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NEAR-ZERO RATE, NEAR-ZERO EFFECT? 

IS ‘‘UNCONVENTIONAL’’ MONETARY 

POLICY REALLY WORKING? 

HEARING 

BEFORE THE

SUBCOMMITTEE ON 

MONETARY POLICY AND TRADE 

OF THE

COMMITTEE ON FINANCIAL SERVICES 

U.S. HOUSE OF REPRESENTATIVES 

ONE HUNDRED THIRTEENTH CONGRESS 

FIRST SESSION 

MARCH 5, 2013 

Printed for the use of the Committee on Financial Services 

Serial No. 113–4 

( 

(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 

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 5, 2013 ................................................................................................... 1 

Appendix: 

March 5, 2013 ................................................................................................... 43 

WITNESSES 

TUESDAY, MARCH 5, 2013 

Gagnon, Joseph E., Senior Fellow, Peterson Institute for International Economics ................................................................................................................... 12 

Malpass, David R., President, Encima Global ...................................................... 7 

Meltzer, Allan H., Professor of Political Economy, Tepper School of Business, 

Carnegie Mellon University ................................................................................ 8 

Taylor, John B., Mary and Robert Raymond Professor of Economics, Stanford 

University, and George P. Schultz Senior Fellow in Economics, Hoover 

Institution, Stanford University ......................................................................... 10 

APPENDIX 

Prepared statements: 

Gagnon, Joseph E. ............................................................................................ 44 

Malpass, David R. ............................................................................................ 48 

Meltzer, Allan H. .............................................................................................. 62 

Taylor, John B. ................................................................................................. 68 

(1) 

NEAR-ZERO RATE, NEAR-ZERO EFFECT? 

IS ‘‘UNCONVENTIONAL’’ MONETARY 

POLICY REALLY WORKING? 

Tuesday, March 5, 2013 

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 10:02 a.m., in room 

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

Members present: Representatives Campbell, Huizenga, Pearce, 

Posey, Grimm, Stutzman, Mulvaney, Pittenger, Cotton; Clay, 

Moore, Peters, Foster, Carney, Sewell, Kildee, and Murphy. 

Also present: Representative Green. 

Chairman CAMPBELL. The committee will come to order. Without 

objection, the Chair is authorized to declare a recess of the committee at any time. 

The Chair now recognizes himself for 4 minutes for an opening 

statement. 

I would like to first of all welcome our distinguished panel of witnesses. 

Last week, Federal Reserve Chairman Bernanke testified in this 

room during the semiannual Humphrey-Hawkins testimony that he 

gives before Congress. He was asked many questions about quantitative easing, so-called ‘‘QE Forever,’’ and the persistently low interest rates that the Fed is holding, and as to whether the benefits 

of this policy still outweighed the risks and negatives of this policy. 

Chairman Bernanke quite vigorously, I would say, defended the 

policy and defended that its benefits are still outweighing the risks 

in spite of some dissension in the Federal Open Market Committee 

itself, and certainly some disagreement here amongst members of 

this committee. 

The purpose of this hearing today is to find out from you all, 

from some of the country’s most distinguished economists, what 

your view is and whether you believe that the benefits of this policy equal the risks, exceed the risks, or outweigh the risks, and 

what, and if at any point in the future, when those different 

metrics might perhaps change to warrant the ending of QE Forever 

or a change in the interest rate environment in which we find ourselves. And so we will look forward to hearing all of your comments 

and thoughts on this issue which is pressing before us now. 

2 

And with that, I will recognize the ranking member of the subcommittee, Mr. Clay from Missouri, for 5 minutes for his opening 

statement. 

Mr. CLAY. Thank you, Mr. Chairman, and thank you for conducting this hearing entitled, ‘‘Near-Zero Rate, Near-Zero Effect? Is 

‘Unconventional’ Monetary Policy Really Working?’’ 

And also, I want to thank the witnesses for appearing. 

Mr. Chairman, I will begin with a short summary of why the 

economy is in its current state and what has led to the Federal Reserve System’s use of quantitative easing policy. 

The U.S. economy has taken a beating over the past 10 years. 

U.S. engagement in two unpaid wars, one in Iraq and a second in 

Afghanistan, has produced record amounts of government debt. 

Also during the past 10 years, bad actors in the housing and financial industries have contributed to the problems in the U.S. economy. 

According to the Financial Crisis Inquiry report, a combination 

of excessive borrowing, risky investments, and a lack of transparency put the financial system on a collision course of self-destruction. The Full Employment and Balanced Growth Act of 1978, 

better known as the Humphrey-Hawkins Act, charges the Federal 

Reserve with a dual Band-Aid, both maintaining stable prices and 

full employment. 

But during the height of the financial crisis, the Federal Reserve 

took major measures to pump more liquidity into the financial system. In September of 2007, the Federal Open Market Committee 

(FOMC) lowered the Federal fund rate from 5.25 percent to between 0 to .25 percent. Currently, the interest rate on overnight 

loans between banks has been close to zero since December of 2008. 

To stimulate the economy, the Federal Reserve used two policies. 

The first is forward guidance regarding the Federal Open Market 

Committee’s anticipated path for Federal fund’s rate. According to 

Chairman Bernanke, ‘‘Since longer-term interest rates reflect market expectations for shorter-term rates over time, our guidance influenced longer-term rates and thus supports a stronger recovery.’’ 

The second type of policy tool employed by the FOMC is largescale purchase of longer-term security, which, like forward guidance, is intended to support economic growth by putting downward 

pressure on longer-term interests rates. Also, the Federal Open 

Market Committee has indicated that it will continue purchases 

until it observes a substantial improvement in the outlook for the 

labor market in context of price stability. 

According to the Federal Reserve, these monetary policies are 

supportive to the recovery while keeping inflation close to the Federal Open Market Committee’s 2 percent objective. One example of 

this policy working is in the housing market. 

Low long-term interest rates have helped spark recovery. With 

rising employment, family wealth, and the growth in the housing 

market, consumer sentiment and spending have been positive. Currently, the unemployment rate is 7.9 percent, down from a year ago 

of 8.3 percent and from 2 years ago of 9.2 percent. 

In regards to inflation, the Federal Reserve remains confident 

that it has the tools necessary to tighten monetary policy when the 

3 

time comes to do so. Currently, inflation is subdued and the expectations appear well-based. 

Again, thank you, Mr. Chairman. I look forward to the witnesses’ 

comments. 

Chairman CAMPBELL. The gentleman yields back his time. Thank 

you, Mr. Clay. 

The vice chairman of the subcommittee, Mr. Huizenga, the gentleman from Michigan, is recognized for 3 minutes. 

Mr. HUIZENGA. Thank you, Chairman Campbell and Ranking 

Member Clay, and thank you for bringing this distinguished panel 

to discuss, ‘‘Near-Zero Rate, Near-Zero Effect.’’ Obviously, we know 

it is an important issue which has tremendous impact on our economy, and I am eager to hear your insight. 

For too long, I believe, the government in many forms has looked 

upon itself as sort of the sole source to solve the social and economic ills that our country faces, and unfortunately, the Federal 

Reserve is no different. The Federal Reserve has continued to implement government-based solutions, whether it was prolonged reduction of near-zero interest rates, sort of, I would argue—excuse 

me—this artificial lowering of interest rates with quantitative easing, quantitative, QE2, QE3, QE Infinity, Operation Twist, and all 

these other things that has, frankly, only just led to prolonged high 

levels of unemployment, continued lack of consumer confidence, 

and frankly, erratic to no growth in the economy. 

So what does the Federal Reserve decide to do in December of 

2012? To continue purchasing mortgage-backed securities at a rate 

of $40 billion a month and $45 billion in long-term Treasury securities per month, so these measures must be working, right? I think 

that jury is very much out and the answer seems to be ‘‘no.’’ 

With our GDP stagnant and unemployment even higher than 

when President Obama took office in 2009, you don’t see many 

economists predicting the economy taking off at anywhere near its 

historic rates and pace in the past. 

So the answer is simple: The policies implemented and prolonged 

by the Federal Reserve have failed to deliver as advertised, and we 

need to correct that. 

Now, when do these failed policies come to an end? The Federal 

Open Market Committee, FOMC, says they plan on keeping these 

zero rates, or near-zero rates, until at least sometime in 2015 with 

a target 6.5 percent unemployment rate. The ranking member 

brought up the Humphrey-Hawkins—this dual mandate; I am looking forward to having that conversation. 

But I think the question is, at what cost? We need to explore 

that. And if not at what cost then, frankly, what benefit are we deriving from this? 

And frankly, as a proponent of the free market and having a 

smarter, more efficient, more effective size of government and government put in place, let me point out that just one of the many 

problems with the Administration’s policy, such as targeting of 

near-zero rates by the FOMC, it is an abomination, in my mind, 

that under this Administration, the new normal for unemployment 

has been around 8 percent. 

We have seen it higher, and we have seen it just under that. But 

we know, frankly, that it is not a success at getting people back 

4 

to work; it is a Bureau of Labor and Statistics that the way they 

keep their counting of this—and unfortunately, we have seen people—unfortunately, people do not becoming employed, but because 

they are getting discouraged and leaving the workforce. 

So thank you. I appreciate that and I look forward to learning 

how we are going to continue to have the private investment grow 

our economy. 

Chairman CAMPBELL. Thank you. 

The gentleman’s time has expired. 

I now recognize the gentleman from Illinois, Mr. Foster, for 3 

minutes for an opening statement. 

Mr. FOSTER. Thank you, Mr. Chairman. 

And I have a couple of slides, if I could have the first one. There 

are two slides here that I think will be useful in framing the discussion of the recovery. 

The first one is a comparison of the drop in household net worth 

during the Great Depression and during the downturn that we just 

went through. When people ask me to reduce to a single number 

where are we and where our economy is, I go to household net 

worth, which is simply the value of everything owned by families 

in America. 

And so the top curve that you can see on there is the fractional 

drop in household net worth during the first Republican big financial collapse in 1929, where over the course of the next 5 years 

household net worth dropped by approximately 12 percent. And 

then when we transition to FDR’s policies, over the course of the 

next nearly-a-decade, we have slowly recovered that. 

If you contrast that to what we just went through in the last 15 

months of the Bush Administration, where household net worth 

dropped by about a trillion dollars a month for the last 15 months, 

households in America lost a quarter of their net worth. So what 

we underwent was a financial drop that was twice as rapid and 

twice as deep as the onset of the Great Depression. It is remarkable, in that context, that we are not in a great depression today. 

Fortunately, after roughly the beginning of 2009 we had a series 

of changes in policies. There was the big intervention by the Federal Reserve, probably 2 quarters before the V-shaped turnaround 

that you see not only in household net worth but in business profitability, the stock market, essentially every financial indicator you 

can look at. 

This also happened, perhaps not as an accident, the quarter after 

we passed the stimulus—the so-called ‘‘failed stimulus.’’ And so 

when you look at these, it is hard to actually look at this and conclude that there was not a positive benefit. 

Interestingly, if you look at this in terms of just return on investment—the costs of the stimulus, and so on—it is less than—it is 

on the order of a trillion dollars. Household net worth has rebounded by more than 10 times that, and so you find a pretty high 

return on investment from that point of view. 

If I could have the second slide, there are a lot of discussions 

about what would have happened if we had done nothing. Many of 

these get to be partisan. I have chosen here to put a bipartisan calculation of what would have happened if we had done nothing. This 

is by John McCain’s financial advisor and also a Democratic econoVerDate Nov 24 2008 18:18 Jun 11, 2013 Jkt 080870 PO 00000 Frm 00010 Fmt 6633 Sfmt 6633 K:\DOCS\80870.TXT TERRI
5 

mist who collaborated, and if you look at what would have happened with no intervention, they estimate that our economy would 

simply not have recovered, in terms of household net worth, and 

that they apportion roughly equal share of the credit for the recovery to the actions of the Federal Reserve and the stimulus. 

So, I would like to bring up a lot of these points in the ongoing 

questioning. And thanks so much. 

Chairman CAMPBELL. Thank you. 

The gentleman’s time has expired. 

Mr. Grimm from New York is recognized for 1 minute for an 

opening statement. 

Mr. GRIMM. Thank you, Mr. Chairman. I appreciate you calling 

this hearing, and I want to thank the witnesses for coming and testifying today. 

I am very glad to see that we are devoting our very first hearing 

of this subcommittee to a very important, if not central, topic to the 

long-term health of U.S. capital markets, and indeed, the economy 

as a whole—namely, examining the long-term risks of the Fed’s extraordinarily accommodative monetary policy over the last 5 years. 

And I personally am very concerned about the risks that the Fed’s 

rapid balance sheet possesses to the stability of the Fed as well as 

its inability to possibly unwind its unprecedented asset purchases 

in a way that will not do significant damage to U.S. markets or, 

even worse, cause world markets to question the very soundness of 

the U.S. dollar. 

So with that, I look forward to hearing what our witnesses have 

to say on these very important topics and I yield back the balance 

of my time. Thank you. 

Chairman CAMPBELL. The gentleman yields back. 

And for the final opening statement, the gentleman from Indiana, Mr. Stutzman, is recognized for 2 minutes. 

Mr. STUTZMAN. Thank you, Mr. Chairman, for holding this very 

important hearing. I want to, of course, welcome the panel, as well, 

and I look forward to their comments. 

Of course, as we are examining the effects of the Fed’s unconventional approach to keeping interest rates so long is of great concern 

for me, and as for as long as they are. I am extremely concerned 

about how this market manipulation invariably distorts private investment decisions in the short and in the long term. 

Furthermore, I look forward to discussing with our witnesses 

whether the Fed’s market intervention is meeting its stated goal of 

creating economic growth and how it may, in fact, be doing just the 

opposite. 

