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38—677 CC

Report of the Federal Reserve Board Pursuant to the
Full Employment and Balanced Growth Act of 1978,
P.L. 95—523
and the State of the Economy

MARCH 5, 1997

Printed for the use of the Committee on Banking and Financial Services
Serial No. 105—6

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JAMES A. LEACH, Iowa, Chairman
BILL McCOLLUM, Florida, Vice Chairman
TOM CAMPBELL, California
EDWARD R. ROYCE, California
FRANK D. LUCAS, Oklahoma
JACK METCALF, Washington
BOB BARR, Georgia
JON D. FOX, Pennsylvania
SUE W. KELLY, New York
JIM RYUN, Kansas
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BOB RILEY, Alabama
RICK HILL, Montana

BRUCE F. VENTO, Minnesota
BARNEY FRANK, Massachusetts
PAUL E. KANJORSKI, Pennsylvania
JOSEPH P. KENNEDY II, Massachusetts
MELVIN L. WATT, North Carolina
JESSE L. JACKSON Jr., Illinois
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JAMES H. MALONEY, Connecticut


Subcommittee on Domestic and International Monetary Policy

MICHAEL N. CASTLE, Delaware, Chairman
JON D. FOX, Pennsylvania, Vice Chairman

EDWARD R. ROYCE, California
FRANK D. LUCAS, Oklahoma
JACK METCALF, Washington
BOB BARR, Georgia

BARNEY FRANK, Massachusetts
JOSEPH P. KENNEDY II, Massachusetts
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PAUL E. KANJORSKI, Pennsylvania
JESSE L. JACKSON Jr., Illinois


Hearing held on:
March 5, 1997

March 5, 1997


  Greenspan, Hon. Alan, Chairman, Board of Governors, Federal Reserve System

Prepared statements:

Castle, Hon. Michael N.
Flake, Hon. Floyd H.
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Jackson, Hon. Jesse L. Jr.
Maloney, Hon. Carolyn B.
Paul, Hon. Dr. Ron
Sanders, Hon. Bernard

Greenspan, Hon. Alan (with attachment)

Additional Material Submitted for the Record
  LaFalce, Hon. John J., prepared statement
Greenspan, Hon. Alan:
Report to Congress from the Board of Governors, Federal Reserve System dated February 26, 1997



House of Representatives,
Subcommittee on Domestic and International Monetary Policy,
Committee on Banking and Financial Services,
Washington, DC.

  The subcommittee met, pursuant to notice, at 2:03 p.m., in room 2128, Rayburn House Office Building, Hon. Michael N. Castle [chairman of the subcommittee] presiding.

  Present: Chairman Castle, Representatives Leach, Fox, Lucas, Metcalf, Paul, Weldon, Roukema, Flake, Frank, Kennedy, Sanders, Kanjorski, Maloney, Hinchey, Bentsen, and Jackson.
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  Chairman CASTLE. The hearing will come to order.

  The subcommittee meets today to receive the semiannual report of the Board of Governors of the Federal Reserve System on the Conduct of Monetary Policy and the State of the Economy, as mandated in the Full Employment and Balanced Growth Act of 1978.

  Chairman Greenspan, welcome back to the House Committee on Banking and Financial Services, Subcommittee on Domestic and International Monetary Policy. You will note that this subcommittee has done its best to accommodate the Fed while meeting the schedule required by the Humphrey-Hawkins Act. We have followed your appearance before our Senate colleagues as closely as we could, so that the same testimony can serve for both hearings. I trust that in turn, you will be as candid as possible in addressing issues raised over the past week.

  Today, we will have 5-minute opening statements by the Members present. In addition, some Members of the full Committee may sit with us today and participate in the questioning. As always, any prepared remarks presented by a Member will be accepted for the record.

  Today the U.S. economy continues to be healthy with inflation apparently in check. We welcome the continued sound performance of the economy which evidently has been assisted by the Fed's monetary policy. Having witnessed what even one of your carefully-calibrated characterizations of the stock market can accomplish, it is clear that what you say can have a significant impact on the market, at least over the short term.

  Following your testimony last week, many analysts have argued both that the current prices of common stocks are justified and that external factors are also somewhat responsible in making this market the investment vehicle of choice. Others dispute the actual amount of influence the Fed is able to exercise using the traditional mechanisms of monetary policy.
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  If you believe that any of your earlier remarks were misinterpreted or unfairly taken out of context, today's hearing offers the opportunity to correct such misreading. Certainly, several percentage points of exuberance have been wrung out of the stock markets, and we can hope that some seeds of inflation have been destroyed as well.

  I am also interested in your assessment of whether the run-up in relative value of the dollar is becoming a limiting factor in the conduct of monetary policy by the Federal Reserve.

  Your chairmanship of the Federal Reserve System Board of Governors continues to be successful as judged by results. Nevertheless, aside from monetary policy there are other aspects of Federal Reserve operations that merit review by Congress. This subcommittee is planning oversight hearings on the Federal Reserve System that will review Fed activity, including the transition from physical to electronic forms of money as the digital age looms in our future. Of particular concern to me, it seems that with the current level of technology available, the Fed's proposal to add an additional day to the current check-clearing process seems to be going in the wrong direction, especially from the point of view of the consumer needing access to his or her money.

  We also hope to review the role of the central bank as a competitor with private sector clearing facilities. We look forward to hearing how the Fed is planning for the potential of new technology to affect systemic security, safety, soundness, and consumer privacy as well as the future conduct of monetary policy.

  In this future hearing, we hope to engage in a discussion of the various ways that the approaching digital revolution in money will affect the operations of the Federal Reserve System. I am increasingly persuaded that dramatic change in how we define and employ money may soon be upon us. This in turn, must affect the payment system and institutions charged with its stewardship. Thus, we should be prepared for the threshold at which this impending change becomes significant in your models of the economy.
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  As always, we are delighted to have you with us and look forward to a lively discussion.

  Before recognizing Mr. Frank for his statement, I want to recognize and welcome the participation of Members of the Banking Committee not appointed to the Monetary Policy Subcommittee and ask unanimous consent that to the extent they wish to participate and ask questions of the witness they may be permitted to do so.

  [The prepared statement of Chairman Castle can be found on page 44 in the appendix.]

  Hearing no objection, it is ordered. At this time I will turn to Mr. Frank for his opening statement.

  Mr. FRANK. Thank you, Mr. Chairman. I welcome this in part as a chance to, I hope, demonstrate my commitment to the value of civility which we talk about a lot. I say that because civility is something that is most important when we have profound disagreements. Mr. Greenspan, you are the perfect subject for this because I cannot think of many people now in Government for whom I have greater respect or with whom I have greater disagreement. I think it is important for us to be able to show that personal respect and very profound disagreement can exist side-by-side.

  The disagreement is that I believe through the performance of your role, given how you have interpreted it, the Federal Reserve System under your governance, with the support of those who work with you, has become an engine for inequality in our society. I think that has terribly negative consequences.
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  A lot of people have talked recently about a poll of the Republican Party done by Mr. Fabrizio in which he talks about various segments of the Republican Party. He found five segments. What I found very interesting was that all five segments, when asked, were negative as to whether or not we should expand NAFTA. There is, I think, almost a certainty that a poll of Democrats would show an even heavier negative. All five of the sectors of the Republican Party which differ on a lot of things were opposed to, according to this poll, to expanding NAFTA.

  We have an increasing degree of resistance on the part of the American people to the kinds of international economic cooperation that you believe are very important to the prosperity of this country and the world, and I agree with you to a great extent. But the problem we have is, I think illustrated by a comment John Kennedy made when he initiated the Alliance for Progress. He said Franklin Roosevelt, who was the model here with the Good Neighbor policy, was able to be a good neighbor abroad because he was seen as a good neighbor at home.

  Increasingly, a lot of Americans do not see this Government, the Federal Reserve System, Congress, the Executive Branch as a good neighbor at home. They see increased inequality. You talk about job insecurity. It is, as you know, a terrible thing to live with. I realize you understand the anguishing factor of it, but most of your statement is about the centrality of job insecurity as a factor in America. Living with job insecurity, which means uncertainty as to whether or not you are going to be able to feed and clothe and educate and care for your children, is a terribly anguishing thing.

  Recently, you have come out very strongly in favor of what, I understand your technical justification for, but what is in fact one of the most regressive policies being proposed: telling old women who live on $7,000 and $8,000-a-year in America that they are getting too much compensation for inflation and that we ought to cut them $100 or $200 every so often. I cannot think of a more regressive policy.
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  Wage increases are, as you see the world, a problem. The lower the rate of wage increases, the better. Meanwhile, of course, there are elements in the economy where things go up that are not a problem.

  It also has to do with tax policy, and I am going to ask you to address this, if not in my 5 minutes, at some later point in writing. We passed a tax bill in 1993 that increased taxes on upper-income people. I thought that helped promote equity and helped reduce the deficit. You said in testimony that you and I discussed that you were committed to the view that this was going to cause problems for the economy. I remember in 1994 you said that this would reduce the growth in the economy, when you raise taxes on upper-income people, or taxes on anybody.

  I asked you this about 1994 or 1995 and you said it was too early for those effects to show. Well, I would have to ask you. We passed that tax increase nearly 4 years ago. In the intervening years since we passed the tax increase your view has been that the economy was growing, if anything, more rapidly than it should. You have leaned more toward restraint. Your policy has been caution.

  So I have to ask, if we damaged the economy by raising taxes, why then has your view been that the economy was, if anything, a little bit too exuberant, to use a word? Does that not mean if we had not raised taxes, presumably you would have shown us less restraint?

  I understand this is not your goal, but it does seem to me, in closing, as you add up the specific policy positions you have taken: let us cut the cost-of-living increase for Social Security recipients which will have its major social impact on the elderly poor; let us worry if wages go up too much; let us worry if unemployment goes down too much; let us oppose a tax increase on the wealthy.
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  The consequence of this is, we pay for lower inflation, if that is in fact what we had to do to get it, with an increase in inequality or, at best, an absence of any measures to fight the inequality that the market inevitably sets forward. That is, as I said, not just a problem of equity. But I have never seen America in a more anti-internationalist mood, and I think that that is one of the consequences of this set of policies.

  Chairman CASTLE. Thank you, Mr. Frank.

  Mr. Lucas is recognized for his opening statement.

  Mr. LUCAS. I do not have one, Mr. Chairman.

  Chairman CASTLE. Thank you.

  Now we recognize the distinguished Ranking Member of this subcommittee, and a pleasure to have him back. Mr. Flake.

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

  I would like to welcome Mr. Greenspan to our biennial Humphrey-Hawkins hearings to discuss the Federal Reserve's conduct of monetary policy and its opinion on the current state of this economy. Given last week's reactionary activity on the stock market and the persistent political commentary of our Nation's economic health, I certainly look forward to hearing your statements today, Mr. Greenspan.
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  I will be brief in these comments, but I do wish to express to you one area of specific concern for me. This concern is the continued neglect of our Nation's poorer communities. The Federal Reserve appears to focus its efforts on macro-economic issues that in general have been good for the overall economic health of our Nation. But in its zeal to control inflation and to stave off economic downturns, the Federal Reserve seems to have forgotten that there are communities in America that are in a persistent cycle of poverty and stagnation.

  These communities are not hearing policies from the Fed that speak directly to their needs. The question thus becomes, does the Federal Reserve focus on all participants in the economy, or does it need to improve its communications process with respect to its concern and compassion for all of society?

  Whichever conclusion we come to, I do believe that these hearings tend to focus too much on macro-economic issues that do not speak very well to Mr. and Mrs. America. I recognize the old saying that a rising tide lifts all boats, and to an extent that your macroeconomic decisions are prudent for the Nation as a whole, I do commend you.

  But let us not forget that the rising tide also has the real potential to set the small boat adrift without direction. Mr. Chairman, there are many communities in America adrift in a sea of unemployment, poor education, deteriorated commercial areas, overall hopelessness. Inside the Beltway, economic and political discourse, unfortunately is often detached from these realities of everyday life.

