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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 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, Weldon, Roukema, Waters, Frank, Kennedy, C. Maloney of New York, Hinchey, Jackson, Watt and Lee.

    Chairman CASTLE. The hearing will come to order, and we welcome you, Mr. Chairman, again, as we do twice a year.

    We meet today to receive the annual midyear report of the Board of Governors of the Federal Reserve System on the Conduct of Monetary Policy and the State of the Economy, and, as you know, this is mandated in the Full Employment and Balanced Growth Act of 1978.

    Mr. Chairman, we welcome you back to the House Committee on Banking and Financial Services and our Subcommittee on Domestic and International Monetary Policy.
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    The American economy continues to perform well, due in part to the work of the Federal Reserve. We are not greedy, but we would be very grateful if you can just announce that the current good economic times will continue for at least another 88 months.

    Let me just say this: Sometimes when I give graduation speeches, I tell a little story about a man standing on a plain giving a speech, and he sees a speck in the horizon, and he doesn't know what it is. And then after a couple of minutes the speck grows, and then he realizes it is a herd of buffalo. And then he realizes the herd of buffalo is getting closer, and he can distinguish what they are, and he also realizes if he is not through his speech in ten minutes, that he is going to be overrun by the buffalo. With the idea that I will speak for ten minutes—I will now cut that to eight minutes by the way. The kids didn't even like the ten minutes, I learned.

    But I feel the same way about Asia and with respect to what I would like to personally extract from this hearing today, and I realize it is very important in your case to make prepared statements, but it terms of our questions and answers, we need to address those particular questions.

    I feel that Asian economic problems came upon us unexpectedly. I don't think we were prepared for it at any segment of the American economy all the way from intelligence to the Government to the private sector. I think it has been more extensive in terms of involving countries than perhaps originally anticipated. I think the longevity of it has extended at least as long as anybody has said, and perhaps longer. And, of course, the threat of it with respect to Japan is perhaps greater than we ever expected.
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    I think the counterpoint to all this, and some of this is set forth, I have a story from U.S. News and World Report: ''Will Japan Trip the Bull?'', the highlights that you talked about, half your testimony before the Senate yesterday. But a good portion of what has happened so far has actually, in my judgment, been beneficial to the American economy in terms of reduced prices for commodities, for oil, for finished products, in terms of capital coming into the United States to avoid problems in other countries. And, yes, there have been some slowdowns on some orders and maybe hitting particular segments of our economy, but for the most part you can almost make an argument as good for positive as has been negative. And yet I have that feeling that we are getting to a precipice at which point it is going to become quite negative rather rapidly, and are we ready for that? Do we really anticipate where that is going?

    When you visited us in February of this year, we discussed our concern over the troubled Japanese economy. The change in the Government of Japan has confirmed, in my judgment, that those concerns were valid. The Asian economic uncertainty, and especially the status of Japan's economy, I believe, are almost certainly the greatest threat to our own economic health. That is a personal judgment; you haven't stated that. More than inflation or any domestic problem we have, I think that is by far the greatest threat to our own economic health, and I hope that you will share with us today through the question and answer period, as well as your speech, your impressions regarding the degree of seriousness with which the Japanese authorities are approaching the solution of their economic problems.

    The rest of Asia is still, at best, digging out of their own problems. Maybe their problems are even worsening, and success, in my judgment, depends heavily on Japan.

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    The danger of spreading this international economic flu seems even more real when we watch the situation in Russia. If oil prices continue to hover around the current low levels, Mexico may again be in crisis, and others in Latin America could follow, so I hope you will comment on the dangers of the regional economic problems reinforcing each other, what they may mean for the world economy.

    As you know, the debate continues to rage right here in Congress almost daily this week, as a matter of fact, over whether the United States should contribute an additional $18 billion to the International Monetary Fund to help meet international economic instability, and I am very eager to hear your views on the role of IMF in addressing these problems.

    While we look to you to alert us to what we should be worrying about, we also expect that when you address the House, the markets will move up, as opposed to occasions when you address the Senate, a trend noticed in recent hearings before the House and the Senate.

    The high relative value of the dollar evidently continues to reflect both the leading position of our economy with regard to Europe, the Far East, and the capital that arrives from areas suffering economic insecurity. Should we anticipate further action such as the June 17 intervention to prop up the yen? As a general rule is this an effective strategy?

    As the economy continues to rewrite the traditional models, we welcome your insight regarding adjustments being incorporated into your models.

    My view is that we must have a full discussion of the potential impact of events in Japan and Asia on the future of our own economy and working Americans, and what steps we as policymakers can take to protect our Nation.
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    As always, we are delighted to have you with us, and we look forward today to a lively discussion.

    Chairman CASTLE. And with that, let me turn to Mr. Frank.

    Mr. FRANK. Thank you, Mr. Chairman.

    I find today's hearing a little different than usual because I think for the first time in my memory we do not meet under what I consider to be the imminent threat of a rate increase being rattled by some of the Chairman's tellings. But I really wanted to talk about, because I think we have a little breathing space now, the overall situation.

    I noted, Mr. Chairman, that you mentioned yesterday and mention again today the danger of inflation, and we have had this conversation before. You do, when asked, acknowledge that there is a concern both about excessive growth and about inadequate growth. But it does seem to me, reading your statements, certainly the emphasis, clearly the thrust, is much more to be concerned with inflation.

    Now, that is partly institutional, obviously, and I understand that you are not, despite what some people say, a one-person board. We recognize that you serve with a number of other appointees and regional bank presidents, and that there is more collegiality, in fact, than journalistic shorthand sometimes suggests, and I understand those concerns that you have to deal with. But what this comes up with is institutionally a Federal Reserve, which is, it seems to me—there is a bias from time to time that you vote. You voted that there is a kind of a predisposition to raise interest rates. It seems to me that is almost superfluous for you to vote it because institutionally the Federal Reserve system is clearly more worried about that.
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    The problem is that the way things have evolved, the Federal Reserve has become, by far, the most potent economic policymaker in the country. So what we have is a disproportion here. There is no entity concerned about banking growths that has the ability to move events, the policy impact and the role that the Federal Reserve has.

    Now, I am very pleased that since March of last year, and that was a fairly minor exception, the Federal Reserve has maintained what seems to be an appropriate posture, and I understand that that could not always, for everybody at the Federal Reserve, be an automatic decision. So I am pleased at the way policy has gone, but I think we continue to have this problem.

    I look at America today. I look at the social problems we still have, the potential growth in inequity, and that is the real problem.

    You know, I have a very odd district. I have a district that the Massachusetts Legislature was particularly whimsical when they drew up. They weren't really specifically concerned with me. The Governor was trying to hurt one guy, the senate president was trying to help another guy. I got what one didn't want and the other one wanted. One guy didn't get what he didn't want, and one guy didn't get what he wanted, and I got the remains. I have a district which, in consequence, if I were African American, would be found to be unconstitutional. Only white people under current jurisprudence may be the beneficiaries of gerrymandering as blatant as happened in Massachusetts in 1992, but it gives me a very interesting look.

    I have a northern part of my district which is very much benefiting from the world economy, people who work at Fidelity, people who provide first-rate medical care, people who develop higher technological and software products. And I have, in the southern part of my district, people who have worked very hard all their lives in traditional manufacturing for whom global integration has not on the whole been a good thing, and they have on the whole lost out.
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    One of the problems we have is that not surprisingly, the children of the people who live in the north overwhelmingly live in homes where there are computers and people to teach them how to use them; and overwhelmingly people in the south—not overwhelmingly, but the majority of people in the south do not have that.

    Whatever one thinks about current problems, not to resolve those problems is to guarantee a worsening of inequity with consequent negative problems to the society, and I worry that we do not have institutionally any entity that is prepared to take that on and that there is a kind of a bias.

    And finally let me say, if I just may be 30 seconds over, Mr. Chairman, but I was thinking about Harry Truman the other day and Harry Truman's famous comment that what he wanted was a ''one-handed economist,'' because he wouldn't be saying, ''...on the one hand'' and ''...on the other hand.'' I would like an economist whose hands are untied.

    What I have found recently is that economists on the whole, and that includes the economists at the Federal Reserve, a very distinguished aggregation, probably the world's most powerful economists are collected at the Federal Reserve in terms of the impact they collectively have on public policy. And there is a distrust of politicians. There is a tendency to filter what you tell us because you are afraid, I think, that if we are told things unvarnished, we may react irresponsibly.

    For example, when we talk about trade, I have had economists privately acknowledge to me that, yes, there are negative effects to trade as well as positive effects, but they believe that the positive effects greatly outweigh the negative effects, and they are afraid that acknowledging the negative effects, that we politicians overuse them.
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    Similarly I have a sense that the economic dues with regard to the inflation on employment tradeoff and the fact that there is not nearly as much of a tradeoff as we thought, I think many economists in their heart of hearts know that things have gotten better, but are afraid to tell us because they are afraid of populistic viewpoints. They are afraid that if we learn what was happening, we might kind of slip the traces.

    And the thing I want to stress again in closing, and I appreciate the indulgence, Mr. Chairman, is even from their own standpoint, they are underestimating the importance of equity. Even as we sit here today, you and I, Mr. Chairman, and I think my colleagues who happen to be here today, most of us are strong supporters of an appropriately worded IMF increase, but we have trouble getting the votes. Until and unless—and this is the final point I wanted to make—until and unless we as a society do a better job of addressing equity issues and particularly reassuring people that globalization is not going to come at the expense of the least educated and the least equipped to compete in the world, we are going to have a resistance to what you see as our rational self-interest regarding international economics, and I worry, just to tie this together, that the institutional trigger finger itchiness about interest rate raising at the Federal Reserve is a constraining factor on that.

    Thank you for your indulgence, Mr. Chairman.

    Chairman CASTLE. Thank you, Mr. Frank.

    Mrs. Roukema.

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    Mrs. ROUKEMA. Thank you, Mr. Chairman. I will abbreviate my remarks, having heard the extension of your remarks. But I do want to welcome Chairman Greenspan here today. I believe that he and the Federal Reserve should be congratulated on their wise conduct of monetary policy. I have no question that it has had positive effects in terms of sustaining a very healthy economy. I certainly look forward to what your analysis is today. I believe that you have shown not only incisive actions, but also clearly articulated your approach to both national and international economic issues.

    Certainly one important issue, most immediate to all of us, and I will be interested in your additional comments, is IMF funding. You and I have always agreed on IMF funding. It is an immediate issue this week. I am hopeful that we cannot only get the $3.5 billion, but that we will ultimately get the full amount. I would like to work with you on that and hope that you address this issue with precision in your statement today.

    I certainly understand and want to work with my Republican colleagues in terms of bringing some reforms to the IMF so it is consistent with what we did in the committee in terms of the question of transparency and conditionality and maybe go farther, but I would hope that this would be an opportunity for you to stress the importance of IMF funding and provide your insights on this issue.

    I did hear the Chairman's references to the Asian crisis, and specifically to the Japanese banking question. I won't go into that again, but I do want to say that I hope you will be precise in addressing the question of the so-called U.S. budget surpluses and the whole question of tax reductions, whether or not they are appropriate and to what degree they are appropriate now in the context of our total economy, monetary policy and the budgetary questions.
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    So I am actively looking forward to hearing what you have to say. You are a true patriot as well as a leader in the world economic situation, particularly our own healthy economy, and hopefully with your leadership we can continue that and spread it to Southeast Asia as well.

    Thank you, Mr. Chairman. Thank you.

    Chairman CASTLE. Thank you Mrs. Roukema, and thank you for abbreviating your statement somewhat. We hope that others perhaps can follow so we can get to the Chairman as soon as possible.

    With that let me turn to Mr. Hinchey.

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

    Welcome, Mr. Greenspan. Pleasure to see you again. I look forward to your testimony, although some of us had an opportunity to see it on C-SPAN last night. I assume that things haven't changed all that much in the intervening 24 hours.

    The availability of the minutes of the Federal Open Market Committee, even though there is a lag, continue to demonstrate their value. Among other things, they have shown us that there has been some disagreement among the members of the FOMC with regard to monetary policy. And in that regard I want to express my personal appreciation to the leadership that you have shown in resisting what at least a couple of the bankers on the committee would have done if they had had their way, they would have increased interest rates, and I think that that would have been a very serious mistake.
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    There are those of us who believe that real interest rates, interest rates as a function of inflation, continue to be too high. I am particularly concerned about our readiness to deal with certain economic circumstances that have begun to express themselves in some cases rather dramatically and other cases less so. Inflation remains very, very low indeed. The latest indicators show that over the course of the last year, June to June, consumer prices and producer prices have gone up less than 2 percent. So inflation remains very, very low.

    We have the Asian crisis, which is now beginning to express itself more fully, and hear at home, the trade deficit is reaching enormous proportions. The Asian crisis is principally responsible for the growing trade deficit, though the strong dollar is also playing a role in it.