As a subcommittee, I believe we need to press the Fed to provide 

greater clarity on what the economic environment may need to look 

like in order for them to roll back some of these policies. Only then 

can we provide precise oversight. 

Of most recent concern to me has been the Fed’s decision to buy 

$85 billion a month until the unemployment rate falls below the 

largely arbitrary rate of 6.5 percent. To avoid some of the unconventional approaches discussed today, I remain committed to focusing the Fed exclusively on price stability by eliminating its dual 

mandate. 

6 

To do just that, I have introduced H.R. 492, the FFOCUS Act of 

2013. I look forward to the witnesses’ testimony and their expertise 

today. 

Thank you, Mr. Chairman. I will yield back. 

Chairman CAMPBELL. The gentleman yields back. 

And so, we welcome our panel of distinguished witnesses. 

Mr. David Malpass is president of Encima Global, LLC. Encima 

Global is an economic research and consulting firm serving institutional investors. He previously served as the chief economist at 

Bear Stearns, as Deputy Assistant Secretary of the Treasury, and 

as Deputy Assistant Secretary of State. 

Welcome, Mr. Malpass. 

Dr. Allan Meltzer is the Allan H. Meltzer professor of political 

economy at Carnegie Mellon University. He is also a visiting scholar at the American Enterprise Institute. 

Dr. Meltzer chaired the International Financial Institution Advisory Commission, also known as the Meltzer Commission—you get 

your name on a lot of things—and was a founding member of the 

Shadow Open Market Committee. Dr. Meltzer served on the President’s economic advisory policy board and on the Council of Economic Advisors. 

Welcome, Dr. Meltzer. 

Dr. John Taylor is the Mary and Robert Raymond professor of economics at Stanford University. He is also the director of the Stanford Introductory Economics Center and the former director—now 

a senior fellow—at the Stanford Institute for Economic Policy Research. Previously, Dr. Taylor served as Undersecretary of the 

Treasury for International Affairs and as a member of the President’s Council of Economic Advisors. 

I welcome my fellow Californian, Dr. Taylor. 

And last but not least, Dr. Joseph Gagnon is senior fellow at the 

Peterson Institute for International Economics. Previously, he 

served as the Associate Director of Monetary Affairs at the Federal 

Reserve Board of Governors and as an economist at the U.S. Treasury Department. 

Welcome, Dr. Gagnon. 

Each of you will be recognized for 5 minutes to give an oral presentation of your testimony. Without objection, each of your written 

statements will be made a part of the record after your oral remarks. 

I suspect you all know the drill, but I will state it anyway. On 

your table, there is a light. It will start out green. When it turns 

yellow, you have a minute to sum up. When it turns red, please 

suspend. 

Once each of you has finished presenting, each member of the 

committee will have 5 minutes to ask any or all of you questions. 

With that, Mr. Malpass, you are now recognized for 5 minutes. 

7 

STATEMENT OF DAVID R. MALPASS, PRESIDENT, ENCIMA 

GLOBAL 

Mr. MALPASS. Thank you very much. 

Chairman Campbell, Congressman Clay, Congressman Grimm 

from New York, and members of the subcommittee, thank you for 

the invitation to testify on the effectiveness of current monetary 

policy. It is a great pleasure to join Allan Meltzer, John Taylor, and 

Joe Gagnon on this panel. 

I think Federal Reserve policies have been weakening and distorting the economy rather than providing stimulus. The policies 

are hurting savers, distorting markets, and redistributing capital 

rather than increasing it. 

The policies subsidize government, big corporations, big banks, 

foreign investment, and gold, none of which is a robust private sector job creator, and it comes at the expense of small and new businesses and other job-creating parts of the economy. The result is 

a departure from market-based capital allocation that is 

contractionary in the same way that price controls, income redistribution, and industrial policy are contractionary. 

What I would like to do, Mr. Chairman, is walk through some 

of the graphs in my written testimony and mention them to you. 

I am on page one. What the Fed has done is keep interest rates 

very low and then substantially lengthen the duration of its assets 

by selling all of its Treasury bills. 

So you see the graph at the bottom of one. The Fed is out of 

Treasury bills, and that used to be the mainstay of U.S. monetary 

policy. 

The result of this extreme monetary policy experiment has been 

an actual decline in the GDP growth rates. Real growth has slowed 

from 2.4 percent in 2010 to 2 percent in 2011 and only 1.6 percent 

in 2012. So basically, the economy has been going backward at the 

time when the Fed is trying to stimulate it. 

The Fed itself has had to lower its original growth projections. 

That is at the top of three. Each year, they have started with a projection and then had to reduce it because the results haven’t turned 

out. 

I think there is a problem in the transmission mechanism of 

quantitative easing to the economy. It isn’t working under current 

circumstances of heavily regulated growth in private sector credit. 

Private sector credit over the 3-year period of this Fed monetary 

policy, 2010 through 2012, is up only 1.6 percent, government debt 

is up 32 percent, and the Fed’s liabilities are up 30 percent. So 

there is not a transmission from what the Fed is doing to what the 

private sector is feeling. 

The Fed is setting an artificially low interest rate. What it hopes 

is that this will encourage consumer spending, but at the same 

time, it is undercutting the normal impetus of the economy to borrow during a recovery to lock in low rates before they go up. 

The low-rate policy penalizes savers, it distorts capital allocation, 

and undermines critical interbank markets. The graph on page four 

shows you the paralysis going on in interbank markets, a point 

Professor Ron McKinnon has made. 

The Fed is also pushing down yields for longer-term credit. That 

benefits a select group of favored borrowers, like the government, 

8 

at the expense of non-favored borrowers, such as new businesses, 

small businesses, and businesses that the government considers 

risky. 

On page 5 of my testimony, I go through a number of other problems. The Fed is contracting the economy. In addition, the Fed has 

greatly expanded its role in the economy. 

The Fed is asserting a legal authority to make unlimited largescale asset purchases on its sole discretion when there is no systemic crisis. That has huge implications for the future, when each 

slowdown will cause the markets to believe the Fed might buy assets. 

By using short-term credit, the Fed has created a maturity mismatch. The result of the Fed policy is a more powerful Fed and a 

risk to taxpayers when interest rates go up. The Fed now owes 

over $2 trillion in floating rate liabilities to commercial banks, 

which itself is a danger. 

So in conclusion, Mr. Chairman—and I am going to flip to the 

end of my statement here—rather than quantitative easing providing stimulus, it is compounding the capital misallocation problem by trying to push more credit into corporate bonds. The Fed 

is operating as a speculator, borrowing short and lending long, 

while ignoring the conflict of interest this creates when it sets interest rates. 

The best exit, in my view, would be for the government to adopt 

growth-oriented tax, spending, and regulatory policies in parallel 

with a new growth-oriented Fed resolve to downsize its role in capital allocation and commit to providing a strong and stable dollar. 

The combination would encourage private sector investment and 

hiring in the U.S. economy and would meet the Fed’s mandate of 

maximizing employment while assuring price stability. 

Thank you, Mr. Chairman. 

[The prepared statement of Mr. Malpass can be found on page 

48 of the appendix.] 

Chairman CAMPBELL. Thank you, Mr. Malpass. 

Dr. Meltzer, you are recognized for 5 minutes. 

STATEMENT OF ALLAN H. MELTZER, PROFESSOR OF POLITICAL ECONOMY, TEPPER SCHOOL OF BUSINESS, CARNEGIE 

MELLON UNIVERSITY 

Mr. MELTZER. Mr. Chairman and members of the committee, our 

Constitution assigns responsibility for monetary policy to the Congress, that is, to you people. The Federal Reserve acts as your 

agent. 

The Federal Reserve has expanded bank reserves more than 350 

percent in the last few years. This is an enormous and unprecedented increase, and it continues. 

In my opinion, no entity or agent in our government should have 

so much unrestrained authority. Current practice violates all our 

beliefs about checks and balances. It sets a terrible precedent that 

should be avoided and it achieves very limited benefits to our economy. 

Many bankers applaud the current expansive policy. They profit 

from it because they can borrow from the Fed or in the money market at a quarter percent or less and lend to the Treasury at 1 perVerDate Nov 24 2008 18:18 Jun 11, 2013 Jkt 080870 PO 00000 Frm 00014 Fmt 6633 Sfmt 6633 K:\DOCS\80870.TXT TERRI
9 

cent or more. They are able to improve their stock prices by paying 

dividends and increase their incomes by paying bonuses. 

Does the Congress approve this transfer from taxpayers to the 

owners and managers of financial firms? I doubt seriously that you 

would vote for such a policy. 

Chairman Bernanke describes the expansive policy as on balance 

of benefit to the economy. I disagree for several reasons. 

First, we agree that the low interest rate policy encourages risktaking, but among those taking their investment risk are retirees 

who cannot live on the income they receive currently from their 

usual source of investment, often bank certificates of deposit. Many 

are said to seek higher income by investing in emerging market 

bonds or domestic junk bonds. 

We know from our history how this practice ends. It ends in 

losses and tears when interest rates rise, bond prices fall, and risky 

assets default. Or note what has happened to the prices of farmland, in part a result of the ethanol program that raised agricultural prices. We have seen this pattern of rising farmland prices 

many, many times. It ends in tears and heavy losses to those who 

invest in it. 

These are examples of a general pattern of increased risk. Increasingly, investors do not want to hold money or low interest rate 

bonds. They shift into holding equities, raising equity prices, and 

taking the risk of holding high-yield bonds or claims on farmland, 

or other risky assets. 

Federal Reserve policy is repeating the same mistake that 

brought us the great inflation of the 1970s. Then and now, the Federal Reserve expanded its balance sheet by financing the government’s budget deficit. This time, the deficits are larger and the 

Fed’s purchases are much, much larger. 

And then, as now, the Fed tried to push unemployment rates 

down. Doing so, they ignored the lessons that Paul Volcker repeated here and elsewhere many, many times: expected inflation is 

the way to get low inflation. 

We know from that experience and repeated experiences all over 

the world how highly expansive policy ends. It ends with inflation, 

followed by a big recession required to end the inflation by reducing money and credit growth and raising interest rates. 

Ask yourselves, please, what you expect to happen to all the low 

interest rate bonds that the banks and others hold. Will they have 

enough equity reserves to absorb the losses that they will surely 

take or will there be another debt crisis? 

The first Federal Reserve balance sheet expansion in 2008 prevented a breakdown of the payments system. That was the right 

thing to do at the time. 

The next large balance sheet expansion, called QE2, added $600 

billion to bank reserves and the Federal Reserve balance sheet. 

$500 billion went into bank excess reserves. That pays some interest to the bankers but does absolutely nothing for employment and 

economic activity. 

Much of the remaining $100 billion went into reserves of foreign 

central banks. They bought the dollars to limit the depreciation of 

the dollar against their currency. Other central banks are now exVerDate Nov 24 2008 18:18 Jun 11, 2013 Jkt 080870 PO 00000 Frm 00015 Fmt 6633 Sfmt 6633 K:\DOCS\80870.TXT TERRI
10 

panding reserve growth rapidly. This prevents their currencies 

from appreciating. 

We are now in the third round of QE expansion. 

Let me close with this comment: The Federal Reserve will be 100 

years old this year. Its history includes 2 multi-year periods during 

which inflation was low—the only two such periods in its history. 

Real income and employment fluctuations were modest and recessions were mild. The two periods are 1923 to 1928 and 1985 to 

2002. In both periods, the Federal Reserve generally followed a 

monetary rule. In 1923–1928, the rule was the gold-exchange 

standard; in 1985–2002 or 2003, the rule was Mr. Taylor’s rule. 

No rule will be perfect all the time, but the lesson you should 

draw is that following a rule gave much better results for the public and the country than policies based on forecasts and judgment. 

That is a lesson you should discuss and implement as you consider 

how to get off the path to crisis and improve on your responsibility 

for regulating the Federal Reserve and its monetary policy. 

Thank you. 

[The prepared statement of Dr. Meltzer can be found on page 62 

of the appendix.] 

Chairman CAMPBELL. Thank you, Dr. Meltzer. 

Dr. Taylor, you are now recognized for 5 minutes. 

STATEMENT OF JOHN B. TAYLOR, MARY AND ROBERT RAYMOND PROFESSOR OF ECONOMICS, STANFORD UNIVERSITY, 

AND GEORGE P. SCHULTZ SENIOR FELLOW IN ECONOMICS, 

HOOVER INSTITUTION, STANFORD UNIVERSITY 

Mr. TAYLOR. Thank you, Mr. Chairman, Ranking Member Clay, 

and other members of the subcommittee for inviting me to testify. 

And also, thank you very much for having this hearing on a very 

important topic. 

You asked us to review monetary policy before, during, and after 

the financial crisis, and some of you in your opening remarks have 

already done that. I think to do that you need to go back almost 

a decade to the period of 2003, 2004, and 2005 when the Federal 

Reserve held interest rates very low by any historical standard, especially the previous 2 decades of the 1980s and 1990s. This caused 

the housing boom to be much worse than it otherwise was. It 

caused the search for yield; it caused risk-taking; and ultimately, 

the bust, which brought on the financial crisis in part. 

When the financial crisis first showed up, the Fed misdiagnosed 

that. They provided liquidity facilities at a time where there were 

problems—credit problems—in the banking sector. This is how I 

think helped bring on the crisis part of the—the panic part of the 

crisis. 

When the panic hit, the Fed did help stabilize things with their 

actions—in particular, the commercial paper market and the 

money market funds. That particular phase, October, November of 

2008, was constructive. 

However, when the emergency ended, the Fed continued with the 

emergency operations—quantitative easing and the other actions 

that have already been mentioned in this hearing. 

