SPEAKERS CONTENTS INSERTS
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CONDUCT OF MONETARY POLICY
WEDNESDAY, JULY 18, 2001
U.S. House of Representatives,
Committee on Financial Services,
Washington, DC.
The committee met, pursuant to call, at 10:00 a.m., in room 2128, Rayburn House Office Building, Hon. Michael G. Oxley, [chairman of the committee], presiding.
Present: Chairman Oxley; Representatives Roukema, Bereuter, Baker, Bachus, Castle, King, Royce, Ney, Paul, Weldon, Ose, W. Jones of North Carolina, Biggert, Cantor, Hart, Capito, Ferguson, Rogers, Tiberi, Miller, Grucci, LaFalce, Kanjorski, Waters, Sanders, C. Maloney of New York, Watt, Bentsen, Sherman, J. Maloney of Connecticut, Hooley, Carson, Meeks, Lee, Mascara, Inslee, Gutierrez, S. Jones of Ohio, Capuano, Ford, Hinojosa, Israel, and Crowley.
Chairman OXLEY. The Financial Services Committee will come to order.
Good morning, Mr. Greenspan. Chairman Greenspan, it is good to have you back before the committee; I note that you were the first and only witness at the very first hearing held by the then new Financial Services Committee, and then, as now, you were here to share with us your views on the state of the economy.
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I am proud to note for the record that since you were here on February 28, this committee has been hard at work and has compiled a long record of hearings and legislation with plenty more to come. I may note also that the Fed has been busy in that same period, cutting interest rates four more times since you were here last.
Chairman Greenspan, we have seen a number of heartening signs for the economy. Energy prices, particularly gasoline prices, are lower. We no longer have daily crisis reports from California about blackouts. The markets, while still volatile, also are up over their levels of 4 months ago, and consumer confidence remains high.
Looking at those indicators and others, it is tempting to think that we have turned the corner, that two or three quarters of slow growth were enough to reverse the economy, and that we are in recovery. However, I sense in all of the economic reporting, continued uncertainty and potential potholes ahead in the road to recovery. That is why I am glad you are here to share with us your insight, some of what William Greider once referred to as ''The Secrets of the Temple.''
Since you were here, Mr. Chairman, Congress has passed and the President has signed a tax cut aimed at stimulating the Nation's economy. The first vestiges of that tax cut will arrive in taxpayers' mailboxes within 2 weeks in the form of rebate checks. The last taxpayers should have these checks before the end of September. The committee would be interested in hearing how you think those checks and the rate cuts enacted will affect the economy in the third quarter and the second half and beyond.
I am sure Members also are interested to learn if you believe any other tax changes, targeted or broadly based, would be useful to get economic growth back on track, keep it there or stimulate productivity. For example, at a hearing in March, Majority Leader Dick Armey and economists Larry Kudlow and Jim Glassman endorsed the idea of allowing companies to expense technology purchases. The idea seems to hold the promise of increasing and maintaining productivity, and we would be interested in your opinion. Perhaps you have other suggestions as well.
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I also hope you will have time while you are here to address ways we might better direct the flows of capital to companies, particularly the newer and smaller ones that are the engines of both job growth and often of innovation in our economy. When capital is not directed efficiently to the companies that need it, in my view, the whole economy suffers.
Also, Mr. Chairman, I think the committee will be interested in hearing your views on trade, on the balance of payments and on the value of the dollar in foreign exchange markets. I, for one, would be especially interested in your views on efforts to increase trade, particularly the Administration's focus on gaining Trade Promotion Authority and developing a Free Trade Area of the Americas.
Most of Latin America, except for Mexico, is suffering economically to one extent or another, though not as badly as Argentina at this moment. It seems to me that its free trade agreement with the United States has helped insulate Mexico from the current slowdown while benefiting the U.S. at the same time. I am sure we will all be interested in your views on creating a hemispheric free trade zone.
In particular, I think we would be interested in hearing your thoughts on currency boards and dollarization of other countries' economies in view of the ravages Argentine currently is suffering. And I imagine many would like to hear your views on why the current level of the dollar has been sustained through this recent round of rate cuts, and whether the level may change naturally next year after the introduction of the euro is complete.
And finally, Mr. Chairman, I think all of us on the committee would like to hear some direct predictions about when you believe the economy will have finally turned the corner. I don't imagine you are carrying any predictions of a return to ''dot.com''-level stock market returns any time soon, but I think we would all like to hear some reassurance that you see a return to strong, steady growth sooner rather than later, and can give us some suggestions about how to get there and how to sustain it. I know I will look forward to your comments with interest.
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And, again, we thank you for your appearance, and I now recognize the Ranking Member, the gentleman from New York, Mr. LaFalce.
Mr. LAFALCE. Thank you very, very much, Mr. Chairman. I was about to open up my remarks by saying, Chairman Greenspan, I know you are reluctant to comment on fiscal policy, but because it is so important to the conduct of monetary policy and our economy, I was going to go ahead and ask you to comment anyway.
And then I heard Chairman Oxley also ask you to comment on a few things such as the desirability of expensing for technological equipment or investments, fast track authority for the Presidency, the hemispheric trade agreement, and so forth. So I decided, no, I shouldn't even be a little bit reluctant to ask you to comment on fiscal policy.
I do believe, returning to that issue, that your support for substantial tax cuts earlier this year was critical to the quick passage of the massive tax cut package this spring. As a matter of sound fiscal policy, not to mention sound public policy, I was deeply troubled by the tax cut package, and I believe we now expect that the Congressional Budget Office is going to be revising their Federal revenue estimates downward as a result of the slowing economy. And you, in your testimony, are going to say there is going to be a slowing economy in comparison to what we initially were projecting. And lower revenue projections also exacerbate the budget problems created by the tax package. In short, we will have too little revenue to achieve the twin goals of meeting current spending requirements and, in my judgment, anticipated future needs.
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To address the anticipated budget crunch, I believe the Administration is laying the groundwork for what I think is going to constitute a raid on the Social Security and Medicare Trust Funds. And Secretary O'Neill has already, in a sense, dismissed the trust funds as an accounting fiction, and OMB Director Daniels has been equally almost contemptuous of the concept.
I believe that good fiscal policy requires a balance of revenues and desired spending, and also an adequate preparation for future needs. This could mean maintaining budget surpluses, but it surely means protecting the Social Security and Medicare Trust Funds in anticipation of the baby boomers' retirement. And on this basis I believe we have failed to achieve sound fiscal policy so far this year.
Now, these are not simply my views. The International Monetary Fund had this to say in its latest article for consultation with the United States. Are you familiar with this, Chairman Greenspan?
Mr. GREENSPAN. I am, Congressman.
Mr. LAFALCE. OK. Good. And I will quote from it. The IMF said, quote: ''The trust funds for Social Security and Medicare were established originally as part of reform plans to partially prefund these programs to allow them to meet their long-term obligations. To achieve this purpose, the surpluses of these trust funds actually have to be saved in order to put aside real resources to meet the programs' future liabilities.''
In this context, the IMF goes to question the wisdom of the Administration's apparent willingness to raid these trust funds.
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In the same statement the IMF questions the sustainability of the tax cuts in the face of spending pressures and suggests that policymakers should be flexible in implementing the tax cut package.
I am concerned that we might be watching a train wreck proceed in slow motion as the tax cut package is phased in, and you have expressed considerable optimism in the past about our ability to accommodate the tax cuts based on expectations for sustained strong productivity growth. I will be interested to hear if you continue to have such optimism, or whether you have any reason to be at least less comfortable about that prospect.
It seems clear to me that we have thrown fiscal caution to the wind this year. We have rolled the dice, and I am troubled that we have seen some signs that the gamble will not pay off.
I thank you, Chair.
Chairman OXLEY. The Chair now recognizes the Chairman of the Subcommittee on Domestic Monetary Policy, Technology and Economic Growth, the gentleman from New York, Mr. King.
Mr. KING. Thank you, Chairman Oxley.
Chairman Greenspan it is a pleasure to welcome you here this morning, and I, on behalf of the entire panel, thank you for coming in and giving us of your time and your knowledge. And I think it is a tribute to the clout that you have that you will find Members of this committee trying to attach you to whatever views they might have on issues that even go far beyond your own. So I wish you well as the morning goes by as you bob and weave the thrusts and parries of Members of this committee.
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I am not going to bore you with a long statement. I would just like to say there were several things on my mind as we are entering this state of the economy. One is, as far as the reduction of interest rates, when do you think that one could reach a point of diminishing returns, when the maximum benefit that could be obtained from cutting interest rates will have been reached? Second, another one is what the continuing strength of the dollar means in the face of the continued reduction of interest rates; but also, second, whether or not it is impairing our export markets to an extent that it is having a negative impact on the economy? And I guess the logical question from that is, is it time to consider perhaps ways of weakening the dollar to help us as far as our trade deficit is concerned?
Another point is I know that over the past several months you seem to put a lot of stock in consumer confidence; that with all the variables out there, maybe the one most important is the maintenance of consumer confidence. And I would be interested in your thoughts as to where you think consumer confidence is going, and, again, how integral is that to the ultimate recovery that we are all hoping for?
And also, I guess, one final thing, and I will leave it at that, is the Trade Promotion Authority. If we are talking about long-term growth of the economy, how essential do you believe it is that something such as TPA is enacted and the President is given that power to negotiate? What impact would that have here and also in world markets and in our relation to world markets?
So with that I will yield back the balance of my time. And again, thank you for your time and interest. Thank you. I yield back.
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Chairman OXLEY. The gentleman yields back.
The Chair is now pleased to recognize the Ranking Member of the subcommittee, the gentlelady from New York, Mrs. Maloney.
Mrs. MALONEY. Thank you, Mr. Chairman.
And welcome, Chairman Greenspan.
I truly hope that the Chairman will tell us this morning that he believes that we have turned a corner, and that better economic conditions are ahead. Unfortunately, in my opinion, the single most dramatic change for Members of the committee to consider since the Chairman's last visit is the worsening fiscal situation of the Federal Government. With the rosy budget forecasts at the beginning of the year, Chairman Greenspan took the position that tax cuts and the relaxing of the Federal Government's decade-long fiscal discipline was the appropriate course for Congress to follow. Since February, economic forecasters have had to dramatically reduce their growth estimates downward. As a result, many budget forecasters are estimating that any remaining surplus outside of the Social Security and Medicare Trust Funds may have been fully committed already to the Bush tax plan.
This situation could be further worsened, given reports in today's Wall Street Journal and other newspapers, that Majority Whip DeLay and other Republicans are urging additional emergency spending this year. Also, since the Chairman's last visit, the Fed continued its dramatic interest rate corrections. First, the Fed raised rates six times through May of 2000, and then sharply reversed the course and lowered rates on six separate occasions this year for a total of 275 basis points.
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Despite these efforts to correct for past actions, the Fed has thus far been unable to spur much of a reaction in long-term interest rates. The interest rate on the 10-year Treasury note averaged 5.3 percent for the week ending on July 11, as compared to 5 percent the week ending January 3. I hope the Chairman will address this issue in his testimony as the impact of static long-term interest rates is felt by all Americans. Some market observers believe investors may be reacting to fears that our worsening Federal fiscal situation—they may be threatening a return to deficits in the next few years.
Finally, I would like to comment on one other issue in which the Fed is heavily involved. I have recently begun to hear complaints that the forthcoming revisions to the Basel Capital Accord that suggests that the new accord could unnecessarily raise capital requirements at U.S. banks. While this issue may sound arcane, it has a major impact on the amount of loans that U.S. banks can make to individual borrowers. I am closely monitoring the work of the Basel Committee, and I urge the Fed to use U.S. influence on the committee to oppose any proposal that increases capital requirements on U.S. institutions that are already considered today to be well capitalized. This is an especially bad proposal given the current weakness in the economy.
I look forward as always to the Chairman's comments. Thank you.
Chairman OXLEY. The gentlelady's time has expired.
We now turn to the distinguished Chairman of the Fed. And again, Mr. Chairman, welcome to the Financial Services Committee.
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STATEMENT OF HON. ALAN GREENSPAN, CHAIRMAN, BOARD OF GOVERNORS, FEDERAL RESERVE SYSTEM
Mr. GREENSPAN. Well, thank you very much, Mr. Chairman and Members of the committee. I will be excerpting from my prepared remarks and request that the full text be prepared for the record.
