U.S. GOVERNMENT PRINTING OFFICE

WASHINGTON : 

For sale by the Superintendent of Documents, U.S. Government Printing Office

Internet: bookstore.gpo.gov Phone: toll free (866) 512–1800; DC area (202) 512–1800

Fax: (202) 512–2104 Mail: Stop IDCC, Washington, DC 20402–0001

88–532 PDF 2014

FEDERAL RESERVE OVERSIGHT: 

EXAMINING THE CENTRAL BANK’S 

ROLE IN CREDIT ALLOCATION 

HEARING 

BEFORE THE

SUBCOMMITTEE ON MONETARY 

POLICY AND TRADE 

OF THE

COMMITTEE ON FINANCIAL SERVICES 

U.S. HOUSE OF REPRESENTATIVES 

ONE HUNDRED THIRTEENTH CONGRESS 

SECOND SESSION 

MARCH 12, 2014 

Printed for the use of the Committee on Financial Services 

Serial No. 113–70 

( 

(II) 

HOUSE COMMITTEE ON FINANCIAL SERVICES 

JEB HENSARLING, Texas, Chairman 

GARY G. MILLER, California, Vice Chairman 

SPENCER BACHUS, Alabama, Chairman 

Emeritus 

PETER T. KING, New York 

EDWARD R. ROYCE, California 

FRANK D. LUCAS, Oklahoma 

SHELLEY MOORE CAPITO, West Virginia 

SCOTT GARRETT, New Jersey 

RANDY NEUGEBAUER, Texas 

PATRICK T. MCHENRY, North Carolina 

JOHN CAMPBELL, California 

MICHELE BACHMANN, Minnesota 

KEVIN McCARTHY, California 

STEVAN PEARCE, New Mexico 

BILL POSEY, Florida 

MICHAEL G. FITZPATRICK, Pennsylvania 

LYNN A. WESTMORELAND, Georgia 

BLAINE LUETKEMEYER, Missouri 

BILL HUIZENGA, Michigan 

SEAN P. DUFFY, Wisconsin 

ROBERT HURT, Virginia 

MICHAEL G. GRIMM, New York 

STEVE STIVERS, Ohio 

STEPHEN LEE FINCHER, Tennessee 

MARLIN A. STUTZMAN, Indiana 

MICK MULVANEY, South Carolina 

RANDY HULTGREN, Illinois 

DENNIS A. ROSS, Florida 

ROBERT PITTENGER, North Carolina 

ANN WAGNER, Missouri 

ANDY BARR, Kentucky 

TOM COTTON, Arkansas 

KEITH J. ROTHFUS, Pennsylvania 

MAXINE WATERS, California, Ranking 

Member 

CAROLYN B. MALONEY, New York 

NYDIA M. VELA ́ ZQUEZ, New York 

MELVIN L. WATT, North Carolina 

BRAD SHERMAN, California 

GREGORY W. MEEKS, New York 

MICHAEL E. CAPUANO, Massachusetts 

RUBE ́ N HINOJOSA, Texas 

WM. LACY CLAY, Missouri 

CAROLYN MCCARTHY, New York 

STEPHEN F. LYNCH, Massachusetts 

DAVID SCOTT, Georgia 

AL GREEN, Texas 

EMANUEL CLEAVER, Missouri 

GWEN MOORE, Wisconsin 

KEITH ELLISON, Minnesota 

ED PERLMUTTER, Colorado 

JAMES A. HIMES, Connecticut 

GARY C. PETERS, Michigan 

JOHN C. CARNEY, JR., Delaware 

TERRI A. SEWELL, Alabama 

BILL FOSTER, Illinois 

DANIEL T. KILDEE, Michigan 

PATRICK MURPHY, Florida 

JOHN K. DELANEY, Maryland 

KYRSTEN SINEMA, Arizona 

JOYCE BEATTY, Ohio 

DENNY HECK, Washington 

SHANNON MCGAHN, Staff Director 

JAMES H. CLINGER, Chief Counsel 

(III) 

SUBCOMMITTEE ON MONETARY POLICY AND TRADE

JOHN CAMPBELL, California, Chairman 

BILL HUIZENGA, Michigan, Vice Chairman 

FRANK D. LUCAS, Oklahoma 

STEVAN PEARCE, New Mexico 

BILL POSEY, Florida 

MICHAEL G. GRIMM, New York 

STEPHEN LEE FINCHER, Tennessee 

MARLIN A. STUTZMAN, Indiana 

MICK MULVANEY, South Carolina 

ROBERT PITTENGER, North Carolina 

TOM COTTON, Arkansas 

WM. LACY CLAY, Missouri, Ranking 

Member 

GWEN MOORE, Wisconsin 

GARY C. PETERS, Michigan 

ED PERLMUTTER, Colorado 

BILL FOSTER, Illinois 

JOHN C. CARNEY, JR., Delaware 

TERRI A. SEWELL, Alabama 

DANIEL T. KILDEE, Michigan 

PATRICK MURPHY, Florida 

(V) 

C O N T E N T S 

Page 

Hearing held on: 

March 12, 2014 ................................................................................................. 1 

Appendix: 

March 12, 2014 ................................................................................................. 27 

WITNESSES 

WEDNESDAY, MARCH 12, 2014 

Bivens, Josh, Research and Policy Director, Economic Policy Institute ............. 8 

Goodfriend, Marvin, Friends of Allan Meltzer Professor of Economics, Tepper 

School of Business, Carnegie Mellon University ............................................... 2 

Kupiec, Paul H., Resident Scholar, American Enterprise Institute (AEI) .......... 4 

White, Lawrence H., Professor of Economics, George Mason University ........... 7 

APPENDIX 

Prepared statements: 

Bivens, Josh ...................................................................................................... 28 

Goodfriend, Marvin .......................................................................................... 40 

Kupiec, Paul H. ................................................................................................. 51 

White, Lawrence H. .......................................................................................... 71 

(1) 

FEDERAL RESERVE OVERSIGHT: 

EXAMINING THE CENTRAL BANK’S 

ROLE IN CREDIT ALLOCATION 

Wednesday, March 12, 2014 

U.S. HOUSE OF REPRESENTATIVES, 

SUBCOMMITTEE ON MONETARY

POLICY AND TRADE, 

COMMITTEE ON FINANCIAL SERVICES, 

Washington, D.C. 

The subcommittee met, pursuant to notice, at 10:03 a.m., in room 

2128, Rayburn House Office Building, Hon. John Campbell [chairman of the subcommittee] presiding. 

Members present: Representatives Campbell, Huizenga, Pearce, 

Posey, Stutzman, Mulvaney, Pittenger, Cotton; Clay, Foster, and 

Kildee. 

Ex officio present: Representative Hensarling. 

Chairman CAMPBELL. The Subcommittee on Monetary Policy and 

Trade will come to order. 

Without objection, the Chair is authorized to declare a recess of 

the subcommittee at any time. And the Chair now recognizes himself for 5 minutes for an opening statement, which will not be anywhere near that long. 

This is another chapter in our continuing examination of the 

Federal Reserve (Fed) on the occasion of the 100th anniversary of 

the Fed this year—last year, technically. I am not going to make 

any pontifications about what I think things are or ought to be, because that is what our distinguished panel is for, but we want to 

examine the idea of quantitative easing, and of setting interest 

rates, and of what the Fed is doing right now and how that is impacting markets, and how that is impacting credit. 

Is it helping some and hurting others? And just what are the 

ramifications of those actions and those decisions, both currently 

and with a perspective on history and on things the Fed has done 

in the past? 

So, I will look forward to the testimony, and I now recognize the 

ranking member of the subcommittee, the gentleman from Missouri, Mr. Clay, for 5 minutes for his opening statement. 

Mr. CLAY. Thank you, Mr. Chairman, especially for holding this 

hearing regarding the Federal Reserve’s role in credit allocation. 

Due to the financial crisis of 2008, the Federal Reserve Bank purchased commercial paper, made loans, and provided dollar funding 

through liquidity swaps with foreign central banks. Because of this 

action, the Federal Reserve Bank balance sheet expanded. 

2 

Currently, the Federal Reserve Bank has gradually tapered its 

asset purchases from $85 billion per month to $75 billion per 

month due to evidence that the economy is improving. The Federal 

Reserve Bank will purchase a total of $65 billion in Treasury and 

mortgage-backed securities each month. This is a $20 billion decrease, and this action was taken due to the improvement in the 

labor market. 

And there has been no other period since 1939 in which government employment has been so weak for so long. This is twice as 

long as the 26 months of the double-dip recessions in the Reagan 

Administration cutbacks of the 1980s. 

The U.S. economy was vastly affected by the financial crisis in 

2008, and one of the most affected markets was the housing market, and one of the major factors that affects the housing market 

is employment and wage level. I will stop there, Mr. Chairman, because I am also anxious to hear the testimony. I yield back. 

Chairman CAMPBELL. The gentleman yields back. 

The Chair now recognizes the vice chairman of the subcommittee, the gentleman from Michigan, Mr. Huizenga, for 5 minutes. 

Mr. HUIZENGA. Thank you, Mr. Chairman. I don’t intend to utilize all that, because I, too, want to get to these presentations. And 

I think, gentlemen, what I am looking for is an answer to my question: What has all this spending in QE2 and 3 and Twist and all 

the others really accomplished? 