    There is also the strike at General Motors, as well as an apparent loss in manufacturing jobs. Current figures show manufacturing jobs dropping off in the most recent reporting period. Those, coupled with a number of other factors which seem to indicate that the economy is slowing, cause me to be concerned that we are not doing all that we can to prepare ourselves for the full impact of all these economic circumstances.

    So, I expect that you will address these issues as you did yesterday to some extent before the Senate Banking Committee, and I would continue to hope that the Open Market Committee and Federal Reserve generally would express a more deep and accurate realization of the impacts of the Asian crisis because I feel that we are not preparing ourselves adequately for the consequences. All the forecasts indicate that we are going to see a downturn in our economy, and it may be that we can do things that will make it less serious. I hope that you will address your remarks to that as well.
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    I thank you very much.

    Chairman CASTLE. Thank you.

    The Chairman of the full Banking Committee, Mr. Leach.

    Mr. LEACH. Thank you, Mr. Chairman. I will be brief, but I think it appropriate to reference when the economic circumstances that are so positive have occurred. I think you will go down as the most thoughtful and successful Federal Reserve Chairman in the country. Having said that, though, I think it should not be lost on anyone that the most important phenomenon of monetary policy is not necessarily the individual stewardship of an exceptional Chairman, but is the independence of the Fed itself. And for those of us in the Legislative branch, it is important that we realize and recognize that. In fact, it is not inconceivable that when people write the economic history of the 20th century, the judgment might not be that the most important institution of governance was established in this century was the Federal Reserve Board of the United States, and that it has been the most successful. And we, in that context, welcome this distinguished Chairman.

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

    I will turn next—I think Mr. Bentsen was the next to arrive. No statement?

    Mr. Watt.
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    Mr. WATT. Thank you, Mr. Chairman. I will be very brief. I certainly won't take the five minutes.

    I just wanted to welcome the Chairman to the subcommittee and express my thanks to him for his recent appearance in Charlotte where he was an outstanding success and drew a record crowd to his comments there.

    I resisted the temptation to stop and listen to your comments on C-Span last night so that I could hear them fresh today, and I am looking forward to hearing them. I hope that you will specifically comment on one concern that I have and certainly not professing to be an expert in this area, but there is a clear interplay between unemployment and interest rates and inflation, as you see it, and unemployment in the aggregate clearly has been very low, but in some parts of our communities, inner cities in particular, unemployment continues to be in double digits. And so I hope you will address your approach to deciding when to raise interest rates, taking that into account, the global aggregate unemployment picture, but also how we address the issue of unemployment in some of the higher unemployment areas in the context of that overall picture. And if you will address that issue at some point during your stay here, I would be most appreciative.

    Thank you Mr. Chairman. I yield back.

    Chairman CASTLE. Thank you Mr. Watt.

    Mr. Paul. Thank you.
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    Mr. Bachus.

    Mr. BACHUS. Thank you. I am not going to make a statement at this time.

    Chairman CASTLE. Thank you.

    Mr. Kennedy.

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

    Welcome again, Chairman Greenspan. Just a brief statement, Mr. Chairman.

    First of all, after reading today's papers and hearing of your testimony yesterday on the Senate side, I am concerned that we are in the midst of a dilemma where, when it comes to the major overriding concern of the U.S. economy, we talk about the threat of inflation, which seems driven by the idea that somehow there is an unemployment number that threatens to create increased prices, and I worry that we essentially put the poorest of the poor in an untenable position.

    And I recognize, as I have heard you testify many times before, that this is an issue that you care about, but it is not an issue that the Fed has direct control over; but it is, on the other hand, an issue that I think needs to be brought out, and that it is helpful to have you acknowledge, Mr. Chairman, in the sense that if, as the statistics that I have seen demonstrate, that the City of Philadelphia has to create by year's end 54,000 jobs for people on welfare, the City of Chicago, 164,000 jobs, the City of Boston has to create almost 3,000 jobs a month just to get the people that are going to lose their welfare benefits the work that they need or else people are going to be thrown out.
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    We cut the housing budget, and yet what happens is when the economy of the country rises to a point where we then say now there is an inflation threat, then you are put in a position where you and evidently, as I understand, other members of the committee then put a great deal of pressure on the committee in general, and you in particular, to raise interest rates, therefore cutting off the very stepladder that these individuals need in order to get a job, and just when the companies are feeling some pressure to actually reach down into the pool of workers that don't have the job skills that they really need and give the kind of job training that these folks have to have in order to get a decent job, we then say, ''Oh, sorry, gang.'' I guess the overall economy is going to be threatened, so therefore we are going to raise inflation, so therefore we are going to cut off the ability of these people to ever get out, thereby creating this sort of perpetual hamster-like treadmill of economic life for the very poor.

    I just think, Mr. Chairman, you know the power that you have or have a sense of the power that you have in terms of how many people listen to you because of the phenomenal record of success that has occurred in our country since you have been Chairman of the Fed, which is really astounding. I mean, the economy has worked at a phenomenal rate, and it is something that you should take great pride in. But I think that I just want to point out that while we have this economy that is roaring along for the vast majority of Americans, and that is terrific, there is a whole group of Americans that is just getting left behind, and we are doing very little to address those needs and those concerns.

    So, I would hope that you would take some time to talk about what we ought to be doing in order to make certain that everybody is allowed to participate to grow to their full potential.
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    Thank you.

    Thank you, Mr. Chairman.

    Chairman CASTLE. Thank you, Mr. Kennedy, and I yield to the Ranking Member of the subcommittee Ms. Waters.

    Ms. WATERS. Thank you very much, Mr. Chairman. First I would like unanimous consent to enter into the record the statement of David A. Smith, Director of Public Policy for AFL-CIO.

    Chairman CASTLE. Without objection, submitted.

    Ms. WATERS. I have an opening statement that I would like to present, Mr. Chairman.

    I would like to welcome my friend Chairman Greenspan here today for the second of our yearly Humphrey-Hawkins hearings on the Federal Reserve's monetary policy.

    We must not forget that while the Humphrey-Hawkins Act set up a system for monitoring the formulation of monetary policy by the Federal Reserve, it also states that a goal of Federal Government economic policy includes the importance of job creation and the maximization of employment for our Nation's citizens.

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    I look forward to the opportunity to hear from you, Chairman Greenspan, in your assessment of the current state of the economy. Press reports indicate that while you praised our robust economy, you did express concerns that if the U.S. economic growth did not slow down, the danger of inflation was real. While I understand the fears of some that current economic conditions are unsustainable without creating inflationary pressures, I encourage you, of course, to refrain from any monetary policy changes that would threaten the much needed growth of our economy and the positive effect on our poorest communities.

    I question whether the numbers present any indication of such a trend. Unemployment rates, currently at 4.5 percent nationwide, have remained at an historic low for more than a year. At the same time inflation has remained low most recently at nearly zero percent. There are also some signs that the economy may be slowing as a result of the continued Asian economic crisis. Recent statistics show the growth rate leveling off as well as an increase in the stocks of unsold goods resulting from decreased demand for our domestic goods. We have already seen the nationwide unemployment rate increase from 4.3 percent in April and May to 4.5 percent in June.

    Additionally, as we review the economic indicators and their implications for monetary policy, I hope that we remain cognizant of the fact that these indicators, while encouraging, do not tell the entire story. Unfortunately many of these statistics do not paint an accurate picture of the economic conditions across all communities and populations. For example, while the overall unemployment for the Nation is 4.5 percent, in California it is 5.7 percent, and in the Los Angeles/Long Beach recent statistics, we see that the unemployment rate is 6.1 percent.

    If you look at the unemployment numbers by ethnicity, the disparity is even greater. African Americans as a group have an unemployment rate of 8.2 percent nationwide, more than twice that of the white population. Those with less than a high school diploma have an unemployment rate of 7.2 percent compared to 1.7 percent for college graduates.
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    My seven other Members of this committee represent many of those Americans whose success depends on an expanding economy which can reach down and include the more marginalized sectors of our country in the economy. Lower unemployment rates create employment opportunities for some sectors of our society who do not currently participate in the formal economy. Unfortunately those in the poor and the lower middle classes tend to be impacted most severely by the dampening effect of increased interest rates. Chairman Greenspan has witnessed firsthand during a trip he made to south central Los Angeles earlier this year the continued economic disenfranchisement of many of our poor and inner-city communities.

    I see the economic boom we are experiencing as giving a wonderful opportunity to grow all sectors of our economy and all of our communities. Any calculation of needed changes to monetary policy through an increase in rates must include this goal.

    I look forward to engaging in a dialogue with you, Mr. Chairman, on these critical issues, and I thank you for being here this morning.

    Chairman CASTLE. Thank you Ms. Waters.

    Dr. Weldon, you have just arrived. We are still doing brief opening statements if you wish to make one.

    Dr. WELDON. I came to hear Mr. Greenspan and not myself. Thank you, Mr. Chairman.

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    Chairman CASTLE. Thank you, sir.

    Mr. Jackson.

    Mr. JACKSON. Just unanimous consent, Mr. Chairman, to enter my opening remarks in the record, sir.

    Chairman CASTLE. Certainly. Without objection they are so entered.

    Mr. JACKSON. Thank you.

    Chairman CASTLE. Ms. Lee.

    Ms. LEE. Thank you Mr. Chairman.

    Let me just extend my welcome to you, Chairman Greenspan, and indicate to you that I am one of the newest Members to the Banking Committee and the newest Member to the subcommittee. However, the subject of today's hearing is not new to me. Of course, I was here during the time when the Humphrey-Hawkins bill was being debated in 1978. Also, as we know, the first Full Employment Act passed in 1946 is known as the Roosevelt-Truman Full Employment Act. And my predecessor, Congressman Dellums, actually introduced the first Full Employment Act bill here recently, H.R. 1050, in the 1993 session, 103rd session of Congress, and it is also known as the Living Jobs for All Act.

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    As a member of the California Assembly and Senate, I introduced parallel bills to H.R. 1050, and I mention this because of the fact that all of these efforts to achieve full employment are efforts that are part of our history, but also today I am very interested in hearing your testimony with regard to the issues that involve what actually constitutes full employment in our country.

    Thank you very much for this opportunity to meet you actually, and I look forward to this hearing.

    Chairman CASTLE. Thank you, Ms. Lee.

    Ms. Kilpatrick, did you wish to say anything at the opening?

    Ms. KILPATRICK. Just briefly, Mr. Chairman, thank you very much, and to Mr. Greenspan, I appreciate your coming and look forward to listening to your remarks. I did hear yesterday and read some of your remarks.

    The General Motors strike, General Motors is in my district, and, as you know, the number one corporation in the world. It does not look like it will be ending soon, although things can change as we speak. The impact of the strike, the unemployment that it will cause, as you probably know, Ford and Chrysler farm out much of their parts. General Motors has parts plants and employ over 150,000 people in those plants, which is the sticking issue in that strike. What impact, if any, will that have, and has it yet begin to spill over in the economy? I will be interested in hearing your remarks.

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    Thank you for coming. Look forward to hearing you.

    Chairman CASTLE. Thank you, Ms. Kilpatrick.

    I think we have given everybody an opportunity who wanted to say something to say something, and we now look forward to your statement, Mr. Chairman. You have heard the concerns of many of the Members, and we look forward to your statement and then a lively discussion and the question and answer period to follow.


    Mr. GREENSPAN. Thank you very much, Mr. Chairman. I have a rather extended prepared set of remarks and request that my excerpted version be included in the record, along with the full text.

    Chairman CASTLE. Certainly. Both would be included in your comments. Thank you, sir.

    Mr. GREENSPAN. Mr. Chairman and Members of the subcommittee, when I appeared before you in February, I noted that a key question for monetary policy was whether the consequences of the turmoil in Asia would be sufficient to check inflationary tendencies that might otherwise result from the strength of domestic spending and tightening labor markets. In the event, the contraction of output and incomes in a number of Asian economies has turned out to be more substantial than most had anticipated. Nonetheless, the American economy proved to be unexpectedly robust in the first quarter.
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    Evidently, optimism about jobs, incomes and profits, high and rising wealth-to-income ratios, low financing costs, and falling prices for high-tech goods fed the appetites of households and businesses for consumer durables and capital equipment. In addition, inventory investment contributed significantly to growth in the first quarter.

    Although national income and product account data for the second quarter have not yet been published, growth of U.S. output appears to have slowed sharply, owing primarily to a further deterioration in our trade balance and a slowing pace of inventory investment. Indeed readings on the elements that make up the real GDP have led many analysts to anticipate a decline in that measure in the second quarter after the first-quarter surge.

    It is worth noting that other indicators of output, including worker hours and manufacturing production, show a somewhat steadier, though slowing, pace over the first half of the year. And underlying trends in domestic final demand have remained strong, imparting impetus to the continuing economic expansion.

    Inflation has stayed remarkably damped. The Consumer Price Index as well as broader measures of prices indicate that inflation moved down further during the first quarter, even as the economy strengthened. The more recent price data suggest that overall consumer price inflation moved up in the second quarter, but even so, the increase remained moderate.

