator MARTINEZ. You mentioned in your remarks also that 

household finance appears solid and that delinquency rates on 

32

most consumer loans, including residential mortgages, were low, 

but you did note the subprime mortgages with variable interest 

rates where delinquency rates have increases appreciably. And it 

is an issue that is of great concern to several of us on this Committee, the issue of predatory lending, the abuse of some of our 

most vulnerable consumers. 

Any comments on that or any issues that you see there which 

could impact the overall economy? 

Chairman BERNANKE. I think, first of all, that this distress in the 

subprime area is a significant concern. I am obviously following it 

very carefully, both in terms of the impact it has on the borrowers 

and lenders as well. 

I do not think that it has at this point implications for the aggregate economy in terms of the ongoing expansion, but as I said, it 

is an important issue for those sectors. 

I could certainly list a wide variety of things that we do to try 

to address predatory lending, which I do think is an important 

issue, and I think the subprime market, which is distinct from 

predatory lending, it is a legitimate market. 

Senator MARTINEZ. Right. That is a good distinction to make. 

Chairman BERNANKE. It also has some issues. 

Just to note one action we have taken recently, along with the 

other Federal banking agencies, we have issued guidance on nontraditional mortgages, mortgages that involve interest-only or option ARM’s that may not be amortizing mortgages. We have emphasized to the lenders that they should be, first, very careful in 

their underwriting—that is, they should ensure that the borrower 

is equipped to deal with payment shock if interest rates go up, that 

they have sufficient income to meet higher payments; and, second, 

that disclosures are adequate so that the borrowers are fully informed about the nature of the contract that they are getting involved in. 

There are some loans that have been made that are not turning 

out well, and to the detriment of both the lenders and the borrowers. We will certainly be watching that carefully and trying to 

provide guidance and oversight to minimize that risk going forward. 

Senator MARTINEZ. Thank you, Mr. Chairman. 

Chairman DODD. Thank you very much, Senator Martinez. 

Senator Bayh. 

Senator BAYH. Mr. Chairman, I would like to ask you some questions about our national security interests and the role of the Fed 

in our financial system in protecting those interests. 

As you probably have read, there are the tentative outlines of an 

agreement with North Korea to begin to get them to change their 

behavior with regard to their nuclear program. And one of the reasons that we were able to at least achieve a tentative understanding was because of pressure that we brought to bear on a 

bank in Macau that the North Koreans used to interact with the 

global banking system. 

Iran, as you know, is pursuing nuclear ambitions as well. Several 

Iranian banks do business in Western Europe. We are currently attempting to do something similar with regard to a couple of Iranian 

banks. 

33

My question to you is: What can the Fed do, what can the United 

States banking system do, to cut off Iranian access to the global 

banking system to exert some pressure on them to behave in a 

more responsible way with regard to their nuclear ambitions? 

Chairman BERNANKE. Senator, the primary responsibility for initiating such measures and enforcing them is with the Treasury, the 

Financial Crimes Enforcement Network, for example, and OFAC. 

They have take the leadership in trying to ensure that American 

banks and, through negotiation, banks from other countries do not 

deal with the banks you are referring to in Iran and North Korea. 

So we are not the leaders in that effort. However, we as bank 

regulators and overseers have an important responsibility to try to 

ensure that it is carried out as the rules dictate, and as a very extensive part of our oversight responsibility, we evaluate banks’ 

compliance with the Bank Secrecy Act and other such rules. 

Senator BAYH. I hope you will make this a priority and bring 

some sense of urgency to it. Iran is a tremendous problem. You 

know, the military option is obviously something that no one wants 

to have to resort to, and so we are looking for other levers that we 

can utilize to try and get them to do the right thing here. And this 

seems to have been effective in the North Korean context. 

My investigations in this area tell me that it has, you know, increased the cost of doing business to the Iranians. It has made 

things more inconvenient for them, and perhaps if we continue to 

pursue this, we might encourage a change in behavior on their part 

as well. So, I would encourage you to be vigorous in this effort because it does affect our national security interests in a very important area. 

Staying on the subject of Iran for a moment—and you are busy 

with many other things; you may not have noticed. But they have 

indicated publicly that their response, if we did get to the point of 

having to take some action against them because of their nuclear 

program, would be to try and cut off the flow of oil from the Persian Gulf by closing the Straits of Hormuz, so that not only they 

would suffer but also the Saudis and others, trying to maximize the 

pain on the global economy. 

I hope that there is some contingency planning being undertaken, so my question to you is: If such an event were to occur, 

what would the impact be on the global economy, on the U.S. economy, obviously the price of oil? You mentioned the role that the 

cost of energy plays in our inflation expectations and that thing. So 

what would the effect of such an act be on the economy? And, second, are you aware of any steps that we can take to mitigate those 

consequences? The President in his State of the Union address has 

suggested doubling the Strategic Petroleum Reserve, for example. 

Are there other things that we could do to prepare for such an 

eventuality so that we would mitigate the consequences? 

Chairman BERNANKE. Senator, you are pointing to an important 

problem. I am not really equipped to say what the impact of these 

actions would be on aggregate supply of oil and on the oil price. I 

assume it would be dramatic, but I do not know exactly how big 

the effect would be. 

34

It would certainly have an impact on the world economy. There 

is no question about that. And I doubt that there is anything we 

can do in advance that would completely offset that impact. 

In the short-run, one of the tools we have you already mentioned—the Strategic Petroleum Reserve—which does provide some 

protection for a certain number of months, anyway, against those 

kinds of disruptions. I think that would be helpful. 

In the longer-term, as many people have noted, reducing our dependence on oil would be beneficial. If we could find ways to diversify our energy portfolio and, therefore, rely less on this particular 

source, that would be helpful from a national security perspective. 

Senator BAYH. Well, I know your people are probably stretched 

to their limits, dealing with a variety of things, but I do think that 

some part of the Government—whether it is your shop or Treasury 

or working in concert with some of the national security agencies—

we need to at least begin to some thinking about this. God willing, 

we have a number of years before we get to such an event, and God 

willing, it will never happen. But I am always a big believer in you 

start with the worst case, protect yourself from that, and you kind 

of work back from there. 

When Secretary Paulson was before us a couple weeks ago, he 

reiterated the comments that had become routine by his predecessors, and that is the Treasury’s belief that a strong dollar is in 

the interest of the United States of America. Do you agree with 

that point of view? 

Chairman BERNANKE. Senator, I do agree with it, and I would 

add that I defer to the Secretary of the Treasury in all matters related to currency policy. 

I would only add that the Federal Reserve, to the extent that we 

can keep our economy strong and attractive to foreign investment, 

will help keep a strong dollar. 

Senator BAYH. Well, I agree with that, and this relates in some 

regard to what Senator Casey was asking about. You may recall 

that previously there had been—oh, there was a rumor in Seoul at 

one point that they were going to diversify in dollar-denominated 

assets, and that caused a run on their currency. A similar rumor 

went through Japan not long thereafter. 

What would be the impact on the value of the dollar in our economy if the Chinese were to, for example, announce that they were 

going to either diversify out of dollar-denominated assets or were 

to, in fact, begin a precipitous sale of such assets? 

Chairman BERNANKE. Well, Senator, first, I think it is important 

to understand that that is not a very likely scenario, and China 

own interests would not be well-served by such actions. They would 

take portfolio losses themselves and——

Senator BAYH. Forgive me for interrupting. That is something 

similar to what the Treasury Secretary said, and the reason for my 

question, Chairman, is this: You are right, it might not be in their 

pecuniary best interests, but nation states do have interests other 

than their financial concerns. Let’s just say hypothetically, you 

know, bringing pressure to bear on Taiwan and Taiwan’s allies 

might be worth the loss of some money to the Chinese at some 

point in time. 

35

So my concern is simply this: Global interdependence is one 

thing, but the dependency is another. And it puts us in the position 

of being somewhat vulnerable to another country’s view of their 

own best interests. And I have real concerns about whether that 

is in our best interest. 

Chairman BERNANKE. I will answer your question, but I just 

wanted to reiterate that I think the costs to them of doing this 

would be greater than the costs to us. 

That being said, I think a substantial move on their part would 

be disruptive in the market in the short-term. In the longer-term 

the dollar, the Treasury yield and so on, would largely recover. 

Part of the reason is that Chinese holdings of United States fixedincome securities—which, of course, include not only Treasury but 

also GSE’s and corporate debt and other instruments as well—

amount to something less than 5 percent of the outstanding dollar 

fixed-income securities in the global market—which is a very significant amount, but is not by itself enough to be a monopoly of 

some sort in this market. 

So if they were to do that—which, again, I do not anticipate—

it would have short-term disruptive effects. I think that most of 

those effects would be short term as the market, which is very deep 

and liquid, began to adjust to that shock. 

Senator BAYH. Thank you, Chairman. My time has expired. 

Again, the reason for my question is simply, as a great power, I am 

reluctant to see us, even for a short duration, to be in a position 

of vulnerability to the actions of another government. 

Thank you. 

Chairman DODD. Senator Bayh, thank you. Those are excellent 

questions, and I appreciate your raising them. 

Senator Allard. 

Senator ALLARD. Thank you, Mr. Chairman. 

We are currently working on our budget, and it is a 5-year budget, I assume, you have looked at 5-year projections as far as how 

our economy is going to be doing. If I remember correctly, you pretty much feel that we are going to have a pretty good economy for 

the next 5 years, certainly within the average. Is that correct? 

Chairman BERNANKE. We have not released any forecasts of the 

economy beyond a couple of years. The projections I gave today 

suggest reasonable growth and inflation over the next 2 years. The 

underlying fundamentals of the economy in terms of productivity 

and so on look good to me, and so my expectation is that the economy will continue to be strong after that period. But we have not 

released any specific forecasts. 

Senator ALLARD. Now, in 2009, our Social Security surplus begins to decline, and that is the projection that we are looking at 

now, where we have had the surpluses but now they begin to reduce. How does that get factored in? That is within the next 2 

years. We will be working on the 2009 budget in a year from now. 

How does that factor into your economic growth projections? Or is 

it too early to begin to have much validity to that? 

Chairman BERNANKE. It is a bit early to be thinking about that. 

From a macroeconomic point of view, if we focus on the cashflows 

of the deficits, current in, current out, it looks like the deficit will 

not be rising significantly and may even be declining for the next 

36

few years for various reasons. So, I do not anticipate that fiscal policy will be a major force shaping the near-term growth pattern of 

the economy. 

The concerns that I emphasized in my Senate Budget testimony 

were really the longer-term issues of solvency and fiscal responsibility in the context of the aging of the population and the large 

increase in entitlement spending. 

Senator ALLARD. The deficit is going down. In my view, it is more 

attributable to revenues. It is not that we have done anything particular to hold down on spending. If we do something—and I do not 

know how you factor in the expiration of these temporary taxes 

that have been put in place. It looks to me like they have had a 

positive impact on the economy and the revenues that are coming 

in. When those expire, what kind of adjustments do you think we 

will have to make in our budget projections from that point on? 

Chairman BERNANKE. Well, again, I am not going to take a position on whether they should be allowed to expire. I think if they 

do expire, it would probably increase revenues somewhat. It would 

have other effects on the economy in terms of incentives and 

growth potential as well. 

From the Federal Reserve’s point of view, we are simply going 

to look at the fiscal situation as it evolves and make our adjustments to try to maintain full employment as the economy goes forward. I think the considerations the Congress should have with respect to near-term tax policy should be less to do with maintaining 

short-term full employment—we will be able to address that—but, 

rather, think about the long-term trade-offs between the benefits of 

lower taxes and the costs of lower taxes, essentially. 