The effectiveness of the Fed’s efforts to stimulate the economy, 

I think, has a lot of us questioning some of those decisions. And, 

I have a serious concern that their encroachment into fiscal policy 

through credit allocation seems to me to break down the historical 

safeguards in a way that is independent from the Federal Government. 

Even former Fed Chairman Bernanke noted in his book, ‘‘The 

Federal Reserve and the Financial Crisis,’’ that ‘‘Central banks 

that operate independently will deliver better results than those 

that are dominated by the government.’’ And I appreciate, Mr. 

Chairman, you setting this time aside so we can explore it, so 

thank you. 

Chairman CAMPBELL. The gentleman yields back. Thank you 

very much. 

Any other opening statements from anyone? Hearing none, we 

will move straight to the witnesses. So, I would like to welcome you 

all. 

First, Dr. Marvin Goodfriend is a Professor of Economics at Carnegie Mellon University. He previously served as the Chief Monetary Policy Adviser to the Federal Reserve Bank of Richmond. He 

also worked as Senior Staff Economist for the White House Council 

of Economic Advisers. Dr. Goodfriend, you are recognized for 5 minutes. 

STATEMENT OF MARVIN GOODFRIEND, FRIENDS OF ALLAN 

MELTZER PROFESSOR OF ECONOMICS, TEPPER SCHOOL OF 

BUSINESS, CARNEGIE MELLON UNIVERSITY 

Mr. GOODFRIEND. Thank you, Mr. Chairman. 

3 

I am pleased to be invited to testify this morning. I am going to 

argue that the 1951 Treasury-Federal Reserve Accord on monetary 

policy should be supplemented with a Treasury-Federal Reserve 

Accord on credit policy. 

Monetary policy can be conducted independently by a central 

bank because the objectives of monetary policy—price stability and 

full employment—are reasonably clear and coherent. Moreover, 

monetary policy is about managing aggregate bank reserves and 

currency to influence the general level of interest rates for the 

whole economy. Assets are acquired only as a means of injecting 

bank reserves and currency into the economy. Hence, monetary policy can be implemented by confining asset purchases to Treasuriesonly. 

Treasuries-only keeps the independent central bank free of politics, because it avoids credit risk and because the central bank simply returns the interest to the Treasury that the Treasury pays to 

the central bank for the Treasury securities that the central bank 

holds. 

Credit policy satisfies none of the conditions that make monetary 

policy suitable for management by an independent central bank. 

Credit policy involves selling Treasury securities from the central 

bank portfolio and lending the proceeds to private financial institutions or using the proceeds to acquire non-Treasury debt, such as 

mortgage-backed securities. Credit policy has no effect on the general level of interest rates, because it doesn’t change aggregate 

bank reserves or interest paid on reserves. 

Credit policy really is debt-financed fiscal policy carried out by 

the central bank. Why? The central bank returns to the Treasury 

interest earned on the Treasuries that it holds. So when the central 

bank sells Treasuries to finance credit policy, it is as if the Treasury financed credit policy by issuing new Treasury debt. 

Credit policy works by exploiting the government’s creditworthiness—the power to borrow credibly against future taxes—to facilitate flows to distressed or favored borrowers. Doing so involves a 

fiscal policy decision to put taxpayer funds at risk in the interest 

of particular borrowers. All central bank credit initiatives carry 

some credit risk and expose the central bank, and ultimately the 

taxpayers, to losses and controversial disputes involving credit allocation. 

The 1951 Accord between the Treasury and the Fed was one of 

the most dramatic events in financial history. The Accord ended an 

arrangement dating from World War II in which the Fed agreed to 

use its monetary policy powers to keep interest rates low to help 

finance the war effort. The Accord famously reasserted the principle of Fed independence so that monetary policy might serve exclusively to stabilize inflation and macroeconomic activity. 

Central bank credit policy, too, must be circumscribed with clear, 

coherent boundaries. Conventional last resort lending by a central 

bank is reasonably compatible with central bank independence. 

Last resort lending to supervised, solvent depositories, on a shortterm basis, against good collateral provides multiple layers of protection against ex post losses and ex ante distortions. So, the fiscal 

policy consequences of conventional last resort lending are likely to 

4 

be minimal and the scope for conflict with the fiscal authorities 

small. 

On the other hand, expansive credit initiatives—such as those 

undertaken in the wake of the 2007–2009 credit turmoil—that extend credit reach in scale, in maturity, and in collateral to unsupervised nondepository institutions and the purchase of non-Treasury 

securities inevitably carry substantial credit risk and have significant allocative consequences. Expansive credit initiatives infringe 

significantly on the fiscal policy prerogatives of Treasury and Congress and properly draw the scrutiny of fiscal authorities. 

Hence, expansive credit initiatives jeopardize central bank independence and should be circumscribed by agreement between the 

fiscal authorities and the central bank. 

Furthermore, an ambiguous boundary of expansive central bank 

credit policy creates expectations of accommodation in financial crises which blunts the incentive of private entities to take preventive 

measures beforehand to shrink their counterparty risk and their 

reliance on short-term finance. Moreover, an ambiguous central 

bank credit reach also blunts the incentive of the fiscal authorities 

to prepare procedures by which fiscal policy could act systematically and productively in times of financial crisis. 

The chaotic, reluctant involvement of Congress in the credit turmoil contributed to the financial panic and worsened the Great Recession, precisely because of the ambiguity about the boundary between Fed policy and the Congress. 

Such reasoning suggests the following three principles as the 

basis for a Treasury-Fed Accord for credit policy: first, as a longrun matter, a significant, sustained departure from Treasuries-only 

asset acquisition is incompatible with the Fed’s independence; second, the Fed should adhere to Treasuries-only except for occasional, 

temporary, well-collateralized, ordinary last resort lending to solvent, supervised depositories; and third, Fed credit initiatives beyond ordinary last resort lending, in my view, should be undertaken only with prior agreement of the fiscal authorities and only 

as bridge loans accompanied by takeouts arranged and guaranteed 

in advance by the fiscal authorities. 

Thank you. 

[The prepared statement of Dr. Goodfriend can be found on page 

40 of the appendix.] 

Chairman CAMPBELL. Thank you, Dr. Goodfriend. 

Next, we have Dr. Paul Kupiec, a resident scholar at the American Enterprise Institute. In the past, he has served as the chairman of the research task force at the Basel Committee on Banking 

Supervision. He was also the deputy chief of the Department of 

Monetary and Financial Systems at the IMF and a Senior Economist in the Division of Research and Statistics at the Federal Reserve Board of Governors. 

Welcome, Dr. Kupiec. You are recognized for 5 minutes. 

STATEMENT OF PAUL H. KUPIEC, RESIDENT SCHOLAR, 

AMERICAN ENTERPRISE INSTITUTE (AEI) 

Mr. KUPIEC. Thank you. 

Thank you. Chairman Campbell, Ranking Member Clay, and distinguished members of the subcommittee, thank you for convening 

5 

today’s hearing and for inviting me to testify. First, let me say 

these are my personal views and not the views of the AEI. 

Banking regulations can have important impacts on economic 

growth and financial stability. In the aftermath of the crisis, the 

government introduced sweeping changes in bank and financial 

market regulation, and today I will discuss the economic consequences of some of these changes. But before discussing them, let 

me first mention that the government housing policies that encouraged the housing bubble and triggered a financial crisis are still in 

place today. 

Let me move first to the qualified mortgage (QM) and ability-torepay (ATR) regulations that were issued by the Consumer Financial Protection Bureau (CFPB). They were intended to limit the 

risk of new mortgage originations and protect consumers from 

predatory lending. But the QM and ATR rules that went into effect 

in January do not accomplish these intended goals. They are reducing consumer access to mortgage credit without providing financial 

stability or consumer protection benefits. These rules raise compliance costs for originating mortgages, especially for smaller banks. 

New evidence has come to the fore which shows that community 

banks have decided to stop offering their customers mortgages because the business is no longer profitable. The impact of community bank withdrawal from mortgage lending will be especially 

large in rural markets and small towns that are not served by a 

large bank. 

Another issue in credit is fair lending enforcement. The regulators are using a new statistical approach for enforcing fair lending laws. In a nutshell, the enforcement approach creates an entitlement for bank credit to high-risk borrowers with protected characteristics. A so-called disparate impact enforcement standard will 

discriminate against high-quality borrowers because banks will be 

forced to pass the costs of lending to high-risk borrowers with protected characteristics onto their unprotected low-risk customers. 

Some legal scholars think that enforcement actions based on disparate impact will eventually be overturned by the courts. Still, the 

CFPB is making aggressive use of this policy, most recently in a 

high-profile action against an auto lender. 

As you know, the Volcker Rule is intended to ban banks from 

proprietary trading. However, restrictions in the Volcker Rule are 

causing unintended consequences for banks that own collateralized 

loan obligations (CLOs). Because many CLO pools include debt securities, and their senior tranches exercise limited power over the 

CLO manager, they appear to be inadmissible investments under 

the final Volcker regulations. 

If banks have to sell their CLOs, it is likely to impose significant 

costs on the banks, and it won’t provide any measurable gain in 

bank safety or soundness. The rule should be amended without 

delay to remove regulatory uncertainty and allow banks to retain 

their legacy CLOs. 