  So I invite you, Mr. Chairman, to join with us in trying to participate in a means by which we bring about the necessary change that lifts all of our communities so that we might have the kind of civilization that we dare to dream about. I would encourage you to speak directly to those of us who represent these types of communities, give illustrations and ideas of policies that you and your colleagues believe will directly benefit what I have come to call America's Third World nation.
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  Chairman Greenspan, I come here today not to single out the Federal Reserve, but with the belief that all of us here in Washington need to become better stewards of the people's Government. Democrats need to come to the realization that social programs to help the poor are not the exclusive answer for social ills, and Republicans should not blindly enact slash-and-burn policies in the name of a balanced budget. Entrenchment of these partisan positions is not good government and only leads to pessimistic opinions about Washington's ability to govern in a responsible manner.

  Obviously, the solution is somewhere in the middle, and thus is the result of compromise between Democrats and Republicans. It is a solution defined by cooperation between Government and the private sector, and is a solution that has Government and the private sector working together in an effort to uplift the poorer communities. This partnership I believe includes improving job growth, education, and the moral fiber of our Nation.

  Therefore, in the coming months I intend to work with all Members in a bipartisan effort to encourage the Federal Reserve to communicate its thoughts on possible efforts for the revitalization of these often neglected and overlooked communities.

  With that, Mr. Chairman, I close. I will listen intensely to the testimony and I thank you, Mr. Greenspan, for coming to share with us this afternoon.

  Chairman CASTLE. Thank you very much, Mr. Flake.

  [The prepared statement of Hon. Floyd H. Flake can be found on page 48 in the appendix.]
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  Dr. Paul is recognized for an opening statement if he wishes to make one.

  Mr. PAUL. No statement, Mr. Chairman.

  [The prepared statement of Hon. Ron Paul can be found on page 53 in the appendix.]

  Chairman CASTLE. Thank you.

  Mr. Kennedy.

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

  Chairman Greenspan, welcome once again to the Banking Committee. I, first and foremost, want to say that I think that despite some of my pessimism about your policies in the past, I think the record that has been established in terms of the continued economic growth as well as the decline in the unemployment rate indicates that there have been times in the past when you perhaps have proven more correct in terms of your analysis of how the economy should be handled than some of the rest of us, myself included.

  But having said that and having reviewed your testimony for today, I think that there are certain issues that need to be addressed more completely in terms of how you actually feel certain issues are going to be resolved. I notice that you talk a lot about stagnant wages. But when it gets to the actual corrective actions that you feel are going to be taken you say, in other words, that the relatively modest wage gains we have experienced are temporary, rather than a lasting phenomenon, because there is a limit to the value of additional job security people are willing to acquire in exchange for lesser increases in living standards.
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  I am not sure that the notion of simple supply-and-demand is going to necessarily take care of those stagnant wages. I think that when you see the kind of wage increases that have occurred, particularly at the top end of many of the corporations that are holding these wages down, that just as you are willing to jawbone the advancements in the stock market, that there is a necessity for you as the leader of this country's economy to take on more actively the issues of justice in terms of the economy as well.

  I think the issue of the CPI is one where it is very difficult to argue the technical issue of the COLA increase. Take for example my neighbor in Brighton who earns around $8,000. When I first moved there she had a husband and two sons. Her husband died. One son moved to New Jersey. The other son became a fireman on Cape Cod. She lives by herself. Even though she worked most of her life, her total income is Social Security benefits, because she never earned a pension. That woman has to tape blankets across her doorways in order to stay warm enough in the wintertime.

  The ultimate result of not granting a full COLA increase is to say that she should remain cold in the winter because there is a technical glitch in how the CPI is treated. I just think that underneath the CPI issue we need to hear from you not on just those technical questions, but as to whether or not the amount of money that Social Security pays the lowest wage earners in this country enables people to have what Social Security promised.

  What I am asking for is a sense of your weighing in on some of the issues pertaining to not just the growth of the economy but who wins and who loses. I firmly believe that is well within your jurisdiction and you can have an important impact.

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  Then finally, just very briefly, my concern is that simply because the unemployment rate drops to a certain number, an automatic result of that will be to increase the interest rates of this country. I would like to hear you address that directly. I think, again, that this is an issue that pertains to justice and to whether or not people who are unemployed can ever expect, particularly with the changes that have taken place in the welfare laws, whether they can ever actually expect to be employed in our workforce.

  Thank you very much, Mr. Chairman.

  Chairman CASTLE. Thank you, Mr. Kennedy.

  Mr. Sanders.

  Mr. SANDERS. Thank you, Mr. Chairman, and welcome, Mr. Greenspan. Thank you for joining us today.

  Like Mr. Frank, I have respect for you personally. I have very, very strong disagreements with your policy. It is incomprehensible to me that President Clinton would have reappointed you in fact.

  Mr. Greenspan, like every American, you are entitled to your political views. According to newspaper reports, over the years you have made political contributions to Jesse Helms, to George Bush, to Bob Dole. You have served on the Committee to Reelect or Elect President Reagan, as I understand it. And of course, you worked as a key economic advisor for President Nixon and President Ford. I respect that. There is nothing wrong. We are all entitled to our points of view.
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  In 1985, as I understand it, you served as a consultant to many in the savings and loan industry. According to Time Magazine, you suffered your ''greatest embarrassment in 1985 when as a private economist you wrote letters to regulators and Congress endorsing Charles Keating and his Lincoln Savings and Loan. Lincoln subsequently collapsed at a cost to taxpayers of $2.6 billion and Keating landed in jail.'' That was from Time Magazine. You also served as a consultant for 15 other savings and loans, 14 of whom eventually failed.

  In your confirmation hearings 1 year ago, despite the fact that the minimum wage of $4.25 is at its lowest point in 40 years--millions of people working for $4.25-an-hour--you noted your opposition to raising the minimum wage. This January, you told the Senate Budget Committee that ''the appropriate capital gains tax rate is zero.'' Currently, many Senate Republicans are calling for a capital gains tax cut. According to the Center on Budget and Policy Priorities, 70 percent of the benefits of that tax cut will go to households earning over $100,000-a-year, and their proposal is far more limited than your proposal suggests.

  Mr. Greenspan, I will grant you consistency in your support for trickle-down economics. In your career up to today, it is clear that you have advocated tax and monetary policies which have benefited the very richest Americans, while at the same time your views reflect policies that come down very heavy on the middle class, the working class, and low-income people.

  In 1983, you were appointed to chair, as I understand it, the Social Security Commission. Under your leadership, the highly regressive payroll tax was increased by about $200 billion. You chose to solve the Social Security crisis by raising the payroll tax on working Americans, while at the same time as an economic advisor you advocated huge tax decreases for the richest people in America.
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  Now currently, as others have suggested, you are a proponent of reducing the Consumer Price Index. Like Mr. Kennedy, I have neighbors and friends, elderly people, who are trying to survive on $7,000- or $8,000-a-year, and I regard it as horrendous and vulgar, to be frank with you, that there are people in Government who want to balance the budget on the weakest and most vulnerable people in this society, and then advocate huge tax breaks for the richest people in this country as you continuously do.

  Now I would like to ask you--and later on maybe you can respond to that. I do not know where you get your information from. I go, and as I am sure many of my colleagues do, we talk to elderly people who are trying to make it. They cannot afford their prescription drugs. In my State it gets 20 below zero. Elderly people cannot afford to heat their homes. Maybe you will tell this subcommittee the last time you have sat in a room with low-income senior citizens and asked them how they are going to survive if they lose $100-a-year in their Social Security benefits, what kind of pain they go through now trying to survive on $7,000- or $8,000-a-year.

  Mr. Greenspan, the United States of America today, not alone through your work but through the help of a lot of other people, both parties, has the most unfair distribution of wealth and income in the industrialized world. The richest 1 percent of the population own 42 percent of the wealth, more than the bottom 90 percent. And the last 20 years, that unfair distribution of wealth has become even worse. I would ask you in your comments to tell us what we can do to equalize wealth in this country so that we do not have such an unfair distribution of wealth.

  You would about economic growth. Between 1983 and 1989, 62 percent of the increased wealth in this country went to the richest 1 percent. You can have all the growth that you want, but the middle class continues to shrink. People in my State are working two and three jobs just to survive because their wages have not kept pace with inflation. I want to ask you what your policies are doing for the middle class, for the working class, for low-income people rather than the wealthy people who I think you end up representing?
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  Thank you, Mr. Chairman.

  [The prepared statement of Hon. Bernard Sanders can be found on page 61 in the appendix.]

  Chairman CASTLE. Thank you very much, Mr. Sanders.

  Mr. Kanjorski, do you wish to follow that, sir?

  Mr. KANJORSKI. Yes. I have to apologize for my colleague's inability to be direct.


  Mr. KANJORSKI. Mr. Chairman, I too however, following this line, am very much interested in what the policy of the Administration and the Congress and the Federal Reserve will be in regard to the Consumer Price Index. I have previously introduced into Congress, and most recently went over the numbers with the Bureau of Labor Statistics, that the Consumer Price Index if geared to senior citizens in America actually are 4/10ths of 1 percent understated in that application of people over 62 years of age.

  I know we are attempting to use that mechanism for two purposes really. I hope the first purpose is to have a legitimate Consumer Price Index that we can all rely on without being driven by politics. But the second purpose, obviously, is a very quick fix to the budget deficit and imbalance that would occur out in the next century.
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  However, I join my colleagues, Mr. Frank, Mr. Kennedy, and Mr. Sanders in asking the question of where fairness is. If in reality, the Consumer Price Index today is understated by 4/10ths of 1 percent if it is applied to people over 62, why do we see there will be any major savings? I understand that about 82 percent of the programs that use the Consumer Price Index for automatic COLAs are senior programs in the budget. So if we were to change that and give the reflection, it does not really give us a great deal of latitude to save any money, if indeed it may cost the Government more money and drive us further into debt.

  But this casual addressing of this issue that I see that is being driven by budgetary considerations as opposed to humanitarian considerations. And it is one thing if we are going to affect the index to reflect truth. I certainly do favor that. And if we need to have an application of a formula of adjustment to help in the budget, I can understand that. But it does not mean that it should apply across the board.

  I think if you went into areas like mine where the average Social Security recipient receives $480 a month, that is hardly in this day and age a sufficient amount to survive on. And 92 percent of the people who receive that, that is their major source of income for sustenance.

  So I would hope that you would exercise the influence of your office in this total debate in seeing that fairness prevail, looking at the means-testing nature of how it applies across the board. Maybe there ought to be people that are exempt from a change. Maybe some people should get more at the lower end of the scale than some that are in more beneficiary positions as a result of their earning capacity where they may not have the need. Call it a means-test, if we will, but we should look at that.
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  Certainly, I hope this all is not driven from the harsh accounting position of merely budgetary means and easy political decisions, whether it be here in the Congress or in the Administration. This is too important an issue for the American people, and senior citizens of today and in the future, for us to be callous about it. So I would appreciate anything you can address yourself on that issue.

  Thank you, sir.

  Chairman CASTLE. Thank you, Mr. Kanjorski.

  Mr. Hinchey.

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

  Mr. Greenspan, welcome. It is very nice to see you again. We are happy to have the opportunity to discuss with you once again the provisions of the Humphrey-Hawkins Bill. I was just looking at the purpose of that bill. It says, to maintain long-run growth of monetary and credit aggregates commensurate with the economy's long-run potential to increase production so as to promote the goals of maximum employment, stable prices, and moderate long-term interest rates.

  Now I know that you have quarreled with the language of that law, and as a matter of fact at one point you were advocating that the law be changed so that the imperative to focus attention on economy growth and increased employment be excised, taken out of the law and that the focus of the Federal Reserve be exclusively on maintaining stable prices. Nevertheless, that has not occurred and the charge of the Federal Reserve is to promote economic growth as well as to stabilize prices.
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  It is disturbing to those of us who believe that the economy can grow at a rate much faster than 2 percent and still not suffer the adverse consequences of inflation, to see the Federal Reserve continually holding back economic growth. Historically, we have experienced economic growth far beyond 2 percent. In the 1960's, this economy was growing at the rate of about 5 percent a year. In the 1970's, we were growing at the rate of about 4 percent a year. In the 1980's, we were growing appreciably faster than we are at the present time.

  Nevertheless, the attitude of the Fed seems to be that anything beyond a 2 percent rate of growth, and any unemployment--it used to be 6 percent. Now I guess you have accepted 5.5 percent. Any unemployment level that goes lower than that is going to produce inflation.

  Now when you add to that some of the things that you have said recently in your admonitions, apparently to Wall Street, with regard to their stock market, talking about the kind of exuberance, or excess exuberance that exists in the market, people are very fearful that when the Federal Open Market Committee meets later this month on the 25th of March that you will be advocating before that committee and that the Federal Reserve will in fact raise interest rates above the level where they are presently. We are fearful of that because we believe that if that happens, that will have the consequence of reducing economic growth even further.

