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

    The subcommittee met, pursuant to call, at 10:04 a.m., in room 2128, Rayburn House Office Building, Hon. Michael N. Castle, [chairman of the subcommittee], presiding.

    Present: Chairman Castle; Representatives Lucas, Metcalf, Paul, Roukema, Cook, Manzullo, Foley, Frank, Sanders, Hinchey, and Bentsen.

    Also Present: Representatives Leach, LaFalce, Watt, Weygand and Sandlin.

    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, the Subcommittee on Domestic and International Monetary Policy. I understand that you are trying to shake a cold, as am I, as probably a lot of other people in this room are. So I hope that we do not overstrain your voice today.
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    Chairman Greenspan, it is clear that our Nation is experiencing a remarkable and perhaps historic period of economic times. This economic expansion is one of the longest since World War II. Yet, there are still important decisions facing us in the areas of monetary and fiscal policy, and these decisions are tightly connected to all aspects of the foreign and domestic issues facing our Nation.

    Obviously, we are interested in your complete assessment of our economy and your assessment and plans for United States monetary policy. As part of this assessment, I have three specific questions that are very much on my mind and I think on the minds of many American people. I hope you will address these issues today.

    First, our country is enjoying a low level of inflation. With the need to maintain the economic growth which is benefiting many Americans in all walks of life, will the Federal Reserve lower interest rates to help American families keep more of what they earn?

    Second, regarding the Federal budget, is it the most sensible policy for the President and Congress to make achieving and maintaining a balanced budget our top priority, above cutting taxes or new spending programs? In addition, with the prospect of a balanced budget, can we expect to see lower interest rates accompany this success if we adhere to sensible budget policies?

    And third, what is your latest analysis of the Asian economic crisis and how it will affect our country? How critical is it for Congress to act on additional U.S. contributions to the International Monetary Fund?
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    I hope you will directly address these questions in the course of our discussions today.

    Since we would surely be blaming the Federal Reserve if the economy was on the skids, we should accord you the credit you undoubtedly deserve for a well-orchestrated monetary policy. The question is what can the Fed do to sustain and build on this success?

    In addition, the balanced budget agreement and responsible fiscal policy agreed to by Congress and the Administration go hand in hand with successful monetary policy. Yet, some are getting giddy over the prospect of budget surpluses and are already making plans to spend the surplus. I know you do not share this view and want to discuss all the ramifications of changing our currently prudent fiscal policy.

    The current Asian economic crises illustrate the dangers of superheated economies hitting the wall. Yet, the United States economy has thus far not suffered from the ''Asian flu.'' Under what circumstances could this change?

    I would be interested in how you view the prospects for economic growth this year in comparison to the 4 percent rate of the last quarter of 1997. The contrasting impact of lower earnings for United States firms with heavy investment in the affected regions of Asia and the potential for even lower-priced imports to keep downward pressure on inflation must make it difficult to call the economy from quarter to quarter.

    Other echoes of the problems in the Far East are our continuing inflows of foreign capital at a rate of 2 percent of gross domestic product. Is this a problem or something our economy can sustain? The troubled Japanese economy remains a major cause for concern, but it is hard to believe that their government will permit that economy to tank.
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    Your opinion on the steps our Government should take in addressing the threat to our own economy from the problems in Asia carries great weight. What is your advice to Congress on this issue?

    From a larger perspective, we should ask is our Nation now in a new economy that can sustain continued growth without reigniting inflation? Should the Federal Reserve worry less about inflation and focus more on allowing more growth to create additional jobs for Americans? Those are questions that Members also want to discuss even if they are addressed in your testimony.

    I believe that this Congress acted responsibly in seeking a balanced budget, and that responsible fiscal policy must go hand in hand with monetary policy to support long-term economic growth. The marketplace first had to believe that the Federal Government was serious about balancing the budget before it could incorporate the possibility of ever arriving at this outcome as a factor in future planning.

    The high relative value of the dollar seems to reflect both the leading position of our economy with regard to Europe and the Far East and the flight capital that has arrived from areas suffering economic insecurities. As integration of the various world economies continues in the direction of a unitary world marketplace, the leverage exerted by the Federal Reserve grows accordingly. There are few obvious negative signals that might predict a turn of the cycle to a downward phase. What we all want to know is how long can we continue with price stability and full employment?

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    As the economy continues to run ahead of what would be indicated by traditional models, we would welcome any insight you can impart about adjustments being incorporated into your model.

    Again, Mr. Greenspan, inquiring minds want to know: Can we expect lower interest rates to sustain the good conditions of our policy? How should the Federal Government handle the prospects of a budget surplus? And how do we effectively address the problems in Asia?

    As always, we are delighted to have you with us and look forward to a lively discussion.

    I will now turn to Mr. Frank for his opening statement.

    Mr. FRANK. Thank you, Mr. Chairman.

    I note you mentioned that Mr. Greenspan has a cold. I hope he will issue a statement very soon thereafter that he is in fact in generally very good health, because I have learned never to underestimate the neurosis of the market. And there is the saying, ''When the American economy gets a cold, the world gets a fever.'' Now we are going to find out what happens when Mr. Greenspan gets a cold. Will the market fall into a swoon? I hope not. But we may have to give him a physical.

    The country has had a major debate over the past few years, and I think it is important to note that, at least as of now, it appears we have gotten an answer to a question. There is this view, I said this before, that you are supposed to pretend that you don't like saying ''I told you so.'' But I never met anyone who did not greatly enjoy saying ''I told you so,'' and I personally find it is one the few pleasures that improves with age. So I think those of us who were very critical of people who thought we had to raise interest rates because the economy was too good a few years ago are entitled to say, ''I told you so.''
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    I think maybe we should have a little burial policy for the concept known as the ''NAIRU'' which recently, about a year ago, was a hot topic. The Non-Accelerating Inflation Rate of Unemployment, which there was a great economic consensus about, it seemed to me, a couple of years ago, that it was close to 6 percent, and that unemployment dropped, and then the NAIRU dropped and unemployment dropped more, and the NAIRU dropped more. It is now clear what the historical role of that is: it is a lagging indicator of the unemployment rate. Whatever unemployment is, the so-called ''Non-Accelerating Inflation Rate of Unemployment'' is one-half a point higher in the hands of some economists.

    We had this debate, and there were people who argued that you could not possibly in the American economy grow at the rate we have grown over the past 4 or 5 years and get inflation down below 5 percent on a consistent basis and not have inflation. Many of us felt that there were trends in the economy that made that explicable and that it would in any case be a grave error to preempt an inflation which had not yet lifted its head at the cost of increasing unemployment.

    And I welcome the fact, Mr. Greenspan, that you resisted what I believe were considerable pressures for you to take the preemptive route. And it was interesting for many of us to watch things evolve, because it did seem that we went from the New York Times, Financial Times, the bastion of orthodoxy in America. The New York Times financial pages is to the high interest rate clergy of Wall Street, it seems to me, what L'Osservatore Romano is to the Vatican. And it was interesting to see them go from being your strong advocates to them seeing you as a little bit of a rebel and being a little bit worried about maverick tendencies on your part. But those who argued that there was no reason to raise interest rates, and I urge people to go back and read the financial pages about this, because it was implicit and sometimes explicit criticism of the failure to raise interest rates, we were proven correct; there have been things in the American economy that have allowed us, apparently, to grow at a higher rate and have a lower unemployment rate without inflation than people thought possible, and that has meant that it would not have been a good thing to raise interest rates.
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    Now it is time to open up the next part of that, and I think it is time now to start talking about a preemptive strike against recession and against disinflation. And it is interesting, given the biases in the financial community, that the notion of a preemptive strike against inflation is the model of fiscal responsibility, but talking about a preemptive strike against a turn-down in the economy will shock some people. But it is clearly where we ought to be.

    To the extent that you can measure, we see no signs of inflation. We do see, as you look ahead, potential problems. Obviously, the troubles in Asia are going to have a deflating effect to some extent on the American economy. How bad, we don't know. But I would hope that we are in the mode of being ready to move preemptively not to do away with a nonexistent, so far, inflation, but to do away with what seems to be a more real threat of a turn-down.

    And I would say, Mr. Greenspan, that you have a very important role to play in this, for this reason: This committee next week will, I believe, take up the question of the International Monetary Fund. The Chairman and the Ranking Member, the acting Ranking Member of the full committee, have been working diligently trying to put something together. Many of us who have some problems with the way things have been done in the past are looking to find a way to work something out now. And the central element, I believe, in whether or not we will succeed in coming to an agreement here, and it is not foretold that we will, but there are some people that would like to reach an agreement, taking into account some important values like the rights of labor and environmental concerns, one critical question will be the extent to which there is a readiness to protect people in the American economy against negative consequences. And a domestic economy in which people think that the Federal Reserve might be prepared to reduce interest rates to offset negative effects on the American economy that come from Asia is a world in which it is going to be easier to get this kind of support.
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    If you want to mobilize American support, domestic support, for what I know you believe to be necessary in Asia, American dollars pledged through the IMF to help out, then the American people need to be reassured that their own economic interests are at least as much in people's minds as those overseas. I understand in your view that they are, and that is obviously—in part you are motivated by that. But I think you understand also that perception is not 100 percent translated domestically, and therefore I think it is essential to create the climate in which you can get the votes for the IMF, that it be clear that American authorities, including the Federal Reserve, will be prepared to respond if things turn down in the United States. And I think that is a very important question that you have to address both for its own worth and because of the climate that I know you want to promote to get passage of international cooperation.

    Thank you, Mr. Chairman.

    Chairman CASTLE. Thank you, Mr. Frank.

    What I would like do now is to give the Chairman and the Ranking Member of the full committee, Mr. Leach and Mr. LaFalce, the chance to use 5 minutes if they wish, and then to try to limit what we say to 2 minutes orally and with submission of statements in order to get to Mr. Greenspan's testimony. Some of you were not here, but Mr. Greenspan has a cold and is not feeling that well, and we would like to leave sufficient time for questions.

    Let me turn to Mr. Leach for his statement if he wishes.

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    Mr. LEACH. I thank the Chairman for his offer, but I would desire to move ahead as rapidly as we can this morning. I will defer to the Chairman and want to thank him for his great leadership in these issues.

    Chairman CASTLE. Mr. LaFalce.

    Mr. LAFALCE. I thank the Chairman, and I won't take more than a few minutes.

    Mr. Greenspan, I am sorry about your cold. Do you think it is safe to say that there is an improbable but not negligible chance that this is the Asian flu?

    Mr. GREENSPAN. I asked my physician whether I could characterize it as Asian flu concerning how appropriate it would be; and he said, ''Medically speaking, no.''

    Mr. LAFALCE. That is the most definitive answer you have ever given.