Chairman OXLEY. Without objection.
Mr. GREENSPAN. I appreciate the opportunity this morning to present the Federal Reserve's Semiannual Report on Monetary Policy.
Monetary policy this year has confronted an economy that slowed sharply late last year and has remained weak this year, following an extraordinary period of buoyant expansion.
By aggressively easing the stance of monetary policy, the Federal Reserve has moved to support demand and, we trust, help lay the groundwork for the economy to achieve maximum sustainable growth. Our accelerated action reflected the pronounced downshift in economic activity, which was accentuated by the especially prompt and synchronous adjustment of production by businesses utilizing the faster flow of information coming from the adoption of new technologies. A rapid and sizable easing was made possible by reasonably well-anchored inflation expectations, which helped to keep underlying inflation at a modest rate, and by the prospect that inflation would remain contained as resource utilization eased and energy prices backed down.
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In addition to the more accommodative stance of monetary policy, demand should be assisted going forward by the effects of the tax cut, by falling energy costs, by the spur to production once businesses work down their inventories to more comfortable levels, and, most importantly, by the inducement to resume increases in capital spending. That inducement should be provided by the continuation of cost-saving opportunities associated with rapid technological innovation. Such innovation has been the driving force raising the growth of structural productivity over the last half-dozen years. To be sure, measured productivity has softened in recent quarters, but by no more than one would anticipate from cylical influences layered on top of a faster long-term trend.
But the uncertainties surrounding the current economic situation are considerable, and until we see more concrete evidence that the adjustments of inventories and capital spending are well along, the risks would seem to remain mostly tilted toward weakness in the economy. Still, the Federal Open Market Committee opted for a smaller policy move at our last meeting, because we recognized that the effects of policy actions are felt with a lag, and, with our cumulative 2 3/4 percentage points of easing this year, we have moved a considerable distance in the direction of monetary stimulus. Certainly, should conditions warrant, we may need to ease further, but we must not lose sight of the prerequisite of longer-run price stability for realizing the economy's full growth potential over time.
Despite the recent economic slowdown, the past decade has been extraordinary for the American economy. The synergies of key technologies markedly elevated prospective rates of return on high-tech investments, led to a surge in business capital spending, and significantly increased the growth rate of structural productivity. Capitalization of those higher expected returns lifted equity prices, which in turn contributed to a substantial pickup in household spending on a broad range of goods and services, especially on new homes and durable goods. This increase in spending by both households and businesses exceeded even the enhanced rise in real household incomes and business earnings. The evident attractiveness of investment opportunities in the United States induced substantial inflows of funds from abroad, raising the dollar's exchange rate while financing a growing portion of domestic spending.
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By early 2000, the surge in household and business purchases had increased growth of the stocks of many types of consumer durable goods and business capital equipment to rates that could not be sustained. Even though demand for a number of high-tech products was doubling or tripling annually, in some cases new supply was coming on even faster. Overall, capacity in high-tech manufacturing industries, for example, rose nearly 50 percent last year, well in excess of its already rapid rate of increase over the previous 3 years. Hence, a temporary glut in these industries and falling short-term prospective rates of return were inevitable at some point. This tendency was reinforced by a more realistic evaluation of the prospects for returns on some high-tech investments, which, while still quite elevated by historical standards, apparently could not measure up to the previous exaggerated hopes. Moreover, as I testified before this committee last year, the economy as a whole was growing at an unsustainable pace, drawing further on an already diminished pool of available workers, and relying increasingly on savings from abroad. Clearly, some moderation in the pace of spending was necessary and expected if the economy was to progress along a more balanced growth path.
In the event, the adjustment occurred much faster than most businesses anticipated, with the slowdown likely intensified by the rise in the cost of energy that until quite recently had drained businesses and households of purchasing power. Growth of outlays of consumer durable goods slowed in the middle of 2000, and shipments of non-defense capital goods have declined since autumn.
Moreover, weakness emerged more recently among our trading partners in Europe, Asia, and Latin America. The interaction of slowdowns in a number of countries simultaneously has magnified the softening each of the individual economies would have experienced on its own.
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Because the extent of the slowdown was not anticipated by businesses, some backup in inventories occurred, especially in the United States. Innovations, such as more advanced supply-chain management and flexible manufacturing technologies, have enabled firms to adjust production levels more rapidly to changes in sales. But these improvements apparently have not solved the thornier problem of correctly anticipating demand. Although inventory-sales ratios in most industries rose only moderately, those measures should be judged against businesses' desired levels. In this regard, extrapolation of the downward trend in inventory-sales ratios over the past decade suggests that considerable imbalances emerged late last year. Confirming this impression, purchasing managers in the manufacturing sector reported in January that inventories in the hands of their customers had risen to excessively high levels.
As a result, a round of inventory rebalancing was undertaken, and the slowdown in the economy that began in the middle of 2000 intensified. The adjustment process started late last year when manufacturers began to cut production to stem the accumulation of unwanted inventories. But inventories did not actually begin falling until early this year as producers decreased output levels considerably further.
The rate of liquidation appears to have been especially pronounced this winter, and the available data suggest that it continued, though perhaps at a more moderate pace, this spring. A not inconsequential proportion of the current liquidation undoubtedly is of imported products, and thus will presumably affect foreign production, but most of the adjustment has fallen on domestic producers.
At some point, inventory liquidation will come to an end, and its termination will spur production and incomes. Of course, the timing and force with which that process of recovery plays out will depend on the behavior of final demand. In that regard, the demand for capital equipment, particularly in the near term, could pose a continuing problem. Despite evidence that expected long-term rates of return on the newer technologies remain high, growth of investment in equipment and software has turned decidedly negative. Sharp increases in uncertainty about the short-term outlook have significantly foreshortened the timeframe over which business are requiring new capital projects to pay off. The consequent heavier discounts applied to those long-term expectations have induced a major scaling back of new capital spending initiatives, though one that presumably is not long-lasting, given the continuing inducements to embody improving technologies in new capital equipment.
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In addition, the deterioration in sales, profitability and cash flow has exacerbated the weakness in capital spending. Pressures on profit margins have been unrelenting. Although earnings weakness has been most pronounced for high-tech firms, where the previous extraordinary pace of expansion left oversupply in its wake, weakness is evident virtually across the board, including most recently in earnings of the foreign affiliates of American firms.
Much of the squeeze on profit margins of domestic operations results from a rise in unit labor costs. Gains in compensation per hour picked up over the past year or so, responding to a long period of tight labor markets, the earlier acceleration of productivity, and the effects of an energy-induced run-up in consumer prices. The faster upward movement in hourly compensation, coupled with the cylical slowdown in the growth of output per hour, has elevated the rate of increase in unit labor costs. In part, fixed costs, non-labor as well as labor, are being spread over a smaller production base for many industries.
The surge in energy costs has also pressed down on profit margins, especially in the fourth and first quarters. In fact, a substantial portion of the rise in total costs of domestic non-financial corporations between the second quarter of last year and the first quarter of this year reflected the increase in energy costs. The decline in energy prices since the spring, however, should be contributing positively to margins in the third quarter. Moreover, the rate of increase in compensation is likely to moderate, with inflation expectations contained and labor markets becoming less taut in response to the slower pace of growth in economic activity. In addition, continued rapid gains in structural productivity should help to suppress the rise in unit labor costs over time.
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Eventually, the high-tech correction will abate, and these industries will reestablish themselves as a solidly expanding, though less frenetic, part of our economy. When they do, growth in that sector presumably will not return to the outsized 50 percent annual growth rates of last year, but rather to a more sustainable pace.
Of course, investment spending ultimately depends on the strength of consumer demand for goods and services. Here, too, longer-run increases in real incomes of consumers engendered by the rapid advances in structural productivity should provide support to demand over time. And thus far this year, consumer spending has indeed risen further, presumably assisted in part by a continued rapid growth in the market value of homes, from which a significant amount of equity is being extracted. Moreover, household disposable income is now being bolstered by tax cuts.
But there are also downside risks to consumer spending over the next few quarters. Importantly, the same pressure on profits and the heightened sense of risk that have held down investment have also lowered equity prices and reduced household wealth despite the rise in home equity. We can expect the decline in the stock market wealth that has occurred over the past year to restrain the growth of household spending relative to income, just as the previous increase gave an extra spur to household demand. Furthermore, while most survey measures suggest consumer sentiment has stabilized recently, softer job markets could induce a further deterioration of confidence and spending intentions.
While this litany of risks should not be downplayed, it is notable how well the U.S. economy has withstood the many negative forces weighing on it. Economic activity has held up remarkably in the face of a difficult adjustment toward a more sustainable pattern of expansion.
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The economic developments of the last couple of years have been a particular challenge for monetary policy. Once the financial crises of late 1998 that followed the Russian default eased, efforts to address Y2K problems and growing optimism—if not euphoria—about profit opportunities produced a surge in investment, particularly in high-tech equipment and software. The upswing outstripped what the Nation could finance on a sustainable basis from domestic saving and funds attracted from abroad.
The shortfall of saving to finance investment showed through in a significant rise in average real long-term corporate interest rates starting in early 1999. By June of that year, it was evident to the Federal Open Market Committee that to continue to hold the funds rate at the then-prevailing level of 4 3/4 percent in the face of rising real long-term corporate rates would have required a major infusion of liquidity into an economy already threatening to overheat.
Chairman OXLEY. Mr. Chairman, if I could just interrupt briefly to announce to the Members that there is a vote on the floor of the House. I plan to continue the hearing and the Chairman's statement, so if the Members want to go over to the floor and vote and then come back, and then we will obviously have that opportunity for questioning when the Chairman is completed with his statement.
Thank you, Mr. Chairman.
Mr. GREENSPAN. The increase of our target Federal funds rate of 175 basis points through May of 2000 barely slowed the expansion of liquidity, judging from the M2 measure of the money supply, whose rate of increase declined only modestly through the tightening period.
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By summer of last year, it started to become apparent that the growth of demand finally was slowing, and seemingly by enough to bring it into approximate alignment with the expansion of potential supply, as indicated by the fact that the pool of available labor was no longer being drawn down. It was well into autumn, however, before one could be confident that the growth of aggregate demand had softened enough to bring it into a more lasting balance with potential supply. Growth continued to decline to a point that by our December meeting, the Federal Open Market Committee decided that the time to counter cumulative economic weakness was close at hand. We altered our assessment of the risk to the economy, and with incoming information following the meeting continuing to be downbeat, we took our first easing action on January 3. We viewed the faster downshift in economic activity, in part a consequence of the technology-enhanced speed and volume of information flows, as calling for a quicker pace of policy adjustment. Acting on that view, we have lowered the Federal funds rate 2 3/4 percentage points since the turn of the year, with last month's action leaving the Federal funds rate at 3 3/4 percent.
Most long-term interest rates, however, have barely budged despite the appreciable reductions in short-term rates since the beginning of the year. This has led many commentators to ask whether inflation expectations have risen. Surely, one reason long-term rates have held up is changed expectations in the Treasury market, as forecasts of the unified budget surplus were revised down, indicating that the supplies of outstanding marketable Treasury debt are unlikely to shrink as rapidly as previously anticipated. Beyond that, it is difficult to judge whether long-term rates have held up because of firming inflation expectations or a belief that economic growth is likely to strengthen, spurring a rise in real long-term rates.
One measure often useful in separating the real interest rates from inflation expectations is the spread between rates on nominal 10-year Treasury notes and inflation-indexed notes of similar maturity. That spread rose more than three-fourths of a percentage point through the first 5 months of this year, a not insignificant change, though half of that increase has been reversed since. By the nature of the indexed instrument, the spread between it and the comparable nominal rate reflects expected CPI inflation. While actual CPI inflation has picked up this year, this rise has not been mirrored uniformly in other broad price measures. For example, there has been little, if any, acceleration in the index of core personal consumption expenditure prices, which we consider to be a more reliable measure of inflation. Moreover, survey readings on long-term inflation expectations have remained quite stable.
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The lack of pricing power reported overwhelmingly by business people underscores the quiescence of inflationary pressures. Businesses are experiencing the effects of softer demand in product markets overall, but these effects have been especially marked for many producers at earlier stages of processing, where prices generally have been flat to down thus far this year. With energy prices now also moving lower and the lessening of tautness in labor markets expected to damp wage increases, overall prices seem likely to be contained in the period ahead.