Senator ALLARD. I am going to move over to the small business 

question. When you look at the economy, it seems as though—most 

of the figures I look at on the small business sector, they contribute 

about 50 percent, 52, 53 percent of the growth in the economy. Is 

that about what you look at? 

Chairman BERNANKE. It is similar—small and large businesses 

are similar in magnitude, and so in that respect, you are correct, 

yes. 

Senator ALLARD. You are saying that the small business sector 

would grow—you think it is 50–50, then, between economic growth 

from large business and economic growth from small business? 

Chairman BERNANKE. I do not recall the exact data, but I believe 

I have heard that number for job creation as opposed to growth. 

But it would be similar, yes. 

Senator ALLARD. Okay. Thank you for that. That was just a point 

of information. I wanted to see how you were looking at that. 

Chairman BERNANKE. We can provide you with more detailed information. 

Senator ALLARD. I would appreciate that, if you could. 

The other question is Sarbanes-Oxley. Apparently, there is a rise 

in private equity firms, and they are increasingly acquiring some 

public companies and apparently taking them private. Does that 

phenomenon concern you? 

Chairman BERNANKE. Not necessarily. It can be a good method 

of enforcing discipline on corporations and management. By taking 

the firms private, they essentially create a situation where the priVerDate 0ct 09 2002 16:41 Nov 20, 2007 Jkt 000000 PO 00000 Frm 00040 Fmt 6633 Sfmt 6633 S:\DOCS\38109.TXT SBANK4 PsN: KEVIN
37

vate equity investors have a short period of time in which to create 

a more productive, more effective, and more profitable firm. They 

then usually try to bring the firm back into the public markets, so 

it is not in some sense an attempt to permanently escape SarbanesOxley, because they do eventually want to come back into the public markets. 

So, generally, it is a policy development in that it creates more 

competition for corporate control and should increase discipline 

among management. There may be some circumstances where the 

leverages are excessive or that there are other problems associated 

with it. 

Senator ALLARD. When I was taking economics in college, I think 

full employment was considered 5 percent. Is there a figure like 

that that most people generally agree is a full employment figure? 

Or are there other variables you have to bring in, you cannot use 

a static number like that? 

Chairman BERNANKE. The Congressional Budget Office uses, I 

think, 5.2 percent. 

Senator ALLARD. Yes. 

Chairman BERNANKE. But the Federal Reserve does not have a 

fixed number that we use. Again, as I indicated earlier, we try to 

look at a wide variety of indicators, both of the labor market and 

of the general economy in terms of prices, for example. In the past, 

we have found that the amount of employment the economy can 

sustain on a long-term basis changes over time. It changes within 

demographics, with the structure of the labor market, and with the 

structure of industry. It is not, I think, good policy to have a fixed 

number in mind. It is important to be flexible, look at all the information that is coming in, and try to make an ongoing judgment 

about how the capacity of the economy is adjusting. 

Senator ALLARD. And do you think the unemployment is at a desirable place in the economy right now? 

Chairman BERNANKE. Well, as I indicated earlier to Senator 

Bunning, we are certainly much closer to the capacity of the economy now than we were a few years ago, as we have seen unemployment come down and capacity utilization go up. Whether we are at 

that level or not, again, I cannot say. We will be looking at a wide 

variety of indicators and trying to make a judgment about where 

the economy should go. 

Senator ALLARD. In addition to that, wages have gone up, haven’t 

they? 

Chairman BERNANKE. Nominal wages have gone up, and we have 

seen some increase in real wages as well, and that is a good development. 

Senator ALLARD. Thank you, Mr. Chairman. 

Chairman DODD. Thank you, Senator. 

Senator Menendez. 

Senator MENENDEZ. Thank you, Mr. Chairman. 

Chairman Bernanke, I want to start where I started off in my 

opening comments to you. I am very concerned about the economic 

squeeze that has been put on the middle class, particularly since 

the turn of the 21st century. Since the beginning of 2001, middleclass families have experienced increased levels of debt, anemic 

growth in real wages, all the while essential costs for food, housing, 

38

and medical services have increased at levels drastically higher 

than inflation. 

As a result, the financial security of middle-class households has 

suffered, and more and more American families are unable to afford life emergencies such as an unexpected health problem or unemployment. 

Employment opportunities are at their lowest level since the 

Great Depression. Since the recession ended in November 2001, job 

growth has averaged a mere eight-tenths of a percent per month, 

less than a third of the 2.7 percent average growth we experienced 

in previous recovery periods since World War II. For the first time 

since the 1950’s, job opportunities have actually decreased from a 

16-percent growth rate in the 1990’s to a 14-percent decrease since 

March 2001. 

I look at that and I add to that factor that families seems to me 

to be living on thin ice. I hear these stories of families in New Jersey that they are only one unexpected illness or lay-off away from 

sinking into perpetual debt. I think one measure of this economic 

insecurity is the percentage of middle-class families who have at 

least 3 months of their salary in savings. The percentage of middleclass families who had 3 or more months salary in savings rose 72 

percent from 16.7 percent in 1992 to 28.8 percent in 2001. So middle-class families are becoming more secure year by year. But, unfortunately, in the span of less than 4 years, that percentage 

dropped by over 36 percent, down to 18.3 percent in 2004. 

Finally, I noted with interest in your written statement, you 

said, ‘‘Consumer spending continues to be the mainstay of the current economic expansion.’’ That is true, but when you add that reality to anemic growth in wages and sharp increases in the cost of 

necessities, household debt in America has risen to record levels 

over the past 5 years. By the third quarter of 2006, outstanding 

household debt was 130 percent relative to disposable income. That 

means that the average family is in debt of over $130 for every 

$100 it has to spend. And, additionally, the average household savings rate has actually been negative for the past seven quarters, 

averaging about a negative 1 percent rate for 2006. 

So, I look at all of this, and I say to myself, you know, I have 

my friends and colleagues who are heralding this great economy. 

I do not get the sense that people back at home and in other parts 

of the country feel that good about it. You see it in every poll of 

the barometer of their feelings. They feel really squeezed and really 

put upon. 

And so my question to you is: Aren’t these indicators a real cause 

for concern as it relates to the struggle that the middle-class families in this country are facing? And how do we create an economy 

that is more inclusive and which the macro benefits end up being 

achieved by those who are the great center of those who keep this 

country afloat? 

Chairman BERNANKE. Senator, in my remarks in Omaha, I did 

the usual economist’s ‘‘on the one hand, on the other hand’’ approach. On the one hand, average living standards in the United 

States have risen very substantially since World War II—very substantially—and that is true for the majority of the population. Even 

in the last 10, 15 years, we have seen on average, or even at the 

39

median, middle parts of the income distribution, pretty good overall 

growth, not year-to-year but over a period of time. So there has 

been a general improvement in living standards, which has affected 

a very large part of the population. 

That being said, on the other hand, there are various issues, as 

I talked about in my remarks, that inequality has increased. We 

have seen more concerns about job security related to trade and 

technology. Health care remains a concern. People are concerned if 

they lose their job they will not be able to afford new health care 

or move their health care between their existing employer and a 

potential new employer. 

You mentioned wealth. Wealth is very unequally distributed in 

the United States. A big challenge is to help people in the lower 

part of the wealth distribution begin to save and accumulate assets 

so they can have some reserve against the kinds of problems you 

referred to, like a health emergency or unemployment or some 

other problem that may arise. 

So my broad answer is that I do think the economy has strengthened over time and the benefits have been felt by a large part of 

the population. But there are persistent issues that relate to people’s sense of security or insecurity, and there is no single answer 

because each of these issues—wealth creation, health care, inequality—are all large issues, and they each require individual attention. 

Senator MENENDEZ. I appreciate that. It seems to me that the 

policies both in the taxing side as well as in the incentive side and 

in the programmatic side that would go to narrow these divisions—

you have mentioned education; I certainly agree with you on that. 

But we have seen educational outcomes rise, and yet we have still 

seen inequality rise. 

We have challenges, as it relates to how families achieve health 

care. We have challenges maybe in policies that incentivize savings 

and find ways to help that segment of society save. It seems to me 

that this consumer-driven expansion of the economy at some point 

at the cost of debt has a consequence to it. And so it is a real concern. 

One last question. In the written version of your remarks to the 

Chinese Academy of Social Sciences in December, you referred to 

China’s currency policies as ‘‘an effective subsidy’’ for the country’s 

exporting industries. I am just wondering why you omitted that 

reference in your presentation on December 15? 

Chairman BERNANKE. I omitted it because I thought at the time 

that it would be more clear to my audience there in Beijing if I explained it a little bit differently. But I stand by my written comment. I think it is accurate. 

Senator MENENDEZ. Thank you, Mr. Chairman. 

Chairman DODD. Thank you very much, Senator. 

Senator Sununu. 

Senator SUNUNU. Thank you, Mr. Chairman. 

I want to first begin by going back to a subject that was brought 

up, and I think inappropriately so, in a discussion about whether 

you, Chairman Bernanke, should be willing to talk about ‘‘policy’’ 

before this Committee. As most everyone has noted, you talked 

about education in your opening statement. And the suggestion 

40

was made, by, I think, more than one Senator, that while education 

is policy and if you talked about education, therefore, you should 

be willing to talk about policy prescriptions on the tax side, and in 

particular talk about raising tax rates. And I think a lot of this discussion about income inequality, quite frankly, is a prelude to a 

policy recommendation from some on the other side of the aisle to 

raise tax rates on entrepreneurs and individuals in certain income 

brackets. 

Well, I think that that sequence of conclusions is just flat wrong 

because it is entirely appropriate for the Fed Chairman to talk 

about education as an input, like productivity or technology. Education and technology affect productivity, productivity affects 

growth rates, and perhaps inflation. That is entirely appropriate. 

But it is, of course, not appropriate for Chairman Bernanke to 

talk about or recommend specific policy prescriptions in the area of 

education at the State, the Federal, or the local level, spending on 

a particular program, school vouchers or issues that people on various sides of the aisle might support. 

So, I think we need to make this distinction. I think it is unfair 

to the Chairman to suggest that because he talks about the value 

of education, generally speaking, to the workforce in terms of its 

flexibility that he should be willing to weigh in on education legislation or tax legislation that Members might be writing. 

I guess that is the opinion piece, and now I will go on to my 

questions. 

You noted that growth in the second half of 2006 was 2.75 percent. Was that higher or lower than you originally expected, or expected, say, a year prior, a year out? And why was it higher or 

lower than your expectations? 

Chairman BERNANKE. It was close to our expectation. Our assessment was that the economy was making a transition to a more 

moderate and sustainable pace, which would be something in that 

general vicinity. 

It does look that the fourth quarter GDP growth number is going 

to be revised down somewhat, and so the actual number will be a 

bit lower. But probably the implications will be slightly stronger 

first quarter, so it does not really change the overall picture, which 

is that we see the economy growing at a healthy pace, but it is one 

that is sustainable and not overheated. 

Senator SUNUNU. Thank you, and I want to apologize for not presenting the option that you might have been correct in your projection. I suppose that should have been one of the choices. 

You noted in your testimony that real incomes should continue 

to rise. At what rate do you project real incomes to rise over the 

next four to six quarters? 

Chairman BERNANKE. Well, it depends on what your definition of 

‘‘income’’ is. We have seen real wages growing the last half of 2006 

by about 3 percent in real terms. I hope to see continued strong 

growth in real wages. I am not quite sure whether it will be quite 

that strong, but I think as long as energy prices do not rise quickly 

again, we should continue to see good growth in real wages. 

Broader measures of income should grow broadly at the same 

pace as GDP, and our forecasts are for something between 2.5 and 

3 percent. 

41

Senator SUNUNU. And when you talk about broader measures of 

income——

Chairman BERNANKE. Including capital income and so on. 