    Dr. Greenspan, I think that both the Chairman of the subcommittee and Mr. Frank have raised some good points with respect to the possible lowering of interest rates. I am hesitant to talk about preemptive strikes this week. We pursue a diplomatic solution, but maybe you could achieve a diplomatic solution.

    In negotiating a diplomatic solution with other countries, might not they like the idea, I want you to get into this, of lower interest rates in the United States? Might not that bring about a better realignment of our dollar with their currencies, cause less flight from their countries to the United States? So isn't that something that might be helpful not only to the United States, but to some of the countries, especially in Asia, experiencing some difficulties?
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    I would also like you to go into the question of the burgeoning trade deficit that we have in the United States and its significance. It is not simply with the countries that are having difficulty in need of IMF assistance, it is with Japan, it is with China, and so forth. But these trade deficits are a double-edged sword to be sure. I want you in your testimony to explore the double-edged nature of it and to what extent is it much more harmful than good. What do we have to be careful of? Is it on our radar screen right now?

    Also, one of the prescriptions the IMF gives to countries is—or very frequently has been in the past at least—export, export. But to what extent can we use that as a model for virtually every country; then who would be left to import? The United States? And who else? Japan has been very reluctant, and there are enough in the European Community. To what extent can we be the safety valve for this policy of export platform approaches that are being taken?

    I would also like you to address what I think is a difficulty on the horizon, and that is, in acceleration of the down-sizing phenomenon, the recent data that I have seen suggests that this is increasing tremendously. What should we be on the lookout for in connection with that?

    And then to a certain extent parochially, but also on a much larger scale, I am interested in the relative value of the United States dollar and the Canadian dollar. Everybody is talking about the Asian currencies, the yen and the mark, and so forth. But in January the U.S. dollar reached its strongest point, the Canadian its weakest point, in the history of our two countries. And this, especially for the ten border States, but for all the United States, certainly Canada, too, has profound significance.
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    It would seem to me that we have had too much of a swing, and we need some type of a stabilization and modification of the extreme swing that we have seen in the past several years. I would be interested in your comments on that.

    I thank you, Mr. Chairman.

    Chairman CASTLE. Thank you Mr. LaFalce.

    Mr. Lucas.

    Mr. LUCAS. No comments, Mr. Chairman.

    Chairman CASTLE. Mr. Sanders.

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

    Welcome, Mr. Greenspan. I am going to have to be running back and forth, so you will forgive me, but I hope maybe you will address maybe two or three concerns in your remarks.

    Number one, as you know, the United States has by far the most unequal distribution of wealth and income in the industrialized world. In 1976, the wealthiest 1 percent of the population owned 19 percent of the wealth, while today they own 42 percent of the wealth. In 1960, the CEO of a major corporation was earning about 12 times more than the average worker. Today that gap is over 200 times. CEOs now make 200 times what their workers make. We are seeing a huge proliferation of millionaires and billionaires, and yet we continue to have by far the highest rate of poverty in the industrialized world. So I hope that you will address the issue of whether or not you think that that very unfair distribution of wealth and income in the United States is healthy and what role you think you can play in trying to change that.
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    Second of all, picking up on a point that Mr. Frank made a moment ago of the IMF, some of us think in fact that the IMF by and large has been a failure, that in Africa and Latin America, after years of IMF structural adjustment programs, what has happened is there has been a significant increase in poverty; major cutbacks in health, in education; increases in unemployment.

    In fact, in Africa what we are seeing is a dismal situation and in recent years has been made even more dismal. In Latin America, I think with the exception of Chile, every country there has seen an increase in poverty. Also, as you know, the IMF told us a year ago how splendidly the Asian economies were doing in Indonesia, in Korea, and so forth, and now they are in the middle of a meltdown.

    Given the very poor record of the IMF, and given the fact that a number of economists think that the major role of the IMF is to help multinational banks and corporations rather than the poor people of Third World countries, perhaps you can elaborate on why you think the taxpayers of this country should put up $18 billion in order to replenish the IMF? So I hope you will address some of those issues.

    Thank you, Mr. Chairman.

    Chairman CASTLE. Mr. Metcalf, I understand you do not have an opening statement. Let's go to Dr. Paul then.

    Dr. PAUL. Thank you, Mr. Chairman.
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    And welcome, Mr. Greenspan.

    It seems like the most appropriate subject for now would be the interrelation of the crisis in Asia with our own domestic monetary policy. And if I am not mistaken, it seems like there has already been in effect the foreign holdings of debt, our debt now has been decreased by approximately $50 billion. It seems like it has changed our domestic monetary policy because we are expanding our Federal Reserve holdings, as well as M–3 is rising now.

    In the old-fashioned definition of ''inflation,'' we are well into it, we are inflating a lot. If we do not rely on the erroneous messages that we get from the CPI—during the 1920's certainly the CPI was rather stable, and yet we had inflation that ended up with a lot of problems.

    I must remind everyone that when we debase a currency, which means we inflate a currency, it inevitably leads to trade deficits which we suffer from, it inevitably leads to uneven distribution of income which we suffer from, and it always gives interest rates that are higher than the people want. But to argue for lower interest rates to me seems to compound our problem, because it requires more inflation of the money supply.

    At the same time, if we want to rescue the Southeast Asian currencies by an IMF bailout, we only do that by inflating our own currency and setting the stage for a dollar crisis.

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    I yield back.

    Chairman CASTLE. Thank you, Dr. Paul.

    Mr. Hinchey.

    Mr. HINCHEY. Thank you very much, Mr. Chairman. And good morning, Mr. Greenspan, and I, too, hope that you are feeling better.

    These are very interesting times indeed. I can recall when I first came to Congress 5 years ago, we were facing the problem of ever-growing budget deficits, up around $300 billion at that time and predicted to be close to $400 billion by now. Thanks largely to the 1993 budget resolution of the Clinton Administration, that deficit has come down very dramatically. We are even facing the prospect of actual budget surpluses this year. So these are extraordinary, and indeed very interesting, times for you and the Federal Reserve and for us in the Congress.

    In that context, we are seeing some dramatic changes in the international economic situation, particularly as it relates to the problems in the Far East. I am particularly interested in your reaction to that situation and its impact on our economy.

    Among other things, inflation is dramatically low, 1.7 percent last year, and continues to go down. The economy remained strong through 1994 and 1995 in spite of the interest rate increases that occurred that year. The impact of the Asian crisis is just beginning to express itself. Our trade deficit is up in the most recent reporting period by almost 25 percent, and that includes everything from electronic products to agriculture. Agriculture is being particularly hard hit in terms of our exports to the Far East.
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    I am very interested in what we are going to do to anticipate the full effects of the Asian financial crisis on our economy. The full effects of it will not be evident until some time later this year, or perhaps not even until next year. Because actions taken by the Federal Reserve have a lag time of about 18 months, it is important for us to act now if we are going to do anything to offset the disinflationary effects of the dramatically dropping prices in East Asia, the growing trade deficit, and the strength of the dollar.

    It is my hope and expectation that the Federal Reserve will take these matters into account and deal with this issue before the Asian crisis has its full impact. That, of course, would mean lowering interest rates at the earliest opportunity. Real interest rates now are very high and I think that this is having a depressing effect on the economy. I think the economy could be even stronger if interest rates were lower. And if we fail to relax interest rates, I think that during the next year, we are going to see some difficult economic circumstances that we ought not to experience.

    I am hoping that in anticipation of the full effects of the Asian crisis, that the Federal Open Market Committee will examine this issue very closely at its next meeting and take appropriate action.

    Chairman CASTLE. Thank you, Mr. Hinchey.

    Mrs. Roukema.

    Mrs. ROUKEMA. I thank the Chairman.
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    Chairman Greenspan, I welcome you here, and I want to leave as much time as possible to get to you, so I will abbreviate my remarks and simply observe that I would like to reinforce some of the observations and questions already raised by the Chairman and the Ranking Member. And I would simply like to reinforce them again because they reflect my own concerns, and particularly with respect to addressing the questions regarding the Balanced Budget Act, the question of interest rates relative to lower taxes or the spending questions.

    I think there has been a lot of premature talk from both sides of the aisle about a spending binge on the one hand, or a tax cutting binge on the other. I would hope that you could address how either action would affect interest rates.

    I also want to reinforce what has already been raised concerning the Asian contagion, and that is in two regards. One, how do we deal with the trade deficit question? I don't know whether or not your assessment is that the IMF proposal successfully addresses that or not, but I would hope that you would focus on the IMF proposal. I believe that it is absolutely essential for this Congress to pass IMF funding. Beyond that, I would like to know if there is anything more that we should be doing in order to address the already developing problems relating to the growing trade deficit? We welcome you and value your opinion on all these issues. Thank you.

    Chairman CASTLE. Thank you, Mrs. Roukema.

    Mr. Bentsen.

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    Mr. BENTSEN. No, Mr. Chairman.

    Chairman CASTLE. Mr. Cook.

    Mr. COOK. In the interest of getting to the Chairman's testimony, I will forego any opening comments.

    Chairman CASTLE. Thank you.

    Mr. Manzullo.

    Mr. Foley.

    Mr. FOLEY. No, thank you.

    Chairman CASTLE. We have two other Members of the full committee here, Mr. Sandlin and Mr. Watt. We welcome them. If we get through with the questioning, we will try to give you an opportunity to participate as well at that time. I think all the Members of the subcommittee who are here and want to speak have had the opportunity.

    So the time comes to turn to you, Mr. Chairman, for your distinguished comments. Mr. Greenspan.

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    Mr. GREENSPAN. Thank you very much, Mr. Chairman. I request that my full testimony be included for the record, and I will excerpt from that a rather extended statement.

    Chairman CASTLE. Without objection.

    Mr. GREENSPAN. Mr. Chairman, and Members of the subcommittee, I very much welcome this opportunity to present the Federal Reserve's Semiannual Report on Economic Conditions and the Conduct of Monetary Policy.

    The American economy delivered another exemplary performance in 1997. Over the four quarters of last year, real gross domestic product expanded close to 4 percent, its fastest annual increase in 10 years. To produce that higher output, about three million Americans joined the Nation's payrolls, in the process contributing to a reduction in the unemployment rate to 4 3/4 percent, its lowest sustained level since the late 1960's. Last year also saw strong growth of real income of workers and corporations. This was not unrelated to the economy's continued good performance on inflation.