Forecasts of inflation, however, like all economic forecasts, do not have an enviable record. Faced with such uncertainties, a central bank's vigilance against inflation is more than a monetary policy cliche; it is, of course, the way we fulfill our ultimate mandate to promote maximum sustainable growth.
In reducing the Federal funds rate so substantially this year, we have been responding to our judgment that a good part of the recent weakening of demand was likely to persist for a while, and that there were significant downside risks even to a reduced central tendency forecast. Moreover, with inflation low and likely to be contained, the main threat to satisfactory economic performance appeared to come from excessive weakness in activity.
As a consequence of the policy actions of the Federal Open Market Committee, some of the stringent financial conditions evident late last year have been eased. Real interest rates are down on a wide variety of borrowing instruments. Private rates have benefited from some narrowing of risk premiums in many markets. And the growth of liquidity, as measured by M2, has picked up. More recently, incoming data on economic activity have turned from persistently negative to more mixed.
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The period of sub-par economic performance, however, is not yet over. We are not free of the risk that economic weakness will be greater than currently anticipated, and require further policy response. That weakness could arise from softer demand abroad, as well as from domestic developments. But we need also to be aware that our front-loaded policy actions this year, coupled with the tax cuts under way, should be increasingly affecting economic activity as the year progresses.
The views of the Federal Reserve Governors and Reserve Bank presidents reflect this assessment. While recognizing the downside risks to their current forecast, most anticipate at least a slight strengthening of real activity later this year. This is implied by the central tendency of their individual projections, which is for real GDP growth over all four quarters of 2001 of 1 1/4 to 2 percent. Next year, the comparable figures are 3 to 3 1/4 percent. The civilian unemployment rate is projected to rise further over the second half of the year, with a central tendency of 4 3/4 to 5 percent by the fourth quarter and 4 3/4 to 5 1/4 percent four quarters later. This easing of pressures in product and labor markets lies behind the central tendency for PCE price inflation of 2 to 2 1/2 percent over the four quarters of this year and 1 3/4 to 2 1/2 percent next year.
As for the years beyond this horizon, there is still, in my judgment, ample evidence that we are experiencing only a pause in the investment in a broad set of innovations that has elevated the underlying growth and productivity to a rate significantly above that of the two decades preceding 1995. By all evidence, we are not yet dealing with maturing technologies that, after having sparkled for a half decade, are now in the process of fizzling out. To the contrary, once the forces that are currently containing investment initiatives dissipate, new applications of innovative technologies should again strengthen demand for capital equipment and restore solid economic growth over time that benefits us all.
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Thank you, Mr. Chairman. I look forward to your questions.
Chairman OXLEY. Thank you, Mr. Chairman.
Let me begin with some questions. I was reminded when you talked about the effects of the tax cut and the interest rate cuts, I was reminded back in 1981, my freshman year in the Congress, and my first major vote was on the Reagan tax cut. And I particularly remember in 1982 the Reagan tax cut, as you will remember, didn't take effect or didn't pass until August of 1981. And we heard some criticisms early in 1982 in the first quarter that the tax cut was not working. And indeed, there were different circumstances, obviously, and the economy was in far worse shape back then, particularly because of stagflation.
What is your sense of the lag time or the time that it would take the effect of the lower interest rates and the lower tax rates to really have a stimulative effect on the economy?
Mr. GREENSPAN. Mr. Chairman, the experience we have had over the years is that such a tax cut tends to impact over a number of quarters. And it is unlikely that we will see any immediate impact, and, indeed, it usually stretches out and accumulates over time. If past experience holds, I think we should be seeing the impact develop as we get into the latter months of this year and into the year 2002.
Chairman OXLEY. And indeed, if you look at the history, I guess the economy really started picking up in 1983, and by 1984 it was rather substantial and initiated the longest—at that time, the longest period of economic growth that we had in a non-war situation. So obviously, I think all of us would caution patience in this regard.
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Let me ask you about the trade promotional authority, formerly known as Fast Track, that is currently before the Congress. How much weight do you attach to that initiative in terms of our ability to maintain competitive areas in trade and sustain our economic growth?
Mr. GREENSPAN. Well, Mr. Chairman, I think the data are unequivocal that the extraordinary expansion in trade in recent decades has been a material factor in rising standards of living throughout the world and has been a major contributor to growth in the United States. I think that the increasing ability to interchange goods and services with our trading partners and the competition which that induces is an important and, in fact, an indisputable and necessary factor for continued cutting-edge growth, which this country is so well known for.
My own impression is that while the overall international trading system would be assisted by Fast Track and the implications of a broader range of trade agreements, I think it is the United States which would benefit the most.
Chairman OXLEY. Thank you.
Let me ask you about the dollar. There are many manufacturers in my home State of Ohio who have been affected by the strength of the dollar and their inability to export as much as they would like. As a matter of fact, since 1995, mid-1995, the dollar appreciation has been about 33 percent in real terms. And indeed, the manufacturing sector has taken the biggest hit. The headlines today were clearly directed at the manufacturing sector and the continued softness in the manufacturing sector.
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Should the Fed, should the Treasury, should the Congress pursue policy that would soften the dollar? Or are you convinced that the marketplace ultimately will work in that regard?
Mr. GREENSPAN. First, as I have said before this committee previously, there is a general agreement within the United States Government, I think for very good reasons, that the dollar's exchange rate is discussed only by the Secretary of the Treasury, and the purpose of that is that over the years it has been our experience that we need a single spokesman, and it has very clearly worked well.
There is no question that econometric models do show that exchange rates obviously affect trade. In fact, trade is one of the factors which impacts on the exchange rate. But the data also show that the really major impact, both plus and minus, on trade is the economic growth or lack thereof of our trading partners. It is far more important to our exporters what is happening in the markets overseas than what is happening to the exchange rate per se.
Chairman OXLEY. Thank you, Mr. Chairman. My time has expired.
I now recognize the gentleman from Vermont, Mr. Sanders.
Mr. SANDERS. Thank you, Mr. Chairman.
And, Mr. Greenspan, nice to see you again.
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Mr. Greenspan, I think many millions of Americans wonder why when issues come down the pike that on one hand affect the wealthy and multinational corporations and on the other hand effect working people, you always seem to side with the wealthy and the multinational corporations. I would like to ask you three questions that I think Americans would like to know the answer to.
My understanding is, unless you have changed your view, that you are opposed to raising the minimum wage, which is today at a disastrously low $5.15 an hour. So I would like you to tell us if you think that a working person or a family can live on $5.15 an hour.
The second question that I would like to ask you is about the recently passed tax bill in which the wealthiest 1 percent of the population received 38 percent of the tax benefits. And at a time when millions of Americans today are working longer hours for lower wages than they used to, why is it that you think it is good public policy the 38 percent of the tax breaks, hundreds and hundreds of billions of dollars, should go into the hands of the wealthiest people in this country?
And my third question deals with the trade issue, as you know, and it doesn't get enough discussion, and, Mr. Chairman, I hope that this committee can get more involved in that issue. United States of America today has a record-breaking trade deficit of over $400 billion. Over the last 20 years we have lost millions of decent-paying manufacturing jobs. Young people who graduate high school who do not go to college, in fact, today, because of the decline in manufacturing, are earning 25 percent less than was the case 20 years ago, because the manufacturing jobs are not there, and they are now working in McDonald's. We have an $84 billion trade deficit with China, and American workers are put in the position of having to compete against desperate people in China who make 20 cent an hour. And I suspect that you are supportive of our trade relations with China, would like to see Most-Favored-Nation status passed again tomorrow.
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Can you tell the American people why you think not raising the minimum wage, maintaining a disastrous trade policy, and giving huge tax credits for the rich works for the benefits of the average American?
Mr. GREENSPAN. Certainly.
Mr. SANDERS. I and millions would love to hear it.
Mr. GREENSPAN. First of all, I think you misclassify me by saying that I always come out on the part of multinational corporations.
Mr. SANDERS. I would love to hear you say something different today.
Mr. GREENSPAN. I hope I come out in favor of the strength and growth and sustainability of the American economy.
First, with respect to the minimum wage, the reason I object to the minimum wage is I think it destroys jobs, and I think the evidence on that, in my judgment, is overwhelming. Consequently, I am not in favor of cutting anybody's earnings or preventing them from rising, but I am against them losing their jobs because of artificial Government intervention, which is essentially what the minimum wage is.
So it is not an issue of whether, in fact, I am for or against people getting more money. I am strongly in favor of real incomes rising, and, indeed, that is the central focus of where I would come out.
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Mr. SANDERS. Are you for abolishing the minimum wage?
Mr. GREENSPAN. I would say that if I had my choice, the answer is, of course.
Mr. SANDERS. You would abolish the minimum wage?
Mr. GREENSPAN. I would, yes, because if what I say is accurate, then the minimum wage does no good to the level——
Mr. SANDERS. And you would allow employers to pay workers $2 an hour if the circumstances provided that?
Mr. GREENSPAN. The issue is that they will not be paying $2 an hour because they won't be able to get people.
But let me go on to your next questions. We have had this argument before. The issue of the tax cut is that, as you may recall, I very studiously avoided committing myself to anybody's tax cut back earlier this year. I was for a tax cut in principle, but whether it was that which was being argued by the Democratic Minority at that time, or whether it was the President's, I never commented on. And therefore, I still don't comment on the structure of the tax cut per se.
With respect to trade, the evidence that I have been able to gather suggests to me that there is no evidence that trade either adds or subtracts jobs. When we were dealing on the side of very strong labor markets and job creation, I never argued in favor of trade expansion because it would create jobs. I argued because it would increase productivity and standards of living. Consequently, I argued that it neither increases nor decreases jobs.
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Chairman OXLEY. The gentleman's time has expired.
The Chair now recognizes subcommittee Chair, Mr. King.
Mr. KING. Thank you, Mr. Chairman.
Chairman Greenspan, I hope you didn't cover this while I was away. I am sorry. I would just like to ask you the extent to which you think the bad economic news out of Argentina will have an impact on the U.S. economy, if so, when and to what extent; and what measures do you think the United States can do to anticipate any of those deleterious impacts?
Mr. GREENSPAN. Congressman, I think that the problems that Argentina is struggling with at this stage are largely domestic. Clearly, they have significant debt problems, and they are working with the International Monetary Fund and other international agencies to come up with a plan to resolve the problems with which they are dealing.
It is evident that there is a slightly better tone in Argentine markets and international markets with respect to Argentine financial instruments, as is evidenced by the apparent agreements that are occurring between President de la Rua and the provincial leaders. That has had a clearly positive effect on markets, and for the moment, it looks as though things are improving. But they have got difficulties ahead of them, and I think they are working very hard to resolve them.
The degree of so-called contagion, which is the effect on us and everybody else, is not very large at this particular point, and frankly, I don't expect it to become very large unless something which is wholly unexpected occurs. But, for the moment, it is a very difficult problem that they have. They are working on it, and we trust that they will resolve it in satisfactory fashion.
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Mr. KING. Could I ask the same question about Japan, the sluggishness of the Japanese economy, the impact that would have on the overall Asian economy, and in fact, the congeneric effect on the United States.
Mr. GREENSPAN. It is apparent the weakness in the Japanese economy is impacting on other economies because they are a major importer of goods and services, especially in the technological goods areas, and as a consequence, you can see some of the effects in Southeast Asian exports—especially the high-tech area, being impacted, because not only are we weakening in that area, but so are the Japanese.
The Japanese problem, as I indicated on many occasions before this committee, is essentially that they have to come to grips with their so-called financial intermediation system, which is largely commercial banks, and the very substantial non-performing loans which have occurred as a result of the fairly dramatic decline in commercial real estate collateral, which is usually the backbone of the Japanese banking system.
If that gets resolved—and Prime Minister Koizumi is clearly pushing on getting that resolved—they are going to have trouble moving forward, but Koizumi, as far as I can judge, is moving in the right direction, and I trust that they are able to implement the types of policies which he has been promulgating for a while.
Mr. KING. On the question of inflation, these interest rate cuts that we have had over the past several months. Do you see a threat of that fueling inflation? I know last year you were concerned about inflation. Do you see now that the cuts are being made that inflation is being fueled?