My view is if you look at this whole period, it is characterized 

by unprecedented actions by the Fed. It has been unpredictable 

11 

movements of their instruments of policy, and I think it has caused 

harm. 

If you think of the Fed’s old criteria for performance, it looks 

very bad. Unemployment much higher than it needs to be during 

this period, and inflation stability no better than in the past. So by 

its own methods of comparing and evaluating itself, the Fed’s performance has been very bad. 

You can get some sense of this by thinking of what the Fed has 

forecast for this recovery. There are some charts in my testimony, 

similar to Mr. Malpass’, which show that the recovery has been 

very disappointing for the Fed. 

They thought growth in 2012 was going to be 4 percent on average. The most pessimistic forecasts were going to be 3.5 percent for 

2012. It turned out to be about 1.5 percent. 

Why the disappointing performance? Of course you can point to 

external factors, and you hear testimony along those lines from the 

Fed. 

In my view, you can’t really explain this by external factors. It 

really is related to the policy itself. 

And what is so bad about the policy? Think about this. I have 

a chart in my testimony, if you can look, perhaps, on page 5, to 

show how unprecedented what we are doing is. This is not just normal monetary policy. 

The Fed has expanded its balance sheet in ways we have never 

even seen before, and it is expected to continue that with its current Quantitative Easing Infinity, if you like. I think this caused 

enormous risks. It is a two-sided risk: one, inflation may pick up 

if the Fed can’t undo this ease fast enough; and two, it is a downside. If they bring the funds back too quickly, that is a downturn. 

It is contractionary. 

So there is this risk overhanging the financial system and the 

economy. I think that is a drag on growth. Firms are sitting on a 

lot of cash. Actually, some consumers are now sitting on a lot of 

cash. They don’t want to go out and buy things with that uncertainty. 

I think it is already a drag. This is not our future risk. This is 

a current risk. 

When you talk about risks and benefits, or costs and benefits, the 

costs are now greater than the benefits and it is a great concern 

to me. It is one of the reasons unemployment remains high. 

You also have the low interest rates, which reduce income for 

savers. And you have this adverse effect in the credit markets that 

has already been discussed by Mr. Malpass. 

It is nice to be able to borrow at low interest rates. It is not so 

great to lend at low interest rates. It is not surprising that credit 

flows, especially to less-credit-worthy borrowers. It is low at this 

point in time. So I think it is basically that is a negative, and I— 

many other reasons why it is negative. 

So on balance, to answer the questions raised in this hearing, I 

don’t think the unconventional monetary policy is working. I am 

very concerned it is having perverse effects. 

My hope is the economy will pick up this year, like everyone 

hopes, and that will give the Fed the opportunity to begin to back 

off some of these extraordinary measures. And if so, I think the 

12 

economy will improve, in which case the Fed can maybe have another reason to back off. I hope that is the case. 

Thank you, Mr. Chairman. 

[The prepared statement of Dr. Taylor can be found on page 68 

of the appendix.] 

Chairman CAMPBELL. Thank you, Dr. Taylor. 

And now, Dr. Gagnon, you are recognized for 5 minutes. 

STATEMENT OF JOSEPH E. GAGNON, SENIOR FELLOW, 

PETERSON INSTITUTE FOR INTERNATIONAL ECONOMICS 

Mr. GAGNON. Chairman Campbell, Ranking Member Clay, and 

members of the subcommittee, I would like to thank you for inviting me to explain why I believe America needs more expansionary 

monetary policy. 

There are four major forces holding back our economic recovery: 

one, consumers are saving more to make up for losses in the value 

of their houses; two, banks are applying tighter-than-normal standards in lending; three, foreign governments continue to resist appreciation of their currencies, thus perpetuating a large U.S. trade 

deficit; and four, State and local governments initially, and now the 

Federal Government, have been cutting spending and raising taxes. 

All of these forces reflect either greater saving or reduced borrowing, both of which hold down spending in the U.S. economy. Expansionary monetary policy is helping to offset these forces. 

Low interest rates encourage consumption and investment, but 

total spending in the U.S. economy remains too low and most private sector forecasters expect employment to remain depressed and 

inflation to remain low for the next few years. This suggests 

strongly that the current stance of monetary policy is still too tight. 

With the short-term interest rate essentially at zero, more expansionary monetary policy must work through unconventional channels. One element of unconventional monetary policy is to use 

newly printed money to purchase long-term assets. 

Another element is to communicate to market participants that 

the future path of the short-term interest rate will be lower than 

they otherwise might expect. In these ways, the monetary authority can lower long-term rates of interest, which are not at the zero 

bound. 

My research shows that the Fed’s purchases of long-term bonds 

have lowered long-term interest rates not only on the bonds being 

purchased, but also on a broad range of long-term assets. Other researchers have confirmed this result. 

I estimate that the 10-year Treasury yield and the 30-year mortgage rate are at least 1 percentage point lower than they would 

have been in the absence of the Fed’s unconventional policies. 

Most market participants believe that these policies have boosted 

stock prices and helped to keep the dollar from appreciating. There 

is no doubt that all of these financial developments encourage 

spending, including on consumption, investment, and exports, and 

thus support economic growth. I note in particular that refinancing 

long-term debts at lower interest rates goes a long way toward repairing household and corporate balance sheets that are holding 

back spending. 

13 

Chairman Bernanke has identified four costs or risks that are of 

greater concern with unconventional monetary policy than with 

conventional policy. In my view, none of these costs is close to 

being significant now or at any time in the foreseeable future. 

The first cost of unconventional monetary policy is that the Fed 

could become the dominant buyer of long-term Treasury and agency securities, potentially reducing the liquidity and efficiency of the 

market for these assets. So far, this concern is purely hypothetical. 

But if it should ever materialize, there are strategies the Fed could 

adopt to prevent harm to financial markets and the economy. 

The second cost is that the public might believe that it will be 

difficult for the Fed to tighten policy at the right time to prevent 

excessive inflation in the future. Such a fear might increase uncertainty and instability in financial markets. 

The Fed has developed several tools to adjust policy that provide 

ample scope for future tightening. However, the real concern may 

be more with the Fed’s willingness than with its ability. 

Experience shows that inflation fears are highly sensitive to 

strong policy actions, or the lack thereof, in response to observed 

inflation. It is within the Fed’s power to prevent this cost from occurring by adjusting its policy stance appropriately and visibly in 

response to unexpected deviations of inflation from its target. 

The third cost is that low long-term yields may encourage risky 

behavior that threatens financial stability. Low long-term yields 

are not in and of themselves risky when they reflect expectations 

of the path of the short-term interest rate that are guided by the 

Fed and are supported by its holdings of long-term securities. 

Moreover, by boosting the economic recovery, increasing corporate 

profits, and decreasing the rate of bankruptcies, unconventional 

monetary policy reduces risks to the financial sector. 

As Chairman Bernanke said last month, the current low level of 

interest rates reflects weakness in the economy. The sooner we can 

return to full employment, the sooner we will return to normal levels of interest rates. Premature tightening will only delay this return. 

Indeed, in my view, if the Fed had been more aggressive in easing earlier, we might already have returned to normal rates of interest. 

The fourth and final cost I will mention is the possibility that the 

Fed could incur financial losses on its enlarged balance sheet. This 

so-called ‘‘cost’’ is a complete red herring. 

Since 2009, the Fed has passed the Treasury record profits on 

unconventional monetary policy and it is likely to continue to do so 

for a least a few more years. Any losses in the more distant future 

must be considered in tandem with the previous windfall profits. 

In addition, Treasury has benefited from higher tax revenues and 

from issuing debt at lower interest rates. 

On balance, there is no doubt that unconventional monetary policy lowers the long-term burden of our national debt. 

Thank you. This concludes my prepared remarks. 

[The prepared statement of Dr. Gagnon can be found on page 44 

of the appendix.] 

Chairman CAMPBELL. Thank you, Dr. Gagnon. 

I will now recognize myself for 5 minutes to ask questions. 

14 

My first question is for the three of you who are not fond of the 

current monetary policy: Last week, amongst the things that 

Chairman Bernanke said was, ‘‘monetary policy must remain accommodative if it is to support the recovery and reduce disinflationary risks.’’ Clearly, the specter of a Japan-type scenario is hovering over the Fed currently, and wanting to avoid deflation. For 

the three of you, do any of you see that as a legitimate reason to 

keep monetary policy accommodative, as it is? 

Mr. MALPASS. No. 

Mr. TAYLOR. No. 

Chairman CAMPBELL. Dr. Meltzer? 

Mr. MELTZER. No. 

Chairman CAMPBELL. No. One word. Would anyone like to elaborate on why the answer is no? 

Mr. MELTZER. Yes. I think the evidence goes in the opposite direction. Since summer of this year—this last year—expected inflation, measured by the gap between nominal and real yields, which 

is not precise but at least indicative, has increased by about 50 

basis points—that is a half a percentage point. It seems to be headed up, not down, indicating that the market is beginning to believe 

that inflation is a problem. And that is exacerbated by the uncertainty about when the Fed will get off its current policy. 

There is a good deal of resistance to the policy within the Federal 

Reserve. Many of them have spoken out about it. One has dissented from it. So there is a growing internal opposition to the policy for many of the reasons that we have all elaborated here. 

Chairman CAMPBELL. Mr. Malpass? 

Mr. MALPASS. I am concerned that as the Fed is setting artificial 

interest rates, it causes the rest of the government, and in particular, the fiscal policy and regulatory policy, not to take the burden. The Fed is taking too much of the burden. 

If there is a disinflationary risk, then a response to that would 

be to create productive growth. Tax reform, for example, would be 

a very important policy to stop a Japan-type loss decade. 

Chairman CAMPBELL. Okay. 

Dr. Taylor? 

Mr. TAYLOR. I just don’t see risk of deflation at all right now. I 

would add, though, that it is frequently mentioned by monetary 

policymakers as a reason, if you like, for excessively accommodative 

policies. And in particular, in the 2003, 2004, and 2005 period I 

mentioned, where I think rates were too low, given what has happened, and one of the reasons frequently mentioned at that time 

was concerns about deflation. 

It is a very common thing that is said. I think it should be looked 

at with some skepticism. Of course, it can occur; it is not like it 

doesn’t ever occur. But it seems to me it is not an issue right now. 

Chairman CAMPBELL. Let me also ask the three of you—Mr. 

Malpass, you mentioned at the end of your remarks that instead 

of this monetary policy we should be doing tax reform, various fiscal matters in order to restore—continue or—or accelerate economic growth. But that is fiscal policy, that is not monetary policy. 

So now, taking fiscal policy aside and assuming for the moment 

that it is what it is, or it will be what it will be, and so you have 

only monetary policy—you are at the Fed now and so you only have 

15 

that trigger to pull, what should we do? What would the correct 

monetary policy be, absent the one that we have now? 

Mr. MALPASS. My thought is to stop digging the hole deeper. The 

Fed is taking on more and more burden and giving people longerand longer-term promises of zero rates. I think those should be 

walked back, and that would allow the economy to begin functioning more naturally and the capital allocation process to resume. 

Chairman CAMPBELL. Dr. Meltzer? 

Mr. MELTZER. I think you need a rule. I think you need a rule 

for two reasons—two major reasons. Many reasons, but two major 

reasons. One is, you need to exercise greater discipline over the 

Fed. No one, as I said in my testimony, should have the authority 

to increase its balance sheet as much as it does without any congressional oversight. So you need a rule that you can enforce on the 

committee on the Fed. 

The second is, you need to give— 

Chairman CAMPBELL. Something like the Taylor Rule, perhaps? 

Mr. MELTZER. You need to give—the Taylor Rule would be fine. 

No rule would be perfect. But a rule will discipline the Fed and it 

will give information to the public about the long-range consequences of monetary policy. Too much of what they do is aimed 

at the very near term. 

Chairman CAMPBELL. Dr. Taylor, 10 seconds? 

Mr. TAYLOR. I think we learned so much about what worked in 

monetary policy in the 1980s and 1990s until recently, so go back 

to that general style of policy as soon as possible. 

Chairman CAMPBELL. Thank you. 

My time has expired, so I will recognize the ranking member, the 

gentleman from Missouri, Mr. Clay, for 5 minutes. 

Mr. CLAY. Thank you, Mr. Chairman. 

Let me start with Dr. Gagnon. Tell me, critics of quantitative 

easing have argued that it is incompatible with the Fed’s price stability mandate. However, in discussing quantitative easing the Fed 

has consistently noted that the program is designed to promote a 

stronger pace of economic growth and to ensure that inflation over 

time is at levels consistent with the Fed’s mandate. 

To what extent has quantitative easing been effective in keeping 

inflation in the desired range of 2 to 2.5 percent, and is there any 

evidence whatsoever that the dual mandate creates a perverse inflation merit base? 

Mr. GAGNON. Thank you. I think the dual mandate is in some 

sense unavoidable. If you look around the world, whether central 

banks have a dual mandate or not, they almost uniformly act as 

if they do. 

So in the interest of transparency, I think we should keep a dual 

mandate. We can’t pretend that monetary policy doesn’t affect both 

inflation and the real economy, employment and activity, so why 

not be open about it? 

I think the Fed’s—we did see a decline in inflation in the early 

years after the recession, and the Fed’s easy policy, I believe, has 

been helpful in preventing that from going lower. One thing we 

have learned, though, out of this is that it is very hard to make 

prices fall. 

16 

Deflation doesn’t come easy. We see that in Japan. And so I don’t 

fear deflation right now. But we would have come closer to it if we 

had not had this easy policy. 

Mr. CLAY. According to Dr. Taylor, the Fed’s current monetary 

policies perversely decrease aggregate demand and increase unemployment while they repress the classic signaling and incentive effects of the price system. Do you agree that current monetary policies increase unemployment? 