Senator SUNUNU. You talked about the fact that there was a 7-

month supply in unsold homes in the third quarter of 2006. Where 

do you expect that inventory to go in the next 6 to 12 months? Has 

it peaked or do you expect the inventories to increase further? 

Chairman BERNANKE. The predicate is that we have seen what 

we call ‘‘tentative signs of stabilization in demand for housing.’’ If, 

in fact, the demand for housing is stabilizing—and, again, we will 

not know that for sure, I think, until we see sales figures in the 

spring—then we should see from here a gradual decline in the 

months for sale inventory. The normal, at least for the last 8 to 10 

years, is 41⁄2 months of homes for sale, and my anticipation would 

be that we would get back toward that general level by the end of 

next year, assuming that demand stabilizes. 

Senator SUNUNU. By the end of 2008, not the end of 2007. 

Chairman BERNANKE. Yes, 2008. 

Senator SUNUNU. The last question. I guess the question is: 

Please explain this to me. It is one of the charts, and the monetary 

policy booklet is, I think, very well written and very informative, 

no surprise there because, as you know, you have very good staff. 

But there is the graph of the savings rate from 1983 to 2006. 

From 1983 to 2006, we had two recessions, three bull markets, 

two market crashes. We had rising and falling deficits. We did 

have a relatively steady trend in improving employment numbers 

and a lowering of the rate of unemployment and a fairly strong 

record of dealing with and containing inflation. And yet the personal savings rate, you know, that chart is a steady downward 

trend through all of these things. And I am curious to know what 

the factors are that go into that steady decline in savings rate. We 

know it means that people are consuming more than they are earning or a greater proportion of what they are earning. But what is 

contributing to that trend? And is this something that the Fed is 

worried about? 

Chairman BERNANKE. Well, you raise a question that a lot of 

people have weighed in on. It is a complicated question. I think 

several factors have been pointed to. One is demographics. Different cohorts or different generations have different propensities 

to save. The baby boomers have not been particularly impressive 

in that respect, and as they have become the biggest recipients of 

income their savings rates have shown through. 

Senator SUNUNU. I apologize for interrupting, but has there been 

an evaluation of the propensities of different cohorts currently? 

Chairman BERNANKE. Yes. 

Senator SUNUNU. And how much of this declining savings rate 

can be attributed to that one cohort? 

Chairman BERNANKE. Well, there have been a number of papers, 

and we would be happy to send you a few surveys or summaries 

of some of the research that has been done. A number of papers 

have looked at this demographic issue and viewed it as being important, although not necessarily the whole story. 

The other important part of the story is that personal savings 

rates are out of current income, and they do not include capital 

42

gains of any kind. So the general strength of the stock market and 

then more recently of the housing market has meant that people 

could increase their wealth without saving, and that has been, I 

think, an important factor in leading to a lower savings rate more 

recently. 

The other technical point to make is that private saving actually 

consists of the sum of the household or personal savings together 

with the savings done by corporations. Savings by corporations has 

become a larger share of the private saving than overall, and in a 

sense, the corporations ultimately belong to the households, whether you are a small business owner who is keeping profits in your 

business or an investor who is enjoying capital gains in stocks. 

Some of that saving is not appearing in households because it is 

taking place in corporations. It is a measurement issue. 

But I think it is an issue because the national savings rate has 

come down, and it contributes to issues like the current account 

deficit we have talked about. Our anticipation, as I mentioned in 

the testimony, is that the household saving rate should rise a bit 

in the next couple of years partly because housing prices are not 

rising as fast and people will turn back to saving from their current 

income. But we do not anticipate anything like the 12 percent in 

1985 anytime soon. It is going to be a slow process. 

Senator SUNUNU. Thank you very much. Thank you, Mr. Chairman, and I would note, since I am not a member of the baby-boom 

generation and you are, I look at every possible opportunity to 

blame something bad on your generation. 

Thank you. 

Chairman DODD. Well, you have not proven you are part of the 

Greatest Generation either yet. 

[Laughter.] 

Senator SUNUNU. And I would never make such a claim. 

Chairman DODD. I was just going to note, I have been on this 

Committee some 25 years, and I recall with great fondness your 

predecessor appearing here on numerous occasions, and I cannot 

recall specifically the Members who may have raised, but the number of times Chairman Greenspan was asked to support specific tax 

cut policies was rather frequent on the Committee. So this is not 

a first-time occurrence that a policy question was raised to a Chairman of the Federal Reserve. 

Senator SUNUNU. But my point is that he would never answer 

the question, and that was the right thing to do. 

Chairman DODD. And I suspect my colleague from New Hampshire may have been one of the people to ask those questions. 

I would just note as well on the savings rate issue here, I am 

told—and maybe you can correct me on this if I am wrong, Mr. 

Chairman—that the last time we had a negative savings rate of 

this magnitude, it was the Great Depression. Is that correct historically? 

Chairman BERNANKE. I think that is correct. 

Chairman DODD. Someone mentioned to me the other day as well 

that, of course, the consumer debt issues are staggering, and at 

least the revolving debt, a good part of which is probably credit 

card debt, on the average is around $9,300 per individual. Does 

that number ring true with you? 

43

Chairman BERNANKE. I do not know the number for revolving 

debt specifically. The incidence of debt issues varies quite a bit 

across the population. For a good bit of the population, particularly 

those of higher incomes, there has been asset accumulation which 

offsets the debt. 

Chairman DODD. Right. 

Chairman BERNANKE. So, in particular, over the economy as a 

whole, the average loan-to-value ratio for homes is about 50 percent. That is, the mortgage companies own half the housing stock 

and the public owns half the housing stock. But there are certainly 

segments of the population who are facing very high debt loads, either through their mortgage borrowing or through credit card revolving debt, and for them it is obviously a hardship. 

Chairman DODD. Thanks very much. 

Senator Tester. 

Senator TESTER. Yes, Mr. Chairman, I do have questions, and I 

do hope to ask them, but my comrade Senator Brown has a commitment, and I will defer to him for now. 

Chairman DODD. Thank you. 

Senator BROWN. I thank my friend from Montana. Thank you, 

Senator Tester. 

Chairman Bernanke, in your remarks last week in Omaha, you 

noted that our policy responses to economic inequality must be informed by our ethics and our values and are ultimately political 

questions. You said a moment ago that inflation was the canary in 

the mine. I have for 5 or 6 years worn a depiction of a canary in 

a cage on my lapel to signify the Government’s role in everything 

from mine safety to the environment to minimum wage to Medicare. 

You also expressed—and I think that the ethics and values in 

our domestic economy, I think those ethics and values are reflected 

in what we do in our domestic economy, like the canary in the 

cage. It is minimum wage and it is Medicare and it is Social Security, and it is helping the middle class thrive, as it has done in the 

last 100 years. And there has been clearly a consensus in this 

country, differences on the edges perhaps, but a consensus that 

those ethics and values drive what we do in our domestic economy. 

It seems to me those values and ethics do not stop at the water’s 

edge, that as a Nation we should continue to propagate and promote those same ethics and values as we have done in our country 

in our domestic policies and our domestic economic issues. We 

should look at those internationally. 

I know you expressed concern that inhibiting trade flows would 

do more harm than good, but I would argue that if our country is, 

in fact, going to live its values and going to live the ethics that we 

discuss and that we sometimes pat ourselves on the back about, we 

would look internationally in some of those cases. 

I would just start by asking if—we have as a Nation our values 

say that we should not buy products manufactured by slave labor 

in China. Do you agree with that? 

Chairman BERNANKE. Absolutely. 

Senator BROWN. Okay. And would you say then that we should 

not import products made by child labor. 

Chairman BERNANKE. Yes. I agree that we should not. 

44

Senator BROWN. Okay. Then I guess that would be—the next 

step would be we should not import products produced in sweatshops, if we, in fact, can agree on a workable definition of ‘‘sweatshops.’’

Chairman BERNANKE. Well, that is a very difficult qualification 

you just added at the end. Just to get where you are going, I think 

it is probably not a good idea to try to enforce Western-level standards of worker benefits in emerging market countries. Since those 

workers have such low productivity, if we were to insist on the 

same standards we have in the United States in terms of benefits 

and the like, the workers would either have very low wages or no 

job at all. I think the way to get to the kinds of living standards 

we have in America is to allow people to participate in the market 

and to produce. 

We in the United States, of course, have come a long way, starting from situations where workers did not have very good protections to a situation now where we have much better protections. 

Senator BROWN. But, Mr. Chairman, if I could, we also did not 

have a foreign government implanting on us an economic structure 

with foreign investment and that international economic structure. 

Let me take this in a little bit different direction. I agree we 

should not impose—we should not have imposed under NAFTA or 

CAFTA minimum wage—the minimum wage that we have in the 

United States, of course, we should not have imposed it in Guatemala. But these are not Western—when you talk about International Labor Organization standards, that is an arm of the 

United Nations, I believe, and that is not Western economic standards. 

Does that mean then you would support, if you were looking 

more internationally, would you support International Labor Organization standards in these trade agreements that we negotiate? 

Chairman BERNANKE. I believe those standards come in many 

different levels, and there are literally hundreds of them. 

Senator BROWN. There are five central International Labor Organization provisions and standards, there are questions within 

those, but the right to organize and bargain collectively, the prohibition on forced labor, the prohibition on child labor, those kinds 

of general standards that we have not—we did in the Jordan Trade 

Agreement, but we have not in the last 6 or 7 years. Is that a policy question reflecting our ethics and values that we should pursue? 

Chairman BERNANKE. I think it is. I think it would be reasonable 

to look to basic human rights, such as slave labor and forced labor. 

I think those are not something we want to countenance. When it 

becomes a question of whether we should require minimum wage, 

for example, it is a much difficult issue, and——

Senator BROWN. That is not one of the ILO standards. 

Chairman BERNANKE. Okay. 

Senator BROWN. Okay. Fair enough. 

Let me shift for a moment to industrial loan companies briefly. 

As you know, the FDIC has extended for 1 year a moratorium on 

commercial firms like Wal-Mart owning a bank through and ILC 

charter. This Committee and this Congress have just a short 

time—a year—to address the important issues involved before the 

45

moratorium expires. Do you have any concerns on the uneven regulatory structure between banks and what perhaps would be an unlimited number of commercial firms owning ILC’s? 

Chairman BERNANKE. The Federal Reserve is concerned about an 

unlimited expansion of the industrial loan company exception. We 

have two particular concerns, which we have talked about on a 

number of occasions. First is the mixing of banking and commerce. 

The Congress in Gramm-Leach-Bliley and other contexts has expressed its desire to keep banking and commerce separated. I agree 

with that, and I think that is an issue for the Wal-Mart acquisition, for example. 

The other concern is about consolidated supervision. If there is 

an acquisition of an ILC by either a commercial or noncommercial 

firm, I think it is important that the oversight of that combined entity be done at the higher level to ensure that there is sufficient 

financial strength in the holding company to ensure the safety of 

the deposit insurance funds for the ILC itself. 

So those two principles are important to keep in mind as we debate this question. 

Senator BROWN. Thank you. 

And, Chairman Dodd, Senator Johnson as you know has been 

very involved in the ILC issue. 

Chairman DODD. Right. 

Senator BROWN. And we clearly in this Committee need to pursue that. 

Thank you, Senator Tester, very much. 

Chairman DODD. Thank you very much, and I am sorry Senator 

Bennett was not here to engage. I know he has some strong interest in this subject matter. I was going to give you the opportunity—

and I thank Senator Brown for raising the question—there has 

been some issue about whether or not this is—tough issues have 

been raised, and I want to give you a chance to respond to this. 

Some have suggested that the reason the Fed has taken the position it has is because it is an area of jurisdiction that they like to 

have. 

I think I know the answer to this question, but what is your response to that particular concern? 