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Mr. GREENSPAN. Congressman, there is very little evidence of inflation in our economy in the sense that, as you go from layer to layer, you may see some inevitable changes in prices, but if you extract out the very substantial direct and secondary effects of energy price increases, which have now crested and are turning down, it is very difficult to find inflationary pressures.
But, as I said in my prepared remarks, forecasting is, at best, something which has a mixed record, and as a consequence, we as central bankers are always watching this process very closely.
All I can say to you is that, at the moment, I see no evidence of it. But that is not the same thing as saying that I can project with great confidence that for the indefinite future it will remain that way.
Mr. KING. Thank you, sir.
Chairman OXLEY. Time has expired.
I turn to Mr. LaFalce.
Mr. LAFALCE. Thank you, Mr. Chairman.
I said I was really going to focus on broad monetary policy rather than other issues, but then you made some statements. Let me go to a statement you made in response to Mr. Sanders' questions, where you said there is no good evidence that suggests that trade either increases or decreases jobs, but that it is good because it increases standards of living.
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Mr. GREENSPAN. I should have said, jobs overall. It does obviously affect jobs within individual industries, certainly.
Mr. LAFALCE. But there is evidence that it does increase standards of living?
Mr. GREENSPAN. Yes.
Mr. LAFALCE. Now, we can always argue for it, because it can open up economies, because it can improve the relations between countries; if you are trading goods, you are not trading armies, and so forth.
But I want to focus on what you did say, there is evidence that it increases standards of living, because the question would be, for whom? I think I am reading between the lines that you are saying ''in the aggregate,'' because you are saying that there are no aggregate increases in jobs, but there may be an increase for some and a decrease for others.
But, also, with respect to the standard of living, although there is an aggregate increase in the standard of living, is it disproportionate? Do the studies indicate that certain countries engaging in trade, for example, developing countries, would see an increase in their standard of living, whereas there may or may not be a causal relationship between that trade and an increase in the standard of living in a developing country?
I don't know the answer. I am searching.
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Mr. GREENSPAN. No. The evidence, as best I can judge, is that trade very significantly increases the average level of real income in developing nations. But the analysis also suggests that there is no evidence that trade alters the distribution of income within a developing country, which suggests therefore, that if you can get the total level of real income to rise, which is another way of saying productivity to rise, you pull up the whole level of income in those societies.
And as a consequence, I would say that the extent to which trade increases productivity—increases competition which generates the productivity—it is across the board.
I do not deny that there are very significant differences that show up in a lot of different countries. But, as a broad general statement, what I have said, as far as I understand it, is what the data do show.
Mr. LAFALCE. I can accept that. But I think that also it indicates that there are going to be a number of pocket areas, or industries, or peoples that would not be beneficiaries that might be harmed. And I really think that public policy has to focus on the best means of dealing with them.
And I don't think we have done a good job of that in the United States, or at least I think we can do a much better job.
Mr. GREENSPAN. I agree with that, Congressman. I think that, as I have indicated before, if indeed we are getting, as a consequence of competition, a movement of capital from the less-productive industries in this country and abroad to the cutting-edge technologies, that is another way of saying that part of the industries in the country or some of the industries and some of the companies are going to be cutting back. And there are workers there, through no fault of their own, who are losing their jobs, and I think that we ought to address that. What I do not think we ought to do, however, is use protectionist legislation in order to prevent that adjustment process from occurring.
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Mr. LAFALCE. OK.
Let me switch to monetary policy. I am always troubled by what I draw to be the good news/bad news dichotomy. If there is bad economic news, well, this could be good news for investors, because it is an indication that the Fed is going to lower rates in the future. And if there is good economic news, well, this could be bad news for investors, because it is an indication that the Fed would be less likely to decrease rates and possibly, you know, increase them, and so forth.
I don't know what, if anything, can be done about that.
But to what extent—I mean, it is one thing to say that you will conduct monetary policy, not with an eye to the markets but with an eye to the economy. On the other hand, there is such a relationship between the markets and the economy that it is—I think not almost, it is impossible to conduct monetary policy without factoring in and giving great weight to what impact the market movements will have on the real economy.
How do you deal with that?
Mr. GREENSPAN. Well, Congressman——
Mr. LAFALCE. With great difficulty, I am sure.
Mr. GREENSPAN. Of course. That is why monetary policy is a difficult activity. I don't deny that. What we do is focus on the economy, and clearly to the extent that financial factors in our judgment are affecting the economy or will affect the economy, clearly we focus on them.
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But remember that there are often occasions when financial activity will not affect the economy. So while it is true that there is a very close relationship, it is not airtight, and it is not the same as saying that if you target the financial variables rather than the economy, you will automatically obtain maximum sustainable economic growth, which is our fundamental goal.
In a number of instances that does happen to be true, but you have to be very careful to make the distinction between what we are focusing on. So that we examine and evaluate financial factors only to the extent that they will impact on the American economy one way or the other.
Chairman OXLEY. The gentleman's time has expired.
The gentlelady from New Jersey, the Vice Chair of the committee.
Mrs. ROUKEMA. I thank the Chairman and Chairman Greenspan. We welcome you here today. And I have listened, tried to listen very intently. But Mr. LaFalce has preempted the focus of my question, which had to do with monetary policy and the rate cut; and I don't know if when I was over there voting, if you had any implications—or if there are any total implications about what your action may or may not be in August when you have the next Open Market Committee meeting.
And I don't want to put you to the test here, but let me just say that I have strongly supported and think that you have been very well advised in the past on your rate cut proposals.
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That having been said, you can feel free to say what you wish or ignore the question in terms of the upcoming evaluation.
Mr. GREENSPAN. I will scrupulously opt for ambiguity on that very specific question.
Mrs. ROUKEMA. I noted that. But we can come to some assurance or conclusion based on what you have said thus far, that is, that there is an improved economy here, that there are heartening signs in the economy. Yes?
Mr. GREENSPAN. I do think that we are seeing signs that the bottom is beginning to structure itself. It is still tentative, and clearly the risks, as we put it in our official statements, are toward economic weakness, and indeed that is the case.
But if you look at it in terms of the rate of deterioration, it is slowing, very clearly. In fact, as I put it in my prepared remarks, what is really quite remarkable is that with this extraordinary litany of negative elements that have been going on day by day, month by month, the economy is still standing, if I may put it that way.
And that is suggestive of the fact that there is some monumental support in the system. And in that regard, while I would scarcely want to forecast the intermediate or short-term period, because there are a lot of negative factors throughout, there are the first signs that something of a positive nature seems to be developing. And as I said, the data that are coming in, which have been unrelentingly negative for quite a period of time, have now turned mixed.
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Mrs. ROUKEMA. I am glad to hear you say that. It underscores what you did say in your formal statement. But I wanted to hear you say it in the context of a question of rate cuts in the future.
Let me ask you this as the Chairwoman of the Housing Subcommittee—by the way, in terms of the overall tax bill, I voted for it, and I voted for it enthusiastically, although I would have had it more savings- and investment-oriented.
But I wonder, on the housing front, if you would make any recommendation or have any opinions about how we not only make it more economical, but provide more incentives through the tax code or investment strategies to get more housing out there, and to make it very accessible to middle-income and low-income people, particularly with respect to mortgages, mortgage down payments, and so forth.
We need that kind of help, and I wonder if you, from your perspective, could give us an insight or a recommendation.
Mr. GREENSPAN. Well, I think it is important first to recognize that we are not doing a bad job on housing. I mean, the housing start figures this morning, for example, were reasonably good despite all of the negative elements involved in the various high-tech areas. If you look at the broad markets for certain consumer durable goods, like motor vehicles, which are still doing reasonably well, and housing, we have to say that the data are not bad.
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We can see by the extraordinarily high level of refinancings that are going on that people are beginning to lower their costs of servicing, and most remarkable is that despite all of the general weaknesses that we perceive in the economy, the underlying market value of one- to four-family homes is moving up significantly.
Capital gains in this area have been really quite remarkable. And as I indicate in my prepared remarks, there is very evident strength that is coming into the consumer markets from the extraction of equity out of homes.
What this suggests is that we have constructed a very sophisticated housing economy, and it is having a significant effect on consumer spending and indeed the rest of the economy, so that while I would certainly not disagree with the desire to improve upon it—and I think there are a lot of things we can do—I think it is important for us to recognize that it is in reasonably good shape at this stage, and that we have done an awful lot which has improved the system as a whole.
Chairman OXLEY. The gentlelady's time has expired.
Mrs. ROUKEMA. Thank you. I appreciate it.
Chairman OXLEY. Mrs. Maloney.
Mrs. MALONEY. Thank you, Mr. Chairman.
Chairman Greenspan, it is widely held that the future of the economy is based on increased productivity from technological excellence. You yourself have said many times that the advances in technology were a primary force in the expansion of the United States economy in the 1990s.
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Unfortunately, many of the companies that drove the successes of the country in the last decade are facing dire circumstances today. As a result, people are losing jobs, investors have seen their savings depleted, and a recent report indicated that the average 401(k) retirement balances have fallen over a 1-year period for the first time. Our technology sector may take years to recover.
It would appear that the Fed's policies may have contributed to this pattern of bubble-and-bust, raising interest rates six times from June of 1999 to May of 2000 and then sharply reversing course and cutting rates dramatically this year.
My questions are about the Fed's actions of the last 2 years and going forward, the impact of severe problems in the technology sector on the fiscal situation here in Washington.
Looking back, why did the Fed continue to raise rates as technology companies were hemorrhaging workers and market cap through May of 2000 and going forward? What is the impact on the fiscal situation of the Federal Government if productivity does not increase but remains strong in the years ahead, especially since many of the increases in productivity of the last 10 years were powered by the technology sector that is suffering now so substantially in our economy.
Mr. GREENSPAN. I tried to address that in some detail while you were out voting, so rather than take your time at the moment, I tried to explain some of that issue in my prepared remarks.
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Let me just say that the productivity data which are showing softness in the last two or three quarters have come down pretty much in line with what one would expect if the underlying productivity trend were rising. So it is not something which suggests that this is a bubble without any underlying fundamentals. Indeed, it is very likely that the second quarter data—which we don't have yet, so I am making very rough approximations—are very likely to be positive, reversing the negative number in the first quarter.
But overall, I think that the budget outlook does depend on productivity increasing at a pace faster than it did in the 20 years prior to 1995. I see no evidence to suggest that that has changed, that is, that the numbers being used by OMB or CBO for long-term projections have been compromised in any significant way.
The important issue that I try to make—not in the remarks I made while you were out voting, but it is in my prepared remarks which I didn't deliver—is that it is to be expected that we will often, as central banks, move up rates and move them down as we confront significant changes in the business cycle, and what we were responding to in the last couple of years was a surge in investment—remember that we were getting increases in production, 50 percent at an annual rate, for all high-tech, on average. That is utterly unsustainable. We were leaning against it, as indeed the capital markets were. And then as the process came to a better adjustment, we reversed, which is precisely what you would expect us to do and what we have done in the past, and I would certainly expect we will do in the future. And the process of trying to address imbalances between investment and savings, which emerged in 1999, and the reverse, is a typical central bank policy process. And looking back, I think we did about as good as you could for that type of cyclical set of events.
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Chairman OXLEY. The gentlelady's time has expired.
The Chair is pleased to recognize the gentleman from Long Island, Mr. Grucci.
Mr. GRUCCI. Thank you, Mr. Chairman.
Mr. Chairman, it is great to have you with us again, and your insight is also helpful to Members here, certainly to me. In listening to the first part of your prepared text—and I apologize for having to step out to vote on the Journal, but I did hear that you talked about inventories as a function of the economy.
My question goes along these lines: we have inflation at a low, and it is in check. We have interest rates at their lowest point in a long time. Access to capital seems to be fine, and the housing starts are strong, as you have indicated. So why are there still high inventories?
And to the extent that you can answer this question, what are the inventory levels, and how long do you think it will take before we can bring them down so that we can get back into manufacturing—which I would assume is the message that will help stimulate the economy; and if indeed that isn't, are we missing something as a stimulus package, for example, omit a capital gains reduction?
