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FULL COMMITTEE HEARING ON THE STATE

OF THE SMALL BUSINESS ECONOMY

COMMITTEE ON SMALL BUSINESS 

UNITED STATES HOUSE OF 

REPRESENTATIVES

ONE HUNDRED TENTH CONGRESS

FIRST SESSION

NOVEMBER 7, 2007

Serial Number 110-58

Printed for the use of the Committee on Small Business

(

Available via the World Wide Web: http://www.access.gpo.gov/congress/house 

HOUSE COMMITTEE ON SMALL BUSINESS 

NYDIA M. VELA ́ ZQUEZ, New York, Chairwoman 

HEATH SHULER, North Carolina 

CHARLIE GONZA ́ LEZ, Texas 

RICK LARSEN, Washington 

RAUL GRIJALVA, Arizona 

MICHAEL MICHAUD, Maine 

MELISSA BEAN, Illinois 

HENRY CUELLAR, Texas 

DAN LIPINSKI, Illinois 

GWEN MOORE, Wisconsin 

JASON ALTMIRE, Pennsylvania 

BRUCE BRALEY, Iowa 

YVETTE CLARKE, New York 

BRAD ELLSWORTH, Indiana 

HANK JOHNSON, Georgia 

JOE SESTAK, Pennsylvania 

BRIAN HIGGINS, New York 

MAZIE HIRONO, Hawaii 

STEVE CHABOT, Ohio, Ranking Member 

ROSCOE BARTLETT, Maryland 

SAM GRAVES, Missouri 

TODD AKIN, Missouri 

BILL SHUSTER, Pennsylvania 

MARILYN MUSGRAVE, Colorado 

STEVE KING, Iowa 

JEFF FORTENBERRY, Nebraska 

LYNN WESTMORELAND, Georgia 

LOUIE GOHMERT, Texas 

DEAN HELLER, Nevada 

DAVID DAVIS, Tennessee 

MARY FALLIN, Oklahoma 

VERN BUCHANAN, Florida 

JIM JORDAN, Ohio

MICHAEL DAY, Majority Staff Director 

ADAM MINEHARDT, Deputy Staff Director 

TIM SLATTERY, Chief Counsel 

KEVIN FITZPATRICK, Minority Staff Director

STANDING SUBCOMMITTEES 

Subcommittee on Finance and Tax

MELISSA BEAN, Illinois, Chairwoman 

RAUL GRIJALVA, Arizona 

MICHAEL MICHAUD, Maine 

BRAD ELLSWORTH, Indiana 

HANK JOHNSON, Georgia 

JOE SESTAK, Pennsylvania 

DEAN HELLER, Nevada, Ranking 

BILL SHUSTER, Pennsylvania 

STEVE KING, Iowa 

VERN BUCHANAN, Florida 

JIM JORDAN, Ohio

Subcommittee on Contracting and Technology

BRUCE BRALEY, IOWA, Chairman 

HENRY CUELLAR, Texas 

GWEN MOORE, Wisconsin 

YVETTE CLARKE, New York 

JOE SESTAK, Pennsylvania 

DAVID DAVIS, Tennessee, Ranking 

ROSCOE BARTLETT, Maryland 

SAM GRAVES, Missouri 

TODD AKIN, Missouri 

MARY FALLIN, Oklahoma

(II) 

Subcommittee on Regulations, Health Care and Trade

CHARLES GONZA ́ LEZ, Texas, Chairman 

RICK LARSEN, Washington 

DAN LIPINSKI, Illinois 

MELISSA BEAN, Illinois 

GWEN MOORE, Wisconsin 

JASON ALTMIRE, Pennsylvania 

JOE SESTAK, Pennsylvania 

LYNN WESTMORELAND, Georgia, Ranking 

BILL SHUSTER, Pennsylvania 

STEVE KING, Iowa 

MARILYN MUSGRAVE, Colorado 

MARY FALLIN, Oklahoma 

VERN BUCHANAN, Florida 

JIM JORDAN, Ohio

Subcommittee on Urban and Rural Entrepreneurship

HEATH SHULER, North Carolina, Chairman 

RICK LARSEN, Washington 

MICHAEL MICHAUD, Maine 

GWEN MOORE, Wisconsin 

YVETTE CLARKE, New York 

BRAD ELLSWORTH, Indiana 

HANK JOHNSON, Georgia 

JEFF FORTENBERRY, Nebraska, Ranking 

ROSCOE BARTLETT, Maryland 

MARILYN MUSGRAVE, Colorado 

DEAN HELLER, Nevada 

DAVID DAVIS, Tennessee

Subcommittee on Investigations and Oversight

JASON ALTMIRE, PENNSYLVANIA, Chairman 

CHARLIE GONZA ́ LEZ, Texas 

RAUL GRIJALVA, Arizona 

LOUIE GOHMERT, Texas, Ranking 

LYNN WESTMORELAND, Georgia

(III) 

C O N T E N T S 

OPENING STATEMENTS 

Page

Vela ́zquez, Hon. Nydia M. ....................................................................................... 1

Chabot, Hon. Steve .................................................................................................. 2

WITNESSES

Mishkin, Hon. Governor Frederic S., Board of Governors of the Federal Reserve System ......................................................................................................... 4

APPENDIX 

Prepared Statements: 

Vela ́zquez, Hon. Nydia M. ....................................................................................... 26

Chabot, Hon. Steve .................................................................................................. 28

Mishkin, Hon. Governor Frederic S., Board of Governors of the Federal Reserve System ......................................................................................................... 30

(V) 

(1)

FULL COMITTEE HEARING ON 

THE STATE OF THE SMALL 

BUSINESS ECONOMY 

Wednesday, November 7, 2007

U.S. HOUSE OF REPRESENTATIVES, 

COMMITTEE ON SMALL BUSINESS, 

Washington, DC. 

The Committee met, pursuant to call, at 9:05 a.m., inRoom 2360, 

Rayburn House Office Building, Hon. Nydia M. Vela ́zquez [Chairwoman of the Committee] Presiding. 

Present: Representatives Vela ́zquez, GonzaAE1lez, Clarke, 

Sestak, Chabot, Bartlett, Akin, Fortenberry, Heller, Davis, Buchanan and Jordan. 

OPENING STATEMENT OF CHAIRWOMAN VELA ́ ZQUEZ 

ChairwomanVELA ́ ZQUEZ. Good morning. I am pleased to call this 

hearing to order. Thank you all for being here today. 

Today’s hearing will examine the production, employment, and 

output of our Nation’s small businesses as the driver of the U.S. 

economy. There can be little doubt that, at its heart, our Nation’s 

economy is truly a small business economy. Research has shown 

that small businesses create most of the Nation’s net new jobs and 

account for almost half of our employer firms. Additionally, they 

produce more than half of the country’s nonfarm private output. 

It goes without question that small firms make significant contributions to the U.S. economy. Today’s hearing will provide a 

forum to hear the Federal Reserve’s perspective on small businesses’ contributions to the economy. This comes at a time when 

we are seeing mounting challenges in the financial markets. These 

challenges, stemming mainly from the housing market, may spill 

over to other sectors of the economy. This would have broad ramifications, including an impact on small businesses. 

Despite this recent turmoil, small businesses remain a critical 

source of growth. A number of new businesses measured as the 

number of firms created has shown a net increase of over 20,000 

since 2004. Just last week, the Labor Department reported nationwide job growth of 156,000 new jobs and a stable rate of unemployment. Small businesses were at the heart of these metrics. And 

whatever our economic future may hold, we can be assured that 

small businesses will be the vanguard for production, job creation, 

and output nationwide. 

Recently, however, we have witnessed increased volatility in the 

capital markets. These conditions have been driven primarily by 

2

weaknesses in the mortgage sector, but virtually every business 

sector has been affected by these events. Mortgage market instability has resulted in a tightening of lending standards that has 

spilled over into the small business credit markets. Indicators reflect that entrepreneurs are experiencing difficulty obtaining credit, 

and more banks are reporting lower demands for small business 

loans. 

I am sure it comes as no surprise to members of this Committee 

that small businesses have more difficulty gaining access to an affordable source of credit compared to large businesses or other 

types of borrowers. Unfortunately, the most recent Federal Reserve 

report on the availability of credit to small businesses revealed that 

this continues to be the case. 

Small businesses continue to rely disproportionately upon more 

expensive alternatives to traditional credit than larger businesses. 

Additionally, the percentage of small businesses that use credit 

cards increased nearly 10 percent since the last Federal Reserve 

survey. These results demonstrate the need for strong Small Business Administration programs aimed at providing small firms with 

access to affordable sources of financing. 

Yet, despite the obvious importance of small businesses, there remains few studies on their economic role. In addressing the need 

for solid information on small businesses, few studies have been 

more influential than the Federal Reserve’s report to Congress on 

the availability of credit to small businesses. Much of the information contained in the report is gleaned from the Survey of Small 

Business Finance, which is itself the most comprehensive and upto-date assessment of small business finance. Over the past decade, 

this report has provided Congress with invaluable insight into the 

small business credit markets. Now, more than ever, such insight 

is the key resource in developing balanced and effective economic 

policies. 