Chairman BERNANKE. If the ILC exemption is limited and not allowed to expand indefinitely, we are perfectly comfortable with the 

FDIC doing the consolidated supervision, and we think they do a 

very good job. 

Chairman DODD. Thank you, Mr. Chairman, very much. 

Senator Crapo. 

Senator CRAPO. Thank you very much, Mr. Chairman. And 

Chairman Bernanke, we appreciate you being here with us. 

I want to return to the global competitiveness issue for a minute. 

I know that others have spoken to you about this already. First 

and foremost, I want to commend Senator Schumer for working 

with Mayor Bloomberg for the McKenzie report. There is also, as 

you know, the new interim report of the Committee on Capital 

Markets Regulation, and both of those reports I think add significantly to this debate and to the issue. I am working on a resolution, and talking with Senator Schumer about it as well, and hope 

to be working with him on a resolution to help highlight this and 

46

to express the sense of the Senate about what steps we need to 

take in terms of better dealing with our global competitiveness. 

Now what I want to focus my questioning on with you is derivatives and hedge funds. I will start by noting that in the McKenzie 

report this following quote occurs.

London already enjoys clear leadership in the fast-growing and innovative overthe-counter derivatives market. This is significant because of the trading flow that 

surrounds derivative markets and because of the innovation these markets drive, 

both of which are key competitive factors for financial centers. Dealers and investors 

increasingly see derivatives and cash markets as interchangeable, and are therefore 

combining trading operations for both products. Indeed, the derivatives markets can 

be more liquid than the underlying cash markets. Therefore, as London takes the 

global lead in derivatives, America’s competitiveness in both cash and derivatives 

flow trading is at risk, as is its position as a center for financial innovation.

Would you agree with that portion of the McKenzie report? 

Chairman BERNANKE. I agree that derivatives are an incredibly 

important part of our expanding financial market, part of financial 

innovation, and I would like to see the United States remain competitive in those areas. 

Senator CRAPO. So you think it would be appropriate for us to 

focus in this Congress on things that we can do or not do to assure 

that we remain competitive or that we become more competitive in 

those arenas? 

Chairman BERNANKE. Again, I think the best way to be competitive is to make sure that the regulatory structure has a minimal 

costs as needed to justify the benefits that are seen to be obtained 

from those regulations. 

Senator CRAPO. One of the common themes that we are seeing 

in terms of the movement of business away from the United States 

to London and other capital markets is just that, the regulatory 

burdens and the regulatory regime that we impose here in the 

United States. I do not think anybody would say that we should 

simply take down our regulatory position, because we do have one 

of the strongest markets in the world. But the question is, are we 

over-regulating. 

I want to go specifically to an issue that you and I have talked 

about many times before, and that is the regulation of energy derivatives. As you know, we have faced proposals in Congress and 

the Senate now for the last 4 or 5 years to increase the regulatory 

climate around the handling of energy derivatives. There has yet 

been another bill introduced just yesterday or day I think, to do the 

same thing, so we are back into the same issue. 

You have expressed a position on this in the past. I have in front 

of me the last letter that was put out by the President’s Working 

Group, of which you are a member. The last paragraph of that letter says, ‘‘several times in recent years the PWG has been asked 

for its views on various legislative proposals to expand regulation 

of energy derivatives. Most recently, in testimony before the Senate 

Banking Committee on September 8, 2005 representatives of the 

PWG agencies reaffirmed the position of the PWG that additional 

regulation of energy derivatives is not warranted.’’

Is that still the position of the PWG, and is it still your position 

that we do not need to further increase the regulatory regime surrounding energy derivatives? 

47

Chairman BERNANKE. The PWG has not discussed it recently but 

I have no reason to think the position has changed. I believe it is 

a reasonable position, that we should be very careful about adding 

additional regulatory costs in this market. There are two reasons 

to regulate. Potentially one is investor protection. But in this market, of course, we have very large institutions, very sophisticated 

institutions who are, I think, able to take care of themselves. 

The other would be a concern about price manipulation. There 

the CFTC does have, of course, ex post powers to investigate potential frauds or manipulation. But it seems unlikely that manipulation in most cases would come from the OTC markets since the exchanges provide a good venue for determining prices. 

So, I have not changed the position I expressed before. 

Senator CRAPO. Thank you. I appreciate you sharing that with 

us. I suspect that we will be asking the entire PWG to reevaluate 

this issue since we now have legislation yet again introduced on 

the issue. So, I would just give you that advance warning that we 

will be coming to you for some guidance as we once more enter into 

this debate. 

Just one last question; moving a little bit to hedge funds. Can 

you explain what is involved in fostering market discipline in the 

hedge fund context? It is my understanding that you believe that 

that is a superior approach to direct regulation. 

Chairman BERNANKE. That is correct, Senator. 

The proposal of the President’s Working Group, once again, in 

their report following the LTCM crisis focused on the so-called ‘‘indirect’’ or market-based regulation of hedge funds. That has essentially two components. The first is through the counterparties, that 

is, the investment banks or the banks, who lend money to the 

hedge funds or serve as their prime brokers. The supervision process requires that these large counterparties manage their 

counterparty risk effectively, that is, that they have good information about the risks being taken by the hedge funds, their financial 

positions, and so on. And it is both in the interest of those 

counterparties, obviously, since they do not want to lose money, 

that they pay close attention to what their counterparties are 

doing, and the supervisors give additional encouragement, incentive, for the counterparties to manage those risks effectively. 

The other type of counterparty is the investor itself, particularly 

large institutions like endowments or insurance companies and the 

like, which also provide a good bit of market discipline on the 

hedge funds by gathering information as they make their investment decisions. 

So we believe that is a very important, and so far, successful 

method of overseeing hedge funds. I would be very reluctant to get 

involved in heavy-handed direct regulation of hedge funds. They 

are a very diverse group of institutions. They have a wide variety 

of strategies, and one of their key characteristics is that they are 

very nimble. They change very quickly. And that is good for the 

economy because they help to create more liquidity in markets, 

they help to spread risks around more broadly. A regulatory regime 

that inhibited that flexibility and nimbleness would eliminate a lot 

of the economic benefits of the hedge funds and the other types of 

48

private pools of capital that use sophisticated instruments to share 

risk. 

That being said, it is always useful for regulators and supervisors to keep abreast of what is happening in the hedge fund market, to speak to hedge fund managers, to understand recent developments. 

The G–7 meeting which I attended over the weekend, in the spirit of information gathering, proposed that the Financial Stability 

Forum, which is an international group consisting of central bankers and supervisors, update a report they did in 2000 about the 

status of this market. I think that is consistent with us simply trying to keep up our information base that we know enough so that 

we are keeping up with developments in that industry. 

Senator CRAPO. Thank you very much, Mr. Chairman. I want to 

just say, personally, I appreciate your candor and the candor that 

we get from the President’s Working Group as we face these kinds 

of issues. The expertise that you and the other members of the 

working group can bring to the issue to help us evaluate them is 

invaluable, so thank you for providing that. 

Chairman DODD. Those are great questions, Senator. I appreciate 

you raising them as well. Very well done. 

Senator Tester. 

Senator TESTER. Thank you, Mr. Chairman. 

I also want to thank Chairman Bernanke for being here today 

and being forthright in your answers. It is very nice. 

The reason I want to stick around and ask these questions, quite 

frankly, is because I value your opinion. It is not for political reasons. It is not for anything other than I want to know your perspective. Because quite frankly, from my perspective of being a farmer 

in North Central Montana, there is a lot of things that are just flat 

backward in this country right now. 

So the first question I wanted to ask is what is the number one 

factor that concerns you as a potential impediment for our economic growth here in this country? 

Chairman BERNANKE. Well, over the medium-term, it is the demographic transition that we are going through. We are getting 

older, our society is aging. We are going to have a much larger 

share of the population in retirement age, or even in the oldest of 

the old, 80 and 90 years old. And we have not really made good 

preparation for that, either in terms of broader savings in the society, or in terms of fiscal policy, which I have discussed in previous 

context. 

Senator TESTER. Does the $8.6 trillion debt fall into that issue 

then? Or is that somewhere else? 

Chairman BERNANKE. Well, it is closely related because if we do 

not take some measures to address how we are going to deal with 

the fiscal implications of an aging society, the debt and deficits are 

going to grow, interest payments on those debt and deficits are 

going to grow, and we will be in an unsustainable fiscal situation. 

So the fiscal picture is closely linked to the underlying demographic changes that are going on. 

Senator TESTER. I have had a tough time struggling with, because quite frankly tax load is something I am very concerned 

49

about, too, as I think everybody on this Committee is. But the debt 

load concerns me, too, very much. 

Could you rank them as what could be the most severe impediment? Is it the debt load or is it tax policy that is flawed? 

Chairman BERNANKE. I do not think I can rank those. The main 

concern would be that Congress has to decide how big the Government is going to be and what share of national resources are going 

to flow through the Government, either for Government spending 

or through entitlement programs. 

The tax collections need to be commensurate with that, and that 

is the main decision. I am not qualified or in a position to tell you 

how big that share should be. 

Senator TESTER. Foreign investment. I hear occasionally on TV, 

I hear from some of my constituents in Montana, that those people 

that are able to save some dough are being encouraged to put a 

certain percentage—I think 20, 25 percent is what I am hearing—

into foreign markets. Is that a concern? 

Chairman BERNANKE. No, not necessarily. Foreign markets have 

strengthened considerably in terms of their quality. Clearly, the 

world is experiencing a lot of growth and so there are a lot of opportunities out there. By investing broadly, an investor diversifies 

his or her portfolio and reduces the overall risk that they face. 

Senator TESTER. How about from an economic growth standpoint 

here in this country? I think from an investor standpoint, I hear 

you. But what about an economic growth standpoint here? Is it a 

negative factor, positive factor, or no impact? 

Chairman BERNANKE. I think it is probably slightly positive in 

the sense that it gives American investors greater diversification. 

And implicit in your question is where do we get the funds for domestic investment? Well, they flow in from abroad. 

And so by swapping essentially between foreign and domestic investors, you get better diversification for everybody. 

Senator TESTER. Sounds good. 

Last question, and this deals with employment versus inflation. 

It has been talked about here a lot today, but when we get near 

full employment, does that necessarily drive inflation up? 

Chairman BERNANKE. There is no specific level of employment or 

unemployment that is a trigger, in some sense, for inflation. The 

main concern is to make sure that the overall spending in the economy, which is driven in turn by financial conditions, does not exceed the underlying productive capacity for a sustained period. 

That seems to generate inflation. 

But as I have mentioned a couple of times, it is not easy to determine exactly where that balance should be struck. And simply looking at the unemployment rate, for example, is not going to tell you. 

You need to look at a wide variety of indicators, including price indicators, to get a sense of when the economy is overheating and 

when it is more or less in balance. 

Senator TESTER. That is great. And that is actually what I was 

hoping to hear. 

So we should be continuing to strive to make employment complete, full to the best of our ability? 

Chairman BERNANKE. Certainly. The Federal Reserve has a 

mandate for maximum sustainable employment, and we want to 

50

achieve that. We do not want to achieve employment which is high 

for a short moment but then crashes. 

Senator TESTER. No. 

Chairman BERNANKE. We want something that is sustainable. 

Senator TESTER. Exactly. 

Once again I just want to go back, thank you, Mr. Chairman. I 

think this has been a great hearing. And I want to thank you, 

Chairman, for your honest forthright answers. 

Thank you very much. 

Chairman DODD. Thank you, Senator Tester. Very good. 

Senator Reed. 

Senator REED. Thank you very much, Mr. Chairman. 

Again, thank you, Chairman Bernanke, for your testimony. 

I was very impressed, as so many of my colleagues were, with 

your speech in Omaha. I thought it was thoughtful, comprehensive, 

and balanced, which is typical of your leadership at the Fed. 