  It may be that you are justified in being concerned about some of the aspects of Wall Street and the rise in prices on the stock market and the fact that the market has gone up above 7,000, although it has settled back a little bit below that now. I do not want to argue that with you. You may be justified in that. You may not be.

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  I would argue with you, sir, though that if you advocate raising interest rates to deal with that phenomenon, if it is a problem, that the use of raised interest rates to deal with that situation is a blunt instrument which will have broad-ranging consequences throughout the economy, far beyond Wall Street and on every Main Street all across this country.

  People, as you note in your testimony, are struggling to make a living. Every American family is struggling in one way or another, with this low economic growth that we have been experiencing. You note stagnant wages. I would say to you that those stagnant wages are a consequence of long-term economic policies that have existed for a long-term, one of them being the trade legislation that we are living with currently.

  The other is a situation that has to do with the oversupply globally of both production and labor at the moment, and the fact that American workers are forced increasingly to compete with labor in other parts of the world because of the multinational corporations, transnational corporations. These are the problems that we are deeply concerned about.

  So I would urge you, sir, to perhaps continue to be concerned about the stock market. But do not attempt to use the blunt instrument of interest rates to deal with any perceived problems in the stock market because that act will have broad-ranging consequences far beyond Wall Street on every Main Street across the country.

  Chairman CASTLE. Thank you, Mr. Hinchey.

  Let me go next to Mr. Jackson, who gets a gold star. He has been in his seat since 2:00. Then if Mr. Bentsen wishes to make a statement, we will come back to him.
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  Mr. JACKSON. Thank you, Chairman Castle, Ranking Member Flake. I would first like to express how pleased I am to have the opportunity to join the Subcommittee on Domestic and International Monetary Policy for my first hearing with this subcommittee. I have just been recently, Mr. Greenspan, granted the honor of serving on this distinguished panel. I very much look forward to learning from your leadership, Chairman Castle, and Mr. Flake, and working with you during this Congress as we address the critical matters which fall in the purview of this subcommittee's jurisdiction.

  There is no better illustration of the significance of this subcommittee's role than the subject matter of the present hearing and the distinguished witness who is before us to testify today. Chairman Greenspan, it is with great pleasure and admiration that I welcome you here today to apprise us of the status of the American economy and your judgments as to the activities of the Federal Reserve System in fulfilling its duty, among others, of conducting monetary policy in pursuit of the objectives of price stability and full employment.

  To that end, Mr. Chairman, in your semi-annual report to Congress, first delivered to the Senate last week, you clearly hailed the strength of the economy, highlighting a 2 percent increase in gross domestic product as evidence of expanding economic opportunities. Relative to previous decades, however, we know that 2 percent is less than the 1980's, 1970's, and the 1960's. You tempered your optimism however with a call for caution when you stated that history is strewn with visions of new eras that in the end have proven to be a mirage.

  I agree completely with your assessment, and today while conventional economic wisdom speaks to expansion and growth, my view deviates just slightly from this conclusion. For the Second District of Illinois, I have devised a vigorous and a stringent economic test. I call it the eyeball test. In order to assess the relevant economic indicators, I merely open my eyes and look around to determine whether my constituents on the south side of Chicago and in the south suburbs are experiencing this relative economic growth. Sadly, Mr. Chairman, my results do not render the same optimistic projections. In my district, things have never been good and they are now getting worse.
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  Nationally, the unemployment rate is 5.4 percent, which means that 7.3-million people who receive unemployment compensation have no job. The actual number of unemployed and underemployed people is closer to 15- to 20-million Americans. These numbers include those who are unemployed, underemployed, working part-time when they want to be working full-time, they have never had a job or they have given up looking for one. These numbers are compounded by those who are faced by corporate and Government downsizing, are on the brink of or worried about the reality that they may fall into one of these categories.

  Mr. Chairman, I believe that those in my district and these particular explanations explain the widespread levels of economic anxiety currently plaguing the American people. In light of the foregoing, Chairman Greenspan, I will listening intently to your testimony, particularly your views on how the Fed can encourage and guide the economy toward attaining true levels of full employment. I have been most concerned, Mr. Chairman, most recently with the reality that whenever unemployment dips beneath a certain percentage point, the Federal Reserve turns off the spigot. It shuts opportunity down and slows down job growth and creation.

  In light of the reality that we most recently passed a welfare reform bill in this Congress, I am very concerned that we could slow the economy down at a time when our Nation's most-vulnerable can no longer turn to the Government for assistance.

  Once again, thank you, Mr. Greenspan, for joining us today and I look forward to hearing your testimony.

  Thank you, Chairman Castle.
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  [The prepared statement of Hon. Jesse L. Jackson Jr. can be found on page 55 in the appendix.]

  Chairman CASTLE. Thank you very much, Mr. Jackson.

  We will now call on Mr. Bentsen.

  Mr. BENTSEN. No statement, Mr. Chairman.

  Chairman CASTLE. Mr. Bentsen has no opening statement. I think that concludes our opening statements at last, Mr. Chairman. We turn to you now for your statement, sir. We appreciate your patience.


  Mr. GREENSPAN. Thank you very much, Mr. Chairman. I want to say, I certainly appreciate the opportunity, as always, to appear before this subcommittee to present the Federal Reserve's Semiannual Report on Monetary Policy.

  The performance of the American economy over the past year has been quite favorable. The growth of real gross domestic product picked up to more than 3 percent over the four quarters of 1996, as the economy progressed through its 6th year of expansion. Employers added more than 2.5-million workers to their payrolls in 1996, and the unemployment rate fell further. Nominal wages and salaries have increased faster than prices, meaning workers have gained ground in real terms, reflecting the benefits of rising productivity. Outside the food and energy sectors, increases in consumer prices actually have continued to edge lower, with core CPI inflation only 2.5 percent over the past 12 months.
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  Looking ahead, the members of the FOMC expect inflation to remain low and the economy to grow appreciably further. However, as I shall be discussing, the unusually good inflation performance of recent years seems to owe in large part to some temporary factors of uncertain longevity. Thus, the FOMC continues to see the distribution of inflation risks skewed to the upside, and must remain especially alert to the possible emergence of imbalances in financial and product markets that ultimately could endanger the maintenance of the low-inflation environment. Sustainable economic expansion for 1997 and beyond depends on it.

  For some, the benign inflation outcome of 1996 might be considered surprising, as resource utilization rates, particularly of labor, were in the neighborhood of those that historically have been associated with building inflation pressures. To be sure, an acceleration in nominal labor compensation, especially its wage component, became evident over the past year. But the rate of pay increase still was markedly less than historical relationships with labor market conditions would have predicted.

  Atypical restraint on compensation increases has been evident for a few years now and appears to be mainly the consequence of greater worker insecurity, possibly owing to the rapid evolution of technologies in use in the workplace. Technological change almost surely has been an important impetus behind corporate restructuring and downsizing. Also, it contributes to the concern of workers that their job skills may become inadequate.

  Certainly, other factors have contributed to the softness in compensation growth in the past few years. The sharp deceleration in health care costs, of course, is cited frequently. Another is the heightened pressure on firms and their workers in industries that compete internationally. Domestic deregulation has had similar effects on the intensity of competitive forces in some industries. In any event, although I do not doubt that all of these factors are relevant, I would be surprised if they were nearly as important as job insecurity.
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  If heightened job insecurity is the most significant explanation of the break with the past in recent years, then it is important to recognize that suppressed wage cost growth as a consequence of job insecurity can be carried only so far. At some point, the tradeoff of subdued wage growth for job security has to come to an end. In other words, the relatively modest wage gains we have experienced are a temporary rather than a lasting phenomenon. The unknown is when this transition period will end.

  Indeed, some recent evidence suggests that the labor markets bear especially careful watching for signs that the return to more normal patterns may be in process. The Bureau of Labor Statistics reports that people were somewhat more willing to quit their jobs to seek other employment in January than previously. The possibility that this reflects greater confidence by workers accords with a recent further rise in the percent of households responding to a Conference Board survey who perceive that job availability is plentiful. Wages rose faster in 1996 than in 1995 by most measures, perhaps also raising questions about whether the transitional period of unusually slow wage gains may be drawing to a close.

  To be sure, the pickup in wage gains has not shown through in underlying price inflation. Increases in the core CPI, as well as in broader measures of prices, have stayed subdued or even edged off further in recent months. As best we can judge, faster productivity growth last year meant that rising compensation gains did not cause labor costs per unit of output to increase any more rapidly. Non-labor costs, which are roughly a quarter of total consolidated costs of the non-financial corporate sector, were little changed in 1996.

  Owing in part to this subdued behavior of unit costs, profits and rates of return on capital have risen to high levels. As a consequence, businesses believe that, were they to raise prices to boost profits further, competitors with already ample profit margins would not follow suit. Instead, they would use the occasion to capture a greater market share. This interplay is doubtless a significant factor in the evident loss of pricing power in American business.
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  Intensifying global competition also may be further restraining domestic firms' ability to hike prices as well as wages. Clearly, the appreciation of the dollar on balance over the past 18 months or so, together with low inflation in many of our trading partners, has resulted in a marked decline in non-oil import prices that has helped to damp domestic inflation pressures. Yet it is important to emphasize that these influences, too, would be holding down inflation only temporarily. They represent a transition to a lower price level than would otherwise prevail, not to a permanently lower rate of inflation, as distinct from levels.

  Against the background of all of these considerations, the FOMC has recognized the need to remain vigilant for signs of potentially inflationary imbalances that might, if not corrected promptly, undermine our economic expansion. The FOMC in fact has signaled a state of heightened alert for possible policy tightening since last July in its policy directives. But, we have also taken care not to act prematurely. The FOMC refrained from changing policy last summer. In the event, inflation has remained quiescent since then.

  Given the lags with which monetary policy affects the economy, however, we cannot rule out a situation in which a preemptive policy tightening may become appropriate before any sign of actual higher inflation becomes evident. If the FOMC were to implement such an action, it would be judging that the risks to the economic expansion of waiting longer had increased unduly and had begun to outweigh the advantages of waiting for uncertainties to be reduced by the accumulation of more information about economic trends.

  I wish it were possible, Mr. Chairman, to lay out in advance exactly what conditions have to prevail to portend a buildup of inflation pressures or inflationary psychology. However, the circumstances that have been associated with increasing inflation in the past have not followed a single pattern.
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  In general, our analysis will need to encompass all potentially relevant information, from financial markets as well as the economy, especially when some signals, like those in the labor market, have not been following their established patterns.

  This year overall inflation is anticipated to stay restrained. The central tendency of the forecasts made by the Board members and Reserve Bank presidents has the increase in the total CPI slipping back into a range of 2.75 to 3 percent over the four quarters of the year.

  The unemployment rate, according to Board members and bank presidents, should stay around 5.25 to 5.5 percent through the fourth quarter, consistent with their projections of measured real GDP growth of 2 to 2.25 percent over the four quarters of the year.

  The Federal Reserve will be endeavoring to help extend the current period of sustained growth. Participants in financial markets seem to believe that in the current benign environment the FOMC will succeed indefinitely. There is no evidence, however, that the business cycle has been repealed. Another recession will doubtless occur some day owing to circumstances that could not be, or at least were not, perceived by policymakers and financial market participants alike.

  History demonstrates that participants in financial markets are susceptible to waves of optimism, which can in turn foster a general process of asset-price inflation that can feed through into markets for goods and services. When unwarranted expectations ultimately are not realized, the unwinding of these financial excesses can act to amplify a downturn in economic activity, much as they can amplify the upswing. As you know, last December I put the question this way: ''How do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions?''
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  We have not been able, as yet, to provide a satisfying answer to this question, but there are reasons in the current environment to keep this question on the table. Clearly, when people are exposed to long periods of relative economic tranquility, they seem inevitably prone to complacency about the future. This is understandable.

  We have had 15 years of economic expansion interrupted by only one recession, and that was 6 years ago. As the memory of such past events fades, it naturally seems ever less sensible to keep up one's guard against an adverse event in the future. Thus, it should come as no surprise that, after such a long period of balanced expansion, risk premiums for advancing funds to businesses in virtually all financial markets have declined to near record lows.