With the economic turmoil we have seen recently, it is paramount that we all work together to restore financial market stability and upset the effects of tighter credit conditions. These developments have created uncertainty over our economic future. Our 

history has proven that as small businesses go, so goes the national 

economy. In this environment it is more important than ever that 

this Committee remain committed to ensuring that small businesses have access to the financial tools they need to grow and 

thrive. 

I want to thank Governor Mishkin for his testimony in advance, 

and I now yield to the Ranking Member Mr. Chabot for his opening 

statement. 

OPENING STATEMENT OF MR. CHABOT 

Mr.CHABOT. Thank you, Madam Chair, for holding this hearing 

this morning to examine the state of the small business economy. 

And I think we all want to thank you as well, Governor Mishkin, 

for taking time out of your very busy schedule to be with us today 

to share your views on this very important topic. 

While the U.S. economy faces real challenges, credit worries, rising energy costs, and a slowing housing market, among others, the 

October Bureau of Labor and Statistics Employment Summary and 

3

the preliminary estimates of third quarter GDP growth show an 

economy that is expanding. Job growth in the third quarter was 

the strongest since the early spring of 2007, with an estimated 

166,000 new jobs created just last month in October. The strongest 

month for job creation since May, October marked 50 months of 

consecutive job growth, 50 months of consecutive job growth. 

In addition to these positive trends, we have seen wage increase 

and growth of the gross domestic product remain steady. These 

numbers surpassed expectations, indicating entrepreneurs and 

small businesses continue to create new jobs, and the labor market 

and overall economy remains strong. These numbers provide great 

insight into the strength of our small business economy. 

Because of their importance to our overall economic health, and 

we all know the statistics, we must continue to be mindful of how 

the policies we pursue and enact here in Congress will affect small 

businesses as we move forward. 

I am concerned over some of the tax policy initiatives that have 

been coming from the Ways and Means Committee leadership in 

the last few weeks. As the White House noted, the most recent legislation would dramatically raise taxes on millions of small businesses, stifling their ability to grow and create jobs. Coupling this 

legislation with runaway government spending, we are setting up 

a scenario that would put a wet blanket on future growth. Small 

businesses are vital to future economic growth, and I believe that 

these regressive tax-and-spending policies put our economic wellbeing in danger. 

I am very eager to hear today how the Federal Reserve Board is 

responding to the credit crunch in the wake of the housing market 

downturn. I am interested to learn the Board’s forecast for how the 

credit crunch is affecting our small businesses now, and how further trickle-down from the housing market fallout will affect them 

in the future. 

I think I speak for many of my colleagues when I say that we 

in Congress would like to know how we can help both individual 

Americans and businesses weather the current credit market 

crunch. 

I look forward to working with Chairwoman Vela ́zquez and all of 

our colleagues in this Committee to ensure that this Congress does 

more than just talk about how small businesses are our economic 

engine, but also acts in accordance with that reality. Under the 

Chairwoman’s leadership, this Committee has remained cognizant 

of small firms’ proficiency in generating jobs and ability to grow 

our economy, and we will continue to ensure small businesses receive their fair shake. 

Just one point. I can’t overemphasize how concerned I am about 

the proposed mother of all tax bills that is being considered in the 

Ways and Means Committee. That gives me and, I think, many 

other people great concern about the impact that could have on the 

small business community; because the taxes that the Chairman of 

that particular Committee is talking about would fall probably 

most heavily on small business owners. That is the people that 

would really be targeted by that. And I think we in this Committee 

should do everything within our power to get that less powerful 

Committee to back down to this more powerful Committee.

4

ChairwomanVELA ́ ZQUEZ. Well, thank you, Mr. Chabot. But I just 

would like to add for the record that the mother of all taxes is a 

long way in front of us. What is more important for us today is the 

mortgage market instability and how that could spill over to other 

sectors of our economy, and the immediate impact on small businesses. 

So, Governor Mishkin, it is a pleasure to have you here today. 

Dr. Mishkin sits on the Federal Reserve Board of Governors, having taken office on September 5, 2006. Before becoming a member 

of the Board, Dr. Mishkin was the Alfred Lerner Professor of Banking and Financial Institutions and A. Barton Hepburn Professor of 

Economics at the Columbia University Grad School of Business. 

During his career, Dr. Mishkin has also served the Federal Reserve 

System in several roles, including executive vice president and director of research at the Federal Reserve Bank of New York, and 

an associate economist of the Federal Open Market Committee of 

the Federal Reserve System. 

Dr. Mishkin is the author of more than 15 books and numerous 

articles in professional journals and books. Dr. Mishkin is one of 

the most respected scholars on monetary policy and its impact on 

financial markets and the aggregate economy. 

You are most welcomed. 

STATEMENT OF FREDERIC S. MISHKIN, MEMBER, BOARD OF 

GOVERNORS OF THE FEDERAL RESERVE SYSTEM 

Mr.MISHKIN. Thank you very much for that kind introduction. 

Chairwoman Vela ́zquez, Ranking Member Chabot, and members 

of the Committee, I am pleased to appear on behalf of the Board 

of Governors to discuss the availability of credit to small businesses. 

Small businesses play a critical role in the U.S. economy, and access to credit is essential for this success. As you know, the Board 

is required to report to the Congress every 5 years on the status 

of small business access to credit, and our most recent report was 

submitted on October 26. While I cannot discuss all of the topics 

covered in our report, I would like to mention a few highlights. I 

will then briefly address how the unusual stresses imposed on credit markets in recent months may affect small businesses. So let me 

turn to the highlights of the 2007 report to Congress. 

Our 2007 report indicates that, since our last report in 2002, financing flows to small firms generally increased along with economic activity. Credit conditions during the period were favorable 

for small firms, and we have no evidence that credit-worthy borrowers faced any substantial constraint on their access to credit. 

Although small businesses obtain credit from a wide range of 

sources, commercial banks are today, as in the past, the leading 

provider. Our report shows that, among small businesses, relatively 

large firms and a lot of the older firms were more likely than 

smaller, younger firms to use a wide range of types of credit and 

were more likely to have their credit applications approved. These 

results are consistent with the conventional view that smaller and 

younger firms are riskier, have shorter credit histories, or less collateral to pledge as security, and are generally harder for lenders 

to evaluate because they are less transparent. 

5

As was true in 2002, the 2007 report emphasized the importance 

to small businesses of geographic proximity to their sources of credit. The importance of local providers of credit to small businesses 

underscores the need to preserve competitive banking markets at 

the local level. Despite the significant consolidation that has occurred in the banking industry, competitive conditions in the Nation’s local banking markets have remained quite stable. 

The use of credit scoring in assessing small business credit applications has become common only since the mid-1990s. Evidence 

suggests that the use of credit scoring increases credit availability 

to some small businesses. Users of credit scoring models generally 

report that, after their adoption, the riskiness of the small business 

portfolio remains about the same or it declines, and the quality of 

the typical credits decision increases. 

The obstacles to securitizing most loans to small businesses remain large. The securitization of small business loans has remained modest, and is unlikely to increase substantially over the 

foreseeable future. 

So let me turn to small businesses finances and recent financial 

market developments. I will now comment briefly on the possible 

effects of the recent financial market turmoil on small business access to credit. I emphasize that the possible effects are complex; 

that we do not yet have much hard evidence; and that it is far too 

early to draw any strong conclusions. 

That being said, there are good reasons to believe and some evidence to suggest that the recent financial market disruptions have 

not seriously harmed access to credit by small businesses; and, if 

the disruptions continue to be resolved in an orderly manner, it 

will be unlikely to do so in the near future. 

For example, the current turmoil has centered on securities 

backed by nonconforming residential real estate loans and loans or 

other debts of relatively large firms. Because the securitization of 

small business loans is still quite modest, we would not expect turmoil in the markets for securitized assets to have a large direct effect on small business lending. 

Recent events have nonetheless almost surely had some negative 

effects on small business access to credit, and we cannot rule out 

further effects. For example, recent surveys have found that the 

market for small business credit has tightened. These surveys also 

suggest that, at least for now, the effects have generally been quite 

limited. 

Perhaps one of the most important concerns for small business 

access to credit is that many small businesses use real estate assets as collateral. Looking forward, a reduction in the value of their 

real estate assets has the potential to adversely affect the ability 

of those small businesses to borrow. Similarly, declines in the value 

of real estate assets held by banks and other lenders may affect 

their ability to supply loans, as real estate losses use up capital 

that could otherwise be used for making new loans. 

Fortunately, the vast majority of U.S. Banks are well capitalized, 

and thus should be able to maintain their lending capacity. Still, 

the possibility remains that reductions in real estate values and 

other factors could affect small business access to credit. The Board 

6

will be monitoring the economy for signs of possible effects over the 

next few months. 