At least one phrase or section struck me as interesting and that 

is you talked not only about technological change and international 

trade as causing this divergence between equality of incomes. But 

you also talked about institutional arrangements. The principal one 

you alluded to was labor unions. 

You say in your speech whatever the precise mechanism through 

which lower rates of unionization affected the wage structure, the 

available research suggests that it can explain between 10 percent 

and 20 percent of the rise in wage inequality among men during 

the 1970’s and 1980’s. I would suspect if it is 10 percent and 20 

percent in the 1970’s and 1980’s, it is at least that now, perhaps 

more, since unions have declined since that period of time. 

And it begs the question is one of the responses to wage inequality a more robust representation in the labor unions in the United 

States. 

Chairman BERNANKE. It is difficult to know the answer because, 

as I indicated in my remarks, there have also been structural 

changes—like changes in the share of manufacturing employment 

in the economy as a whole—which have affected the rate of unionization. It is a little hard to tell whether it is the decline of unionization itself or the structural reasons for that that are the causes 

of the inequality. 

I do think that if workers want to be represented by a union, of 

course, they should be allowed to do that. 

Senator REED. One of the issues here is that this is not just the 

hidden hand of the marketplace and technological change. There is 

Government policies. Policies which, until recently, one might say 

favored more, encouraged more participation in unions. Policies 

pursued by this Administration seem to go against it. The National 

Labor Relations Board, court decisions, Congressional activities. 

So this is an area, too, I think, that should be on the table, I presume, in terms of at least consideration by the Congress, if we are 

really concerned about narrowing this gap in terms of the economic 

equality. Is that a fair statement? 

Chairman BERNANKE. Well, again, there is the problem of deciding how much of the effect comes from the structural changes that 

underlie the changes in unionization patterns and how much comes 

51

from changes in unionization propensity itself. So, I do not really 

know how much effect that would have. 

Senator REED. Well, I think you have opened up a very serious 

line of inquiry, and I applaud you for doing that. Because once 

again, I think this is an issue that is there. 

And maybe anecdotally, I grew up in a State where everyone 

seemed to be in a union and they seemed to make pretty good 

wages and had health benefits. And now that is declining dramatically. And that, I think, contributes to this anxiety we have all referred to. 

Today, of course, I alluded in my opening statement, 13,000 

workers from Chrysler presumably—I would guess with some sense 

of probability that they are union workers—are losing their jobs 

and probably will not find union employment again. So, I think this 

is something we should consider. 

Again, I think mentioning it in your speech opens up a line of 

inquiry that is important. 

There is another issue, too, that you talked about and we all talk 

about the average income being stagnant for many working Americans. There is something else that I am hearing, is that the volatility of incomes for individual Americans fluctuates so wildly and 

causes huge problems. You could be a vice president for sales in a 

jewelry manufacturing company in Rhode Island making a handsome salary of $100,000. The next year you are making $35,000 because you are working at a lumber yard. 

That seems to be more common these days. And again, it gets 

lost in the aggregate, but for individuals we have to do something. 

Do you have any first thoughts about this phenomenon? 

Chairman BERNANKE. Well, it is an issue that has been raised 

by Mr. Hacker and others, and I have a footnote in my speech 

about some of the impact it might have on measures of inequality. 

It is a little bit mysterious exactly what the source of this is. It 

could be more or less benign things, like job changes and so on. It 

could be less benign things like periods of unemployment or health 

problems. 

There does not seem to be an increase in this pattern. The 

1990’s, if anything, seemed a little bit less volatile in that respect. 

There is no data that I know of for the most recent years. So it is 

a little bit of a black box, a little bit not clear what policy implications of that volatility should be. 

Senator REED. By the way, anyone who has footnotes to his 

speeches should be commended, so you are commended on that. 

Is this an area of inquiry, though, that you intend to pursue at 

the Federal Reserve, in terms of this volatility as well as the aggregate income levels? 

Chairman BERNANKE. We looked at that in preparing the speech 

and we did discuss it. And we were not, again, able to come to a 

strong conclusion about what the policy implications might be, and 

so we did not highlight it in the remarks. 

Senator REED. I know that you are—and I think you do this very 

well—wary of making endorsements of particularly policies. But in 

your speech you did allude to some policies that should be considered. 

52

So in the spirit of what we should be considering, you talk about 

portability of health and pension benefits as one area. There are 

other areas, for example wage insurance proposals that have been 

made. Again, rather than taking a position, is that something that 

we should be considering? 

Chairman BERNANKE. The general principle I was trying to address was the insecurity the people feel about job loss and job 

change. And I think it would be beneficial if we could reduce that 

insecurity. 

One way to do that would be to increase portability of benefits 

across jobs. There are many ways to do that, so I am not taking 

a specific means. Wage insurance is an interesting idea that has 

been advocated by a number of economists. Again, I am not sure 

I can take a specific position on it. 

One of the things I said, and I should reiterate, is that it is easy 

enough for me to say we should address these issues. The actual 

implementation is quite difficult. These are very complex problems. 

I just urge Congress to look at them and try to get as much good 

input and advice as they can in thinking about how to best address 

these issues. 

Senator REED. A final issue, which is the Earned Income Tax 

Credit, which seems to me to be a very efficient way to deal with 

this issue that has been the constant source of our discussions this 

morning, inequality of wages, inequality of opportunity. Is that 

something that we should be looking at seriously, to expand it? 

Chairman BERNANKE. Well, I was asked in the past about the 

minimum wage and, at that time, I said the Earned Income Tax 

Credit had some advantages compared to the minimum wage and 

that it was better targeted to the poor, to lower income people. And 

I still believe that to be the case. 

Of course, it does not come without cost. But I think it does have 

some advantages. 

Senator REED. Thank you very much, Mr. Chairman. 

Thank you. 

Chairman DODD. Thank you. 

Senator Carper. 

Senator CARPER. Chairman Bernanke, I would like to say that 

we saved the best to the last. That is probably not true, but I might 

be the last. And for you, that is probably blessed relief. 

Thanks for coming today. Thanks for sharing your thoughts with 

all of us, and responding to our questions. 

Senator Reed mentioned an announcement earlier today by 

DaimlerChrysler, that they are taking steps to cut their work force, 

it sounds like, by as much as 13,000 across the country. Sometimes 

we listen to those announcements and they do not strike very close 

to home. In our case, in Delaware, they do. We have a 

DaimlerChrysler assembly plant we have had for over 50 years in 

Newark, Delaware, close to the university. And so this one is one 

that is troubling to us. 

Having said that, I want to ask you a question. I telegraphed my 

pitch. And then I want to say a couple of other things. 

I am going to come back and talk to and raise an issue that the 

leaders of the big three—GM, Ford, and Chrysler—raised with 

President Bush 2 months ago when they came to Washington. 

53

Among the concerns that they raised was concerns about whether 

or not the Japanese are manipulating their currency in order to 

make their products more competitive in this country. So that is 

where I am going with this. 

But with respect to our own State, we build all of the Dodge Durangos and Chrysler Aspens in our plant. We have a reputation for 

doing a good job, and have had for a long time. About 14 years ago, 

literally the month I was elected Governor of Delaware in November 1992, our friends at General Motors announced that they were 

going to close their assembly plant in Wilmington, Delaware, along 

with a bunch of other plants, assembly plants and parts plants, 

across the country. 

They ended up closing, I think, just about all of them except this 

one in Wilmington, Delaware. It is one of two auto assembly plants 

that is still operating on the East Coast. I think the Ford Taurus 

plant down in Norfolk is going to close fairly soon. Then there will 

just be two plants, and one is the GM plant in our State. The other 

is the DaimlerChrysler plant. 

Our friends at DaimlerChrysler have announced today that they 

were going to go back to one shift at our plant in Newark. They 

are going to prepare to idle the plant at the end of 2009 if they 

do not have a new product for the plant then, then the plant might 

close, which is worrisome to us all. 

But we have seen this movie before and we did not just wait for 

the inevitable to happen. We fought very hard to make sure that 

it did not happen. The workers at GM, the labor and the management people, did a great job. I hope the State did, as well. And we 

averted what could have been a bad situation, not there is a very 

successful operation there. 

There are a number of things, I think, that can be done. This 

question relates to how do we revitalize manufacturing in our country, particularly auto manufacturing, which I hope we can do and 

think we ought to. But there are a number of things, in my own 

view, that can be done and should be done. I will just start with 

Chrysler, and then I am leading up to monetary policy. 

The people at Chrysler, they have to make vehicles that people 

want to buy. They have to make vehicles that are energy efficient, 

environmentally friendly, have good quality. The people at Chrysler, they have to go to what Toyota has done very well, flexible 

manufacturing where the people at Toyota make maybe three or 

four vehicles at a plant. And if the demand for product A is stronger than B, they make more A. If product C gets hot, they make 

more C. They usually have a fourth vehicle that is a pilot vehicle 

that they are getting ready to develop and to sell when it is time 

to launch it on the market. So there is a lot of things that 

DaimlerChrysler can do. Those are some. 

There are things that we can do at the local level, in Delaware 

or any other State that is affected by announcements by this. You 

could take a page from what happened at our GM plant. It is being 

more committed to quality, more committed to productivity, more 

committed to good labor management relations, more committed to 

innovation, and willing to work and think outside the box. We did 

that 14 years ago and we need to do that again here, at our Newark plant. 

54

The State can work even harder to provide a nurturing environment for manufacturing jobs. There is a lot that we have done and 

there is more than can still be done. 

And at the Federal level, and I am finally coming to my question 

to you, but at the Federal level we do a fair amount with R&D. The 

President has proposed, in his budget, significant investments in 

research and development with respect to new battery technology, 

these lithium ion batteries that can be used to plug in hybrid vehicles, flex fuel/plug-in hybrid vehicles, which I think is a very promising technology. 

We have an opportunity to use the Government’s purchasing 

power on the civilian side and on the defense side, to help commercialize technologies that have a great deal of promise, whether they 

are variable fuel, flex fuel, plug-in hybrids, or next generation hybrids or low emission diesel. 

We have tax credits in our law. We have a tax credit for people 

who buy highly energy efficient hybrids and it caps out at 60,000. 

After 60,000 units have been sold by a manufacturer, I think that 

tax credit begins to go away. But until it does, there is a tax credit 

that can incentivize people to buy high energy efficient hybrids. 

We have a mirror tax credit that not many people know about 

but they are going to be learning about, that works on the diesel 

side, highly energy efficient low-emission diesel, which 

DaimlerChrysler is beginning to bring onto the roads here, also 

qualifies for a similar tax credit. 

We can do better work on the health care costs, harnessing information technology, and all kinds of things to work on the health 

care side. Those are things for the people at DaimlerChrysler to do, 

State and local, at the plants themselves that are put here in 

harm’s way. And there are opportunities for us at the Federal level. 

Now to you. The people who run these three companies—GM, 

Ford, and Chrysler—suggested to the President that the Japanese 

were manipulating the currency. Secretary Paulson was there, he 

pushed back and said no, in fact, we talked about this here in the 

last month. And he said no, I do not think they are. Maybe they 

were at one time, but we do not think they are today. 

There was a time not long ago when the Japanese economy was 

in such a fund, they were going through deflation. And we wanted 

them to take strong actions to change that. 

But fast-forwarding to the present, what is going on? Are these 

concerns or allegations, are they baseless? Is there some basis to 

them? Is this something that we should be mindful of, concerned 

about, do something about? 

Chairman BERNANKE. The Treasury and the Federal Reserve 

have expressed the view that exchange rates should be determined 

in free and open markets. As best as we can tell, the yen’s value 

is being determined in a free, open, and competitive market. There 

is no evidence of any intervention going on. The last time the Japanese purchased dollars was in March 2004. 