Moving to other powers that came under the Dodd-Frank Act, 

mandatory stress tests. There is no scientific evidence that supports the use of macroeconomic stress scenario simulations for the 

regulation of individual financial institutions, yet the Dodd-Frank 

Act imposes multiple new stress test requirements on large bank 

6 

holding companies. Stress test models have very limited accuracy 

for explaining individual bank historical profits and losses. Perhaps 

this is one reason the Fed keeps its stress test models a secret, 

even from the other bank regulatory agencies that are involved in 

the CCAR stress tests. 

The stress test requirement gives the Fed unchallenged power to 

exercise regulatory discretion over bank operations and shareholder property rights. The Fed can and has failed banks without 

providing the banks with the Fed’s projection methodology that 

predicts the bank’s future capital shortfall. The methodology remains a Federal Reserve trade secret. 

Bank regulators have also used systemic powers to stop banks 

from making high-yield syndicated loans. They argue that the 

loans are creating a systemic risk by fueling a bubble in high-yield 

mutual funds. If there is a bubble, stopping the supply of these 

loans would be the wrong policy. It would only drive yields lower, 

further distorting the price of credit risk, which would only make 

the bubble worse. 

Mutual fund investors are demanding high-yield floating-rate 

corporate loans as a rational response to the Federal Reserve’s continuing zero interest rate monetary policy and its announced plans 

to taper its QE purchases. The Dodd-Frank Act grants financial 

regulators broad new powers and responsibilities to prevent systemic risk without providing a clear definition of systemic risk. 

This ambiguity gives regulators wide latitude to exercise their 

judgment to identify firms, products, specific financial deals, and 

market practices that create systemic risk and impose new regulatory constraints, and regulators, especially bank regulators, are 

aggressively exercising this authority, both to designate non-bank 

firms as SIFIs over objections of other FSOC members and to direct bank lending decisions with the goal of altering investments 

made by mutual funds that they do not regulate. 

Indeed, non-bank SIFIs are being identified well before the Federal Reserve has revealed their enhanced prudential standards 

that will apply to these non-bank institutions. The FSOC can and 

has designated non-financial institutions as systemically important 

using only the most general of arguments. For example, in its designation decision, the FSOC is not required to explain the changes 

a newly designated institution might take to reverse the decision. 

Regulatory systemic risk powers and SIFI designation create 

enormous regulatory uncertainty for many private sector financial 

firms and Congress should act to limit this power. Thank you very 

much for the opportunity to testify, and I look forward to your 

questions. 

[The prepared statement of Dr. Kupiec can be found on page 51 

of the appendix.] 

Chairman CAMPBELL. Thank you, Dr. Kupiec. And by the way, 

without objection, all of your written statements will be made a 

part of the record, in case any of you are unable to finish. 

Next, Dr. Larry H. White is a senior scholar at the Mercatus 

Center and a professor of economics at George Mason University. 

He also serves as a member of the Financial Markets Working 

Group; previously taught at the University of Missouri, St. Louis, 

7 

and at the University of Belfast; and previously worked as a visiting scholar at the Federal Reserve Bank of Atlanta. 

Dr. White, you are recognized for 5 minutes. 

STATEMENT OF LAWRENCE H. WHITE, PROFESSOR OF 

ECONOMICS, GEORGE MASON UNIVERSITY 

Mr. WHITE. Thank you, Chairman Campbell, Ranking Member 

Clay, and members of the subcommittee. 

I think my written testimony in many ways complements that of 

Professor Goodfriend, in that I argue that the Federal Reserve’s attempts to direct the allocation of credit, especially since 2007, are 

an overreach that not only conflicts with independent monetary 

policy and the independence of monetary policy from fiscal policy, 

but it is also wasteful, it is inefficient, and it is fraught with serious governance problems. 

The Fed has traditionally had five main roles. Two of them are 

routine—clearing checks; and issuing paper currency—and three 

are more important—supervision and regulation of commercial 

banks; serving as a lender of last resort; and conducting monetary 

policy. Since 2007, and at its own initiative, the Fed has greatly 

expanded the range of its activities by undertaking unprecedented 

credit allocation policies that don’t fit into any of these traditional 

categories. 

A central bank that is already charged with these five tasks and 

is not excelling at all of them shouldn’t be expanding the range of 

its activities beyond them, so I think the Fed should be removed 

or should remove itself from the formulation and implementation 

of credit policy. 

Now, what I mean by credit policy is not only QE1 and QE3 that 

have been mentioned, but all the special lending programs that the 

Fed undertook during the financial crisis, ranging from dollar swap 

lines for foreign-domiciled commercial banks doing U.S. dollar business, to asset-backed commercial paper money market mutual fund 

liquidity facility, to bridge loans to JPMorgan Chase, to the Maiden 

Lane subsidiaries of the New York Fed. There is a long list in my 

written testimony, 22 programs in all. 

To the extent that these programs actually do affect the allocation of credit, they are more likely than not to have directed credit 

to less productive uses than would otherwise have occurred, even 

if Fed policymakers have the best of intentions. We have to consider the costs of these programs, which is to divert credit away 

from those who have been judged creditworthy in the market toward those who are favored by Federal Reserve policy, and when 

we throw good money after bad, when we lend money to insolvent 

institutions, we are not increasing the efficiency of financial markets, but the reverse. 

Now, the Dodd-Frank Act recognized a problem with the lending 

programs that were directed at specific institutions, and it imposes 

a restriction on the Fed to limit its lending in the future to broadbased programs. I think this is a step in the right direction. If this 

rule had been in place before 2010, though, it would have only 

ruled out about half of the credit allocation programs on the list. 

The logic of broadening credit programs leads to wanting the Fed 

to behave in the broadest way possible, and that means not lending 

8 

to segments of the financial market, money market funds here, 

credit broker-dealers here, and so on, but to the entire market, 

which is monetary policy, which is open-market purchases of Treasury securities to make more bank reserves available to where the 

market will allocate them. 

The QE1 and QE3 purchases of mortgage-backed securities have 

been defended as monetary policy, but they are not monetary policy. The purchase of securities is monetary policy, but the choice 

of mortgage-backed rather than Treasuries is not monetary policy, 

because it doesn’t affect monetary aggregates or things that depend 

on monetary aggregates. It is a credit allocation choice. 

And the Fed has, in fact, used interest on reserves to negate the 

monetary policy impact of the huge purchases of mortgage-backed 

securities. In my written testimony, I have a figure showing that, 

as the monetary base has spiked, M2 has just chugged along on a 

very smooth path, so the Fed has deliberately offset the monetary 

policy effect of these purchases. 

The targeted lending programs are not lender of last resort programs, as they have sometimes been defended. They don’t fit the 

classical criteria for lender of last resort, which is lending liquidity 

to solvent institutions. They have been lending or providing capital 

and boosting net worth for insolvent institutions. Traditional lender of last resort is for banks, and the special lending programs have 

extended it way beyond banks to other kinds of financial institutions. 

The bailout programs, of course, go way beyond that to the sort 

of thing that used to be considered the responsibility of the fiscal 

authorities. And the Fed, by paying interest on reserves, is, in effect, borrowing money and spending it the way the Fed sees fit, 

which is the description of a fiscal policy. Thank you very much. 

[The prepared statement of Dr. White can be found on page 71 

of the appendix.] 

Chairman CAMPBELL. Thank you, Dr. White. 

Next, Dr. Josh Bivens is the research and policy director at the 

Economic Policy Institute. He is the author of, ‘‘Everybody Wins, 

Except for Most of Us: What Economics Teaches About 

Globalization.’’ He is also a frequent communicator on many highprofile news outlets. 

Dr. Bivens, welcome. You are recognized for 5 minutes. 

STATEMENT OF JOSH BIVENS, RESEARCH AND POLICY 

DIRECTOR, ECONOMIC POLICY INSTITUTE 

Mr. BIVENS. Thank you. My name is Josh Bivens, and I am the 

research and policy director at the Economic Policy Institute. My 

remarks are just my personal views. I thank the committee members for the invitation to testify today. 

My remarks and my testimony are largely framed as responses 

to the concerns raised about the Fed’s quantitative easing program 

in the introductory memorandum for this hearing. Before moving 

on to some of those specific concerns, most of which center around 

threats to the Fed’s independence, I am going to just say a couple 

of words about useful ways to define that central bank independence. 

9 

I think for far too many in this debate, independence seems synonymous with putting very little or even zero weight on the maximum employment target that is part of the Fed’s dual mandate. 

And sometimes this demand for independence gets translated into 

an implicit demand that the Fed sort of always and everywhere 

lean against the stance of fiscal policy, and the presumption seems 

to be that most policymakers have an inflationary bias that will 

reap short-term gains in economic activity and employment, but 

only at the long-run cost of overheating the economy and sending 

up interest rates and prices. 

If you took this presumption as a given, then it would make 

sense that for a Fed that cared only about price stability, it would, 

indeed, always have to lean against what other macroeconomic policymakers, especially fiscal policymakers, are doing. 

And while there have been historical episodes where central 

bank independence was surrendered and bankers became excessively deferential to other policymakers’ desires for inflationary policy, that is just not what is happening in the U.S. economy today. 

Since the beginning of 2008, the U.S. economy has been plagued 

by a large shortfall in aggregate demand, a shortfall that has put 

downward pressure on prices and interest rates and has kept joblessness excessively high. In this kind of situation, pursuing stability of inflation and maximum output is not a delicate tradeoff. 

Both demand that all levers of macroeconomic policy try to push 

the economy back to potential by generating more spending from 

households, firms, and governments. 