Mr. GREENSPAN. Congressman, I think the evidence suggests that inventories are still declining. In other words, the rate of liquidation, while it has slowed some, is still adjusting, and it is a reflection of the improvement in the technologies which has enabled rapid adjustments to take place. And I think it will go on for a while in the high-tech area where, for example, in communications equipment we are only now beginning to see the inventory rise come to a halt. In other areas of high-tech there is some liquidation, but just now beginning. In the first quarter, a very significant part of the adjustment was in motor vehicles, which had extended inventories to their days supply well in excess of normal, and with a few model problems now, inventories are reasonably well in place.
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The important issue is that you do not need an end to inventory liquidation before production starts to come back. What you need is a dramatic slowing in the rate of decline, because if consumption holds up and production is below consumption, which is inventory liquidation, just slowing the rate of liquidation raises the level of production and jobs.
We have not yet got to that point, but that is the process which we expect to evolve, especially if overall final demand holds up reasonably well.
Mr. GRUCCI. To the issue of capital gains, do you see that as a help to the economy at this point, capital gains reduction?
Mr. GREENSPAN. Congressman, I have always been in favor of capital gains reductions as a general, overall policy. I have stipulated that I did not think that the capital gains tax as such was, from an economist's point of view, an effective means of raising revenue.
I think it is a public policy issue, but from an economic point of view, I find it not a useful tax to raise revenue. So that I am obviously, other things being equal, and they rarely are, but other things equal, I am always in favor of addressing the capital gains tax in the effort to reduce it. I wouldn't say that I would be in favor under all conditions, but as a longer-term issue, if you could substitute other taxation for capital gains taxation, I would always be in favor of that.
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Mr. GRUCCI. Thank you.
I yield back the remainder of my time.
Chairman OXLEY. The gentleman yields back the balance of his time.
The gentleman from Pennsylvania, Mr. Kanjorski.
Mr. KANJORSKI. Thank you, Mr. Chairman.
Mr. Chairman, welcome to the committee. I want to follow on something Mr. Sanders said. He gave you an opportunity to defend your purest position as a free marketer when you testified you were opposed to the minimum wage.
That is a little disappointing. I understand your——
Mr. GREENSPAN. Remember, it is not because it is a free market issue; it is because I think it destroys jobs, and I don't like to see people lose their jobs.
Mr. KANJORSKI. Mr. Chairman, we were down to about 4 percent unemployment. We couldn't find hide nor hair of employees to work. There are still a great deal of American employees who are being paid the minimum wage.
But not to argue that point with you, you may have provided the answer, too.
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In my area of Pennsylvania, in the last 3 weeks, we have lost about 1,500 highly prized manufacturing jobs to Mexico; and the statements of the companies that were leaving were that they can't pay $18 an hour in Pennsylvania, but they certainly could compete at $1 an hour in Mexico. And maybe by doing away with the minimum wage, we can save those jobs in Pennsylvania, because then we can compete with Mexico.
If that is the policy, I would assume that would result. But I am not getting into that.
I am going to give you the other side of the coin. Most recently, something troubling, a company that was losing money, significant loss of money and potentially going into insolvency, had just paid one of its CEOs a bonus of $16 million. And then a health care company, which is in dire straits as a result of the entire health care field, announced as a salary for their CEO to be $40 million a year with stock options of $160 million a year.
Obviously, he is not affected by the minimum wage. But I was wondering whether you think there are any policy considerations there that—if we can reduce the minimum wage, do we just set this economy afire and let hell be damned and anybody draw anything that they can support.
Mr. GREENSPAN. Well, Congressman, I am disturbed by some of those numbers myself. I don't think that shareholders are essentially looking after their interests properly, and I think some of the reasons why some outsized payments are being made, especially under so-called ''golden parachutes'' or the like, are based on motives which I don't consider to be particularly sterling.
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Whenever you deal with an economy such as we are dealing with, which is effectively an open market, competitive economy, it is very difficult to find all forms of what appears to be cut-throat competition and egregious actions, I don't deny that. The problem basically is that the countries or the economies which try to eliminate that end up as stagnant economies, and I think that is inappropriate.
But if you ask me whether I feel comfortable with some of those payments, I do not.
Mr. KANJORSKI. The final question is really more to policy, Mr. Greenspan. I looked at your statement and heard your testimony, and I would project that you are one of those economists that has seen an end-year turn, and the economy is OK.
I am not as optimistic in that, particularly in light of the problems still continuing in Japan and now the potential in the EU of going under. From what I understand of the American economy, other than really housing and the auto industry and unusual consumer optimism, we could slowly be deteriorating into a recessionary problem.
My question is, assuming things do not occur as you anticipate, is it time that we have a contingency plan, since we are facing a global economy without the institutions in place to necessarily put on the brakes or control the stimulant effect that Government could have on various economies around the world, even though we have a rather sophisticated way of doing it in the United States?
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Can you give me some assurances that the Federal Reserve is working with those people, if not the Congress, toward a contingency plan if, come December or January of this year, the downturn is continuing and the stabilizing base that you are talking about doesn't readily appear?
Mr. GREENSPAN. Well, first of all, let me just say Congressman, that it is difficult to take our economy and take consumers and housing—consumer expenditures and houses—and say the rest is not doing well. If you have stable consumer and housing sectors, that is going to support the total system, because that is a very big part of the economy.
Mr. KANJORSKI. Do you believe that is going to continue and not deteriorate?
Mr. GREENSPAN. I can't say that.
Mr. KANJORSKI. Well, I guess I am.
Mr. GREENSPAN. All I can say to you is it has been remarkable.
Mr. KANJORSKI. Should we worry if housing starts to deteriorate and consumer confidence starts to fall in the next several months?
Mr. GREENSPAN. Oh, sure. As I said in my prepared remarks, I think that we are not out of the woods, and there are clearly risks that a number of things that could go wrong could very well go wrong.
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But to respond to your question very specifically, we obviously are in continuous contact with our trading partners abroad. We have meetings periodically amongst central bankers in various different areas of the world. And there is, working through finance ministers and central bankers, especially for the G–7 and the G–10, a secretariat and infrastructure to effectively integrate all of our various different policies and discuss them one way amongst ourselves.
So that the answer is, yes, we do obviously communicate. We are in constant communication in one sense, in that we know how to get in touch with somebody very quickly, and when we have to, we always do.
Chairman OXLEY. The gentleman's time has expired.
The gentleman from California, Mr. Royce.
Mr. ROYCE. Thank you, Mr. Chairman.
Welcome, Chairman Greenspan. We here in the United States have one of the lowest personal savings rates in the world, and in the past, that has been because we have run deficits in every year and because Americans just don't save.
We have done something about the deficit situation; with a little bit of fiscal discipline, we have turned that around. But we are still down to the fact that Americans don't like to save and invest. We have got—in 1999, I think it was—a 2.2 percent investment rate, which was the lowest savings rate since the Great Depression.
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Now, in order to affect that, one of the things we have tried to do in the past is to push the creation of IRAs, 401(k) plans, medical savings accounts, flexible spending accounts for health care, education savings accounts, items like this.
I would argue that maybe that has done some good. But our support for these things has been half-hearted.
For example, with medical savings accounts it is very, very difficult under the regulations that were set up to actually have those offered to many Americans with flexible spending accounts for medical care. They, in fact, can't be rolled over from year to year. So 70 percent of the employees that are offered that option don't do it because they will lose it at the end of the year because it is not a true health banking system.
And I guess my question is, if we were to actually expand this type of savings incentive in the market for people, could the creation of true medical savings accounts and flexible savings accounts and so forth lead to a significant expansion of the economy, because you would have that savings and investment in the capital markets that would go on then to cause increasing production activity? And I would like your view of that.
Mr. GREENSPAN. Well, first of all, let me just say that the average householder would not agree that they are saving less. The reason they would argue that is that when they think in terms of savings, they take all of their assets, and so that where our savings rate, the one that we publish, shows a very low savings rate, in fact, it is negative if you take it literally, it is partly a fiction in the sense that what we do is we exclude the capital gains that people perceive as a value. So that if you have, as indeed we do, a reduction in disposable income by including taxes on capital gains and indeed taxes on the capital gains of stock options, you actually reduce disposable income significantly, but don't take into consideration the fact that those taxes were paid on incomes or receipts which are not included in disposable income.
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So the average householder doesn't view it as a reduction. Their view is that despite the fact that their 401(k)s have gone down in the last year, as the Congresswoman mentioned before, they are up very sharply from where they were 5, 10 years ago, and the average householder has a significant rise in net worth.
Our statistics may show that they are not saving. They are saying, ''I don't understand what you are talking about.'' But having said that, I do think that the issue of 401(k)s and IRAs specifically have been very useful vehicles to enable the average householder to accumulate wealth, and, in my judgment, there is nothing more important for the stability of a society of our type than everybody believes that they have a piece of it, they are a part of it, they benefit from it. I think anything that can be done to increase wealth at all income levels is highly desirable.
Mr. ROYCE. You spoke last year here of our tendency in the markets to rely increasingly on savings from abroad or on investments from abroad. Would the creation of true medical savings accounts and the expansion of flexible spending accounts for medical care and other health banking concepts, would that help in terms of accruing savings in the market?
Mr. GREENSPAN. Congressman, I don't want to discuss any particular form of program as such.
Mr. ROYCE. I see.
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Chairman GREENSPAN. All I can say is that what is crucial for this country going into a period when we are going to get a very significant increase in the ratio of retirees to workers, it is crucially important that we increase the savings rate generally and enable a pickup in investment which will accelerate productivity, because it is a necessary condition for producing an adequate amount of goods and services to essentially service both the retirees and the workers. Whatever financial system we construct to do that should focus on answering the question, does this enhance savings, and therefore does it assist in addressing this long-term problem that we have?
Mr. ROYCE. Thank you.
Chairman OXLEY. The gentleman's time has expired.
The gentlelady from California, Ms. Waters.
Ms. WATERS. Thank you very much.
I would like to welcome you to our committee today. We, as always, are very pleased to have you come, Chairman Greenspan.
Before I focus on the question that has been most on my mind, I just would like to take exception to your description of housing in this country. We have been holding extensive hearings in this committee, and many people on this committee, many Members, believe there is a housing crisis. There certainly is a housing crisis in California, and I am very surprised at your description of housing and the fact that you believe that it is doing well in this country, and we shouldn't have to worry about it at this point in time.
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Having said that, we have to make public policy here to take care of all of our taxpayers. We are not only concerned about the middle class and the upper middle class and the way we have to take care of a lot of poor people, we have to do that, and we have to develop public policy to do that.
You and I may disagree on a lot of what we have to do for poor people. We may disagree on minimum wage, subsidized housing, Federal intervention, capital creation for business. We disagree on all of that, but, at the same time, I and others have to be concerned about public policy to deal with all of these issues to make sure that we do what we can do to have a decent quality of life for Americans who may not fit into the middle-class or upper-middle-class model.
Having said that, this tax cut that has been passed in this Congress is public policy. Based on the projections of the income, the revenue now that was supposedly going to be received by our Government, it was based on the generous surplus that was being projected over a period of time. Now, you have described more than once here today that there is a softening of the economy, that the money that went into the high technology sector of our society oftentimes may have been money that was taken away from other sectors of our society. But there is a free fall now in that sector, and the jobs are being lost. The layoffs are perhaps more than were expected.
Given that and some of the problems that are being described here in Argentina and Brazil and other kinds of things that are impacting on this economy, how are we going to protect the programs and the services that many of us have worked very hard to provide for the average American, given the tax cuts? We are going to now have to take away from funding these programs and services to pay for this tax cut.
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Now, I know this is not politically popular to have to discuss this tax cut, but I would like to ask you again to reflect on housing, and what you said to us about housing being in good shape and the fact that there is a lot of refinancing going on, but talk to us a little bit about people who don't own housing, who are looking for a place to live who can't afford rents and can't afford down payments, and then talk to us about how we implement a tax cut and take care of the very basic programs that we have become accustomed to in this country to take care of the average person.
Mr. GREENSPAN. Well, Congresswoman, let me say the reason why I say that housing is better than we talk in terms of, let's look at the positive side. We have had a significant increase in the proportion of families who own homes. A disproportionate part of that rise has been minorities and lower-income groups. Indeed, a goodly part of the reason why housing is doing as well as it is is immigrants buying homes. So the issue of merely saying what has to be done, and I don't disagree with you that a lot has to be done, should not blind us to the fact that there has been some fairly significant improvement. Indeed, all of the activities that have been under way for a number of years have actually done a lot of good.