Mr. GAGNON. No, I do not. I think a good analogy for where the 

economy is right now, we often hear the story that monetary policy 

is like driving a car, only with no windshield and only a rearview 

mirror. You can just see a little bit of where you have just been, 

so you don’t know what is going on. 

I think we have hit a hill that may be steeper than any of us 

have seen in our lifetimes and we didn’t know it. When you hit a 

hill when you are driving, you step on the accelerator, and you 

hope that you will go faster. But if you are starting up a steep hill, 

you might go slower. 

Then the question becomes, what is wrong? Some people think 

that perhaps the car is broken down, perhaps the brake pedal and 

the accelerator have mixed up. Maybe if we press on the brake, we 

will go faster. 

I don’t think so. I think if we press harder on the accelerator, we 

will go faster; we are just facing a very steep hill. 

Mr. CLAY. Anyone can take a stab at this one. What is the tipping point? What tips us that inflation is about to kick in? 

And I will start with you, Dr. Gagnon. What are good indicators? 

Mr. GAGNON. I think you would see—if you see broad and— 

measures of prices, sort of—not just a few extreme ones, like commodities, but broad measures, and especially in the labor market, 

if you start seeing large pay increases that were well ahead of productivity, that would be an early indicator that maybe this is becoming a problem. I don’t see any evidence of that. 

Mr. MELTZER. May I answer that? 

Mr. CLAY. Each one of you can. I am trying to get to everybody. 

Go ahead. 

Mr. MELTZER. Asset prices start to rise, money starts—people 

start to get out of money and bonds and shift into asset prices. 

Farmland prices start to rise. All the things that we see happening 

now are happening. The Fed missed that completely in the run up 

to the 2007–2008 fiasco because they don’t pay much attention to 

asset prices, but they should. 

Mr. CLAY. But does that include housing prices, too? They are 

starting to rise. Is that a signal of a recovering housing market or 

inflation coming? 

Mr. MELTZER. Part of that is people buying houses on speculation. That is a sign that they expect prices of houses to rise. When 

prices of houses rise, don’t you think rents are going to rise? 

Mr. CLAY. That is not what the housing market is indicating to 

us now, is that this is the spring—spring is coming and people are 

starting to buy houses. 

Chairman CAMPBELL. The gentleman’s time has expired, so 

maybe someone else can follow up with that. 

17 

The gentleman from Michigan, the vice chairman of the subcommittee, Mr. Huizenga, is recognized for 5 minutes. 

Mr. HUIZENGA. Thank you, Mr. Chairman. 

I appreciate you all being here today, and I’m sorry I had to step 

out for a quick radio call-in. 

But, Mr. Malpass, you hit on something that I exactly used those 

words, artificially low rates, and it seems to me—and I don’t want 

to put words in your mouth; I want a few of you to address this— 

but you are saying that these artificially low interest rates have 

not spurned economic activity as was hoped, correct? 

Mr. MALPASS. That is right. 

Mr. HUIZENGA. Okay. So what you are saying is if I am going to 

go buy a house, maybe the make it and break it isn’t whether it 

is a 3.75 percent interest rate on my 30-year mortgage versus a 4 

percent 30-year mortgage, or maybe, like my family’s circumstance, 

we own a construction company in Michigan. You may have noticed 

that it has been a bit soft in the last few years. 

I have a 12-year-old loader that I need to replace. It doesn’t matter what the interest rate is because banks and, frankly, their regulators, are coming in saying, ‘‘We don’t want construction equipment on your books.’’ So who is going to give me that loan, because 

I haven’t had a whole lot of time here to ramp up my savings to 

try to get enough cash together to go purchase that? 

So I just wanted you to maybe talk a little bit about these artificially low interest rates. 

And then the other thing, this really struck me as—the best exit, 

as you were talking about, is not just spending, but tax as well as 

regulatory policies. And it seems to me that those tax and regulatory policies—and I tried bringing this up with Chairman 

Bernanke last week at our hearing as well—has a huge amount of 

impact. Isn’t that true? 

Mr. MALPASS. Yes. Thank you, sir. 

The Fed had the rates at zero for more than 4 years, and yet the 

recovery has been very subpar. The reason for that is because it 

is an artificially low rate. 

Economics is very, very clear. When you set the price of something too low, you end up with shortages, and that is what you 

were describing in Michigan. 

The big corporations and the government can get lots and lots of 

loans, but smaller businesses can’t. That is a natural part of a 

price-fixing mechanism, which is what the Fed has been doing. 

What you are describing is logical, that some parts of the economy are feeling this asset price inflation that Dr. Meltzer has described, and then other parts are not feeling the growth at all. That 

is because the capital is getting channeled and redistributed. 

Mr. HUIZENGA. I can tell you, the housing prices in Michigan 

have bottomed. Raw land has bottomed. There is only one way to 

go but up, and people are literally sitting there saying, ‘‘I don’t 

know if I could buy a home for cheaper than what I could build a 

home right now.’’ And, lots that used to go for $75,000 or $100,000 

are going for $25,000, maybe $30,000. 

Dr. Meltzer, I do want to—on page 3 you talked a little bit about 

being in the third round of quantitative easing, and I thought you 

put it beautifully here. Why does the chairman claim greater beneVerDate Nov 24 2008 18:18 Jun 11, 2013 Jkt 080870 PO 00000 Frm 00023 Fmt 6633 Sfmt 6633 K:\DOCS\80870.TXT TERRI
18 

fits than costs? Mainly, he makes the mistakes of looking only at 

interest rates, never mentioning what happens to growth of credit 

and money. 

I am not a Ph.D. economist like you all, all right? But I did take 

a few economics classes, and I recall one of my first economics 

classes discussed the law of diminishing returns. It seems to me 

that is exactly what we are talking about right here and what we 

are going after. ‘‘Well, if maybe we just lower it a little bit more 

then we will get this greater cost, or maybe if we spend or stimulate the economy by spending twice as much we will get double the 

amount of activity.’’ 

Could you address that a little bit? 

Mr. MELTZER. Yes. The only time—I have written the Fed’s history, so I read most of their minutes from the 1920s to the 1980s. 

There is hardly ever a time when they say the following: ‘‘If we do 

this today, where will we be a year, or 2 years from now?’’ That 

is a question because we know that monetary policy doesn’t work 

quickly. 

The one time that they actually discussed the policy that would 

relate to your question was at the end of the Volcker disinflation. 

They had very high real interest rates. Real interest rates during 

that whole expansion were 5 to 7 percent after allowing for inflation, and money growth was very high. 

And they discussed the question, which one of these things will 

dominate? Will we have a slow recovery because of the high real 

interest rate or a fast recovery because of the fast money growth 

and the fast growth of credit? 

The answer is pretty obvious now, in hindsight. In 1983, the 

economy grew at gangbuster rates despite the high real interest 

rates. 

That is, the interest rate matters, but so does the money and 

credit growth. And we are not getting the money and credit growth 

because most of the reserves that the Fed are creating are going 

to finance the government’s deficit and sitting in excess reserves. 

Chairman CAMPBELL. The gentleman’s time has expired. 

And you should know, Mr. Huizenga, that Dr. Meltzer and I both 

have economics degrees from UCLA. Now, his happens to be a master’s and a Ph.D., and mine is a bachelor’s, but I think that is an 

insignificant distinction. 

Mr. HUIZENGA. I didn’t want to point out anything beyond that, 

Mr. Chairman— 

Chairman CAMPBELL. Oh, yes. Okay. I just thought that was an 

interesting point— 

Mr. HUIZENGA. I will note that he is on that side of the table, 

though. 

Chairman CAMPBELL. So no, we are basically the same. Yes, 

okay. 

And now, I recognize the gentlelady from Wisconsin, Ms. Moore, 

for 5 minutes. 

Ms. MOORE. Thank you so much, Mr. Chairman. 

And I want to thank the witnesses for appearing. 

It is hard to dispute the expertise of this panel with respect to 

the Fed policy sort of forcing the investor to chase the highest 

yield, and that might have a negative impact on bonds and so 

19 

forth. But in an effort just to defend the Chair a little bit, he is 

trying to create some kind of economic activity by lowering the interest rates, maybe trying to increase some risk-taking so that 

there is some economic activity. 

I will start with Dr. Gagnon. With those stipulations, Chairman 

Bernanke also said that he thought a more direct way of helping 

our economy is to deal with people who don’t have a lot of bonds— 

maybe those mothers who need Women, Infant, and Children programs, or those seniors who need low-income heating assistance, or 

senior meals, that if we were to stop the sequesters and this cut— 

cutting—being concerned about the debt on a short-term basis instead of a more long-term strategy, that might be more stimulative 

to the economy than just continuing to do the quantitative easing. 

But to the extent that we keep cutting and cutting and cutting, 

the Fed is doing the only thing that it can do. 

Mr. Gagnon, would you respond to that? 

Mr. GAGNON. Yes, certainly. And I think Chairman Bernanke 

himself even would support what you just said. I think this is not 

a good time for further cuts right now. We had a big—we had a 

tax increase this year. That is, in my view, more than enough for 

1 year. 

We don’t need any further spending cuts this year. I would 

stretch them out in the out years. It is certainly holding back 

growth in the economy. 

Ms. MOORE. Okay. 

Dr. Taylor, I wanted to ask you about your economic models that 

produced the connection between interest rates and the housing 

boom, and I was wondering if you had any models that demonstrate that the Fed’s QE could just briefly in 20 seconds just sort 

of outline the models that you have that the Fed policy is hurting 

the economy. 

Mr. TAYLOR. The study of quantitative easing that I did was 

right after it began in 2009. It focused on the mortgage-backed securities purchases. I looked at the—tried to control for other things 

that affect risk and found that did not reduce the mortgage interest 

rates. 

That was my main, own research, so it is quite contradictory to 

what Mr. Gagnon has stated. That model is well-documented and 

published. 

The other model used to show that the rates were too low in 

2003, 2004, and 2005 was a different model that was simulated, 

and I think that has been proven to be pretty accurate. 

Ms. MOORE. Okay. Thank you, Dr. Taylor. 

I guess the question I would like to ask the other two gentleman 

in my remaining time is, with respect to, again, the sequestration 

and our worry that we are going to have interest rates which are 

too low, don’t you think it would be very harmful to the economy 

to just immediately raise interest rates? Aren’t we concerned about 

inflation with respect to the Fed suddenly pulling back from these 

low interest rates? 

Dr. Meltzer? 

Mr. MELTZER. Yes. I don’t think that we want to go through a 

draconian policy of suddenly raising the interest rate a lot. We 

20 

want to get on a path toward a long-term, stable policy. We have 

to send people a message— 

Ms. MOORE. Do you think that stopping dramatic cuts and taking 

huge sums of money out of the economy immediately is part of 

that? 

Mr. MELTZER. The money isn’t going into the economy. Most of 

it is going into bank— 

Ms. MOORE. I am talking about with respect to consumer spending, like the sequester. 

Mr. MELTZER. There isn’t much financing of consumer spending 

coming out of the QEs. 

Ms. MOORE. I understand that. 

Mr. MELTZER. I don’t question—let me just say, I do not question 

Chairman Bernanke’s intentions. I question his results. His results 

are not nearly consistent with his stated intentions. 

We are not getting growth of money and credit at a very rapid 

rate that would stimulate consumption or investment. And we are 

not getting a great deal of investment. We need investment for 

growth. We need a long-term policy. We are not getting that. 

Chairman CAMPBELL. The gentlelady’s time has expired. 

But I must say, Ms. Moore, when—at one point there where you 

said you wanted to defend the Chair, for a brief instant I thought 

you were defending me rather than— 

Ms. MOORE. Oh, I always defend you. 

Chairman CAMPBELL. Oh, okay. All right, rather than Chairman 

Bernanke. But then you went on about Chairman Bernanke, so I 

am a little hurt. But I will get over it. I will get over it. 

Now, I would like to recognize for 5 minutes the gentleman from 

South Carolina, Mr. Mulvaney. 

Mr. MULVANEY. Thank you, Mr. Chairman. 

Dr. Gagnon, I would like to start with you. You mentioned in 

your written testimony a couple of the costs of unconventional policy. I guess I could ask questions about each one, but I will go 

through them very quickly because I want to talk about the last 

one more specifically. 

The first one, you say that the risk is that the Federal Reserve 

would become the dominant buyer and holder of long-term Treasuries. I think the Treasury bought about 77 percent of all the debt 

last year. I wonder what more it would take for them to become 

the dominant buyer. But again, that is not my question. 

The second risk you discuss is that the public might believe it 

will be difficult for the Federal Reserve to tighten policy, thus leading to worry of inflation. I would suggest to you that some members of the Federal Reserve Board, sir, are doing exactly the opposite, which is that I think late last year the head of the Minneapolis Fed said that he would be willing to go above the 2 percent range to 2.5 percent. San Francisco Fed said they would go to 

2.5 percent. And the head of the Chicago Fed said he would like 

to go to 3 percent on inflation. So I would suggest to you that those 

risks are real and that certain members of the Federal Reserve are 

doing the exact opposite of what you would suggest. 

Third, you talk about encouraging risky behavior. The long-term 

yields being at a low rate for a long period of time would encourage 

risky behavior. And I was stunned here a little bit ago to see you 

21 

go into the effects of systemically important institutions and how 

risk managers could handle this. 

But I think Dr. Meltzer made the excellent point that I am not 

really concerned about the important financial institutions as much 

as I am about the individuals. And it is the retirees and the folks 

living on fixed incomes who are really the ones we are encouraging 

to engage in risky behavior. And as Dr. Meltzer correctly pointed 

out, I think that ends in no good. 

But again, with 5 minutes, I only get one question to ask. 