The behavior of the yen appears to be consistent with the monetary policies they are conducting which, in turn, are closely related 

to the state of their domestic economy. So we do not see any manipulation or intervention in the value of the yen. 

Senator CARPER. How would we know if they were doing it? 

55

Chairman BERNANKE. We can see it, for example, in the case of 

China where there is a very closely managed exchange rate. It 

moves very slowly and there are large capital inflows. In order to 

maintain the yuan within the range that they are trying to achieve, 

they have to acquire huge amounts of reserves and they have to 

sterilize the effects of those reserves on the domestic money supply. 

And so there is a very clear type of behavior that we can see. 

Now it is true that there are many factors that affect the value 

of a currency. But to my knowledge there are no overt interventions or any such factors affecting the yen at this time. 

Senator CARPER. My last, if I could, just in closing. If you are giving advice to domestic auto manufacturers on what to do to regain 

market share to return to profitability, what are some of the steps 

that you would suggest that they and we take? 

Chairman BERNANKE. You made a number of good points. One 

of them, I think, is R&D. It is not really true that U.S. manufacturing is disappearing. That is not the case. The output of U.S. 

manufacturing has grown more quickly than almost any other industrial country in the last 10 years and it has been supported by 

enormous increases in productivity, which is one of the reasons 

why we need fewer and fewer workers. But the output continues 

to rise. 

The other feature of U.S. manufacturing is that it has shifted 

very much from lower tech type production to the most high tech 

type production. We see that in airplane exports and sophisticated 

capital equipment, medical equipment, silicon chips and so on, 

things that we currently export. 

And indeed, one more point, one effect of that has been that the 

demand for labor and manufacturing has shifted very dramatically 

from low-skilled workers to the highest skilled workers. 

One of the things that has really supported those successful 

areas of manufacturing has been our leadership in R&D and technology. The Government can support that in various ways. Among 

them, helping to support basic research, which may not be in the 

interest of any specific company to undertake on its own, but with 

Government assistance or Government coordination the industry as 

a whole can undertake and find, in the case of automobiles, new 

fuel efficient technologies, for example, or other changes that make 

the cars more attractive. 

Senator CARPER. Mr. Chairman, you have been good with your 

time. 

Thank you, Chairman Bernanke. Thank you, Mr. Chairman. 

Chairman DODD. Thank you. 

Senator CARPER. That is probably good advice, not just for auto 

manufacturers, but for people running for President. 

Chairman DODD. Or any office, for that matter. 

Senator CARPER. There you go. Thank you. 

Chairman DODD. The basic research point is an excellent one. I 

do not have the numbers on the top of my head here, but the decline of the U.S. Government’s commitment to basic research has 

dropped precipitously. I think over the last number of years, it is 

not something that has occurred in the last couple of years. I am 

pleased to hear you say that. That is something we do not pay 

enough attention to, and how much we have benefitted over the 

56

years for applied research to live off the basic research commitments we have made in the past, so it is worthwhile. 

If I can, Mr. Chairman, just a couple of points I wanted to raise 

with you, and I thank my colleague from Delaware for his comments. Just a couple of cleanup things. 

I mentioned earlier, the issue we had in the hearings on the 

predatory lending issue. We did not bring up GSE’s today. My colleague from Delaware has a strong interest, as I do. And we are 

going to move fairly quickly here on a Senate bill. It is an important issue. 

Although I think things are in pretty good control. It is not as 

if there is some immediate threat out there. There are a number 

of things we need to be doing and we intend to move in that direction. 

One of the things I wanted to raise with you, because with 

Fannie Mae and Freddie Mac, is the purchasing of some of these 

ARM’s that are pretty abusive. Understand in these things, the 

broker and the bank is out of it pretty quickly, 10 to 12 weeks. 

These things are bundled and then go off and are securitized. 

And the fact that Fannie and Freddie are purchasing these at a 

pretty high standard, AA or AAA, whatever the standard is they 

are applying to them, concerns me in a sense. One good way to 

begin to try and reverse some of these practices, in addition to 

what regulators may be able to do, is to have some different requirements here in terms of the securitization of these products. 

I wonder if you have any comment on that at all you care to 

share. 

Chairman BERNANKE. I am not quite sure about how one distinguishes so-called ‘‘legitimate ARM products’’ from those which may 

be less legitimate. If you could do so, then that would be a direction 

to go. 

I think more broadly that it would be a good thing for the GSE 

portfolios to be more consistent with their housing mission. According to OFHEO, the GSE portfolios are only 30 percent related to 

affordable housing. The rest is all different other kinds of things. 

So to match their mission with their portfolios would be, I think, 

very desirable. 

The specific suggestion you make might be feasible, but it would 

require some way of determining which types of loans are to be acceptable or not. 

Chairman DODD. I just wanted to raise that point with you. 

Let me come back, if I can, to the points that Senator Carper was 

raising about trade and foreign governments. It was reported yesterday, you have heard this again from some other colleagues this 

morning, that our trade deficit has now reached a record $763 billion last year. That is the fifth straight year that we have had a 

record trade deficit. 

The Wall Street Journal reported, ‘‘Following yesterday’s report, 

economists on Wall Street said the Government, later this month, 

would likely lower its final growth estimate sharply for the fourth 

quarter.’’

In order to finance our trade budget and current account deficits, 

we are required to have an influx of something in the neighborhood 

of a little less than $2.5 billion of foreign capital on a daily basis, 

57

as I am told. Now some have argued that this is all right and it 

is no great threat because it is coming from the private investors 

offshore. 

But in your report the Fed states, ‘‘On net private foreigners purchased few U.S. treasuries.’’

The obvious question is then it is governments who appear to be 

buying them. I put that in the form of a question. I should not 

make the statement. Is it your conclusion that the decline in private investors here, it is governments then that are purchasing 

this? 

Chairman BERNANKE. Are you referring to private foreign investors or private domestic? 

Chairman DODD. Yes, private foreign investors. 

Chairman BERNANKE. Private foreign investors are still holding 

significant U.S. assets, but it is true that acquisition of treasuries 

and other fixed income instruments for the purposes of foreign reserves are an important component of the in-flow. 

Chairman DODD. The end of the line was, in fact, that foreign direct investment flows in the United States remains robust. So 

again, it is that public commitment that we are relying on at this 

particular junction. So it is not so much the private foreign investor, it is the governmental investor that we are——

Chairman BERNANKE. We can send you some numbers. It depends on the instrument. Foreign private investors are more likely 

to buy equities, for example, than central banks. 

Chairman DODD. Going back to the issues raised earlier about 

China, and again the question is a good question Senator Carper 

was raising. He talks about the yen and I think you had—and I 

agree with your answer on the yen, based on what I have known. 

It is troubling, to some degree. We have the cost like a health care 

cost, I think at a GM automobile, is $1,500. I think someone has 

made that conclusion. At Toyota, it is $150. 

So in addition to what other factors may exist out there, we have 

some built-in costs that I think have contributed to the lack of competitiveness, in some cases, in our American-produced automobiles. 

But there is an issue of China’s manipulation of their currency. 

What would recommend, if anything at all? I accept the fact that 

they are getting better. And I heard you say that is the case. But 

we get this all the time. When Senator Carper and I go back to our 

constituencies, one of the first questions that come up, if we get 

into any discussion of economics at all, is this issue. I am just wondering if we are not doing enough or there is something else we 

could be doing to take what you have said here and call it what 

it is. I agree with you, it is manipulation of their currency. There 

is no question about it. 

Then what do we do about that? How do we respond to this? 

Chairman BERNANKE. Senator, I did not use the word manipulation. 

Chairman DODD. I thought I heard you say that? 

Chairman BERNANKE. No, sir. If I did, it was a mistake. 

Chairman DODD. I tried. 

Chairman BERNANKE. I think a point to make, and this is, to 

some extent, recognized in Secretary Paulson’s Strategic Economic 

dialogue, is that while the exchange rate is a very important issue 

58

and one that we are continuing to press China on, we have many, 

many other issues of mutual concern in economics. 

Just to talk specifically about the trade balance, another dimension besides the exchange rate is whether China can become more 

reliant on its own domestic demand, its own consumption spending 

as a source of growth, rather than relying on exports to the United 

States. 

I think it is somewhat encouraging that the Chinese have officially recognized the problem of a growing trade surplus and both 

the economic and political risks that that poses. They have proposed a plan for trying to increase domestic consumption which, 

over time, should reduce the reliance of China on exports. It should 

reduce their trade surplus. So there are some other measures that 

they are taking, albeit ones that will take some time to work. 

But again, rather than putting everything on that particular 

issue of the exchange rate, we should also note that we have common interests with the Chinese on matters of the environment, for 

example, on matters of energy, trade and investment, and immigration and visas. 

So, I would hope that while we continue to press China to make 

progress on this very important issue of the exchange rate, it is not 

exclusive of all the other very important issues that we have in 

common and that we could collectively benefit from if we were to 

work with the Chinese to come to better arrangements than we 

have. 

Chairman DODD. I appreciate that. Again, I know you appreciate 

the concerns we hear about and using your language in China, the 

subsidy notion here. And clearly, when you have lost your job because the company you work for can no longer compete because 

your competitor is able to adjust that currency to such an extent 

that it causes your job to disappear, that level of frustration is beyond just an intellectual exercise. If you are walking home that 

night to face your family because there is no longer the job there, 

and what it means. 

I want to return last, if I can, to one point. Again, your candor 

has been terrific and your comments. The quote that Jack Reed 

raised in your Omaha speech, where too often this discussion about 

unionization falls on an ideological fault line. And I appreciate immensely here that you talked about it based on just data here, 

rather than drawing conclusions about whether you like or dislike 

unions. 

But the important role they played, in terms historically of closing income gaps. This is not the first time we are talking about income gaps. In fact, income gaps were far more pronounced during 

the early part of the 20th century. 

And what I read from your quote here is that, and I will ask the 

question here in a sense. You talk about these numbers back in the 

1970’s and 1980’s, and I presume even earlier, some of those income gaps that closed up, you attribute to the fact that there was 

the ability of people to organize and to negotiate for better wages 

and working conditions for themselves. 

I wonder if you might just expound on that a little bit, without 

getting involved in the ideological discussion. I am not asking you 

to do that. But it is a very important point, I think, as those of us 

59

try to assist in this effort of closing that gap, to realize how important that particular element can play in making it possible for people to move up that economic ladder. 

Chairman BERNANKE. I was reporting some research, which I 

think is good research. 

Chairman DODD. I know you were. 

Chairman BERNANKE. Again, I think that workers who wish to 

be represented by unions have every right to do, and we should not 

block that in any way. We should give them the opportunities to 

do that. 

The implications of unionization for income equality or inequality, as I indicated before, are a bit difficult to tease out because 

there have been changes in union rates. But there have also been 

changes in the structure in the economy, the most notable one 

being the decline of manufacturing jobs and manufacturing employment, and the increase in international competition. There certainly was a time when GM, for example, had a certain amount of 

monopoly power and was able to charge probably a higher price 

than it otherwise could. And now, of course, GM is in very intense 

competition with other companies around the world. 

So it is an open question, a very interesting question, to what extent that association between wage changes and unionization is 

causal—that the changes in unionization have changed the wage 

pattern—or to what extent they are both the product of a third 

force such as the change in manufacturing employment or the 

change in the extent of international competition. 

The kinds of studies we have seen so far really cannot distinguish between those two hypotheses. 

Chairman DODD. I appreciate your comments. This will be part 

of an ongoing conversation. But the comments here, based on just 

hard data I thought were very valuable to contribute to the debate 

and discussion as to what we need to be doing to move forward in 

closing that gap that you have spoken about so eloquently. 