  Is it possible that there is something fundamentally new about this current period that would warrant such complacency? Yes, it is possible. Markets may have become more efficient, competition is more global, and information technology has doubtless enhanced the stability of business operations. But, regrettably, as has been commented, history is strewn with visions of such new eras that in the end have proven to be a mirage. In short, history counsels caution.

  Such caution seems especially warranted with regard to the sharp rise in equity prices during the past 2 years. These gains have obviously raised questions of sustainability. Caution also seems warranted by the narrow yield spreads that suggest perceptions of low risk, possibly unrealistically low risk, not just in the stock market but throughout the financial system.

  Why should the central bank be concerned about the possibility that financial markets may be overestimating returns or mispricing risk? It is not that we have a firm view that equity prices are necessarily excessive right now or risk spreads patently too low. Our goal is to contribute as best we can to the highest possible growth of income and wealth over time, and we would be pleased if the favorable economic environment projected in markets actually comes to pass. Rather, the FOMC has to be sensitive to indications of even slowly building imbalances, whatever their source, that, by fostering the emergence of inflation pressures, would ultimately threaten healthy economic expansion.
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  Mr. Chairman, I will conclude on the same upbeat note about the U.S. economy with which I began. Although a central banker's occupational responsibility is to stay on the lookout for trouble, even I must admit that our economic prospects in general are quite favorable. The flexibility of our market system and the vibrancy of our private sector remain examples for the whole world to emulate. The Federal Reserve will endeavor to do its part by continuing to foster a monetary framework under which our citizens can prosper to the fullest possible extent.

  Thank you, Mr. Chairman. I am available for questions.

  [The prepared statement of Mr. Greenspan can be found on page 63 in the appendix.]

  Chairman CASTLE. Thank you, Mr. Chairman.

  Mr. GREENSPAN. May I ask, incidentally, that the full testimony be included for the record?

  Chairman CASTLE. Without objection, it will be included in the record and we do appreciate that, Mr. Chairman.

  Mr. GREENSPAN. Thank you.

  Chairman CASTLE. We appreciate your testimony and we appreciate your commitment to being here for this process. As you know, we now enter into a period in which we each have 5 minutes in which to ask you questions and get your answers in, which is always a little bit difficult for each Member, so we will try to go as efficiently as we can. I will take the Chairman's prerogative and start the process.
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  You said yesterday that there was 100 percent probability that the CPI overstates inflation. As I understand it, you have proposed a two-track approach toward improving the accuracy of the CPI by urging the Bureau of Labor Statistics to accelerate its efforts to correct some errors in the creation of a rotating expert advisory committee that would periodically select the inflation adjustment factor that in its judgment best represents the modification of the CPI rise needed to measure the increase in the cost-of-living. Is this correct? Did I state it correctly, and how do you envision this two-pronged approach would work in practice?

  Finally, is it your feeling, based on what you know, read, have seen, discussions with the White House, that the time has come that this or some similar mechanism may be put into place at some time in the near future? I know that is conjecture and you may not wish to, but I wanted to ask you the question.

  Mr. GREENSPAN. No, I cannot answer that, largely because I really do not know. You probably have more insight in that than I.

  Chairman CASTLE. I doubt that, but it is kind of you to say so.

  Mr. GREENSPAN. The issue is clearly on the table. It is fairly clear that Senator Moynihan has considered it a very high priority over in the Senate. Let me, if I might, address the questions that your other colleagues on your right have been raising with respect to this issue as I respond to your question.

  There has been an extraordinary amount of analysis of the Consumer Price Index which the BLS stipulates, and I think quite correctly, is not a cost-of-living index. It was the intent of the Congress, as best I can judge, in 1972 to endeavor to insulate Social Security recipients from increases in the cost-of-living and in, I believe it was 1980, to insulate taxpayers similarly from bracket creep as a consequence of cost-of-living increases. In both instances, there was a general view that what was involved was adjustment for the cost-of-living increases only.
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  I fully recognize that in removing the bias from the CPI--and indeed the evidence in my judgment is just overwhelming, and I can go into it in detail, that that is in fact the case--if the Congress decides that it wants to do more than the cost-of-living, then I think it is perfectly appropriate as a third track to bring forward legislation to increase the real benefits. I think it is inappropriate for the Government of the United States to be using an index as a proxy for the cost-of-living, which clearly does not reflect cost-of-living.

  I regret that this issue is in the context of the budget, and it does have significant momentum because of the budget issue. But my main concern is that the index is a very crucial statistic for policy purposes and a lot of other purposes, and I think to improve it in a significant manner would be very useful to this country.

  What I had in mind is that there are a number of technical adjustments which the BLS can implement, and indeed, are in the process of doing so. They are moving forward at a fairly pronounced clip at this stage. As I understand it, the Administration has put additional funds for the BLS in this year's budget.

  Nonetheless, as hard as they may endeavor to move, there are certain things that are going to take quite a number of years to adjust, and I am referring mainly to the biases very obviously in the quality area of the statistics and in so-called new products. That is, the statistics are not picking up the very dramatic improvements in quality in a number of major areas.

  I suggested, in line with the Boskin Commission and in earlier comments that I made with respect to this issue a couple of years ago, that there be a second track in which an additional adjustment would be made on the basis of the evaluation of professionals in this area, appointed by the President and confirmed by the Senate, to make judgments on the basis of what studies have been made about what the remaining bias is. And say every October, that commission would meet to define in its judgment what the appropriate estimate should be. In my belief, Mr. Chairman, that would address this issue in the most reasonable way.
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  As I indicated before, should the Congress decide that there are many recipients who would be unduly affected by correcting what is an incorrect measure, then I think a third track would be perfectly appropriate to address those issues.

  I might say with respect to the question of changing the cost-of-living index to reflect the expenditures of the population over age 65, the BLS does have an index of that nature at this stage. The spread incidentally is less than .4. Last year it was only .1. But it is true, Mr. Kanjorski, the index is somewhat higher. And if the Congress chooses to make that sort of adjustment, I think that is a perfectly appropriate thing for you to be examining.

  Chairman LEACH. [presiding]. Thank you, Chairman.

  Mr. Flake.

  Mr. FLAKE. Thank you very much.

  Mr. Chairman, going back to my statement and the concerns that I raised earlier, I would like to just ask, as you consider where the Nation is going now, I think most of us agree that you have to make changes in welfare. That is not a big issue.

  The question becomes, as you talk about moving toward workfare, and the people who are most affected are living in certain communities where there has been devastation and deterioration to the degree that it is impossible to attract industry. It is impossible in many instances even to attract the small sector jobs from franchisors. It is impossible to get banks to see these communities as necessary places for making investment. Corporate entities really do not even look at them as a potential place for opportunities for building businesses.
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  Yet, those same corporate entities will go abroad where the environment is much worse than it is in many of these urban and poor rural communities, will make the investments, will take the risk, and in many instances take a loss. I would just like to know if within the scope of your analysis, has there been or will there be some means of looking at what might be done over the next 5 years or so in trying to determine what kind of industries can go into these communities, and how we might be able to assure that the same corporations that look abroad in these Third World countries will look at these communities as places of opportunity?

  Is that something that you think you can influence? If so, what kind of direction would you suggest we might go in trying to assure that it happens?

  Mr. GREENSPAN. Mr. Flake, you are raising one of the most difficult but important problems that this country has. I know our colleague Jack Kemp has addressed this with his enterprise zones in an endeavor to find a means to go in there to enhance economic development. We have so far made very little progress in the area of our knowledge of how to induce companies to go into areas to expand plants and to gain profitable opportunities. I have been dealing with this issue for many, many years and I must tell you, I feel very frustrated by the terribly small amount of results that have been achieved.

  Monetary policy itself cannot do anything. We only have one single instrument and that can only affect the economy as a whole. But I do think all of us who are involved in trying to observe what the various forces engendering growth in this economy are doing are also trying to understand better what is causing the locational differences among various areas and see whether we can alter them. There has probably been some progress, but I would suspect that you would argue, and with some reason, that the results have been far inferior to what you would like to see happen.
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  Mr. FLAKE. I think on the question from a monetary side, obviously corporations do not see these as the fertile fields of opportunity that I would see. I think on the other side though, the level of your influence as primary spokesperson as it relates to the monetary policy of this Nation can probably influence in a much more positive and meaningful way. We created a way abroad with NAFTA, and we create other means through taxing capability, or changing tax law.

  It would seem to me to suggest that if we indeed want a Nation that is strong enough to be able to absorb these individuals without having to make the kind of expenditures, capital expenditures for what is a growing industry, which is the penal system, that somehow the transference of even those dollars would make a major difference and a major impact in helping to solve problems, not only unemployment problems, but clearly, I think give an advantage to many of those corporations who were looking for a marketplace where there is a labor base, but a labor base that has nowhere to work.

  So that long-term, I think it represents a drain on the Nation. If you have all of those persons unemployed in jail, either way, the long-term benefits are not in the best interest of developing positive kind of monetary policy for the Nation.

  Mr. GREENSPAN. I must say I agree with you, Mr. Flake.

  Mr. FLAKE. And that is it?

  Mr. GREENSPAN. I agree that we all should be endeavoring to do something. We, as you know, have been trying through the Community Reinvestment Act indirectly to come at this issue. It does not, as you know, work directly because it only refers to lending, and to a very large extent to mortgage lending. But there has been some general awareness, growing awareness, that there are foregone loan opportunities, profitable loan opportunities, in small business in a number of our urban communities which are not being exploited.
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  I think that the one thing we can do is to try to find the ways in which that can be expanded. Because it is true, if you bring a large corporation in, that helps a lot. If you cannot bring a large corporation in, at least have a lot of small ones because they can grow. They may, in fact, be a better investment than the larger ones.

  Mr. FLAKE. Thank you, sir.

  Yield back, Mr. Chairman.

  Chairman CASTLE. [presiding]. Thank you, Mr. Flake.

  Mr. Chairman, I apologize for departing in the middle of your answering my question. My mother would not have been happy about that, but I am on the Education and Workplace Committee which is 179 running steps away, and if I get a phone call I can go vote in our markup over there. So that is why I had to go. It may happen again.

  Mr. FRANK. If the gentleman would yield?

  Chairman CASTLE. I yield.

  Mr. FRANK. If you guys would reinstate proxies, you would not have to run around like a nut.

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  Chairman CASTLE. If you think I have enough influence to reinstate or not reinstate proxies, you are wrong. You are sadly mistaken.

  Chairman Leach.

  Mr. LEACH. Thank you, Mr. Chairman.

  As I listened to several of the comments in the opening statements, I must say I think as Chairman of the Federal Reserve you see a distinction between this body and the other body. We are the people's House. We have a little bit broader perspectives sometimes than the other body. We are represented by socialists, libertarians, Republicans, Democrats, and combinations of those.
  I consider myself a little bit toward the center right in American politics, but I must say that not infrequently those at the outer edges describe problems better than the rest of us. When Congress' only socialist defined the problem of income inequality, I think he was speaking very profoundly about an American issue.

  As I am sitting here thinking of the problems of wage stagnation, which may or may not be now on the move a bit, I am wondering if as Chairman of the Federal Reserve Board you would care to comment on what I consider to be an ethical umbrage in corporate governance. This whole precept that not only do we have wage stagnation at certain levels, but we also have incredible compensation escalation at other levels. The notion in the last month that a head of a given company received a $771-million compensation package describes to me a problem in our system. I am wondering, as Chairman of the Federal Reserve Board if this is an issue that you would wish to jawbone on?
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  Mr. GREENSPAN. No, but I must say that when I was in the private sector, when I actually had some capability as a member of a number of boards, I argued that stock options should not be priced directly but priced as a ratio to the overall stock price level. If one is doing something in corporate governance which is competitively superior to everyone else, one should be rewarded. But one should not be rewarded if the stock market overall goes up, which drags up all prices irrespective of whether a company is doing well or not well.

  I would suggest to you that if that type of view had prevailed--which it clearly has not--many of these outsized compensation packages which you are looking at would not at this stage exist.

  Mr. LEACH. I appreciate your decision not to totally bite on that bone. Turning a little bit differently, in a historical sense, in Humphrey-Hawkins hearings the Chairman of the Federal Reserve Board speaks to levels of interest rates, levels of unemployment, now increasingly, levels of the Dow Jones Industrial Average. Would you care to comment, and perhaps with the historical perspective of, for example, the 1987 downturn and the role of the Federal Reserve Board in terms of being a liquidity-supplying institution, of the rationale for commenting on the market itself? How appropriate or inappropriate is that?