    So far this year, our economy has continued to enjoy a virtuous cycle. Evidence of accelerated productivity has been bolstering expectations of future corporate earnings, thereby fueling still further increases in equity values, and the improvements in productivity have been helping to reduce inflation. In the context of subdued price increases and generally supportive credit conditions, rising equity values have provided impetus to spending and, in turn, the expansion of output, employment, and productivity-enhancing capital investment.
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    The essential precondition for the emergence and persistence of this virtuous cycle is arguably the decline in the rate of inflation to near price stability. In recent years continued low product price inflation and expectations that it will persist have promoted stability in financial markets and fostered perceptions that the degree of risk in the financial outlook has been moving ever lower. These perceptions in turn have reduced the extra compensation that investors require for making loans to, or taking ownership positions in, private firms.

    To a considerable extent investors seem to be expecting that low inflation and stronger productivity growth will allow the extraordinary growth of profits to be extended into the distant future. Indeed, expectations of earnings growth over the longer term have been undergoing continual upward revision by security analysts since early 1995. These rising expectations have, in turn, driven stock prices sharply higher and credit spreads lower, perhaps in both cases to levels that will be difficult to sustain unless the virtuous cycle continues.

    Probably only a few percent of the largely unrealized capital gains have been transformed into the purchase of goods and services in consumer markets, but that increment to spending, combined with the sharp increase in equipment investment, which has stemmed from the low cost of both equity and debt relative to expected profits on capital, has been instrumental in propelling the economy forward.

    The consequences for the American worker have been dramatic and for the most part highly favorable. A great many chronically underemployed people have been given the opportunity to work, and many others have been able to upgrade their skills.

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    Government finances have been enhanced as well. In the Federal sector the taxes paid on huge realized capital gains and other incomes related to stock market advances, coupled with taxes on markedly higher corporate profits, have joined with restraint on spending to produce a unified budget surplus for the first time in nearly three decades.

    The fact that economic performance has strengthened as inflation subsided should not have been surprising, given that risk premiums and economic disincentives to invest in productive capital diminish as the economy approaches price stability. But the extent to which strong growth and high labor force utilization have been joined with low inflation over an extended period is, nevertheless, exceptional.

    For one thing, increases in hourly compensation have been slower to pick up than in most other recent expansions, although, to be sure, wages have started to accelerate in the past couple of years as the labor market has become progressively tighter. For another, a couple of years ago, almost at the same time that increases in total hourly compensation began trending up in nominal terms, evidence of a long-awaited pickup in the growth of labor productivity began to show through more strongly in the data: this accelerated increase in output per hour has enabled firms to raise workers' real wages while holding the line on price increases.

    Notwithstanding a reasonably optimistic interpretation of the recent productivity numbers, it would not be prudent to assume that even strongly rising productivity, by itself, can ensure a noninflationary future. Certainly wage increases per se, are not inflationary unless they exceed productivity growth, thereby creating pressures for inflationary price increases that can eventually undermine economic growth and employment. Because the level of productivity is tied to an important degree to the stock of capital, which turns over only gradually, increases in the trend growth of productivity probably also occur rather gradually. By contrast, the potential for abrupt acceleration of nominal hourly compensation is surely greater.
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    As I have noted in previous appearances before Congress, employment growth has been significantly outstripping expansion of the working-age population. This gap will inevitably close. What is crucial to sustaining this unprecedented period of prosperity is that it close reasonably promptly, given already stretched labor resources, and that labor markets find a balance consistent with sustained growth marked by compensation gains in line with productivity advances. Whether these adjustments will occur without monetary policy action remains an open question.

    While the United States has been benefiting from a virtuous economic cycle, a number of other economies unfortunately have been spiraling in quite the opposite direction. The United States, Canada and Western Europe have been enjoying solid economic growth, with relatively low inflation and declining unemployment, but the economic performance in many developing and transition nations and Japan has been deteriorating. How quickly the latter erosion is arrested and reversed will be a key factor in shaping U.S. economic trends in the year ahead.

    In the current circumstances, we need to be aware that monetary policy tightening actions in the United States could have outsized effects on very sensitive financial markets in Asia, a development that could have substantial adverse repercussions on U.S. financial markets and, over time, our own economy. But while we must take account of such foreign interactions, we must be careful that our responses ultimately are consistent with a monetary policy aimed at optimal performance of the U.S. economy. Our objectives relate to domestic economic performance, and price stability and maximum sustainable economic growth here at home would best serve the long-term interests of troubled financial markets and economies abroad.

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    Although external economic conditions have deteriorated, some of the key factors that have supported strong final demand by domestic purchasers here remain favorable. With their incomes and wealth having been on a strong upward track, American consumers remain quite upbeat. For businesses, decreasing costs of and high rates of return on investment, as well as the scarcity of labor, could keep capital spending elevated. These factors suggest some risk that the labor market could get even tighter, and even if it does not, under prevailing tight labor markets, increasingly confident workers might place gradually escalating pressures on wages and costs, which would eventually feed through to prices.

    But a number of factors likely will serve to damp growth in aggregate demand, helping to foster a reasonably smooth transition to a more sustainable rate of growth and reasonable balance in labor markets. We have yet to see the full effects of the crisis in East Asia on U.S. employment and income. Residential and business fixed investment already have reached such high levels that further gains approaching those experienced recently would imply very rapid growth of stocks of housing and plant and equipment relative to income trends.

    Inflation performance will be affected by developments abroad as well as those here at home. The extent and pace of recovery of Asian economies currently experiencing a severe downturn will have important implications for prices of energy and other commodities, the strength of the dollar, and competitive conditions on world product markets.

    On a more fundamental level, it is the balance of supply and demand in labor and product markets in the United States that will have the greatest effect on inflation rates here. As I noted previously, wage and benefit costs have been remarkably subdued in the current expansion. Nonetheless, an accelerating trend in wages has been apparent for some time. In addition, a gradual upward tilt in benefit costs has become evident of late.
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    Given that compensation costs are likely to accelerate at least a little further, productivity trends and profit margins will be key to determining price performance in the period ahead. We at the Fed will be closely monitoring a variety of indicators to assess the degree to which productivity is on a stronger long-run track after what is likely to appear in the data as a weak second quarter.

    Significant risks attend the outlook. One is that the impending constraint from domestic labor markets could bind more abruptly than it has to date, intensifying inflation pressures. The other is the potential for further adverse developments abroad, which could reduce the demand for U.S. goods and services more sharply than anticipated, and which would thereby ease pressures on labor markets. While we expect that the situation will develop relatively smoothly, we believe that given the current tightness in labor markets, the potential for accelerating inflation is probably greater than the risk of protracted, excessive weakness in the economy.

    As I have stated in previous testimony, Mr. Chairman, the recent economic performance, with its combination of strong growth and low inflation, is as impressive as any I have witnessed in my near half-century of daily observations of the American economy. Although the reasons for this development are complex, our success can be attributed in part to sound economic policy. The Congress and the Administration have successfully balanced the budget, and indeed, achieved a near-term surplus, a development that tends to boost national saving and investment. The Federal Reserve has pursued monetary conditions consistent with maximum sustainable long-run growth by seeking price stability. These policies have helped bring about a healthy macroeconomic environment for productivity-boosting investment and innovation, factors that have lifted standards of living for most Americans. The task before us is to maintain disciplined economic policies and thereby contribute to maintaining and extending these gains in the years ahead.
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    Thank you very much. I look forward to your questions.

    Chairman CASTLE. Thank you, Mr. Chairman.

    I yield first to myself for five minutes of questions, and I would like to go back to my opening statement and what probably was involved in at least a third of your testimony, which is a lot different than probably would have been a year or two ago, and that is the Asian crisis which just a year ago was just getting under way.

    I like to try to be a little more precise in some of the things we are trying to determine here. Have we seen the end of it? If not, and I assume the answer is probably going to be no, how do you see it playing out? And is it likely to spread to Latin America; help with the problems or add to the problems in Russia, for example?

    I indicated in my statement that I think if anything, you can almost argue that if you weigh the pluses and minuses, it has actually benefited the American economy more than hurt it because of the flight of capital and cost reasons and other reasons. But what are its likely future effects? And I am sure that you almost sit there and model this stuff on a regular basis in terms of the most drastic-type things that can happen, but I am more interested in what everyone views as the most likely scenario. It seems to me that this has been quite poorly predicted so far, I mean, at least in terms of the extent of it in many ways. So I am concerned about the future. I don't expect you to have precise answers because we are talking about unfolding developments, but I would like to hear your response to some of those points.

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    Mr. GREENSPAN. I agree with your comments, Mr. Chairman. First of all, let me just say that the evidence we have to date as yet shows no evidence of stabilization and that the most recent data still exhibit deterioration. The question of most fundamental importance to all of us, obviously, is how long will that continue, and where will it spread, and to what extent will the stampede of buffalo, as you implied, stomp over us before we can stem it.

    You point out quite correctly that the crisis was not forecast in any meaningful way by really the vast majority of analysts, and indeed I know of no one who really did say at the point when the crisis was emerging that it was about to occur. That tells us something very important about the nature of the process itself.

    As I have indicated in other testimony, what we have is a situation in which you can build up imbalances in an economy which may or may not induce significant erosion or major contraction, but periodically these buildings up of imbalances are like water backing up against a dam. Most of the time they are held by the dam, but every once in awhile the dam cracks, and you get a huge rush.

    It is a vicious cycle indeed, precisely the opposite of the virtuous cycle that we have seen in the United States. You get an implosion of confidence in which pessimism feeds on pessimism. Everyone withdraws from activities related to an economy. Trust, which is crucial to any particular social organization, especially an economy, falls, and the situation feeds on itself in a downward spiral.

    It is very difficult to forecast where that eventually stabilizes or how it comes out, but this clearly is the process which we have seen which is by its nature almost impossible to forecast. We can stipulate the conditions which are probably necessary for such an event occurring, but rarely, if ever, the sufficient conditions to do that.
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    I would say at this particular time that we do not know at what point this will turn. It will depend to a very substantial extent on the restoration of confidence, and the restoration of confidence will depend on the types of economic policies that these countries are involved with.

    Chairman CASTLE. Thank you, Mr. Chairman.

    I am going to ask you one different question. I would love to pursue that line, but as you know, we have a limited time, so I am going to change subjects altogether because I am interested in another answer.

    You have previously suggested that reducing the Federal budget deficit was a high-priority item, and I agree with that, and because of this issue, you have urged Congress to defer cutting taxes. Would the prospect now before us of a large and growing budget surplus this year and in future years, do you now feel that this may be an appropriate time for a tax cut?

    Mr. GREENSPAN. Mr. Chairman, it is really quite a pleasant event to have this type of problem confronting us as distinct from the problem of how do you bring a chronic budget deficit down. So it is an issue of good choices rather than bad choices.

    Let me just first say before we even contemplate what is done with this extraordinary surplus, which is being projected into the indefinite future, that we have not been able to forecast with great accuracy where the budget balance ends up, as the history of recent years has amply demonstrated. There is no doubt that the very sharp increase in stock market values and the whole huge increase in market wealth, which has occurred both in households and in businesses in this country, is spilling over into various types of capital gains and incomes coming from stock options and bonus payments and have markedly increased revenues in our budget.
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    How we handle those stock market-related taxes, if I may put it that way, in the future projections is very crucial to how much you think the surplus out there is going to be.

    I merely wish to comment as an issue of caution that while we haven't seen the other side of a stock market decline, and hence, its potential impacts on revenues, it is instructive to observe that the Japanese had a quite similar phenomenon; their revenues rose far faster in the latter part of the 1980's than their nominal taxable incomes, and subsequent to 1990, it went exactly in the opposite direction.

    So before I would be very comfortable about the existence and solidity of these surpluses, I would like to see some evidence in more detail of how we are projecting and expecting the outcomes of the revenues on the other side of this cycle.

    Having said that, let me just repeat what I have said before you previously. Reducing the debt to the public is a very important and useful thing for economic growth. It creates lower interest rates, the level of interest payments falls, the level of the total spending falls because of that, the surplus rises even more, and it is a virtuous cycle which evidence suggests decreases real long-term interest rates, and over the long run probably increases growth. So don't immediately dismiss the advantages of just having the surplus exist and the debt be paid off accordingly.

    Having said that, I am fully aware that that is very difficult to do, and if I am given my choice as to the long-term stability of the fiscal process, I would much prefer to see taxes cut than expenditures raised to diminish the surplus. But my first choice is still to reduce the debt, which is another way of saying there is no need to rush into any particular action, because the debt will be reduced automatically, as long as the surplus exists.
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    Chairman CASTLE. Thank you.

    Ms. Waters.

    Ms. WATERS. Thank you very much.

    Chairman Greenspan, as you know, there is a raging debate about replenishment of the International Monetary Fund going on here in Congress, and we are constantly reminded that the Asian crisis may cause a tremendous negative impact on our economy.