Let's acknowledge that, because if we are going to consciously say we have got a long way to go but we haven't made any progress, then people get discouraged. In other words, if you just keep saying, we are trying to move from A to B, but we never can get there, you lose confidence in what you are doing.
I think it is important for us to say we have made progress in this area, but we have got a lot more to make, and that the actions that were taken previously with respect to housing affordability have paid off, have worked. If you are not going to say that, then you are basically saying new initiatives have no more reason to work than the old.
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So I think it is a question of whether or not you are looking at the glass half full or half empty. I am happy to think that there is a very positive story to be said—to be put out front here, and, frankly, I think it is a story which effectively stipulates that if we go forward, there is good reason to presume that we will succeed. That is good, not bad.
Chairman OXLEY. The gentleman's time has expired.
Mr. Miller.
Mr. MILLER. Thank you, Mr. Chairman.
I agree with your statement that the housing market is extremely robust today. I have been in the industry for over 30 years myself, but I go back to the early 1980s when, you recall, the prime rate reached close to 25 percent. People couldn't buy homes, they couldn't sell their homes, and it took until the mid-1980s for recovery to start. I built mainly in the California area, and when the recovery started, builders were basically building on foreclosed properties, and they had artificially lower market value on those properties than they should have normally paid if they had bought vacant land and gone through the entitlement process at that point in time.
So prices were kept down fairly low through the mid-1980s. Late 1980s, though, you saw a huge, robust market similar to what we have today, especially 1989, first of 1990. Builders at that point in time were building on newly entitled property, but, as today, they could not keep up with the pace and demand based on the protracted process they had to go through to get entitlements to develop land.
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And then in 1991 a huge recession hit California. The State of California made it worse by increasing taxes, which drove many families out of California. So you did have some relief in the demand for housing, but, at the same time, many people owned homes that they owed more on the home than the house was worth based on market value, because they had bought homes in an artificially inflated market in 1989, first of 1990, because you could build a home; a line would stand in front of it to buy the home.
It took through the middle 1990s for that to start to change, and even as 1996 and 1997 approached, many builders were still building on foreclosed properties that were taken back by lenders, and they were buying them at reasonable rates, and they were ready to go.
In the last few years, though, specifically in California, where you have demand about five times the supply that is being provided in the marketplace, builders are having to go back and build on newly entitled property, and, as you know, the EIR process has completely eliminated any time line where in the Government has to respond to the entitlement process on maps.
Today we are facing the same situation that we faced back in the late 1980s, is when you build a home, you build a subdivision, people are standing in line to buy it. They are buying at high prices. People today are able to refinance their properties and take a lot of money out of them because prices are high based on demand that is tremendous, yet the supply is not keeping up with the demand again.
My question is specifically based on the historical perspective. Do you see us entering a problem like we did in the 1980s, like we did in the 1990s, when demand cannot keep up with the free market system because they are unable to entitle properties at the rate necessary to build?
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Mr. GREENSPAN. I think the issue varies very significantly by sectors of the country. That is, the problems that emerge in housing always seem as though they are unresolvable. I think that one of the things we have found is that the homebuilding industry in this country is really remarkable in the sense that it continues to come back, no matter what the problems are.
Mr. MILLER. But with different players, it comes back.
Mr. GREENSPAN. Indeed. In fact, I was about to comment that I remember, I think it was back in the 1950s or the 1960s, I was in southern California, and everyone was bemoaning that the homebuilding industry was absolutely dead, all of the home builders had gone out of business, and 2 years later they couldn't build enough homes.
It was a whole new set of players. But what has happened, as you well know, is that we have smoothed out the building cycle, and indeed, with the finance that has been built into the system, we have taken a lot of the movement out of the cycle. But there are very considerable problems—I don't want to get into them as you know them far better than I.
Mr. MILLER. We have taken the financing problem out; that is, rates going up tremendously like they did in the 1980s, which caused the recession to occur in housing. They have remained stable. But my concern, and I hear some friends of mine on the Democrat side, they are concerned about affordable housing. You cannot build homes rapidly enough to guarantee an affordable housing market, because there is such demand, we are artificially inflating the cost of housing again.
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That is my concern: if we can sustain a marketplace that is robust with Government processing artificially decreasing the amount of supply on the market.
Mr. GREENSPAN. Clearly if that happens, then there is a problem. But we have had a very long period of very significant demand. It is unlikely to continue to grow. In other words, as you know, there has been a significant decline in building and in prices of very high-priced homes, especially in California, and, in fact, it is pretty much across the board so that we are going to see ups and downs. I don't deny that there is a problem, but you don't see it in the macro-data at this particular point, although I certainly acknowledge the fact that for individual areas or individual types of housing, there are difficulties.
Chairman OXLEY. The gentleman's time has expired.
The gentleman from Illinois, Mr. Gutierrez.
Mr. GUTIERREZ. Thank you very much, Mr. Chairman. I am from the city of Chicago, and I built a lot of the bungalow belt in the city of Chicago. So there is a lot of home ownership, but there is also a lot of renters.
And let me just share with the Chairman my experience. My experience is that we have a market in which more and more people are put into poverty because more and more of them are paying in excess of 30 percent of their income for rent. It is not a question, Mr. Chairman, not even of people being able to own a home, it is the difficulty of people to pay rent. I have increasingly seen numbers of people who are paying 40, 50, up to 60 percent of their income in rent relative to their income.
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So I know the macro-picture. I want to share with you that in the inner cities, which I think is important to our national economy and to a robust economy that we don't have a Nation that is so divided, we are normally between those that are further and further put away from ever owning a home and are having difficulty every day in raising their rent.
I want to go back, Mr. Chairman, to your comment on immigrants and the fact that home ownership has increased. I was hoping I could encourage you to speak again about the importance of immigrants to the Nation's economic health.
The last time you were here, in fact, in front of the committee last year, in the midst of a relatively low unemployment, you, said, quote: ''There is an effective limit to new hirings unless immigration is uncapped.'' I was hoping that you could take a minute to speak a little bit more on that point and why it is important, what is the importance of immigration and its vitality to our economy, and, to take it a step further, what it would mean for U.S. businesses if the immigration population was rapidly reduced.
Mr. GREENSPAN. What was the last part of it?
Mr. GUTIERREZ. If the immigrant population was rapidly reduced in this country.
Mr. GREENSPAN. Congressman, I have always argued that this country has benefited tremendously from the fact that we draw people from all over the world, and the average immigrant comes from a less benign environment. Indeed, that is the reason they come here. They appreciate the benefits of this country more than those of us who were born here, and it shows in their entrepreneurship, their enterprise, and their willingness to do the types of work that make this economy function.
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I would be very distressed if we were to try to shut our doors to immigration in this country. I frankly don't envision that happening, but I understand that there is always that tendency on the part of people who are here, having come here or having come here four generations earlier, to want to shut the door. I don't think that is a good idea.
Mr. GUTIERREZ. Mr. Chairman, I agree. I have a congressional district that, when you look at per capita income, we rank the lowest of all of the congressional districts in the State of Illinois. We also have the lowest unemployment in my congressional district, which can only lead me to believe that incomes are low, but people are working. Obviously I have the highest immigration population in the State of Illinois or anywhere in the Midwest, so I agree with you.
You also spoke about the necessity to increase savings and wealth so that as we have an older population, they can sustain themselves. Could you talk a little bit about immigrants and—because I understand that in the 1950s, there might have been, I think it was 15-, 16-to-1 for every one that was on Social Security vis-a-vis our Social Security Trust Fund, and then in the next 10 to 15 years it may be 2-to-1, that is 2 people paying in to every one. And the relationship of immigrants being 70 percent of them are of working age—they tend to think that they are all children coming across the borders—and if 70 percent of them are of prime working age, what that could do to our Social Security Trust Fund.
And if you have any figures on what immigrants contribute to the trust fund vis-a-vis—I am talking about net, vis-a-vis what they receive, because a lot of people complain about immigrants, because they say they cost more than they contribute, but I once saw a study that said in the next 20 years, they are going to contribute $500 million more net into the Social Security Trust Fund. That is immigrants, people who were not born in the United States, but are legally and lawfully here in this country.
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Mr. GREENSPAN. Well, I think the law stipulates that with, obviously several exceptions, you don't draw Social Security benefits until you are 62 at a minimum, but you contribute very substantially to it prior to that. To the extent that immigrant population on average is well below 62 years, it necessarily flows that you do build up the fund as a consequence of that.
I wouldn't, however, argue for immigration on the grounds that it helps the Social Security system. It does. I grant you that. I think we ought to do it on the grounds that it is the right thing to do.
Chairman OXLEY. The gentleman's time has expired.
The gentleman from Florida, Dr. Weldon.
Dr. WELDON. Thank you, Mr. Chairman. As always, it is a pleasure to hear your testimony. I apologize I had to run out.
I did want to ask you, Chairman Greenspan, when do you expect the economy to rebound?
Mr. GREENSPAN. Well, I think the best way to answer that is what we see at this stage is an economy which is still weak, and indeed in certain respects is still deteriorating. But the rate of deterioration is clearly slowing, and indeed there is considerable evidence to suggest we are approaching stability at a lower level.
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The next stage, of course, is as you put it, a rebound. I don't know whether or not you would describe what is going to occur as a rebound, but clearly, as things begin to coalesce in a positive manner, you get cumulative reduction in uncertainty and risk premiums, and people reach out, start to invest, and the economy starts coming back.
Dr. WELDON. Let me press you a little further. Are we talking about the fourth quarter? Are we talking about the next calendar year?
Mr. GREENSPAN. I purposefully don't want to answer that in a specific way, because I don't think that we know exactly. If I had to make a forecast, I would say that toward the end of this year we will see things improving, and clearly some next year, but you can't forecast that well, and I think is it a mistake to have a point estimate. Indeed, as I discuss in my prepared remarks, what we recognize is there are distributions of probabilities around a number of different forecasts, and we can't forecast that well. We can observe the process and make projections on how we think things are evolving, but other than saying what I just said, we can't go very much farther now. I know that there are probably people who will tell you that the economy is going to grow 6.25 percent over the next 3 years.
Dr. WELDON. I wouldn't ask you to be that specific.
Mr. GREENSPAN. What I am trying to get at is it is outside of the scope of anybody's capacity to be that specific.
Dr. WELDON. Well, I appreciate your frankness. I just have one other quick question for you.
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As you know, GDP was growing back in 1995 at about a little over 2 percent, and then it bound up to a little over 4 percent in 1996, and then it went really high in 1999. My observation was that a certain portion of that was due to the tremendous amount of speculation in the dot.com community, and as we all know, many of those investment opportunities were built on business assumptions that didn't pan out.
Would you say it is reasonable to assume that barring any further kind of robust speculation in an economic sector like that, we should not expect those levels of growth again? As you know, we have got up to 5 percent growth rate in GDP, and a lot of people were saying that, in so many words, it is impossible to sustain and that it was built on that speculative environment that existed.
Mr. GREENSPAN. Congressman, the way we make that judgment is to look at whether or not both capital and labor resources are being strained. What we observed in 1999 was that the number of workers who were willing and able to work was going down, meaning we were draining our pool of people who had no jobs but wanted to work. And we observed that our excess facilities were being dissipated in the sense that we were putting pressure on both labor and capital resources.
What that tells you is you cannot go on indefinitely at that growth rate. And whatever that growth rate is at that time, it is higher by definition, than what is sustainable.
Dr. WELDON. If I understand you correctly, you look at those figures, employment levels more so than the percentage of growth in the economy per se.
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Mr. GREENSPAN. Yes. And the reason essentially is that the missing element is the rate of growth of productivity, output per hour growth. And if you really want to judge whether the economy is straining or not, meaning whether it is growing beyond its long-term capabilities, there are all sorts of signposts which can give you that type of evidence—whether it is the unemployment rate, whether it is those not in the labor force, but who would work if a job were available, whether or not operating facilities and plants are being pressed, or whether there are shortages of capacity in certain areas.
There are all of those signals that we employ to determine whether, in fact, a specific rate of growth is sustainable. And back in 1999 it was not.
Chairman OXLEY. The gentleman's time has expired.
Let the Chair announce that there is a vote on the floor. That is a second notice. We plan to keep the hearing going. Mr. Paul is going to go over to vote and then come back in the chair.
So we will continue with recognition of the gentleman, Mr. Bentsen from Texas.