  Mr. GREENSPAN. It has become ever clearer in recent years that as the economy has become more complex, internationalized, and as balance sheets, both household and corporate have increasingly become factors in the economic outlook, and in the production of goods and services, we have had to broaden our view of the particular range of issues which we cover in the context of developing monetary policy.
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  It is probably inevitable as our standards of living overall rise that the assets that individuals have become an increasing part of their decisions to spend or not spend. Therefore, because of that fact, and because of the lag that monetary policy invariably has with respect to the economy, we have to forecast what we think is developing in the economy. Were we not to be looking at balance sheets and asset spillovers as I like to call it, I do not think we would be getting a full, comprehensive understanding of what the forces driving the economy are.

  I decided that we cannot be making changes up or down in the Federal funds rate without a fairly extensive explanation to the Congress and the American people of what the factors are we that are looking at. Years ago, we looked mainly at the money supply in a fairly restricted range and we communicated that as best we could. As a consequence of that, it was pretty easy to communicate why we were moving policy one way or the other.

  Since the money supply has grown in recent years in a manner which has been inconsistent with economic events, and only recently has seemed to get closer to its historical norm, we have been forced to broaden the whole area of indicators to make judgments as to how the economy functions. We therefore concluded that it was necessary for us to express the fact that we were doing that, and to evaluate various changes in balance sheets and markets in much the same way we do home building, personal consumption expenditures, consumer debt, and export markets.

  I recognized that as soon as we raised the issue in my speech back in December about the nature of the stock market that it would probably have some effect. I, however, did not speculate as to which direction I thought the market was going. I was merely raising a broad question. Today, in my prepared remarks you will find that I take a look at the various factors affecting the stock market and conclude that if profit margins continue to rise as analysts on Wall Street expect them to, then the market is properly priced, as best we can judge on the basis of the level of interest rates.
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  If, however, profit margins, which are quite high but below where they were in the 1960's, fail to rise further, then the market will run into some difficulty. I think in the process of evaluating that, we do not know what is likely to happen. Is it possible for margins to rise further? It certainly is. At this rate of inflation back in the 1960's, margins were indeed higher from where they are now. So that despite the fact that they have come up a considerable ways since 1991, they could very well continue further as analysts expect them to.

  Our basic judgment is that we need to look at all of these various things, and we have to communicate our views to the Congress if we are going to give you an essential view of the types of things we are going to look at.

  The one thing I was not endeavoring to do, because I do not think it is possible to do, was to jawbone the stock market. Stock markets in this world, especially in the United States, are extremely sophisticated, complex, very liquid markets with millions of investors. You cannot talk those markets up or down. Anyone who thinks they can has just not looked at the evidence.

  What we will inevitably be required to do as the years go on, and as this economy becomes increasingly more complex, and especially as an ever-increasing proportion of American households own all sorts of assets, is evaluate how they will respond to price changes, whether it is in real estate, whether it is in residences, whether it is in any of a variety of other things which appear on the balance sheets.

  What I was endeavoring to do, and I have hopefully effectively tried to communicate today and to your Senate colleagues last week, is to say that is what has evolved as a natural consequence of the increased complexity of the economic system with which we are dealing. It is not any longer, if it ever was, a simple thing with which to deal. And we use a number of different techniques for evaluating where we are with respect to what our fundamental objective is; namely, we believe that our goal is maximum sustainable economic growth. But that, in our judgment, requires low inflation, or more appropriately, stable prices.
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  Our evaluation of that process, whether we look at the supply and demand forces which are driving the economy, or direct measures of inflationary expectations such as the gold price or money supply, if it ever gets back into place, and the newly issued index bonds, these are all elements involved in how we endeavor to determine what is going on, as best we can, and to make a judgment as to what as a consequence is the most appropriate policy stance.

  So it is not a stock market issue we are involved with, and to answer Congressman Hinchey, who has left, specifically, we do not view monetary policy as a tool to--I do not know how he put it--prick the stock market bubble, or something like that. What we do is look at a wide variety of things, income and consumption, assets and liabilities, combining them all to make judgments as to what it is that one should be doing with respect to our policy stance.

  Mr. LEACH. Thank you.

  Chairman CASTLE. Thank you, Chairman Leach.

  Mr. Frank.

  Mr. FRANK. Mr. Chairman, I take you at your word that you were not trying to jawbone the stock market. But when you say that it is impossible, looking at what happened, I guess I am not sure whether I am supposed to believe you or my own eyes, to quote Marx. But let me get on to a couple--let me just ask you----

  Mr. GREENSPAN. Can I just answer very quickly?
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  Mr. FRANK. Yes. The stock market does not seem to know that.

  Mr. GREENSPAN. I ask the Chairman to put this on my time, not his.

  Mr. FRANK. I thank you.

  Mr. GREENSPAN. There is a lot of volatility in the market, and markets will move on rumors. They will move on statements by myself or my colleagues. But what you cannot do is affect the underlying forces. You can do it on a day-by-day basis. If you try to do it more than that, you will fail.

  Mr. FRANK. That I would accept.

  I was also pleased to actually hear your articulation that your concern on the CPI is with its role as a measure for use in the economy. By the way, I note parenthetically, because you refer for instance to the generally steady performance of the CPI and no great increases, in fact I gather the news is even better than the number might look. Because to the extent that the CPI overstates inflation, that means there has been even less inflation in the economy than that low number shows, and that is an encouraging sign.

  Mr. GREENSPAN. That is correct. But it has been that way for a very long time.

  Mr. FRANK. I understand. But people do not often talk about that side of it as much as they talk about the other. But I also take it, what you are saying then is that you express no opinion then on whether or not we should be reducing the cost-of-living adjustment, or whatever adjustment we give--let us forget cost-of-living. You are not expressing any opinion that we are overcompensating Social Security recipients as a matter of policy.
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  If we were to decide that low-income recipients should be treated separately and that the CPI calculation should be separate, that is not a problem for you?

  Mr. GREENSPAN. Correct.

  Mr. FRANK. Thank you, because I think that helps remove some of what people have been arguing as a driver of Social Security. As a statistical, that is a separate issue.

  Two other points. One, you conclude by saying you are going to conclude on an upbeat note. It is partly professional and partly the style that you think appropriate, but you upbeat is most peoples' depressed, you realize.


  Mr. GREENSPAN. I fully understand that.

  Mr. FRANK. What you say is, in your upbeat phase, Mr. Greenspan, you say, even I must admit that our economic prospects are quite favorable. This is not what most of us would consider to be the source of an admission.

  What I am concerned about is this, it does seem to me over the years that you have been somewhat pleasantly surprised by the fact that we have had as steady a growth and as great a reduction in unemployment as we have had with so little inflation. Am I correct in inferring that you have been somewhat pleasantly surprised; that your expectations were somewhat more pessimistic over the past say 4- or 5-years?
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  Mr. GREENSPAN. That is correct, Congressman.

  Mr. FRANK. I think that is a fact. Because I think what some of us are worried about when you talk about preemptive strikes is, that you might be a little bit too preemptive because there has been this historic mis-estimate. A lot of people missed it, and you did as well as anyone could. But that is part of our problem, where you have a history of a little bit more pessimism than turned out. We just hope that that correction gets factored in.

  I do want to talk specifically then about the question I asked you before. I recall when I was on the Budget Committee I think it was, asking you your view of the effect of the tax increases of 1993, and you did say to me in either late 1994 or 1995, you believed they would have a negative effect on the economy but it was too early for that to happen. They are now over 3 years.

  I guess the question is, do you still believe that the tax increases of 1993 had a negative effect on growth? Then the second part of the question is, if they did and growth would have been even higher, would that not have simply meant you would have been more restrictive?

  Mr. GREENSPAN. Let me put it this way. It is certainly the case, as you point out quite correctly, that the economy is doing exceptionally well from our point of view. It is almost certainly the case that there is no direct evidence that you can see at this stage that capital investment or other things have slowed down.

  Nonetheless, it is very hard for me to believe that when you increase marginal tax rates it has no effect. But there are so many other things going on in the economy that it is hard to disentangle them. So all I can say to you is that the hypothesis that it has had a demonstrable negative effect is not capable of being proved.
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  Mr. FRANK. That is a very comfortable----

  Mr. GREENSPAN. That is as much as I can say.

  Mr. FRANK. We just voted on that. That could be the 11th Commandment. It is OK to invoke faith, because that is all we voted on this week was religion, and we were in favor of it by two-thirds. But I do think it was relevant to note that this is not an assertion that you believe provable.

  But I do have to say the second part, to the second extent that your ideological view, your view was correct that the tax increases of 1993 did slow the economy down, is it not the case that had that not happened you would have then been more restrictive?

  Mr. GREENSPAN. Not necessarily. It is hard to know what would have happened in the context of inflation, because it is not growth, per se, that we respond to. It is evidences of imbalances, inflationary imbalances which upend the economy. But it is not growth, per se.

  Mr. FRANK. I appreciate that. If I can just have my last 30 seconds. That I am particularly glad to hear, because what you are saying, and I am pleased to hear this is, that the fact that unemployment could drop further and growth would continue, in and of itself is no reason for people to get nervous or to make preemptive, absent some specific--I think that is something that you reassure me when you say that. Because there has been this view that your position might be that too much good news, even absent specific indications of imbalances, might lead to that preemptive strike.
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  Mr. GREENSPAN. I want you to understand that a very substantial part of the academic community does believe that. I am very skeptical about that relationship myself.

  Mr. FRANK. That growth necessarily leads to that.


  Chairman CASTLE. Thank you, Mr. Frank.

  Mr. Lucas.

  Mr. LUCAS. Thank you, Mr. Chairman.

  Chairman Greenspan, I certainly want to reiterate, in a sense, the words of our Committee Chairman, Mr. Leach, when he described the differences of economic philosophy on this subcommittee. We are certainly very diverse in our views. Could you reassure me for just a moment, after listening to a number of my distinguished colleagues that I respect intensely about the nature of these things. I sometimes get the feel that there are those who have the goals of maybe affecting how we allocate the income and resources in this country.

  On page 15 of your testimony you state that the goal is the highest possible growth of income and wealth over time. Just reassure me a little bit that that is indeed the goal of the Fed.

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  Mr. GREENSPAN. It is. Indeed, you have to remember that prices, employment and the like, are all intermediary goals. The ultimate goal has got to be the physical well-being of the American people, meaning maximum sustainable economic growth. The financial relationships are only important as they contribute to those goals. We function in the financial market and therefore must deal with them. But we deal with them in the context, as we see the relationships over the years develop, which in our judgment contributes to maximum growth.

  Mr. LUCAS. So as we would say in Oklahoma, our goal is to make the economic pie of this country larger?


  Mr. LUCAS. Thank you. One other question I have and an issue close to my own heart. I am a proponent of either eliminating, or at the very least, providing substantial decreases in the capital gains tax rate. It is my view that such action would encourage a more productive use of our investment resources. Could you elaborate whatever point of view you might have on that subject for a moment?

  Mr. GREENSPAN. I have always argued, since I came out of graduate school I guess, that the capital gains tax is an inappropriate tax for purposes of raising revenue. All taxes suppress economic growth one way or another. This, because it focuses very directly on entrepreneurial activity, in my judgment, has the most restrained effect on economic growth. If you are going to raise revenue, I think it is far better to do it with a different form of taxation.

  Mr. LUCAS. I share that view completely. On that note, thank you, Mr. Greenspan.
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  Mr. Chairman, I yield back my time.

  Chairman LEACH. [presiding]. Thank you.

  Mr. Kennedy.

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

  Mr. Chairman, I want to go back to the issues that I tried to bring up in my opening statement, which were your quote on this issue of wage stagnation where you explain why the suppressed wages have been caused by worker anxiety about job security. But then you seem to conclude that there will be an end to that, because there is a limit to the value of additional job security people are willing to acquire in exchange for lesser increases in standards of living.

  I wonder what your thoughts are on the idea that in 1974, as I understand it, statistically, the typical CEO earned 34 times the pay of the lowest worker. Today, that has risen to about 173 times.