Quantitative easing is one such lever. While long-term interest 

rates have generally been driven very low by the extraordinary economic weakness in recent years, interest rates low enough to drive 

a full employment recovery by themselves requires they be even 

lower, but they are hampered in this by the zero bound on shortterm interest rates. 

Through its forward guidance and quantitative easing programs, 

the Fed has aimed to push long-term rates even lower than the 

economic weakness has pushed them, and this policy action has led 

to higher rates of economic activity in employment and higher 

rates of inflationary expectations, which today is a good thing. 

How much have they contributed? There is a lot of uncertainty 

about just the precise degree of economic impact of the quantitative 

easing programs. There is almost no uncertainty that the direction 

is positive, that is the quantitative easing programs have surely 

pushed the economy in the direction of more activity and more employment. 

With this backdrop, I will move very quickly onto the three specific concerns raised in the introductory memorandum for this 

hearing. The first one is, has quantitative easing enabled higher 

government spending? The short answer is, it has not, and that is 

actually a bad thing. 

Between 2008 and 2010, it is true that fiscal policy and monetary 

policy generally pulled in the same direction, leading to expansion 

in the economy. This wasn’t a problem. This is what the economy 

needed. There is a huge shortfall in demand relative to productive 

potential. 

10 

Since then, however, the empirical fact is that Federal spending 

has slowed so much that it is now the slowest growth of Federal 

spending during any recovery of comparable length in postwar history. And the very slow growth of public spending overall can essentially explain entirely why economic growth in this recovery has 

been the slowest on record. 

So in summary, the quantitative easing programs have been associated in recent years with very slow, not fast, growth of spending, and we would have a much healthier economy today if that 

hadn’t been the case. 

The second concern raised in the memo was, have QE purchases 

of mortgage-backed securities disproportionately aided the housing 

finance sector? Yes, they have, but that is a perfectly appropriate 

response to the financial crisis accompanying the bursting of the 

housing bubble. This sector was extraordinarily impaired. A primary channel through which lower interest rates are supposed to 

help boost economic growth is through the mortgage refinance 

channel, and the impairment in the mortgage-backed security sector was impeding that channel, so I would say, yes, it is true that 

by targeting that sector, they were going after a sector that was extraordinarily impaired by the crisis, and that is exactly what they 

should have done. 

And then lastly, have regulations promulgated since the Great 

Recession provided an incentive for banks to favor certain asset 

classes over others? I would say, yes, they have, and, again, that 

is an entirely appropriate response to the crisis. The crisis was 

caused in large part because financial institutions took on too much 

leverage in far too little liquidity when they were unregulated in 

the run-up to it. 

Basically, the regulations mentioned in the memorandum require 

banks to hold a higher share of liquid assets on their books. A big 

problem with the crisis was that the assets which banks had were 

not liquid when markets went bad. Treasuries are very, very liquid, so regulations that encourage them to have a higher share of 

those on their books is a very good thing. 

I am happy to answer any questions from the committee, and 

thank you again for the invitation. 

[The prepared statement of Dr. Bivens can be found on page 28 

of the appendix.] 

Chairman CAMPBELL. Thank you, Dr. Bivens. And I thank all 

four members of our panel of doctors today. 

I now recognize myself for 5 minutes for questioning. And in 

these hearings, I always like to pursue it when I hear something 

I hadn’t necessarily heard before—we had a hearing a month or so 

ago on how QE was affecting international finance, where a group 

of people, which may have included one of you, talked about the 

fragile five and how we were creating instability in Turkey and Argentina and, boom, about 3 weeks later, said instability showed up. 

Something I heard today from Dr. Goodfriend and Dr. White that 

I haven’t heard before or if I have heard it, it went in one ear and 

out the other, which is entirely possible, is that what we see the 

Fed doing, ranging into credit policy or credit allocation, as you 

have suggested, and various other things, actually threatens the 

Fed’s independence, or is incompatible, as you said, Dr. Goodfriend. 

11 

You would think that it would be logical to assume that when 

the Fed does other things that is showing their independence, rather than threatening or being incompatible with their independence. 

So would either of you like to expound on why this thing, which 

seems counterintuitive, is what you believe to be the case? 

Mr. GOODFRIEND. I will start. So you are right, Mr. Chairman. 

If the Fed pursues expansive actions, it demonstrates its power to 

do things independently. And if you didn’t understand the difference between credit policy and monetary policy and the boundaries that Larry and I have been describing, you might think that 

is a good thing. 

But Congress grants the Fed’s independence grudgingly, and 

only because monetary policy can be independently monitored and 

because monetary policy, as I describe it, does not involve fiscal 

policy at all. And so, let me revisit this issue and describe why. 

Monetary policy is about changing currency and bank reserves in 

the economy. The assets that the Federal Reserve acquires to 

change currency and bank reserves are immaterial for monetary 

policy to work. So the Fed can acquire Treasury securities in expanding the money supply, currency and reserves. And when the 

Fed buys Treasury securities, it simply returns all the interest that 

the fiscal authorities give it back to the Treasury to spend as they 

see fit. 

So, monetary policy is really beautifully suitable for delegation to 

an independent central bank because it separates monetary and 

fiscal policy very well. 

When the Fed expands policies in the credit direction, it really 

has nothing to do with monetary policy, per se. Why? Because credit policy is a policy where the Fed sells Treasury securities, it takes 

the money that it gets and immediately puts the money back into 

circulation without changing the quantity of money in order to 

channel credit to distressed or favored borrowers, financed by the 

sale of Treasury securities from its portfolio. 

Now, the trick about credit policy is that when the Fed is holding 

those Treasury securities, the interest that it earns from the Treasury is simply round-tripped back to the Treasury. So when the Fed 

sells Treasuries in order to take the funds and allocate those funds 

somewhere else, it is exactly as if the Treasury issued new securities, took the cash, and made loans. 

Chairman CAMPBELL. Okay, I get that. Why does it make them 

less independent? Or why is that incompatible or threatening? 

Mr. GOODFRIEND. Because credit policy is a fiscal policy action 

that is not essential for the Fed to do monetary policy, which is its 

primary mission, and there is no way to do a credit policy action 

without favoring one particular group or another. You have to 

make a loan to somebody or some sector, and so credit policy is a 

matter for public policy, for the due process of law under the Congress, to decide who should get the loan and who shouldn’t. 

Chairman CAMPBELL. I want to make sure Dr. White has some 

time. 

Mr. WHITE. Yes, some Fed officials have suggested that criticizing the Fed’s lending decisions during the crisis are challenges 

to its independence, but the principle of independence applies to 

monetary policy, not to fiscal policy. So it doesn’t challenge the 

12 

Fed’s traditional independence to conduct monetary policy when 

people want to know what the Fed has done, who it has lent to, 

even when they want to audit the Fed’s lending programs, because 

then the Fed is straying into fiscal policy. 

So we don’t want backseat-driving of monetary policy, right? But 

we do need oversight when the Fed is lending to some people and 

not to other people, especially when it is lending to insolvent institutions, especially when we have the governance problems that we 

see at the New York Fed. 

Chairman CAMPBELL. Okay, thank you. My time has expired. Dr. 

Bivens, I will be interested in your viewpoint on this, but it will 

have to be in later questioning or whatever, because my time has 

expired. 

I now recognize for 5 minutes the ranking member, the gentleman from Missouri, Mr. Clay. 

Mr. CLAY. Thank you, Mr. Chairman. 

Dr. Bivens, in his testimony today Dr. White wrote that it is desirable to retain member banks’ influence for the sake of monetary 

policy, because Reserve Bank Presidents as a group have a better 

track record in Federal Open Market Committee (FOMC) voting 

than do members of the Board of Governors. 

In your view, how would further empowering the influence of the 

regional banks in FOMC decision-making affect policy outcomes 

and Federal Reserve independence? 

Mr. BIVENS. I think as an empirical matter, we definitely disagree on who has the better voting record on Federal Open Market 

Committee decisions. From my perspective, the Board of Governors, the Members of the Board of Governors have consistently 

been more aggressive in pursuing the maximum employment part 

of the mandate in recent years, which is the appropriate way to go. 

And I think as a more structural matter, I would say the one 

case where I think there is some real worry about Federal Reserve 

independence is the influence of the financial sector on their decisions. If you look at the regional Federal Reserve Bank Presidents, 

they are largely chosen by the commercial banks in their districts, 

so anything that provides them with more authority and more 

sway over the decisions of the FOMC will be surrendering even 

more Federal Reserve independence to the desires of the financial 

sector. 

So as an empirical matter, I don’t think the regional Fed Presidents have done a better job at responding to the crisis, and I think 

as a structural matter, that would actually be moved backwards if 

you were actually concerned about Federal Reserve independence. 

Mr. CLAY. How might further empowering the regional banks’ influence affect the Fed’s focus on the employment part of its dual 

mandate? 

Mr. BIVENS. There are two reasons. One, I think, again, empirically, it is just a fact that the regional presidents have seemed 

much more concerned about the price stability part of the mandate 

in recent years, which I think is the wrong part of the mandate to 

be overly concerned about. To me, the maximum employment mandate is the bigger one. 

And just as a central fact, the financial sector has an interest in 

very low rates of inflation that sometimes conflicts with other secVerDate Nov 24 2008 12:13 Sep 04, 2014 Jkt 088532 PO 00000 Frm 00018 Fmt 6633 Sfmt 6633 K:\DOCS\88532.TXT TERRI
13 

tors’ desire for pursuing maximum employment. And so anything 

that gives a louder voice to the concerns of the financial sector in 

setting Open Market Committee decisions I think would be a bad 

thing. 