So I want to talk about the last one which you talk about, which 

you describe as a red herring, which is the losses that the financial, 

that the Federal Reserve could incur on its enlarged balance sheet. 

And you go on to say that the Federal Reserve is—the term, I 

guess, is remittance—giving a lot of money back to the Treasury. 

Elsewhere in your testimony, you said you thought that the current interventions policies probably depress interest rates by about 

1 percent. I ran the math on that in the back of my head and on 

the tablet in front of me, and that tells me that if the Federal Reserve gets out of this business tomorrow, interest rates on a 10- 

year would go up by 1 percent. If I translate that into a capital loss 

on the balance sheet of the Federal Reserve, which is roughly $3 

trillion—I know it is not all in 10 years but it makes the math easier—roughly you are talking about a 10 percent loss, $300 billion 

worth of capital loss in an instant, which, I would suggest to you, 

exceeds the total remittances that the Federal Reserve has given 

to the Treasury since 2009. 

They gave $90 billion, roughly, last year, according to Chairman 

Bernanke’s testimony last week. They have given about $290 billion since 2009. That doesn’t include the losses that they would 

incur on paying additional interest on the reserves they hold from 

the financial institutions. 

So I want you to tell me why this is a red herring. A 1 percent 

increase in interest rates would lead to several hundreds of billions 

of dollars of capital losses and operating losses, perhaps, at the 

Federal Reserve. So tell me why that is a red herring. 

Mr. GAGNON. Sure. The Federal Reserve has already given extra 

profits, above normal profits, that are almost equal to the costs of 

$300 billion that you mentioned, and in the next couple of years, 

it will have done so. So you will be subtracting $300 billion from 

excess profits that exceeded $300 billion— 

Mr. MULVANEY. But that is only 1 percent. Let’s think about 

what happens if we go back at the historical average of 5.5 percent. 

That is 450 basis points, or 400 basis points over where we are 

now. 

Mr. GAGNON. It is possible there could be larger losses than $300 

billion, that is correct. But again, profits will be quite a bit higher 

than that going in. 

Also, what you are not including is the gains to the Treasury. 

The Treasury will have issued long-term Treasury bonds yielding 

much less, and those gains are locked in forever, or for the life of 

the bond, 10 to 30 years. That is money the Treasury would have 

had to pay in interest it will not, and that is hundreds of billions, 

too. 

22 

And on top of that, by getting the economy growing faster, and 

more spending, and a bit more inflation than otherwise, tax revenues will be higher. And that is paying down the debt, too. 

So it all adds up. If you add all the pieces together, there is no 

way it does not lower the burden of our debt. 

Mr. MULVANEY. So several hundred billion dollars, potentially a 

trillion dollars of capital losses, an additional billions of dollars in 

operating losses is something we shouldn’t be concerned with because it will be, what, made up someplace else? 

Mr. GAGNON. Exactly. 

Mr. MULVANEY. Thank you, Dr. Gagnon. 

Chairman CAMPBELL. The gentleman yields back. 

Mr. Foster of Illinois is recognized for 5 minutes. 

Mr. FOSTER. Thank you, Mr. Chairman. 

In Dr. Taylor’s testimony, he emphasized the role of monetary 

policy in the early 2000s as a real driver of the housing bubble, 

presumably. But there are really three legs of policy. There is monetary, fiscal, and regulatory policy. 

And I was wondering how you would apportion the credit or 

blame for the financial collapse or the bubble that led to the financial collapse between those three legs of policy. What fraction of it 

was due to each? 

Mr. TAYLOR. I think the regulatory policy is maybe equivalent 

and equal to the monetary policy measures. It is very hard to quantify, to be sure. 

But there you had, I think, a situation where certain entities 

who should have been not taking the risks they took, took the 

risks, and they were overlooked by regulators. Fannie Mae and 

Freddie Mac are an example, but in addition, a lot of the large 

commercial banks were certainly, in retrospect, taking risks that 

the Federal Reserve should have been watching for—the New York 

Fed, in this particular case, mainly. 

So I think that is very high. It raises questions about the way 

that regulators enforced regulations, and that should be examined. 

It is not that you need more regulations; just means the ones on 

the book need to be taken seriously. 

So I would put that up there along with the monetary policy. It 

is actually part of monetary policy. 

Mr. FOSTER. So for example, the Fed’s apparent refusal to enforce mortgage origination standards nationwide, which was, I 

think, given to them in 1994, sometime in there, and then despite 

repeated urging, then-Chairman Greenspan decided not to enforce 

that. You view that as a significant driver of the housing bubble? 

Mr. TAYLOR. I would focus more on the risks that the banks were 

taking and holding as securities. 

Mr. FOSTER. And then the other—the third leg of the triad is fiscal policy, where, of course, during the Republican years it went 

from basically a surplus to a trillion dollar structural deficit by the 

time President Bush left office. How would you mix that in, in 

terms of— 

Mr. TAYLOR. By 2007, the Federal deficit was a little over 1 percent of GDP, and Federal spending had increased to 19.7 percent 

of GDP. And remember, in the year 2000, Federal spending was 

only— 

23 

Mr. FOSTER. But by 2008, when the bubble popped, there was a 

huge structural deficit because of all the costs that the government 

incurs when household net worth drops by $17 trillion. 

Mr. TAYLOR. I would say that in the year 2007, before— 

Mr. FOSTER. During the peak of the bubble. Right. 

Mr. TAYLOR. —near the end of that year, during that year you 

could argue we were close to full employment and the deficit was 

a little over 1 percent of GDP, so that would be one measure, 

maybe somewhat larger than one measure of the structural deficit. 

But I think it is hard for me to see why that is the cause of the 

crisis, because—obviously, we would like to have a smaller deficit, 

but you can see that 1 percent is—hard to see why that would 

drive things. 

Mr. FOSTER. I would like to talk quickly about the rules-based— 

Dr. Meltzer has emphasized the need for rules-based things, and 

particularly when you look at the housing bubble, which I view as 

the main driver—that along with the buildup of leverage in the financial system. There have been, at the American Enterprise Institute, as Dr. Meltzer may be aware, a panel of discussions and there 

will be a workshop this summer on countercyclical loan-to-value requirements for real estate, which other countries very successfully 

use to fight bubbles. Israel, for example, and other countries have 

squelched housing bubbles by turning up the downpayment requirement at times when they see bubbles developing. 

There are rules-based approaches to this, the simplest being, for 

example, just a requirement that federally-backed mortgages cannot exceed the value the property had 3 years ago, being one simple example of one. And I was wondering if you could comment, 

maybe starting with Dr. Meltzer, on the feasibility and desirability 

of having countercyclical elements in the real estate market, and 

particularly ones that might protect for the federally-backed section 

of the real estate market, ones that might protect the taxpayer 

from the sort of damage they have seen in the collapse of the bubble. 

Mr. MELTZER. Most countries have housing policies—housing 

without having as many subsidies as we have, and one of the problems—you mentioned regulatory policy. Regulatory policy was really a big factor in this crisis. 

You had a system in which people like Angelo Mozilo, a wellknown name, could make tens of millions of dollars by just shoveling bad mortgages onto Fannie Mae and the regulators did nothing about that except to encourage it. That is a terrible problem 

with regulation. Regulation gets captured, it gets circumvented, it 

breeds crony capitalism. 

I am convinced that the only regulations which are really effective are regulations which change the incentives of the people you 

regulate. You want them to want what you want. You don’t want 

to give them rules which tell them, ‘‘Be good,’’ because they will circumvent them and ignore them. 

Chairman CAMPBELL. The gentleman’s time has expired. 

And without objection—we have three more questioners here in 

this round—we will have a second round of questioning, but I will 

now move to the gentleman from North Carolina, Mr. Pittenger, 

and he is recognized for 5 minutes. 

24 

Mr. PITTENGER. Thank you, Mr. Chairman. 

Thank you, gentlemen, for your assistance to this committee and 

your service to our country. 

I would like to Dr Meltzer, the central planning model that this 

Administration has pursued, albeit through the Fed’s expansionary 

monetary policy, has clearly not achieved their desired objectives, 

trying to find 6 percent unemployment and 4 percent economic 

growth. But more importantly, of concern to me is the unprecedented legal authority that has been advanced by the Fed. 

In light of that, we recognize that the Fed is an independent central bank. However, are there any reforms you think that Congress 

should consider as it pursues its relationship with the Fed and trying to improve the accountability of the Fed? 

Mr. MELTZER. Yes. Absolutely. 

I believe the Congress has an obligation, in order to fulfill its requirement under the Constitution, to adopt a rule which restricts 

what the Federal Reserve can do without your permission. I think 

the Taylor Rule is an acceptable rule. A price stability rule would 

be a fine rule. 

No rule will be perfect under all circumstances, so the rule has 

to say something about what you do when you don’t think it is appropriate. 

Years ago, I made a proposal to the Reserve Bank of New Zealand. I said, adopt a target. If you hit the target, fine. If you don’t 

hit the target, you send two messages. One says, ‘‘Here is our resignation; we failed. And here is our explanation of why we failed.’’ 

And the authorities have a right to choose among those explanations because there are legitimate reasons why you may miss. 

Now, 20 countries have adopted something which improves on 

that rule by adding price stability. The United States has not. 

It is time that we adopt a rule for monetary policy to assure 

yourself that you can say to the Federal Reserve when they appear 

here, ‘‘Look, you told us that in this year, 2 years from when you 

made—no, 3 years from when you made the forecast, that we 

would have this outflow, and this inflation, and you haven’t done 

it. Explain to us why you haven’t done it.’’ That puts the Congress 

back into the game where it belongs. 

Mr. PITTENGER. Thank you. 

Mr. Malpass, Chairman Bernanke testified before us last week 

that there are not any asset bubbles forming as a result of his exceptionally accommodating monetary policy. Does this coincide with 

what you and your clients are seeing in asset markets today? 

Mr. MALPASS. Thank you, sir. Today, the stock market hit a new 

all-time high, so there is a levitation going on in equity prices. We 

have also seen high-yield markets levitate. The yields fall, the price 

goes up, and the Fed has been explicit in its policy in stating that 

it is trying to cause asset prices to go up. 

My concern is that tends to be a narrow set of financial assets 

and not connected to job growth and small business growth that 

would be more desirable in the economy as a whole. Dr. Meltzer 

mentioned farmland, and the Federal Reserve Board itself has 

talked about asset price bubbles in farmland and also in the highyield market. A recent statement by a Fed official talked about it 

25 

being a tip of the iceberg in terms of what banks are now holding 

on their balance sheet in terms of appreciated assets. 

May I come back to your previous point very briefly? 

Mr. PITTENGER. Sure. 

Mr. MALPASS. Sir, there is also the question of whether you want 

to leave the Fed with unrestricted asset-buying authority, which is 

the implication of the current policy of the Fed. Apart from our current crisis, 20 years from now I am worried that the markets and 

the economy will look to the Fed to keep buying things and they 

will expand their desire for the Fed to buy municipal bonds, or 

other assets. I am worried about that open-ended authority. 

Mr. PITTENGER. Slippery slope. Never ends. Thank you very 

much. 

Chairman CAMPBELL. The gentleman’s time has expired. 

The gentleman from Delaware, Mr. Carney, is now recognized for 

5 minutes. 

Mr. CARNEY. Thank you very much, Mr. Chairman. 

And I thank the panelists for being here. 

Dr. Taylor, it is good to see you again. We met out in California 

in your office. 

Very interesting, if not a little esoteric, conversation today for 

me. I am a first-time member of this subcommittee, certainly no expert. I don’t have the kind of economics training that you all do, 

so I appreciate your expertise. 

I have just a few questions, if I may. One is about the dual mandate of Humphrey-Hawkins—price stability and full employment. 

Do each of you think that is an appropriate mandate for the Fed, 

and if not, I think you have had—we have had some discussion 

about maybe how it would be different. 

But why don’t we start with Mr. Malpass? 

Mr. MALPASS. If I may defer to Dr. Meltzer or Dr. Taylor— 

Mr. CARNEY. Sure. Please do. 

Mr. MELTZER. I find it acceptable because it is politically desirable, and it is important that what we do is acceptable to the public. I would prefer a price stability target, because that is what the 

Fed is really capable of doing. It is capable of enforcing price stability, and that is a very desirable thing. 

As Paul Volcker testified many, many times before this committee and elsewhere, the way to get low unemployment is to get 

low expected inflation. 

Mr. CARNEY. Is it your view that has become maybe the primary 

focus of the Fed, in terms of price— 

Mr. MELTZER. One of the things I object to in the way the Fed 

operates is it concentrates on one of the goals in the dual mandate 

until the other one gets out of line and then it concentrates on that. 

That puts additional variability into the economy. 

Professor Taylor has measured variability several times. Chairman Bernanke, before he was a policymaker, when he was an academic, measured variability. We could reduce the variability in the 

economy, and that would be good, if we didn’t shift from looking 

at—worrying about unemployment until inflation rises, and then 

worrying about inflation and raise the unemployment, and worrying about unemployment and so— 

Mr. CARNEY. Dr. Taylor, do you have—my time is ticking— 

26 

Mr. MELTZER. That is a bad bicycle to ride. 

Mr. TAYLOR. Just briefly, I am concerned about the way the dual 

mandate is being used. For most of Paul Volcker’s term, he focused 

on price stability as the way to get unemployment down, and it did 

come down with that. 

Recently, the dual mandate is already put forward as a reason 

to intervene, a reason for the quantitative easing. We heard much 

more about it recently. 

I think the reality is when the Fed focuses too much on that goal, 

it gets worse. If you think of the 1970s, they focused on unemployment, and unemployment became high. In my view, one of the reasons unemployment is high now is because they focused on that too 

much in 2003, 2004, and 2005. 