  It just seems to me that there is perverse equality going on where we end up seeing the stock market having these huge run-ups for companies that lay off more and more workers, sending a very strange message to the American worker in general. As a result of those stock run-ups, we see the salaries of the top CEOs skyrocketing, and there does not seem to be anywhere near a comparable rise in wages.
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  I wonder if you might just comment on the phenomenon, and whether or not you feel that you could in fact take a more aggressive role in this phenomenon of these huge corporate wages versus the average wage to the average worker?

  Mr. GREENSPAN. First of all, let me just say that there are two reasons of which I am aware which are engendering this type of opening up of the gap. One is the stock option issue and the way that is paid is tied to the stock market. The stock market goes up for everybody. In other words, the underlying key evaluation process affects all individual stocks. Once the average has been set in that regard, then differences between companies emerge largely as a result of differences in overall outlooks.

  Were you here when I was mentioning to Chairman Leach about the stock option question?

  Mr. KENNEDY. No, I do not think I was.

  Mr. GREENSPAN. What I was mentioning is that when I was in the private sector I was a very strong advocate of tying stock options not to the price of a stock, but to the ratio of the price of a stock to some overall price index, so that the general change in stock prices does not accrue to the benefit of individuals who really had nothing to do with it.

  Second, however, there has been, as we know and discussed over the years, a significant opening up of income spreads, largely as a function of technology and of education with the increased premium of college education over high school, and high school over high school dropouts becoming stronger. That whole spread goes right through the basic system. It is a development which I feel uncomfortable with. There is nothing monetary policy can do to address that, and it is outside the scope, as far as I am concerned, of the issues with which we deal.
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  Mr. KENNEDY. But, Mr. Chairman, excuse me. I think the problem with that is that somebody else could make the same argument about your statements about the stock market.

  Mr. GREENSPAN. They have and I think they are wrong. And I think they are wrong because I think that is part of the bailiwick of the overall financial system and affects what it is we do.

  Mr. KENNEDY. But do you now think that the idea that we are having a greater and greater disparity between the incomes of working families and the poor as well as the very, very rich--do you not think ultimately that this will have an effect on the economy of this country?

  Mr. GREENSPAN. The answer is yes, in the very broadest sense that all things have an effect. But that is very indirectly related to our particular portfolio. It is there only to the extent that as private citizens we obviously are concerned about the status of our society, and I am concerned when I see very significant changes in income distribution. I cannot demonstrate to you that it has a significant effect on the way in which we implement monetary policy. If I saw that way, then I would say I would have to agree with you. There would have to be some way we could address it, if we could figure out what we could do to change it.

  Mr. KENNEDY. I would have some ideas on that.

  Mr. Chairman, if I could just ask one very brief question that would require a one-word answer.

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  Is there an unemployment rate number at which the unemployment rate falls to where you automatically feel interest rates have to rise?


  Mr. KENNEDY. Thank you.

  Thank you, Mr. Chairman.

  Chairman LEACH. Thank you, Mr. Kennedy.

  Mr. Metcalf.

  Mr. METCALF. Thank you, Mr. Chairman. I have three questions so I will hurry.

  As is Chairman Leach, I am deeply concerned about wage stagnation. In your speech you highlighted the fact that workers are becoming more and more concerned about job security. As you know, we talk a lot about modernization; specifically in this subcommittee, financial modernization. Do you see any indication that with the growing concentration of economic power that that could exacerbate unemployment and also heighten job security? Should this not be a major concern of this subcommittee as we move forward on financial modernization?

  Mr. GREENSPAN. It is a very difficult question to answer because we know very little as to the impacts that are likely to arise as we move into a very complex and evolving state of technology in the 21st Century. It is a complex issue which I do not think I can add terribly much to, unless you want me to be very specific to a specific question.
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  Mr. METCALF. That is OK, I just have that concern and want to register it.

  Mr. GREENSPAN. I understand it and it is the right type of question that should be on the table when you are discussing the modernization issue.

  Mr. METCALF. Thank you. Last week in the Senate hearings, the issue of paying interest on sterile reserves was brought up. I authored a bill last year and I will reintroduce it shortly, to allow sterile reserves to gain interest, and also allow small businesses to earn interest on their demand deposits, which they cannot do now under Regulation D and Regulation Q. There are significant budget implications; specifically, the way CBO scores this issue.

  Do you see the benefits of this action outweighing the budget scoring process, and would the Fed support such action?

  Mr. GREENSPAN. Congressman, we have supported the payment of interest on required reserve balances for a very long period of time, and indeed, the elimination of the prohibition on the payment of interest on overall demand deposits as well. We continue to do so. There is no question that there would be a not insignificant loss to the Treasury as a consequence of that; somewhere between $300-million and $500-million annually.

  Mr. METCALF. Thank you. The Fed's open market intervention procedures were changed as of the first of the year. Could you briefly outline to us what the changes were and why they were needed? And also, any impact the changes might have on the ability of the Fed to execute monetary policy.
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  Mr. GREENSPAN. I am sorry, I am not familiar with what particular changes you are referring to.

  Mr. METCALF. I heard or read that the Fed's open market intervention procedures were changed as of the first of the year.

  Mr. GREENSPAN. I am sorry. We, for a long period of time, used to enter into the market, which we do daily, later in the morning than the period where maximum transactions were occurring. What we have done is speed up our process of evaluating the various needs for reserves during the day that might accrue over the so-called maintenance period. What we have been able to do is to enter the market at an earlier part of the day and engage a thicker part of the market, the part where more transactions are going on. I do not consider this an important issue and I do not think it has been creating a particular problem for us, Congressman.

  Mr. METCALF. Thank you very much. I read about it and I just wanted to ask about it in case it was something more than----

  Mr. GREENSPAN. No, it is an interesting issue. I am just, quite frankly, surprised that anyone noticed.

  Mr. METCALF. Thank you, Mr. Chairman.

  Chairman LEACH. Thank you, Mr. Metcalf.

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  Mrs. Maloney? Excuse me, I am sorry, the gentleman from Vermont. I apologize.

  Mr. SANDERS. I may be an independent, Mr. Chairman, but geez. Thank you, Mr. Chairman.

  Mr. Greenspan, the wealthiest 1 percent of Americans now own 42 percent of the Nation's wealth; more than the bottom 90 percent. In 1976, the wealthiest 1 percent owned 19 percent of the wealth. So we have seen the upper 1 percent more than double the percentage of the wealth in this country that they own.

  Does this concern you, the fact that we today have, by far, the most unequal distribution of wealth and income in the industrialized world? A, does it concern you? And B, what do you intend to do about it? And I have a number of questions to ask you, so I would appreciate if your answers could be brief.

  Mr. GREENSPAN. Yes, the answer is, it does concern me. It is not clear to me what monetary policy can do to alter that in any material way.

  Mr. SANDERS. Mr. Greenspan, from what I just heard a moment ago you talked that from your point of view the economy is doing ''very well.'' Did I hear you correctly?

  Mr. GREENSPAN. That is correct.

  Mr. SANDERS. I would love to take you to the State of Vermont where you can talk to working families where workers are working two or three jobs trying to pay their bills; where women who would prefer to stay home with the kids are now being forced to work; where jobs in our economy which used to pay $15-an-hour in manufacturing are now paying $5-an-hour working for McDonald's.
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  But more importantly, during the past 20 years we have seen a decline in wages, or stagnation, for 80 percent of all American families while the people on top have never had it so good. Twenty years ago, American workers were the best compensated in the world. Today, we rank 13th in the world. In 1973, the average American worker earned $445 a week, and 20 years later in 1993, that worker was making $373 a week. Please tell the working people of Vermont and the working people of this country how the economy is doing so good for them as opposed to the very rich who have never had it so good.

  Mr. GREENSPAN. Congressman, at any time throughout our history there have always been areas in our economy which are doing far less well than others. All we can measure is the average changes. I can suggest to you that in terms of the average changes, the economy by any measure which we have available to us, is doing well.

  Mr. SANDERS. But Mr. Greenspan, is not the concept average change totally meaningless? If you make $1-million-a-year and I make $10,000-a-year, on average we are making a little bit less than $500,000-a-year. You are doing very well. I am dead broke. Does not this whole on average concept perpetuate a fraud when the vast majority of the people in this country have seen a decline in their wages, working longer hours; when the new jobs that are being created are terribly low wage jobs? So what are we talking about average? If the rich are getting richer, that distorts the whole figure.

  Mr. GREENSPAN. First of all, let me question your data. It is not true that the vast majority of people have lower wages at this stage.

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  Mr. SANDERS. You question the statistic that I gave you?

  Mr. GREENSPAN. I do. I do indeed.

  Mr. SANDERS. What do you believe? You believe that the working people of this country have seen higher wages?

  Mr. GREENSPAN. No, I am just saying, you said the vast majority.

  Mr. SANDERS. That is right.

  Mr. GREENSPAN. So that is a number which means 60, 70 percent?

  Mr. SANDERS. I have said that in 1973, the average American worker earned $445 a week. Twenty years later that worker was making $373. That 80 percent of our working people have seen a significant decline.

  Mr. GREENSPAN. You are using BLS' payroll employment figure, and the average weekly earnings that is associated with that. That figure is questionable, I must tell you that.

  Mr. SANDERS. Why do you think it is questionable, sir?

  Mr. GREENSPAN. It is questionable basically because of the fact that those data are not produced in an appropriate sample. The employment figures are, but not the wages and they are not revised. Let me just say this, the Bureau of Census has alternate data which they do on a more scientific basis which are far less pessimistic than that.
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  Mr. SANDERS. I believe it was the Labor Department came out recently with statistics which says that for high school graduates who are entering the labor market, for young men the wages are 30 percent less than they were 15 years ago; for women I believe it was 27 percent less. Significant drop in wages for high school graduates. Is that also not a good figure?

  Mr. GREENSPAN. I can believe that figure.

  Mr. SANDERS. Given that reality, what about the figure that the inflation-adjusted median income for young people are doing worse than older families, with children? Young families with children headed by persons younger than 30 plunged 32 percent between 1973 and 1990. Meanwhile, we have seen a proliferation of billionaires going from 12 to 135 from 1982 to today. Do you really deny that while the wealthiest people of this country have never had it so good, the vast majority of the people have seen a decline in their standard of living?

  Mr. GREENSPAN. The Consumer Price Index, which is employed to deflate those data is precisely the index which I have been arguing is mis-specified. If you make the appropriate adjustments, that declining trend disappears. Nonetheless, I grant you that it is pretty stagnant.

  Mr. SANDERS. I would simply say, I would welcome you. Please give me a ring. You come to the State of Vermont with me and I will take you around our State, and I would love to hear the response when you tell the working families of our State that the economy is doing very well. It is not doing well for the middle class, for the working class. It may be doing well for upper-income people, but not for the vast majority of the people.

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  Mr. Chairman, thank you very much.

  Thank you, Mr. Greenspan.

  Chairman CASTLE. [presiding]. Thank you very much.

  Dr. Paul.

  Mr. PAUL. Thank you, Mr. Chairman.

  Mr. Chairman, I want to bring up the subject again about the CPI. We have talked a lot about the CPI and an effort to calculate our cost-of-living in this country, and specifically here, to measure how much we are going to increase the benefits that we are responsible for. But in reality, is not this attempt to measure a CPI or a cost-of-living nothing more than an indirect method or an effort to measure the depreciation of a currency? And that we are looking at prices, but we are also dealing with a currency problem.

  When we debase or depreciate a currency we do get higher prices, but we also have malinvestment. We have distorted interest rates. We contribute to deficits. And also, we might not always be looking at the right prices. We have commodity prices, which is the usual conceded figure that everybody talks about as far as measuring inflation. But we might at times have inflated prices in the financial instruments.

  So to say that inflation is under control and we are doing very well, I would suggest that we look at these other areas too, if indeed we recognize that we are talking about the depreciation of a currency.
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  One other thing that I would like to suggest, and it might be of interest to my colleagues, is that one of the characteristics of a currency of a country that depreciates its currency systematically is that the victims are not always equal. Some suffer more than others. Some benefit from inflation of the currency and the debasement of the currency. So indeed, I would expect the complaints that I hear. I would suggest that maybe this is related to monetary policy in a very serious manner.

  The consensus now in Washington, all the important people have conceded that we should have a commission. But when we designate a commission, this usually means everybody knows what the results are. I mean, nobody complains that the CPI might under-calculate inflation or the cost-of-living for some individuals, which might be the case. So we have this commission.