So, let me conclude. In conclusion, the health of the U.S. economy depends importantly on the vitality of the small business sector. Our 2007 report indicates that since our 2002 report, small 

business access to credit has been robust. Credit conditions have no 

doubt tightened since mid-August, but small businesses seem generally to have been able to retain access to credit. However, the 

current level of uncertainty is unusually high. Thus, the Federal 

Reserve will continue to monitor closely the effects of financial 

market conditions on small business finances as part of our efforts 

to ensure that the stress on foreign financial markets does not spill 

over into the broader economy. 

Thank you. I would be happy to answer any questions you may 

have. 

ChairwomanVELA ́ ZQUEZ. Thank you, Governor Mishkin. 

[The prepared statement of Mr. Mishkin may be found in the Appendix on page 30.]

ChairwomanVELA ́ ZQUEZ. In fact, you discussed the effect of the 

recent tightening of credit standards has on small businesses and 

financing. So my question to you is to what extent does the SBA’s 

lending—Small Business Administration lending and investment 

programs bridge gaps in private markets for access to financing 

during periods of tighter credit conditions? 

Mr.MISHKIN. Well, SBA financing, I am sure, does help; but the 

recognition is that it is actually only a small part of actually financing of small businesses, on the order of 5 percent. So clearly 

what is really very key is the overall health of the U.S. economy 

and also the overall health of the financial system to be able to provide the credit to small businesses. 

ChairwomanVELA ́ ZQUEZ. The Federal Reserve makes policy decisions weighing both inflation and economic growth. During the 

September 18 Federal Open Market Committee meeting, the decline in inflation was expected to be sustained throughout the year, 

but needed to be watched carefully. The meeting minutes stated 

that inflation remained a risk due in part to the continuing weakness in the dollar. How has the recent slide in the value of the dollar affected your inflationary expectations? 

Mr.MISHKIN. Well, clearly when the dollar declines in value, that 

increases both the prices of imports, what we buy from abroad, but 

actually also increases the demand for exports and therefore prices 

for exports. In fact, we think of these as just tradable goods, and 

it actually would lead to higher prices in those goods. 

However, the pass-through of the effects of exchange rate depreciation are very much affected by how anchored inflation expectations are. If inflation expectations are well anchored, which is extremely important and, in fact, part of what the Federal Reserve 

needs to achieve and has achieved in recent years, then we find 

that the impact of the dollar depreciation on the overall price level 

is actually quite limited. 

ChairwomanVELA ́ ZQUEZ. Sir, with the weaker dollar and inflation concerns expressed by the Board in meeting minutes, are some 

inflationary risks being ignored? 

7

Mr.MISHKIN. Well, I hope not. We definitely don’t want to ignore 

them. It is extremely important to the health of the economy that 

inflation, in fact, remains contained. This has been one of the great 

successes of the Federal Reserve System in recent years and, actually, also in other central banks throughout the world. Indeed, if 

you anchor inflation expectations and anchor inflation, it actually 

gives you more flexibility to deal with negative shocks to the economy. 

ChairwomanVELA ́ ZQUEZ. We all know that businesses of all sizes 

must plan and account for inflation. Would you please describe to 

us your view on the idea of an explicit target, explicit inflation target, and its likely effects on small business’ ability to make informed decisions? 

Mr.MISHKIN. Well, at this stage the Federal Reserve has been 

discussing communication strategies, so I really don’t want to comment on the issue of inflation target. What I will say, however, is—

ChairwomanVELA ́ ZQUEZ. But let me ask you, can you discuss 

how an inflation target impacts the small business sector? 

Mr.MISHKIN. Well, I think the issue here is rather than thinking 

so much of an inflation target impacting the small business sector, 

the way I would think about this is the control of inflation and how 

that impacts the small business sector; that clearly having price 

stability, which is part of our dual mandate, and not only do we 

care about price stability, but we also care very much about what 

happens to economic growth and employment—but having price 

stability actually makes it much easier for small businesses to plan 

and make better investments and, therefore, do better actually. 

I come from a small business background, actually maybe even 

was in your district. There was manufacturing in Manhattan, quite 

extensive manufacturing, which, of course, is no longer there. And 

I worked in my father’s plant, and, in fact, it is now a restaurant, 

by the way, which is what has happened to Manhattan. It was on 

West 14th street. So, I don’t know where that is relative to your 

district. But, clearly, the years where, in fact, inflation was highly 

volatile actually created tremendous problems in terms of planning. 

So I saw this by talking to my father every day at the dinner table. 

When you have a stable price environment, it makes it much 

easier for businesses to plan. Secondly, when you have stable 

prices, it means that interest rates actually stay lower. So part of 

our so-called dual mandate, there is a third element to the congressional act for the Federal Reserve, which actually said not only do 

we want to have price stability, maximum sustainable employment, 

but also that we should have stable interest rates. Well, in order 

to get that, you also have to, in fact, make sure that inflation is 

under control. 

Also, we find that when central banks control inflation better, it 

means that you can be more aggressive when, in fact, there is negative hits to the economy. But always you must keep your eye on 

the inflation ball to make sure that you do not end up in a situation such as ones we have had in the past, particularly in the 

1970s, where you actually had both high inflation and actually an 

economy that did not do very well. 

ChairwomanVELA ́ ZQUEZ. It is no secret, sir, that the turbulence 

we have recently witnessed in the markets grew out of the mortVerDate 0ct 09 2002 09:48 Dec 20, 2007 Jkt 033615 PO 00000 Frm 00013 Fmt 6633 Sfmt 6633 G:\CLERK SB\HEARINGS\TRANSCRIPTS\39379.TXT LEANN
8

gage market. The Federal Reserve lowered the Federal funds rate 

at both of its last meetings in response to tightening credit conditions that could restrain growth. Housing prices have leaped, vacancy rates are rising, and home starts are declining. As a result, 

several prominent Wall Street firms had unexpected record writedowns. Given the length of a typical foreclosure process, is it possible that the worst is still to come? 

Mr.MISHKIN. Well, clearly the situation in the housing sector is 

one that we have to monitor very closely. The weakness in housing 

has been a significant drag on the economy in the second half of 

this year, on the order of about 1.5 percent of GDP. So this is a 

very significant impact. And, clearly, the housing market is not out 

of the woods yet. There is a big overhang of inventory, a lot of 

houses that builders have built and they have not yet sold, and this 

is actually depressing the effect on the housing market. 

So one of the difficult things for a central banker is that you actually have to look at the economy. And, unfortunately, we don’t 

have a crystal ball. Luckily, we do have a very, very strong staff 

at the Federal Reserve to help us think about where the economy 

will head, and particularly monitoring the housing market and the 

housing sector is absolutely one of the key things that we have to 

do now, because we do have to worry about the fact that housing 

may not do well in the future and when it will turn around. 

ChairwomanVELA ́ ZQUEZ. And isn’t it true that financial institutions cannot predict as to the extent the foreclosure crisis will have 

on them, since the process could take from 6 months to a year? 

Mr.MISHKIN. I am sure they do have some forecasts of how serious these foreclosures are going to be. It is clear that, in fact, there 

are going to be a lot of foreclosures down the road, and some of 

that has already been taken into account in terms of predictions in 

terms of the earnings of these financial institutions. 

This is actually part of the nature of lending, that they sometimes do make mistakes; and, in fact, clearly in this instance we 

have had a lot of mistakes made in terms of people not being able 

to pay back loans. And this is something clearly that the financial 

institutions do have to worry about and something that we have to 

be concerned about as well. 

ChairwomanVELA ́ ZQUEZ. Well, let’s take, for example, that in 

January and July of this year, Chairman Bernanke testified before 

the House and Senate Banking Committees to report on the conduct of monetary policy. In both hearings, the Chairman expressed 

confidence that weaknesses in the housing market will not spill 

over in the wider financial markets. Clearly, the perspective was 

overly optimistic. 

If the downturn in the housing sector continues throughout the 

next year, what effect do you believe this may have on the broader 

markets? 

Mr.MISHKIN. Well, clearly one of the things that has happened 

is that the problems in the mortgage sector have actually spilled 

over more widely to the financial markets in general. Indeed, when 

we think about what financial markets are supposed to do, they are 

basically solving information problems; they are trying to allow 

people to take funds and give it to people who have good, productive investment opportunities. And this is particularly important in 

9

the small business sector, which is one of the key drivers of the 

U.S. economies. It is really quite extraordinary how vibrant the 

small business sector is in this country. 

ChairwomanVELA ́ ZQUEZ. Will this affect commercial lending for 

the small businesses? 

Mr.MISHKIN. So there are clearly a whole set of issues here, but 

one of the things that happened is that the markets had much 

more confidence in their understanding of not only what is going 

on in the mortgage markets, but the very complex products which 

are related to mortgages. And we have seen, in fact, that these surprises have meant that the financial markets have actually had a 

disruption, and that does have impacts on small businesses. In particular, we have seen a tightening of lending standards. We have 

a survey of senior loan officers, and there clearly has been a tightening of lending standards. 