Mr. CARNEY. Dr. Meltzer, and I think Mr. Malpass, both said 

that you thought that the focus on monetary policy alone has taken 

the focus off fiscal policy. What would be more appropriate? Do you 

think the fiscal policy we have now is the right one, and what 

would be more appropriate, if not? 

Mr. MALPASS. The issue is whether monetary policy is going to 

carry the burden of stimulus. 

Mr. CARNEY. You said it shouldn’t, and so what— 

Mr. MALPASS. The Fed has taken on too much of that burden. 

Mr. CARNEY. So what should we be doing on the fiscal side for 

stimulus? 

Mr. MALPASS. There should be corporate tax reform. There 

should be a streamlining and simplification of the individual tax 

system, which is very cumbersome, and costly to the economy. 

And on the regulatory policy side, we have an array of very costly Federal regulations that are burdensome. 

Mr. CARNEY. Sorry for interrupting, but my time is expiring. 

Dr. Meltzer or Dr. Taylor, on fiscal policy? 

Mr. MELTZER. Fiscal policy—I agree with exactly what he said. 

And I think I want to emphasize what he said at the end. Regulatory policy, particularly at the present time, makes businessmen 

think that the Administration is hostile. I don’t know whether the 

Administration is hostile or not, but they think it is hostile. That 

deters investment and creates uncertainty. 

Mr. CARNEY. What about the idea of automatic spending cuts 

that are taking effect right now as part of that fiscal policy equation? 

Dr. Taylor? 

Mr. TAYLOR. The Congress has laid out a strategy to reduce 

spending gradually over time. I think moving back off of that would 

be a mistake. It would reduce the credibility of the government, so 

stick to the path that has been agreed to, try to deal with the sequester itself by giving flexibility to— 

Mr. CARNEY. The problem was that it wasn’t quite an agreed-to 

strategy. It was the fallback plan, if you will. 

But thank you very much, each of you, for coming today and for 

your advice. 

Chairman CAMPBELL. The gentleman’s time has expired. 

And now the gentleman from New York, Mr. Grimm, is recognized for 5 minutes. 

Mr. GRIMM. Thank you, Mr. Chairman. 

27 

I will start off with Mr. Malpass. 

Mr. Malpass, you mentioned before and in your testimony that 

the policies favor a select group, which would be the government, 

but not new businesses, small businesses, et cetera. Can you expand on that a little bit? Just because the average person out there 

would say, doesn’t a small and new business benefit from having 

very low interest rates? So can you just explain that a little bit? 

Mr. MALPASS. Thank you, Mr. Grimm. 

The National Bureau for Economic Research has a study out this 

morning talking about how banks are actually responding to the 

current interest rate policy. It explains a little bit of what Mr. 

Huizenga was saying he felt in Michigan, that small businesses are 

having trouble getting credit, whereas larger businesses and, of 

course, the government are having an easy time getting credit. 

My explanation in the testimony is that this is normal economic 

behavior when you fix the price of something. For example, if the 

government said that gasoline prices should be lower and then put 

a ceiling of $1.50 on a gallon of gasoline, what would happen? People who were privileged would get the gasoline. Businesses that 

were wasteful of gasoline would use too much. And that is basically 

going on. 

The Fed has set the price of credit artificially low. It is causing 

people who don’t need the credit—for example, the government or 

big corporations—to snarf up the credit and take too much. 

Mr. GRIMM. I am sorry, because I have limited time. So basically 

what you are saying is, it sounds great in theory that new businesses and small businesses will also have low, low interest rates, 

but the truth is, they don’t get access to the credit—to take—to get 

the benefits of those low interest rates. 

Mr. MALPASS. That is exactly right. 

Mr. GRIMM. Great. Thank you. 

Mr. Meltzer, can you also expand for just 1 minute on why bankers applaud the current policy? And my question is, is it similar almost to an arbitrage, where it is a riskless transaction? I am going 

to borrow lower, then I know I can give it back to the government 

at higher, so there is really no risk. And if that is the case, if that 

is accurate, then does this limit—it goes back to what we just 

said—the appetite or the desire for a bank to lend to who they are 

supposed to be lending to, which is these businesses that desperately need it? 

Mr. MELTZER. Yes. To amplify that, in addition to the interest 

rate, there is the risk. The bank looks at the risk and it says, 

‘‘These new startups are a heck of a lot riskier than lending to the 

government. So I can make a good profit by borrowing from the 

Fed at a quarter of a percent or less and lending on government 

bonds at 1 percent or 2 percent, and why not do that and make a 

huge profit,’’ which is what they are doing. 

That isn’t in the public interest and that isn’t getting us toward 

the goal that we all agree on, which is good growth, a stable economy, and low inflation. 

Mr. GRIMM. Dr. Gagnon, you had mentioned before, and I know 

it was touched upon when my colleague went into this, but I am 

still not satisfied, so I would like to just talk about it for the last 

minute. My understanding is that the Fed is buying up longer-term 

28 

instruments to push—put pressure on mortgage rates and the 

longer-term instruments that have interest rates as—to go down, 

as well. But they don’t have any T-bills at all in their balance 

sheet. 

If they don’t have short-term instruments and interest rates do 

start to rise, the Fed has said that to avoid capital losses, they will 

hold them to maturity. But if they hold them to maturity then they 

don’t have anything to sell to actually affect the interest rates or 

the potential for a run on the bond market. So isn’t that dangerous? 

Mr. GAGNON. No, because they have unlimited ability to repo 

them out to the market at short term— 

Mr. GRIMM. I am sorry, say—say that one more time— 

Mr. GAGNON. They can lend them to the market at short terms, 

so it is as if they sold short term—borrowed short term from the 

market. They can borrow short term from the market using them 

as securities—long-term bonds as securities, so they can regulate 

short-term interest rates that way. 

And the key thing will be that they need to set interest rates 

where they need to be for the economy, and they have the tools to 

do that. They can print money; they can repo out securities; and 

they can choose whether or not they want to sell those bonds in 

their portfolio. I would urge them never to sell them. 

Chairman CAMPBELL. The gentleman’s time has expired. 

The gentleman from Florida, Mr. Murphy, is recognized for 5 

minutes. 

Mr. MURPHY. Thank you, Mr. Chairman. 

And thank you all for being here today. We appreciate your time. 

Similar to many Members of Congress, I came here to talk about 

real solutions and what we can do to address the problems. I have 

been working very closely with the gentleman from North Carolina, 

who is stepping out, on focusing on a grand bargain, and I think 

that is perhaps one of the single biggest things we can do in our 

country to get our country on the correct fiscal path and then get 

out of the way. 

In this hearing we have talked about unconventional monetary 

policy. What would it mean for unconventional monetary policy if 

Congress were to really do its job and get this grand bargain—in 

perhaps a perfect world, say we were to get this grand bargain immediately—what would that mean for monetary policy? And this is 

for all of you, starting with Dr. Gagnon. 

Mr. GAGNON. I think the Federal Reserve traditionally is like the 

second mover in this process. The Federal Reserve looks at what 

Congress and the President do with regard to taxes and spending 

and then it responds as best it can, and that is always the way I 

think it needs to be, because the Federal Reserve has the ability 

to move quicker. 

I think ideally you would like to delay spending cuts and tax increases until the unemployment rate had fallen further or inflation 

were a risk, neither of which is an issue now, and that would make 

the Fed’s job easier, yes. 

Mr. MURPHY. Dr. Taylor? 

Mr. TAYLOR. I think a consolidation plan for fiscal policy would 

improve monetary policymaking because it would reduce a lot of 

29 

the uncertainty the Fed is trying to deal with. I think it is quite 

remarkable to me, a lot of the concerns I have about monetary policy—the unconventional, the unpredictability—also characterize fiscal policy. They go together and it hasn’t always been that way. We 

used to have regular order for budgeting. We don’t have that anymore so it is unpredictable. 

So I think the more that fiscal and monetary policy can get more 

predictable, get more sensible, like you are trying to do, the better 

off the country will be. 

Mr. MURPHY. Thank you. 

Dr. Meltzer? 

Mr. MELTZER. Yes. To your efforts, I say amen and good luck, because I can’t think of any policy operation that would be more important at the present time than to put us on a predictable path 

to a balanced budget achieved over a sequence of years. 

And what would it do for monetary policy? It would make—hopefully encourage them, make them do the corresponding thing: put 

us on a path toward price stability over the longer term. And the 

last thing that would need to be done would be to improve the regulatory policy. 

But you are on a great track, and I wish you every good wish 

I can. 

Mr. MURPHY. Thank you. 

Mr. Malpass? 

Mr. MALPASS. I will give a caution on the fiscal policy and also 

on the monetary policy, if I may. As I have seen the grand bargains 

done in the past, the concern is the taxes go up in the early years 

and the spending reductions are put off into the out years. Try to 

make sure that there are spending restraints at the beginning of 

the process. 

I testified last week to the Senate Budget Committee and talked 

about the positive impact that has on the private sector. If the U.S. 

private sector saw the Federal Government in a continuous process 

of spending restraint rather than the one-off sequester that we are 

doing, a permanent process that held back the rapid growth that 

we keep seeing in government spending, it would cause a true 

boom. There would be job growth. 

With regard to the Fed, I am worried that it will have trouble 

conducting monetary policy. It is true that they can repo bonds, but 

the Fed is right now the dominant player in the bond market, so 

it makes it very difficult and distortive to markets if the Fed were 

to begin a repo operation in an effort to conduct monetary policy 

under the current conditions. I think it would be disruptive for 

markets. 

Mr. MURPHY. The question I propose is under a sort of perfect 

scenario. Under the reality of this Congress and the current dysfunction we have, what do you recommend, Mr. Malpass, that Fed 

Chairman Bernanke do in these times? 

Mr. MALPASS. I mentioned earlier to stop digging the hole deeper. Because the policy is not working, the Fed’s response has been 

to double the policy. And that has made it work even less well, so 

the growth rate has come down. 

I would encourage the Fed to stop making promises about future 

interest rates and future bond purchases, to walk back. 

30 

Mr. MURPHY. Thank you. 

Thank you all. 

Chairman CAMPBELL. The gentleman’s time has expired. 

Without objection, Mr. Green of Texas will be recognized for 5 

minutes. 

Mr. GREEN. Thank you very much, Mr. Chairman. Thank you especially for allowing me to be an interloper, given that I am not 

officially a part of this committee. 

I would like to thank the witnesses for appearing and to address 

Mr. Gagnon. 

Sir, you have indicated from your testimony that you believe that 

more expansionary monetary policies are necessary. We do know 

that the Fed announced on December 12th that it would keep buying $40 billion in mortgage-backed securities per month and that 

it would begin buying $45 billion in long-term Treasury securities. 

I assume that you concur with what the Fed is doing. Is that a 

fair statement? 

Mr. GAGNON. Yes. 

Mr. GREEN. All right. Given that you concur, will you elaborate 

on the type of monetary policies you think would benefit us, in 

terms of them being expansionary? 

Mr. GAGNON. Sure. Over 3 years ago now, I warned that the Fed 

was on a path to being too tight and urged it to do a lot more in 

terms of buying long-term assets to hold long-term rates to get 

spending up. Over the years the Fed has belatedly, begrudgingly 

moved to pretty much do what I had asked 3 years ago. 

At this point, I think what they could usefully do is to give some 

more assurance to the housing market that mortgage rates will 

stay low for a fixed period of time, perhaps 12 months. That would 

give banks comfort that if they want to make a mortgage to a borrower they can sell the MBS to the Fed at a fixed price, say 2 percent, for 12 months. 

It would encourage banks to staff up their mortgage departments, to make more mortgage loans, and it would give house buyers that if they go into the market this year, they would have several months to shop for a house, and the credit would be there, and 

they wouldn’t have to worry about rising rates. And it would really, 

I think, have a nice dynamic for the housing market. I think that 

is an important thing the Fed could do, which would be better than 

what they are doing. 

Mr. GREEN. You also mentioned other types of refis. Would you 

elaborate on some of the other refis that might stimulate the economy? 

Mr. GAGNON. What would really be helpful, and this is sort of beyond the Fed’s ability, would be to really get the housing agencies 

to stop discouraging refinancing of old conforming mortgages. A lot 

of people still have 6 percent mortgages. 

Mr. GREEN. Just for edification purposes, when you say ‘‘housing 

agencies,’’ would you be more specific? Are you talking about 

Fannie and Freddie? 

Mr. GAGNON. Yes. 

Mr. GREEN. And that would be under FHFA? 

Mr. GAGNON. That is correct. 

Mr. GREEN. And that would be Mr. DeMarco? 

31 

Mr. GAGNON. That is correct. 

Mr. GREEN. Continue, please. 

Mr. GAGNON. I do not understand why FHFA has been allowed 

to not push the agencies harder. A refinance—fairly automatic refinance of—automatic approval of refinances of existing mortgages, 

mortgages that are already guaranteed by Fannie and Freddie but 

are paying high interest rates. 

Mr. GREEN. For edification, are you saying an automated system 

that would allow FHFA to ascertain which of these products can 

be refinanced and streamline a process so that we can sort of clear 

out many of the homes where persons are underwater and would 

probably walk away from, some of them—I don’t know how many, 

but a good many might—but if they can refi they will get a reduced 

payment and they will stay in that home. Is that some of what you 

are saying? 

Mr. GAGNON. That is exactly what I am saying, and I think it 

would reduce the risk to the government, because if people can get 

a lower payment they are less likely to walk away from their mortgage. And since the government is already guaranteeing that mortgage, it is better to reduce the payment to make it less likely to 

fail. 

Mr. GREEN. This is not something that the Fed can do; this is 

obviously within FHFA’s purview. 