  But is it conceivable that this is nothing more than a vehicle to raise taxes? the New York Times just this week editorialized in favor of this because it raised taxes, and also it cuts benefits, and they are concerned about cutting benefits. But would it not be much more honest for Congress to deal with tax increases in an above-board fashion, especially if we think the CPI is not calculable? I think it is very difficult.

  Also, I think that if it is a currency problem as well, we cannot concentrate only on prices. There have been some famous economists in our history who say, look to the people who talk about prices because they do not want to discuss the root cause of our problem, and that has to do with the inflation of the monetary system or the depreciation of the currency.

  Mr. GREENSPAN. Dr. Paul, the concept of price increase is conceptually identical, but the inverse of the depreciation of the value of the currency. The best way to get a judgment of the value of the currency as such, if one could literally do it, is to separate the two components of long-term nominal interest rates into an inflation premium component and a real interest rate component. The former would be the true measure of the expected depreciation in the value of the currency.
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  We endeavor to capture that in these new index bonds that have been issued in which the Consumer Price Index, for good or ill, is used to approximate that. It does not exactly, and I think that is what I have been arguing with respect to the commission is to take the statistical bias out of the CPI and get a true cost-of-living index.

  It is certainly the case that that is a measure of inflation. There are lots of different measures of inflation. I would argue that commodities, per se, steel, copper, aluminum, hides, whatever, used to be a very good indicator of overall inflation in the economy when we were heavily industrialized. Now they represent a very small part of the economy and services are far more relevant to the purchasing power of the currency than at any time, so that broader measures of price, in my judgment, are more relevant to determining what the true rate of inflation is.

  Mr. PAUL. Can the inflated prices in the financial instruments not be a reflection of this same problem?

  Mr. GREENSPAN. They are. This is a very important question and one which I was implicitly raising: do asset price changes affect the economy? And the answer is clearly, ''yes.'' What you call it, whether it is inflation or not inflation, that is a nomenclature question. But the economics of it clearly means that if one is evaluating the stability of the system, you have to look at product prices, that is, prices of goods and services, and asset prices, meaning prices on items generally which have rates of return associated with them.

  Mr. PAUL. Thank you.
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  Chairman CASTLE. Thank you very much, Dr. Paul.

  Mrs. Maloney.

  Mrs. MALONEY. Thank you very much, Mr. Chairman. First, may I request that my opening statement be submitted in the record as read?

  Chairman CASTLE. Without objection, so done.

  [The prepared statement of Mrs. Maloney can be found on page 59 in the appendix.]

  Mrs. MALONEY. Second, I would like to welcome a former constituent from the great city of New York, Mr. Greenspan. It is always good to see you.

  First of all, I would like to know, why are you as a central banker commenting on the stock market? I have never heard of other central bankers doing that. I thought that the law, the 1946 Employment Act intended the Fed to stabilize the price of goods and services.

  Mr. GREENSPAN. That is correct, Congresswoman. As I mentioned to your colleagues earlier today, the reason why we are moving our analysis to a far broader plane than merely what we used to do is because it is becoming increasingly evident in this increasingly complex economy that asset prices generally are having an important impact on the production and consumption of goods and services and on the general state of inflation. As a consequence, what we are doing and have been doing in recent years, is to gradually broaden what we are evaluating in the economy as the economy becomes more complex.
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  While it is certainly the case that our mandate, as you put it, is on goods and services, if we are to appropriately fulfill that mandate, it is required that we evaluate and endeavor to look at asset price changes in the same manner we look at changes in residential construction, exports, consumption, or various other elements of demand.

  Mrs. MALONEY. But your statement on irrational exuberance rolled the stock market by 100 points, and it is a concern to me because it may have been a move potentially designed to impact on Wall Street, but it had a far further impact on every Main Street in our country. It seemed to me like a tremendous broadening of your mandate.

  Mr. GREENSPAN. Let me say this----

  Mrs. MALONEY. And the fact that it was a broadening, maybe there was an over-reaction to your statement.

  Mr. GREENSPAN. I was fully aware, as were my colleagues, that just merely mentioning the word stock market or something of that nature would create a price reaction. We are also aware of the fact that we are dealing with very sophisticated markets which are international in scope, have millions of investors.

  While, to be sure, you can, as rumors do, as statements by myself and my colleagues do periodically, induce short term changes, you cannot fundamentally affect the broad trend in market prices. That requires real economic changes, and I do not care what any central banker endeavors to do, we will never succeed in altering the path of major economic markets.
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  Mrs. MALONEY. But you rolled it 100 points. Let us go on to your statement on page seven. In your opening statement you said, ''We cannot rule out a situation in which a preemptive policy tightening may become appropriate before any sign of actual higher inflation becomes evident.'' Yet in the other materials that you submitted, it showed that the real economic growth that you predicted is 2 percent to 2.25 percent. The Clinton Administration predicts it at 2 percent. This is not great growth. This is a very limited growth.

  Then when you talked about inflation, some people say that in 1996 it was at 3.2 percent, the rate of inflation represented by the CPI which many people today have said are overstated. In your former statements you said that you thought inflation may be overstated by 1.5 percent, which means that inflation really could be 1.7 percent, which is low. The economic growth is low.

  Why are you talking about a preemptive policy with numbers like that?

  Mr. GREENSPAN. It is not the expected forecasts which drive policy, it is the various distribution of risks on that policy, meaning what happens if we make a projection and we are wrong? What we try to do is to evaluate the consequence of mistakes in judgment. The reason we have to do that is that monetary policy, by all of our measures, has a very delayed effect on the economy. So, we are forced to make projections pretty far out--a year or more. As a consequence of that, we have to recognize that inflationary pressures can start to mount well before they become evident in any of the published statistics.

  We have made judgments in the past that the economy was weakening well before it became evident and we started to ease monetary conditions. In that sense, it was preemptive in the other direction. There is no alternative--and I really wish it were otherwise--to acting preemptively because of that long lag between what we do and what happens.
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  Mrs. MALONEY. I do not believe ever in my lifetime there has been a preemptive action with a 1.7 percent inflation and a 2 percent growth.

  Mr. GREENSPAN. Yes, but remember that the inflation rate has been biased upward for a very long period of time. So you cannot compare it with earlier data. In short, if you took the inflation bias out of the Consumer Price Index going all the way back, the inflation rate data at a very earlier period would have been much lower than they are now.

  It is the type of situation in which you are doing more than making an average expectation. In other words, if we were assured that inflation would stay down, that is a forecast which in my judgment would mean we would do nothing.

  Mrs. MALONEY. But we have no indication that it is going up.

  Mr. GREENSPAN. I am not saying we----

  Chairman CASTLE. Mrs. Maloney, we are going to have on. I am sorry.

  Mrs. MALONEY. Mr. Chairman, may I do one brief follow-up question that really feeds on----

  Chairman CASTLE. Let us try to come back to you. We are trying to be--several of us have other subcommittee problems today, so we are trying to run through the questions, if you will excuse us. I am sorry, we are without relief here at this point. We will try to come back if we go quickly.
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  Mr. Bentsen, please.

  Mr. BENTSEN. Thank you, Mr. Chairman.

  Mr. Greenspan, it is good to see you again since I guess yesterday morning in the Budget Committee. I want to follow up on a couple things we talked about yesterday and then I have some other questions for you.

  First of all, I appreciate in your testimony today you made some comments regarding education. That issue was raised yesterday at the Budget Committee. Today, you did underscore I think the importance of enhancing our education, trying to invest in human capital potential. I think that is correct as well and I am glad that you have gone on the record in doing so, regardless of whether it is through tax credits or whatever form we might take. I realize that you do not want to get into taking a position on that.

  I do want to follow up very briefly on the CPI question which I did not get to ask yesterday. This may be more of a political question, but you state you believe there is a 100 percent probability that we are understating----

  Mr. GREENSPAN. Virtually.

  Mr. BENTSEN.----Virtually a 100 percent probability that we are understating CPI; that we should form a commission. Now a commission quite possibly might not come to a 100 percent perfect solution as to what real CPI is, but they would presumably try and get as close as they could. But there would obviously be some error and they would be working on an average.
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  Do you think in that case that it would be better, if Congress were to take that route, for us to enact some sort of flat CPI or flat COLA or dollar-average COLA? In effect, means-test the COLA to make up for the inexactness of what a commission might come up with?

  Mr. GREENSPAN. So you mean like CPI minus X; is that what you mean?

  Mr. BENTSEN. Something along those lines.

  Mr. GREENSPAN. That is surely an alternative approach.

  Mr. BENTSEN. But also to say, perhaps those that may be at the mean or at the median would be held harmless, those above might get less, those below might get more?

  Mr. GREENSPAN. Yes, the Congress can certainly do that.

  Mr. BENTSEN. Let me ask you also with respect to CPI, you stated yesterday that if we are understating CPI, we are probably understating productivity because we are looking at companies that continue to have increasing earnings; therefore, we must be understating productivity. Therefore, would that mean that a 5 percent to 5.5 percent unemployment rate is not necessarily as dangerous from an inflationary standpoint as we once thought it might be?

  Mr. GREENSPAN. Congressman, I think you are raising the question of so-called ''NAIRU'' that is the unemployment rate in which the rate of inflation, by hypothesis, neither rises nor falls. I have been quite skeptical about that as a stable notion. In other words, I think that there is a reasonable concept of a NAIRU for a metropolitan area, for example, where there is competition in the labor market and people can go from one part of the area to another part and take another job.
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  I am very skeptical that that concept can be globalized for the United States as a whole, implying that the demand and supply for labor can somehow operate between Portland, Maine and Portland, Oregon, for example.

  Implicit in a national NAIRU is that somehow all of these metropolitan area NAIRUs average out in a fixed way. I think the evidence is very questionable on that, and I think that the concept itself is so unstable that I would be very careful in employing it as a means for any form of monetary policy. I do not deny that it is useful to give you a hint as to the way things are going, but certainly not something which in any way is sufficiently stable to give one confidence that it works.

  Mr. BENTSEN. Let me ask you this, your comments before the Senate Banking Committee a week ago set off fear within the markets that there will be a rate hike sometime in the near future. Yet when I look at your testimony, I look at the report that you all have provided to the Congress, I am not sure I see where that is coming from.

  There is a little pressure in the employment cost index. Are you looking at the monetary aggregates? You have some that are at the top of the span, some that are near the top of the span. Interest rates, in your report you talk briefly about the last time you took action in early 1994, and yet you look at interest rates today compared to where they were in late 1993, early 1994 and rates are higher today.

  So I am curious as to where--is this all based on price-earning ratios and concern about the market? How does that now play into the Fed's calculations?
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  Mr. GREENSPAN. The market does not know anything more than you read. They get the same information. So what we try to do is detail as fully as we can what it is we tend to look at. As I indicated in my formal remarks, it is not easy to give you a road map because we do not have one at this stage of exactly the types of things which are likely to emerge which could create a destabilizing of the expansion.

  As a result of that, the only point that I wanted to make, which is an important point, is that we have to recognize that monetary policy acts with a lag. And if it acts with a lag, it is conceivable that we will, on certain occasions, be required to move policy in either direction in advance of particular events becoming clearly evident. The economy at this particular stage in time, as we have indicated in previous comments, is clearly running very close to any measure of capacity. As I have said in my prepared remarks, it is not indicating one that is clearly overheated; one in which inflation is clearly accelerating. That is not the case at this particular point as I have suggested.

  But the question that is on the table for all of us, in fact really since July, is that when you are in this particular zone the risks are on the upside. But we monitor it very closely, and as I indicated, we chose not to move through all of the second half of last year even though we were in that zone because the evidence of inflation acceleration was clearly lacking.

  Mr. BENTSEN. Thank you.

  Thank you, Mr. Chairman.

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  Chairman CASTLE. Thank you, Mr. Bentsen.

  Mr. Jackson has earned his second star because he got here on time and he stayed through the whole proceedings and we appreciate that. Mr. Jackson?

  Mr. JACKSON. Thank you, Mr. Chairman. I just have two questions of the Chairman.

  In the past when the economy slowed and millions of our country's workers lost their jobs, people knew there was a safety net that would allow them to scrape by even if they exhausted their unemployment benefits. Under the new welfare reform law the Federal floor under the poor has been removed because welfare benefits have been terminated after 2 continuous years on welfare. The new rules then dictate that the poor find a job or join the homeless or beg for food.

  I would like your assessment of the need for full employment policy in light of the new welfare reform law, and whether or not you think that the Federal Reserve has a role to play in accomplishing full employment, particularly as those of us on Capitol Hill keep dictating and mandating that the poor beyond their public assistance find some work.