    Taken together, recent evidence supports the view that such low inflation, as closely approaching price stability as we have known in the United States in three decades, engenders many benefits. When changes in the general price level are small and predictable, households and firms can plan more securely for the future. The perception of reduced risk encourages investment. Low inflation also exerts a discipline on costs, fostering efforts to enhance productivity. Productivity is, as you know, the ultimate source of rising standards of living, and we witnessed a notable pickup in this measure in the past two years.
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    The dramatic improvements in computing power and communication and information technology appear to have been a major force behind this beneficial trend. Those innovations, together with fierce competitive pressures in our high-tech industries to make them available to as many homes, offices, stores, and shop floors as possible, have produced double-digit annual reductions in prices of capital goods embodying new technologies. Indeed, many products considered to be at the cutting edge of technology as recently as 2 to 3 years ago have become so standardized and inexpensive that they have achieved near ''commodity'' status, a development that has allowed businesses to accelerate their accumulation of more and better capital.

    With new high-tech tools, American businesses have shaved transportation costs, managed their production and use of inventories more efficiently, and broadened market opportunities. The threat of rising costs in tight labor markets has imparted a substantial impetus to efforts to take advantage of possible efficiencies. In my Humphrey-Hawkins testimony last July, I discussed the likelihood that the sharp acceleration in capital investment in advanced technologies beginning in 1993 reflected synergies of new ideas, embodied in increasingly inexpensive new equipment, that have elevated expected returns and have broadened investment opportunities.

    More recent evidence remains consistent with the view that this capital spending has contributed to a noticeable pickup in productivity—and probably by more than can be explained by usual business cycle forces. For one, the combination of continued low inflation and stable to rising domestic profit margins implies quite subdued growth in total consolidated unit business costs. With labor costs constituting more than two-thirds of those costs and labor compensation per hour accelerating, productivity must be growing faster, and that step-up must be roughly in line with the increase in compensation growth. Our more direct observations on output per hour roughly tend to confirm that productivity has picked up significantly in recent years, although how much the ongoing trend of productivity has risen remains an open question.
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    The acceleration in productivity, however, has been exceeded by the strengthening of demand for goods and services. As a consequence, employers had to expand payrolls at a pace well in excess of the growth of the working age population that profess a desire for a job, including new immigrants. As I pointed out last year in testimony before the Congress, that gap has been accommodated by declines in both the officially unemployed and those not actively seeking work but desirous of working. The number of people in those two categories decreased at a rate of about one million per year on average over the last 4 years. By December 1997, the sum had declined to a seasonally adjusted 10 1/2 million, or 6 percent of the working-age population, the lowest ratio since detailed information on this series first became available in 1970. Anecdotal information from surveys of our twelve Reserve banks attests to our ever-tightening labor markets.

    Rapidly rising demand for labor has had enormous beneficial effects on our work force. Previously, low or unskilled workers have been drawn into the job market and have obtained training and experience that will help them even as they later change jobs. Large numbers of underemployed have been moved up the career ladder to match their underlying skills, and many welfare recipients have been added to payrolls as well, to the benefit of their long-term job prospects.

    The recent acceleration of wages is likely owed in part to the ever-tightening labor market and in part to rising productivity growth, which, through competition, induces firms to grant higher wages. It is difficult at this time, however, to disentangle the relative contributions of these factors. What is clear is that unless demand growth softens or productivity growth accelerates even more, we will gradually run out of new workers who can be profitably employed.
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    Should demand for new workers continue to exceed new supply, we would expect wage gains increasingly to exceed productivity growth, squeezing profit margins and eventually leading to a pickup in inflation. Were a substantial pickup in inflation to occur, it could, by stunting economic growth, reverse much of the remarkable labor market progress of recent years.

    History teaches us that monetary policy has been its most effective when it has been preemptive. The lagging relationship between the Federal Reserve's policy instrument and spending, and, even further removed, inflation implies that if policy actions are delayed until prices begin to pick up, they will be too late to fend off at least some persistent price acceleration and attendant economic instability. Preemptive policymaking is key to judging how widespread are emerging inflationary forces, and when, and to what degree, those forces will be reflected in actual inflation.

    Over most of the last year, the evident strains on resources were sufficiently severe to steer the Federal Open Market Committee toward being more inclined to tighten than to ease monetary policy. Indeed, in March, when it became apparent that strains on resources seemed to be intensifying, the Federal Open Market Committee imposed modest imcremental restraint, raising its intended Federal funds rate a quarter of a percentage point to 5 1/2 percent.

    We did not increase the Federal funds rate again during the summer and fall, despite further tightening of the labor market. Even though the labor market heated up and labor compensation rose, measured inflation fell, owing to the appreciation of the dollar, weakness in international commodity prices, and faster productivity growth.
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    Although the nominal Federal funds rate was maintained after March, the apparent drop in inflation expectations over the balance of 1997 induced some firming in the stance of monetary policy by one important measure—the real Federal funds rate, or the nominal Federal funds rate less a proxy for inflation expectations. Some analysts have dubbed the contribution of the reduction in inflation expectations to raising the real Federal funds rate a ''passive'' tightening, in that it increased the amount of monetary policy restraint in place without an explicit vote by the FOMC. While the tightening may have been passive in that sense, it was by no means inadvertent. Members of the FOMC took some comfort in the upward trend of the real funds rate over the year and the rise in the foreign exchange value of the dollar because such additional restraint was viewed as appropriate given the strength of spending and building strains on labor resources. They also recognized that in virtually all other respects financial markets remained quite accommodative, and, indeed, judging by the rise in equity prices, were providing additional impetus to domestic spending.

    Mr. Chairman, there can be no doubt that domestic demand retained considerable momentum at the outset of this year. Production and employment have been on a strong uptrend in recent months. Confident households, enjoying gains in income and wealth and benefiting from the reductions in intermediate- and longer-term interest rates to date, should continue to increase their spending. Firms should find financing available on relatively attractive terms to fund profitable opportunities to enhance efficiency by investing in new capital equipment. By itself, the strength in spending would seem to presage intensifying pressures in labor markets and on prices. Yet, the outlook for total spending for goods and services produced in the United States is less assured of late because of storm clouds massing over the Western Pacific and heading our way.
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    This is not the place to examine in detail what triggered the initial problems in Asian financial markets and why the subsequent deterioration has been so extreme. I covered that subject recently before several committees of the Congress. Rather, I shall this morning confine my discussion to the likely consequences of the Asian crisis for demand and inflation in the United States.

    With the crisis curtailing the financing available in foreign currencies, many Asian economies have had no choice but to cut back their imports sharply. Disruptions to their financial systems and economies more generally will further damp demands for our exports of goods and services. American exports should be held down as well by the appreciation of the dollar, which will make the prices of competing goods produced abroad more attractive, just as foreign-produced goods will be relatively more attractive to buyers here at home. As a result, we can expect a worsening net export position to exert a discernible drag on total output in the United States. For a time, such restraint might be reinforced by a reduced willingness of U.S. firms to accumulate inventories as they foresee weaker demands ahead.

    The forces of Asian restraint could well be providing another, more direct offset to inflationary impulses arising domestically in the United States. In the wake of weakness in Asian economies and of lagged effects of the appreciation of the dollar more generally, the dollar prices of our non-oil imports are likely to decline further in the months ahead. These lower import prices are apparently already making domestic producers hesitant to raise their own prices for fear of losing market share, further contributing to the restraint on overall prices. Lesser demands for raw materials on the part of Asian economies as their activity slows should help to keep world commodity prices denominated in dollars in check. Import and commodity prices, however, will restrain U.S. inflation only so long as they continue to fall, or to rise at a slower rate than the overall pace of domestic goods prices.
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    The key question going forward is whether the restraint building from the turmoil in Asia will be sufficient to check inflationary tendencies that might otherwise result from the strength of domestic spending and tightening labor markets. The depth of the adjustment abroad will depend on the extent of weakness in the financial sectors of Asian economies and the speed with which structural inefficiencies in the financial and nonfinancial sectors of those economies are corrected.

    If, as we suspect, the restraint coming from Asia is sufficient to bring the demand for American labor back into line with the growth of the working-age population desirous of working, labor markets will remain unusually tight, but any intensification of inflation should be delayed, very gradual, and readily reversible. However, we cannot rule out two other, more worrisome possibilities.

    On the one hand, should the momentum of domestic spending not be offset significantly by Asian or other developments, the American economy would be on a track along which spending could press too strongly against available resources to be consistent with contained inflation. On the other hand, we also need to be alert to the possibility that the forces from Asia might damp activity and prices by more than is desirable by exerting a particularly forceful drag on the volume of net exports and the prices of imports.

    When confronted at the beginning of this month with these, for the moment, finally balanced, though powerful forces, the members of the Federal Open Market Committee decided that monetary policy should most appropriately be kept on hold. With the continuation of a remarkable 7-year expansion at stake and so little precedent to go by, the range of our intelligence gathering in the weeks ahead must be wide and especially inclusive of international developments.
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    Before closing, Mr. Chairman, I would also like to flag a few areas of concern about the economy beyond those mentioned already in regarding Asian developments.

    Without doubt, lenders have provided important support to spending in the past few years by their willingness to transact at historically small profit margins and in large volumes. Equity investors have contributed as well by apparently pricing in the expectation of substantial earnings gains and requiring modest compensation for the risk that those expectations could be mistaken. Approaching the eighth year of the economic expansion, this is understandable in an economic environment that, contrary to historical experience, has become increasingly benign. Businesses have been meeting obligations readily and generating high profits, putting them in outstanding financial health.

    But we must be concerned about becoming too complacent about evaluating the payment risks. All too often at this stage of the business cycle, the loans that banks extend later make up a disproportionate share of total nonperforming loans. In addition, quite possibly, 12 or 18 months hence, some of the securities purchased on the market currently could be looked upon with some regret by investors.

    As one of the Nation's bank supervisors, the Federal Reserve will make every effort to encourage banks to apply sound underwriting standards in their lending. Prudent lenders should consider a wide range of economic situations in evaluating credit; to do otherwise would risk contributing to potentially disruptive finance problems down the road.

    A second area of concern involves our Nation's continuing role in the new high-tech international financial system. By joining with our major trading partners and international financial institutions in helping to stabilize the economies of Asia and promoting needed structural changes, we are also encouraging the continued expansion of world trade and global economic and financial stability on which the ongoing increase of our own standards of living depend. If we were to cede our role as world leader, or backslide into a protectionist policy, we would threaten the source of much of our own sustained economic growth.
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    A third risk is complacency about inflation prospects. The combination and interaction of significant increases in productivity-improving technologies, sharp declines in budget deficits, and disciplined monetary policy has damped product price changes, bringing them to near stability. While part of this result owes to good policy, part is the product of the fortuitous emergence of new technologies and of some favorable price developments in imported goods.