However, it is important to note that because the problems in the 

financial markets have actually been more in the securitization 

part of the markets, and small businesses typically do not get credit through securitization the way some other sectors have, that the 

impact seems to have been greater for larger firms rather than for 

smaller businesses. So there clearly has been an impact that this 

is one of the issues in terms of an economy that is weaker than 

we might have expected a little while ago. It clearly is one of the 

reasons why the Federal Reserve has acted to lower the Federal 

funds rate by 75 basis points in order to forestall or counteract the 

negative effects from this credit tightening. 

ChairwomanVELA ́ ZQUEZ. Thank you, Governor Mishkin. I have 

other questions, and I will come back in the second round. 

Now I recognize the Ranking Member Mr. Chabot. 

Mr.CHABOT. Thank you, Madam Chair. 

First, I would like to talk about the credit crunch or the credit 

availability problem that we have. And many of us are concerned 

that the response to the long forecast housing and mortgage crisis 

has been insufficient and late in coming. 

Now that communities around the country, and we see this particularly in my State of Ohio, are suffering its effects, could you 

discuss what should have been done or could have been done sooner and what could or should be done now, in your opinion? 

Mr.MISHKIN. Well, from a viewpoint of the firms that were engaged in the business of making mortgages, clearly there were mistakes made; that there was not as good an understanding of the 

kind of risks that were inherent in some of the products that were 

produced. In fact, when we look at financial development over time, 

this is very common, that you have new products which eventually 

can actually be very useful, but in the process—and particularly 

solving these information problems, to actually get funds to people 

with productive investment opportunities—but in the process of developing them, mistakes are made. 

So clearly one of the things, I think, that is going to happen is 

that people—that firms are going to be looking at whether the way 

they designed the products that they had for, in fact, getting funds 

to both businesses and households, whether, in fact, those were the 

best models for doing so. So clearly we are seeing a situation where 

people are trying to figure out how to, in fact, understand these 

10

products better, set the procedures up so we don’t have some of the 

problems that have occurred in terms of loans being made to people 

who couldn’t pay them back. And so we will see a process of getting 

the financial markets to work better. Unfortunately, mistakes were 

made, and we are paying some of the price of that at this particular juncture. 

Mr.CHABOT. Thank you. 

How do you anticipate that these credit and lending issues will 

affect small business? And what is the Federal Reserve doing to reduce the negative impact on small businesses, and especially on 

their employees, because that is, after all, who oftentimes pays the 

price when the business suffers. 

Mr.MISHKIN. One of the good things is that going into this situation where we have had this financial market disruption, that the 

balance sheets of firms has been quite strong, and this is true for 

small businesses as well as large businesses, which actually helps 

them have the resources to weather these kinds of problems better 

than they otherwise would. 

The other issue that I think that is important here is the nature 

of small businesses, which actually was pointed out in the opening 

statement of the Chairwoman of the Committee, that they actually 

have not been able to get access to certain credit vehicles the way 

other people have because the information about them is harder to 

get. Particularly if a firm is smaller and also it has been around 

less time, it is a younger firm, there is not as much information 

about it, it is actually harder to take the loan to that person and 

then bundle it together and then securitize it. The aspect of that 

actually helps small businesses now is that they are not quite as 

exposed as some of the other sectors of the economy. 

So, nonetheless, there clearly has been an impact on small businesses because of the tightening of credit conditions, and there has 

been an impact in this financial disruption on aggregate demand 

in the economy. 

In a situation like that, a central bank is supposed to act in order 

to counteract those negative shocks. Our job is to keep the economy 

on an even keel, which means prevent inflation from being too high 

or actually even preventing it from being too low. But it is similarly 

also trying to prevent economic fluctuations that are undesirable. 

So in this context what the Federal Reserve has done has been 

to lower interest rates in order to counteract the negative shock 

that has occurred from the financial disruption. And, clearly, not 

only is that going to help the overall economy, but particularly help 

small businesses as well. 

Mr.CHABOT. Thank you. 

I had mentioned Chairman Charlie Rangel’s so-called mother of 

all tax bills in my opening statement and voiced my concern about 

it. And it has been said that millions of Americans who own small 

businesses and who pay taxes on that income on their individual 

tax returns are going to face in effect what is a triple whammy. 

First, they will be hit with a 4 percent surtax on some of their income. Second, many of them will lose the section 199 manufacturing deduction that lowers taxes on their business income. And, 

third, this is happening at the same time as large corporations 

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er for these small business engines of job creation to compete with 

the larger corporations and for those business owners to deal with 

these increases in taxes. Is that scenario one that should give us 

concern? Do you have any comments about that? 

Mr.MISHKIN. Well, the Federal Reserve has plenty to do, but we 

actually don’t decide on tax policy. In fact, this is exactly what our 

elected representatives are supposed to focus on; and so it is something that I am going to leave to you to make the decisions on. 

Mr.CHABOT. All right. Well, as I said, a lot of us have an awful 

lot of concern about that. And hopefully reasonable minds will prevail, but only time will tell where we are at. 

Finally, and this may again get into an area where you may or 

may not want to comment, but I am going to jump into it anyway. 

Would you agree that permanency and certainty in the Tax Code 

is beneficial to our economy, because businesses can then determine what policies they are going to be faced with and how to deal 

with those kind of on a long-term basis? And, in general, do you 

believe that the tax relief that we passed back in 2001 and 2003 

helped the recent growth in our economy? And do you believe that 

it would make sense to make those tax policies permanent so that 

small businesses can depend upon those in the future? 

Mr.MISHKIN. Again, I don’t want to comment on tax policy, but 

in general, clearly the less uncertainty that you have, the better. 

And this is clearly an issue in terms of Federal Reserve policy; 

that, in fact, making sure that people think that the economy is 

going to not be volatile is, in fact, something that actually helps 

both directly in terms of actually business decisions, but also just 

makes people much more comfortable. So clearly there is an issue 

about having less uncertainty, and then the question is, how do you 

achieve that? And, again, on tax policy, I am going to leave that 

up to you. 

Mr.CHABOT. Thank you very much. 

ChairwomanVELA ́ ZQUEZ. Mr. Sestak. 

Mr.SESTAK. Thank you, Madam Chairwoman. 

In your testimony, sir—if you don’t mind, I very much appreciate 

all your comments about small business and all, but in your testimony, you made the very important point, I thought, the most important point, that half of all net new jobs annually come from 

small business. 

If I could disconnect the small business just for a moment and 

focus on jobs, because jobs lead to wages. What is your comment 

about the—if you don’t mind just using your expertise—that the 

study by AEI, conservative, and Brookings, liberal, came together, 

and despite all the nice prose that has been presented, that for the 

very first time the intergenerational promise has not been achieved 

in America? 

It took two cohorts in the early 1970s, age 35, with some kids, 

about the time when you are in the prime of just beginning to say 

this is where I am going to be living for my kind of wages, and 

said, what did they earn in the 1970s real terms? AEI, with Brookings, jumped ahead 35 years when those children had grown up 

and were of similar age with children and said, in real terms today, 

the next generation for the first time in America is earning less 

than their parents. 

12

How do we address that issue? Love new jobs, but the median 

level of real wages has declined in the last 6 years. So jobs are interesting, but wages apparently is what we really want them for. 

How do you fix that? How do you address that intergenerational 

broken promise? 

Mr.MISHKIN. Well, I am not going to comment on the studies 

themselves. There always are very complicated issues in measuring 

issues, but there clearly is an issue in terms of what is happening 

to the median job holder, and, in particular, when you have growth 

in the economy, actually, how does it get spread throughout the 

economy. And this is an issue, for example, about the whole question about income and equality and what this means for this society. 

The problem here is that the research on this indicates that it 

is hard to actually decide exactly what the source of these problems 

are. Some of the issue of what has been happening may also have 

to do with just the nature of technological change, which is something that central banks and even policies from the government 

may not be able to affect that strongly, and, in fact, some of the 

technological change, of course, can be very beneficial in the long 

run to the economy. So the problem here is that it is not obvious 

what the simple solution to this issue is. 

Mr.SESTAK. But it is an issue, it is not the issue. 

Mr.MISHKIN. It clearly is an issue that, in fact, you want to have 

all Americans benefit from economic growth. And this is not only 

true from the point of view of issues of equity, but issues from a 

point of view of getting everybody to buy into good policies for the 

country. 

Mr.SESTAK. Thank you for that. I mean, because, please, take 

this right when I say your job is hard. I have never met a onearmed economist, because they are always saying on the one hand 

and on the other hand. 

My next question comes then; we are $9 trillion in debt. As 

President Clinton handed over to President Bush the economy, the 

Congressional Budget Office said by fiscal 2008 we would have a 

$5 trillion surplus. Well, we are $9 trillion in debt today. 

In 2002, this Congress, Republican Majority, decided no longer to 

do pay-as-you-go, which President Clinton with a Republican Congress had come to an agreement upon. And I understand your comments about uncertainty, but there was a lot of uncertainty when 

that was done away with. 