    While some of us are looking at this very closely, we are still concerned about some of the problems that were articulated here this morning about communities that are still trying to be involved in this growth that we are witnessing in our own country. So while we are cognizant and aware of the problem of the Asian crisis, we are still trying to deal with these communities that are not benefiting from the growth here in America, and we need what we are calling a domestic fund of some kind in order to invest in these communities and have some growth.

    As I look at the great mergers that are being contemplated and your role in that, what do you think about capital formation strategies that would encourage those who are moving into these big mergers to get involved with this? For example, many of the banks or some of the banks who are talking about merging and some who have merged in the past made commitments or are making commitments.

    I am told that Mr. Sandy Weil up at Travelers just made a commitment of $2 trillion to be invested in communities as a result of the merger. We had Wells Fargo, I believe, when they merged in California, that made a $40 billion commitment. I think Bank of America at one point in time made had a $30 billion commitment. But we cannot track these investments. We do not know what happens with these commitments.
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    We think that if there is a domestic fund of some kind that is put together by those who are getting involved in these big mergers, we could help them honor these commitments that they make for huge sums of money. We believe that there are strategies for formulation of capital where we could show a return on investment, where we could help people get involved in joint ventures, we could invest in businesses that oftentimes are overlooked but have tremendous potential.

    We are not talking about grants, we are not talking about giveaways. We are talking about putting together the kind of plans where people who know what they are doing could take this capital and place it out there in businesses and opportunities that would certainly have a return on investment. We need some discussion about that.

    I want to know what you feel about that. Would you be willing to even look at some of these plans to at least make some comments about viability or sensibility? We are interested in capital formation for growth in our communities.

    Mr. GREENSPAN. As you know, Congresswoman, I am a very strong supporter of trying to get equity investments into the inner cities. Initially it is probably worthwhile to get an awful lot of debt where it had not been feasible previously. But unless you get a mixture of debt and equity, you will end up with an extremely difficult balance sheet which is very hard to service and does not promote economic growth. You need risk capital in there.

    Ms. WATERS. Yes.

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    Mr. GREENSPAN. The issue of the substantial agreements or substantial dollar amounts which are involved in a number of these agreements are not part of the supervisory or regulatory structure of the Federal Reserve. We cannot enforce a private agreement between two parties.

    It strikes me that the problem is to try to trace what they are doing and what they are not doing, and we try to do as much of that in our CRA exams as we can. But we cannot get to the point of literally tracking, dollar for dollar, what they agreed to in a number of these private agreements. I should think that if there is a problem of evaluation of action and enforcement, that those would be issues which would be in some way addressed as part of the agreement.

    In other words, my suspicion is that the vast proportion of these agreements are entered into with full good will and are probably very substantially implemented. If there is a concern on your part, the only way that I am aware of which could conceivably capture whether or not anything of substance is happening is to have in the agreements some mechanism by which there is communication between the private parties as to whether or not they are being fulfilled and in what manner.

    As I said previously, I suspect that you will find, if you do that, that in most instances they actually do what they say they are going to do. But short of some means of evaluation, I, too, would not know whether or not you could certify that indeed, if a commitment was X, that X was actually implemented.

    Chairman CASTLE. Thank you, Ms. Waters.
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    Mr. Lucas.

    Mr. LUCAS. Thank you, Mr. Chairman.

    Chairman Greenspan, as you well know, I represent a region of the Southwestern United States that is very heavily into agriculture production and energy production. In those two industries, in agriculture, thanks to, at least through the first quarter of this year, some very favorable weather, which has now turned in the other direction, and to a degree both in agriculture and energy, because of the financial problems in the Western Pacific, Eastern Asia, the effect it has had on demand, we have had declining cash prices for both grain and energy.

    Could I get you for a moment to share, perhaps, some of your insights or feelings in regard to what the potential impact is on the economy as a whole as we see this what I would describe as vulnerability of both industries coming to the top, here? I would add, also, that my constituents think they have damned well done their part to provide price stability by having declining energy and agriculture prices this quarter.

    Mr. GREENSPAN. Most price stability is not voluntary, Congressman.

    Mr. LUCAS. Good point.

    Mr. GREENSPAN. You can observe the emergence of the crisis last fall with a dramatic weakening in all sorts of commodity prices, from oil through materials to agricultural products, pretty much across the board.
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    In oil it is fairly apparent that what has happened is that you have taken out a chunk of the expected increased demand in East Asia, which has been a very large part of the expected world demand for crude oil. In fact, it is working in reverse.

    What happens is that it does not take very long for oil storage facilities, both at the crude level and at the product level, to fill up very dramatically. We have even seen examples of inventories now being held in tankers, which is not an efficient way of doing it. So we have effectively glutted the market, and the price effect has been pretty pronounced.

    There has been an endeavor on the part of a few producing countries to cut back, and that has evidently firmed the price somewhat from its June nadirs. But it is still, obviously, quite low and is having a significant impact, incidentally, on drilling rig activity.

    Much the same has occurred in agriculture. The weakening of prices has been fairly pronounced, and we also see it in our export performance, which is in part being hurt by the fact that a number of the grain exporters like Canada and Australia, because they are also commodity producers, have seen their currency weakened vis-a-vis the American dollar, which means that their competitive positions have marginally improved relative to ours.

    So all in all, the Asian crisis, as I indicated in my prepared remarks and others of your colleagues have commented on, has had a positive effect because it has lowered interest rates and a number of other things in the overall economy, but that has clearly not been the case in both agriculture and energy in the United States.
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    Mr. LUCAS. Absolutely. It would appear at least the local perception is that, because both industries are very capital-intensive, if we continue in the direction we go, and that optimism that permeates, it seems, virtually the whole economy starts to dry up in those two areas, that by not making the long-term capital investments, that we could come to a point where we will start down a different trail. And even with the recovery, it might well take another extended period, as we went through in the late 1980's and early 1990's, to cycle back up again. So there are some real concerns there.

    You would agree—I would assume, I think—that you would agree that the best solution there is to attempt to, in some form or fashion, help our consumers and customers, so to speak, recover their vitality?

    Mr. GREENSPAN. Indeed.

    Mr. LUCAS. Thank you.

    Chairman CASTLE. Thank you.

    Mr. Frank.

    Mr. FRANK. Mr. Chairman, I was impressed, at the bottom of page 8 onto page 9, you talk about the great many chronically unemployed people given the opportunity to work; people have upgraded their skills, welfare recipients absorbing—there has been a significant increase in the utilization of sort of low-skilled workers at that level.
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    Over what period of time were you talking about?

    Mr. GREENSPAN. The last two or three years.

    Mr. FRANK. In other words, exactly the time that the last minimum wage increase went into effect. Can we infer from that that the increase in the minimum wage did not have the negative consequences on employment that some people predicted it might have?

    Mr. GREENSPAN. No. I would say the minimum wage did have a negative effect. It has just been overwhelmed by far stronger forces.

    Mr. FRANK. So overall, if we had not passed the minimum wage, would employment rates have been higher?

    Mr. GREENSPAN. Well, possibly, yes. Let me put it to you this way.

    Mr. FRANK. If they were, wouldn't you have had to raise interest rates? So in other words, you have told us in your statement that employment—the biggest potential cloud on the horizon that you see appears to be the inadequate growth in the worker force.

    Mr. GREENSPAN. I would not argue that a rise in the minimum wage by restricting employment is good monetary policy, because it reduces——
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    Mr. FRANK. I would not, either. That is not what I am arguing. What I am trying to do—see, I think what happens is sometimes there is this ideological screen that gets in the way of the facts. If the theory is good, so much the worse for the facts.

    The fact is that you have a whole statement in here about how we are outrunning our ability to find workers; that the biggest problem is the work force. That happened during the time the minimum wage was increased, so that any overall negative effect of increasing the minimum wage, in macroeconomic terms, appears to be zero.

    Mr. GREENSPAN. Look, if you are asking me——

    Mr. FRANK. What I am asking you, I am not ''iffing''—I am asking you what I am asking you, which is, given the circumstances in which we increased the minimum wage, what negative effects did that have on the economy?

    Mr. GREENSPAN. I would say at this particular stage none. But the issue is longer term.

    Mr. FRANK. I will settle for none now, because the notion that with that relatively small increase, you are going to have a longer-term effect is fine, because, besides, since you came out against tax cuts, I don't want to argue with you too much today. We are on the same side, being against tax cuts. You may have lost yesterday on the economy, you may lose today that you are against tax cuts. As to two and three we have different views, but I am with you on one. The number one priority was tax cuts.
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    Mr. GREENSPAN. I didn't say I was against tax cuts. I would prefer that at the moment we let the surplus run, because it is——

    Mr. FRANK. Which means no tax cuts right now?

    Mr. GREENSPAN. That is correct, right.

    Mr. FRANK. You were not against tax cuts forever, let me stipulate. You have not said that the minimum wage might not cause problems in 2006, and you have not said you were against tax cuts forever, but as for now you would prefer letting the surplus accumulate and reducing the debt to cutting taxes?

    Mr. GREENSPAN. I would say there are unquestionably numbers of people, not many, but numbers of people who probably are not working today because the minimum wage is higher, and could have been working.

    Mr. FRANK. Although, on the other hand, as we say, if, in fact, that had happened, they probably would still not have been working for different reasons. You would have had to raise interest rates. We have already stretched——

    Mr. GREENSPAN. It is a supply factor. I am saying that these people who are held down because they cannot produce at the level of the minimum wage are being held out of the market.

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    Mr. FRANK. We are running out of workers in the economy. You are saying that the economy needs workers, but it does not—these workers——

    Mr. GREENSPAN. Unfortunately, what you need is workers whose productivity matches what they get paid. You do not want to distort the market in that regard. It does not help them.

    Mr. FRANK. Except that, again, it seems to me, overall, the point that we have, in fact, overstretched the work force makes it very hard.

    Let me just go back. I will accept the fact that you said it had none to date. People can speculate about the future. I will accept that for now.

    The other problem we have, though, is the continued disproportion in the values. What is fascinating is how optimism can become pessimism, and vice versa.

    I know there are people for whom every cloud has a silver lining, but there is this tendency, I think institutionally, for the Federal Reserve, while some people look for the silver lining in the cloud, it is your job to remind people that the sun causes cancer, and I think that is what we are basically doing here.

    On page 22, you say, ''We expect the situation will develop smoothly.'' This is the crux of my concern. ''The committee believes that the potential for accelerating inflation is probably greater than the risk of protracted, excessive, weakness.'' It is the imbalance there.
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    Yes, I am sure that is true. An acceleration in inflation, versus two adjectives on weak conditions, weakness, we get one noun and two adjectives. And the acceleration is the problem over here, but it is protracted and excessive.

    What is the danger of protracted, excessive inflation? That is the problem. It is the disproportion. Any inflation is to be more feared than a protracted—it equates to a protracted, excessive weakness. That is the problem.

    There is an institutional bias to overemphasize the threat of inflation and, as I said, if you had said the potential for accelerating inflation is probably greater than the risk of weakness in the economy, I would have passed over it. If you would have said the potential for rapidly accelerating inflation is greater than the risk of protracted, excessive weakness in the economy, I would give you two adjectives for one, it would not have been a problem.

    But I really do believe this reflects the mindset where any inflation equates as a harm protracted and excessive weakness. I think that is the danger in the policymaking that I fear.

    Mr. GREENSPAN. It is not an institutional bias, it is an institutional evaluation. If, as we think, the evidence has increasingly affirmed in recent years that low inflation or stable prices is a major contributor to sustainable, long-term economic growth, then if we are concerned about the reemergence of inflation, as we should be, it is because it is a threat to sustainable, long-term economic growth and employment. In that regard, I should think that we ought to be more concerned about the emergence of inflation than of temporary economic weakness.
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    In that regard, yes, I would acknowledge that the central bank's major concern is stability of the currency, which is what a central bank should do. I can conceive of an argument which we did have, say, several years ago where the hypothetical question of price stability increasing economic growth over the long run was an arguable case. We asserted it, but recognized that the evidence was mixed.

    What we have found in the last four or five years is a very considerable addition to the case that a necessary condition for long-term stable economic growth and employment is a stable inflationary environment, a noninflationary environment.

    Chairman CASTLE. Ten seconds.

    Mr. FRANK. Ten seconds.

    I don't deny that should be the focus of the central bank. What I am concerned about is excessive deference to a central bank which has exactly the orientation you say, which, in my judgment, exaggerates potential inflation and undervalues growth.

    Chairman CASTLE. Thank you.

    Dr. Paul.

    Dr. PAUL. Thank you, Mr. Chairman.

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    Mr. Greenspan, over a period of time, the dollar has been weak. If you look at it from 1971 until now, the curve is obviously downward. If you look at the last three years, the dollar has been relatively strong, and some people consider this a problem. Even our Government, our Fed and Treasury, just recently thought our dollar was too strong.

    Of course, in free markets, the purchasing power of money is never tampered with, but under today's conditions it was felt that it was too strong in relationship to the yen. Of course, we intervened and had some effect to the currency markets.