Thank you immensely. I thank my colleagues, they have had to 

leave here. But there were great questions that came up this morning and your answers were very candid and very straightforward 

and forthright, and we appreciate it immensely. 

So we look forward to having an ongoing conversation with you 

and we thank you for your appearance here this morning. 

This hearing will stand adjourned. 

[Whereupon, at 1:18 p.m., the hearing was adjourned.] 

[Prepared statements, response to written questions, and additional material supplied for the record follow:] 

60

PREPARED STATEMENT OF BEN S. BERNANKE

CHAIRMAN, BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM

FEBRUARY 14, 2007

Chairman Dodd, Senator Shelby, and other Members of the Committee, I am 

pleased to present the Federal Reserve’s Monetary Policy Report to the Congress. 

Real activity in the United States expanded at a solid pace in 2006, although the 

pattern of growth was uneven. After a first-quarter rebound from weakness associated with the effects of the hurricanes that ravaged the Gulf Coast the previous 

summer, output growth moderated somewhat on average over the remainder of 

2006. Real gross domestic product (GDP) is currently estimated to have increased 

at an annual rate of about 23⁄4 percent in the second half of the year. 

As we anticipated in our July report, the U.S. economy appears to be making a 

transition from the rapid rate of expansion experienced over the preceding several 

years to a more sustainable average pace of growth. The principal source of the ongoing moderation has been a substantial cooling in the housing market, which has 

led to a marked slowdown in the pace of residential construction. However, the 

weakness in housing market activity and the slower appreciation of house prices do 

not seem to have spilled over to any significant extent to other sectors of the economy. Consumer spending has continued to expand at a solid rate, and the demand 

for labor has remained strong. On average, about 165,000 jobs per month have been 

added to nonfarm payrolls over the past 6 months, and the unemployment rate, at 

4.6 percent in January, remains low. 

Inflation pressures appear to have abated somewhat following a run-up during 

the first half of 2006. Overall inflation has fallen, in large part as a result of declines in the price of crude oil. Readings on core inflation—that is, inflation excluding the prices of food and energy—have improved modestly in recent months. Nevertheless, the core inflation rate remains somewhat elevated. 

In the five policy meetings since the July report, the Federal Open Market Committee (FOMC) has maintained the Federal funds rate at 51⁄4 percent. So far, the 

incoming data have supported the view that the current stance of policy is likely 

to foster sustainable economic growth and a gradual ebbing of core inflation. However, in the statement accompanying last month’s policy decision, the FOMC again 

indicated that its predominant policy concern is the risk that inflation will fail to 

ease as expected and that it is prepared to take action to address inflation risks if 

developments warrant. 

Let me now discuss the economic outlook in a little more detail, beginning with 

developments in the real economy and then turning to inflation. I will conclude with 

some brief comments on monetary policy. 

Consumer spending continues to be the mainstay of the current economic expansion. Personal consumption expenditures, which account for more than two-thirds 

of aggregate demand, increased at an annual rate of around 31⁄2 percent in real 

terms during the second half of last year, broadly matching the brisk pace of the 

previous 3 years. Consumer outlays were supported by strong gains in personal income, reflecting both the ongoing increases in payroll employment and a pickup in 

the growth of real wages. Real hourly compensation—as measured by compensation 

per hour in the nonfarm business sector deflated by the personal consumption expenditures price index—rose at an annual rate of around 3 percent in the latter half 

of 2006. 

The resilience of consumer spending is all the more striking given the backdrop 

of the substantial correction in the housing market that became increasingly evident 

during the spring and summer of last year. By the middle of 2006, monthly sales 

of new and existing homes were about 15 percent lower than a year earlier, and 

the previously rapid rate of house-price appreciation had slowed markedly. The fall 

in housing demand in turn prompted a sharp slowing in the pace of construction 

of new homes. Even so, the backlog of unsold homes rose from about 41⁄2 months’ 

supply in 2005 to nearly 7 months’ supply by the third quarter of last year. Singlefamily housing starts have dropped more than 30 percent since the beginning of last 

year, and employment growth in the construction sector has slowed substantially. 

Some tentative signs of stabilization have recently appeared in the housing market: New and existing home sales have flattened out in recent months, mortgage 

applications have picked up, and some surveys find that homebuyers’ sentiment has 

improved. However, even if housing demand falls no further, weakness in residential investment is likely to continue to weigh on economic growth over the next few 

quarters as homebuilders seek to reduce their inventories of unsold homes to 

morecomfortable levels. 

61

Despite the ongoing adjustments in the housing sector, overall economic prospects 

for households remain good. Household finances appear generally solid, and delinquency rates on most types of consumer loans and residential mortgages remain 

low. The exception is subprime mortgages with variable interest rates, for which delinquency rates have increased appreciably. The labor market is expected to stay 

healthy, and real incomes should continue to rise, although the pace of employment 

gains may be slower than that to which we have become accustomed in recent years. 

In part, slower average job growth may simply reflect the moderation of economic 

activity. Also, the impending retirement of the leading edge of the baby-boom generation, and an apparent leveling out of women’s participation rate in the workforce, 

which had risen for several decades, will likely restrain the growth of the labor force 

in coming years. With fewer jobseekers entering the labor force, the rate of job creation associated with the maintenance of stable conditions in the labor market will 

decline. All told, consumer expenditures appear likely to expand solidly in coming 

quarters, albeit a little less rapidly than the growth in personal incomes if, as we 

expect, households respond to the slow pace of home-equity appreciation by saving 

more out of current income. 

The business sector remains in excellent financial condition, with strong growth 

in profits, liquid balance sheets, and corporate leverage near historical lows. Last 

year, those factors helped to support continued advances in business capital expenditures. Notably, investment in high-tech equipment rose 9 percent in 2006, and 

spending on nonresidential structures (such as office buildings, factories, and retail 

space) increased rapidly through much of the year after several years of weakness. 

Growth in business spending slowed toward the end of last year, reflecting mainly 

a deceleration of spending on business structures; a drop in outlays in the transportation sector, where spending is notably volatile; and some weakness in purchases 

of equipment related to construction and motor vehicle manufacturing. Over the 

coming year, capital spending is poised to expand at a moderate pace, supported by 

steady gains in business output and favorable financial conditions. Inventory levels 

in some sectors—most notably at motor vehicle dealers and in some constructionrelated manufacturing industries—rose over the course of last year, leading some 

firms to cut production to better align inventories with sales. Remaining imbalances 

may continue to impose modest restraint on industrial production during the early 

part of this year. 

Outside the United States, economic activity in our major trading partners has 

continued to grow briskly. The strength of demand abroad helped spur a robust expansion in U.S. real exports, which grew about 9 percent last year. The pattern of 

real U.S imports was somewhat uneven, partly because of fluctuations in oil imports 

over the course of the year. On balance, import growth slowed in 2006, to 3 percent. 

Economic growth abroad should support further steady growth in U.S. exports this 

year. Despite the improvements in trade performance, the U.S. current account deficit remains large, averaging about 61⁄2 percent of nominal GDP during the first 

three quarters of 2006 (the latest available data). 

Overall, the U.S. economy seems likely to expand at a moderate pace this year 

and next, with growth strengthening somewhat as the drag from housing diminishes. Such an outlook is reflected in the projections that the Members of the Board 

of Governors and Presidents of the Federal Reserve Banks made around the time 

of the FOMC meeting late last month. The central tendency of those forecasts—

which are based on the information available at that time and on the assumption 

of appropriate monetary policy—is for real GDP to increase about 21⁄2 to 3 percent 

in 2007 and about 23⁄4 to 3 percent in 2008. The projection for GDP growth in 2007 

is slightly lower than our projection last July. This difference partly reflects an expectation of somewhat greater weakness in residential construction during the first 

part of this year than we anticipated last summer. The civilian unemployment rate 

is expected to finish both 2007 and 2008 around 41⁄2 to 43⁄4 percent. 

The risks to this outlook are significant. To the downside, the ultimate extent of 

the housing market correction is difficult to forecast and may prove greater than 

we anticipate. Similarly, spillover effects from developments in the housing market 

onto consumer spending and employment in housing-related industries may be more 

pronounced than expected. To the upside, output may expand more quickly than expected if consumer spending continues to increase at the brisk pace seen in the second half of 2006. 

I turn now to the inflation situation. As I noted earlier, there are some indications 

that inflation pressures are beginning to diminish. The monthly data are noisy, 

however, and it will consequently be some time before we can be confident that underlying inflation is moderating as anticipated. Recent declines in overall inflation 

have primarily reflected lower prices for crude oil, which have fed through to the 

prices of gasoline, heating oil, and other energy products used by consumers. After 

62

moving higher in the first half of 2006, core consumer price inflation has also edged 

lower recently, reflecting a relatively broad-based deceleration in the prices of core 

goods. That deceleration is probably also due to some extent to lower energy prices, 

which have reduced costs of production and thereby lessened one source of pressure 

on the prices of final goods and services. The ebbing of core inflation has likely been 

promoted as well by the stability of inflation expectations. 

A waning of the temporary factors that boosted inflation in recent years will probably help foster a continued edging down of core inflation. In particular, futures 

quotes imply that oil prices are expected to remain well below last year’s peak. If 

actual prices follow the path currently indicated by futures prices, inflation pressures would be reduced further as the benefits of the decline in oil prices from last 

year’s high levels are passed through to a broader range of core goods and services. 

Nonfuel import prices may also put less pressure on core inflation, particularly if 

price increases for some other commodities, such as metals, slow from last year’s 

rapid rates. But as we have been reminded only too well in recent years, the prices 

of oil and other commodities are notoriously difficult to predict, and they remain a 

key source of uncertainty to the inflation outlook. The contribution from rents and 

shelter costs should also fall back, following a step-up last year. The faster pace of 

rent increases last year may have been attributable in part to the reduced affordability of owner-occupied housing, which led to a greater demand for rental housing. 

Rents should rise somewhat less quickly this year and next, reflecting recovering 

demand for owner-occupied housing as well as increases in the supply of rental 

units, but the extent and pace of that adjustment is not yet clear. 

Upward pressure on inflation could materialize if final demand were to exceed the 

underlying productive capacity of the economy for a sustained period. The rate of 

resource utilization is high, as can be seen in rates of capacity utilization above 

their long-term average and, most evidently, in the tightness of the labor market. 

Indeed, anecdotal reports suggest that businesses are having difficulty recruiting 

well-qualified workers in certain occupations. Measures of labor compensation, 

though still growing at a moderate pace, have shown some signs of acceleration over 

the past year, likely in part the result of tight labor market conditions. 

The implications for inflation of faster growth in nominal labor compensation depend on several factors. Increases in compensation might be offset by higher labor 

productivity or absorbed by a narrowing of firms’ profit margins rather than passed 

on to consumers in the form of higher prices; in these circumstances, gains in nominal compensation would translate into gains in real compensation as well. Underlying productivity trends appear favorable, and the markup of prices over unit labor 

costs is high by historical standards, so such an outcome is certainly possible. Moreover, if activity expands over the next year or so at the moderate pace anticipated 

by the FOMC, pressures in both labor and product markets should ease modestly. 

That said, the possibility remains that tightness in product markets could allow 

firms to pass higher labor costs through to prices, adding to inflation and effectively 

nullifying the purchasing power of at least some portion of the increase in labor 

compensation. Thus, the high level of resource utilization remains an important upside risk to continued progress on inflation. 

Another significant factor influencing medium-term trends in inflation is the 

public’s expectations of inflation. These expectations have an important bearing on 

whether transitory influences on prices, such as those created by changes in energy 

costs, become embedded in wage and price decisions and so leave a lasting imprint 

on the rate of inflation. It is encouraging that inflation expectations appear to have 

remained contained. 