Do you believe that, in view of not just tax, but the principle 

here, that there is some tough decisions to be made as 23 million 

Americans, if we don’t get this tax thing right, will enter the AMT 

area and pay more taxes? So, is pay-as-you-go important, and 

should it be not just discretionary but mandatory funding? 

Mr.MISHKIN. Again—

Mr.SESTAK. Because you talked about the principles of certainty, 

so I think this is kind of in your ′′principles of′′ area. 

Mr.MISHKIN. Clearly having long-run fiscal sustainability is very 

important to the country. And in fact, not only is it important to 

the country; in order to do monetary policy well, you have to have 

fiscal sustainability. So one of the things we have learned from particularly looking at other countries, we haven’t had as much probVerDate 0ct 09 2002 09:48 Dec 20, 2007 Jkt 033615 PO 00000 Frm 00018 Fmt 6633 Sfmt 6633 G:\CLERK SB\HEARINGS\TRANSCRIPTS\39379.TXT LEANN
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lem here, but in the emerging market economies, in fact, that they 

frequently had big problems because they have not had fiscal sustainability. How you actually achieve that is again your responsibility. 

Mr.SESTAK. Is pay-as-you-go—because the Federal Reserve 

Chairman spoke on this in years past. Is it a good principle to 

have? 

Mr.MISHKIN. My view on this is that there are many different 

ways to actually try to solve the problem on fiscal responsibility. 

Mr.SESTAK. On the one hand, but on the other hand. 

Mr.MISHKIN. I not only have 2 hands, I also have 10 fingers. So 

on this one I have got to leave this up to you as our elected representatives. 

Mr.SESTAK. Thanks. It is tough to get advice in this town. Thank 

you. 

Mr.MISHKIN. Depends on what kind of advice. 

ChairwomanVELA ́ ZQUEZ. Mr. Bartlett. 

Mr.BARTLETT. Thank you. Yesterday, as you know, oil went through $97 a barrel. Is the 

small business community going to be more or less impacted by increasing oil prices as compared to the rest of the business world? 

Mr.MISHKIN. Well, I am not sure whether there will be more or 

less impact because I just don’t know the details. It clearly depends 

on what sector the small business is in. If they are very dependent 

on energy—so, for example, if the small business is one which is 

providing a service which doesn’t use a lot of energy, then the impact will be fairly small. If it is a small business that is very energy-intensive, then of course the impact is larger. And I don’t really have the information to tell you where small businesses—which 

sectors they are relative to large businesses, so I can’t really be 

sure on this. 

Clearly, the issue of high oil prices is, in fact, going to impact 

American businesses in general because it is a factor increasing the 

cost of their doing business. The good news is that, over time, 

American businesses have become more and more efficient in terms 

of using energy, and so the impact on businesses in terms of the 

higher energy prices is much, much smaller than it was, let’s say, 

20, 30 years ago where the impact was much larger. And that is 

very good news. This is part of the ingenuity of the American capitalist structure, that when you have higher prices and a key product for you, that you figure out how to substitute away from it. 

So is it an issue in terms of businesses for higher energy prices, 

and also for households? Every time I know I am going to fill up 

my car, and it gets more and more expensive when oil prices go up, 

does it impact? Certainly, it does. But the potential problems from 

this are not what they used to be. 

Mr.BARTLETT. In your role of being the primary entity that tries 

to stabilize our economy, you obviously need to be looking to the 

future. Where do you see oil prices going? 

Mr.MISHKIN. Well, I am not a forecaster of oil prices. I can tell 

you the future markets do see that the oil prices will be coming 

down from their current very high levels. But the reality is that we 

have been very surprised, in fact the markets have been very surprised, by this very sharp run-up in oil prices that we have seen, 

14

and so there is a lot of uncertainty about oil prices. And, in fact, 

it is something that, because most oil is produced outside the 

United States, that we don’t have a lot of control over. 

So I think the answer here is that the best bet is that oil prices 

will come down from their current elevated levels, but realize there 

is a huge amount of uncertainty about where oil prices may be 

heading. 

Mr.CHABOT. Will the gentleman yield? 

Mr.BARTLETT. Yes, sir. 

Mr.CHABOT. When you say that they are likely to come down, I 

would assume what you mean is in the short term; whereas, I 

think what the gentleman may be asking is in the long term do we 

anticipate that they are ultimately probably going to be going up. 

Mr.MISHKIN. This is really hard, hard to decide. We clearly have 

had a situation where the fact that many countries that were extremely poor have been developing very rapidly, and this is particularly true of China, has actually increased demand for petroleum 

products very substantially. And so in that context, that does have 

an impact. But we also may see these countries actually realizing 

that they need to conserve on the use of energy. So we see actually 

now policies where subsidies, for example, which keep energy 

prices exceedingly low in some of these countries, which therefore 

increases demand, that they are being rethought. So exactly what 

will happen here is hard to say. 

The other key issue here is that there is a geopolitical element 

to this, and a very key geopolitical element. And that is awfully 

hard to forecast, and there are people who are much more better 

qualified than I to do so. 

Mr.BARTLETT. There is a bit of a scare factor in the oil price now, 

and for the short term oil prices may come down a little. For those 

who believe that in the long term oil prices will come down probably also believe in the tooth fairy. 

In 1970, our country went through a phenomenon that the world 

is now going through. We reached our maximum oil production in 

1970. And in spite of drilling more oil wells than all the rest of the 

world put together, we now are producing about half the oil we produced in 1970. There is accumulating evidence that the world has 

reached its maximum production of oil now. There will be some 

temporary downturns, but the future is just up, up, and away as 

far as oil prices are concerned. 

Is there anything that the Federal Reserve or our Congress can 

do to minimize the negative effects of this for the future on our 

businesses? 

Mr.MISHKIN. Well, I think that what the Federal Reserve can do 

is, in fact, to do our job properly. So one thing that is very important, and an important change in the success of monetary policy, 

is that in the 1970s when oil prices went up, the view was the that 

Federal Reserve was not going to be able to control inflation, and, 

in fact, policies were not such that inflation was controlled, and 

that then had very negative implications for the economy. 

So, clearly, we don’t want to go through that again, and the Federal Reserve, as other central banks, now focuses very much on 

making sure that inflation is kept under control and, therefore, has 

the benefits that I mentioned not only in terms of inflation control, 

15

but also in terms of the second part of our dual mandate, stabilization of the economy. 

The problem here is that what can be done about oil prices. In 

fact, much of this is just out of control of the Federal Reserve. 

Clearly, there are issues in terms of, can technology help? For example, what kind of other energy sources might we be able to access? What kind of conservation can be done in terms of minimizing the use of oil? 

There have been positive developments in this regard. As I said, 

the use of oil per dollar of GDP has actually dropped very, very 

substantially since the 1970s, and this is one of the reasons why 

the fear of higher oil prices has been much lessened than it has in 

the past. The economy has been really quite resilient in the face 

of these higher oil prices. 

So, can more be done? I am sure more can be done. But the Federal Reserve, really the only thing that we can do is to make sure 

that higher oil prices don’t spill over into higher inflation in the 

long run, and that also we monitor what the impact of oil prices 

will be also on what will happen with other economic activity. 

Mr.BARTLETT. Thank you, Madam Chair. 

ChairwomanVELA ́ ZQUEZ. Ms. Clarke. 

Ms.CLARKE. Thank you very much, Madam Chair, and thank 

you, Ranking Member Chabot. 

Good morning to you, Governor. 

Mr.MISHKIN. Good morning. 

Ms.CLARKE. I am glad we get this chance to explore the state of 

small business economy. Small businesses are the engine to our 

Nation’s economy, and we must do all that we can to ensure that 

all the tools are in place to create new and more jobs in this country. As we all know, successful small businesses are beneficial both 

from a macroeconomic and microeconomic point of view by both increasing the gross national product and personal income. 

I just want to refer to what our Chairwoman has said in her 

statement about the mortgage market, its instability, and which 

has resulted in the tightening of lending standards that have 

spilled over into the small business credit markets, and also add 

to that what our colleagues have brought up about the rising oil 

prices, and then talk about tools that could perhaps insulate to a 

certain degree small business. 

Microfinance, for instance, tries to expand economic opportunities 

and community development by providing small loans and other 

business services to people who have not been able to get help from 

mainstream banks. 

Can you tell us today if there is any correlation between the 

microcredit movement and its impact on the national economy? 

And, if so, what is the economic outlook? 

Mr.MISHKIN. Well, I think that improving the way financial markets work, particularly for not just small businesses, but very small 

businesses, is something that can be very helpful. And, in fact, in 

places where microfinance has been around longer, for example, in 

Bangladesh where it was originally set up, it actually has been 

able to alleviate a lot of poverty. 