    When do you suppose the time would be appropriate for the money managers to intervene in a much more aggressive manner, if the dollar continues to be very, very strong, and pressure is put on the Federal Reserve, political pressure, to say, ''We cannot sell our goods, we want some help''? Can you foresee that? And not a token amount of interference, intervention in the market, but a major intervention in the market to change the direction of the dollar, can you foresee that in the near future?

    Mr. GREENSPAN. Congressman, let's first emphasize that we do consult with the Treasury and ultimately the Secretary of the Treasury is the legally authorized determiner of the extent to which intervention occurs or doesn't occur. The Secretary has indicated on numerous occasions that it is fundamental values which will determine the value of the dollar and other currencies, and over the long run, intervention doesn't do very much one way or the other. I think that the evidence over the years has demonstrated that that particular statement is clearly sustainable.

    I can't anticipate what particular policies will be under hypothetical circumstances. It is an important question, there is no doubt. But overall, the presumption that somehow we, meaning the monetary authorities, the Fed and the Treasury, can somehow alter the value of a currency in a significant manner when fundamentals are going in the opposite direction is an illusion. We cannot.
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    Dr. PAUL. So in a way what we have done just recently was just wasted money, since we do know that intervention does not have much effect? Why do we bother on occasion——

    Mr. GREENSPAN. First of all, we don't waste money. We are taking a position in a currency, and very often over the years we turn out to actually have a profit in the process. When you intervene, you don't spend the money. You are just taking an investment position or a speculative position.

    Dr. PAUL. Unless that currency happens to go down, which it well could.

    Mr. GREENSPAN. Yes. That is certainly the case, and if you do it in large volume, then the answer is there are speculative risks. We have taken very few of those.

    The very few times which we intervened, and we have not intervened for years until this most recent event occured, was when we believed that the markets were unstable and that intervention might have an impact. You need both of those conditions to exist. It was the judgment of the Secretary of the Treasury, to which we agreed, that action taken would have the effect of breaking a pattern of a very quick run in the currency. I don't think any of us believed it would have more than a temporary impact.

    Dr. PAUL. A very quick question. You seem to welcome, and you have been quoted as welcoming, a downturn in the economy to compensate for the surge and modest growth in the economy. Is it not true that in a free market, with sound money, you never welcome a downturn in the economy? You never welcome the idea of decreased growth, and you don't concern yourself about this? And yet, here we talk about when is the Fed going to intervene and turn down the economy?
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    It seems that there is a welcoming effect to the fact that the Southeast Asia has tampered—you know, price pressures. Couldn't we make a case that the free market would operate a lot better than the market we use today?

    Mr. GREENSPAN. I think you have to define what you mean by a ''free market.'' If you have a fiat currency, which is what everyone has in the world——

    Dr. PAUL. That is not free market.

    Mr. GREENSPAN. That is not free market. Central banks, of necessity, determine what the money supply is. If you are on a gold standard or other mechanism in which the central banks do not have discretion, then the system works automatically.

    The reason there is very little support for the gold standard is the consequences of those types of market adjustments are not considered to be appropriate in the 20th and 21st century. I am one of the rare people who have still some nostalgic view about the old gold standard, as you know, but I must tell you, I am in a very small minority among my colleagues on that issue.

    Dr. PAUL. So I guess we have to accept the downturns?

    Mr. GREENSPAN. No. We are not accepting downturns, nor do I think we look at it as desirable. What we do look at is an economy which is running at a pace which is unsustainable over the long run and will eventually run off the tracks and create significant disruption. So we do not look forward to a weakening in growth. All we are concerned about is a pattern of growth which is sustainable.
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    In other words, when we talk about our goal as maximum sustainable economic growth, the ''maximum'' and the ''sustainable'' are both crucial elements to that. We can get a maximum growth in the short run, which is not going to help anybody over a longer-term period. That we would consider to be an unacceptable or undesirable pattern of growth.

    Dr. PAUL. Thank you.

    Chairman CASTLE. Thank you, Dr. Paul.

    Mr. Kennedy.

    Mr. KENNEDY. Thank you, Mr. Chairman.

    I want to go back to the statement I made, Mr. Chairman, at a time when all of us get to talk and you don't, and you have to listen to us for a minute or two, or for more than that.

    I want to lead into it by following up on the comments that you just made with Dr. Paul. It seems to me that if you look at the general state of the economy, and you look at all the numbers, the aggregate numbers, they are all very, very encouraging. But there are some storm clouds that would appear out there on the horizon.

    You have a major General Motors strike. You have got Bob Rubin, who has been rumored to perhaps be leaving the Treasury Department. You have a major crisis that is almost every day on the front page of the newspapers with regard to Japan, that leads to an Indonesia crisis. It could lead to a Korea crisis, as well. You have got a potential war between India and Pakistan. You have mentioned inflation a number of times, there is a tight labor market, and how all of those sort of play into your maximum sustainable growth policy.
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    If I understand it, there was a period of time in the late 1960's that the stock market came close to a thousand points, and it then, I believe, declined, really, for a period of almost 13 or 14 years. I think that there is a whole group of investors in this country that, for the first time in their lives, have an IRA or some kind of Keogh or retirement plan. They look at these reports that they receive from their money market managers that tell them every month that their portfolios have increased by another 5 or 10 or 15 percent, and they look at these numbers that come in, which tell them that they have for the first time in their lives this real wealth.

    I just wonder what advice or what thoughts you have; not really advice, but whether or not you feel that the notion that somehow this economy can never, in fact, adjust will create perhaps even greater problems if, as has always occurred, there is an adjustment, and if, for the first time, people actually see losses, and how they will react to those losses, and whether or not that bears on your thinking and perhaps other members of the Market Committee's thinking in terms of how to deal with what you view as, it seems, unsustainable growth.

    Mr. GREENSPAN. We don't view the current growth rate, say, during the last few years, as unsustainable. I have argued elsewhere, and indeed this morning, that productivity, as best I can judge, is probably accelerating. That in and of itself, with the same labor force, will give you greater economic growth overall. I suspect that the evidence suggests that that is indeed happening.

    But the broader question you are raising is the issue of the emergence of a really quite extensive expansion in the holdings of equities among households which have risen by almost a half, depending on how you mark it, and who holds it.
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    It does turn out to be that the very substantial amount of capital gains is in the upper and middle income groups and above, and the dangers that you have if you count on these types of expansions are largely whether or not you took out debt against it. In other words, the only way you can spend, so to speak, your capital gains is either to sell your stock and get the cash or somehow borrow, not necessarily against the stock, but with the feeling that you have this huge block of new assets, you feel as though borrowing is not a particular problem because your balance sheet is in such good shape and your net worth is so much better.

    The real danger exists if there is an awful lot of debt which, in the event of a significant stock market contraction, that all of a sudden becomes unserviceable.

    Mr. KENNEDY. Isn't there also an issue, though, Mr. Chairman, that where people for the first time recognize that they can actually lose money in the stock market, and therefore pull out of the stock market, that that could create a much greater downturn in the stock values than might be normally anticipated as a result of these other economic indicators?

    Mr. GREENSPAN. I doubt it. In other words, the market ultimately is driven by real forces. Once you get a decline started, it is not clear whether, in fact, people choose that as a reason to sell or to buy. Indeed, most of the evidence of recent years is that people who have built up 401(k)s and other forms of investment and have become quite familiar with the stock market have been the ones who have been buying on the declines, and indeed, have turned out to be prescient, and wealthier.

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    So it is not clear exactly how they are going to behave. Forecasting that they are automatically going to start to sell any more than the full professional managers of large pension funds would—is probably futile, because we——

    Mr. KENNEDY. Do you believe there is going to be a market correction which could result in a significant contraction in the size of their portfolios?

    Mr. GREENSPAN. I would say, ultimately, yes. History tells us that there will be a correction of some significant dimension. What it doesn't help you on very much is when. Indeed, history is strewn with periodic contractions of significant dimensions, and I have no doubt that human nature being what it is, it is going to happen again and again and again. How individuals behave in that particular environment is not clear or necessarily forecastable.

    Mr. KENNEDY. Thank you, Mr. Chairman.

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

    We will next go to Dr. Weldon. After that we will switch sides. Mr. Leach will be after that, Mrs. Roukema, and then Mr. Metcalf, just so people will know where they are, because it is always a little bit of a problem. We will keep going in order over here.

    Dr. WELDON. Thank you, Mr. Chairman.

    Mr. Greenspan, you in your testimony made a statement that changes in monetary policy here would have an outsized effect in Asia. I am assuming you are talking about an increase in interest rates in the United States would have a disproportionately large effect there. Could you just elaborate on that a little bit, please?
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    Mr. GREENSPAN. Certainly.

    The American dollar has become a key currency throughout the world, and especially in Asia.

    Dr. WELDON. Is that really a reserve currency throughout the world?

    Mr. GREENSPAN. To a very substantial extent, the reserves of central banks are disproportionately in the U.S. dollars, and that is true of Asia as well as even Europe. The consequences of dollar-denominated interest rate changes, as a result, are really important.

    Obviously, if they, as indeed a number of the economies did, tied their currencies to the dollar, either tightly or sort of in a modest way, they will pick up dollar interest rate effects in their economies, which has an impact of not insignificant proportions, if, especially, their financial systems are fragile or weak, as they are today.

    So when we discuss monetary policy, one of the major areas where considerable interest exists far beyond the academic interest of central bank policy are in those areas which find the value of the dollar, both in the exchange market and dollar-denominated interest rates, which a lot of them borrow in, of quite significant importance to them.

    Dr. WELDON. Are you following the developments in Indonesia at all?
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    Mr. GREENSPAN. Yes.

    Dr. WELDON. I recently read that the cost of basic commodities for the Indonesian citizens is extremely high, particularly food. Can you comment at all on that, and the implications of that? Because there are some reporters in the media making claims that the country is on the verge of chaos, and certainly, though our major concern here today in this hearing is the United States economy and United States policy, we all know that developments like that can have implications for us domestically.

    Mr. GREENSPAN. Whenever you have a currency fall as sharply as the rupiah has fallen, which is approximately 80 percent, and you import any significant amount of materials or foodstuffs, which they do, then clearly the domestic price of many of the things which they import obviously skyrockets, unless, as indeed there is the case currently, at least to the extent that the Government does not subsidize them. The Indonesian government does do a considerable amount of subsidization for foodstuffs that are imported, but nonetheless, prices have risen to extraordinarily high levels.

    The food distribution system also has been disrupted by a goodly number of political problems, especially with the ethnic Chinese, who have been major players in the distribution system in Indonesia. As a consequence, there are concerns, increasing concerns, of food shortages and food prices which are too high for those average Indonesian citizens to afford.

    Dr. WELDON. I am going to run out of time in a second. Let me get to the meat of the question that I wanted to ask you. Can you comment on the involvement of the IMF in the developments of Indonesia, particularly in light of the political situation where many people are asking for more involvement of the IMF?
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    Mr. GREENSPAN. Yes. As I indicated to you earlier, the crisis that emerged in Southeast Asia was not forecastable, and indeed, as it began to evolve, the extent of how deep it would become was also not forecastable.

    Vicious cycles, which Indonesia's economy was characterized by more than any of the others, was a massive implosion that was very difficult to handle, and I think that the IMF has done as much as it thought it understood it could do. I don't know what alternative policies could have been implemented which would have significantly altered the pattern that emerged once the vicious cycle began to accumulate in the degree that it did.

    Dr. WELDON. Did the IMF policy play a role in the 80 percent decline of the value of the rupiah?

    Mr. GREENSPAN. I think not. That results largely from the internal policies of the Indonesian government, which were inadequate to the nature of the problem that they confronted.

    Dr. WELDON. Thank you, Mr. Chairman.

    Chairman CASTLE. Thank you, Mr. Weldon.

    Mrs. Maloney.

    Mrs. MALONEY. Thank you, Mr. Chairman.
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    Good morning, Mr. Greenspan. Reports in the press yesterday after your testimony interpret your remarks that the Fed will raise interest rates because of the threat of inflation. Could you clear the air today, or would you rule out that interpretation?

    Mr. GREENSPAN. I don't think that is what I said. I said very much what I said this morning, which is that there are lots of ifs, ands, or buts in those types of evaluations. What I did say is that we are on a path at this particular point, with the working age population, including immigration, going up at about 1 percent a year, and the job growth, as a consequence of economic growth affected by increases in productivity, is running 2 percent a year.

    That gap is being met by a fairly pronounced reduction in the number of people who are either officially unemployed or those who are not in the labor force because they are not seeking jobs actively, but who nonetheless say they would like to work. The combination of those two groups of people in our society is declining fairly rapidly, reflecting the difference between the 2 percent growth in employment and the 1 percent growth in the working-age population.