    However, as history counsels, it is unwise to count on any string of good fortune to continue indefinitely. At the same time, though, it is also instructive to remember the words of an old sage that ''luck is the residue of design.'' He meant that to some degree we can deliberately put ourselves in a position to experience good fortune and be better prepared when misfortune strikes. Some of what we now see helping rein in inflation pressures is more likely to occur in an environment of stable prices and price expectations that thwarts producers from indiscriminately passing on higher costs, puts a premium on productivity enhancement, and rewards more effectively investment in physical and human capital.

    Continuing to make progress toward this objective will make future supply disruptions less likely and our Nation's economy less vulnerable to those that occur. In this way, Mr. Chairman, we raise the odds that the outstanding performance of our Nation's economy in recent years can be sustained.

    Thank you very much, and I look forward to your questions.

    Chairman CASTLE. Thank you very much, Mr. Chairman. We appreciate your statement. I found it to be very upbeat in the register of statements that you have made before this subcommittee and perhaps before the Congress. I even saw a silver lining in the Asian crisis in terms of the dampening of inflationary aspects in the United States. So, hopefully, all this will come to bear.
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    We will each take 5 minutes on questioning, and I will begin.

    I would like to ask you a two-part question. It is going to be two related parts. First, since we seem to agree that achieving a balanced budget is a higher priority than cutting taxes or new spending, and the markets appear to accept this as a serious goal, if we stay on course to balance, can the Federal Reserve lower interest rates further?

    And then second, the related part to that first question, in testimony before the Congress over the last several years, at least while I have chaired this subcommittee, I believe you said that a balanced budget will result in about a 2 percent reduction in interest rates. In your testimony today you indicated we have seen some of these savings. How much remains to be realized?

    Mr. GREENSPAN. That is a very good question, Mr. Chairman. When I made the statement with respect to reaching a balanced budget would bring long-term interest rates down approximately 2 percentage points or thereabouts, interest rates at that time were quite significantly above where they are today, and the budget deficit was in excess of $200 billion.

    I do think that the evidence strongly suggests that a substantial part—we don't know how much—of the very considerable decline in long-term interest rates in recent years has been a function of the decline in the budget deficit, because it has removed pressures of Federal Government borrowing from the marketplace.

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    As I have said in other testimony, I do believe that were we to now move to a unified budget surplus and start to repay the debt to the public, that that would have further downward impact on long-term interest rates. I don't know how much. And the reason I don't know how much is that it is pretty clear that even though we have now had a very substantial reduction in inflation expectations in this economy in recent years, there is still evidence that there is an inflation premium of not insignificant dimension still embodied in long-term interest rates, a residue of the big inflationary pressures of the 1970's. Unless and until we can get that down to where it was, say, in the 1950's and 1960's, the downside move of long-term rates while there is clearly much more limited than the declines that have occurred in recent years.

    I would hesitate to put a specific forecast on it, but as I said in testimony to other committees recently, if we have a Federal surplus, we are very likely to get further downward pressures on long-term rates, and as we have observed in recent years, it has been that decline which perhaps more than anything else in our economy has been the factor which has been driving this really quite extraordinary 7-year economic expansion. And further declines in long-term rates as a consequence of further fiscal improvement is something which is of great importance.

    Chairman CASTLE. Thank you.

    The Dow Jones Industrial Average is now above where it was when you expressed the opinion that it might be overvalued. Is that still your view today?

    Mr. GREENSPAN. You are referring to my now rather infamous two-word remark, which I will leave unrepeated in this context.
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    What I indicated back then—in December 1996—was that I was quite concerned about how we would know, as I put it at the time, when the markets exhibited ''irrational exuberance,'' meaning when it got beyond various different measures of evaluation.

    What has occurred since, as I have in fact indicated in my testimony, is that the market has been driven by very significantly improved expectations of increase in earnings, in part a reflection of a real improvement in underlying productivity which had not been apparent back then. Nonetheless, even when looking at various different evaluation processes, there is no question, as I point out in my prepared remarks, that the extent to which so-called equity premiums are being embodied in the evaluation of stock prices are on the low edge of historical experience.

    But then again, an awful lot of things are at the lower edge. We have all sorts of risk premiums lower and various different types of margins lower, and the implication is that the market is saying that there is something different about this particular economic environment. I am not inclined to go that far. I have been around much too long to expect another new era. But there is no question that there is something different about what is going on in this economy.

    As I pointed out earlier, we have not had, as I recall in any recent measurable experience, 7 years of a business cycle expansion in which not only did the underlying forces of destabilization not occur, but things are improving. And that really is an extraordinary element in this recovery.

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    Chairman CASTLE. Thank you, Mr. Chairman.

    Mr. Frank.

    Mr. FRANK. I agree, Mr. Greenspan, it is not only an extraordinary element in the recovery, but this state of unexpected good news is something I sometimes feel economists may never recover from. I have to say their dismay at the inaccuracy of their negative predictions sometimes seems the dominant emotion we get here.

    Let me ask you, on page 5 of your prepared statement, you talk about ''...rising demand for labor has had enormous beneficial effects...Previously, low or unskilled workers have been drawn into the job market...large numbers of underemployed have been moved up the career ladder...welfare recipients have been added to payrolls.''

    Now, that obviously happened while we were raising the minimum wage. Can we infer from this that the most recent increase of the minimum wage had no significant, if any, negative effects on the employability of people in those categories? Because I would assume, if anybody in the economy is in the minimum wage category, it is low-skilled workers, welfare recipients, and the large numbers of underemployed.

    Mr. GREENSPAN. No. I would say, first of all, the minimum wage has, from what we can judge, filtered through into higher nominal wages in various different segments of the economy. You cannot find, as best I can judge at this stage, any significant reduction in employment as a consequence, because what we are observing, as I indicated earlier, is an overall demand for labor, which at this moment, exceeds the supply.
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    Mr. FRANK. And the fact that we were raising the minimum wage, therefore, had no negative effect that we could see.

    Mr. GREENSPAN. No, I would not say that. I would say it has not.

    Mr. FRANK. I know you do not want to say that, Mr. Greenspan, but what is the evidence?

    Mr. GREENSPAN. The question really is a much broader issue. If you are asking me broadly does history tell us——

    Mr. FRANK. No, I did not ask you specifically about history, because I am asking you about what happened last time. I am asking about this past minimum wage increase. Because the economy changes. Look, your whole statement is a discussion of why the lessons of history have in many ways no longer been directly relevant.

    Mr. GREENSPAN. The way you phrased the question, you made it as a more general statement.

    Mr. FRANK. I am talking about the most recent minimum wage increase.

    Mr. GREENSPAN. The most recent minimum wage increase has not, as yet, shown through.
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    Mr. FRANK. I think the ''as yet'' is a testimony to the continuing power of the economic theology, because we have just been through this.

    My next question: In 1993, when taxes were increased as part of the budget package and they were increased more on higher income people, you said at the time you thought that would have a negative effect on growth. Has that had a negative effect as yet, or are we still in the ''as yet'' phase on that one?

    Mr. GREENSPAN. I would say it has had a negative effect. There are other effects which have overridden that. If you ask me in general——

    Mr. FRANK. No, Mr. Greenspan, I would never ask you anything in general in a 5-minute question period. I am asking you specifically about your prediction that raising taxes—or your comment that ''...having raised taxes in 1993 would have a negative effect on growth.'' And I am looking at a statement which talks about how we could barely live with the amount of growth we have had. We have had more growth than we expected. You are worried that we may have too much growth, although fortunately we have not. So I am wondering about the 1993 tax effect.

    Mr. GREENSPAN. Well, first of all, I did not say that the President's 1993 budget proposal would have a contractionary effect on the economy.

    Mr. FRANK. I asked you specifically, and I will get you the transcript and send it to you. In the past, I asked you if you thought the fact that taxes were increased was going to have a negative effect, and you said it was.
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    Mr. GREENSPAN. Yes, I generally believe that over the longer run, if you raise marginal tax rates, you will get a lower extension of long-term growth than you would have had otherwise.

    Mr. FRANK. I often, when I do not have any specific evidence, talk about general trends over the long-run, too. I do think we have two arguments here, because Mr. Sanders talked about equity, and I think this is important. There have been two efforts in recent times to deal with the equity question, the minimum wage increase and an effort to make the tax incidence fairer. In both cases, we had very negative consequences predicted, which I do not think have been borne out and which certainly do not appear. If they were borne out, they were overborne, clearly from your statement, by other things.

    The last point I want to make I will make briefly, and you can respond. Right here on page 10 and 11 you say there were two sort of equal dangers as you raise them. On the one hand, should momentum of domestic spending not be offset significantly, we can get into inflation. On the other hand, we also need to be alerted to the possibility that they might dampen activity by more than is desirable. So it is one or the other.

    My problem is, and I go back to my opening statement, on page 6 you talk about preemption, but you have got a one-way preemption here. You have two dangers. There is a danger that Asia will not offset growth enough and it will be inflationary, or that Asia will do too much and it will be inflationary. But you are only going to preempt one of those dangers.

    Mr. GREENSPAN. I was not aware that I said that.
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    Mr. FRANK. Said what?

    Mr. GREENSPAN. That I want to preempt one and not the other.

    Mr. FRANK. Page 6, your discussion of preemption, ''History teaches us that monetary policy has been most effective when it has been preemptive.''

    Mr. GREENSPAN. That is correct.

    Mr. FRANK. And the whole discussion of preemption is about preempting inflation.

    Mr. GREENSPAN. No, I was talking about the extent of inflation.

    Mr. FRANK. But you do not talk about preempting the negative. It is just your mindset. When you think preemption, you think about cutting off inflation. You never think about—apparently, I think this is a fact when the people in the Federal Reserve talk about preemption—you are never preempting something negative. And I urge you to look at your discussion on page 6 and page 7. Preemption occurs only in the context of cutting off inflation, not in the context of offsetting too much.

    Mr. GREENSPAN. Mr. Frank, I would suggest in our previous conversations on this that I have made statements on both sides of that issue; namely, that preemption works both ways.
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    Mr. FRANK. I agree when I press. But I am continually disturbed by what seems to be the mindset, and I understand you are representing the institution there as well, that preemption still tends to be a one-way street and there is not enough concern about preempting the negative of too little growth.

    Mr. GREENSPAN. No, I would disagree with that. I would say that our fundamental goal is to maintain maximum sustainable growth, which means effectively that you want to try to fend off tendencies of monetary policy instability on one side and on the other.

    In previous discussions which we have had on this, in fact, in the last 6 months this issue has come up and we discussed both sides of that. The problem that is relevant right here is that, with these very finely balanced sets of forces on both sides of this issue, we may not be fully successful in preemptive policy. In other words, preemptive policy requires that one has the capability of capturing a change in direction significantly far in advance so that actions can be taken to fend it off.