The issue here, again, is that having funds get to people with 

productive investment opportunities, even if they are poor, is actuVerDate 0ct 09 2002 09:48 Dec 20, 2007 Jkt 033615 PO 00000 Frm 00021 Fmt 6633 Sfmt 6633 G:\CLERK SB\HEARINGS\TRANSCRIPTS\39379.TXT LEANN
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ally very, very beneficial. In fact, I have done actually research on 

this looking at the role of finance and growth. It is actually very 

critical for very poor countries to have better financial systems, and 

microfinance is one part of that picture. It is now actually happening in the U.S. To the extent that it can help—

Ms.CLARKE. Distressed communities. 

Mr.MISHKIN. In distressed communities. I think that is a terrific 

thing. I do know, however, that because it is micro and the word 

′′micro′′ is in there, that it is actually still going to be a small part 

of the economy, not necessarily unimportant, because for the people 

that it can help, it could be a very big deal. But there is the issue 

that, in general, our financial system is, in fact, very, very large, 

and microfinance is only going to be a small part of it, even though 

it can actually target and help a very important sector of our economy. 

Ms.CLARKE. In your written testimony you stated that there are 

many reasons why lending to small business may be riskier and 

may be more costly than lending to larger firms. But it has been 

recently reported that small neighborhood banks have been immune to the credit crisis because their loans are backed by customer deposits and not by complex debt instruments favored by 

major corporations. It appears what favors small businesses is 

their robust local economies. 

Do you believe that these community banks play a pivotal role 

in making sure that small businesses can continue to be the engine 

to our country as we move forward in the 21st century? 

Mr.MISHKIN. Yes. I think community banks are extremely important in this regard. In fact, research on the way financial systems 

work actually talks a lot about this issue, that small firms—and 

particularly the smaller they are and the younger they are, the 

more they are going to be dependent on what we call relationship 

finance, so that they actually have somebody who knows what they 

do. And particularly very small businesses, they don’t necessarily 

have the records that a General Motors will have that you can take 

a look at. You actually have to have a lot of local knowledge. 

One of the things that we have seen is that community banks 

have been a very vibrant part of the banking community, and part 

of the reason that this occurs is because, number one, they can get 

local deposits; but importantly, they have information that the big 

guys don’t have. Because they are actually in the community, they 

know who is a trustworthy person. And, in fact, this is not just, by 

the way, for businesses, but also for households. My wife’s family, 

my wife grew up quite poor, but her parents were always able to 

get loans from the local community bank, and the reason was they 

knew these people would pay back that, no matter what happened. 

So, this idea of, in fact, having this relationship kind of financing 

is extremely important. And the U.S. actually has this very vibrant 

community banking sector which plays a very important role in exactly this regard. 

ChairwomanVELA ́ ZQUEZ. Would the gentlewoman yield? 

Governor, your agency noted that a significant amount of consolidation in the banking industry is taking place. That is the trend. 

We discussed how small businesses have this relationship with 

small bankers, small banks; and small banks are less exposed beVerDate 0ct 09 2002 09:48 Dec 20, 2007 Jkt 033615 PO 00000 Frm 00022 Fmt 6633 Sfmt 6633 G:\CLERK SB\HEARINGS\TRANSCRIPTS\39379.TXT LEANN
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cause those businesses will be able to pay. So, what is the risk of 

banking consolidation regarding availability of financing for small 

businesses? 

Mr.MISHKIN. Well, we know that large banks do not do as much 

as small business lending because they are not always set up to do 

so. But what we found is when consolidation occurs, that there is 

less lending being done by the larger entity, that other banks come 

into the picture, and particularly the small banks will take up the 

slack because they can make money from it. So what we find is 

that the small business sector still has been able to access credit 

even with bank consolidation taking place. 

ChairwomanVELA ́ ZQUEZ. Thank you for yielding. 

Ms.CLARKE. Thank you, Madam Chair. You sort of stole my 

thunder there with that question. Thank you very much. 

ChairwomanVELA ́ ZQUEZ. Mr. Fortenberry. 

Mr.FORTENBERRY. Thank you, Madam Chair, for holding this 

hearing. 

And, good morning, Governor. 

Before I make my comments, I would like to respond to the gentleman from Pennsylvania’s assertion of an anti-PAYGO spirit 

among Republicans. I voted for the PAYGO rule. 

Mr.SESTAK. May I correct that? I did not say that. 

Mr.FORTENBERRY. You accused the Republicans of being against 

PAYGO. I voted for PAYGO, and I did so because in the same spirit I think you did, that it is an important principle to uphold that 

we pay for what we spend. And yet I did so with some reservations, 

because it does not take into account some of the dynamic effects 

of tax reductions as they lead to increased revenue. So that is the 

point I wanted to make. 

The issue there raises the point as to how do we help stimulate 

small business capital investment, and one of the key ways was 

some of the tax reductions that took place that allowed for accelerated or higher levels of write-offs. We tend to point to the issues 

that we can quantify most easily in terms of helping small business, whether that is access to capital or education. But I don’t 

think we have as clear of an understanding of how tax policies, 

such as the one implemented a few years ago that significantly 

raised the accelerated write-off levels, can stimulate investment, 

which leads to productivity, which leads to jobs, which leads to revenues and help for families. So I would like you to comment on 

that as well as any other barriers to entry or expansion for small 

businesses since it is such a critical component of our economy. 

Mr.MISHKIN. Well, I am not a public finance economist, so, again, 

I really can’t tell you what is a good tax system or not. I would 

rather have experts that do that for a living, focus on exactly that 

issue. 

Mr.FORTENBERRY. Well, that doesn’t help. Let me find some common ground with my friend from Pennsylvania saying on the one 

hand—but it would be helpful to unpack, you are an expert and in 

charge of our financial system, to unpack some of the either barriers to entry or barriers to expansion that we don’t commonly talk 

about. I will give you one that we commonly raise in this hearing, 

and it is health insurance. Health insurance tethers a person to 

what they are currently doing and increases the cost of risk-taking 

18

by venturing out into a new entrepreneurial venture; that is one. 

But again, tax policy I think is an absolute critical component as 

well. It helps accelerate decisions that might be pushed off to the 

future to the current moment. I think that was some of the dynamic effects that we saw regarding the particular tax reduction 

that allowed for accelerated write-off of capital purchases earlier in 

this decade. 

Mr.MISHKIN. If I was in charge of tax policy, I would be very 

happy to give you my views on this, but what the Federal Reserve 

can do to help small businesses is to do our job under the mandate 

that has been given to us by Congress. If we do that well, small 

businesses, I think, will prosper. 

In general, the United States actually has one of the most, I 

don’t know the exact figures, but I think we have one of the most 

vibrant small business economies. This is something that is a very 

important feature of the way that things work in this country, and 

it is an opportunity for people actually to actually grow rich by 

starting small businesses and actually working very hard. 

So this is extremely important. I think the kind of environment 

that we have to allow businesses to do their jobs well is very important. To have a financial system that works well, so that it can 

get access to credit; if somebody has a good idea, they can start 

small. They can start it in their garage with a couple of computers 

and then become one of the richest people in the world. This is 

what makes America great. 

However, the Federal Reserve, in terms of these microeconomic 

policies, it is not what we are actually in charge of, so on this basis, 

I really can’t tell you exactly what the best way to solve these problems are. I think they are extremely important, and in fact, it is 

very important that you focus on exactly these issues. 

Mr.FORTENBERRY. Thank you, Madam Chair. 

ChairwomanVELA ́ ZQUEZ. Mr. Davis? . 

Mr.DAVIS. Thank you, Madam Chair. 

Thank you, Governor. I would like to go back to a question that 

was asked a moment ago about oil prices. One of the statements 

that you said, and this is a quote, your job is to make sure how 

a process doesn’t spill over into higher inflation. 

Can you expand on how the Federal Reserve makes sure that it 

doesn’t spill over. 

Mr.MISHKIN. Let me qualify this. Clearly higher oil prices in the 

short run does spill over into inflation, but it is very important to 

understand that the Federal Reserve and any central bank can’t 

determine what is going to happen, inflation, in the very short run 

when there are shocks, because our policies take a fairly long time 

to have an impact on the economy on the order of several years, 

particularly in terms of inflation. 

So what this means is, we have to look far out and ask, will this 

shock to oil prices have a potential effect on inflation further out? 

And if it does, what are we going to do about it? And this is one 

of the reasons why even though an oil price shock may have temporary effects on inflation, you have to make sure those temporary 

impacts on inflation don’t spill over into long-term impacts on inflation. 

19

This is why it is important that the Federal Reserve make it 

clear that we will do what we need to, to make sure that inflation 

in the long run will stay stable, that is an incredibly important 

part of our mandate, that the great success of central banks 

throughout the world, or at least the Federal Reserve has been the 

leader in this, has been our focus on price stability. That was not 

always as true 30 years ago. In fact, not only did that mean we had 

high and variable inflation, which made it very difficult for firms 

to plan and actually hurt small businesses in exactly that way. But 

it actually led to an economy that under performed in terms of economic activity and in terms of producing jobs. 

