[Joint House and Senate Hearing, 108 Congress]
[From the U.S. Government Publishing Office]



                                                        S. Hrg. 108-667



                          THE ECONOMIC OUTLOOK

=======================================================================

                                HEARING

                               BEFORE THE

                        JOINT ECONOMIC COMMITTEE

                     CONGRESS OF THE UNITED STATES

                      ONE HUNDRED EIGHTH CONGRESS

                             SECOND SESSION

                               __________

                             APRIL 21, 2004

                               __________

          Printed for the use of the Joint Economic Committee



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                        JOINT ECONOMIC COMMITTEE


    [Created pursuant to Sec. 5(a) of Public Law 304, 79th Congress]


SENATE                               HOUSE OF REPRESENTATIVES
Robert F. Bennett, Utah, Chairman    Jim Saxton, New Jersey, Vice 
Sam Brownback, Kansas                    Chairman
Jeff Sessions, Alabama               Paul Ryan, Wisconsin
John Sununu, New Hampshire           Jennifer Dunn, Washington
Lamar Alexander, Tennessee           Phil English, Pennsylvania
Susan Collins, Maine                 Adam H. Putnam, Florida
Jack Reed, Rhode Island              Ron Paul, Texas
Edward M. Kennedy, Massachusetts     Pete Stark, California
Paul S. Sarbanes, Maryland           Carolyn B. Maloney, New York
Jeff Bingaman, New Mexico            Melvin L. Watt, North Carolina
                                     Baron P. Hill, Indiana



        Donald B. Marron, Executive Director and Chief Economist
                Wendell Primus, Minority Staff Director


                            C O N T E N T S

                              ----------                              


                      Opening Statement of Members


Senator Robert F. Bennett, Chairman..............................     1
Representative Jim Saxton, Vice Chairman.........................     3
Representative Pete Stark, Ranking Minority Member...............     3

                                Witness

The Honorable Alan Greenspan, Chairman, Board of Governors, 
  Federal 
  Reserve System.................................................     4

                       Submissions for the Record

Prepared statement of Senator Robert F. Bennett, Chairman........    31
Prepared statement of Representative Jim Saxton, Vice Chairman...    31
Prepared statement of Representative Pete Stark, Ranking Minority 
  Member.........................................................    32
Prepared statement of The Honorable Alan Greenspan, Chairman, 
  Board of Governors, Federal Reserve System.....................    32
    Written response to questions from Senator Paul S. Sarbanes..    35
    Written response to questions from Senator Susan M. Collins..    37
    Written response to questions from Representative Jennifer 
      Dunn.......................................................    39

 
                          THE ECONOMIC OUTLOOK

                              ----------                              


                       WEDNESDAY, APRIL 21, 2004

                     Congress of the United States,
                                  Joint Economic Committee,
                                                     Washington, DC
    The Committee met, pursuant to notice, at 10:00 a.m., in 
room SH-216 of the Hart Senate Office Building, the Honorable 
Robert F. Bennett, Chairman of the Committee, presiding.
    Senators present: Senators Bennett, Sununu, Alexander, 
Collins and Sarbanes.
    Representatives present: Representatives Saxton, Ryan, 
Dunn, English, Putnam, Paul, Stark and Hill.
    Staff present: Donald Marron, Natasha Moore, Chris Frenze, 
Brian Higginbotham, Colleen J. Healy, Mike Ashton, Lucia 
Olivera, Zach Jones, Wendell Primus, Chad Stone, Frank 
Sammartino, and Matthew Solomon.

        OPENING STATEMENT OF SENATOR ROBERT F. BENNETT, 
                            CHAIRMAN

    Senator Bennett. The Committee will come to order.
    We meet this morning in fulfillment of one of our statutory 
requirements, which is to hear from the Chairman of the Federal 
Reserve on an annual basis.
    Because of the interest in Chairman Greenspan's testimony, 
we expect a large attendance at this particular hearing. And in 
an effort to accommodate Chairman Greenspan, who has his own 
schedule, I will lay down the ground rules.
    We will have opening statements from the Chairman, the 
Ranking Member, and the Vice Chairman. We ask other Members not 
to give an opening statement, but to hold their comments until 
we go to the question period.
    I will recognize people in the order in which they come. 
And I ask the staff to keep track of that order so that I don't 
have to write everybody down as they come in.
    But we'll observe the early bird rule and say those who 
come first get to question first, regardless of their seniority 
on the Committee.
    I've asked Vice Chairman Saxton and Ranking Member Stark to 
hold their opening statements to four minutes, and I intend to 
set the example and do that myself, so that we can have maximum 
time for Members in the question period. And we will try to 
hold each questioner, each Member, to a five-minute period in 
an effort to give everyone the opportunity to question Chairman 
Greenspan and at the same time conclude the hearing in a timely 
enough manner so that he can meet his other scheduled 
requirements.
    So with that, Mr. Chairman, we're pleased to have you here 
today. We always appreciate your views on the current economic 
situation, as well as your broad perspective on economic and 
fiscal issues facing Congress.
    One of the things that has impressed itself upon me since 
I've been a Member of the Senate is that very few people in 
public life have any kind of perspective beyond today's 
headline or this afternoon's deadline.
    And you are an outstanding exception to that rule, as you 
can see things in a perspective that goes across not only 
quarters and years, but decades. And I think that that kind of 
perspective is very important to us.
    We're grateful that you're willing to come share it with us 
this morning.
    You visit us at a time of good economic news. The economy 
is growing rapidly and adding new jobs, thanks to well-timed 
tax relief, an aggressive Fed policy over which you've presided 
and, most importantly, the amazing resilience of the American 
economy itself.
    I can't help but notice what a difference a year makes. 
When we were having this hearing a year ago, we talked a great 
deal about deflation. But today, we meet amid speculation about 
inflation.
    Last week, we learned that consumer prices have been rising 
faster than expected and commodity prices are much higher than 
they were a year ago, due to the strengthening world economy 
and the lower dollar. Higher commodity prices may eventually 
lead to higher consumer and producer prices. We've already seen 
that with gasoline. But the real question is whether they 
signal broader price increases ahead.
    In the sometimes topsy-turvy world of economics, the bond 
market has treated recent gains in employment as bad news, 
driving bond prices down and interest rates up. Employment 
growth is, of course, an unmitigated good for the economy, but 
it does sharpen the question of how long the Fed will be able 
to maintain the current low interest rates and how and when the 
Fed may move to a more neutral policy stance. And we, of 
course, will welcome your insight on this issue.
    I'd also like to indicate we'd be interested in your 
thoughts on the housing market. Housing has been remarkably 
strong in recent years. It's boosted the recovery, built wealth 
for millions of American families, and low mortgage interest 
rates have been key to housing strength. But the concomitant 
result has been that home prices have been lifted in much of 
the nation, raising the cost of living for new home buyers, 
even as it creates a sense of wealth for existing home buyers. 
We need to understand how rising home prices might contribute 
to inflation. And looking ahead, we also need to understand how 
rising interest rates might affect the housing market.
    So those are the issues that are on my mind, Mr. Chairman. 
We welcome you again and look forward to your testimony.
    I now yield to the Vice Chairman, Mr. Saxton.
    [The prepared statement of Senator Robert F. Bennett 
appears in the Submissions for the Record on page 31.]

        OPENING STATEMENT OF REPRESENTATIVE JIM SAXTON, 
                         VICE CHAIRMAN

    Representative Saxton. Thank you, Mr. Chairman. It gives me 
great pleasure to join with you in welcoming Chairman Greenspan 
once again before the Joint Economic Committee.
    Let me just say that the evidence shows that the U.S. 
economy has displayed an amazing resilience in recent years and 
has now emerged from a painful adjustment process. The bursting 
of the stock market and technology bubbles began in 2000. The 
subsequent economic slowdown and recession, terrorist attacks, 
and wars harmed the economy, but did not prevent the current 
economic expansion, which began in November of 2001.
    The economic data released in recent quarters indicate that 
the U.S. economy continues to grow at a healthy rate. Over the 
last half of 2003, economic growth adjusted for inflation was 6 
percent. This recent pick-up in the economy was expected for 
some time, but had been delayed by weakness in business 
investment.
    However, the long-awaited rebound in business investment is 
now underway and has boosted the economy and has led to a more 
balanced pattern of economic expansion. For example, in the 
last two quarters of 2003, investment in equipment and software 
increased at rates in excess of 15 percent. The increases in 
investment have contributed to a strong recovery in 
manufacturing activity.
    Meanwhile, consumption and housing activity continue to 
hold up well. Productivity is very strong and inflation is 
under control. Recent data indicate that payroll employment 
growth has resumed. Independent economists have noted that tax 
relief and accommodative monetary policy have made important 
contributions to the recent strength in the economy.
    Finally, the Blue Chip Consensus forecast is that the U.S. 
economy will grow at an inflation adjustment rate of nearly 5 
percent this year. The return to sustained and healthy economic 
growth is a tribute to the flexibility and resilience of the 
American people and our free market economy.
    Mr. Chairman, thank you, and I'll be delighted to hear from 
Chairman Greenspan when you are ready.
    [The prepared statement of Representative Jim Saxton 
appears in the Submissions for the Record on page 31.]
    Senator Bennett. Very good.
    Mr. Stark.

        OPENING STATEMENT OF REPRESENTATIVE PETE STARK, 
                    RANKING MINORITY MEMBER

    Representative Stark. Thank you, Mr. Chairman. And welcome, 
Chairman Greenspan.
    I know we all have questions, the same questions that are 
in everyone's mind today--when? Which way? How much?
    We're all waiting to see. Chairman Bennett and I will 
become very wealthy if you'd whisper those things in our ear 
and give us a heads-up.
    But I don't think that will happen for us today.
    Consumer prices went up. Some are fearing inflation. The 
Fed has committed itself to be patient. My concerns still are 
job growth. We haven't seen such persistent job losses since 
the 1930s. And it wasn't much fun in the 1930s. I remember 
that.
    But we should talk about extension of unemployment 
benefits. I know that you testified a month or so ago that you 
would support extending unemployment benefits. I think it would 
help. I think it would help the economy. And it would certainly 
help 3 million unemployed workers to avoid financial ruin. Our 
counties and states are less able than ever to provide public 
assistance to these people who are out of work.
    I don't think training is the answer, because I don't know 
whether you can take an unemployed electrician and train him or 
her to be a chiropractor. They're out of work because there 
aren't jobs and not because they are unemployable.
    In the House, extending unemployment benefits has become a 
partisan battle. We passed extensions a couple of times, or 
asked to pass them. The leadership in the House has dug in and 
is not doing anything. The President and the Republican-
controlled Congress could pass an extension if they wanted to.
    So I look forward to your statements today, Mr. Chairman, 
about what you see, what kind of good news you may see ahead of 
us for this spring and summer.
    Thank you.
    Thank you, Mr. Chairman.
    [The prepared statement of Representative Pete Stark 
appears in the Submissions for the Record on page 32.]
    Senator Bennett. Thank you.
    Chairman Greenspan, we appreciate your being here and look 
forward to your testimony.