    What I have been saying for actually quite a long period of time is that somewhere, at some point, that gap must inevitably close, because we will run out of people to employ. Prior to that happening, either it will occur because the economy slows down by itself, which means that employment growth will slow down closer to the gain in the working-age population, or if it doesn't happen and wages accelerate as a consequence, if the laws of supply and demand exist—and you have free labor markets—history tells us that wages will tend to accelerate.
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    If that happens in excess of the growth of productivity, and to date it hasn't, then other actions, mainly monetary policy, may have to be involved in order to constrain what would be, effectively, a destabilizing adjustment, which could have a major negative impact on the economic prosperity, which has been so extraordinary and so beneficial to this economy, especially the remarkable things it has done to enhance the quality of our work force, who have successively been able to gain the skills and move up the scales because the labor market has been as good as it has.

    Mrs. MALONEY. My colleague, Mr. Frank, pointed out today, your comments on page 22, the potential for accelerating inflation is probably greater than the risk of protracted, excessive weakness in the economy. As I said, some of the press interpreted your comments yesterday and then your comments today—they seem to sound like there is a bias toward raising interest rates. You are saying that that is not true, that you are open to any policy, even lowering interest rates?

    Mr. GREENSPAN. I am saying at the moment that the most probable outcome, as I stipulated in my prepared remarks, and indeed, I even quoted some of the prepared remarks, is that we are going to get a continuation of what is really quite a remarkable and benign economic environment.

    To the extent that we see that the probabilities that that does not happen—the minority probabilities, the less than 50 percent probabilities—are, as best we can judge the environment, more likely skewed in the other direction, than if we are wrong in the evaluation we are making, namely, that things will be reasonably stable and benign, the probability is greater that we will end up with an acceleration of inflation, as distinct from a weakening, or as Barney Frank said, an excessive weakening in the economy.
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    That is a statement of the way we view the probabilities, but let me assert what I in fact said, and I will repeat it; namely, the most likely scenario is more of what we have seen in the most recent past.

    Mrs. MALONEY. Very, very quickly and briefly, after the Russian loan, the IMF is dangerously low in their reserves, down to $7 to $12 billion.

    What will happen if we follow the leadership of the Republican Majority in their call not to fully fund the International Monetary Fund? What happens with Asia and other countries that look to the United States for leadership? What will be the impact if we fail to fund the International Monetary Fund?

    Mr. GREENSPAN. Congresswoman, as I have testified before this subcommittee previously this year, the probability is that if the funding is not made, that we will probably muddle through; that the probability that something significantly adverse will happen to the United States as a consequence is less than 50/50. In fact, it is a relatively small probability.

    Nonetheless, if we are wrong and that probability, that event, actually emerges, then the consequences will be very severely negative for the United States. In my judgment, taking out what is effectively an insurance premium, which I believe the funding of the IMF would be, is a wise policy.

    I am not saying that I think that at the end of the day we should not be looking at the whole structure of the international financial institutions, the IMF being, of course, the prominent one. I do think we are going to have to do that, because the global financial system is changing. It is just that I am arguing that now is not the time to do that. We don't have the luxury not to have available an institution such as an IMF, if it is necessary, to fund and assist in the containment of crises.
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    But after this situation in Asia becomes history and the world financial systems stabilize, then I think many of those who have been arguing that a review of the structure of the system is on the table I think are correct. We ought to be looking at it.

    It is just that this is comparable to when your house is potentially burning down, and your neighbor's house is on fire and the sparks are going in your direction, your concern is to make sure that the fire doesn't spread. Tomorrow you can complain to the neighbor that they shouldn't have lit matches in their kitchen or something like that. It is just the timing is all wrong to do it in the midst of the fire.

    Chairman CASTLE. Thank you, Mrs. Maloney.

    Chairman Leach.

    Mr. LEACH. Thank you, Mr. Chairman.

    Whenever a Federal Reserve Chairman comes to the subcommittee under the Humphrey-Hawkins approach, it is always interesting to try to figure out what perspective to apply. It seems to me the biggest perspective to apply is that the Federal Reserve of the United States has just established a new economic doctrine, what I would describe is as, using your terms of art, Greenspan virtuosity.

    You have talked about a new theory of a virtuous cycle, which, as I read your testimony, is characterized by accelerated productivity, which reduces inflation, which bolsters expectations of future corporate earnings, which increase equity values.
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    What is intriguing about this is it is the first conjunction of morality and economics that I have seen in terms of a label, so I have gone to the standard dictionary to look up what the term ''virtuous'' means for most people. ''Virtuous'' means righteous. It means, ''characterized by chastity, or exhibiting virtue.'' So I looked up ''virtue.'' That means moral excellence or righteousness, it means chastity, it means one of the order of angels. It comes from the Latin ''virtus,'' which means manliness or goodness. So what we have is a chaste, manly economic doctrine that I think is of serious significance.

    Having said this, this appears that it is an economic virtue to have lower inflation. One of the interesting theoretical notions that has come into being or has been in being in pastimes in history, and people have thought might be passe, but may not be, is the question of deflation. Is there virtue in deflation? Is this a circumstance that the Fed is concerned about?

    Some have suggested that we may have a global overcapacity in manufacturing, and that there may be seeds of a deflationary trend. Is the Fed concerned about this, and will there be a policy response if there is a concern? Is a policy response other than lower interest rates the only kind of response to meet this type of circumstance, or might there be others?

    Mr. GREENSPAN. Mr. Chairman, let me emphasize that our goal is price stability, not price deflation; or, more exactly, not noninflation. Noninflation includes price stability and deflation. That is not the goal, as we see it. Indeed, as we evaluate the relationship between inflation, price stability, and deflation, to the extent we are able to analytically disengage or disaggregate the effects on the economy, it appears that both inflation and deflation, because they create uncertainty and risk premiums, are consistent with a slower rate of maximum sustainable long-term growth than price stability.
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    Price stability would have the lowest set of risk premiums, because if you have a set of prices which are generally stable, some prices will go up, some prices will go down, the risk into the future is perceived to be less, and hence, the degree of investment will be more, productivity growth will be more, and standards of living will be rising faster.

    So we would be just as adamant against the instabilities and rising risk premiums that would be associated with deflation as we would with inflation. We do believe that there are forces out there in the rest of the world which have clearly moved from inflation to disinflation and, in certain areas, deflation.

    We do not believe it has moved anywhere near in that direction in the United States as yet, but were we to see that occurring, or were we to see the stampede from a small dot to something much larger coming, obviously, we would evaluate and respond to it as we perceive appropriate.

    Mr. LEACH. As men and women of virtue? Yes. Thank you.

    Mr. GREENSPAN. Yes. With respect to the rest of your statement and questions, Mr. Chairman, you do leave me speechless.

    Chairman CASTLE. Thank you, Mr. Chairman, for your chaste, manly questions. We appreciate that.

    Mr. Jackson.
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    Mr. JACKSON. Thank you, Mr. Chairman.

    Welcome back to our subcommittee, Mr. Greenspan.

    Just two questions, if I may. I want to pick up on something that Representative Maloney said just a few moments ago, in an analogy that you used; her question, again, regarding the International Monetary Fund.

    I believe your quote went something to the effect that when a neighbor's house is on fire and sparks are coming our way, what do you do? The IMF is a way to contain the fire. Unfortunately, because this is an election year, the IMF and its replenishment may be bogged down in election year politics.

    Your agency was created, in part, to be free of political influences and considerations. I am interested in how you and your agency contain fires of the magnitude of the Asian crisis so that the effects of contagion or the sparks do not undermine our economic growth and expansion. And a hypothetical, and I am sure in the world of economics we deal with them all the time, if the fire does spread, does that mean higher or lower interest rates?

    And then I have a second question unrelated to this one.

    Mr. GREENSPAN. Congressman, it is very difficult to evaluate potential hypothetical events without fully grasping all of the complexities of what they are when we make policy. I have tended to stay away from trying to project what we might or might not do under certain hypothetical cases, because I have found that, over the years, when those cases actually emerge, they look quite different from the way I thought they would. The reason is that we have such an extraordinarily complex economy that it tends to do things which surprise us more often than not.
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    Obviously, to the extent that deflationary forces are moving in the way the Chairman was indicating earlier, clearly they raise questions as to how we might or might not respond. But raising interest rates in the context of a deflationary set of forces is obviously not something which central banks as a general rule engage in.

    Mr. JACKSON. I guess I am going to follow up on my first question. I want to make it clear that, again, the ability of this Congress—in light of this being an election year, it may not be possible for us to fully replenish the International Monetary Fund for political reasons. All of us are facing reelection. It is very difficult to argue why we should be bailing Asian economies out and why we would cast a vote to bail out an Asian economy.

    Yet, in your remarks to Mrs. Maloney, you indicated that our neighbor's house is on fire, which it is clearly on fire. Chairman Leach and I took a trip, along with Members of this committee, and we studied the nature of the fire. You said that sparks are potentially coming our way. Now, I don't know what size those sparks are, but one——

    Mr. GREENSPAN. Nor do we, essentially.

    Mr. JACKSON. I am assuming then that your remarks are either to downplay the significance of the sparks or to acknowledge that the sparks are of an enormous magnitude, and one way to contain the fire is to replenish the International Monetary Fund until such time as we are able, beyond this particular crisis, to develop the appropriate international monetary funding agency and discuss some of the problems that we have with the agency in general.
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    So in case this institution is incapable of responding to the magnitude of this fire. Whether it is a small fire, whether it is a large fire, it is clear that your agency is the next line of defense in terms of fire containment and spark containment. If it is a small crisis, your agency will respond because the Congress couldn't. If it is a large crises, your agency will respond because of the nature of the crisis. And my only question is if it is a fire that is spreading, in which direction, higher or lower, based upon the magnitude, small or large, is your agency likely to respond?

    Mr. GREENSPAN. Higher or lower interest rates, is that what you mean?

    Mr. JACKSON. It is usually the response from your agency when there is some——

    Mr. GREENSPAN. As before, as I indicated in my prepared remarks, it is very clear that the contagion that has occurred and the crisis that has occurred in Asia, and indeed in a goodly number of other parts of the world have been factors which we think have diffused some of the underlying inflationary pressures that were building in the United States. In that regard it is pretty clear that if those forces, international forces, were not there and events were developing the way they were in the last two or three years, I would say that the pressure for us to have tightened monetary policy further would clearly have been higher. So in that regard, obviously, the extent to which there is a degree of weakening in the rest of the world which is spilling over into the United States, that, as other things equal, kept interest rates somewhat lower in the United States, in the short end of the market I should point out.
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    Mr. JACKSON. I thank you for that response, Mr. Chairman, and what that tells me is that there indeed then is no pressure on this Congress at all to replenish the International Monetary Fund because there are international forces that have somehow reconciled and provided us the time that we need, and unfortunately many of us in the Congress have been operating as if there is great pressure for us to replenish this particular fund under certain conditions, that notwithstanding.

    Mr. GREENSPAN. May I just—no, I would disagree with that.

    Chairman CASTLE. May we go on to——

    Mr. GREENSPAN. Let me disagree with that.

    My position is that it is precisely because we do not wish the contagion to get out of hand and create exceptional problems for the United States that I have argued in favor of the replenishment.

    Mr. JACKSON. I thank you, Mr. Chairman.

    Chairman CASTLE. Thank you, Mr. Jackson.

    Mrs. Roukema.

    Mrs. ROUKEMA. Thank you.
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    As it turned out, my questions will give you the opportunity to follow up in a very real way and amplify on what you were just saying with respect to IMF. I will get to that, but first let me say that particularly given the report in the Wall Street Journal today on massive tax cuts being planned by my Republican leadership. I have heard you, and I hope this group and the press have heard you loud and clear, that relative to paying down the national debt, waiting for the surplus to solidify and maintaining the balanced budget, that you would delay tax cuts.

    If you want to comment on that, please do. Maybe you would like to tell us which tax cut you would give a priority to.

    But first I must get back to that IMF question. I am glad that you said to Mr. Jackson that it should not be interpreted that you are not supporting IMF. You do indeed support IMF funding. When I read my opening statement, I had not known that our House Appropriations Committee yesterday deferred indefinitely, and probably until September, acting on the appropriation for the IMF.

    I would like to have you, Mr. Chairman, speak very definitively on why this is not a bailout and why this is in our own economic self-interests, and what could be the consequences of deferring indefinitely this proposal.

    I am deeply concerned that problems have now resurfaced again and caused this delay. I am convinced that you and the business community have got to undertake an offensive here to help us get the IMF funding passed. We do not want to provoke a worse situation where the contagion really is spread. We are not talking about cinders any more, or fire hazards from one house to another, but we are talking a real conflagration.
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    Mr. Chairman, please.

    Mr. GREENSPAN. Congresswoman, I haven't changed my view on this since we discussed it in this subcommittee early this year, and indeed even late last year.

    The issue is that there are significant emerging contagions throughout the world. The crisis, as I indicated in my response to the Chairman's first question, has shown no evidence of stabilization at this point. We do not know how far it is going to carry or what its spillover is going to be. It is very difficult to forecast this. There are those who make forecasts. I know that the basis of those forecasts are very fragile.