Mr. GAGNON. That is correct. 

Mr. GREEN. Now, quickly, one more thing: Are you familiar with 

the term, ‘‘expansionary fiscal contraction?’’ 

Mr. GAGNON. Yes. 

Mr. GREEN. Would you quickly explain, in your opinion, whether 

this term applies to the current economic circumstances? 

Mr. GAGNON. Absolutely not. 

Mr. GREEN. And if you would quickly, I only have 30 seconds, but 

maybe you will be allowed to go over to give your explanation. 

Mr. GAGNON. One of the things we are learning is that the effect 

of fiscal policy on the economy depends a lot on the state of the 

economy and it depends a lot on how the Federal Reserve will react 

to fiscal policy. And so when the economy is booming, fiscal policy 

has a very big effect, because the Fed tends to offset it. If you cut 

taxes in a boom, it doesn’t stimulate the economy any more; it just 

tends to raise interest rates. 

But if you cut taxes or raise spending in a low state of the economy, the Fed will not react, and it will pass through to spending 

much more strongly. So a lot of studies are coming out and saying 

that fiscal policy has a big effect on the economy in a recession, but 

it has very little effect in a boom. 

Mr. GREEN. Thank you, Mr. Chairman. 

Chairman CAMPBELL. Thank you. 

Without objection, we will go to a second round of questioning 

now and I will first recognize the gentleman from South Carolina, 

Mr. Mulvaney, for 5 minutes. 

Mr. MULVANEY. Thank you, Mr. Chairman. I appreciate the second round of questions. 

Dr. Taylor, I would like to talk to you a little bit, because you 

have introduced something in your written testimony and talked a 

little bit about it briefly today that was news to me—a new topic. 

32 

We have talked a little bit here today about the risks of the unconventional policy, and generally speaking, a lot of the debate has 

been focused on how maybe it is not working as well as it should 

or it is not working at all. 

But you have introduced a new concept, which is that it is actually making things worse. And in your written testimony on page 

7, you talk about the relationship, you say, ‘‘The perverse effect 

comes when the ceiling is below the—what would be the equilibrium between borrowers and lenders who normally participate in 

that market. While borrowers might like a near-zero rate, there is 

little incentive for lenders to extend credit at that rate.’’ And then 

you go on to talk about the fact that with lenders not supplying 

enough credit that the decline in credit availability reduces aggregate demand, which tends to increase unemployment, ‘‘a classic unintended consequence of the policy.’’ 

That is the first I have heard of this. Would you mind exploring 

that a little bit with us, giving us more detail? 

Mr. TAYLOR. Sure. It is very similar to what my colleagues over 

here have indicated, somewhat different words, and maybe mine is 

more academic-sounding, but it is very similar. 

The idea here is if you think about monetary policy, it is not simply just the interest rate; it is the credit system. It is getting the 

funds from, if you like, the—intermediating from the lenders to the 

borrowers. And that credit system is not taken account of when you 

are thinking about the low interest rates. Of course you are going 

to stimulate some spending—investing with low interest rates, but 

if the credit doesn’t come because of the very low interest rate because people don’t want to lend at those rates, the margins are too 

small, then you will get— 

Mr. MULVANEY. And that impact is immediate, isn’t it? 

Mr. TAYLOR. That is credit intermediation, yes. 

Mr. MULVANEY. But, for example, we are talking about certain 

risks. There is risk of inflation—that is down the road. There is 

risk of credit bubbles, or asset bubbles—that would be down the 

road. 

This depressing impact, the downward pressure on GDP that you 

are talking about, is happening right now. 

Mr. TAYLOR. In my view, it is. I think it is something that isn’t 

emphasized enough. You are thinking about risks in the future but 

it is a present issue. I think that is why the Fed has been disappointed in its policies, is the policies have been implemented and 

they haven’t worked—that is my assessment—and so they have actually had more. They have done more of it, and I hope that vicious 

circle stops. 

Mr. MULVANEY. Mr. Malpass, do you want to add something to 

that? 

Mr. MALPASS. It is, sir, an immediate response because the market looks forward. In my work on this in 2009, I called it a rationing process, meaning if the Fed sets an artificial price for something then the market begins to ration through shortage, which is 

a very common economic phenomenon, and it is exactly what we 

have seen happen in 2010 in the credit markets of the United 

States. 

33 

I think as the Fed set this up they didn’t think about the 

deleveraging going on in the banking system. They were thinking 

that if you put in a very low interest rate, it must cause more credit. Yet, the regulators were causing less credit or the same amount. 

So you have a rationing or a redistribution of credit rather than 

growth. 

Mr. MULVANEY. Thank you, gentlemen. 

Mr. Malpass, I want to stay with you on another topic, because 

my colleague from New York, Mr. Grimm, asked a question of Dr. 

Gagnon regarding exit strategy, and in response to one of his questions Dr. Gagnon suggested that maybe the Fed could hold these 

Treasuries to maturity but enter into the repo market. You didn’t 

look very satisfied with that answer. 

At the risk of asking a question I don’t know the answer to, what 

were your thoughts on that, sir? 

Mr. MALPASS. I am not sure I know the answer because we 

haven’t done this before. The Fed has become an absolutely dominant player in the government bond market. In the past when the 

Fed did repo operations, they were a very small player in a large 

market. Now, they are a very large player relative to the market. 

There are unpredictable consequences from the idea of the Fed 

lending a bond into a smaller market. 

Mr. MULVANEY. Is it possible that the efficacy of that particular 

tool has been reduced because of the size of the balance sheet? 

Mr. MALPASS. More than possible. It is likely that it has been reduced and probably wouldn’t be very workable when the Fed gets 

to that point. 

The point Mr. Grimm had made was that the Fed doesn’t have 

any short-term Treasury bills. Dr. Meltzer is a world expert on Fed 

history. In the past, the Fed never used any other instrument than 

short-term Treasury bills and repos in a robust government bond 

market. We are in unexplored territory. 

Mr. MULVANEY. Thank you, gentlemen. 

Thank you, Mr. Chairman. 

Chairman CAMPBELL. Thank you. 

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

Mr. FOSTER. Thank you, Mr. Chairman. 

I would like to return for a moment to the issue of asset price— 

bubbles that—and I was interested in your view of the state of the 

art of macroeconomic modeling of the housing market, and in particular, whether various things can actually be understood in terms 

of how the housing market in other countries who have consciously 

suppressed housing bubbles and whether those things are accurately modeled. Can we get some understanding of possible policy 

or rules we can put in place, such as the one I mentioned, and how 

they might have worked and might work in the future to suppress 

housing bubbles in an automatic way. Because I personally, from 

a political point of view, am very skeptical that unless we have an 

automatic punchbowl retractor, it is going to be very difficult to 

hold back. 

Anyone may answer. 

Mr. MALPASS. I will make a brief comment. The point that you 

are making is very strong, that we need to have a countercyclical 

34 

policy. My one observation is we are actually going the other way. 

With each year the Federal Government is lowering the standards, 

making the equity requirement less and less for FHA. 

I think you are right in what you are suggesting and I am afraid 

we are going the other way. 

Mr. TAYLOR. I also think your concern about bubbles or excesses 

is well-taken. I think the experience, though, with monetary policy 

is that frequently the bubbles are coming at a time when policy is, 

if you like, overly easy. In other words, it is almost like the central 

bank is helping to cause the bubble rather than prevent it. And 

that is what I think we saw in 2003 and 2004. 

It is also, if you look at Europe, countries which experience these 

real bubbles, say Greece and Ireland and Spain, the same kind of 

thing. One interest rate for Europe didn’t really handle their situation. Often, it is the monetary policy that is the cause, so I would 

address that first. 

And with respect to automatic changes in capital requirements, 

we haven’t seen those work very well yet. But if it does, if we have 

something like that I agree 100 percent. It should be— 

Mr. FOSTER. They were done sort of by fiat. For example, in 

Israel, they very aggressively turned up the downpayment requirements for houses, and you can imagine rules that kick in that 

force—at least for the federally-backed part of the mortgage market, you can imagine rules that would automatically pull the government out of the housing market when it starts to heat up. 

I think that one of the things we are wrestling with is the phase 

lag between—the reason the system oscillates is that you are trying to regulate on lagging indicators, like unemployment, which is 

one of the most— 

Mr. TAYLOR. Absolutely. I couldn’t agree more. You need to work 

these through with models, and lags, and uncertainty, and there 

hasn’t been enough of that done, unfortunately, to say this is what 

we should do, but I encourage it. 

Mr. FOSTER. All right. 

And on a related thing, there are various rules that you can 

imagine, and one of them is this so-called ‘‘targeting of nominal 

GDP,’’ and it is an example of—it is one of the exit rules. If I remember properly, Dr. Taylor actually testified in 2010 on possible 

exit rules for—which is actually, the transparency as we exit I 

think will be important in getting business confidence back and the 

predictability of the system. 

And one of those possibilities is simply to target nominal GDP 

and say it is simply the sum of inflation and GDP growth. Or you 

can obviously sort of feedback and try to regulate any linear combination of all the variables you can imagine, or some nonlinear 

function of them. 

I was just wondering what you thought of that as a general approach. 

Mr. TAYLOR. I think a predictable exit strategy is essential to lay 

out what the strategy would be when the time comes. And everyone wants to have stable nominal GDP growth. The question is, 

what should the Fed do to get that? What should the changes in 

the instruments be, the changes in the interest rate? And that is 

left open when people talk about a nominal GDP target so it needs 

35 

to be supplemented with some other kind of rule, if you like, for 

what the Fed should do to get to that target. 

Mr. FOSTER. So the gain of the feedback loop, as it were. 

Mr. TAYLOR. Yes. 

Mr. FOSTER. Okay. I guess that is it. 

I yield back the balance of my time. 

Chairman CAMPBELL. Okay, thank you. 

The gentleman from Indiana, Mr. Stutzman, is recognized for 5 

minutes. 

Mr. STUTZMAN. Thank you, Mr. Chairman, and I apologize if my 

question maybe repeats some of the questions that were asked earlier. I had to jump out due to another meeting, but I want to talk 

a little bit about the dual mandate, but also how the Fed’s policies 

are affecting seniors, affecting Main Street, and what they are seeing and what they are feeling right now. 

I have several friends that I spoke to before this hearing and just 

asked them what they are seeing and where people are putting 

money, and they said other than just the old principles of a balanced portfolio, there is nothing really out there that is attracting 

dollars because of Fed policy, low interest rates. 

People are not putting money into CDs because there is not 

much return. Maybe they are getting pushed towards the stock 

market but people still are very wary of the stock market. My 

wife’s grandmother, who lives on Social Security but has her savings, pulled everything out and is just sitting on it. 

What kind of message is that sending from the Fed to Main 

Street? People are very skeptical and especially—and Dr. Taylor, I 

guess I will ask you this question, that the Federal Reserve predicted that GDP would be at 4 percent growth in 2012, but it actually just turned out to be 2 percent. Is it possible that the Fed’s 

policies, whether it is dual mandate, it is working against American especially seniors right now, and especially the amount of retirees who are going into retirement, they are not seeing any 

growth in their pensions or their savings. 

Mr. TAYLOR. Absolutely. That is the distributional effect that we 

are concerned about with monetary policy. It is helping some and 

hurting others. 

I think the question about the overall effect being negative is 

based partly on that but also on the uncertainty that the policy is 

causing, which is a drag on investment. Remember, firms are sitting on a lot of cash, and they are holding back, and one reason 

is the uncertainty about monetary policy. Other policies too, but 

that is a big part of it. 

And so again, you might think that low interest rates are good, 

and it is easy to talk about it and you can try to convince people, 

but there is this other side of the coin with the policy, which is actually, I think, a drag, and makes—one of the reasons why growth 

has been slower than the Fed forecast. 

Mr. STUTZMAN. Mr. Malpass, I don’t know if you would want to 

comment on that as well? And also, are we pushing more dollars 

into the stock market because there is just not the return on bonds, 

long-term or short, that could be creating a bubble here? We are 

just about to top the old record today. I haven’t seen the numbers 

if we have, but I fear— 

36 

Chairman CAMPBELL. Dow is up 144. 

Mr. STUTZMAN. I am sorry, what? 

Chairman CAMPBELL. Dow is up 144, so they have blown through 

the record. 

Mr. STUTZMAN. Did they? Okay. 

Mr. MALPASS. One of the complaints is that the Fed is in so 

much control of this. The Fed was somewhat explicit over the last 

couple of years that it wanted to see more money go into stocks. 

I think that is too broad a role for the Fed. 

There have been questions about the dual mandate today. It 

seems to me that there is a way to seek maximum employment in 

the context of price stability and those go together well enough. 

The Fed could go in a better direction. The Fed has gone way beyond the rules and the thoughts of what the boundaries should be. 

That creates risk for financial markets going forward and for the 

economy. 

Mr. STUTZMAN. Anyone else want to speak to that or touch on 

that? 

Let me ask just another question. Going back a little bit to where 

people are putting dollars, I don’t know if Dr. Gagnon—what are 

we seeing internationally? Are we seeing the same trends internationally? Are we seeing anything that is different here that we 

could maybe learn from somewhere else or learn not to do? 

Mr. GAGNON. Actually, that is a good question, because I think 

we do see different policies. The only other country that has really 

done what the Federal Reserve has done is the United Kingdom, 

and I think if you compare them to their neighbors in Europe, despite being much more the center of the—they had a much more 

important financial sector that was much more hurt by this crisis, 

and they have equally tough fiscal contraction right now—tax increases and spending cuts—and yet they are doing better than the 

rest of Europe, in part because they have chosen to do quantitative 

easing and Europe has not. 

Mr. STUTZMAN. Thank you. I yield back. 