               OPENING STATEMENT OF THE HONORABLE

         ALAN GREENSPAN, CHAIRMAN, BOARD OF GOVERNORS,

                     FEDERAL RESERVE SYSTEM

    Chairman Greenspan. Thank you.
    Mr. Chairman and Members of the Committee, I'm pleased, as 
always, to be here to offer my views on the outlook for the 
U.S. economy.
    The American economy appears to have emerged around the 
middle of last year from an extended stretch of subpar growth 
and entered a period of more vigorous expansion. After having 
risen at an annual rate of 2\1/2\ percent in the first half of 
last year, real GDP increased at an annual pace of more than 6 
percent in the second half. Aided by tax cuts, low interest 
rates, and rising wealth, household spending continued to post 
sizable gains last year. In addition, an upturn in business 
investment, which followed several years of lackluster 
performance, and a sharp rise in exports, contributed 
importantly to the acceleration in real GDP over 2003.
    Although real GDP is not likely to continue advancing at 
the same pace as in the second half of 2003, recent data 
indicate that growth of activity has remained robust thus far 
this year. Household spending has continued to move up, and 
residential home sales and construction remain at elevated 
levels. In addition, improvement in business activity has 
become more widespread.
    In the industrial sector, nearly two-thirds of the 
industries that make up the index of industrial production have 
experienced an increase in output over the past 3 months. More 
broadly, indicators of business investment point to increases 
in spending for many types of capital equipment.
    And importantly, the latest employment figures suggest that 
businesses are becoming more willing to add to their 
workforces, with the result that the labor market now appears 
to be gradually improving after a protracted period of 
weakness.
    Looking forward, the prospects for sustaining solid 
economic growth in the period ahead are good. Monetary policy 
remains quite accommodative, with short-term real interest 
rates still close to zero. In addition, fiscal policy will 
likely continue to provide considerable impetus to domestic 
spending through the end of the year.
    Importantly, the caution among business executives that had 
previously led them to limit their capital expenditures appears 
to be giving way to a growing confidence in the durability of 
the expansion. That confidence has, no doubt, been bolstered by 
favorable borrowing conditions, ongoing improvements in 
efficiency, and rising profitability, which have put many firms 
on a more solid financial footing.
    Nevertheless, some of the strains that accompanied the 
difficult business environment of the past several years 
apparently still linger. Although businesses are replacing 
obsolescent equipment at an accelerated pace, many managers 
continue to exhibit an unusual reluctance to anticipate and 
prepare for future orders by adding to their capital stock. 
Despite a dramatic increase in cash flow, business fixed and 
inventory investment, taken together, have risen only 
moderately. Indeed, internal corporate funds exceeded 
investment over the course of last year for the first time 
since 1975.
    Similar cautious behavior has also been evident in the 
hiring decisions of U.S. firms, during the past several years. 
Rather than seeking profit opportunities in expanding markets, 
business managers hunkered down and focused on repairing 
severely depleted profitability, predominantly by cutting costs 
and restricting their hiring. Firms succeeded in that endeavor 
largely by taking advantage of the untapped potential for 
increased efficiencies that had built up during the rapid 
capital accumulation of the latter part of the 1990s. That 
process has not yet played out completely. Many firms seem to 
be continuing to find new ways to exploit the technological 
opportunities embodied in the substantial investments in high-
tech equipment that they had made over the past decade.
    When aggregate demand accelerated in the second half of 
2003, the pace of job cuts slowed. But because of the newfound 
improvements in the efficiency of their operations, firms were 
able to meet increasing demand without adding many new workers.
    As the opportunities to enhance efficiency from the capital 
investments of the late 1990s inevitably become scarcer, 
productivity growth will doubtless slow from its recent 
phenomenal pace. And, if demand continues to firm, companies 
will ultimately find that they have no choice but to increase 
their workforces if they are to address growing backlogs of 
orders. In such an environment, the pace of hiring should pick 
up on a more sustained basis, bringing with it larger 
persistent increases in net employment than those prevailing 
until recently.
    Still, the anxiety that many in our workforce feel will not 
subside quickly. In March of this year, about 85,000 jobless 
individuals per week exhausted their unemployment insurance 
benefits--more than double the 35,000 per week in September, 
2000. Moreover, the average duration of unemployment increased 
from 12 weeks in September, 2000, to 20 weeks in March of this 
year. These developments have led to a notable rise in 
insecurity among workers.
    Most of the recent increases in productivity have been 
reflected in a sharp rise in the pretax profits of nonfinancial 
corporations from a very low 7 percent share of that sector's 
gross value added in the third quarter of 2002 to a high 12 
percent share in the fourth quarter of last year. The increase 
in real hourly compensation was quite modest over the period. 
The consequence was a marked fall in the ratio of employees 
compensation to gross non-financial corporate income to a very 
low level by the standards of the past three decades.
    If history is any guide, competitive pressures at some 
point will shift in favor of real hourly compensation at the 
expense of corporate profits. That shift, coupled with further 
gains in employment, should cause labor's share of income to 
begin to rise toward historical norms.
    Such a process need not add to inflation pressures. 
Although labor costs, which compose nearly two-thirds of 
consolidated costs, no longer seem to be falling at the pace 
that prevailed in the second half of last year, those costs 
have yet to post a decisive upturn. And even if they do, the 
current high level of profit margins suggests that firms may 
come under competitive pressure to absorb some acceleration of 
labor costs. Should such an acceleration of costs persist, 
however, higher price inflation would inevitably follow.
    The pace of economic expansion here and abroad is evidently 
contributing to some price pressures at earlier stages of the 
production process and in energy markets, and the decline in 
the dollar's exchange rate has fostered a modest firming of 
core import prices. More broadly, however, although the recent 
data suggest that the worrisome trend of disinflation 
presumably has come to an end, still-significant productivity 
growth and a sizable margin of under-utilized resources, to 
date, have checked any sustained acceleration of the general 
price level and should continue to do so for a time. Moreover, 
the initial effect of a slowing of productivity growth is more 
likely to be an easing of profit margins than an acceleration 
of prices.
    As I have noted previously, the federal funds rate must 
rise at some point to prevent pressures on price inflation from 
eventually emerging. As yet, the protracted period of monetary 
accommodation has not fostered an environment in which broad-
based inflation pressures appear to be building. But the 
Federal Reserve recognizes that sustained prosperity requires 
the maintenance of price stability and will act, as necessary, 
to ensure that outcome.
    Thank you very much, Mr. Chairman. I look forward to your 
questions.
    [The prepared statement of Chairman Greenspan appears in 
the Submissions for the Record on page 32.]
    Senator Bennett. Thank you, sir.
    Your final comment that the Fed must act at some point to 
deal with inflation, raises the question of how we should 
measure inflation.
    What are the best indicators of measuring inflation? You've 
indicated previously that the CPI may be overstating inflation. 
But a fellow who talked to me yesterday said that many families 
do not perceive inflation to be low right now, a legitimate 
question as to whether or not inflation indices correctly 
incorporate housing prices. I referred to that a little bit in 
my opening statement.
    So could we talk about the CPI and other indicators and 
could you give us some indication of what you look for when you 
try to determine whether or not inflation is just over the 
horizon?
    I remember you saying to the Committee some years past, if 
you wait until you have clear signs of inflation, it's too 
late, and you ought to see what's over the horizon.
    Well, as you look over the horizon, what are you looking 
for and what indices do you pay attention to?
    Chairman Greenspan. First, Mr. Chairman, let me indicate to 
you that, as you've heard from, I presume, many witnesses, the 
Consumer Price Index--that is, the regularly published index--
despite the fact that it has been improved immensely by the 
Bureau of Labor Statistics, which has taken out a significant 
part of the bias, is, nonetheless, still significantly biased, 
largely because it's a fixed-weight index and doesn't reflect 
the changing composition of consumer purchases.
    And by the nature of its weighting, it inordinately weights 
the housing sector far more than it should in the context of 
the overall economy.
    As a consequence, we have chosen what we perceive to be a 
far more general view of consumer prices, which is the monthly 
index which is published by the Bureau of Economic Analysis of 
the Department of Commerce for the deflation of personal 
consumption expenditures.
    It uses virtually all of the individual prices that are in 
the Consumer Price Index. Indeed, that's the basic source of 
all data.
    But it reweights them and estimates various different 
components in ways which tend to create an index which has been 
running below the Consumer Price Index.
    That means it is less upward-biased than the CPI. But it is 
still upward-biased.
    And indeed, so is the CPI chain index, which also endeavors 
to pick up implicitly the mix that is changing in the consumer 
area. And that index is published every month by the BLS and, 
in my judgment, is a far superior index to the existing one 
that currently is published.
    Now we look at all price indexes and we look at individual 
prices. And I must say to you----
    Senator Bennett. Including commodities?
    Chairman Greenspan. Yes, including commodities, and 
including the broadest index of all, which is the deflator for 
the gross domestic product, which picks up capital investment, 
government and other individual items which are not captured in 
any of the Consumer Price Indexes.
    With respect to the question of housing, that has always 
been a very difficult issue to handle.
    First of all, there is the much broader question as to 
whether, in fact, you include prices only of goods and services 
or whether you start to look at asset prices as well, or a 
futures price.
    In short, the debate on what the price environment is has 
spread beyond the usual notions of single index.
    We estimate the housing costs, or I should say, the BLS 
does, essentially by, one, getting rental costs, obviously for 
rental dwellings. But it imputes a price to homeownership by 
effectively using the data that are picked up on rents and re-
adjusting them to try to capture what is the implicit foregone 
rent of homeowners, on the grounds that shifting from being a 
renter to a homeowner creates costs. They may be higher, they 
may be lower. But a number of the costs involved in 
homeownership are not captured in the sense that you're not 
paying any rent.
    And so, that is an adjustment which takes place. There are 
very significant disputes on the appropriate handling of this 
issue and we probably will find that there will be revision 
after revision, as indeed, there has been for a number of 
years.
    Senator Bennett. Thank you.
    I'd like to follow up, but I want to set the example of 
staying within the time limit. We will do the early bird rule.
    Mr. Saxton was here next and so we'll go to him, and then 
we'll go to Ranking Member Stark.
    Representative Saxton. Thank you, Mr. Chairman.
    Let me follow up on your question. For many years, we have 
tried to look over the horizon, and you've led a great example 
for us, particularly with regard to trying to figure out what 
inflation may be over that horizon.
    In recent months, we have waited anxiously for growth to 
take place in all sectors of the economy. And finally, we 
appear to be there.
    But wouldn't it be prudent to wait for more data before 
making changes in the current accommodative stance of monetary 
policy? That is a question which is obviously on the minds of 
many Americans today and we're anxious and interested in your 
response.
    Chairman Greenspan. Well, obviously, those are issues which 