I would advise the Members if they want now to go over and vote, and then come back, we will try to keep the same order of questions.
Mr. Bentsen.
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Mr. BENTSEN. Thank you, Mr. Chairman.
Chairman Greenspan, your testimony and also your semi-annual report seem to me to be a little more bearish than what you told us when you were here in February. And obviously, since that time, we have had more experience with the economy. You and the Fed have had more opportunity to see things that we may not see, or more time to look at those things and think about them.
But it seems, when you testified back in February, that while the Fed was concerned about the backup in inventories and the inventory sales ratio, there was a feeling that with this sort of new paradigm in the economy, that that would be able to correct itself—hopefully, be able to correct itself more quickly. And the bigger concern was consumer confidence and consumer behavior, which obviously, none of us can interpret.
In your testimony today and looking at what the central tendency of the Board is, that the concern about inventory sales backup and the manufacturing sector of the economy is much more pronounced than perhaps it was in February; that as opposed to looking at maybe a third and fourth quarter recovery, we are seeing, if I quote you correctly, the structure of the bottom coming together at this point in time. And so the problem does seem to be more profound.
What also concerns me is that based upon your report, you do not seem to indicate—contrary to some of the columnists in the Washington area—you don't seem to indicate that this is a liquidity issue necessarily, that there is still sufficient liquidity in the capital and credit markets, but that this is clearly a demand side problem.
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What I would like to ask you is—and I guess reading your testimony—obviously you give us no indication of where the Fed is going which is, of course, your primary role when you come here. But it does seem to me that you all appear to be still somewhat concerned about the lack of strength in the economy.
At the same time, it appears, since you were here in February, the world economic condition has worsened as well, and we know that there continue to be problems in Turkey. Argentina is suffering problems. The European economy has not rebounded. The Japanese economy has fallen back into recession and the Asian economy, except for perhaps the Chinese, is appearing to be slack as well.
At the same time, the dollar remains exceedingly strong to the other main foreign currencies, and what concerns me is a new round of contagion that doesn't necessarily affect just emerging economies, but has a negative impact on the U.S. economy. And I would be interested in your comments on that.
Also, the fact that the Bush Administration has signaled that perhaps there will be a change in the U.S. approach to contagion and to how we address international economic meltdowns, although I don't think they know exactly what their policy is. And fine, I don't want to delve into the fiscal policy, and you may not want to answer this.
But in your comments—which, again, if you read through them are very bearish, I think you do mention that you think that there is a potential for an uptick in the outlook, in part because of reducing energy prices and the tax cut. And I have to ask you, because again I know you are not a Keynesian, that the tax cut, as I see it, is rather back-loaded, and I find it hard to believe that you or the Fed would think that it is stimulative, as you might make it appear, unless you think it is stimulative from a psychological standpoint and not a quantitative standpoint.
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Mr. GREENSPAN. Congressman, let me just say that if you go back and you read the February testimony, you will find an awful lot of qualifications as to what was going on at that particular time. And in a certain sense, even though the actual point forecast is lower now than it was back then, if you want to take it literally, the risks were greater back then. In fact, you may recall I was talking about the possibility of the fabric of consumer confidence being breached by the weakening of the economy going on, which would have been a very significant downside contraction. That has not happened. And, indeed, in a certain sense, I would say I am far less concerned today about the type of breach in the structure that was emerging late last year and early this. And as I pointed out in my prepared remarks, it is important to recognize that despite all of the shocks that are involved in both the domestic and international economy, our economy is still doing, not well, but clearly far better, given what has happened, than I would have forecast 6, 8, 9 months ago.
So let me just say that, yes, the forecast is lower, but the range around that forecast is much narrower than it was, at least from my point of view, going back 6 months ago. And I think that is a very important issue.
I am not saying that we are about to recover in a strong way. In fact, in the remarks I have indicated the long litany, as I put it, of the negatives that are out there are things that we can't just push aside. But in a more important sense, we have come a long way through this adjustment process, and we are still standing. And that is good news as far as I am concerned.
Chairman OXLEY. The gentleman's time has expired.
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The Chair would announce a brief recess for the vote.
We would expect that when Mr. Paul returns, he could take the chair and we could begin the questioning again.
Mr. BENTSEN. Mr. Chairman, the other issues, if he could answer for the record, I would appreciate that.
Chairman OXLEY. Absolutely.
The hearing stands in recess for 5 minutes.
[Recess.]
Dr. PAUL. [Presiding.] You mention about the Keynesian approach to economics of a few decades ago, believing that they could eliminate the business cycle; and your conclusion is, really you can't, because you can't control human nature. And I agree that you can't control human nature and I agree that human nature and subjectivity is very important.
But I would also argue that businessmen are human beings and enjoy human nature—they are rational humans, and they react in a rational way to interest rates and the signals they get from you and the Federal Reserve. And therefore, when interest rates are artificially kept low, they will do precisely what they have done; they generate to overcapacity. And, of course, in a recession, this has to be liquidated and we are now in that stage.
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It doesn't surprise the hard money school that we are in this phase of liquidating this overcapacity, and it should be; but we would also argue that the Fed may be doing exactly the wrong thing.
Everybody criticizes you. Nobody comes to you and says, ''Oh, Mr. Greenspan, you print too much money; you generate too much credit; your interest rates are too low.'' But the argument from this other school is saying that, precisely the opposite.
It says that because, in the past, you manipulated interest rates, you have caused the boom, therefore, you have made it a certainty that we would have a recession. And literally, by quickly resuming the inflation, the debasement of the currency, that sometimes works and sometimes it doesn't work and that we are now in a period where it isn't working.
It didn't work in Japan, and this is part of human nature too, or the way the businessman responds. One time he responds the way you want and the next time he does not.
So, is there a possibility that you recognize that maybe interest rates were manipulated in the wrong direction, and maybe if we had to live with a fiat currency, it would have been better, since 1990, to take the average rate of the overnight rate and just make it 4.5 percent, just left it there, rather than doing this and causing all these gyrations?
I would like you to comment on this, these ideas about monetary policy, in the hopes that maybe we can avoid what we in the hard money school see as a very serious problem and one that could get a lot worse, where we do not revive our economy, just as Japan has not been able to revive theirs.
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Mr. GREENSPAN. Mr. Chairman, so long as you have fiat currency, which is a statutory issue, a central bank properly functioning will endeavor to, in many cases, replicate what a gold standard would itself generate.
If you take the period in the United States where the gold standard was functioning as close as you can get to its ideal, which would be from probably 1879 probably through the turn of the century, you had a number of business cycles in that period. And in many respects, they had very much the same characteristics that we just observed in the last couple of years: the euphoria that builds up when the outlook improves and people overextend themselves and the markets shut them down.
Well, what shut down the market was the very significant rise in real, long-term interest rates in 1999, and in that regard, that is the way a gold standard would have worked. So I would submit to you that the presumption that if you have a hard currency regime, you will somehow alter human nature any more than a fiat currency one will, I will suggest that that does not happen.
I certainly agree with you that if we would just pump out liquidity indefinitely, the distortions that would occur in the system would be very difficult to pull back together. I submit that is not what we do, and indeed, I would argue that given the fact that we have a fiat currency and that is the law of the land, we do as good a job as one can do in the context of the issues that you raise.
Dr. PAUL. I would like to follow up, but I can't break the rules. I would like to recognize Mr. Inslee from Washington.
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Mr. INSLEE. Well, Mr. Chairman, I ask unanimous consent to allow the Chair to break the rules and allow you to continue your testimony and your questioning.
Dr. PAUL. Oh, no. That's OK. Go ahead.
Mr. INSLEE. Thank you.
Mr. Chairman, I noted several places in your testimony references to the high energy prices that we have experienced over the last several months. And it is at least some small comfort to my constituents—I am from the State of Washington—that you and others recognize how we have been hammered, particularly with wholesale electrical rates on the western coast of the United States, to the extent that in the State of Washington the estimates are that we will lose 43,000 jobs as a result of that spike in energy prices that we really could not accommodate. We were not that flexible.
And unfortunately, the Administration, despite our repeated requests, took absolutely no action to deal with this for at least 7 months. They now have encouraged, and the Federal Energy Regulatory Commission, as you are aware, has done something, at least modestly, to curtail some of this disproportionate pricing. But unfortunately, the FERC has still refused—although they have moved ahead to request refunds for some ratepayers in California, they have refused to do so for the Pacific Northwest. And that is of particular importance to us in the Northwest because, while prices are going down to some degree now, we had massive incursion of debt by a lot of outfits to try to stay solvent during this period of ramp-up in their rates, and we continue to have this hangover from this rapid escalation of rates.
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We are now trying to work to get some refunds for ratepayers in the Pacific Northwest. We hope that FERC eventually will be dragged, kicking and screaming, to that position to help out.
I don't want to ask you for a specific comment on the propriety of refunds on the West Coast, but I would like to ask you, assuming that they are legal and practical and FERC can accomplish them, I just want to know if you can give us your comments as to whether that might have some beneficial effect on the demand side, that I know you are interested in.
Mr. GREENSPAN. You mean on whether or not refunds will improve the supply and demand for energy in the Northwest?
Mr. INSLEE. Or whether it will perhaps bolster our confidence, which right now has been taking a real hit in the Pacific Northwest.
Mr. GREENSPAN. Congressman, I think in your State one of the really very serious problems has been the drought and the obvious shortfall of potable water availability. And a part of the job loss you suggest is the aluminum reduction plants, which found, not to anybody's surprise, if you are talking 10-, 20-, 30-cent kilowatt hour, you cannot make primary aluminum profitably in the world market at those prices. So what they did is they shut down and they sold their power contracts. The alternative would have been essentially to eat the costs, which would be very difficult.
As you are well aware, there has been a fairly significant decline in wholesale prices, pretty much across the whole western grid. And indeed, in California, they have slumped to levels they haven't seen for a couple of years.
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I think that it is remarkable that you have the capacity to meet the demands, and we are a good way through the summer and have not really seen some of the awesome concerns materialize that a lot of people had. And I think quite legitimately, there has been a very significant amount of conservation that is going on of electric power, especially in the West. And for the moment, at least, the system seems to be working well.
And I do think that we are seeing fairly dramatic declines, or will be seeing them, in spot prices for both natural gas and for electric power. In the Consumer Price Index that was released this morning, as I recall, there is a remarkable decline in natural gas residential prices, and that is reflecting the two-thirds decline in the spot price of natural gas since late last year. There was a surge in electric power, which was the big increase, especially in California, but I think if you take a look at the wholesale structure now, it is going to come down. And that is going to be a positive factor, not only, as I pointed out in my prepared remarks, to profit margins of corporations, but I do think it is going to be a factor, as you imply, in the consumer area, and I think it could be an important one.
Dr. PAUL. The gentleman's time has expired.
Mr. INSLEE. Thank you.
Dr. PAUL. The gentleman from North Carolina.
Mr. JONES. Mr. Chairman, thank you very much.
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Dr. Greenspan, it is a privilege to hear you today. I was not able to be in attendance when you spoke in the spring, so my question will go back to a news article that I read at that time. But first, I would like to say, in your response about the capital gains tax to a couple of my colleagues, that among those who are retired or close to retirement, I sincerely believe as—not as an economist; I was a history major in college, so that tells you—but that the average person that has investments, I believe sincerely would start moving those investments around and actually, I think, helping the economy if we, as a Congress, could drop that capital gains tax anywhere from 3 to 5 points.
But I did hear your answer on that, so I am not going to ask you to repeat yourself.
My question is, back in February there was an article in U.S. News and World Report, and you might have covered this in your prepared remarks; I was not here at that time. But it is called ''A Debt Thing.'' And it says the recession could swamp consumers and companies. My question is, if over 34 percent of the average household income is going out into payments on installments such as loans, mortgage loans, home equity debt and vehicle leases and vehicle payments, at what point do you, as the Chairman, you as an economist, get concerned about the average debts of the household?
Mr. GREENSPAN. It is difficult to say, because it will often vary depending on the type of debt that we are talking about. Debt service charges, for example, when you are dealing with short-term loans, are very high—in other words, you borrow and then you pay it off very quickly, and that will create a significant debt service charge, whereas long-term mortgages relative to the amount of debt do not.