    I think the real concern we have today is that what we have are two basic forces—both rather powerful, but both 180 degrees apart. And what we hope to be able to do is to capture the trend in either direction sufficiently in advance to focus policy in a manner which most effectively increases the probability that we can maintain this 7-year long economic expansion with its benefits.

    Mr. FRANK. I like that better than your prepared statement.

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    Chairman CASTLE. Thank you, Mr. Frank.

    I would like to at this time go to the Chairman and acting Ranking Members of the subcommittee for their questions. Then we will go in regular order through the subcommittee.

    Chairman Leach.

    Mr. LEACH. Thank you, Mr. Chairman.

    Just looking at your statement, I want to focus on one paragraph for a second. You note that our own standard of living depends on us ''...joining our trading partners and international institutions in helping stabilize the economies of Asia.'' You also note that we would ''...threaten the source of much of our own sustained economic growth if we were to cede our role as a world leader or backslide into protectionism.'' I take it that means you strongly endorse the IMF approach that the Administration has proposed to Congress?

    Mr. GREENSPAN. I do, Mr. Chairman.

    Mr. LEACH. Second, you have in your past testimony been a little bit inebriated with the exuberance of the skepticism of the market. But in your statement today, you say that 12 or 18 months hence some of the securities purchased in the market could be looked upon with some regret by investors. So what you are suggesting is that in the next 18 months some stocks may go down, not necessarily that the market as a whole may decline; is that correct?
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    Mr. GREENSPAN. I am basically saying that at this stage, when you look at all the relative value relationships, which get to the questions of equity premiums in stocks, the rate of return that is required for equity investments is lower than it usually is. It is not outside of any credible range, but it is in the lower end. Similarly, yield spreads on various types of private bond issues are relatively low.

    And, if you take a look across the spectrum of commercial bank lending, spreads are low. In other words, the notion of benevolence which has been continuously spreading during this 7-year growth in economic activity, much to the contrary of what history tells us, is creating a state in which one must presume that, if history returns, we will find these spreads will start to open up.

    And I am mainly concerned, frankly, in this particular paragraph, about the issue of bank lending. Banks never make bad loans on purpose. Nobody does. But what we do find, in retrospect, is that a higher proportion of loans which turn out to be bad are made at times when yield spreads are low and risk premiums are perceived to be exceptionally low. There are very few bad loans that are made when the economy is not doing well. It is only in periods, such as today, that those tendencies are higher than normal.

    Mr. LEACH. I appreciate that.

    One final question. In terms of the subject of preemption, we discussed monetary policy here, and now I want to get your advice on fiscal policy. Is it good preemption at this time to increase by three to five times the inflation rate the Federal spending, or is it greater preemption to try to keep a little greater discipline in Federal spending given what might be new forces on the economy?
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    Mr. GREENSPAN. Mr. Chairman, when we look at the budget projections we should have some contingency plans. Those which are demographically determined are the ones which we can have some reasonable assurance of, and what we do know is that our retirement demographics are changing in a really quite dramatic way as we move into the latter part of the next decade and into the second decade of the 21st Century, and the pressures on spending are going to be really quite significant.

    And it is important for us, as I indicated elsewhere, to recognize that it is far easier to pass legislation today that focuses on a period 10 years from today than it is to wait for 5 years or 6 years and then find that the politics become unbelievably difficult.

    I think it is crucially important that if we are going to make significant changes in various different elements of what I would call retirement and demographic spending that we end up with the necessity of communicating to the people who are the recipients sufficiently well in advance what they can expect from Government so that they can plan their lives accordingly. I think we owe it to that generation.

    Mr. LEACH. Well, I appreciate that. Mr. Chairman, that was not exactly the answer to the question I asked, but it was a better answer than it was a question. So thank you very much.

    Mr. FRANK. We will give you unanimous consent to redo the question in the record if you want.

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    Chairman CASTLE. Thank you, Chairman Leach.

    Mr. LaFalce.

    Mr. LAFALCE. Thank you, Mr. Chairman.

    Chairman Greenspan, everyone is concerned about the declining values of various currencies vis-a-vis the dollar. And I alluded in my opening comments to the probability that these countries might like to see the United States lower their interest rates and that would perhaps help them stabilize their dollars, increase the value of their currencies. It would minimize the flood of imports coming into the United States. We probably would be in a better position to do that than ever before because of the fact that we are going to get a flood of imports now minimizing inflation risks.

    I am wondering what other countries are saying to you about this and to what extent you are factoring this into the judgmental equation?

    Mr. GREENSPAN. As I have mentioned many times in the past, there are innumerable things which converge and determine what monetary policy is. And even as we think our way through various implications with respect to international financial forces, it is ultimately the long-term benefits of the American people which are at root, the determinants, of our policy. So to the extent that we recognize that the international financial system is much to our advantage—because it has facilitated trade and there is just no question that the expansion of trade has been a major factor in rising standards of living around the world, and in the United States especially—we have from our general purview a very considerable interest on what is going on with respect to our trading partners.
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    I have not heard any real discussions about the effect of American rates on other exchange rates because there have been so many other profound forces involved. Mr. LaFalce, you raised the Canadian issue in your opening remarks. The weakness——

    Mr. LAFALCE. The Canadians raised their interest rates recently, didn't they, as a means of coping with the declining value of their currency?

    Mr. GREENSPAN. Yes. And, in fact, they have succeeded. The Canadian dollar is up about 3 percent from where it was at the bottom. But the primary cause of the Canadian problem, as best I can judge, was the Asian deterioration. Because the Asian deterioration contributed to a major weakness in international commodity prices and the Canadian economy.

    Mr. LAFALCE. If you are looking at it from the period of the last several months, yes. If you are looking at it from the period of the last several years, no.

    Mr. GREENSPAN. That is true. I am saying the short-term recent Canadian experience has been essentially a reflection of the weakness in commodities which the Canadian economy is so dependent on. And that, as you point out, has had a significant effect on numbers of American competitors along the border. For example, we compete across the Canadian border in virtually the same types of materials.

    Mr. LAFALCE. I am very sensitive to this bilateral relationship because we have more trade with the country of Canada than we do with the entire European Community. We have more trade with the province of Ontario than we do with the second largest trading company we have, Japan. We trade more with Ontario than we do with Japan. And so, the relative value of our two currencies is extremely important. And whether they are raising their interest rates, that is going to have consequences on their economy and on ours. And I was just wondering if maybe we should not be thinking of lowering our interest rates.
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    Let me point to one last question, Dr. Greenspan. We tend to focus in on large macro figures to be sure. But to what extent does the Federal Reserve Board have figures with disparities that exist within our economy, disparities not only with respect to wages—and I think we probably do have some fairly decent data on that—but also disparity with respect to wealth?

    And you have spoken considerably about the stock market recently. I am wondering to what extent this rise in the wealth of those individuals who are participating within the stock market may well be bringing about disparities within the United States economy, and I am wondering what policy implications exist now or in the future on account of that, and I am wondering to what extent the Federal Reserve is studying this and thinking about it?

    Mr. GREENSPAN. Well, we do, as you know, periodically survey households and others to get a general sense of the distribution of wealth. It is not the direct purpose of a lot of these evaluations, but it turns out that we have a fairly good insight as to what is going on. And, as you know, we do have aggregate data on balance sheets of all aspects of the American economy and we can see this extraordinary change as it occurs as a consequence of the huge increase of equity values in our system.

    First of all, the one thing that is very apparent from the data that we have is the extent to which equity ownership, both direct and indirect, has risen very substantially in this economy. The extent of mutual fund ownership, 401Ks and just plain equity purchases, has really been very large. And the proportion of households which own stocks directly and indirectly, as you know, has gone up a very significant amount in the last 6 or 7 years, so that there is a substantial amount of participation really by a very large part of the society. And hence, the rewards have been fairly widespread.
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    Nonetheless, there is no question because of the inherent distribution of wealth vis-a-vis incomes, that as equity values have risen substantially relative to the values of homes, which has historically been the major place of where middle income wealth has been, we have had a spreading of the wealth effect in this economy. How significant it is is not easy to tell.

    Mr. LAFALCE. When you say, ''a spreading of the wealth effect,'' you mean a growing disparity?

    Mr. GREENSPAN. Growing disparity. Dispersion is increasing. The disparities have increased. However, the disparity is not that one gains and the other loses; it is that one is gaining more than others.

    Mr. LAFALCE. At least for those participating within it. There are still sizable segments of the populous that are not participating.

    Mr. GREENSPAN. Yes, as I have indicated before this subcommittee before, and it is an important issue, there are noneconomic questions which we do have to be terribly concerned about with respect to an economy in which you have very great disparities of wealth. And we are certainly nowhere near where we were in generations past. But I do feel uncomfortable when I see data which suggests increasing disparities, because I know it creates tensions in societies which are not healthful.

    Mr. LAFALCE. Dr. Greenspan, I do not have the time to pursue this now. My time has expired. I would like to pursue this with you subsequent to this hearing in greater detail. And I would also love to see the Federal Reserve Board sponsor some symposium or conference regarding the issue of the growing wealth disparity in the United States and its social public policy implications. Because I think in the future they are going to be profound.
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    Chairman CASTLE. Thank you, Mr. LaFalce.

    Mr. Lucas.

    Mr. LUCAS. Thank you, Mr. Chairman.

    Chairman Greenspan, could we step back for just a moment and visit about the comments that you made about the potential impact of the financial situation in Asia and the Western Pacific countries would have both positive potential on the demand for labor and other things in the United States, but also along the lines of the comments about the Canadian wheat growers, what the potential impact could be on those segments in our economy that are very export-driven into the region, agriculture being close to my particular heart.

    Mr. GREENSPAN. Well, the first thing that we have seen with respect to the Asian problem is not so much a huge acceleration of exports from those countries into the United States. What we are seeing is somewhat surprising: namely, there is a very large adjustment, but it is occurring as a consequence of sharp reductions in imports. And as a consequence of the inability to effectively import, it has curbed exports out of Asia even though, with their depreciated currencies, one would think that their competitive advantage had been materially increased.

    So that what we are seeing are data from Southeast Asia, East Asia generally, which suggest a fairly substantial swing in trade balances, current account balances, but very largely from declining imports, which means it is going to be impacting lower exports from the United States. We do not as yet see significant impacts.
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    We do see, for example, that a number of agricultural areas, in wheat and apples and numbers of other agricultural commodities, especially in the West, have been severely impacted. We do not as yet see a very substantial impact throughout the export-producing areas of American manufacturing.

    What we do see, as I indicated in my remarks, is that the effects are more materially at this stage in price, not in volume. In other words, American exporters are finding that they are having price problems more than volume problems, which in part is a consequence of the Asian experience.