  Mr. GREENSPAN. Did you say full employment law?

  Mr. JACKSON. Full employment policy as a goal.

  Mr. GREENSPAN. What I trying to get at is, where is the incidence of the policy? Because as far as the Fed is concerned, we agree with you in the sense that we should think there should be maximum sustainable economic growth, and that translates into the lowest sustainable rate of unemployment implicitly.
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  Mr. JACKSON. Let me comment on that quickly, Mr. Chairman. In 1972, respectfully, sir, that was 3 percent. In 1997, it is about 5.3 percent, 5.4 percent. So that is 7.5-million Americans, not counting the underemployed or the unemployed. So we move people off of public benefits, welfare to work, that is the policy we passed in the 104th Congress, my question is does the Federal Reserve have a role to play in making sure that an expanded economy remains expansive so that it reaches those who have been unemployed or underemployed?

  Mr. GREENSPAN. As I said before, our goal is maximum sustainable economic growth. That is about as strong a commitment as I think one could make toward maintaining the job creation and sustainable income levels. With respect to the structural problems which are clearly there as you point out, there is very little that monetary policy can do. That is an issue for other forms of policy. That is the reason why I raised the question about where is the locus of the policy as such, because it has got to be broader than just mainly monetary policy.

  Mr. JACKSON. That may be a source of concern, respectfully, Mr. Chairman, for all of us. I know the President most recently in his State of the Union Address congratulated several companies for hiring people and expanding their hiring programs to reach out to welfare recipients.

  But if in fact there is a rate hike, it slows the economy down. It obviously slows down job creation at a time where we are operating here on Capitol Hill under the assumptions that an expanded economy is going to employ people that we are going to move off of public assistance. Any effort to slow the economy down really runs contrary to many of the assumptions that we have been functioning with here on Capitol Hill.
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  I am interested in your comments, sir.

  Mr. GREENSPAN. First of all, we do not raise rates for the purpose of slowing the economy. When we raise rates it usually is for the purpose of stabilizing elements which threaten the growth of the economy. So all I can say to you is that we do not believe that the purpose of the Federal Reserve is to restrain growth, as is often the comment and indeed some of your colleagues have made that statement. I will tell you, that is not the purpose of monetary policy, and it should not be.

  Mr. JACKSON. I appreciate your answer. Let me move on to my second question, if I can. You said in your testimony that wages are not rising rapidly because of workers' job insecurity. That was on page four and global competition on page six. And on page six of your written testimony you said that these influences would be holding down inflation only temporarily. Then you go on to say on page seven that preemptive policy tightening may become appropriate before any sign of actual tightening becomes evident.

  Mr. Chairman, there are many hard-working people in my district who have not seen a significant wage increase in many years. Their wages corrected for inflation have, quite frankly, been stagnant. I wanted to know, do you really want to slow down the economy if these workers receive a raise even if the prices of goods and services rise at the present levels of inflation?

  Mr. GREENSPAN. All I can say to you, Congressman, is that one must measure, from the point of view of monetary policy, what we call unit labor costs, meaning the change in compensation adjusted by productivity. So to the extent over the long-run that wages go up on average with the rate of growth in productivity, there is no inflationary bias that is perceivable.
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  If inflation begins to take hold and as a consequence, as it invariably has in the past, unbalances the economy, what then happens is that economic growth comes to a halt and more often than not we move into a recession. I scarcely want to see that happen, and it strikes me as an outcome which is one which would create far more difficult problems for everybody. I think that a little inflation may sound like it is harmless. A little leads to more, and more leads to slower economic growth.

  Chairman CASTLE. Mr. Jackson wants to ask a follow-up and we will allow it. Then Dr. Paul had one or two brief other questions he wanted to ask, and Mr. Bentsen has one brief question. I want to try to wrap it up, but I do not want to cut anybody off. So let us go in that order. We will start with Mr. Jackson.

  Mr. JACKSON. Thank you, Mr. Castle.

  Very quickly, in the last 3 years I did a little analysis of the salaries of senior staff at the Fed and I have also noticed that they have been rising somewhat rapidly. In 1993, there were 35 employees at the Board of Governors earning $125,000-per-year with the highest at about $174,100. I was really wondering, were these inflationary wage increases, and what could my constituents and workers throughout the country come to understand about salaries at the Fed seeing as though they are being paid for by their taxes? That is my follow-up.

  Thank you, Mr. Chairman.

  Mr. GREENSPAN. We observed a few years that we were having very considerable difficulty hiring the types of people that we needed to accomplish the particular responsibilities that the Congress has given to us. What we then did at that point is to come up to both the leadership of the House Banking Committee and the Senate Banking Committee and indicated that since we were not required by law to stipulate any particular level of wages that we decided that it would be wise for us to move up the whole structure, which is what we have done. Since then, the average increase has slowed very dramatically.
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  Mr. JACKSON. Thank you, Mr. Chairman.

  Chairman CASTLE. Thank you very much.

  Dr. Paul.

  Mr. PAUL. Thank you, Mr. Chairman.

  Much has been said about your statements regarding the stock market and I wanted to address that for just 1 minute. In December when you stated this, of course, the market went down and this past week there was as sudden drop. The implication being that if you are unhappy with it, they assume that you will purposefully push up interest rates. But really since the first time you made that statement it seems that almost the opposite has occurred. M3 actually has accelerated, to my best estimate in the last 2 months it has gone up at a 10 percent rate. The base actually has perked up a little bit. Prior to this time it was rising at less than a 5 percent rate and now it is rising a little over 8 percent.

  But then too we have another factor which is not easy to calculate, and that is what our friends in the foreign central banks do. During this short period of time they bought $23 billion worth of our debt. We do know that Secretary Rubin talks to them and that maybe there is an agreement that they help you out; they buy some of these Treasury bills so you do not have to buy quite so many.

  Mr. GREENSPAN. There is no such agreement, Dr. Paul.
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  Mr. PAUL. You read about that though.

  Mr. GREENSPAN. Sometimes what you read is not true.

  Mr. PAUL. OK, we will get your comments on that. But anyway, they are accommodating us, whether it is policy or not. Their rate of increase on holding our bills are rising at over 20 percent, and even these 2 months at maybe 22 percent.

  My suggestion here and the question is, instead of the sudden policy change where you may increase interest rates, it seems like to me that you may be working to maintain interest rates from not rising. Certainly, you would have a bigger job if we had a perfect balance of trade. I mean, they are accumulating a lot of our dollars and they are helping us out. So if we had a perfect balance of trade or if their policies change, all of a sudden would this not put a tremendous pressure on interest rates?

  Mr. GREENSPAN. We have examined the issue to some extent on the question of what foreign holdings of U.S. Treasuries have done to U.S. interest rates. I think the best way of describing it is that you probably have got some small effect in the short run when very large changes in purchases occur. There is no evidence over a long run that interest rates are in any material way affected by purchases.

  The reason, incidentally, is that they usually reflect shifts--in other words, some people buy, some people sell. Interest rates will only change if one party or the other is pressuring the market. There is no evidence which we can find which suggests that that is any consistent issue, so that the accumulation of U.S. Treasury assets, for example, is also reflected in the decumulation by other parties. We apparently cannot find any relationship which suggests to us that that particular process is significantly affecting----
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  Mr. PAUL. For the past 2 years, the accumulation has been much greater.

  Mr. GREENSPAN. That is correct, it has been.

  Mr. PAUL. Thank you.

  Chairman LEACH. [presiding]. Thank you, Dr. Paul.

  We are going to have two more questions, one coming from Mr. Bentsen. But I think it is fair to place in the record at this moment in time that when the Chairman of the Federal Reserve Board of the United States speaks with confident exuberance, the market goes up, as it just has 90 points.

  Mr. Bentsen.

  Mr. BENTSEN. Now it is too late to do anything about it.


  Mr. BENTSEN. Mr. Chairman, first of all, last year in your response to my previous question we talked a little bit about capacity utilization; I think it was last year or the year prior. At that time--and my numbers are probably incorrect--we were seeing somewhere around 81 percent, 82 percent, I think. It was near the level where in the past we had said, or economists had said, you are about to breach the wall of capacity utilization which will cause bottlenecks and price increases. You said, I think at that time, that has probably changed because of new efficiencies and production and all.
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  I guess it is coming down, and what your response was to that question in trying to look at that, monetary aggregates and other things is the old rules of determining or foreseeing inflation have changed and now it is almost, you know what it is when you see it.

  But let me move to a question. I would be remiss if I did not ask a question regarding the oil economy, since it is important to my State. Your report states that you expect oil prices, which have declined quite dramatically in recent years, to stay relatively flat and not be a pressure point on the price index.

  There was an article in yesterday's Wall Street Journal, however, where some are speculating that oil prices in fact may rise, for a couple of reasons. But one of the points they made was that worldwide oil production is now at about 95 percent of capacity, which seems quite high. I would like your comments on that.

  And I would also like your comments on the fact that the article goes on to say, some argue that a potential price increase in oil might be tempered by the fact that North Sea and other world markets could flood the oil market and drive prices back down.

  But it comes back to the fact that in the United States, the capacity of the oilfield services industry has declined so much as we have seen imports continue to rise, and now we may be seeing the effect of that on domestic prices. It is good for Houston. It is good for the oilfield services economy that is still around, but perhaps that is bad for the general economy of the United States. I would appreciate your comments on that.

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  Mr. GREENSPAN. We have a fairly broad set of data, some of which are good, some of which are less good on oil production around the world. What I was saying in my prepared remarks was essentially, that analysts are projecting or something of that nature. What they are saying effectively, and we have no direct verification on this, is that projections of increases in the North Sea and in the Gulf are more than adequate to meet the expected worldwide demand for crude, and in addition build some inventories back into the system.

  As a consequence, what we observe is a fairly significant decline recently in West Texas intermediate crude prices. They had gotten as high as $28 a barrel. Now I guess they are down to a little over $20. Forward markets are projecting a price a little lower, as you know.

  It is true, nonetheless, that the oil services industry is very tight, and the drilling rig availability, especially offshore, is very tight. There are people, and this was expressed in that article to which you refer, who think that the exploration and development requirements to keep the oil flowing in an adequate way is being constrained by service industry capacity. I am not aware that that is a general view.

  I am aware that there is difficulty in getting equipment, but I am not aware that there is a significant concern that crude availability will be foreshortened in a manner which could induce significant acceleration of prices. That can happen, obviously, in the sense that there are many things we have seen in the past which have induced major increases in crude prices, and I would certainly not rule that out. But the evidence at this particular stage seems to be more consistent, as the forward markets are pricing, that increases in supply in the next year should be marginally larger than increases in consumption.

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  Mr. BENTSEN. Thank you.

  Thank you, Mr. Chairman.

  Chairman CASTLE. [presiding]. Thank you very much, Mr. Bentsen.

  For our final question we will turn to Chairman Leach.

  Mr. LEACH. To skip issues slightly, one of the responsibilities of this subcommittee this year is going to relate to a whole spectrum of issues related to the IMF, including possible increases in quotas, and so forth. As Chairman of the Federal Reserve Board would you give us your opinion on the wisdom of Congress moving in this direction or not?

  Mr. GREENSPAN. We work, as you know, with the Secretary of the Treasury and his colleagues on this issue and we give them our advice on various things and then support them, because so far as international affairs are concerned, monetary authorities should be one. We have supported directly the new borrowing facility, which we think is wise, and we have communicated that to the Secretary.

  In general, we think that our international responsibilities are such that it is important that we make certain that we maintain the effectiveness within those institutions that we have had over the years. In that regard, we are supportive of the Secretary of the Treasury in his initiatives.

  Mr. LEACH. Thank you, Mr. Chairman.
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  Chairman CASTLE. Thank you, everybody, particularly those who were able to stay with us. We thank you, Chairman Greenspan. Chairman Leach has already announced that the Dow Jones average is up 93-some-points today, which is good, which indicates to us that you should always testify before the House and not the Senate because the results are better. But I should warn you that gold was down $6 today. So there may be some repercussions on that side of it for you to worry about.

  But again, we thank you. You are always very patient with all of us, and we thank all of our Members who participated.

  We stand adjourned.

  [Whereupon, at 4:28 p.m., the hearing was adjourned.]

  [Insert offset folios 1 to 64 here.]