the Federal Open Market Committee discusses at great length and 
we are meeting in a couple of weeks and we will be discussing 
the issue. And we'll be meeting periodically thereafter.
    I can only speak for the Federal Open Market Committee when 
they tell me I can speak for it.
    So I'm not going to suggest to you that I can give you a 
pattern of what we may or may not do over the next quarters and 
potentially, years.
    But what we do do is endeavor to look over the horizon. And 
we have numbers of different scenarios which we believe are 
credible more or less. And as a consequence of that, we have a 
sense not only of what we might do in the near-term, but where 
that eventually leads us, because there is no such thing as a 
monetary policy which is ad hoc or what do you do next?
    Unfortunately, on occasion, that has been our history and 
it does not work for precisely the reasons the Chairman 
mentioned earlier.
    So we try to be forward-looking and to think in terms not 
only of whether we will move or not move on a particular date, 
but what does that imply about a whole program of change, if 
indeed we are changing.
    And remember that the fact that we have done nothing with 
respect to the federal funds rate for almost a year is a 
program.
    In other words, it's not that nothing has happened and 
that, therefore, we saw no reason to make any changes. It's 
been an active program, the conclusion of which is that where 
we were is where we wanted to be.
    So it's a process which we're still learning from.
    In other words, we're still developing the means by which 
we formulate policy and it's becoming more programmatic in the 
sense that it thinks in terms of strategies rather than 
individual, period-by-period developments.
    And that, as you might imagine, is a rather difficult thing 
to do--engaging 19 people who are members on the FOMC and none 
of whom are reluctant to say what they believe.
    Representative Saxton. Well, thank you very much, Mr. 
Chairman.
    Mr. Chairman, I'll yield to the next questioner and follow 
your great example.
    Senator Bennett. Thank you very much.
    Mr. Stark.
    Representative Stark. Thank you, Mr. Chairman.
    I have three questions, Mr. Chairman. I'll just run through 
them and you may whack away at them in any manner you see fit.
    First, I would like to have your comment as to whether you 
still believe, as you testified earlier, that it would be 
sensible policy to extend unemployment benefits.
    My next question deals with the recent proposal of FASB--
the Financial Accounting Standards Board--requiring recognizing 
the cost of employee stock options.
    Some of my colleagues would like to block that proposal and 
I wonder whether you have any position on whether we should, in 
fact, follow the FASB rules, or at least stay out of their 
turf.
    My third question deals with a topic that we're discussing 
a good bit, and that is whether we should fix our tax code so 
that it does not encourage U.S. firms to move capital and jobs 
to foreign tax havens.
    And I don't necessarily refer to just outsourcing, which 
may go on where labor markets are attractive. But whether we 
should, in fact, add to that by creating a tax incentive that 
might encourage companies to move.
    Those would be my three areas. If you'd have time to deal 
with them, I'd appreciate it.
    Chairman Greenspan. Mr. Stark, I indicated in my prepared 
remarks that 85,000 a week of the unemployed are losing their 
unemployment insurance, which is an exceptionally high number.
    I'm of the belief that our unemployment insurance system 
has been crafted and has evolved in a way which seems to me as 
close to optimum as you can make such a system.
    It does not encourage undue unemployment by creating excess 
benefits, so that people don't seek jobs when they could. And 
yet, its replacement rate on existing wages is--of course, it's 
never adequate, but it's at a reasonable level.
    We have extended, of course, unemployment insurance on 
previous occasions when it was fairly clear that large numbers 
of the unemployed were unemployed through no fault of their 
own.
    And as I indicated a month ago, which you are reporting on, 
my view is that if we make the extension short, because it's 
not going to be required very long, I do think it's a good idea 
and I think it's a good idea largely because of the size of the 
degree of exhaustions, which is, in a sense, almost a special 
case.
    With respect to stock options, I think it would be a bad 
mistake for the Congress to impede FASB in this regard.
    First of all, this is an accounting question. I've always 
argued that accounting is for the purpose of determining 
whether particular strategies of companies are profitable or 
not profitable. The whole point of accounting is to tell 
somebody whether a specific strategy is working or not.
    The cost of worker input, labor cost, irrespective of the 
form in which it's paid, is a critical determinant of the 
production process and the determination of whether or not a 
strategy is profitable.
    In other words, in simple terms, if your output values are 
greater than your input values, within certain limits, it's a 
profitable strategy.
    If you take one of the significant elements of input of 
costs and take it off the table--if you don't expense stock 
options--then you're getting a distorted view as to what the 
profitability of a particular operation is and you will get a 
distortion in the allocation of capital.
    Now it may very well make individual firms look more 
profitable than they are, and people don't like to change that. 
But the point at issue is not whether it is more or less 
profitable, but are the figures right?
    And in this regard, as best I can judge, the FASB 
recommendations with respect to accounting procedures strike me 
as correct. And it's not clear to me what the purpose of 
Congress is in intervening in this particular procedure.
    With respect to the tax code question, that's a very 
complex issue because the tax code, as it affects the 
allocation of capital within a multinational firm, is never 
simple. And every time you change one element, you change 
something else.
    And the presumption that you could essentially calibrate 
taxes to somehow provide major incentives within a 
multinational corporation to move employment from overseas to 
domestic I'm not sure works.
    I do not deny that you can set up taxes which would prevent 
employment going abroad. But that doesn't mean that it's coming 
back home. It just disappears.
    Representative Stark. My question, Mr. Chairman, was 
relative not to labor, which I don't think we can control with 
the tax code. That will always be attractive to people who 
choose to outsource.
    But when you can retain profits overseas and not pay taxes 
on them, that encourages a capital investment in addition to 
what the normal labor market----
    Chairman Greenspan. Well, you're referring to the issue of 
bringing back capital and therefore, it would be invested in 
the United States?
    The evidence on that, Congressman, is that capital 
investment in the United States is largely determined by the 
potential rate of return in the United States relative to the 
domestic cost of capital.
    Our financial markets are sufficiently liquid and our 
corporations in large measure are not limited for cash flows.
    So it's quite conceivable that if you change the tax code 
in a manner which induces a much larger flow of undistributed 
earnings from abroad to domestic affiliates, it's going to have 
very little effect on capital investment. It probably will 
increase the payment of dividends to shareholders.
    In other words, what will happen is that money will come 
through the United States and go out to shareholders in 
general.
    There's very little evidence that I've seen, even though I 
know that some of my friends have made calculations in this 
regard. I frankly find them most unpersuasive.
    Representative Stark. Thank you very much.
    Thank you, Mr. Chairman.
    Senator Bennett. Yes. Senator Alexander.
    Senator Alexander. Thank you, Mr. Chairman, for being here.
    Mr. Chairman, I want to refer to your comments about hiring 
as we look to the future. And I want to ask specifically about 
up to 6 million or so people working in this country who I 
don't think we're counting when we figure out who is working 
and who is not working.
    I'm referring to undocumented aliens or to illegal 
immigrants.
    We have two reports each month about who is working. The 
employers' survey samples 400,000 people who are on payrolls, 
as I understand it.
    The household survey is a telephone question of up to 
60,000 people, asking in many different ways, do you have a 
job? Are you working?
    And there's been a lot of discussion which Chairman Bennett 
has participated in about which is more accurate. My question 
is not that. My question is that in both these surveys, which I 
gather we use to decide how many people are working and how 
many are unemployed, I don't think we count about 6 million 
people who are working in America, and those are illegal 
immigrants.
    Most estimates are that we have 8 to 10 million living in 
America who are not legally here. Most estimates are that about 
6 million of those people are working.
    Now I'm assuming they're not counted in the payroll survey 
because it's illegal to hire somebody who's illegally here.
    So that's 6 million people who are not counted.
    And I'm assuming they're not counted in the household 
survey because if you're legally here and you've got a phone 
call from the government, you're not likely to spend much time 
answering the questions about anything.
    And the reason I ask these questions is, if the report says 
that we have 129 million people working in America today and 
we're not counting people, 6 million people--or up to 6 million 
people who are illegally here--what difference would that make 
in your estimates and projections.
    Or in the household survey, if we're saying that we have 
7.8 million people unemployed in America, but we have 6 million 
people illegally here, what does that say about our solutions 
for those unemployed persons?
    Are we to assume that if those 6 million illegal immigrants 
were not here, that we'd have no unemployment in America? Are 
we understating or overstating our jobs and unemployment 
figures because we're not counting up to 6 million people who 
are illegally here and who are working?
    Chairman Greenspan. Well, Senator, this issue has bedeviled 
statisticians--basically, the Bureau of Labor Statistics--for a 
long period of time.
    The issue gets down to a few facts. The base of the payroll 
survey, which is monthly, as you point out, a survey of 400,000 
establishments, is actually a quarterly posting of all 
employment that is subject to the unemployment insurance 
system, which we presume under the law is full coverage, but as 
you point out, of legal coverage.
    Now the question really gets down to, when the individual 
companies submit their reports to the unemployment insurance 
system, do they include all people whom they have hired? Or do 
they include only those who they perceive to be legal?
    The answer seems to be that they can't or shouldn't or 
probably can't, in general, make that distinction. And so, you 
have to assume that, presumably, people are working a plant, if 
they are illegal aliens, are counted.
    The question of the household survey really is a two-
pronged question. First, what the 60,000 sample does is 
basically try to get the proportion of people working within 
households as a percent of the non-institutional population, 
age 16 and older. Now, when that figure is calculated, they 
then multiply it by the estimate of the non-institutional 
population, which the Census releases.
    I assume we have perfect numbers on legal immigration. But 
I have trouble finding them all the time. But, clearly, we are 
guessing on illegal immigration.
    So that the aggregate number of employees depends on, one, 
the illegal immigration estimate in the population and two, the 
answer to the issue that you raise--when people are called in 
that 60,000 sample and there are illegal-employed people within 
that household, do they say they're employed?
    Now the problem is that, when you put all of these data 
together, and you match the payroll data and the household 
data, it is difficult to find the wedge of illegal immigrants.
    In other words, it doesn't show up in a manner which you 
can basically say, the reason why the household figure is this 
or the unemployment rate is that is illegal aliens; the bottom 
line is nobody knows for sure.
    But the data are internally consistent, over the years, 
between the payroll data and the household data, and give 
roughly the same results.
    And unless the illegal alien figure is not captured in 
equal proportions in both of these surveys, then we have to 
assume that the illegal aliens are being counted in large 
measure.
    But the bottom line, as I said, is we don't know that and I 
think it would be a major advance in our statistical 
understanding if we'd get a much better handle on that 
question.
    Senator Alexander. Thank you.
    Senator Bennett. Mr. Hill.