    Now, I do not know yet, and I do not think anyone has any way of really figuring out exactly how this is all going to evolve. The trauma has been so great there that unless we can have a fully effective insight into how this impacts among the countries of East Asia and Japan, it is not going to be possible for us to get a really good fix on what the impact is back here. That is the reason why I say that we do not yet have a really useful sense of what will happen.

    Mr. LUCAS. But it is reasonably safe to say that, in addition to Canada, there are places like Australia and New Zealand that compete with us in those markets and that, with the conditions you have just described, it will make it probably more competitive for all of us trying to move pricewise, move our products into that region and, yes, that will play out one way or the other?

    Mr. GREENSPAN. Yes. Obviously, in the wheat market, for example, we basically compete with the Canadians and the Australians. And both being commodity-based economies, have had their exchange rates fall, vis-a-vis the American dollar, which, since we are dealing with a homogeneous commodity like wheat, gives them a competitive advantage over American shippers.
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    Mr. LUCAS. Change shoes for just a moment. The comment made earlier, I believe, by the Chairman in regard to the savings and cost of interest rates because of the balanced budget, is it not also reasonable to assume that now that we are in the beginning of, I guess, year four of a Congress that is attempting very strongly to restrain the growth in the Federal spending, when I came in in 1994, we were borrowing a couple-hundred-billion dollars a year to fund the Federal deficit. If it was possible to have this kind of expansion and possible to be in the same budget situation we were in in previous years, wouldn't that produce a huge demand out there for capital to do what the economy has been doing and at the same time do the Federal spending things that were done in the past? Wouldn't that have led to industries that certainly would not have gone down?

    Mr. GREENSPAN. Are you saying if the deficit would start back up it would impact industries? Oh, most certainly.

    Mr. LUCAS. Because you cannot fund all those capital demands both in the private and public sector without seeing the cost of capital go up.

    Mr. GREENSPAN. Right.

    Mr. LUCAS. So, as one Member, let me say I do enjoy the prosperity that we are in.

    Thank you, Mr. Chairman.

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    Chairman CASTLE. Thank you, Mr. Lucas.

    Mr. Hinchey.

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

    Mr. Greenspan, thank you very much. This has been a very interesting session. I appreciate these semiannual meetings very much. But I continue to be impressed with the ability of the Fed to concentrate almost exclusively on one aspect of its responsibility—for example, inflation—to the detriment of other aspects of the economy.

    It seems to me that one of the things that you ought to be concerned about is the need to increase demand. There is an oversupply of virtually every manufactured item around the world. As you just pointed out in your discussion of commodities, we are seeing commodity prices drop dramatically as a result of oversupplies in Australia, New Zealand, and Canada because of the collapse of the market for those agricultural commodities in East Asia. That is having a significant effect on our agriculture commodity prices here in the United States. Oil prices are falling dramatically, in part due to weather conditions, but also due to a decline in demand.

    You expressed the belief in your testimony that steps being taken by East Asian countries seem adequate to deal with their problems. As we observe those steps, we can be comfortable in the belief that what they are doing will ameliorate whatever negative effects their economic troubles might otherwise have on our economy. Others would disagree with that.

    For example, steps being taken by Japan are regarded as wholly inadequate to increase their domestic demand. Our own Secretary of the Treasury among others, has expressed that view. Without an increase in domestic demand in Japan, producers in East Asia are going to increasingly look at the American economy as the market of last resort. European countries, certainly, are not presently in any condition to absorb the excess production that is coming out of East Asia and elsewhere.
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    I wonder what we might do in order to deal with the demand side of the equation. We have concentrated so heavily on the supply side, both domestically and in terms of international development around the world. But we have not done enough to increase demand. We have not done enough to make sure that people have the resources to participate fully in the economy. And we see the effects here in our own country.

    A number of Members have pointed out the fact that we are seeing increasing disparities of wealth and income in spite of the fact that there have been some reversals during the Clinton Administration. Workers are only just beginning to experience some benefits of the growing economy. Nevertheless, we are not nearly where we ought to be.

    So what really is your position with regard to the financial crisis in East Asia? What are its expected effects on the American economy? What can we do to increase demand? And why do we still have real interest rates that are high by historical standards? And I use that phrase ''high by historical standards'' because that is the phrase that was used at the meeting of the Federal Open Market Committee last August when members admitted that real interest rates are, in fact, high by historical standards.

    Mr. GREENSPAN. Well, Mr. Hinchey, let me start with the last question and work back. Statistically, it is a fact that real interest rates are higher now than they have been on the average of the post-World War II period. They are not high by standards of the last 15, 20 years.

    Mr. HINCHEY. During that period, Mr. Greenspan, we have had excessively high interest rates. I am talking about high by historical standards, not within that narrow timeframe.
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    Mr. GREENSPAN. No. I was about to say why it is relevant. We had a different type of financial system when we had Regulation Q, when in effect there were limits on to what extent interest rates could rise for deposits. And that created a different response in short-term interest rates to economic activity. There are those who argue as a consequence that using the data prior to the last 20 years is to average a short-term interest rate effect over two different types of economies. But leave that aside. Because it really doesn't matter.

    The crucial question of whether or not real interest rates are biting or not is to look at what happens to interest-sensitive areas of demand within the economy, and what we see today is that despite the fact of where real interest rates are, the interest-sensitive areas of the economy—namely housing, motor vehicles, certain consumer elements of spending—are all doing exceptionally well. And it is very hard to find a case in which real interest rates are significantly retarding demand in the United States at the moment.

    The one area where we are arguing that the demand is likely to run into some trouble is foreign accounts. Namely, we perceive and we are in fact projecting that there will be an easing off of demand as it works its way through the system as a consequence of events in southeast Asia. But it is not because of the fact that we believe real interest rates are high and, therefore, suppressing the economy. I just think there is no evidence of that.

    Mr. HINCHEY. No. But the fact is that if you have that kind of effect taking place in East Asia, and you have cheap products being dumped on the American market—which is beginning to happen and which we can expect will happen increasingly—and if interest rates are high by historical standards, that is going to complicate the economic situation for the American economy and particularly for American workers.
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    Mr. GREENSPAN. Well, Mr. Hinchey, I would say that we would respond one way or the other to whatever is going on. As I indicated in my prepared remarks, we are, in effect, looking at two countervailing forces and it is not clear how the balance is coming out.

    What I am saying is that the policy that will be implemented by the FOMC, as it always is, will be responsive to events as they emerge. But I do not think it is appropriate.

    Mr. HINCHEY. Well, I am used to hearing you say that it is necessary to anticipate events, not wait until they emerge, because there is an 18-month or so lag time.

    Mr. GREENSPAN. Actually, 18 months is more related to inflation. We have shorter lags in certain other aspects. But look, it is quite conceivable to me that even though we would like to be preemptive, we may not be able to be preemptive largely because there are certain types of events in world economies which are very difficult to anticipate.

    What I certainly would think would be a mistake would be if we take a preemptive move in either direction which turned out to be 180 degrees wrong. That would worsen the situation rather than make it better. So we may find ourselves being less preemptive than we would like to be. I would say the optimum policy is to be as preemptive as we possibly can, but we may not always be able to implement optimum policy.
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    Chairman CASTLE. Thank you, Mr. Hinchey.

    Mr. Metcalf.

    Mr. METCALF. Thank you, Mr. Chairman.

    Washington State is the State most dependent on trade with Asia. You stated today support of Secretary Rubin and replenishment of the IMF. Can you specify potential problems that might affect our markets in the short term or the long term from failures of Asian economies if the IMF is not replenished?

    Mr. GREENSPAN. Well, as I said in earlier testimony, I believe that if we were to do nothing at this stage with respect to IMF funding, the likelihood is that we will get through reasonably well and the probability is definitely significantly better than 50/50 that that is the way that it would evolve.

    The reason why I find myself in strong support of Secretary Rubin and his particular requests is that the low probability that we may be wrong on that is a probability which has very large potential consequences.

    I would much prefer that we give the authority to the IMF, to effectively give them a letter of credit, which may not have to be used and, indeed, probably will not have to be used, than not have those resources available in terms of crisis when they would be needed. In the low probability that they would be needed, I do not believe that the Congress would have adequate time to move through authorizations which would be sufficiently useful.
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    Mr. METCALF. Thank you. This is on a totally different subject, sort of off the wall. But as the stock market reaches dizzying heights, does that not represent in a sense, and just in a sense, an increase in the money supply, and is the Fed concerned specifically about that?

    Mr. GREENSPAN. That is an interesting question, because what we're dealing with is distinctions between money and credit in certain respects or claims; and the issue of asset value changes, which clearly is not the same thing as an increase in the money supply, is nonetheless interrelated.

    What we try to do, with hopefully some success, is to be able to understand the interrelationships between money on the one hand, asset value changes on the other, and how both impact on the real economy. I wish we knew more about a lot of these things. They continuously change and we continuously get proxies for what we think real money is and find out that this is not a useful proxy.

    The one thing I will say is that all of these elements are essentially monetary phenomena and how money is produced in this economy has profound effects not only on the United States, but on the American dollar and as a consequence of the whole trading system.

    Mr. METCALF. Last quick question.

    The Fed for a long time was very careful to try to regulate money supply and it seems to me that that is not the case now; that maybe they have given up or it is impossible or whatever. Just a quick comment on that.
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    Mr. GREENSPAN. We truly have problems with respect to using M2 specifically in a way we used it in the past as a reasonably good indicator of where the economy was going or where spending was likely to go because the relationship between the nominal value of the gross domestic product and M2 was reasonably stable and forecastable. That has changed. But nonetheless, the central bank's fundamental purpose is to maintain a stable financial system.

    Unless we recognize that the value of the currency is very crucial to what occurs in the economy, we can find ourselves as central bankers creating either too much or too little in the way of money supply. And even though we may not at this particular stage feel very comfortable in using the specific values of M2 to make judgments about how that is going to impact on the economy, that does not mean we are wholly indifferent to what is happening to money supply or bank credit or all of the other variables in the system of which we have so many difficulties.

    Mr. METCALF. Just a quick last question.

    Apparently the Fed is creating cash, cash money, Federal Reserve notes, at an increase of about $3 billion a month. I read an article, it may not be right, but about $3 billion a month. And that seems to me surprising. Is that because of so many more cash machines?

    Mr. GREENSPAN. Creating what? I missed a word that was used.

    Mr. METCALF. In the creating of more cash. The dollar bills, the Federal Reserve notes. It seemed to me that I read in an article that said about $3 billion a month increase.
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    Mr. GREENSPAN. Yes, that is about right.

    Mr. METCALF. And what is the reason for that? Is that because of the increasing number of cash machines? And then I can understand it. If it isn't that, then I do not understand.