So, in this context, we really do carefully monitor what happens 

to oil prices. We try to make our best guesses about what might 

happen in the future, but actually respond to information as it 

comes in, but always have this long run as perspective. And this 

is why it is very important to not, for example, overreact to a rise 

in oil prices, but actually to think about what is the impact in a 

longer run context and then take exactly the steps that will in fact 

create an environment which is one which is successful both in the 

inflation front and on the output front. 

Mr.DAVIS. I think I hear you say that part of your job is forecasting. 

Mr.MISHKIN. Oh, it is a big part of our job, absolutely. 

Mr.DAVIS. And with that being said, where are you in your forecasting now in the foreseeable future? 

Mr.MISHKIN. Well, we have actually talked about this in the 

statement that we made after last FOMC meeting. Clearly, there 

is an issue with potentially slower growth in the short term, but 

in fact, we see moderate growth in a longer-term horizon. Of 

course, having the right monetary policy is part of getting that to 

happen. And indeed a reason why in fact we felt a need to lower 

interest rates by three quarters of a percentage point was in fact 

to ensure that the economy would actually keep growing at a moderate pace, and felt that we could do that and actually not have a 

negative consequence on inflation because of the nature of the inflation numbers have come in favorably in recent months and also 

that the kind of situation in the overall economy, the balance of 

supply and demand indicates that we hope that inflation would not 

rise in the future. This is something that we have to really to keep 

our eye on. 

The difficult problem for central bankers and maybe we actually 

need five hands to think about, but we actually have to really balance these risks. And unfortunately, we don’t have a crystal ball, 

but the Federal Reserve has been quite strong in its forecasting operation. 

One of the great pleasures for me having come to the Federal Reserve about a year ago is to interact with our staff and the extraordinary capability of our staff, which has been very strong in terms 

of thinking about where the economy might be heading and giving 

us a perspective which I think has enabled us to do pretty well in 

terms of the setting of policy instruments. So this is a part of what 

makes central banking interesting. There is a lot of science in central banking, but there is also a lot of art as well. And I think so 

far we have been doing pretty well in this, but it is a tough job. 

20

Mr.DAVIS. Let me change the question just a little bit. With 

small business being the backbone of our economy, the job creator 

in our economy, could you talk about as small business owners go 

out to find those loans, the increase in credit card debt amongst 

small businesses and what effect it is having in small businesses? 

Mr.MISHKIN. There has been a substantial increase in the use of 

credit cards by small businesses. What we have found is that most 

small businesses are using it for transaction purposes, so that it is 

much easier to use a credit card. In fact, when I go in the store, 

I don’t like to carry change, so I use a credit card for very small 

purchases. It doesn’t always make me very popular with the store 

owner, but that’s what I do. Small businesses are finding this is 

an important tool for them. 

It is not the main source for them in terms of their financing, 

because they find that there are other sources of financing that are 

cheaper. So the credit cards do have an important role here. There 

are firms, particularly sometimes start up firms, you hear stories 

about them starting up a firm in the garage, and they borrow with 

their credit card. And many of those cases actually help them to 

become successful. But clearly, because credit card debt is not usually the cheapest form of debt for small firms, that they actually 

seek out other sources of financing and have been able over the 

years to be pretty successful at getting it, and in fact, this sector 

has been an incredibly important engine that broadens the U.S. 

Economy. 

Mr.DAVIS. One last question, I am not sure if you are familiar 

with the Community Reinvestment Act, which doesn’t require 

banks to lend to small business, but it does encourage. Could you 

talk about that? 

Mr.MISHKIN. Clearly, one of the things, as a result of the Community Reinvestment Act, in fact, banks do worry about the communities that they serve. And in that context, it is not only dealing 

with households, which is what the Act tells them to do, but they 

also have outreach to small business as well. It is an important 

issue in terms of these communities. It is not good enough just to 

lend to households. Wealth generation and wealth creation is typically coming from businesses and small businesses can play a very 

important role in these communities. 

So the banks actually do in fact try to reach out to these communities, and in fact, I think the Community Reinvestment Act by 

getting them to think about this in terms of households has helped 

them to think about this in terms of small businesses as well as. 

One thing that should be said is that there is an interaction between households and small businesses. In fact, sometimes they 

are the same thing because—do you have a little business? I actually had something I set up for a while and then actually got rid 

of it, but I, at one point, was a corporation. So there was only one 

person in the corporation; it was me. And so, clearly, this issue of 

worrying about households actually means also that you indirectly 

worry about small businesses as well. 

Mr.DAVIS. Governor, thank you and I yield back. 

ChairwomanVELA ́ ZQUEZ. Governor, since 2001, our National debt 

has increased by $3 trillion. Factors, such as tax policy and spendVerDate 0ct 09 2002 09:48 Dec 20, 2007 Jkt 033615 PO 00000 Frm 00026 Fmt 6633 Sfmt 6633 G:\CLERK SB\HEARINGS\TRANSCRIPTS\39379.TXT LEANN
21

ing, have been responsible for that increase. What impact is there 

on small businesses when the government has such a large debt? 

Mr.MISHKIN. Well, there are several issues here, which are, if 

that debt expands too much, it actually can impact on interest 

rates and raise interest rates. Clearly, higher interest rates make 

it harder to finance investments, and so it can impact on small 

businesses. So, again, fiscal sustainability, in the long run having 

fiscal balance, is actually very important in many dimensions. 

Clearly one of the areas it is important to is potential impact to the 

cost of financing for small businesses. 

ChairwomanVELA ́ ZQUEZ. In the letter accompanying the most recent survey of small business finances, former Chairman Greenspan encouraged the business owners selected for the survey to 

participate, noting that the data collected by past surveys has been 

critical for policy decisions at the Federal Reserve and in other 

parts of government. If the survey is discontinued, what alternative 

source of direct information will your agency use to make policy decisions affecting small businesses? 

Mr.MISHKIN. The issue of discontinuance, I think, is an important one. The question is, what is the best way to get information 

about small business finance? One of the things that is very important is that the Federal Reserve be an efficient organization. In 

fact, the Congress has insisted that, in fact, the Federal Reserve 

run its operation efficiently. Part of the efficiency is, how do we get 

the best information in the best way? 

The Federal Reserve has taken the view that we can do better 

by actually getting information, by getting it from the small—the 

Survey of Consumer Finances and that the advantage to that survey is that it is more frequent. It happens to be 3 years rather than 

every 5. As I mentioned, there is interaction between households 

and small businesses. It is very important. So one of the things 

that the Federal Reserve has looked at is expanding the Survey of 

Consumer Finances both by expanding the number of people that 

are asked but also by asking a lot more questions on small business finance. Our view is that, in general, that can actually provide 

us with a better way of getting information and also do it more efficiently. 

ChairwomanVELA ́ ZQUEZ. Sir, and if you conclude after this new 

survey or instrument or tool is conducted, put together, that it 

doesn’t reflect small businesses, will you go back to have your own 

small business survey? 

Mr.MISHKIN. Well, certainly, if it is not getting the information 

we need about small businesses, we will in fact figure out how to 

improve it. 

ChairwomanVELA ́ ZQUEZ. I cannot stress enough how important 

this survey is for us Members of Congress when we are dealing 

with decisions, policy decisions. And I guess that you need to look 

at how we do business here. And when it comes to small businesses, quite often they are overlooked. Either tax policies or energy policies or any type of tax relief, they become an after thought. 

And I don’t want for that to happen when you need to have information in order to make decisions that are important to small businesses. 

With that, I will recognize Mr. Chabot. 

22

Mr.CHABOT. Thank you, Madam Chair. I just have a couple more 

questions. I don’t think they will be too long. 

We have had a number of hearings here about more and more 

small businesses are engaging in trade. And as part of their profit 

and bottom line is their success or lack of success in trading. And 

we have got a couple of trade agreements before us now, Peru, Panama, South Korea, Colombia. And they are somewhat controversial, 

depending on the country. And I tend to be one who thinks it is 

good for us to be trading. We ought to keep tariffs down and all 

that sort of thing. 

We also have issues, such as China artificially manipulating. 

Their currency has been discussed, things of that nature. I don’t 

want to ask a specific question, and say, hey, that is your job. I 

have thrown it out there. What can you tell us about trade that 

could be helpful to us? 

Mr.MISHKIN. I think actually having the U.S. Economy participate very fully in the global economies is actually critical to our 

economic well-being. First of all, it promotes competition, and one 

of the things that makes the American economy so strong is, in 

fact, that you have to be competitive. This means you actually have 

to produce a better product, and by producing a better product, you 

do better. And indeed, having competitive markets is really the engine of our productivity growth, because when you have competition, you have to do a good job. And if you don’t, you don’t stay in 

business very long. 

So also being very open to global markets means that if somebody is making a product cheaper abroad, then in fact either you 

have to get better and improve the quality of your product and 

lower its price or you are going to find that you are going to be in 

trouble in not being able to sell the goods. What we have found is 

American businesses have been able to perform extremely well, and 

we have an economy in fact that has very high employment right 

now. So, in that context, my view is that trade is something that 

is an important element in a successful economy. And turning our 

backs on the global economy would not be very healthy, and it of 

course would be very unhealthy for other countries as well. 