    Representative Hill. Thank you, Mr. Chairman.
    Welcome, Chairman Greenspan. I would indicate that in the 
past you have said that deficits matter. Yesterday you said 
that they're not an immediate threat right now.
    But you have also said that you have supported the idea of 
budget enforcement rules like PAYGO.
    You've also endorsed the concept of permanent tax cuts. How 
do we get to the bottom of this deficit problem if you support 
permanent tax cuts and PAYGO rules that apply both to spending 
and tax cuts?
    And I do have a second question that I would like to get 
out there, and I'd just throw it out there now and let you 
address yourself to it.
    Back in February, when you were testifying before the 
Congressional committee, you generated a lot of telephone calls 
into my congressional office by suggesting that we cut Social 
Security in order to rectify the growing budget crisis.
    And I would like for you to address that as well, if you 
would.
    Chairman Greenspan. First of all, I argued strenuously and 
ineffectively before the Congress in September, 2002, not to 
allow the PAYGO rules and discretionary caps to expire because 
I thought that over the previous decade they had worked 
remarkably well, and indeed, were a major factor in 
constraining deficit expansion and, indeed, contributed largely 
to the contraction of the deficit.
    I still believe that we need, before we get involved in 
budget negotiations, budget discussions, budget programming, to 
restore those budget rules because there is no way, that I'm 
aware of, which the Congress can appropriately allocate various 
priorities in the way in which 535 Members of the Congress can 
effectively come to a conclusion.
    You have to have a mechanism to do that. And the best that 
has been adduced in recent decades has clearly been PAYGO.
    I reconcile the issue of taxes and PAYGO by stipulating 
that, one, I visualize the PAYGO rules in place. But I would 
like to see--I don't have a vote, so I'm just expressing my own 
point of view--a lower level of spending, largely because we 
are going to be confronted with a very major increase----
    Representative Hill. Well, where would you cut?
    Chairman Greenspan. I could give you a long list of cuts 
that I would do, and I would submit to you that your telephone 
bill would go up immensely.
    [Laughter.]
    First of all, that is the issue of why we have budget 
committees and various different mechanisms by which the 
Congress comes together to take the limited resources that we 
have and effectively comes up with fitting some of the parts in 
the total.
    Now, is that easy?
    No. But I do think that the point that I have been making 
is that we have an unprecedented change occurring in the next 
decade with a doubling of the number of retirees. And that is 
going to have a huge impact on benefit payments and fiscal 
pressures.
    Now I have argued over the years that Social Security, 
being a defined benefit program, requires change, but not a 
great deal of change because we know within limits what type of 
benefits will be paid under the existing statutes.
    We don't have such confidence on Medicare. We cannot 
anticipate the processes that are going to occur in medical 
technology and in medical application so we do not have any 
reasonable way to come at what the costs are going to be.
    We have a standard procedure where we say, benefits per 
retiree are going to rise X-percent faster than per-capita GDP. 
That's not, frankly, very helpful, nor very informative.
    Because of the fact that of that great uncertainty, I have 
argued that it is essential that we have fiscal caution in this 
regard.
    With respect to the issue of my allegedly saying that we 
ought to cut Social Security to fund the tax cuts, I object to 
the tying of those. I never made such a statement.
    I have argued in favor of changes in benefits for a 
significant period of time wholly independently of whether the 
tax cut is continued or not continued and, indeed, even before 
the tax cut was enacted.
    So to suggest that I am recommending cuts in Social 
Security to fund tax cuts, I find a rather misplaced 
conclusion.
    All in all, I think the issue that is going to confront 
this country, unless we come to a far more organized way of 
looking at fiscal problems, is we're going to find that we get 
up to the year 2008, 2009, and the pressures from the financial 
markets are going to start to really begin to bite. And that's 
a little late in the game to resolve this issue, which I must 
say to you concerns me most because I don't believe that we can 
assure the next generation that what we have promised under 
current law, we can actually deliver in real terms.
    And, if indeed, that is the case, it is incumbent on public 
policy-makers to communicate that to those who will be retiring 
in 10 years, so that they can plan in a manner which is far 
more rational, rather than find that at the day they retire, 
the government says, whoops, we miscalculated. We cannot give 
you what we promised.
    That's just unacceptable to me as public policy.
    Senator Bennett. Mr. Paul.
    Representative Paul. Thank you, Mr. Chairman.
    Good morning, Chairman Greenspan. I find it interesting 
that you, as the previous Chairman of the Federal Reserve--I 
remember four, total--they've always advocated that we in the 
Congress spend less.
    And really, the advice hasn't been taken.
    Currently, our national debt is going up over $700 billion, 
and we're pursuing once again a policy of guns and butter and 
nobody seems to have much concern.
    But I think the Fed participates in this. As long as you 
control the monopoly control over money and credit, and you can 
accommodate the Congress--I mean, if we spend, and nobody's 
going to buy those Treasury bills. We know if you want interest 
rates at 1 percent, you're going to buy them.
    So, in a way, you're complicit in what we do here in the 
Congress. But I don't see that coming to an end with the 
monetary system that we have.
    I do have a question dealing with your statement in the 
first paragraph about rising wealth contributing to the 
recovery.
    This last recession has been written about quite 
extensively as being unique, that it came about not because you 
raised interest rates as the traditional--as it is 
traditionally for the Fed to raise rates. We go into a 
recession. Then there's liquidation and debt is wiped off the 
books. Then there's a restarting.
    This time, it just stopped because people ran out of steam. 
There wasn't enough consumer purchasing power and we had a 
recession.
    But you very, very quickly and efficiently came in and 
lowered interest rates very aggressively and prevented the 
conventional liquidation and the corrections that have come in 
the previous recessions.
    And Congress didn't hesitate for a minute to follow in its 
Keynesian path and rapidly and excessively raise spending.
    But in addition to this, we have this very unusual and 
unique form of financing our houses which has caused tremendous 
inflation in our housing prices through the financing of Fannie 
Mae and Freddie Mac, which in some ways the Fed participates 
and in many ways, the foreign central banks participate 
extensively in this.
    Anyway, we have a housing bubble. Housing prices go up and 
that, I assume, participates in this wealth because the 
consumer has gone and borrowed sometimes more than their 
equity.
    Of course, equity prices are soaring.
    And that to me is like saying that we had great wealth when 
the NASDAQ was 5,000. And all of a sudden, that great wealthy 
dissipated rather quickly.
    So I do not see how we can say that we have true wealth 
without savings that's created artificially by the excitement 
of easy money and easy credit and artificially rising prices. 
And then people go out and get into further debt.
    To me, it seems like the bubble leaked and you patched it 
up quickly. So we're back on the same track again of very 
excessive spending, excessive borrowing, and we never had the 
liquidation.
    What really are you thinking about when you're talking 
about the rising wealth that has helped in this recovery?
    Chairman Greenspan. The term ``wealth'' in this context is 
a technical statistical term which is related solely to the 
question of the market value of the net assets of households.
    Now one can argue whether or not the market values that are 
placed on claims on physical assets are high or low. Remember 
that all judgments of wealth essentially are discounted values 
of forward-expected returns, and that a people's sense of risk 
aversion is a critical fact in determining where stock prices 
are and, hence, where that wealth is.
    But having said that, whatever it is does impact, by all of 
the statistical analysis we are able to adduce, on consumer 
expenditures. And the reason for that is that people, when they 
become wealthier in paper terms as you would put it, do have 
collateral to borrow against and to spend, and they do.
    And that has indeed been an important factor in consumer 
expenditures over the last decade.
    Representative Paul. My question is, is it real collateral? 
That's the question.
    Chairman Greenspan. Well, the point at issue is, it gets to 
the more fundamental question, if you're sitting out there with 
a big steel plant and you say, that is wealth, the question is, 
it's people's judgment as to the amounts of steel that will be 
produced and sold, and the profitability that will be 
engendered, that will determine the ongoing value of that steel 
plant.
    And people's views can change quite dramatically, even if 
the physical plant doesn't change one iota, even if, indeed, 
the amount of steel they're producing and selling doesn't 
change.
    So what I'm trying to get at here is that you're raising 
the much broader question with respect to how are assets valued 
in the market place. And we have rational and non-rational 
procedures by which those evaluations are made.
    Representative Paul. I'm afraid we're confusing debt with 
assets. That's my contention.
    Chairman Greenspan. Debt and assets are two wholly 
different things. The Federal Reserve, I will say, does not 
make that mistake.
    [Laughter.]
    Senator Bennett. Senator Sarbanes.
    Senator Sarbanes. Thank you very much, Mr. Chairman. I want 
to join you in welcoming Chairman Greenspan before the 
Committee.
    Mr. Chairman, I have a number of questions for you. I'll 
try to be brief in asking them. And if you could be brief in 
answering them, maybe we can run through the list, or come 
close to completing it.
    The IMF is apparently urging the Fed to prepare the economy 
for higher rates so as to avoid financial market disruption, 
both domestically and abroad.
    What is the IMF referring to in this urging?
    Chairman Greenspan. I'm sorry? What is the IMF doing?
    Senator Sarbanes. What are they referring to with this 
urging? What is the disruption both domestically and abroad 
that they're referring to?
    Chairman Greenspan. I think they're referring to two 
things, although I don't know this because I haven't actually 
seen the detail and they may explain it in more detail.
    But in 1994, for example, when we moved 300 basis points, 
we did create a lot of movement in the market place. And I 
think that there is a concern that because in the last 10 
years, the international financial system has expanded to such 
a large extent, that we're now more inter-related than 
previously. And obviously, any significant problem in the 
United States' financial markets would inevitably spill over 
into the rest of the world.
    I don't know what the IMF is saying because I haven't read 
what that is.
    However, it's also important to understand that the degree 
of sophistication that has emerged in the last decade in our 
financial markets has induced all of the participants to 
effectively make a judgment as to where they think interest 
rates are going and to effectively hedge those positions.
    So that whatever one may say about where they think Federal 
Reserve policy is going or interest rates in general are going, 
I will say to you that, for the average, it's effectively 
hedged.
    And the question has got to be whether markets move or less 
than are currently being discounted.
    Senator Sarbanes. Now as of this August, you will have been 
Chairman of the Fed for 17 years, I believe. Looking back over 
your 17-year tenure, once the Fed starts moving the rates up, 
how long does that period usually last?
    Chairman Greenspan. Well, first of all, there's an 
implication that once we start, we continue for a protracted 
period.
    Senator Sarbanes. Is that not the case?
    Chairman Greenspan. That is not the case. There have been 
many occasions in which we have made one move and stopped.
    But, on average----
    Senator Sarbanes. Well, if you do a two-step, for how long 
does it usually last?
    [Laughter.]
    Chairman Greenspan. I don't know. But, on average, if you 
just look back over the period, when we've gone through 
protracted moves in either direction, it's usually a year or 
so.
    But as I said in the very beginning, we do program 
analysis, if I may put it in those terms, with respect to 
strategies for moving rates in one direction or the other, and 