The projections of the Members of the Board of Governors and the Presidents of 

the Federal Reserve Banks are for inflation to continue to ebb over this year and 

next. In particular, the central tendency of those forecasts is for core inflation—as 

measured by the price index for personal consumption expenditures excluding food 

and energy—to be 2 to 21⁄4 percent this year and to edge lower, to 13⁄4 to 2 percent, 

next year. But as I noted earlier, the FOMC has continued to view the risk that 

inflation will not moderate as expected as the predominant policy concern. 

Monetary policy affects spending and inflation with long and variable lags. Consequently, policy decisions must be based on an assessment of medium-term economic prospects. At the same time, because economic forecasting is an uncertain enterprise, policymakers must be prepared to respond flexibly to developments in the 

economy when those developments lead to a reassessment of the outlook. The dependence of monetary policy actions on a broad range of incoming information complicates the public’s attempts to understand and anticipate policy decisions. 

Clear communication by the central bank about the economic outlook, the risks 

to that outlook, and its monetary policy strategy can help the public to understand 

the rationale behind policy decisions and to anticipate better the central bank’s reacVerDate 0ct 09 2002 16:41 Nov 20, 2007 Jkt 000000 PO 00000 Frm 00066 Fmt 6621 Sfmt 6621 S:\DOCS\38109.TXT SBANK4 PsN: KEVIN
63

tion to new information. This understanding should, in turn, enhance the effectiveness of policy and lead to improved economic outcomes. By reducing uncertainty, 

central bank transparency may also help anchor the public’s longer-term expectations of inflation. Much experience has shown that well-anchored inflation expectations tend to help stabilize inflation and promote maximum sustainable economic 

growth. Good communication by the central bank is also vital for ensuring appropriate accountability for its policy actions, the full effects of which can be observed 

only after a lengthy period. A transparent policy process improves accountability by 

clarifying how a central bank expects to attain its policy objectives and by ensuring 

that policy is conducted in a manner that can be seen to be consistent with achieving those objectives. 

Over the past decade or so, the Federal Reserve has significantly improved its 

methods of communication, but further progress is possible. As you know, the 

FOMC last year established a subcommittee to help the full Committee evaluate the 

next steps in this continuing process. Our discussions are directed at examining all 

aspects of our communications and have been deliberate and thorough. These discussions are continuing, and no decisions have been reached. My colleagues and I 

remain firmly committed to an open and transparent monetary policy process that 

enhances our ability to achieve our dual objectives of stable prices and maximum 

sustainable employment. I will keep Members of this Committee apprised of developments as our deliberations move forward. I look forward to continuing to work 

closely with the Members of this Committee and your colleagues in the Senate and 

House on the important issues pertaining to monetary policy and the other responsibilities with which the Congress has charged the Federal Reserve. 

Thank you. I would be happy to take questions. 

64

RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY

FROM BEN S. BERNANKE 

Q.1. I have been concerned for some time about the implementation of the Basel II Capital Accord and the impact Basel II may 

have on the safety and soundness of the U.S. banking system. In 

particular, I am worried that Basel II may lead to a sharp reduction in the amount of capital banks are required to hold, which 

would put U.S. taxpayers at risk of having to pay for expensive 

bank failures. Accordingly, I believe that it is critical that Basel II 

be implemented with the utmost care and diligence. Would you 

please update the Committee on the status of the Basel II Capital 

Accords and the current timeframe for implementing Basel II? I 

would like you to comment on whether there is enough time for 

banking regulators to finalize the rules implementing Basel II, so 

that banks adopting Basel II can start the test run for Basel II 

presently scheduled to begin next year. What, if any, is the likelihood that the timeframe currently envisioned may need to be adjusted?

A.1. First, let me reiterate that the primary goal of the agencies 

in implementing Basel II in the United States is to enhance the 

safety and soundness of the U.S. banking system. Accordingly, we 

will not permit capital levels to decline under the Basel II framework so as to potentially jeopardize safety and soundness. We remain committed to ensuring that regulatory capital levels at all 

U.S. banking organizations remain robust. It is important to keep 

in mind that under Pillar II, banking supervisors will be reviewing 

total capital plans relative to risk at each Basel II bank, not just 

the minimum capital requirements calculated under Pillar I. We 

also continue to believe, subject to the receipt of comments on the 

outstanding Basel II notice of proposed rulemaking (NPR), that it 

is critical to move forward with Basel II implementation so that 

our largest and internationally active banking organizations have 

the most risk reflective regulatory capital framework and can remain competitive with other banking organizations that apply similar risk sensitive frameworks. 

The Basel II NPR issued in September 2006 remains open for 

comment through March 26, 2007. As outlined in the NPR, the first 

opportunity for a bank to be able to begin a parallel run (that is, 

apply the Basel II framework and report results to the appropriate 

supervisor, but continue to use Basel I ratios for regulatory purposes) would be January 2008. The first opportunity for a bank to 

begin applying the Basel II framework subject to the proposed 

transition floors would be January 2009. We remain committed to 

this schedule; however, it will be challenging to meet the previously announced June 2007 date for a final rule. We are very interested in public comments submitted on the proposal. We will 

need to take sufficient time to fully consider comments and to 

make corresponding modifications to the proposed framework as 

the agencies deem to be appropriate. Because the comment period 

is still open, it is difficult to estimate how comprehensive the comments will be. While we already are aware of a number of issues 

raised by the industry, in complex rulemakings such as this one 

there are always unanticipated issues as well. The extent and complexity of the comments overall will have an impact on the ultiVerDate 0ct 09 2002 16:41 Nov 20, 2007 Jkt 000000 PO 00000 Frm 00068 Fmt 6602 Sfmt 6602 S:\DOCS\38109.TXT SBANK4 PsN: KEVIN
65

mate timing for issuing a final rule. We continue to believe that it 

is important to meet the previously stated first live start date of 

January 2009 and at this time do not anticipate that that start 

date will need to be adjusted.

Q.2. Your testimony noted that the U.S. current account deficit remains large, averaging about 61⁄2 percent of nominal GDP. You also 

note that economic growth abroad should support further steady 

growth in U.S. exports this year. Do you anticipate much improvement in the current account deficit over the next year as a result 

of export improvement? Do you see any other economic factors 

changing over the next year that might lead to an improved trade 

deficit?

A.2. In the past year, U.S. exports have grown strongly, reflecting 

a number of factors, including solid foreign economic growth, increases in investment spending abroad that have boosted sales of 

capital goods produced in the United States, and the booming market for agricultural goods and other commodities. These developments have played out against the backdrop of continued innovation and productivity growth in the U.S. economy that, along with 

the decline in the foreign exchange value of the dollar since earlier 

in this decade, have buoyed the attractiveness of American-made 

products. As a result of strong export growth, in combination with 

sharp declines in the price of imported oil, the trade deficit has 

narrowed from 6 percent of U.S. GDP in the third quarter of last 

year to about 51⁄4 percent of GDP in the fourth, and the current 

account deficit has improved by a broadly similar extent. These 

movements, coming as they did toward the end of 2006, may well 

cause the trade and current account deficits for 2007 as a whole, 

measured as a share of GDP, to be smaller than those for 2006. 

Focusing on their evolution from the current quarter onwards, 

however, it is uncertain whether our Nation’s external deficits will 

narrow further over the next few years. On the export side, the extraordinary growth in overseas sales of some U.S. products during 

2006 may be difficult to sustain; for example, exports of aircraft 

grew more than 20 percent last year. On the import side, the price 

of imported oil has bounced back from recent lows, and futures 

markets suggest that further increases may be in the offing. Another important determinant of U.S. trade flows, the foreign exchange value of the dollar, is volatile and extremely difficult to predict. Finally, even if the trade balance were to continue to improve, 

it is not clear that the current account balance—which is equal to 

the trade balance plus the balance on international income flows 

and transfers—would follow suit. The need to finance continued 

trade deficits, even if these deficits are smaller than in the past, 

puts upward pressure on the Nation’s external debt and thus investment income payments to foreigners, thereby tending to expand the current account deficit.

Q.3. This Committee continues to have a great degree of interest 

in the Chinese economy, particularly currency practices. China’s 

foreign exchange reserves now stand at over $1 trillion, creating 

excess liquidity in their banking system. Some financial experts 

have stated that the United States should not view China’s large 

stock of foreign currency reserves as a problem. What is your view 

66

of this level of reserves? Do you believe China’s ratio of reserves 

to money supply is reasonable? To what extent do you believe that 

China’s reserves are the result of speculation? Could this, in fact, 

result in an even lower value for the RMB should that currency become more flexible in the future?

A.3. For some time now, the monetary authorities in China have 

been resisting upward pressure on the value of the renminbi in foreign exchange markets by purchasing dollars and perhaps other 

foreign currencies. Even though these accumulated purchases have 

reached a value of more than $1 trillion, it is not certain that the 

accumulation has created excess liquidity in China’s banking system. Reserves and liquidity do not move in lockstep in China, because Chinese authorities have policy tools available to drain liquidity, including issuance of official securities (so-called ‘‘sterilization bonds’’) and increasing banks’ reserve requirements. At 

present, it does not appear that China has had any substantial difficulty using either of these tools to drain liquidity, although that 

may change in the future. Because the linkage between reserves 

and money need not be tight, it would be hard to determine a reasonable range for the ratio of reserves to the money stock appropriate for China’s economy. 

I do not believe China’s substantial accumulation of reserves in 

itself represents a problem for the United States or for United 

States monetary policy. Official demand in China and other countries for United States assets reflects the dollar’s role as preeminent reserve currency, which results in great part from the 

strength of our economy and the safety and liquidity of the United 

States financial system. Because foreign holdings of U.S. Treasury 

securities represent only a small part of total U.S. credit market 

debt outstanding, U.S. credit markets should be able to absorb 

without great difficulty any shift in foreign allocations. And even 

if such a shift were to put undesired upward pressure on U.S. interest rates, the Federal Reserve has the capacity to operate in domestic money markets to maintain interest rates at a level consistent with our domestic economic goals. 

It is not easy to identify the portion of the upward pressure on 

the renminbi, and hence on the accumulation of reserves, that 

might be the result of speculation. It is also difficult to predict 

where the renminbi would settle were the currency to float freely. 

However, speculation in the renminbi would not occur if investors 

did not expect the Chinese currency to appreciate at some point. 

It seems reasonable to conclude that, at the present exchange rate 

with the dollar, the renminbi is undervalued. 

RESPONSE TO A WRITTEN QUESTION OF SENATOR SUNUNU

FROM BEN S. BERNANKE 

Q.1. Does the arbitrary deposit cap, which bars any U.S. bank from 

an acquisition that would give it more than 10 percent of the Nation’s total bank deposits, make American banks vulnerable to foreign acquisition?

A.1. Federal law currently prohibits a bank holding company or 

bank from acquiring an additional bank if, after the acquisition, 

the resulting banking organization would control more than 10 percent of all deposits held by insured banks and savings associations 

67

in the United States. At the present time, it appears unlikely that 

this restriction makes U.S. banks materially more vulnerable to acquisition by a foreign entity than they would be if this deposit cap 

were not in place. Of course, as the banking and financial systems 

evolve, the impact of the current deposit cap also may change, and 

thus the Congress may wish to review the benefits and costs of the 

current restriction at regular intervals. 

The deposit cap could potentially increase the likelihood of foreign acquisitions of U.S. banks if it prevented U.S. banks from 

reaching the size needed to achieve important economies of scale 

or scope. However, research overwhelmingly indicates that economies of scale in banking are achieved at sizes far below those of 

our largest banks. In addition, the landmark Gramm-Leach-Bliley 

Act significantly expanded the ability of U.S. banking organizations 

to achieve any important economies of scope that may exist within 

the broad financial services industry. Indeed, U.S. banks are 

among the most profitable, most efficient, and best capitalized in 

the world.

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