    As a consequence, the concern that we ought to have is that with the resources of the IMF significantly depleted, which indeed, as I indicated in the Senate yesterday, they are, that we can take the risk that there will not be replenishment, that there will not be significant resources available easily for the IMF to contain the particular conflagrations that may arise which we cannot immediately foresee. We can essentially position ourselves to hope that nothing happens as a consequence of these events, and the chances are, frankly, we probably will luck out in that regard, and no particular action will be required. But if we are wrong in that regard, the consequences could be very substantially negative for the United States, and as I said to one of your colleagues earlier, I view that as an issue of taking out insurance, important insurance. While I acknowledge, as many of the critics of the IMF have indicated, that there are many things that ought to be changed there, I think now is not the time to do that. There is more than enough time to address this after this crisis is over.

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    Mrs. ROUKEMA. Would you care to comment on the question of waiting until September to act on IMF funding?

    Mr. GREENSPAN. There are risks involved in doing that. It is important more that it be done in this particular Congress than it be delayed, because the real danger is to delay when the Congress is not in session.

    Are there risks in delaying until September? I think there are. I do not think they are major risks. The real risk is to do nothing after the Congress adjourns. Then I do think we have a situation in which there is no
sitting Congress easily available, and if the crisis were to
arise, it would be very difficult to address expeditiously.

    Mrs. ROUKEMA. Thank you.

    Chairman CASTLE. Thank you, Mrs. Roukema.

    Ms. Lee.

    Ms. LEE. Thank you, Mr. Chairman.

    Chairman Greenspan, I mentioned in my opening statement that I am still trying to get some understanding of this definition of full employment as defined by the Humphrey-Hawkins Act. It states expressly that Congress should establish as a national goal the right to full opportunities for useful paid employment at fair rates of compensation for all individuals able, willing and seeking to work.
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    Now, we know that in many of our communities, we see thousands of people work and walking around who are unemployed, yet we have this very low unemployment rate. We also know that many individuals are working, for instance, 20 hours a week at $8 an hour. Now under the full employment, the Humphrey-Hawkins Act, what constitutes the unemployment rate, and how do we view unemployment, or how do we define employment given what we know that is really occurring with many of our workers in this country are seeking work and are unemployed?

    Mr. GREENSPAN. Congresswoman, the notion of full employment is something which goes back basically to the early post-World War II period as a concept which economists and policymakers tended to deal with in some detail. Prior to that we didn't even have the data to know what the degree of unemployment was. We didn't, for example, in the 1930's have the type of data system that we now have. In the 1950's and 1960's there were many different judgments about what is the rate of frictional unemployment, meaning the extent to which, if you had a free labor economy, there would undoubtedly be some people between jobs who are voluntarily unemployed, and clearly you don't wish that number to force people to work when they don't wish to work.

    On top of that, there is supposed to be some various different evaluations of how much unemployment is stable over the long run. What occurred in the 1970's is a set of stagflations, as they became to be known, which was really quite alien to the view that low unemployment would increase inflation and you couldn't have inflation with high unemployment. It turned out in the 1970's that you could. This led to this whole new notion of the optimum unemployment rate, which we now call the NAIRU, which is sort of related to the Humphrey-Hawkins requirements for the administration of 4 percent and I think it is 3 percent adult unemployment.
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    But even the NAIRU is now, as you know, coming under considerable uncertainty, and as a result of this, the language in the Humphrey-Hawkins Act is very rarely directly adhered to. It requires, I recall, in the language that the Administration indicate how it will obtain the unemployment rates that are embodied in the statute.

    For the first few years, immediately thereafter, I do believe that such evaluations were embodied in the President's Economic Report. But that has not been the case in recent years. It has gone by the wayside because it has been perceived of as a more complex issue. So while it is still in the statute, it really is a throwback to earlier periods of the notion of full employment and what it means.

    I don't know how to interpret it in today's environment. Administrations over the years have essentially chosen to discuss the issue, but not in the full detailed notions that are embodied in the statute. My own view is that it is probably advisable to revise the statute to bring it up to the realities of the current period, but that has not been an issue. That has been on the table in the Congress for quite a long period of time, as I understand it.

    Chairman CASTLE. Thank you, Miss Lee.

    Mr. Metcalf.

    Mr. METCALF. Thank you, Mr. Chairman. I apologize for arriving late.

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    You may have covered the question, but I do have a couple of questions.

    As you know, debate has emerged between economists as to the principle causes of the Asian crisis. One school lays the blame largely on ample global liquidity combined with weak national financial systems and the corrosive impact of crony capitalism. The other school asserts that the Asian economies were fundamentally sound, and that the rational herd instincts of market participants combined with the pernicious influence of short-term capital flows and poor IMF policy advice caused the crisis.

    Can you comment on who might be right on this?

    Mr. GREENSPAN. Yes, I think the first is more right than the second.

    Mr. METCALF. OK.

    Mr. GREENSPAN. In fact, I don't think the second is right at all.

    Mr. METCALF. OK, thank you very much.

    Second question. Regarding the Asian situation, I wanted to ask you how much Japanese markets are redeeming U.S. Treasury notes? They have been recently redeeming some, and we know that they hold a significant amount of U.S. treasuries. About how much do they hold?

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    Mr. GREENSPAN. I think 400—there is a technical problem that we have. I will submit a figure for the record. We are unclear on what information is private and what is not. Some of it, obviously, we get from the Japanese government, which is private, but what I will do for the record is give you a number. It is several hundred billion dollars incidentally.

[Chairman Greenspan subsequently supplied the following information:
[According to revised estimates by the Treasury Department, holdings of U.S. Treasury securities by Japanese residents (official and private) amounted to $264 billion at the end of April 1998. This estimate is based on the value of holdings of bonds and notes reported in the 1994 portfolio benchmark survey and Treasury International Capital reports of holding of bills and certificates as of the end of April 1998. Treasury makes no attempt to adjust their estimates of foreign holdings for changes in value resulting from changes in interest rates.]

    Mr. METCALF. OK. Several hundred billion. OK.

    Do you believe that we could see a scenario here where Japanese financial institutions feel that they are in such serious trouble that they dump large amounts of U.S. securities? Now, they are done with—selling some, but we see this as a potential problem. It seems to me that it is.

    Mr. GREENSPAN. Well, it is conceivable, but remember that the rate of interest, especially the real rate of interest, doesn't really depend on who owns which securities, and very recently the Bank of Japan, in an endeavor with the Ministry of Finance to support the yen, sold huge amount of U.S. dollars actually through sale of securities, and the impact on the price was de minimis.
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    Mr. METCALF. OK. Thank you.

    I have no other questions.

    Chairman CASTLE. Thank you, Mr. Metcalf.

    Mr. Watt.

    Mr. WATT. Thank you, Mr. Chairman. I want to apologize to the Chairman for having to leave. We have a hearing going on in Judiciary right around the corner on hate crimes, and some days I feel like when I come to the Banking Committee and I go to the Judiciary Committee, it is the difference between day and night as just a whole dichotomy, two different worlds going on.

    I perhaps should not even ask a question and let you out as quickly as possible since they tell me that the market has gone down another hundred points today, at least, and as 2 days you have been over here, we got to stop you from testifying if the market is going to recover.

    Chairman CASTLE. Would you yield for a moment, because I made the statement earlier the market always goes up when he testifies here, so it is probably a pretty good time to invest because it is going to turn around and have a big bump before the afternoon is over.

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    Mr. WATT. Oh, you think it is coming back this afternoon? OK.

    Let me ask a question that I hope is not duplicating something that was asked while I was out. In your opening statement you referred to a dramatic increase in labor productivity, and I recalled that in your comments in Charlotte, you spent quite a bit of time talking about the impact of technology on productivity. And I guess the first question I have is is it your assessment that this increase in labor productivity is attributable to a better prepared work force, or is that being driven by this technological advance in combination with just having people working with the technology? Which one of those things or ones of those things are driving this labor productivity, in your assessment?

    Mr. GREENSPAN. I would say it is both, Congressman. That is, it is an interaction between a highly efficient capital stock in the United States and an increasingly skilled work force, and it is very difficult to disaggregate the two. We try in some of our productivity analyses to do that, and the truth of the matter is if you don't have any people, having the capital equipment there isn't going to help you. And if you don't have any capital equipment, having people, even if they are skilled, isn't going to create very much in the way of value added.

    So it really is an interaction, and we call it labor productivity not because we are either implying that it is all out of labor, but it is merely a measure of the aggregate output per unit of labor input, because ultimately the standard of living of human beings is determined by the output per worker.

    Mr. WATT. Let me then spin off from that issue to the question that I raised in my opening comments and ask you to address, and that is this issue of the aggregate unemployment, which obviously is important, but also in some areas, particularly inner-city areas, unemployment is still very high. Are there policies—or maybe I should just ask how can the Fed address that, that issue of the specific areas of unemployment, and in your assessments are you looking at just the overall unemployment in determining whether to raise interest rates, determining whether inflation has taken place or likely to take place, or how do you factor that in and put it into the equation?
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    Mr. GREENSPAN. Remember that what we look at is the potential development of an inflationary process which we believe would, if allowed to accelerate, undermine economic growth and, therefore, employment. Because of the efficiency of the American capital markets, there really is only one set of interest rates for the Nation as a whole, and the only thing that we have control of, in part at least, is short-term interest rates because of the Federal funds rate which we can control arbitrages against other short-term rates, and as a consequence we sometimes affect the longer-term rates, but only because—as the impact of short-term rates filters out into longer-term rates.

    What we cannot do is affect interest rates in individual areas of the country. We used to be able to do that years ago. We cannot anymore, and we are situated in a manner where we cannot readily affect the distribution of incomes or the distribution of employment nationwide because we only have one instrument with which we deal, and as a consequence monetary policy per se cannot very readily impact on individual areas within cities or rural areas.

    What we do tend to do is to try through other aspects of the Federal Reserve System, our Federal Reserve Banks and branches' community affairs divisions, for example, to try to work with individual groups to try to involve them and ourselves in a manner to try, as I indicated earlier to one of your colleagues, to see if we can get equity capital or debt capital or means of financing which could be of assistance.

    But as far as monetary policy is concerned, we have one tool for one market, and all we can do is try to attain, as I indicated before, our ultimate goal, which we perceive to be maximum sustainable growth for the economy as a whole. We don't have the instruments in monetary policy to go beyond that.
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    Mr. WATT. Thank you, Mr. Chairman.

    Chairman CASTLE. Thank you, Mr. Watt.

    Mr. Bachus has waited patiently.

    Mr. BACHUS. Thank you.

    Chairman Greenspan, I was looking at your testimony from March 8th of 1995, where you described the budget deficit as putting upward pressure on interest rates, especially nominal rates, and that it also tends to be inflationary. And I would suppose, first of all, that the converse is true; is it not?

    Mr. GREENSPAN. Yes it is. In fact, it is quite symmetrical in that regard.

    Mr. BACHUS. Now, Chairman Castle mentioned to you tax cuts, and he said we are now in a surplus. Being in a surplus, and we are in a surplus, but whether or not it is transitory, do you think it is having an effect on the economy now?

    Mr. GREENSPAN. Indeed I think it is. Long-term interest rates, I suspect, are significantly lower than they would have been, for example, if we continued with that $200 billion deficits, and to the extent that that is the case, interest-sensitive areas of the economy have prospered to the extent they would not have if we had those large deficits.
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    Mr. BACHUS. If we continue to have a surplus, would you continue to think it would be an influencing factor on lowering interest rates?

    Mr. GREENSPAN. Yes, I do. One of the reasons why I have argued that we shouldn't be hasty in trying to find uses for the surplus is that the surplus is doing an awful lot of good. It is basically reducing outstanding public debt, reducing interest costs to the Treasury, and increasing the surplus even more as a consequence. But the overall effect of large surplus is to increase national saving, reduce long-term interest rates, and create positive add-ons to the economy.

    Mr. BACHUS. You know, you have talked about how you can influence the Fed fund rate, and you talked about an orientation right now toward preventing inflation as opposed to reducing interest rates; that is, your primary concern is inflation. If we are in a surplus, and if it has taken off some of the inflationary pressure, in making interest rate policy decisions, do you consider that we are in a surplus now? Is that something that you are factoring in?

    Mr. GREENSPAN. The way we determine monetary policy is to look at the development, as I indicated before, of potential inflationary or deflationary processes to which we respond one way or the other. It is our judgment based on evaluation of the effect of budget deficit on the economy that the emerging surplus, and indeed we have had one now for a number of months, is acting in a positive manner keeping down inflationary pressures, which means that less is required on the part of monetary policy.

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    Mr. BACHUS. So, as it continues, it is something that is a factor that you consider in setting a Fed fund rate?

    Mr. GREENSPAN. Well, we don't consider——

    Mr. BACHUS. Or in setting monetary policy?

    Mr. GREENSPAN. We don't consider it directly, but what we do is recognize that because it impacts the economy overall, and we respond to the economy directly, the answer is clearly it does have an effect on how the central bank behaves.