there is no timeframe that we essentially associate with that.
    Senator Sarbanes. And once you start moving rates beyond 
the two-step, by about how much do you usually raise them up?
    Chairman Greenspan. It varies.
    Senator Sarbanes. What is the smallest amount by which you 
have raised rates once you've started raising them in the 
course of your tenure as Chairman?
    Chairman Greenspan. I think it was 25 basis points, which 
was the short----
    Senator Sarbanes. I'm trying to eliminate the one-step 
scenario.
    Once you get to a two-step and you start raising them----
    Chairman Greenspan. I have a general knowledge, but I'd 
much prefer to answer that for the record to get it exact, if I 
may.
    Senator Sarbanes. Well, it would be helpful if you could 
submit that to us, Mr. Chairman.
    [The written response appears in the Submissions for the 
Record on page 35.]
    Would you regard the current levels of inflation as 
extraordinarily unusual in historic terms, and therefore, the 
economy has somehow been passing through a unique period?
    Chairman Greenspan. I would, Senator.
    Senator Sarbanes. What do you think is the more normal 
inflation rate?
    Chairman Greenspan. Well, it's not that there is a more 
normal rate. I'm saying what we have gone through is a really 
quite extraordinary process in the last 20 years to diffuse 
inflation expectations in a way which I would have thought 
would have been extraordinarily difficult to do, looking at it 
from a 20 years ago viewpoint.
    It's very apparent that globalization has been a very 
important characteristic of this, and I have no doubt that the 
ending of the Cold War and the opening up of many of the 
markets, especially in Europe, have been factors here.
    But something different and unusual has been going on. The 
question that you're asking is, where do we go from here? And 
there's a certain sense of normality.
    I'm not sure that there is a normal inflation rate. As far 
as we at the Fed are concerned, what we would like to see is 
the normal inflation rate, is price stability.
    Senator Sarbanes. I see that my time is up. If I could just 
add one more question very quickly.
    I notice that inflation-protected bonds are apparently 
selling at a rate that anticipates inflation of about 2\1/2\ to 
3 percent as we move forward.
    Is that correct?
    Chairman Greenspan. The difference between the TIPS, which 
are inflation-indexed bonds, and the nominal Treasury rates, 
are the numbers which you are suggesting.
    The problem is that that is not necessarily a pure forecast 
of price, largely because, as the liquidity in these inflation-
indexed bonds has increased, their yields have gone lower than 
they would have gone and hence, the spread between the higher 
nominal rate and the TIPS rate has opened up more than one 
would expect is wholly the consequence of inflation.
    We don't know what the size of that liquidity change is. We 
do suspect, however, that there's an upward bias in that 
measure of inflation expectation.
    We use it and we evaluate it and we try to understand it. 
We also use a lot of other indicators of underlying inflation 
expectations. And when they all come together, we feel 
comfortable. When they don't, we try to determine what are the 
differences and what is likely to be the truth.
    Senator Sarbanes. Thank you, Mr. Chairman.
    Senator Bennett. Mr. English.
    Representative English. Thank you, Mr. Chairman.
    Chairman Greenspan, thank you very much for giving us this 
opportunity today. I have two rather narrower questions that I 
would like to pose and I will simply pose them and allow you to 
take them wherever you wish.
    The first of these, you note in your testimony the 
importance of capital investment in the current recovery.
    What I guess I would be curious to have you comment on is, 
given the tax legislation that passed last year, and some of 
the specific incentives for capital investment that were 
included in them, do you feel comfortable making a causal 
connection between a higher level of capital investment and 
some of the incentives that were included in that bill?
    And specially, if Congress were to act to continue those 
incentives and make them permanent, would that have a 
potentially beneficial impact on the economy?
    My second question has to do with another side of the 
recovery, specifically in manufacturing.
    I think that the indicators right now, as you've noted, are 
that manufacturing is recovering. But I am concerned about the 
cost of some of the inputs for manufacturing.
    Specifically, steel scrap, coke for some aspects of the 
steel industry, and for manufacturing generally, the high cost 
of energy.
    And I wonder if you feel there is any evidence to suggest 
that those higher costs potentially will have an impact on 
manufacturing, have a potential to slow down the recovery. And 
do you anticipate that those costs may come down?
    And I'm particularly interested in any comment you would 
feel comfortably offering on the issue of steel scrap.
    And I thank you.
    Chairman Greenspan. Congressman, the evidence does suggest 
that the partial expensing element in the tax bill is having an 
impact, in part because it's limited.
    In other words, that it will come to an end, as I recall, 
at the end of this year. But it's probably the most potent 
factor involved.
    Over the longer run, I suspect, although it is difficult to 
prove, that the lower tax on dividends will ultimately flow 
through into higher capital values which indirectly will impact 
on capital investment.
    So the answer to your general question is, yes, I think 
there is evidence that capital investment has been affected.
    With respect to the steel inputs, it's not that long ago 
that we had the Mesabi Range operating at a fraction of its 
capacity. Now, everything is going flat out and everybody wants 
to buy everything they can.
    And the one thing I have never thought we would have a 
shortage of is coke. And coke prices, as you know, have moved 
very materially.
    And if you really wanted to get to the bottom of the heap, 
what you would call scrap, which has really been the star price 
performer, and essentially, what all of this does, both the 
issue of iron requirements and steel scrap generally, is a huge 
increase in metallic demands around the world, of which China 
has been a very material element.
    It's hard to tell what the level of actual consumption of 
metallic materials is in China because we've had big surges in 
prices not only in steel, but in aluminum, copper, and other 
metals as well.
    The rate of increase on the shipments strikes me as 
unlikely to be matching a consumption pattern. History tells me 
that there's some inventory building in that process.
    And therefore, it's hard for me to believe that the surge 
in steel scrap prices, which seems to be tilting over now, 
incidentally, is one that's going to resume and continue 
higher.
    So my general view is that the underlying costs in the 
steel industry have induced a lot of the producers, especially 
those with electric furnaces, which essentially use scrap, to 
put premiums on prices and create some significant problems for 
metal-using industries.
    And it has indeed induced the slow-down.
    When you insert the natural gas issue on top of that, it's 
really becoming a serious problem. And I do think it is an 
element slowing down durable goods manufacturing over the long 
run.
    Fortunately, in the short run, things seem to be coming 
back reasonably well. And as you know, the order books of the 
steel companies are flat out. And indeed, recently, one of the 
major motor vehicle manufacturers acquiesced in essentially 
taking a premium price of steel, even though it wasn't in their 
contract.
    That tells me something very unusual is going on here.
    Representative English. Thank you, Mr. Chairman.
    Senator Bennett. Mr. Ryan.
    Representative Ryan. Thank you. Well, Mr. English asked one 
of the questions I wanted to ask. So I'm going to take a 
different tack.
    But I think if you take a look at the last year, over 
monetary and fiscal policy, I think it's a good story that can 
be told.
    Number one, when the tax cuts were announced last January, 
the markets responded favorably. When we got more into the 
serious business of actually writing the legislation in the 
spring, the markets clearly took that as a serious note. And 
when they passed in July, I think we saw a great recovery where 
we had the greatest quarter growth in 20 years.
    Combine that with the fact that we had very accommodative 
monetary policy with expansion of the monetary base, I think 
what you saw last year was a great success story in economic 
expansion to where we are today, where consumption is growing 
well, where we have business capital expenditures growing at 
double digits. We have exports growing at double digits.
    To the point where we are today where the foretold 
employment expansion to the household survey tells us a good 
story. And even now, the employment survey has shown that we've 
created 500,000 jobs since January, and to the point where we 
now see that disinflation or deflation is off of the horizon.
    My question to you, Mr. Chairman, is this. Now that we do 
see that essentially, deflation is off the horizon, why does 
the Fed seem to be ignoring sensitive market signals like gold, 
commodities, and the steep, upward-sloping yield curve?
    These signals have traditionally placed advanced warnings 
of excess liquidity and inflation. Shouldn't the Fed at this 
time be looking at normalizing the federal funds rate?
    After all, having an economy that's growing an average of 
about 5 percent and a Fed funds rate at 1 percent seems to be 
an unsustainable posture over the long run.
    Wouldn't it be prudent to have small adjustments now, say 
before gold hits $500, so that we can avoid larger adjustments 
in the future, such as what took place in 1994?
    Chairman Greenspan. Congressman, I can't obviously 
stipulate where the Federal Open Market Committee is going to 
go or not go because, one, while I can guess, I'm not sure. And 
in any event, if I could guess, I shouldn't say what I guess.
    But the crucial difference between now and in the past is 
an extraordinary productivity acceleration.
    Remember that if you take the non-financial business 
structure of our domestic economy, you can disaggregate it in a 
manner to get the causes of price change.
    In other words, we know that two-thirds of consolidated 
costs are unit labor costs. We know what proportion are import 
costs and if you take the non-energy part of our non-financial 
business, we know what parts are energy costs.
    So that we can see the structure of costs moving.
    What is different from the past is that, in the past, we 
had very little productivity gain and a very rapid response.
    Here, what we are finding is that productivity is running 
in excess of compensation of employment, or has been, which 
means that unit-labor costs are falling.
    To be sure, they're falling at a pace less than had been 
the case last year, but they are still falling. And that means 
that the price pressures are not anywhere near what they would 
be under normal circumstances.
    And when you look at the past, the issue of addressing a 
particular potential inflation problem has got to take into 
consideration all of the various elements involved in that 
current situation. And remember that any particular monetary 
policy that you embark upon has risks. And you have to balance 
the risks against the benefits.
    When you have the benefit of a very significant increase in 
output per hour, it means that you can go in a much more 
measured pace than you would be required to go in the past.
    And the reason why we have stayed at a 1 percent federal 
funds rate over all of this period is not that we thought that 
inflation had gone away and that it was no longer a problem. 
It's that we believe that given the underlying structure of 
costs and prices and profitability, that the emergence of 
inflation at a reasonably rapid pace, which would create great 
concern on our part, was nowhere on the horizon.
    And that, therefore, we could calibrate monetary policy in 
a way that we did not have to take undue risks, which 
invariably you do no matter what policy is. And that 
essentially is what our recent history has been.
    Where we go from here is an issue that the Federal Open 
Market Committee will address in a couple of weeks and 
thereafter.
    Representative Ryan. Well, if and when you adjust or 
increase the Fed rate this year, will you make that decision 
based on the economy or based on the budget?
    Chairman Greenspan. I'm sorry? On the economy or----
    Representative Ryan. Or based on the budget that Congress 
passes. The question is, some will try to link any potential 
increase to what the budget deficit is or what the budget that 
passes the Congress is versus whether or not you're going to 
look at all the other things, the factors in the economy.
    Chairman Greenspan. We look at the economy only. But to the 
extent that the budget affects the economy, that then becomes 
part. But we don't, as you put it, link monetary policy to 