    Mr. GREENSPAN. Part of the problem, remember, is that a very substantial part of the currency that we issue is held abroad, and when there are crises abroad, really quite remarkable things that the American dollar—currency, cash—has got a terrific demand and it is very hard to know in general where the demand is coming from.

    We do, after the fact, know what has been shipped to various countries and the like. But I am sure we do have a very substantial increase in the ability to create, or I should say distribute currency through ATMs domestically. But I would doubt whether that is a big element because so much of our cash demand, currency demand, is foreign.

    Mr. METCALF. Thank you, Mr. Chairman. And I will write you a letter. I'd like to get a list of how much we ship to various countries and I will write you a letter on that. Thank you very much for your testimony.

    Chairman CASTLE. Thank you, Mr. Metcalf.

    Mr. Bentsen.

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    Mr. BENTSEN. Thank you, Mr. Chairman and Chairman Greenspan. Reading your testimony and reading the report of the Board, it would appear that for the most part, things are pretty good and in reading the wire story of your testimony this morning, it indicates that nowhere in there did you trip the wire that caused the market to be concerned that maybe the Fed is going to tighten.

    And if you look at the semiannual report that you have provided us, everything in here seems to be coming up quite good from the standpoint of inflation. Labor costs still are not out of control, interest rates are down, interest cost to businesses are down. Obviously, we know that the Government expenditures are coming down below the rate of inflation. The income to businesses, the corporate sector income, is good. At the same time, we are starting to see real wages rise for American workers.

    And in your testimony you comment that the Asian storm clouds in effect are perhaps going to provide us with the regulator that we need in order to keep inflation under wraps. And even I see in the back that your previous concerns about price earning ratios in the equity markets after 3 years, a rational exuberance has apparently become mainstream and now and maybe that will continue on. I agree with your comments that this is all good and it may get bad. But I guess, from what you are telling us, nobody really knows for certain.

    I do have a couple of questions for you. And the first is, you talk a lot about productivity growth; and when you testified six months ago, and I think in the prior testimony to that, you indicated that you or the Fed were beginning to believe that we were seeing a jump in productivity growth.

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    Now, we have the statistics, and it is clear that we have seen a dramatic rise in productivity growth over the last two years, which is quite beneficial not only to workers today, but probably to workers in the future. Do you believe that trend will continue?

    And second of all, from reading your testimony, it would appear that the only bottleneck that is occurring, because in your report you also indicate that there is sufficient capacity in the manufacturing sector more so than in previous expansions, but the only bottleneck that would appear is the availability of skilled labor. And would it now be time that when we have been talking about the need for increasing capital formation that we also look at human capital potential and the fact that maybe looking beyond capital gains tax treatment policy it is time to start looking at education policy and further enhancing that?

    And I would also ask if you could give some correlation. I recently looked at some statistics that came from the Council of Economic Advisors that indicated if you look at the past three expansions, including the one we are currently enjoying, that at the top of the expansion, and I do not know whether we are at the top of the expansion or not at this point in time, we saw inflation go up.

    Now, obviously in the late 1970's period we did have the second oil price hike that exacerbated the situation. But if you look at rates of 1987, 1988, 1989 starting to go up into the 6 percent range and yet now we see a period of rates coming down 1995 to 1996. So is this a different trend than what we have seen in previous expansions since the Second World War or in the 20th Century?

    And the last question I would ask, and I hope you testify before the Budget Committee. We held one hearing in the budget this year and maybe that is all we are going to have, but I hope you do testify. We have had some interesting discussions with the head of the CBO regarding debt held by the public and total debt held owed the Government. But I would be interested in your comments.
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    Now, that we are in a period of at least annual budget surpluses or operating surpluses, what, in your opinion, is, if at all, the appropriate level of debt-to-GDP?

    Mr. GREENSPAN. Congressman, first of all, let me just say that I fully subscribe to your notion that the issue of human capital is becoming increasingly evident from the types of bottlenecks that are emerging. And I wouldn't only put it to skilled labor. I would say it is skills all across the board. There are really pressures virtually everywhere, and we have seen a very fairly dramatic increase in on-the-job training, a very considerable increase in number of people going back to college or starting college in their mid- to late twenties to pick up the skills that they perceive to be required to maintain themselves in work throughout their working careers. So that you are beginning to see a substantial move of the educational resources going to very specific types of skills which are required in this increasingly high-tech economy. That should be encouraged, and it is clearly something which market forces themselves are really beginning to have a significant impact on.

    It is hard at this stage to know precisely to what extent the evident acceleration in productivity is a major or a modest change in the long-term underlying trend. We will not know that for a number of years. But in my judgment, and not everyone shares my view on this, there has been a marked change in the long-term trend. I do not think it is a very large shift, because that is hard to engineer in this type of economy, but I do think it is a meaningful one, and I do think it is going to have an effect on our growth rates in the future.

    Mr. BENTSEN. Do you think it is a sustainable trend?

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    Mr. GREENSPAN. Part of it is, yes. Clearly if we go into a degree of economic weakness in any period ahead, what historically happens is that fixed costs all of a sudden become a big problem, and productivity slips. But what we are talking about is the longer-term growth, and what productivity is at successive peaks in the business cycle. The evidence here is that the cyclically-adjusted productivity trend has moved up.

    With respect to the debt-to-GDP, there are numbers of ratios which people use. Both numbers are too large to be useful to take a ratio one to the other and get some really useful conclusions. So I would say that, obviously, the extent to which that implies interest payments—and the interest payments must be coming out of the income that is implicit in the GDP—there obviously are relationships. But I would hesitate to give a specific number.

    There is difficulty in any particular ratio of one to the other. I think it is too aggregative a set of numbers.

    Mr. BENTSEN. With the Chairman's indulgence, though, I guess the question, and we will have to debate this in the future, is, is the appropriate number better than zero?

    Mr. GREENSPAN. You mean the aggregate level of debt?

    Mr. BENTSEN. I guess the question is should there be any debt at all, or, in your opinion, there should be zero debt?

    Mr. GREENSPAN. You are talking about Federal debt?
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    Mr. BENTSEN. Yes.

    Mr. GREENSPAN. That is an interesting academic discussion, but I do not think it is something that is likely to be relevant relatively soon.

    Mr. BENTSEN. I agree with that as well.

    Mr. GREENSPAN. The evidence does suggest, however, that, as the Federal debt-to-GDP ratio falls, interest rates tend to also move in that direction. But I am not sure what the cause-and-effect relationships necessarily are.

    But going to the other extreme, there is no question that at some point countries get themselves into levels of debt-to-GDP which are marginally explosive. In other words, you can get to a point where you have a progressive debt cycle, where the debt goes up, the interest payments go up, which means that the deficit goes up because interest payments become very large, which means the debt goes up, and you can have an unstable acceleration of debt. And indeed we have seen this on innumerable occasions in a number of emerging economies which have run into a debt barrier.

    But we, the United States, are nowhere near there at the moment. And if you are asking me would it be better to get our debt down than up at this point, I would say the answer is yes, because that would be far more effective for long-term economic growth than anything I can think of.

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    Mr. BENTSEN. Thank you, Mr. Chairman.

    Chairman CASTLE. Dr. Paul.

    Dr. PAUL. Thank you, Mr. Chairman. I have two brief points to make, then I have a couple of questions.

    First, your comment about the deficit is very important in keeping interest rates high. It seems to me that the level of Government spending has to be even more important, because if you have a $2 trillion budget, and you tax that money out of the system, that is very detrimental, just as detrimental as if you borrowed out of the economy. So I think the level of spending is probably more important.

    And as a follow-up to the question from the gentleman from Washington on the currency, we certainly do export a lot of our currencies. More than 60 percent ends up in foreign hands. And it serves a great benefit to us because it is like a free loan. It is not in our own country, it does not bid up prices, So we get to export our inflation. At the same time, they are willing to hold our debt; central banks are holding $600 billion worth of our debt. So again, we get to export our inflation, and the detriment is the consequence of what we are seeing in Southeast Asia.

    But the real problem, though, is not the benefits that we receive temporarily, but the problem is when those dollars come home, like in 1979 and 1980, and then we have to deal with it because it is out of your hands, this money has been created. So I think we should not ignore that.
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    But my first question has to do with Mexico. It is bragged that we had this wonderful bailout of Mexico three years ago, and yet Mexico still has some of its same problems. They have tremendous bank loans occurring right now. The peso has weakened. Last month it went down 5 percent. Since the conditions are essentially the same, my question to you is when do you anticipate the next currency crisis in the Mexican peso?

    And then another question that I would like to get in as well has to do with a follow-up with the gentleman from Massachusetts dealing with the inequity in the distribution of income. And in your statement you come across almost hostile or fearful that wages might go up. And I understand why you might be concerned about that, because you may eventually see the consequence of monetary inflation, and it will be reflected in higher wages. But where has the concern been about the escalation of value of stocks? People are expecting them to go up 30 percent a year. They are benefiting, but labor comes along and they want to get a little benefit. They want to raise their salaries 5 or 10 percent. Unlike the other side, I think the worst thing to do is interfere in the voluntary contract and mandate an increase in wages and give them minimum wage rates. That is not the answer.

    But to understand the problem I think is very important. This is a natural consequence. They want to share as well, and this is a natural consequence of monetary inflation is that there is an equal distribution of income.

    I would like you to address that and tell me if there is any merit to this argument and why you seem to have much greater concern about somebody making a few bucks more per hour versus the lack of concern of a stock market that is soaring at 30 percent increases per year.
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    Mr. GREENSPAN. Let me say that when I believe that there are trends within the financial system or in the economy generally which look to me and to my colleagues to be unsustainable and potentially destructive of the economic growth, we get concerned.

    I am not aware of the fact that if I see things which I perceive to be running out of line, that I have not expressed myself. At least some people have asserted that I have expressed myself more often than I should. And I have commented on innumerable occasions, as I have, in fact, done today, that there are certain values in the system which by historical standards, are going to be difficult to sustain. And I am concerned about that, because it potentially is an issue which relates to the long-term values within the economy.

    I have no concern whatever about the issue of wages going up. On the contrary, the more the better. It is only when they are real wages, whether they are wages which are tied to productivity or related to productivity gains. But wages which are moving up more than the rate of inflation, for example, I think are highly undesirable, and indeed to the extent that we do not get real wage increases, we do not get increases in standards of living. So I am strongly in favor of any increase in real wages and not strongly in favor at all of wages that go up and are wiped out by inflation.

    Dr. PAUL. But the real wage is down compared to 1971. You have a little flip here or so, but since 1971 it is down.