    Mr. BACHUS. Back on March 8, 1995, you said that you think one of the first things that is likely to happen if we do get a budget surplus is that long-term interest rates will fall significantly. I will tell you as a Member of Congress that the budget is balanced now, and we are looking to see those long-term rates——

    Mr. GREENSPAN. Well, they are. They are significantly below where they were back then. So, in fact, we have had long-term interest rates down quite considerably since 1993.

    Mr. BACHUS. The surplus has only been in effect for the last——

    Mr. GREENSPAN. That is true, but remember that it is the reduction in the deficit as it moves into surplus that is relevant. There is no magic point which is—when you go into surplus, all of a sudden something happens. It is a continuum. Just reducing the deficit has the same effect as eventually just getting into surpluses.
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    Mr. BACHUS. Thank you.

    Now, let me ask one other question, and this is totally switching gears, but we have talked about the terrible problem in the world community now with Japan, Asia, Russia and whether or not Russia will fall, whether or not Japan will pull out of its dive. I would simply ask you if you would like to comment on this.

    The debate in Congress seems to be, will Russia fall, will Japan pull out of its dive characterizes whether we lend them money and how much. And I would submit to you at least my view is that whether or not Russia falls, whether or not Japan pulls out is dependent not on whether we lend them money or not, or how much, but how much they reform their systems.

    Mr. GREENSPAN. Absolutely. I agree with that. The issue of lending the money is only useful if it is a transitional bridge to assist them in reforming their economies. If they don't reform their economies, I don't care how much you lend them, it is not going to help.

    Mr. BACHUS. And I think what some of us who have advocated withholding money, insist on policy changes, and then the money will come.

    Now, you have talked about a fire, but, in Russia for two or three years now they have not upheld the U.N. sanctions against Iraq; they have cooperated with Iran, which promotes international terrorism; they have taken a course of action which leads to proliferation of weapons of mass destruction. And I think what some of us have said is we want to see a policy change. I would say to you that the proliferation of weapons of mass destruction is probably more harmful to our economy than a Russian nose dive.
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    Mr. GREENSPAN. That is the judgment which the Congress is employed to make, tough tradeoffs that you have to be involved with.

    Mr. BACHUS. And I am not sure, do you consider when you say we should lend Russia money, you have come——

    Mr. GREENSPAN. I am not saying we should loan Russia. I am just saying we should replenish the IMF.

    Chairman CASTLE. Mr. Bachus, can you ask a final question?

    Mr. BACHUS. Yes. I guess when you say that—do you make foreign policy considerations?

    Mr. GREENSPAN. No. I just make them on the grounds of the issue of international financial stability and how it affects us.

    Mr. BACHUS. And you understand there are other factors.

    Mr. GREENSPAN. Certainly, of course.

    Mr. BACHUS. Thanks.

    Chairman CASTLE. Thank you very much. We appreciate it.
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    Mr. Hinchey.

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

    On the issue of long-term interest rates, I find myself, of course, agreeing with Mr. Bachus' line of questioning just a few moments ago. I anticipated that real interest rates would be coming down as the budget deficit was erased and as we moved into a period of surplus and am equally disappointed that we haven't seen that happen. I hope that it will not take a serious downturn in the economy in order to press the Federal Reserve into doing something about real interest rates.

    Perhaps the most interesting debates that we have had on this subcommittee since I have been a Member is the efficacy of Humphrey-Hawkins in its dual responsibilities to promote maximum economic growth while maintaining low inflation, and also the debate that we have had over the course of the last several years on this subcommittee with regard to the level of growth that the economy could see without triggering an increase in inflation.

    Many of us on this side of the subcommittee have argued that we could see substantially higher rates of growth beginning back in 1993 in the present context without triggering inflation, and indeed history has borne that out. We have seen the economy grow very substantially over the last five years, and inflation, if anything, has declined during that time and continues to do so now. However, there are some very dangerous things that we see abroad that do not bode well for our economy at home.

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    The National Association of Purchasing Managers' Index shows that manufacturing actually began to fall last month. There is a deepening decline in export orders. The export index fell, as a matter of fact, last month for the sixth consecutive month. The trade deficit and other factors have resulted in a decline in factory jobs. We lost 29,000 of these jobs just last month. Perhaps we may see bigger declines in factory jobs ahead. There is a reduction in the economic growth and a reduction in wage pressure. Trade deficit in goods alone for May was a little over $21.5 billion.

    So there are indications that we are going to see a sharp decline in growth ahead, largely attributed to the financial crisis in Asia. I wonder what you think about all of those factors in concert, Mr. Chairman, and what we might do, both in terms of monetary and fiscal policy to, in effect, gird our loins against this onslaught, which is so apparent and indeed increasingly palpable.

    Mr. GREENSPAN. Obviously we are looking at the same data base that you are referring to, and one of the reasons why we have argued that we thought the rate of growth would slow down to a sustainable pace which would not be destabilizing is that we expect the Asian internationally-related events to be of a nature which would slow growth in the United States, which it has, as far as we can judge.

    The issue of forecasting how far it will go is exceptionally difficult to do. I have been in the forecasting business for 50 years, and I know when I can forecast something reasonably well and not. This is a tough one. It is an exceptionally difficult one to make projections about, which is the reason we spend so much time day by day just trying to evaluate what is going on and try to be prepared as best we can for events altering in a manner which we did not anticipate. So far it has not reached a stage that the Chairman characterized in his opening remarks, but we recognize that there has been no evidence of stability yet. Contagion is still there. Latin America has held up better than we would have expected at certain occasions. Southeast Asia has turned out to be worse than we had expected. But all of these pieces have to fit together in an overall policy framework, and that is what we try to do, and we try to come to an appropriate balance.
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    It is certainly the case that inflation has come down in recent years. It is an interesting issue as to whether, had we not, when we had the big underlying cost pressures in 1994, engaged in some tightening to cutoff the top of what we saw was a bulging inflationary set of forces, whether we would have ended up with as benign an outlook as apparently emerged in the last two or three years.

    Let me say with respect to real interest rates, real interest rates have actually been declining in the long end of the market in the last couple of years. To be sure, they have risen in the short end because we have kept the funds rate constant, and inflation expectations have doubtless been declining.

    But the ultimate determination as to whether or not interest rates are containing or expanding the economy can only be judged by looking at the economy itself, and we see that interest-sensitive areas of the economy, such as housing and motor vehicles, have been actually quite strong. If monetary policy were exceptionally restrictive at this stage, or even mildly restrictive, it is very hard to make the case that housing starts, for example, would be as buoyant as they have been, and motor vehicle sales as strong as they have been.

    So while it is certainly the case that short-term real interest rates have risen, it is quite conceivable that the falling long-term real rates has more than offset that, but either way we have not yet seen any constrictive elements within the domestic economy as a consequence of monetary policy. Obviously, to the extent that we do see that or the potential of that occurring, that will affect what our policy is, as it should.

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    Mr. HINCHEY. If I can have one more?

    Chairman CASTLE. Very briefly. We are running quite late here.

    Mr. HINCHEY. I appreciate your sensitivity to that, Mr. Chairman. I don't pretend to have any impact on your philosophy or your thought process, but I appreciate your sensitivity to this situation.

    My concern is simply this: Real wages for real workers have recently begun to go up, and they were stagnant for a long, long time, and there was a lot of unrest in this country, and appropriately so, because of the fact that people were working harder and longer and not getting ahead. They have begun to see some progress recently.

    I am deeply fearful that if we do not act appropriately, that the present problems that we are facing, largely originating in Asia, are going to have an impact on those people who have just now begun to enjoy the fruits of this growing economy. So whatever we can do to continue to assure that working people who work for wages particularly get the benefits of this economy, the better off we are all going to be in the long run.

    Mr. GREENSPAN. I agree with that.

    Chairman CASTLE. Mr. Bentsen.

    Mr. BENTSEN. Thank you, Mr. Chairman.

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    Chairman Greenspan, I apologize for having to leave during the early part of the questioning for some debate on the House floor. I have a number of questions, a number of which I will, of course, have to submit for the record, because I have got as much chance of getting an answer to all them as winning the lottery in the amount of time that I have. But let me ask one very quickly.

    With respect to the IMF, the House Majority Leader Dick Armey has stated, and I will paraphrase him, that he sees no reason to support policies of the IMF which are counterproductive. Is it your opinion that the policies the IMF and the G-7 have imposed on the Asian countries, specifically South Korea, Thailand, Indonesia, that those are counterproductive, or do you think those are productive policies?

    Mr. GREENSPAN. Some of them probably were mistaken in the early stages, but I would say, overall the policies, I think, have probably been positive.

    Mr. BENTSEN. Particularly since, say, the Christmas period or——

    Mr. GREENSPAN. In other words, there were a couple of false starts, and I would certainly scarcely give them an A, but I wouldn't give our policies As either in many areas, so that it is not an issue of do they always do exactly the right thing? I think not. But overall they have been a force mainly for good rather than evil, if I may put it into moral terms that the Chairman of the committee was putting it in. We are better off having done what has been done there, especially with endeavoring to contain monetary growth and monetary base expansion in a lot of these areas, than where there are no such facilities available.
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    Mr. BENTSEN. Thank you.

    My next question goes to what the Chairman of the subcommittee raised and my colleague from Alabama raised with respect to the unified budget surplus, and you, I think appropriately, point out that nonetheless there is still a $5.4 trillion debt outstanding. If you look at the figures, our debt-to-GDP ratio, and we have had this discussion before, has doubled since 1981, and our interest on the debt as a percentage of GDP has increased as well since 1981 to about 3 percent of GDP.

    Now, I think what you said was that you would prefer us paying down the debt, but if we were to break the virtuous cycle of the spending discipline or budget discipline we have had in the last few years, that you would prefer tax cuts to spending. I assume, because you would believe that, while both are a form of consumption, tax cuts may well be more efficient than Government spending.

    My first question is is that correct, but my main question is this: Wouldn't it be a mistake for us not to use this windfall that we may or may not have of $1.5 trillion over ten years—and you are right, we don't know if it is going to stay at that—to pay down the debt, which, in effect, would be more of an investment nature than a consumption nature, and can't we look at previous history and see that consumption, whether for spending or for tax cuts, does carry a price, and that price being the additional interest costs that we have had to pay if you look at just the 1981 to 1998 cycle? And would you feel that any change in the spending caps or in the revenue side which breaches the budget discipline we have had would have a negative market reaction as well?
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    Mr. GREENSPAN. It may well incidentally. My concern is that if you look at our commitments into the future that are currently embodied in the law, that the stability of the system, unless we get very major continued improvements in revenues, is in doubt. In other words, long-term CBO and OMB projections over the years have indicated that we are going to have to adjust, for example, Social Security. There are questions about outlay growth implied in the aging of the population more generally, which includes both Medicare and Social Security, and whether or not we have the real resources to meet those commitments. And what has happened in the last two or three years is a big bulge in receipts, the source of which is not altogether clear.

    And so my concern is that we commit further to new, various different type of entitlement programs which will make the situation worse, not better, if it turns out that the presumed receipts are really ephemeral, and that as I indicated earlier, the Japanese experience, where when they have this huge increase in asset values, the ratio of their tax receipts to nominal income rose significantly, and when it turned around, they reversed, and what I am not at all convinced of at this particular stage is that those very large surpluses which we are calculating are real, and I would be very concerned if we committed them on the expenditure side because I think it would be difficult to reverse. I think there is less danger on the tax side.

    Mr. BENTSEN. Thank you.

    Chairman CASTLE. Mr. Bentsen, this will be the final point.

    Mr. BENTSEN. I appreciate that, but nonetheless could you quantitatively state that whether it is expenditure or on the tax side, it would be better to put it on the investment side in retiring debt rather than either expenditure or tax reduction?
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    Mr. GREENSPAN. Yes. My first choice is to retire debt as much as we can because it has a positive economic impact, and in the event that some of this expected surplus is indeed ephemeral, it doesn't create a particular problem for us. But if we commit something which we are not sure we have, we are taking a risk. As I said in the Senate yesterday, if it turns out that it is just not possible to keep surpluses of these orders of magnitude without using them one form or another, I would very much be inclined to cut taxes than to put them into expenditure programs, because over the long run it is easier to get fiscal stability if your expenditure numbers are not escalating at a pace in excess of nominal income or nominal taxable base of the society.

    Mr. BENTSEN. And it is easier to change the revenue side than the entitlement side.

    Mr. GREENSPAN. Far easier too.

    Chairman CASTLE. Thank you, Mr. Bentsen.

    And, Chairman Greenspan, we thank you. It is as always a fairly exhaustive period of time that we go through this, but hopefully the questions that need to be asked were asked, and the answers that you should provide were provided, and we appreciate it, and we appreciate your continuing good work. We need you to go back in the field and make sure the stock market goes up before the end of the day.

    Mr. GREENSPAN. Yes, sir.
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    [Whereupon, at 12:53 p.m., the hearing was adjourned.]