whatever the Congress does with respect to fiscal policy.
    Representative Ryan. Thank you.
    Senator Bennett. Senator Collins.
    Senator Collins. Thank you.
    Good morning, Mr. Chairman. I'd like to get your thoughts 
on an issue that is very important to my home state of Maine. 
And that is the loss of manufacturing jobs that we're seeing.
    Over the past 3 years, Maine has seen some 18,000 
manufacturing jobs disappear. It has really hurt our economy.
    In fact, we've had the greatest loss on a percentage basis 
of manufacturing jobs of any state.
    The recent news on the jobs front has been very 
encouraging, but it's unlikely to help a lot of these 
individuals who worked in our paper mills and other factories 
in Maine for many, many years.
    And I want to point out that I realize that job losses in 
the manufacturing sector are not a new phenomenon. If you look 
back from World War II on, the percentage of employment in the 
manufacturing sector has declined as a share of total 
manufacturing. And in absolute terms, the number of American 
manufacturing jobs has fallen each year since 1997.
    Recognizing that the job losses in the manufacturing sector 
reflects a long-term trend, I would welcome your thoughts on 
what you see as the outlook for the American manufacturing 
sector and what policy options you believe Congress should be 
looking at to help stem the loss of jobs in this very important 
sector.
    And just one final comment.
    Another reason that this is of such great concern to me is 
the new jobs that are being developed, at least in my state, 
pay far lower wages and have fewer benefits than the relatively 
high-wage manufacturing jobs that we're losing.
    Chairman Greenspan. Senator, as you point out quite 
correctly, this is a long-term phenomenon and it's essentially 
the result of two long-term very strong trends.
    One is that this economy is inexorably becoming more 
conceptual. That is, an ever greater proportion of our gross 
domestic product is made up of ideas and less in the way of 
physical things.
    And obviously, transistor radios do what large Stromberg 
Carlsons used to do in the 1930s. And there's all sorts of 
miniaturizing and essentially eliminating physical things in 
the value-added, in the sense that it's our ideas that have 
created so much value.
    For example, the identification of the possibility of the 
transistor itself has induced a huge increase in wealth in the 
sense of what it has reproduced.
    On top of this, and I might add, as a consequence of this, 
with less physical things, manufacturing per se has gradually 
reduced its proportion of value-added in the total GDP.
    More importantly, however, has been the extraordinary 
advance in productivity in manufacturing. It is just awesome 
what people have been able to do.
    The regrettable secondary collateral damage, if I may put 
it that way, of that process is that they need fewer and fewer 
people to produce any particular level of output.
    And that process will continue. But I must say that with 
the turn-around in the economy, and we're beginning to see, 
obviously, significant improvement in manufacturing in recent 
months, we're fortunately in an up-cycle and I think that 
things will improve over the longer run.
    What public policy should be in this regard I think is a 
very complex issue, and I don't think I could address it in any 
way which, if I knew what to do, I could express it very 
simply.
    But not knowing, all I can do is give you various 
alternatives. And I'd be glad to do that at some time if you'd 
like.
    Senator Collins. That would be very helpful. Thank you.
    [The written response appears in the Submissions for the 
Record on page 37.]
    Senator Bennett. Thank you.
    Ms. Dunn.
    Representative Dunn. Thank you very much, Mr. Chairman. And 
thank you, Mr. Chairman, for coming to meet with us today.
    It's so useful to the perspective that we need to develop 
as we handle some of these issues in Congress. And I've been 
interested in what you've said on a number of the questions, 
particularly your perspective on the unemployment compensation 
problem that we now face.
    I come from a part of the country where the economy is 
rather fragile, where unemployment continues to stay higher 
than in almost every other state in the nation, Washington 
State.
    I just want to make sure that I represent my area and urge 
caution to the Fed as they consider raising the federal funds 
rate.
    It would hit our region I think very hard and perhaps put a 
chill on what is beginning to bubble up in terms of an emerging 
vitality that is far behind the rest of the country.
    I'd like your thoughts on whether we should take a cautious 
approach to raising interest rates at a time like this in my 
state.
    And secondly, every day when I wake up and listen to the 
news, I hear about the number of jobs that have been lost or 
the unemployment rate. Or recently, in the recent news, more 
happy news--308,000 new jobs being created.
    Because of our situation with rising productivity at the 
same time that we're not increasing new jobs in the way that 
many of us would like to be, do you think that we should no 
longer be using the new jobs created measurement to indicate 
the health of our economy?
    And my last question is, once before when you were here, I 
think in this very room, you talked to us about a way of 
helping, not solving, but helping the outsourcing problem, but 
also the job loss and manufacturing and in trade-related 
industries. You talked about increasing TAA to help handle some 
of this retraining.
    And I'm wondering what you think about where we stand on 
TAA, whether we should be covering services, whether you think 
that we're at the proper point or we ought to pay more 
attention to that.
    Thank you.
    Chairman Greenspan. Well, with respect to the issue of 
trade assistance, I've gradually changed my view on this issue.
    First of all, that we ought to assist those who, through no 
fault of their own, happen to be in industries which are under 
significant international competitive pressure, I think ought 
to be a priority in this nation.
    But I wonder whether we can actually, in any real sense, 
identify the cause of a job that is lost, whether it is 
productivity, imports, outsourcing, or a number of various 
things.
    And that's the reason why, I should think, policy ought to 
be directed largely, so far as income support is concerned, 
through the unemployment insurance system.
    The issue of training is a different issue, largely because 
as you get an ever-increasing pace of change in our economy, in 
the world economy, the old notion of getting out of high school 
or even college and having a job for the rest of your life is 
no longer the credible option.
    And as a consequence, that means that people have to have 
broad general training in school which enables them to change 
professions if necessary.
    In other words, the nature of education is, of necessity, 
changing, and the role of community colleges, which largely 
tend to be focused on how do you go from one profession to 
another, has undergone explosive growth.
    And I think we are addressing the issue of the 
instabilities that inevitably occur as a consequence of 
creative destruction.
    I would say the training aspects of trade assistance should 
be integrated as best we can with other job loss training 
programs.
    In other words, to make training as a consequence of 
imports different from what we do with people who lose jobs 
because of increased technology, I think, is an awkward public 
policy structure. And if we could consolidate the issue and 
recognize a job loss is a job loss and that people have got to 
get to the next job, it doesn't matter why they lost their job.
    The main issue is what do we do as public policy. And I 
would coordinate or even consolidate a lot of these various 
programs to address them as a single issue, not as disparate 
issues.
    Representative Dunn. Then the question should be, would we 
be using jobs created as a measure of the health of our 
country?
    Chairman Greenspan. Sorry, I forgot to mention that.
    New jobs are a measure of the health of the economy. As I 
pointed out in my prepared remarks, there seems to have been a 
remarkable lack of anticipatory aggressiveness towards a change 
in economic activity, which usually one associates with people 
building new plant, hiring new workers in anticipation of 
changes that are occurring.
    There's been very little of that until perhaps very 
recently. And if you're looking for a measure of vitality of a 
growing economy, you'll often find that capital investment in 
areas in which orders are not immediately on the horizon, and 
the hiring of people, when you don't necessarily need them to 
produce what's going to occur a month from now, are measures of 
confidence, and in that regard, measures of the vitality of the 
business process itself.
    Senator Bennett. Thank you.
    Senator Sununu.
    Senator Sununu. Thank you, Mr. Chairman.
    Chairman Greenspan, yesterday, you began giving testimony 
to the Banking Committee a little bit after 2:30. And at that 
point, the markets were nominally up for the day. And over the 
next 45 minutes or so, the markets dropped about 125 points.
    What types of assumptions were being made by those selling 
off stocks? And do you think that their interpretations of your 
remarks were appropriate?
    Chairman Greenspan. As I read in the papers this morning, 
the implication was that whatever I said, they interpreted as 
at some point higher interest rates. And that one would presume 
that, under the normal discounting procedures of forward 
expectations of earnings, stock prices go down. Now, are they 
right or wrong? I don't know.
    [Laughter.]
    Senator Sununu. That was good.
    [Laughter.]
    Is there any reason for us to be optimistic? Have you seen 
any patterns or concrete steps in the last several months to 
provide optimism that over the next 2 to 3 years, we will see a 
substantive removal of capital controls on the Chinese 
currency?
    Chairman Greenspan. I do, Senator. I think that China has 
moved remarkably from a centrally-planned system to certain 
aspects of market capitalism which have turned out to be quite 
vital. But they are still subject to a very significant amount 
of central control. Obviously, their state-run enterprises are 
still big issues there. They are finding that the dynamism, the 
strictly free-market part of the system, is creating 
distortions all throughout the remainder of the economy, which 
is largely rigidified because of the central planning 
characteristic.
    To their credit, they're aware of this. One of the problems 
they have, as you know, is that they have imposed capital 
controls on the part of domestic residents of China on the 
purchase of foreign assets. And that creates an upward bias in 
the Yuan relative to the U.S. dollar to which it is effectively 
pegged.
    And at some point, that's going to break down and, indeed, 
I think they're already engaged in processes to weaken those 
capital controls. And at the end of the day, you really won't 
know where the true value of the Yuan should be until those 
controls are gone.
    Senator Sununu. What are the most important next steps for 
them to take in that process?
    Chairman Greenspan. In my judgment, it would be basically 
to gradually remove controls and see what happens to capital 
flows as a consequence and be able to calibrate the degree of 
their intervention in the marketplace, which has largely been 
through the purchase of U.S. Treasury instruments to support 
the suppressed value of their currency.
    Neither of those paths are projectable over the longer run 
and it's only a matter of time that the policies which they're 
clearly embarked upon will lead them, as indeed they have said, 
to a more flexible exchange rate structure.
    Senator Sununu. There have been some discussions on both 
the House and Senate side, in the respective banking 
committees, about the federal role of regulating insurance.
    The House has had a number of hearings on this and 
recently, the Chairman of the House Banking Committee indicated 
an interest in moving legislation that would set national 
standards for regulating insurance, in particular, price and 
form on insurance products.
    There have also been proposals out that go a little further 
to establish an optional federal charter for insurers, 
insurance underwriters, along the lines of our optional federal 
charter system for federal banks.
    Do you think that that type of an optional federal charter 
regulatory structure is appropriate for the insurance industry?
    Chairman Greenspan. We at the Fed have not taken a position 
on that, nor have I, largely because it's a very complex 
question with respect to state versus federal regulation.
    And I don't think we've got very much to add to that that's 
not already in the public domain.
    Senator Sununu. Mr. Chairman, since he didn't answer that 
question, could I ask one shorter one?
    Senator Bennett. Surely.
    Senator Sununu. Chairman Greenspan----
    Chairman Bennett. We've dwindled down to the precious few, 