    Mr. GREENSPAN. Part of that issue, Congressman, is a statistical problem. I do not believe the real wage is truly down since 1971.
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    Dr. PAUL. But we cannot convince our workers of that. At least in my district they are not convinced by some statistic.

    Mr. GREENSPAN. Let me put it this way: Productivity after the early 1970's flattened out fairly dramatically, and that slowed real wage increases very dramatically as well. And to the extent that the sense in which earlier generations experienced significant increases in standards of living during the 1950's and 1960's and the early post-World War II period, of course productivity was advancing rapidly. That came to a dramatic end in the early 1970's and persisted until very recently. And if people were concerned about that, they should be, and they should have been, and we should have been, as I think we were.

    Dr. PAUL. Do you have a comment on when the next Mexico crisis is going to occur?

    Mr. GREENSPAN. Yes. I am not concerned about a crisis in Mexico at this particular stage. I think they are doing reasonably well. The peso at this particular stage is floating appropriately. I do not see any immediate crisis at the moment. And while I do not deny that, as in any country, things can go askew, they have come out of the 1995 crisis frankly, somewhat better than I expected they would.

    Chairman CASTLE. Thank you, Dr. Paul.

    Mrs. Roukema.

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    Mrs. ROUKEMA. Thank you.

    Mr. Chairman, did I hear correctly your response to Mr. Metcalf concerning his export-related State of Washington State? Of course, New Jersey is in a very similar situation. And of course we heard your reference to the agricultural needs with respect to Mr. Lucas, all related to IMF and the Asian contagion.

    I appreciate your response to Mr. Leach in strong support for the IMF letter of credit, as you put it. I would like to know, because I am very concerned that the Congress might not feel the urgency that I think we should be feeling, your opinion regarding the timing of congressional action and its relationship to forestalling, if possible, further economic disadvantage with respect to trade deficits. I am particularly interested in your comments regarding the effect on our export markets.

    Mr. GREENSPAN. As Secretary Rubin said, it may have been before this subcommittee in fact, the amount of free funds available in the IMF after we adjust for the fact that members of the IMF have automatic claims coming from their quota, when you get the net number, it is a relatively small number, meaning that what has been committed to date there are funds for, but if a substantial new problem arises, there may not be. And I think that would be unfortunate. So it is that particular contingency we are endeavoring to cover.

    Mrs. ROUKEMA. That is the letter of credit you were referencing?

    Mr. GREENSPAN. Yes. Remember that if it is not used, for example, if our quota, or everybody's quota goes up 45 percent, which was indicated in the request of the Secretary, if that happens and there are no crises or no particular problems that are emerging, then it has no impact, in the same sense a letter of credit which is not drawn has no impact. But even if it is drawn in part, it is a highly collateralized loan: it is not an expenditure. You know, we are not buying something, we are making a loan with fairly significant collateral, and over the past 50 years we have always gotten paid back, and there is no reason to expect it to be otherwise.
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    Indeed, in the late 1970's, we were one of the borrowers. So, I mean, it is not as though the United States is always lending and everyone else is always borrowing. There have been occasions where that situation has been reversed, and we needed the assistance.

    Mrs. ROUKEMA. I am sorry, I didn't mean to interrupt you.

    Mr. GREENSPAN. Go ahead.

    Mrs. ROUKEMA. Your thoughts regarding the timing of Congressional action on IMF funding?

    Mr. GREENSPAN. I would say the sooner the better. Obviously, I am saying at the moment I do not see any immediate requirement. That is the problem in the sense that it is not going to be anticipatable, and we are not going to be able at one point to say, ''The IMF needs funds to stem a particular crisis, a crisis which would rebound negatively on the United States, but we do not have resources to move,'' and I would find that most undesirable.

    Mrs. ROUKEMA. Well, I thank the Chairman. I appreciate his contribution. I think there are too many people that are demagoguing the issue, making this sound as though we are bailing out big banks or bailing out foreigners, and that is not the case. This is our own economy, and we benefit significantly from exporting to foreign countries.

    Mr. GREENSPAN. That is correct.

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    Mrs. ROUKEMA. I thank you for that observation.

    Now, we may not have time for this, or you may choose to defer this question, but in talking about the budget and balancing the budget and the so-called surpluses, I indicated in my opening statement that I was hopeful that we were not going to go on either a spending binge or a tax-cutting binge. You addressed very adequately the spending issues and the paying back the debt issues. Would you like to make any comment about cutting taxes? And if so, what types of tax cuts would you believe to be most favorable?

    Mr. GREENSPAN. Well, I have said before this subcommittee for 10 years or more that I am strongly supportive of keeping marginal tax rates low and, hopefully, the capital gains tax at zero. I still support that as a general proposition and under all conditions, largely because I think that in the long run that would create the highest level of incentives for the overall system.

    I would not, however, at this particular stage be moving aggressively to dispense or disperse the pending—I use the word ''pending''—unified budget surplus, because it is not clear that we have got one. In the last 12 months, actually ending in January, there was a very small budget surplus, but we have not yet seen anything which resembles something which we feel secure with.

    Until we believe we have got a chronic surplus, and until we address the fact that we have got a very large pending outlay scheduled for both Social Security and Medicare as we move into the period 2008 and beyond, and until we address the implications of all of that, it is important for us to think through, before we take any actions, exactly where we want our fiscal stance to be 10 years, 15 years out.
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    I would very much hope that we could contain expenditures and cut taxes, because I have always argued that the only way that you are going to fundamentally keep deficits down or surpluses up is by restraining expenditures. And I trust that this surplus that seems to be emerging has not softened our order to contain outlays, which I think has been one of the most important elements in fiscal policy that this Congress has been involved with in recent years.

    Mrs. ROUKEMA. I thank you. You have confirmed yourself as a traditional fiscal conservative, and I appreciate that. Thank you so much.

    Chairman CASTLE. Thank you, Mrs. Roukema.

    Mr. Cook.

    Mr. COOK. I certainly want to thank you, Chairman Greenspan, for your testimony today.

    Following up on the question from the gentlelady from New Jersey, some have estimated that the Federal Government could operate at about a $50 to $100 billion surplus in fiscal year 1999. Let's just assume for a minute that that is true. Members of Congress, for the first time in a generation, would be faced with the challenge of what to do with that surplus.

    In your view, which of the following would yield the greatest economic benefit in terms of growth, in terms of investment and incentive and even price stability: a tax cut involving the marginal rates to exactly offset that surplus, or using that $50 to $100 billion to pay down the $5.5 trillion national debt?
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    Mr. GREENSPAN. It is a difficult call. In other words, I am delighted that if those are the two choices that we have, it is one of those choices which I think the policymakers would like to choose between, because both are very positive toward the economy. I do not think we know the answer to that question. Both do work toward economic growth. The third possibility, raising outlays, does not.

    And at this particular point, I would be more inclined to allow the unified budget surplus to accumulate at least for a while because there is no urgency to dissipate it. In other words, I know of no economic downside of allowing the surplus to run for a while. Once you perceive that you have a structural surplus, you could always cut marginal taxes and capital gains taxes and the like, and I would under those conditions. But I do not think we ought to be moving until we are sure we have got the surplus in hand. It is one thing to forecast; it is another thing to achieve it.

    Mr. COOK. Sure. But assuming that we do, and if we did use that money for a tax cut, it would still be true, would it not, that our national debt as a percentage of GDP would probably continue to shrink even if we were not paying that down?

    Mr. GREENSPAN. That is true.

    Mr. COOK. One of your objectives.

    Mr. GREENSPAN. Sure. Because, obviously, if the budget were in balance, meaning the total debt to the public were not undergoing change, but the GDP nominally was rising, then obviously with a numerator which does not change and with a denominator which is rising, the ratio does fall. And that is something that we should endeavor to accelerate in part by picking up part, at least, of the surplus rather than dissipating it for any reason before we actually see it.
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    Mr. COOK. And without engaging in new spending programs, I guess there is another alternative use for that forum, you know, a budget surplus, and that would be in dedicating it to the Social Security Trust Fund or doing what many of my Salt Lake City constituents have called our office and asked us to do: take Social Security off budget, protect it totally as a trust fund. What is your opinion of that approach or that alternative?

    Mr. GREENSPAN. Well, I have always been supportive of the issue of privatizing a significant part, if not all, of the Social Security system. The issue of the bookkeeping of whether in the current system we include it off or on budget is useful for analytical purposes, but from the point of view of the economy, we have found that the unified budget is the one which seems to be most closely tied to economic effects. And in that context, while certainly taking Social Security off budget certainly gives a much better insight into the degree of full funding that is going on in the Social Security system, it has no impact on the unified budget and, hence, no impact on borrowing from the public, which is the crucial element which affects economic activity.

    Mr. COOK. Could I just follow up on that and ask if, based on what you just said, you would probably not agree with the President in terms of utilizing the surplus, every last dime of it, for Social Security Trust Fund purposes?

    Mr. GREENSPAN. Well, actually——

    Mr. COOK. I know it is two different things, but I almost sense that you do not share that opinion.
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    Mr. GREENSPAN. Leaving aside the issue of at what point you do it, but merely allowing the Social Security Trust Fund to pick up the surplus, since it is a bookkeeping entry, it does not have any effect. In other words, it effectively pays down the unified debt. And to that extent, there are values to be there.

    In other words, it is a question of how you interpret what, in fact, he is doing. There are those who say there is a lot of spending in his budget, and then only after the fact is he doing that. That is an issue which the Congress has to address. But if you are merely asking the sole question of putting the unified budget surplus into the Social Security Trust Fund, that is an intragovernmental transfer which has no effect on the unified budget, and, consequently, if the unified budget is running a surplus, that the debt will be paid down, whatever you call it, you are doing with respect to that intragovernmental transfer.

    Mr. COOK. Thank you.

    Chairman CASTLE. Thank you, Mr. Cook.

    I'd like to thank you, Chairman Greenspan, for being here today. I find it a little hard to believe that we are actually having a serious discussion of what to do with the Federal budget surplus. I wonder if, in your tenure of the Federal Reserve, if you thought that discussion would take place and you are seeing it today?

    Mr. GREENSPAN. Never.

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    Chairman CASTLE. We do appreciate your being here and your attention to the questions we asked. We know that, like a lot of us right now, you are suffering from a cold. We hope you recover from that quickly. There may be questions individual Members may wish to submit in writing, and I hope that you and the people working with you could help us with that, if indeed that occurs, in getting us some answers to that.

    With that, again, we very, very much appreciate your taking the time, and your staff taking the time, to be here as well. And we have listened to your comments, and hopefully the economy will continue to prosper.

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

    Chairman CASTLE. This hearing stands adjourned.

    [Whereupon, at 12:20 p.m., the hearing was adjourned.]