Mr. CLAY. And in your testimony, you note that it is too bad that 

the Fed’s QE actions have not encouraged higher levels of Federal 

spending. You also wrote that very slow rates of Federal spending 

are the primary reason why at this stage in the recovery, demand 

remains so muffled. How might additional spending today impact 

the short- and medium-term macroeconomic outlook? 

Mr. BIVENS. We still have a very large shortfall of aggregate demand relative to productive capacity in the economy. Demand is 

too low, and to reduce that gap, we need more spending. I think, 

for example, a large package of infrastructure investments would 

go a long way to boosting employment in the short run, and boosting productivity in the long run. And then something that has fallen off the radar, which is too bad, extending the unemployment insurance extended benefits would provide a good economic boost in 

the next year, as they increase spending, it would provide real relief to people who need it. 

Mr. CLAY. If the Congress and the Fed push stimulative policies 

at the same time, is there any inherent reason this would call the 

Fed’s independence into question? 

Mr. BIVENS. Not as long as the economy remains so weak that 

the inflation rate that we now see is well below the Fed’s, I would 

argue, probably too conservative target and joblessness remains 

high. Theoretically, there could be a point where recovery was 

reached, unemployment was very low, inflation started rising off 

the charts. In that case, independence on the part of the Fed would 

require they start to reduce their stimulus, but starting from today, 

no, a coordinated response to push joblessness lower and try to 

meet the inflation target from below would be a good thing. 

Mr. CLAY. Thank you for your responses. 

Dr. Goodfriend, would you consider full employment monetary 

policy or fiscal policy? 

Mr. GOODFRIEND. Full employment is an aggregate condition, 

and in general, you need an aggregate policy to pursue it. And 

monetary policy is an aggregate policy that affects the general level 

of interest rates. Credit policy favors necessarily lending to one 

group or one sector of the country. So credit policy is not going to 

be a suitable policy to achieve full employment for the country as 

a whole. 

Mr. CLAY. Thank you. And, Mr. Chairman, I yield back. 

Chairman CAMPBELL. The gentleman yields back. 

We will move now to the vice chairman of the subcommittee, the 

gentleman from Michigan, Mr. Huizenga, for 5 minutes. 

Mr. HUIZENGA. Thank you, Mr. Chairman. 

The ranking member started down a path that I am curious 

about, and, Dr. Bivens, I would like you to clarify for me, because 

I heard the word in your testimony ‘‘entirely,’’ government growth 

is entirely the reason—or lack of government growth is entirely the 

reason why we have a slow economic recovery right now. Is that, 

in fact, what you believe or what you said? 

14 

Mr. BIVENS. I probably said it. I might say almost entirely, but 

more than 90 percent. If you sort of look at the gap in growth at 

this point in the recovery compared to all other postwar recoveries, 

and then you look at the impact of government spending on that 

growth, the slow government spending at all levels—I said that 

pretty specifically in the testimony—can explain almost entirely 

the gap. 

Mr. HUIZENGA. So if we had simply doubled our level of stimulus 

spending, we wouldn’t be where we are at? 

Mr. BIVENS. Doubled, that is about right. 

Mr. HUIZENGA. Okay, so we needed to go $1.8 trillion in debt in- stead of $900 billion more in debt, and then we would have been 

okay? 

Mr. BIVENS. We would have been much closer to a full recovery. 

And it should have been spread over years. The problem with it 

right now— 

Mr. HUIZENGA. And have you looked at long term what an additional trillion dollars on our long-term debt would have been in the 

interest rate situation that we are at? 

Mr. BIVENS. Yes, interest rates will begin to rise when we reach 

full recovery and not before. So basically, if we had done the degree 

of spending needed to push us back to recovery, we would have 

higher interest rates today, and that would be a sign of recovery 

for— 

Mr. HUIZENGA. Are we doing anything, though, to then mitigate that—what would be $18.5 trillion in debt instead of $17 trillion 

in debt for our long term? Because, hey, I pay attention to the Fed, 

too, and the Fed has said that interest rates are going to be going 

up. At some point or another, we have to service that debt, not 

through artificially low interest rates through QE, but through actual market rates. 

And I think as Dr. Goodfriend was pointing out, on page 3 of 

your testimony, you skipped over the part about the 1951 agreement where—the sentence that you did not use is the Fed officials 

argued that keeping interest rates low would require inflationary 

money growth that would destabilize the economy and ultimately 

fail. 

That is where my concern is, because the shovel-ready jobs from 

the first tranche of $900 billion weren’t so shovel-ready. The key, 

as I understand it, is we have to return to private sector productivity, not government sector productivity, to build and sustain true 

wealth. And what I hear from business owners and from those that 

are those private sector productivity makers is uncertainty with 

their health care costs, uncertainty what is going to be happening 

with their unemployment obligations, their tax uncertainty, their 

regulatory uncertainty. 

These policies—in addition to what the Fed has done to drive 

more activity into the stock market, which then gives them more 

incentive to play on Wall Street than it is to buy equipment or hire 

people, is what has stalled out a lot of that recovery. 

So I would appreciate your take on this, Dr. Goodfriend, especially, as you had sort of kind of gone through that. 

Mr. GOODFRIEND. I would distinguish the Fed’s policy actions in 

the wake of the credit turmoil in the following ways. In the turmoil 

15 

itself, the Fed’s expansive policy was called for because the economy was collapsing. Later, you get QE1, QE2, QE3. QE1, okay. 

QE2, not so—I wasn’t so favorably disposed to QE2. And QE3, I 

thought was premature and unnecessary, and I think the fact that 

the Fed pulled the plug rhetorically within 6 months indicated that 

they found that it was premature and unnecessary, as well. 

Mr. HUIZENGA. Does anybody else believe that if we had simply 

doubled our stimulus spending, we wouldn’t be where we are at 

economically? 

Mr. GOODFRIEND. I would not want to take that bet. 

Mr. HUIZENGA. Dr. White? 

Mr. WHITE. No, I don’t think so. 

Mr. HUIZENGA. Dr. Kupiec? 

Mr. KUPIEC. I would offer that we got into the problems we got 

into because we had very much a bubble in the housing markets. 

And to use credit policy to try to stimulate housing markets, we are 

back to the same policies that caused the bubble, so it is very much 

in line with the fact that the use of credit policy can distort the allocation of resources. 

Mr. HUIZENGA. My fear is that we are whitewashing the longterm effects here. My fear is that these are serious financial instruments that affect the global economy, whether it is the fragile five, 

as the chairman has talked a bit about. We are in uncharted 

waters here, and we are not selling cupcakes, you know? This is 

serious stuff that affects the global economy. 

And how we are going to unwind this, I think, is my biggest fear 

and question that I have, so—and I have run out of time. And we 

need to double these to—just like Dr. Bivens, maybe we need to 

double our question time, Mr. Chairman, so we can really get at 

the heart of this. So with that, I yield back. 

Chairman CAMPBELL. I will take that up with the House majority leader and the chairman of the committee. 

The gentleman from Illinois, Mr. Foster, is recognized for 5 minutes. 

Mr. FOSTER. Thank you all for your testimony here. Just a quick 

yes-or-no question for all four witnesses. If you were in charge of 

management of the financial crisis in October of 2008, would you 

have let the money markets collapse? Just give a quick yes-or-no 

answer. 

Mr. GOODFRIEND. No. 

Mr. KUPIEC. No. 

Mr. WHITE. I am not sure what not letting the money markets 

collapse would have meant, but— 

Mr. FOSTER. Extraordinary support necessary— 

Mr. WHITE. —no, of course, we don’t want the money markets to 

collapse. 

Mr. BIVENS. No. 

Mr. FOSTER. No, okay. And so is this—it seems to me that is allocation of credit to a specific sector in trouble, and so that is not an 

absolute principle with any of you here. In fact, you acknowledge 

there are times when adults in the room have to allocate credit to 

segments of the industry that are in trouble, despite the moral hazard? Okay. Thank you. That is not a universally held point of view 

16 

around here, and it got our economy into a tremendous range of 

difficulty. 

Now, during the financial collapse and the extraordinary accommodation in response to it, many of my colleagues on the right routinely predicted runaway inflation. You saw talk about debasing 

our currency and so on. And in terms of the runaway inflation, 

which I think we have not seen in the 5 or so years since then, how 

could they have been that wrong? And if we just go down the line 

and understand why the predictions of runaway inflation that we 

heard so much were so wrong. 

Mr. GOODFRIEND. We had—the typical model of money supply in 

the textbooks that uses a money multiplier which says, for every 

$1 of reserves the banks have, they create $10 of money. That is 

the way the world worked, as long as—this is a little technical— 

the interbank interest rate was above zero and interest on reserves 

was zero, so there was an opportunity cost of holding reserves so 

that banks had a fraction of reserves that they would hold against 

their money. 

Now, what happened when the Fed dumped reserves into the 

system was the interbank interest rate went to zero, which was the 

interest on reserves. In the jargon of academics, there was a zero 

opportunity cost of holding reserves. We hardly ever see that. And 

so people who aren’t taking money and banking, my class, they are 

not going to notice that, but that is what happened. 