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I think that you do, however, get concerned when you begin to see the overall charge against a weekly paycheck get to a level which begins to affect people's ability to function. And while that doesn't usually impact on the economy, as such, what it does do is put you in a position that in the event that you get a decline in income, you create some fairly significant retrenchment requirements on the part of consumers.
So, as you point out, at the moment, the debt service burden, which is essentially the repayment of debt plus interest as a percent of cash incomes, at this stage is up to levels that have been pretty high in the past. So it is high at this stage. It is not at a level way beyond the experience of the last decade or two, but it is high, but not yet anywhere near the point given the level of assets which exist in the household sector—where it has moved to the edges of great concern. It could get there, but it has not gotten there yet.
And judging from the delinquency rates that we see in the banks and in the finance companies which, while they have moved up a bit, are not of particular concern, we are not at a point where one has to worry materially about that. But should it continue and should we find that the process gets to a point where you are beginning to see the stretching of the borrowing capacity, then it would. It has not gotten there yet, but it could.
Mr. JONES. Thank you, Mr. Chairman.
Dr. PAUL. The gentleman yields back.
The gentlelady from California, Ms. Lee.
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Ms. LEE. Thank you.
Good afternoon Mr. Chairman. Good to see you.
First, I would like to follow up on Mrs. Roukema's and Ms. Waters' comments regarding housing; and I am, quite frankly, surprised at your response. At the same time that we have an increase in home ownership, Mr. Chairman, we also have a record increase in foreclosures. Also in California, of course, one of the highest cost areas in the country, 2 percent of all conventional loans were made to African Americans, only, and 2 percent of our largest lenders made less than 2 percent of their home loans to African Americans.
So I guess, just based on your view of the world, should we really assume that the Federal Reserve will not consider economic strategies actually to stimulate home ownership, especially for those making $40,000 or less?
And you also indicated that you believe in the importance, actually, of increasing and accumulating wealth in our society, yet African American and Latino unemployment rates are still twice that of whites. And so I haven't heard, really, any investment strategies from the Federal Reserve to address these horrendous—and they are horrendous—economic disparities.
Mr. GREENSPAN. I agree with you, Congresswoman, and we do have a law: it is called the Community Reinvestment Act, which presumably addresses precisely the issue that you are addressing. I think you have to distinguish between the Community Reinvestment Act and the overall macro-housing policy in this country, which addresses home ownership and new construction in markets generally. For everybody, on average, that is working well.
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It is not working well for a number of people, basically minorities, and we address that. In other words, we address that because if you could bring everybody up to the average or even just below the average, it would have a major, positive effect on the economy.
And so what we endeavor to do, in the context of an overall policy which I think is working, is recognize that parts of it are not. That doesn't mean that you don't address the parts that are not.
Ms. LEE. Sure. But what do we do for the parts that are not? I indicated home ownership. Fine. Great. We are moving in the right direction for some. But for those who are not part of that track——
Mr. GREENSPAN. Well, this is the reason why I say you have to build up standards of living. You have to build up wealth. You have to build up productivity and you have to raise people's levels so that they can afford housing.
I mean, when I was a kid, the thought of living in an owned home was so far remote from any conceivable notion that I had. We could not remotely consider purchasing a home.
Ms. LEE. But if you don't support increasing the minimum wage——
Mr. GREENSPAN. I don't support increasing the minimum wage, because I think it does precisely the opposite of what people think it does. And the facts are the facts. I have strongly argued this issue—and I grant you I am in a minority on this question—but I think the evidence is overwhelming that it does not do what a lot of people think it does in a positive direction. I think it is negative for the people at the lower end of the income structure.
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Ms. LEE. So then how do you increase the standard of living?
Mr. GREENSPAN. You increase the standard of living by raising the overall level of productivity in the society and make certain that everyone has an opportunity to effectively engage in that economy. It is called ''opportunity,'' and I think that is the most important thing that we can do to eliminate discrimination, create opportunity, enable people to pull themselves up from the bottom wherever they are and engage in this fairly prosperous economy.
So when I say that I think that the overall housing market is fine, which it is, that is not to say that I think that it is doing fine for everybody.
Ms. LEE. Thank you very much for at least clarifying that fact.
And finally, let me just ask you, with regard to Reg B, with regard to voluntary reporting, with regard to small business lending, are you going to schedule a vote on this sooner or later?
Mr. GREENSPAN. Where are we on Reg B now?
Mr. MATTINGLY. Congresswoman, I think the staff is still analyzing the——
Dr. PAUL. Could the gentleman identify himself at the mike appropriately?
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Mr. MATTINGLY. I am sorry, sir.
My name is a Virgil Mattingly. I am General Counsel of the Federal Reserve Board.
Congresswoman, the Board staff is still evaluating those proposals. We did get a lot of extensive comment, but I am not sure when it is going to be scheduled.
Ms. LEE. Thank you very much.
Chairman OXLEY. [Presiding.] The gentlelady's time has expired.
The gentlelady from the great city of Cleveland, Ohio.
Mrs. JONES. Thank you, Mr. Chairman.
Chairman Greenspan, good afternoon. I am going to follow up with some of the questions that my colleague, Ms. Lee from California, asked. If you don't raise the minimum wage, and you wait on rising levels of productivity, what are the people who are making less than minimum wage, with no health care, paying high gas taxes, high gas prices, $2 for a gallon of milk, $3 for a loaf of bread, to do in the interim?
Mr. GREENSPAN. Let me ask you this: If you raise the minimum wage, and they lose their jobs as a consequence, does that help them?
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Mrs. JONES. Mr. Greenspan, that is fear tactics. People have to have jobs, and I am suggesting to you that when we live in a community where the living standards are so low that people have no opportunity, what they do is they go to criminal enterprise in order to support their families.
But don't ask me a question; you answer my question. My question was, what do you——
Mr. GREENSPAN. Well, sometimes you can offer—look, I have expressed my view on this. I am in a minority on this. I acknowledge the fact that most people don't agree with me on this particular issue. But when the facts are what they are, I cannot but say what I believe. And I honestly do not believe that it helps the lower income.
Mrs. JONES. You know, I heard that answer, and I don't mean to interrupt you.
My question is, what do the people who are in that dilemma do in the interim while we are waiting for rising levels of productivity to occur?
Mr. GREENSPAN. Well, if I believed that the minimum wage actually helped, I would support not only the minimum wage but to increase it because——
Mrs. JONES. Do you support a living wage?
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Mr. GREENSPAN. Well, I don't know what that means. I support the highest wages that people can get in the marketplace. I started off making $35 a week when I was a kid. That was barely a living wage and I worked my way up. So the question really is, do we have levels in this country which I think are extraordinarily difficult? The answer is yes, I do.
Do I think—I will ask myself the questions.
Mrs. JONES. Well, that is not fair, Mr. Greenspan. Now, you may be the Chairman of the Federal Reserve, but at this point this is my 5 minutes.
Mr. GREENSPAN. OK. Go ahead.
Mrs. JONES. I think I ought to be able to ask you some questions, right?
Mr. GREENSPAN. I am sorry.
Mrs. JONES. And I don't mean that derogatorily in any way. Let me ask this question.
We have high levels of household debt in the Nation currently. Do you favor some form of debt relief for highly indebted consumers at these interest rates or interest rate ceilings, or aggressive measures to curb predatory lending? All of these things come as a result of what I have said.
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Mr. GREENSPAN. Yes. We, as you know, have been strongly supportive of actions to eliminate predatory lending. I personally find the individual cases most distressing, and it is an aspect of our financial system which has not shown, I think, great status. I think it is a small issue, relatively speaking, but it should be eliminated.
Mrs. JONES. It is a small issue. Let me stop you just for a moment, please.
Mr. GREENSPAN. No, I am trying to say when you look in terms of 8,000 banks and a lot of other institutions, it is a small issue in the sense that subprime lending is a large part of the market, and subprime lending, I think, helps minorities. It is a very important part of our financial——
Mrs. JONES. I can't disagree with you. But I only have probably 2 seconds and I want to take you just to one area. You say it is a small area, but when you are dealing with—most of the predatory lending occurs in minority and low-income communities that are already deeply in debt, and it is the only place by which they get some type of ability to build wealth through home ownership. It is a big problem, not a small problem.
Mr. GREENSPAN. I agree with you. I think it is a big problem for particular groups of individuals, and the reason why the issue has difficulty moving forward is it is not a big enough issue in the total financial system to get the type of support that you need to eradicate this particular practice.
Mrs. JONES. But I could get you to help me eradicate this.
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Mr. GREENSPAN. I am on your side on this one.
Mrs. JONES. OK. I am going to call on you. I thank you, Mr. Chairman.
I yield back the balance of my time.
Chairman OXLEY. The gentlelady's time has expired.
The Chair is now pleased recognize the gentleman from California whether he is out of breath or not.
Mr. OSE. Mr. Chairman, thank you.
Mr. Chairman, thank you for joining us today. I want to specifically ask a prospective question dealing with the President's proposal on energy. I have been quite involved in the stuff with the FERC on the electricity and the like.
The fact of the matter, what they did was based on something I put in about a month prior to that. But I would appreciate any comments you might wish to offer about the economic benefits of the President's energy policy, as proposed, particularly relating to increasing the supply of oil and gas, FERC the electricity grid or making it operate more efficiently—better gasoline, the issue of boutique fuels, natural gas distribution, issues of that nature.
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Mr. GREENSPAN. Well, Congressman, I think that because the world economy has slowed its rate of growth, the demand for energy overall has slackened and it has taken the pressure off what appeared to be capacity restraints in the system, which we know are there, and they are there, as you point out, in a number of different areas.
We have had a very dramatic decline in natural gas prices in the last 6 months, in part because we have had a fairly marked pickup in drilling and the ability to find new sources, but also to a very large extent due to a decline in the rate of growth in consumption in a number of areas and actual declines in other areas.
We have seen a fairly dramatic decline in gasoline prices because we had a shortage of refinery capacity late last year, or early this year, and even though inventories of crude oil were building up at refineries, you couldn't put it through the refinery system to create inventories of gasoline. But now that has happened, and the price of gasoline has come down a considerable degree.
The same arguments are relevant to what has been going on in the electric power grid system and electric power use.
That should not in any way alter our view that there are long-term infrastructure problems out there, and that we need to get significant new energy-generating facilities, improved energy grids, the ability to drill for natural gas very specifically, because while we can import crude oil, there is a limit to how much natural gas we can bring in. In fact, we really are getting it largely from Canada, and liquefied natural gas is a very tough thing to import from other countries, so that we have to focus on making certain that we have adequate supplies of natural gas. And when we begin to look at the longer term, I think we are going to find that long-term policy is going to be required to make certain that the energy supplies in this country are adequate to the long-term needs of the economy.
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Mr. OSE. Is the President's willingness to at least engage on this subject a positive first step?
Mr. GREENSPAN. I am sorry?
Mr. OSE. Is the President's willingness to engage on this subject of energy policy, is that a positive first step?
Mr. GREENSPAN. Oh, indeed. No question. I think that it is the type of issue which has importance in the longer term and can only be addressed in the longer term. And usually you have to come at issues when they are not perceived to be problems to get them appropriately addressed in that regard. I think it is important that we evaluate our whole, long-term energy needs and how they are going to be met.
Mr. OSE. I appreciate, in particular, your last remark about focusing on issues of this nature when they are not problems.
Given the abatement in pricing that we have all seen, both on the spot and the futures markets for natural gas and electricity, I think, Mr. Chairman, if there were one piece of counsel that we should share with our colleagues, it is that the way to avoid having problems is to address them before they are problems.
Thank you, Mr. Chairman.
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Chairman OXLEY. The gentleman's time has expired.
I would agree with the gentleman from California and also say that markets work.
Mr. Chairman, we thank you again for providing us with your testimony and answers to our many questions. We appreciate it.
And let me say on a personal note, we thank you for your help on the SEC rulemaking authorities that dealt with broker-dealers and banks. And we are pleased to note that the SEC announced this morning that they would be extending that deadline till May of next year, which hopefully will give us all an opportunity to work in a concerted manner among the regulators to bring about the intent of Gramm-Leach-Bliley, and for that we thank you very much.
Without objection, the record for this hearing will remain open for 30 days for Members to submit questions in writing to the Chairman and have his responses placed in the record. Thank you again.
[Whereupon, at 12:45 p.m., the hearing was adjourned.]