so I can be more lenient now than I was when we had the whole 
panel here.
    Senator Sununu. When you were asked about expensing of 
stock options, the phrase that I wrote down that I believe you 
used was that it would be a bad mistake for Congress to impede 
FASB.
    Now that struck me as a fairly unusual phrase. Typically, 
you'd be more likely to express displeasure with words like 
``awkward'' or ``unusual'' or ``poorly-timed,'' ``not optimally 
timed,'' something like that. ``Bad mistake'' seemed a little 
bit--well, refreshingly direct.
    Did you err in choosing your words, and would you like to 
elaborate on precisely what you meant by either ``bad'' or 
``mistake''?
    [Laughter.]
    Chairman Greenspan. I chose my words appropriately and I 
think the Congress would err in going forward in endeavoring to 
impede FASB in its particular activities.
    Senator Sununu. Thank you very much.
    Senator Bennett. Thank you, Mr. Chairman.
    And I thank the Members of the Committee who have heeded my 
admonition to stay within their limits, so that we have, in 
fact, acted a little more expeditiously than we might have 
anticipated.
    May I ask you a question perhaps stimulated by some of the 
comments that have been made in the election season? But are we 
in a wage recession, in your opinion?
    Chairman Greenspan. You mean are wages going down in real 
terms, in that sense?
    Senator Bennett. Yes.
    Chairman Greenspan. I think we have been in a period where 
real compensation, and especially real wages, have been going 
up very moderately, if at all.
    I think that's about to change, as I indicated in my 
prepared remarks, because the consequence of that has been that 
virtually all of the gains in productivity have ended up in 
rising profit margins and hence, in a decline in the portion of 
the national income going to compensation of employees.
    History tells us that the range in which the proportions of 
profits versus compensation move are reasonably narrow and 
without any significant long-term trend.
    And I suspect that what we're about to find is that, with 
margins now up to fairly high levels, competition is going to 
start to move in because, remember, with wages moderate and 
profits reasonably high, the mark-up from wages, which is the 
major cost, to profits, suggests a fairly considerable amount 
of opportunities on the part of business management for 
profits.
    And the way that happens historically is businesses start 
to hire and bid up wages in the process, and that's the process 
by which compensation of employees rises relative to the 
national income, and eventually starts a new cycle.
    So I don't know whether I'd use the term ``wage recession'' 
but whatever one terms what has been going on, it is about to 
change.
    Senator Bennett. We are faced here in the Congress with the 
decision as to whether or not to make the President's tax cuts 
permanent. And you've indicated support for that, that they 
should be made permanent.
    But let us suppose we are unable to do that. Do you have 
any feelings or forecast as to what might happen if, in fact, 
the tax cuts did expire this year?
    Chairman Greenspan. Obviously, if the tax cuts have been 
helpful, which I think they have been, it will have some 
negative effect.
    But there are other forces in the economy which have been 
developing and I would presume and hope that in the event that 
the tax cuts are not extended, that the momentum of the economy 
will be enough to carry us into next year at a reasonably good 
pace.
    But while we can seek to look over the horizon, it doesn't 
necessarily follow that we can see all that far. Economists 
tend to be fairly explicit in making long-term forecasts 2, 3 
and 4 years out.
    We are fortunate in that there is no service out there 
which collects all these forecasts and reports them back to us 
2 years later.
    It would be a major embarrassment to most of us 
forecasters, probably all, if I may put it exactly.
    Senator Bennett. I once was told, and often repeat, that 
the way to be a competent forecaster is give them a date or 
give them a number. But never give them both.
    [Laughter.]
    Chairman Greenspan. That is sage advice, Mr. Chairman.
    Senator Bennett. My own expectation is that the markets 
generally have assumed that the tax cuts will, in fact, stay in 
place and that there would be a negative reaction in the 
markets if that assumption were to prove not to be the case.
    Is that a reasonable position?
    Chairman Greenspan. Well, certainly, if the markets are, in 
fact, presuming they remain in effect, if they do not, I think 
you do, by definition, get a market reaction.
    Senator Bennett. One last question for an issue that you 
raised the last time you were here.
    I was a little surprised that you raised it, because it's 
not something one expects from the Fed, but that I'm very glad 
that you raised it, because I think it is something that will 
impact the economy to a degree that requires the kind of 
visibility that your testimony gave it.
    You got into it a little in your exchange with Mr. English. 
This is the impact of higher energy prices, specifically 
natural gas.
    Natural gas has become the fuel of choice everywhere. And 
we cannot repeal the law of supply and demand. So that the 
price of natural gas has become elevated and looks like it will 
continue to rise if we can't somehow relieve the pressure on 
the demand by going to alternative fuels such as nuclear to 
generate electricity, or some other form.
    We are now, perhaps in response to the comments you made, 
we are now changing our ports to allow the importation of 
liquefied natural gas. You made the point that if we were going 
to import this particular fossil fuel, we had to do it from 
Canada or Mexico because that's the only place where we can get 
it in by pipeline.
    Now we're making a significant capital investment at a 
number of ports to allow the importation of LNG. But we have 
significant natural gas in the United States on our public 
lands and elsewhere, with a particularly large supply up in 
Alaska that we don't seem to be able to get down here.
    Could you once again address the question of the shortage 
of natural gas? Or rather, the increased demand for natural gas 
and therefore, the increased prices of natural gas and what you 
see that might do in the economy?
    Chairman Greenspan. Well, Mr. Chairman, you're quite 
correct. One of the reasons why we took a look at natural gas 
is that if our mandate is to look at the economy overall, it's 
important that we know where the pressure points are and try to 
identify them because it's only by evaluating those pressure 
points that we get a full context of what the economy is likely 
to do over a year, 2 years, or 3 years, where our policy 
processes focus.
    Natural gas growth in the United States, as you know, has 
been quite significant and in part, as you point out, because 
it's the fuel of choice for so many different reasons, and it 
will continue to be so, largely because electric generation 
turbines--the ones on the order books--are exceptionally heavy 
users of natural gas.
    So we know that that's what the demand is going to be out 
there.
    Despite fairly extensive drilling in the United States, the 
reservoirs continue to decline fairly significantly, in part 
because the technology is so good. So we're having trouble 
increasing the net marketed production in this country.
    When we had that problem in oil, we had the capability of 
very quickly importing either crude or products from all over 
the world because the trade in oil and oil products is about 
twice the volume relative to world consumption that it is for 
natural gas.
    And it occurs to me that looking at the various supply and 
demand forces here, the only flexible alternative that we have 
got is to look at these so-called vast reservoirs of stranded 
gas around the world and find ways to import it into the United 
States in liquefied natural gas form, which gives us a safety 
valve, in effect, for the shortages that periodically occur and 
shortages which create sharp spikes in natural gas prices with 
great significant problems.
    People constructed industrial facilities in this country 
largely on the expectation that gas prices would stay in the 
area of $2 per million BTU. And indeed, long-term futures 
markets exhibited that price.
    And the overall structure of industries which use natural 
gas pre-suppose that that price would prevail over the long 
run. Now we, of course, are aware that the spot price is up in 
the $5 area. But more importantly, the 6-year futures price has 
doubled. And this suggests that the shortages which we are 
gradually beginning to get a sense of are now projected longer 
term.
    And that's going to mean that the structure of the gas-
using industry in the United States is going to change. And 
what we need to do is get in place as soon as we can the 
capability of fairly substantial imports that enable our 
manufacturers who use natural gas to compete internationally.
    We are losing a lot of business, especially in the 
chemical-related areas, because we can't compete at these 
prices. And we've got to find a way to bring down the price of 
gas. And the only way that I know of is essentially to open us 
to the world supplies, which are substantial and whose prices 
are well below our prices.
    Senator Bennett. Thank you very much. I will continue to 
push for the pipeline in Alaska for natural gas, however, 
because I think we've got a lot up there that we're not 
getting.
    Ms. Dunn, you have been the most persistent in hanging in 
there. Do you have a last question for the Chairman before we 
leave?
    Representative Dunn. I do have one, if the Chairman is 
willing to take one more question. It has to do with trade.
    In your testimony, you say that the sharp rise in exports 
contributed importantly to the acceleration of real GDP over 
2003.
    And I think my worry right now is that there seems to be a 
mood in the Congress against free trade. I'm worried about it. 
It has to do with outsourcing. It has to do with invasion of 
sovereignty. It has to do with manufacturing jobs.
    And I just think that we have to figure out a way to 
explain to people why free, and fair, trade is important to our 
economy.
    I wonder if you have any thoughts on that.
    Chairman Greenspan. What is remarkable is that the abstract 
idea of free trade, which developed basically amongst the so-
called classical economists of the latter part of the 18th 
century and early 19th century, showed that they began to 
understand a process embodied in Adam Smith's ``Wealth of 
Nations,'' which is a tribute to how ideas can be spread.
    And it's a very complex and a very difficult idea to push. 
But American society has essentially accepted free trade.
    To be sure, in recent years, there have been growing 
concerns about it, in part because of the fact that trade has 
opened up so dramatically, so that furthering the expansion of 
trade is not that easy to do. And the way I'd like to put it is 
that the low-hanging fruit of trade negotiations has already 
been picked. And it is difficult to find new avenues to 
continue to expand. And there's lots of friction, because by 
the very nature of the process, there are winners and losers.
    And we've got to, as I indicated earlier, find a way to 
address the problems that are associated with those who lose 
jobs or are disadvantaged in business as a consequence of this 
very dynamic process which we characterize as global free trade 
and of which the United States has been the largest 
beneficiary.
    It has been a major factor in the extraordinary increase in 
American standards of living since the end of World War II.
    And one of the things that the statistics tell us is that 
our economy has been capable of maintaining a very high job 
input in a sense that, on average, we've employed more than 94 
percent of our work force decade-in and decade-out, and real 
wages have increased inexorably decade after decade.
    And this has occurred irrespective of whether or not we 
have trade surpluses or trade deficits, or whether outsourcing 
was high or low.
    There are more fundamental forces in our economy which 
create increased standards of living. And free trade has been a 
very major facilitator of those forces.
    And our ability to basically engage in increasing 
specialization of labor has, decade after decade, created ever 
higher standards of living for American households.
    When I was very young and just got into business, my 
recollection was that little more than half the households 
owned a car, and none to speak of owned more than one.
    Now there are as many cars and trucks in households as 
there are people of driving age. And this is an extraordinary 
change. And you can go product by product. This is the result 
of our ability to engage the world as a whole and come up with 
great benefits as a consequence.
    Representative Dunn. Thank you, Mr. Chairman.
    Senator Bennett. Thank you very much, Mr. Chairman. We 
appreciate your candor and your wisdom.
    The hearing is adjourned.
    Chairman Greenspan. Thank you very much, Mr. Chairman.
    [Whereupon, at 11:55 a.m., the hearing was adjourned.]