The Fed, by dumping so many reserves in the system, created a 

zero opportunity cost environment, and the banks just held their 

reserves. The last time we saw anything like that was in the 1930s. 

So I forgive people who kind of didn’t catch what the Fed was doing 

and what would happen. 

Mr. FOSTER. Yes. Dr. Kupiec? 

Mr. KUPIEC. I would just like to add to that, it was worse than 

that, because they pay them 25 basis points on holding the reserves. 

Mr. GOODFRIEND. Yes, that is true. 

Mr. WHITE. Yes, so I think that is right. If you just look at the 

monetary base and see it double and triple the Fed’s balance sheet, 

that is, then you think high inflation is coming, but you have to 

recognize that the Fed has sterilized those injections it is paying 

on those reserves. 

Mr. FOSTER. Yes, so you would generally attribute— 

Mr. WHITE. I just said attribute them to— 

Mr. FOSTER. Right, so you would attribute the failure of those on 

the right to correctly anticipate the fact that there wasn’t runaway 

inflation to a lack of economic sophistication, roughly speaking? 

Mr. WHITE. On the right and on the left, yes. 

Mr. FOSTER. Okay. Those on the left, I think, did not share this 

mania about runaway inflation. Dr. Bivens, do you have a diagnosis of this failure to understand the problem? 

Mr. BIVENS. Yes, I think inflation remains so low despite those 

predictions because people totally overestimated how quickly the 

economy would recover. We still have a deeply depressed aggregate 

demand in the economy. That is what is keeping prices low. 

I just don’t buy that a quarter percent interest rate on reserves 

is what is keeping all those reserves from flying out into the econVerDate Nov 24 2008 12:13 Sep 04, 2014 Jkt 088532 PO 00000 Frm 00022 Fmt 6633 Sfmt 6633 K:\DOCS\88532.TXT TERRI
17 

omy. What is keeping prices low is the enormous gap between potential supply and demand in the economy even today. 

Mr. FOSTER. Okay. Now, in terms of the housing market, the 

enormous intervention—if you look at the history of housing bubbles, when they burst, they often undershoot, so that if you look at 

the long-term trend line of house prices, a bubble develops, and 

then the prices crash, and they actually go below the long-term 

trend line, which is tremendously destructive to families and the 

economy as a whole. 

And so the timing of the massive intervention in the big volume 

mortgage-backed securities and so on had the effect, whether intended or not, of actually flattening out housing prices along their 

long-term trend line, which is where they have to return. 

And I was wondering if you had comments on whether this actually ended up—the fact that housing prices have steadied down on 

their long-term trend line, whether this is actually a correct and 

good result of the massive intervention, in terms of the housing 

market? 

Mr. GOODFRIEND. I would start by saying the question in my 

mind is, what is the policy vis-a-vis housing in the future? Because 

subsidizing or directing credit toward housing is taking it away 

from other sectors. I want to turn it over to Dr. Kupiec in a minute, 

but I am worried that the housing policy, should it continue, is 

draining credit from other sectors where we would get more productive capital. 

Mr. KUPIEC. I would agree with that. I think that when you try 

to figure out what the long-term trend in housing would have been, 

you have to take out all the growth that happened with the bubble 

before. Housing was way overpriced. There was way too much investment in housing for a number of reasons—financial policies, 

tax policies, and housing. The building of housing creates new 

GDP, but after that, it is not a productive tradable good. 

Mr. FOSTER. Okay, now would— 

Chairman CAMPBELL. The gentleman’s time— 

Mr. FOSTER. I will yield back. 

Chairman CAMPBELL. —has expired. Thank you. 

Now, we will move over here to the gentleman from New Mexico, 

Mr. Pearce, who is recognized for 5 minutes. 

Mr. PEARCE. Thank you, Mr. Chairman. And I appreciate each 

one of your testimonies. 

I guess I would start with Dr. Goodfriend. My question is actually sort of a follow up to Mr. Foster’s questions about the speculations of what was going to happen to inflation based on the creating of money kind of out of thin air. What would happen if the 

United States is removed as the world’s reserve currency? What 

would happen to inflation with all these printed dollars out there 

that have yet to be pulled back in? 

Mr. GOODFRIEND. If— 

Mr. PEARCE. Dr. Kupiec, I will follow up with you, too. 

Mr. GOODFRIEND. —the United States loses its status as a reserve currency country, essentially that means in practice that 

holdings of dollar-denominated Treasury securities abroad, which 

are the vehicle by which the dollars are held, would be returned 

to the United States. There would be a big depreciation of the exVerDate Nov 24 2008 12:13 Sep 04, 2014 Jkt 088532 PO 00000 Frm 00023 Fmt 6633 Sfmt 6633 K:\DOCS\88532.TXT TERRI
18 

ternal value of the dollar. In other words, the currency would depreciate on foreign exchange markets, and that would create inflation at home. 

Mr. PEARCE. I will just let each one of you comment on that. 

Mr. KUPIEC. I agree with that. We get enormous benefits vis-avis the rest of the world, because we have reserve currency status. 

Mr. WHITE. I would agree with those two statements that the 

danger is a collapse in the exchange value of the dollar. 

Mr. PEARCE. Dr. Bivens? 

Mr. BIVENS. I think the reserve status also hurts us by keeping 

the dollar too strong. We have very large trade deficits and have 

for a long time, and that is because the dollar is too strong to balance our trade, and so there would actually be a countervailing 

benefit of we would get some export growth if we actually had less 

demand for foreign reserves of our currency. 

Mr. PEARCE. What would happen to the value—what would happen to inflation, in your opinion, if we are removed? 

Mr. BIVENS. There would definitely be upward pressure on inflation. It would not be mammoth. We only import 15 percent to 20 

percent of our GDP, so there would be an increase in import prices, 

but actually I think we need higher inflationary expectations, so it 

is hard for me to see that as a catastrophe. 

Mr. PEARCE. We need higher inflationary expectations? That is 

somewhat curious. I represent one of the poorest districts in America, and inflation hurts the poor worse than anybody else. And so 

basically, these policies which are being implemented are devastating to the retirees and to the poor. The zero interest rate is 

helping Wall Street on the backs of the retirees who tell me in my 

town halls, ‘‘We have lived our lives correctly, we paid for our 

house, and we saved money, and we have money in the bank.’’ Retirees typically have less sophisticated investment instruments. 

And so, that is a curious statement. 

In a previous hearing, that effect on seniors and the poor was 

called collateral damage that has to just be acceptable, and I sort 

of disagree with that, because, again, these are people’s lives. 

But I think that this whole idea that we can export inflation to 

200 other countries, we can export this fabricated money to 200 

other countries is one that, I think, holds alarm. And then you get 

the additional effect that other countries now are beginning to respond in kind, so they are beginning to create their own currencies, 

too. If it is good for us, and it seems like that the people who really 

strongly favor this quantitative easing policy, they don’t have an 

answer when you ask, if it is okay for us, it ought to be okay for 

Japan and the other countries. 

I was interested in Dr. Bivens’ comment on page nine, and so I 

was wondering if maybe, Dr. Kupiec, if you have some comment 

about it, but he makes the point that—because the sector was so 

impaired by the burst housing bubble and resulting financial crisis, 

and because QE works best when focused on impaired markets, I 

think this was economically appropriate thing to do, and that is the 

buying of MBS certificates. Is that the same perception that you 

would have? Is Would you agree with that particular take on the 

matter? 

19 

Mr. KUPIEC. I view the need to support housing after the housing 

bust as sort of a political constraint on the system. From a purely 

economic standpoint, we had too much investment in housing, and 

housing prices were too high before the crisis. And the need to try 

to create a recovery in housing was a purely political need at the 

time. But long term, more emphasis on investing in housing is 

probably not the right way to create new GDP growth. 

Mr. PEARCE. Okay. Thank you, Mr. Chairman. My time has expired. 

Chairman CAMPBELL. The gentleman’s time has expired. 

The gentleman from Michigan, Mr. Kildee, is now recognized for 

5 minutes. 

Mr. KILDEE. Thank you, Mr. Chairman. 

And thank you to the witnesses for being here today. This is obviously an important hearing, and one that I thank the Chair for 

calling. 

So today’s hearing—while it concerns the independence of the 

Fed in its role in credit allocation, I do want to just focus in on— 

I have been here a year-and-a-half, that Chairman Bernanke in his 

role did come to Congress several times, referencing the independence of the Fed, imploring this Congress to fulfill its role in 

strengthening the economy and supporting the economy and dealing with our set of responsibilities regarding the important mandates that also relate to the role of the Federal Reserve. 

And although while there were lots of folks here in Congress who 

were ready to act, and, in fact, structurally Congress, even before 

my arrival, had sort of set in motion an effort that was purported 

to create a condition that would force Congress to act, creating the 

sequester, the fact is that somewhere along the way, there were 

some who simply embraced that policy. And obviously, from the 

perspective of many, that has weakened economic growth. 

The point being that the Fed took some of the few steps that it 

could to improve the economy, holding down interest rates, and 

then pursuing the purchase of Treasury and mortgage-backed securities. And now that the economy is improving, as it said it would, 

the Fed is reducing those security purchases. 

In many respects, it appears to me that the Fed stepped in to 

address a number of the challenges that were not confronted as 

they should have been by Congress. So while some question the 

independence of these actions because the Fed stepped in when 

Congress would not or did not, and because the Fed basically directed these actions, and they did have, in fact, by most accounts, 

positive outcomes, it does feel a tad disingenuous to me that because Congress was unwilling to do its job, one could presume that 

nobody else should do theirs or use the tools that are available to 

them to deal with the weakness in our economy. 