Mr.CHABOT. Thank you. Just to follow up on that, those that are 

more skeptical about trade and freer trade—I won’t say free trade, 

but freer trade—argue that manufacturing jobs and other jobs end 

up going overseas, and there is a net loss of jobs they would argue. 

They would also argue, even if we do create more jobs here, they 

tend to be low-paying jobs that don’t have benefits. They are flipping hamburgers at McDonald’s, that type of thing. That is sort of 

the rhetoric that you hear out there. To the extent you are able to, 

could you shed any light on whether those allegations are for the 

most part true or for the most part not true? 

Mr.MISHKIN. Well, we have certainly seen that, with this increase in globalization, that we have not had a problem producing 

jobs in this country. So it is true that there are people who are hurt 

because they lose jobs because they are in competition with workers abroad, but there are also new jobs that get created. 

So the issue, of course, is how do we deal with some people that 

maybe could get hurt by this. This is something again that I think 

the Congress has to think about because it is important. But on 

23

net, the global economy has been very helpful to the overall U.S. 

Economy. And clearly, our ability to actually come up with good 

ideas and actually have them used abroad is also helpful to countries elsewhere. 

So, in terms of employment, certainly the economy, which in fact 

has had employment grow very substantially over time, and in fact, 

during this period of increased globalization, employment growth 

has been very rapid in the United States. 

Mr.CHABOT. Thank you. 

Finally, relative to the spending and the national debt and our 

deficit that we have each year, some would argue that we still have 

a few hundred billion dollar deficit each year, and to some extent, 

it went up. When I came up here and the Contract with America, 

that was one of the main things, balance the budget; it got balanced because of Congress and President Clinton. I will give him 

credit as well. We worked together and got it done, some credit, not 

all of the credit—

Mr.GONZA ́LEZ. Yeah. 

Mr.CHABOT. Not all the credit but at least some of it. As one of 

the House managers who was involved in the impeachment of the 

President, I am sure he’ll appreciate me saying that. I will give 

him some credit for that. 

Now, unfortunately, since that time, we had September 11th. We 

had the stock market plunge. We had the bubble burst of the Internet stocks and all that stuff. And we’re now fighting a war in Afghanistan and Iraq. And we have additional expenditures, et 

cetera, et cetera. So the deficit shot back up, and it seems to be 

coming down again, although not as fast as a lot of us would like 

it to. But what I am getting at, you will hear people say the deficit, 

even though it is X amount, if you look at it in terms of the overall 

GDP as a percentage, it is not as high as it was earlier, and therefore, it is not really as big a deal. I am not saying that, but I am 

saying that is what some will argue. 

The impact that all of that has on the economy and job growth 

in the future, could you comment on that? 

Mr.MISHKIN. Again, I think this issue of fiscal sustainability is 

very important. The point here is not just what the deficit is now; 

it is the long run wrong fiscal sustainability that is very key. In 

fact, it is not just our current spending versus revenue, but also 

what kind of obligations do we have in the future, for example Social Security and Medicare? And this is something that I think is 

something that I do worry about. I think it is something that 

should be a major concern for Congress. But then how to actually 

deal with this and get fiscal sustainability to happen—that is why 

you get paid the big bucks. 

Mr.CHABOT. Thank you very much. 

I yield back, Madam Chair. 

ChairwomanVELA ́ ZQUEZ. Mr. Gonza ́lez. 

Mr.GONZA ́LEZ. Thank you very much, Madam Chairwoman. My 

apologies to my colleagues and to the witness for being late. We always have two or three things and still try to make it, and I appreciate your patience. I don’t know if you have covered this. If you 

have, I will just move onto the next question, but did you all cover 

24

the Community Reinvestment Act? I know you touch on it in your 

testimony. 

Mr.MISHKIN. There was a question from Mr. Davis on exactly 

that issue. 

Mr.GONZA ́LEZ. The question really goes to how active the banks 

are today with the mergers and such. I know, in San Antonio, we 

only have fewer banks. In essence, community banks hardly compete anymore and, of course, with the mergers and such of the 

banks. Is there any attention being paid to the CRA obligations to 

the banks? Because we know when they comply, then small business men and women definitely benefit. And I don’t know if Mr. 

Davis basically asked the same question. You already answered it, 

and if he did, I can move on. 

Mr.MISHKIN. Certainly our compliance with the Community Reinvestment Act is something that the Federal Reserve scrutinizes 

carefully. It is part of what we are supposed to do to make sure 

that the banks are doing what they are supposed to be doing in 

these communities. And so part of our supervisory process is to 

look at banks in this regard and to ensure that they are complying 

with the Act. 

Mr.GONZA ́LEZ. And with the mergers, if you have fewer players, 

how does that impact, if anything? 

Mr.MISHKIN. I think, if there are fewer players, it doesn’t change 

the need for them to comply. 

Mr.GONZA ́LEZ. No, no, I understand that. 

Mr.MISHKIN. The bigger players, we have to supervise them similarly to the way we have to look at smaller players. 

Mr.GONZA ́LEZ. Do you have any report that is forthcoming or any 

recent studies? I know Barney Frank, in Financial Services, was 

thinking of having a hearing on it. I don’t know if that has transpired. Madam Chairwoman you may be more aware of that. 

ChairwomanVELA ́ ZQUEZ. No. 

Mr.GONZA ́LEZ. Are you doing anything on it? 

Mr.MISHKIN. I’m not sure, but if we are doing something on it, 

I would be happy to get back to you on it. 

Mr.GONZA ́LEZ. If you would, I would really appreciate that. 

On free trade agreements, this came up the other day when we 

had the ambassador with the trade representative being here: Why 

is it important to include environmental and labor provisions in 

there as far as compliance, a regulatory scheme that we want to 

make sure is imposed on our trading partners? 

Mr.MISHKIN. Well, again, I really don’t want to comment on the 

details of free trade agreements. I have expressed that I am somebody who believes that the global trade is a positive influence on 

the American economy. And also, I think importantly, a positive influence on economies elsewhere in the world where very many poor 

people in the rest of the world in fact benefit by a global economy. 

In fact, one of the great things about our history is that the U.S. 

Actually encouraged this global economic system after World War 

II. 

Mr.GONZA ́LEZ. I understand the international implications and 

good policy; we need to be engaged and so on. The point I am always trying to make from a business perspective is, we need a level 

playing field for our domestic men and women. So if we have a regVerDate 0ct 09 2002 09:48 Dec 20, 2007 Jkt 033615 PO 00000 Frm 00030 Fmt 6633 Sfmt 6633 G:\CLERK SB\HEARINGS\TRANSCRIPTS\39379.TXT LEANN
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ulatory scheme that actually imposes greater costs on the product 

or service that we actually provide and they don’t, it is a tremendous disadvantage. A lot of people say, you are into the environment because you are a tree hugger or into labor because you are 

being pro-labor. Well, you know, you may be. But the other reasons 

are very practical and very important, and I am afraid that we just 

have never really emphasized that part of it. 

The last question I have is just the cost of energy and the poten- tial economic impact. I mean, we are going to have $100 barrel of 

oil. It hasn’t translated yet to the pump, but it is going to, obviously, by Christmas, if not sooner. But look at the small business 

impact. They are on the margins all of the time. They don’t absorb 

or don’t get to really pass on as easily as, I think, some of the bigger outfits. Are you evaluating the rising costs of energy? I am not 

just talking about gasoline but natural gas and such. This is going 

to be huge this winter. 

Mr.MISHKIN. We do actually look carefully about what is going 

on in terms of the energy markets and the impact both on businesses and households. So, clearly, there is an issue of, what is the 

relationship, for example, to what is happening in oil prices to gasoline prices? What impact does it have on natural gas prices? These 

prices actually do have an important impact on the economy. And 

in fact, it is something we have to monitor in order to think about 

what is going to happen to the economy in the future. We talked 

about we have to forecast in order to do policy well. And indeed, 

thinking about what the role of energy prices and the higher energy prices that we’ve experienced lately has on the economy is in 

fact a key element of what we have to do in thinking about how 

we conduct policy. 

Mr.GONZA ́LEZ. My concern is the disparate impact that it has on 

small businesses. They are just too close, as I always say operating 

on the margins. So when their operating costs go up, it really is—

I am not sure if the Fed looks at the very distinct position that 

small business has, as opposed to in the overall economic picture 

and then we can say, gee, they are the economic engine of the 

United States and stuff, but the truth is we don’t really look at specifically what relief will we try to provide them to confront and actually survive, because I don’t think they survive very long, but 

again, thank four your testimony, and I yield back. 

ChairwomanVELA ́ ZQUEZ. Questions? 

Well, Governor, thank you so much for your contribution this 

morning. 

Mr.MISHKIN. My pressure. 

ChairwomanVELA ́ ZQUEZ. Members will have 5 legislative days to 

submit statements for the record. Without objection this hearing is 

adjourned. 

[Whereupon, at 10:30 a.m., the committee was adjourned.]

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