Chairman CAMPBELL. The gentleman from Delaware, Mr. Carney, is recognized for 5 minutes. 

Mr. CARNEY. Thank you, Mr. Chairman. I have come back. I had 

a couple other questions I just wanted to ask, now that we have 

the distinguished panel before us, and it piggybacks a little bit on 

what my friend from Indiana was just talking about in terms of 

short-and long-term interest rates. At a conference in San Francisco recently, the Chairman of the Fed, in response to questions, 

said raising interest rates prematurely would carry a high risk of 

short-circuiting the recovery, possibly leading, ironically enough, to 

an even longer period of lower long-term interest rates. 

The idea that if we short-circuit the recovery now then that is 

going to have that negative impact on the long-term. But Dr. 

Meltzer or Dr. Taylor, do you have any response or thoughts on 

that question? 

Mr. TAYLOR. I think there is just a disagreement, different views 

about the impact of the policy. He feels that if he starts moving off 

of the quantitative easing or even just delays it, that is 

contractionary. I don’t agree with that. 

37 

I think it is actually going to be a bonus or a benefit if we go 

back—it has to be gradual, as Dr. Meltzer indicated—to a policy 

that has worked in the past in similar circumstances. 

Mr. CARNEY. What would your rule dictate? Your rule has been 

referred to several times. 

Mr. TAYLOR. My rule would not have the quantitative easing. 

That is the most important thing right now. The interest rate 

would remain low but we wouldn’t have the quantitative easing. 

Mr. CARNEY. So the second question really relates to a statement 

that Dr. Meltzer made earlier that we are, in some ways, abdicating our constitutional responsibility for monetary policy here in 

the Congress, which suggested to me that somehow we ought to be, 

I don’t know, involved. It is hard for me to believe that we could 

get it right. In fact, it sounds like the worst possible thing, to involve the Congress in the activities of the Fed. I just can’t imagine. 

Dr. Meltzer, I don’t—you probably didn’t mean that, but what 

did you mean by that, because I can’t think of a worse idea, frankly. 

Mr. MELTZER. Yes, I can’t imagine the Congress doing that either, not running the policy. Prescribing a rule and enforcing the 

rule, that is what you want to do. 

Mr. CARNEY. So isn’t the rule— 

Mr. MELTZER. So when the Chairman comes in here or the Members of the Board come in here to testify, you want them to say, 

‘‘Look, in 2 years we are going to have low inflation and high employment, and these are the numbers that we are aiming for.’’ 

And then 2 years later when they come in you can say, ‘‘Well, 

you didn’t get there, so what we want you to do is explain to us 

why you didn’t get there, and if we don’t think the explanation is 

good, we think you should resign and we will get people who can 

do the job better.’’ That is what I think is the Congress’ responsibility. It is an oversight responsibility. 

Mr. CARNEY. Yes, so we— 

Mr. MELTZER. What you have now, it is just very difficult for you 

to do it because the Chairmen—not just Chairman Bernanke but 

Chairman Burns, Chairman Volcker, Chairman Greenspan—can 

run circles around you talking about things that are very difficult 

to sort out and for you to clearly know. 

Mr. CARNEY. That is a fact. 

Mr. MELTZER. Yes. 

Mr. CARNEY. Just like this panel can as well, I might add, but— 

Mr. MELTZER. I don’t think we are trying to do that. I think we 

are trying—my own view and I am sure the view of my colleagues 

here, including Mr. Gagnon, are trying to help you. 

Mr. CARNEY. I appreciate that. And we do, I think, have a framework anyway. It is called Humphrey-Hawkins. We had a conversation about that a few minutes ago, and you conceded that the full 

employment piece, although it wouldn’t be your preference, it is a 

political thing, and of course, that is what drives us. We are driven 

by the people that we represent every— 

Mr. MELTZER. Yes, and you need to add to Humphrey-Hawkins 

something which incentivizes the Fed to pay attention to it, and 

that is— 

Mr. CARNEY. In terms of a rule. 

38 

Mr. MELTZER. That is the rule and the addition to the rule, 

which says if you don’t hit the target that you said you were going 

to hit, if you don’t achieve what we have told you to achieve or 

what you have told us you were going to achieve, then you have 

to tell us why and offer a resignation, and political authorities have 

to be willing to make that choice. That gives incentives. 

Regulation that is goodwill regulation doesn’t work. Regulation 

works when they incentivize the people who are regulated. That is 

what you need to do both in banking and with the Fed. You have 

to give them an incentive to follow the rules which you and they 

agree upon. 

Mr. CARNEY. I see my time has expired. 

Let me thank each of you again for coming and for your expertise 

and your advice. 

Chairman CAMPBELL. The gentleman from Delaware yields back. 

And now, the vice chairman of the subcommittee, the gentleman 

from Michigan, Mr. Huizenga. 

Mr. HUIZENGA. Again, thanks, Mr. Chairman, for doing this. 

And I want to thank the panel for coming in. I can tell you that 

every time I have a conversation with you all, I feel like I am making significant leaps toward having a Ph.D., or maybe a master’s, 

in banking and financing and economic theory, so thank you very 

much. 

I have a couple of very short, kind of quick questions. In your 

opinion, who is benefitting the most right now from our current 

policy? And I would love to have you just kind of go down the row. 

Who is benefitting from it and is this the path that we need to be 

on? 

Mr. MALPASS. My thought is that the government is the biggest 

beneficiary because it is the biggest debtor. The interest rates are 

being kept artificially low; that helps the debtor. The cost is borne 

by the savers, and in the United States the biggest saver is the 

household sector. So it is a direct transfer from the private sector 

saver to the government. 

Mr. MELTZER. I agree with what he said, the government, but I 

would add, would you vote for a policy which said, we are going to 

bail out the banks and increase their returns? 

But that is what the Fed is doing. It is allowing them to borrow 

from the market or from the Fed at a quarter a percent or less and 

lend to the Treasury for 1 percent or more, and they make big profits. 

What is the social benefit of that? None, as far as I am concerned. It has a social cost, and that social cost is high because it 

is keeping interest rates too low, and we have talked about that a 

lot. 

So you wouldn’t vote for that policy and yet you have that policy. 

Mr. TAYLOR. I just think it is focused on the overall macro effects, which I think are negative, in terms of trying to figure out 

who are the winners and who are the losers here. It is very difficult. But I would say my main concern is that the overall effect 

is negative. 

Mr. GAGNON. I would say the beneficiaries, as Mr. Malpass said, 

are the U.S. Government, the Federal Government particularly, as 

I said before, but also, younger people and people with mortgages 

39 

are benefitting. I think the people who are losing are, it is true, 

older savers are losing something, and the other big loser is foreign 

governments who are investing in our country and getting a low 

rate of return and I think that is fine. 

Mr. HUIZENGA. But it is fair to say it is not the mom sitting 

around the kitchen table trying to figure out how she is going to 

feed her kids and how she is going to put gas in the minivan, and 

all those things, right? 

Mr. GAGNON. Well, if she has a mortgage and she refinanced it, 

she is much better off now. 

Mr. HUIZENGA. If she qualifies, if she can get through the DoddFrank Act. 

Mr. GAGNON. Yes, that is an issue—can I make one very brief— 

Mr. HUIZENGA. Please. 

Mr. GAGNON. —point about—one thing I don’t understand is this 

talk about credit rationing. It seems to me that is confusing the 

level of rates with the spread of rates. Banks charge a spread over 

what they can borrow at. The Fed sets that at zero and no one tells 

the banks how much—limits how much they can charge on—to borrowers, so there is no rationing going on. 

And if you give banks a lower cost to funds, they can lend it at 

a lower rate. So I don’t see any way this could hurt— 

Mr. HUIZENGA. That beautifully ties into my next question, actually, which is, I would like you all to touch on what some of the 

effects are of the regulation that has been on there. And this might 

be a little outside of what we are specifically talking about today 

but it seems to me it is not just our spending and it is not just 

monetary policy; it is the regulatory environment and the tax policy that dramatically impacts that, and I hear that all the time. 

And I used this with Dr. Bernanke. It is not one grain of sand 

that is going to gum up the works on that machine, and you can’t— 

who can argue with, okay, one little grain of sand, a regulation 

that is going to be added, but when suddenly it is a whole handful 

and suddenly you are using a rubber mallet to pound it into the 

gears, now you have a problem, and it seems to me that we have 

done that. So that might go to some of my concern about what you 

are bringing up, but would anybody care to comment? 

Mr. MALPASS. When I say the government is the beneficiary, I 

mean in the sense of Washington, D.C., government employment, 

and the real estate boom. This is the center of the beneficiary of 

these policies, whereas outside of Washington is having a harder 

time. 

And with regard to the regulatory side, Sarbanes-Oxley and 

Dodd-Frank are putting very real costs onto businesses. The regulators in the banking sector are causing challenges in the allocation 

of capital. Some banks are able to make more loans, but many 

banks are constrained or scared by the regulators into not making 

loans that are considered risky loans. 

Mr. HUIZENGA. I know my time has expired, but I appreciate 

that. 

And if anybody has any other comments they would like to share 

in writing, I think probably, or unless the chairman so chooses to 

do something different, I would love to hear your views, so— 

Chairman CAMPBELL. I thank the gentleman. 

40 

And the gentleman’s time has expired. I saved myself the final 

5 minutes to bat cleanup, and so I will yield myself 5 minutes at 

this time. 

I think this hearing has been very interesting, very productive, 

and very helpful. And one of the things that has come to me from 

this hearing that I didn’t necessarily have coming in was, the risks 

of the current monetary policy out—the sort of tail risks are obvious. The Fed acknowledges them, et cetera. 

What I heard today was a lot of not risks but, in fact, negatives—current negatives. Things that are from the current monetary policy that are depressing current employment and current 

GDP growth, which—and I would like to just touch on a few of 

these. 

One we talked about was the loans being priced below where 

they should be, and even if milk is free, it doesn’t help you if you 

can’t get it. Now, Dr. Gagnon just suggested that it is about the 

spread and not about the price of the loans. How do those of you 

who believe that is a constricting factor respond to Dr. Gagnon on 

that? 

Mr. MELTZER. If a bank can lend to the government and make 

quite nice profits, why would it want to take risk that—to a new, 

unsecured— 

Chairman CAMPBELL. So are you saying, then, that the spread 

between a no-risk loan and a risk-loan has compressed? 

Mr. MELTZER. And that is what they are doing. 

Chairman CAMPBELL. Right. Okay. 

Dr. Gagnon? 

Mr. GAGNON. I would say that the issue is whether that is because of monetary policy, or because of regulatory policy, or because banks have felt they have been burned through their misbehavior in the past and are overcompensating now, and— 

Chairman CAMPBELL. Okay, but it is probably a fact, though, 

right, that spread is down and that is going to limit the availability 

of loans? 

Mr. GAGNON. I don’t see it from the point of view of monetary 

policy. I do see it from the point of view of regulatory policy and 

bank— 

Chairman CAMPBELL. However, it may be the— 

Mr. MELTZER. Of course, it is due to monetary policy. It is the 

monetary policy which is keeping the interest rates down there and 

telling banks—Dr. Taylor wrote a piece in The Wall Street Journal 

and talked about it here. Sure, the borrowers want to borrow, but 

try to get a mortgage if you are an unsecured, not-well-known borrower coming into the mortgage market. You just won’t find a bank 

or mortgage company that is going to want to lend to you when 

that is the case. 

If you are a commercial real estate operator speculating on the 

future of asset prices, commercial market prices in New York or 

the Silicon Valley, you can get all kinds of credit. 

Chairman CAMPBELL. Okay. 

We talked about cash on balance sheets not deployed, and it is 

not just on corporate balance sheets. Again, I see that anecdotally 

all the time—people just sitting on cash because interest rates are 

41 

too low, returns are too low now but they think they are going to 

go up in the future so they just sit. 

And so everybody just sits until the Fed takes action. Rather 

than trying to read a market, they are trying to read what the Fed 

is going to do, which is very distorting, in my view. 

We talked about banks borrowing at a quarter percent and selling to the Treasury at a percent. Older people or savers—and, Dr. 

Gagnon, you acknowledged this as well—are losing in this environment. And when I asked Chairman Bernanke last week about how 

the benefits of this were going to big banks and governments, he 

pushed back hard, saying, ‘‘Oh, no, no, there is all this employment 

and stuff that is being created.’’ 

We haven’t looked at all the things. What are the cutbacks of 

savers? What are they doing differently? What are seniors who are 

largely or partially dependent on fixed incomes doing to cut themselves back on that? 

And then, Dr. Gagnon, you said a minute ago that you felt—you 

acknowledged that but you felt younger people were getting some 

benefit, and I saw a great deal of angst from the other end of the 

table when you said that. 

So either Mr. Malpass or Dr. Meltzer, I believe both of you lit 

up on that? 

Mr. MALPASS. The unemployment rate for young people is very 

high, and that is, I think, in part the result of a contractionary and 

distortive monetary policy. 

Mr. MELTZER. What Chairman Bernanke never says or discusses 

is, why is this the slowest recovery in the whole post-war period? 

There hasn’t been another one like this since 1937 to 1938. It is 

very slow, harming lots of people, especially new entrants to the 

labor force. 

That is a question which the Fed doesn’t approach. It is helping 

bankers make large profits lending and borrowing with the government. That is not a policy which gets us substantial growth and 

employment. 

Chairman CAMPBELL. Thank you. 

My time, and all time having expired, I very much appreciate all 

four of you coming. And I very much appreciate the nature and 

tenor of the discussion, and as I said, I think it was very helpful. 

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. 

The hearing is now adjourned. 

[Whereupon, at 12:17 p.m., the hearing was adjourned.] 

(43) 

A P P E N D I X 

March 5, 2013 

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