In particular, I am concerned about this, because I think too 

often we tend to look at data, particularly economic data, on a national scale and completely aggregate it. I represent an older industrial corridor that includes cities like Flint, Saginaw, and Bay City, 

Michigan, which even during periods of economic growth and expansion have not experienced that growth and expansion, so I am 

particularly concerned, and I would ask Mr. Bivens and perhaps 

others to comment on actions that you think, from the standpoint 

20 

of the Federal Reserve, the Fed might take in order to promote economic growth and development in places that have not experienced 

growth even during those periods of economic expansion, the 1990s 

being a good example? Could you specifically address policies that 

you think the Fed might pursue in that regard? 

Mr. BIVENS. In that regard, I think that the best thing the Fed 

can do is actually to focus on the aggregate national labor market 

and to not withdraw support from boosting employment and economic activity until there is something like genuine full employment. 

I think even the Fed’s decision to begin tapering its purchases 

is a worrisome signal to me that mostly because of political constraints, they are going to sort of take the foot off the accelerator 

a little prematurely and that is going to keep the recovery from 

reaching really deep into distressed communities. 

I think other policymakers are much better positioned to do targeted interventions. To me, the Fed can set the overall conditions 

to make sure the overall economy and labor market is as strong as 

possible, and then if there are still pockets of distress, I think that 

is actually a case for other policymakers to step in. 

Mr. KILDEE. So even in the event where other policymakers are 

either unwilling or unable in the—does the Fed have tools? Because to me, it seems that in order to meet the mandates of the 

Fed, looking at the aggregate data is obviously important, but it is 

sort like the old line about an economist: If your head is in the 

freezer and your feet are in the oven, but on average you feel fine, 

you should leave things alone. I represent one of those communities 

in the freezer. And I am just curious as to whether you think the 

Fed has specific tools that could be targeted for those sorts of 

places. 

Mr. BIVENS. I actually don’t think the Fed has very good tools 

for targeting sort of pockets of distress when the overall economy 

is generally doing okay. It is too bad, but I actually don’t think that 

they really have the right tools for that. 

Mr. KILDEE. Thank you. 

Chairman CAMPBELL. The gentleman’s time has expired. 

We will now move to the gentleman from South Carolina, Mr. 

Mulvaney, who is recognized for 5 minutes. 

Mr. MULVANEY. Thank you, Mr. Chairman. I have a couple of different questions on a couple of different topics. 

I was having a conversation with a friend of mine at Heritage 

the other day about whether or not the Fed was fixing the price 

of money, fixing the price of debt through fixing an interest rate. 

So let see if I can bring any clarity to this discussion, if you have 

any thoughts on this: If QE was to go to zero tomorrow, if they 

were to simply stop quantitative easing tomorrow, do you gentlemen have any opinions as to what the yield would be on the 1-year 

Treasury? The last couple of weeks, it has stayed pretty stable at 

about 12 basis points. Have you given any thought to that topic as 

to what would happen—what we would have to pay to borrow 

money in this country if the Fed wasn’t providing us essentially 

with all of our debt through QE? 

Dr. Goodfriend? 

21 

Mr. GOODFRIEND. I think as a technical matter the Fed could 

stop QE tomorrow. And because it can promise within the 1-year 

timeframe and because its promise is credible to keep the Federal 

funds rate near zero, that 1-year rate would not move. 

Mr. MULVANEY. What about the 3-year? 

Mr. GOODFRIEND. Now, you are getting interesting. The 3-year 

might move and, of course—and I believe that the Fed would have 

relatively little control over rates 4, 5, 6 years and beyond. I do 

think that the Fed is overselling its ability to manage longer-term 

interest rates today with its so-called forward guidance and QE. I 

agree with you. 

Mr. MULVANEY. Interesting. If they were to not give any forward 

guidance, or if the forward guidance was that QE has ended and 

we are not going to do it anymore, would that impact the 1-year? 

Mr. GOODFRIEND. I don’t think so, just because it is short enough 

that, again, the Fed’s promise on the overnight so-called Federal 

funds rate is credible at 1-year horizon. 

Mr. MULVANEY. Anybody else on that topic? Dr. Bivens? 

Mr. BIVENS. I think it would have really modest effects on—especially even long-term rates, but especially short-term, for two reasons. One, I actually don’t—and most of the empirical estimates of 

what QE has done to long-term rates, they are pretty modest. The 

reason why long-term rates are extraordinary low in historic perspective, it is just because the economy is so weak. 

And then I would also say, there are two countervailing impacts 

of QE on interest rates. Part of a long-term interest rate, it is the 

sum of inflationary expectations, expectations about what the 

short-term rate is going to do, and then the term premium. But if 

people think inflationary expectations are a little higher because of 

QE, if people because of the QE and forward guidance combined 

think short-term rates are going to stay low for a long time, I 

think—and if you reverse that, I think both those could put upward 

pressure, it would be very modest effects on interest rates if we 

just stopped QE tomorrow. 

Mr. MULVANEY. Okay. I guess in a roundabout sort of way, that 

ties in to my next question. I want to come to what Dr. White mentioned in his testimony, and also went into more detail in his written testimony about the differences or the comparison, I guess, the 

juxtaposition between the monetary base and M2. And I have not 

read anybody else saying this, that really what the Fed is doing is 

using its monetary tools to effectuate fiscal policy, that they have 

manipulated the monetary base through QE, but they are sucking 

the money back out of the system through the interest rates they 

pay on excess reserves. 

Dr. White, is it appropriate for the Federal Reserve to be—let me 

ask it this way. Dr. Bivens, do you agree with Dr. White that the 

Fed is exercising fiscal policy in this particular circumstance? 

Mr. BIVENS. I don’t. 

Mr. MULVANEY. If they were, would that be appropriate? Could 

we agree that they shouldn’t be doing fiscal policy? This goes back 

to Mr. Kildee’s question, and I think what you were getting at is 

that you can’t get at specific sub-pockets, specific communities, specific parts of the economy through monetary policy. That is the role 

of fiscal policy. That is correct? 

22 

Mr. BIVENS. I think that is fair to say, yes. 

Mr. MULVANEY. And I think we can generally agree across both 

sides of the aisle that the Federal Reserve should not be doing fiscal policy. That is our job. Is that an accurate statement? 

Mr. BIVENS. I would—yes, I would say that. I would also say it 

is impossible to think of a completely allocatively neutral monetary 

policy. So just the fact that there are allocative implications of the 

Fed doing something does not automatically mean it is not monetary policy. 

Mr. MULVANEY. And that is what I want to go back to Dr. White 

on, because I have seen the graphs you have provided. I have read 

your testimony. And here is my question. Is it—you think they are 

doing—you would think they are doing it on purpose. What you 

have suggested is that they are using their monetary tools to effectuate fiscal policy. Defend that against somebody who simply says, 

it looks like that on paper, but really this is just an accident, we 

are exercising monetary policy that might look on a graph like it 

is fiscal policy, but we are actually not exercising fiscal policy. So 

defend your position a little bit more if you would, please. 

Mr. WHITE. If the Fed were borrowing money by issuing bonds 

that were IOUs of the Federal Reserve System and paid interest, 

and then used the proceeds to, say, subsidize development in 

Michigan, I think everybody would agree that is a fiscal policy. 

Mr. MULVANEY. Yes, sir. 

Mr. WHITE. The way the Fed is borrowing money is not by 

issuing bonds, but by paying interest on bank reserves, which 

amounts to the same thing. It is a different way of borrowing 

money. And then they have used the proceeds not to promote development in Michigan, but to promote housing development, to buy 

mortgage-backed securities, pump their prices up, and that is directing it to one sector of the economy and not the economy as a 

whole. 

Mr. MULVANEY. And I wish we did have a chance to talk more 

about credit allocation, because one of the things that you and I 

have talked about, Mr. Chairman, is really what we think they are 

doing is allocation—they are practicing credit allocation, and one of 

their favored areas is government, and they are making it easier 

for us to borrow money, just like they are propping up the prices 

of mortgage-backed securities, but we won’t get that chance today. 

Thank you, Mr. Chairman. 

Chairman CAMPBELL. Thank you. 

Moving up the road a little bit to North Carolina, Mr. Pittenger 

is recognized for 5 minutes. 

Mr. PITTENGER. Thank you, Mr. Chairman. And I thank each of 

you for being here. 

Chairman CAMPBELL. Wait. He lives south of you? 

Mr. MULVANEY. The State runs— 

Chairman CAMPBELL. Okay, don’t confuse me with these things. 

Yes, we are starting the 5 minutes over again for Mr. Pittenger, 

who lives in North Carolina, which is south of South Carolina, apparently. 

Mr. PITTENGER. I have to think about that one. Thank you, Mr. 

Chairman. 

23 

Dr. White, do you think the government has taken advantage of 

the low interest rate environment to run larger deficits than it otherwise would have? 

Mr. WHITE. I don’t see any evidence that Congress looks at the 

interest rate on Treasury bills before it decides the size of the deficit to run, but maybe I am wrong about that. 

Mr. PITTENGER. All right. Dr. Kupiec, this committee has focused 

extensively on the QM rule and how it affects consumers and lending institutions. Dr. Kupiec, you stated the following: ‘‘The QM rule 

on its own does not seem to force a particular lending outcome. A 

bank can impose underwriting rules stricter than those specified in 

the QM rule and underwrite only high-quality mortgages. The 

problem with this strategy is that such an underwriting rule risks 

fair lending legal challenges.’’ 

What are your concerns regarding the QM rule? Are there things 

that this committee should consider doing to reaffirm a non-distorted allocation of credit? And what steps would those be? 

Mr. KUPIEC. As I discuss at length earlier in my testimony on 

the QM rule, it imposes a scorecard- or model-based approach to 

underwriting mortgages that is typically not the approach used in 

community banks. In many small community banks, loans are 

made on a relationship basis, where the bankers are familiar with 

the people in the community and what they do, and they don’t have 

a very model-driven computer, data-driven approach to lending. 

And what the QM rule does is, the QM rules makes them adopt 

these type of approaches, which are expensive, and the extra expense of making mortgages originations is they just can’t cover it 

in small markets, so it is really forcing small community banks in 

more rural areas and towns out of the mortgage market. They are 

not making mortgages for their customers, and there is some recent evidence in a survey just out in February that a significant 

share of banks are just getting out of the business. 

Mr. PITTENGER. Correct. Can you give some other examples outside of QM where the U.S. regulatory policy has begun to influence 

how credit is allocated in our economy? 

Mr. KUPIEC. There has been this new phenomenon where the big 

Federal banking regulators have stopped some of the banks from 

making syndicated loans. And this is kind of unusual, because they 

are stopping specific syndicated loan deals on the premise that 

these loans are part of a credit bubble that is fueling a bubble essentially in high-yield mutual funds. 

And so they are trying to stop banks from originating loans that 

aren’t even staying in the banks. They are going to the mutual 

fund sector and arguing that they are trying to quash a bubble. 

The real source of the demand for this, though, is the zero interest rate policy in the QE easing. Investors, as you may all have experienced, savers over the last 6 or 8 years, you make more money 

on your credit card rebates than you do by any money you have in 

a bank account or a savings account, and it is rational to look for 

yield. And these particular types of loans are floating-rate loans. 

They are high-yield floating-rate loans. There is risk in them, for 

sure, but at least they pay a decent rate of return, and they are 

not subject to long-term interest rate risk, because the rate floats. 

24 

And so it is a very natural sort of demand that savers would 

have in this type of environment, and essentially the bank regulators are trying to shut that down, and that is sort of a new use 

of regulatory powers to direct credit that I don’t think we have 

seen in the past. 

Mr. PITTENGER. Thank you. Let’s go back to the question, Dr. 

Kupiec, that I asked Dr. White. Do you think the government has 

taken advantage of this low interest rate environment to drive 

larger deficits than it otherwise would have? 

Mr. KUPIEC. I really don’t have an opinion on that. That is not 

my area, exactly. 

Mr. PITTENGER. Dr. Goodfriend? 

Mr. GOODFRIEND. No opinion. 

Mr. PITTENGER. No opinion. I have some, but I won’t labor 

through that at this time. 

I yield back my time. Thank you. 

Mr. MULVANEY [presiding]. The gentleman yields back. 

We now recognize the gentleman from Illinois, Mr. Foster, for 5 

minutes. 

Mr. FOSTER. Yes, I would like to return to something that was 

mentioned, which is the implicit credit allocation effects of stress 

tests, which are real, and I think probably unavoidable. In just a 

simple example, imagine that you had—one of the macroeconomic 

stress factors was simply that housing prices revert to where they 

were several years ago. Had that been applied to a bank with a 

large exposure in Las Vegas, where prices had doubled in 2 years, 

that would have resulted in very strong capital requirements and 

a restriction in lending in Las Vegas as the bubble developed, 

whereas the same identical requirements applied to a bank with a 

heavy exposure in Cleveland, for example, which never experienced 

a bubble would have no credit allocation, no credit restrictions applied to it. 

And so I was wondering what your attitude is toward general 

policies, for example, requiring that you stay well-capitalized if 

housing prices revert to where they were previously, even if they 

have very specific effects, for example, constricting credit in one 

area of the United States and not in another. Is that necessarily 

a bad thing? And how do you—and a related question is, what is 

the appropriate level of public disclosure? The big banks might not 

be too enthusiastic about having public disclosure of exactly why 

they failed or came close to failing a stress test. So I was wondering if we could just have another round of comments on that, 

starting, actually, on the right this time with Dr. Bivens. 

Mr. BIVENS. On the appropriateness of sort of national-level 

stressors affecting sort of regional banks differently, I haven’t 

thought extensively about it. It does strike me as a little reasonable, though, to at least ask how regional banks would react to, 

say, a fall in national home prices. It is just not the case anymore 

that financial institutions only have a portfolio of regional assets 

that affect regional prices. They probably hold some assets that are 

correlated with national home prices. And so as long as the proper 

weight of national home price movements on the effect—on regional bank assets is given, that strikes me as appropriate. 

25 

And in regards to public disclosure, my general view is the more, 

the better. I would like to see more transparency in the stress test 

models being used, so, yes. 

Mr. FOSTER. Dr. White? 

Mr. WHITE. I think the important thing at the most general level 

is to get the incentives right for banks to take accurately into account the risks they are undertaking in their portfolio decisions. 

And it seems to me the wrong way to approach that to ask if we 

tweak this rule and look in retrospect at how it would have affected 

the regional allocation of credit, would that have been a good 

thing? We don’t want banks to put unrealistic values on the assets 

in their portfolio and thereby overstate their capital. But that is 

sort of a supervision and regulation question, rather than what we 

have mostly been addressing today. 

Mr. KUPIEC. I would be happy to take that on. I ran the stress 

testing group in the FDIC for a number of years, and so I am very 

intimately familiar with these issues. The problem is when you do 

a stress test, the Fed will specify some national path for housing. 

And as you are quite right, regional housing prices don’t follow the 

same path. 

Now, what happens is, the banks have to translate the national 

path and the GDP path into something that happens in their own 

area, and there are different ways to do that. The problem is, it is 

not easy to do it, and econometrically, these models fit very badly, 

so it is a guess. It is a guess how housing prices are going to 

change. 

But when the bank does its stress test and presents its models, 

the Federal Reserve does its own, and it doesn’t tell you how it 

models it. And if the Federal Reserve wants to assume a different 

transfer of the national house price path to, say, Cleveland versus 

Las Vegas, it can do it, and it can claim, this is what we think, 

and what we think is what matters. 

So the stress test ends up allocating capital in these different 

markets because the Federal Reserve is the one deciding what the 

right way to translate this overall very fuzzy macro scenario into 

specific things that happens in specific markets. And if the bank 

disagrees, well, it is too bad. There is no scientific give-and-take. 

There is no objectivity here. It is all an art. It is all a simulation. 

And the models fit very badly anyway. So having any discussion on 

it based on, really, sound economic grounds is a very difficult thing 

to do. 

Mr. FOSTER. Are you a fan of larger disclosure of the debate that 

happens or not? When you said that the Fed did not tell you why 

you passed or failed, are you then a supporter of more disclosure, 

more public discussion of the factors that led to banks— 

Mr. KUPIEC. The first point I would make is, it is a very arbitrary regulatory rule, since so much of it depends on the interpretation of the central bank or the regulator versus the interpretation 

of the bank, so it is very arbitrary. In an arbitrary setting like that, 

there is no—the property rights, the ability for a business to make 

decisions, it is all sort of overturned. 

So transparency would be a first step, but in general, the science 

isn’t there—isn’t really developed enough, nor do I think it ever 

will be that you could actually make this a hard and fast rule that 

26 

was totally objective. There is a lot of subjectivity in it, and in general, it is imposing government regulators’ views on business decisions that should be the banks in the area. 

Mr. FOSTER. I yield back. 

Mr. MULVANEY. Thank you, Mr. Foster. And that appears to be 

the end of the questions. 

The Chair notes that some Members may have additional questions for this panel, which they may wish to submit in writing. 

Without objection, the hearing record will remain open for 5 legislative days for Members to submit written questions to these witnesses and to place their responses in the record. Also, without objection, Members will have 5 legislative days to submit extraneous 

materials to the Chair for inclusion in the record. 

And without any further objections, we will be adjourned. 

Thank you, gentlemen. 

[Whereupon, at 11:18 a.m., the hearing was adjourned.] 

(27) 

A P P E N D I X 

March 12, 2014 

28 


88532.001
29 


88532.002
30 


88532.003
31 


88532.004
32 


88532.005
33 


88532.006
34 


88532.007
35 


88532.008
36 


88532.009
37 


88532.010
38 


88532.011
39 


88532.012
40 


88532.013
41 


88532.014
42 


88532.015
43 


88532.016
44 


88532.017
45 


88532.018
46 


88532.019
47 


88532.020
48 


88532.021
49 


88532.022
50 


88532.023
51 


88532.024
52 


88532.025
53 


88532.026
54 


88532.027
55 


88532.028
56 


88532.029
57 


88532.030
58 


88532.031
59 


88532.032
60 


88532.033
61 


88532.034
62 


88532.035
63 


88532.036
64 


88532.037
65 


88532.038
66 


88532.039
67 


88532.040
68 


88532.041
69 


88532.042
70 


88532.043
71 


88532.044
72 


88532.045
73 


88532.046
74 


88532.047
75 


88532.048
76 


88532.049
77 


88532.050