                       Submissions for the Record

=======================================================================

       Prepared Statement of Senator Robert F. Bennett, Chairman
    Good morning and welcome to today's hearing. We are pleased to have 
as our guest today Chairman Alan Greenspan of the Federal Reserve. We 
always appreciate your views on the current economic situation, as well 
as your broad perspective on the economic and fiscal issues facing 
Congress.
    Mr. Chairman, today you visit us at a time of good economic news. 
The economy is growing rapidly and adding new jobs, thanks to well-
timed tax relief, aggressive Fed policy, and the amazing resilience of 
the American economy.
    What a difference a year makes. A year ago, Mr. Chairman, you 
appeared before this committee, and we talked a great deal about 
deflation. Today, we meet amid speculation about inflation.
    Last week we learned that consumer prices have been rising faster 
than expected. Moreover, commodity prices are much higher than they 
were a year ago, due to the strengthening world economy and a lower 
dollar. Higher commodity prices may eventually lead to higher consumer 
and producer prices--as we have already seen with gasoline--but the 
real question is whether they signal broader price increases ahead.
    In the sometimes topsy-turvy world of economics, the bond market 
has treated recent gains in employment as bad news, driving bond prices 
down and interest rates up. Employment growth is, of course, an 
unmitigated good for the economy, but it does sharpen the question of 
how long the Fed will be able to maintain such low interest rates and 
how and when the Fed may move to a more neutral policy stance. We 
welcome any insight you can provide on this issue.
    We also welcome your thoughts on the housing market. Housing has 
been remarkably strong in recent years, boosting the recovery and 
building wealth for millions of American families. Low mortgage 
interest rates have been key to housing's strength, lifting home prices 
in much of the nation, but also raising the cost of living for new home 
buyers. We need to understand how rising home prices may contribute to 
inflation. And looking ahead, we also need to understand how rising 
interest rates may affect the housing market.
    With that, we welcome you, Chairman Greenspan, and look forward to 
your testimony.
                               __________

           Prepared Statement of Representative Jim Saxton, 
                             Vice Chairman

    It gives me great pleasure to join in welcoming Chairman Greenspan 
once again before the Joint Economic Committee.
    The evidence shows that the U.S. economy has displayed amazing 
resilience in recent years, and has now emerged from a painful 
adjustment process. The bursting of the stock market and technology 
bubbles began in 2000. The subsequent economic slowdown and recession, 
terrorist attacks, and wars harmed the economy, but did not prevent the 
current economic expansion, which began in November of 2001.
    The economic data released in recent quarters indicate that the 
U.S. economy is growing at a healthy rate. Over the last half of 2003, 
economic growth adjusted for inflation was 6 percent. This recent pick-
up in the economy was expected for some time, but had been delayed by 
weakness in business investment.
    However, the long-awaited rebound in business investment is now 
underway, and has boosted the economy and led to a more balanced 
pattern of economic expansion. For example, in the last two quarters of 
2003, investment in equipment and software increased at rates in excess 
of 15 percent. The increases in investment have contributed to a strong 
recovery in manufacturing activity.
    Meanwhile, consumption and housing activity continue to hold up 
well. Productivity is very strong and inflation is under control. 
Recent data indicate that payroll employment growth has resumed. 
Independent economists have noted that tax relief and accommodative 
monetary policy have made important contributions to the recent 
strength of the economy.
    The Blue Chip Consensus forecast is that the U.S. economy will grow 
at an inflation-adjusted rate of nearly 5 percent this year. The return 
to sustained and healthy economic growth is a tribute to the 
flexibility and resilience of the American people and economy.

                               __________

           Prepared Statement of Representative Pete Stark, 
                        Ranking Minority Member

    Thank you, Chairman Bennett. I want to welcome Chairman Greenspan 
and thank him for testifying here today.
    In January, the Federal Reserve's Open Market Committee signaled a 
willingness to consider hiking interest rates. The questions on 
everyone's minds here today are: When will interest rates rise, by how 
much, and how quickly? We will all be reading between the lines of your 
statement for the clues that will answer these questions.
    Consumer prices rose sharply last month, sparking inflation fears 
in some quarters. The Fed has committed itself to ``be patient'' in 
considering rate hikes. Certainly, it will take more than a month's 
worth of data to know if the inflation threat is real. It seems to me 
that the labor market is still weak enough that the Fed can afford to 
be very patient. But I am interested in hearing more from Chairman 
Greenspan today about the inflationary pressures we face.
    Concerns about a blip in inflation shouldn't distract us from the 
critical task of putting people back to work and keeping the economy 
growing. l hope, Chairman Greenspan, that you will be able to reassure 
us that the Fed is committed to getting the economy back to full 
employment as quickly as possible, and avoiding the danger of fighting 
phantom inflation.
    Job growth has only recently shown some signs of recovery and wage 
growth has been stagnant. Although the recession officially ended 
nearly 2\1/2\ years ago, we still have a payroll employment gap of 1.8 
million jobs since President Bush took office. We haven't seen such 
persistent job loss since the 1930s.
    Leading forecasters, including the Federal Reserve, expect the 
economy to post solid economic growth this year, with inflation 
remaining relatively low. However, that growth is not expected to be 
enough to substantially reduce the unemployment rate. The unemployment 
rate edged up slightly to 5.7 percent in March--more than 8 million 
Americans remain unemployed, with 2 million out of work for 6 months or 
more. While 308,000 payroll jobs were created last month, this was the 
first significant job gain of the entire Bush presidency.
    We are still in a deep hole and we can't really talk about a jobs 
recovery until we see robust job creation for several months. In the 
meantime, Congress can do something now to help the long-term 
unemployed. Even though jobs grew last month, long-term unemployment 
rose again. An extension of unemployment benefits has gained support 
from bipartisan majorities in both houses of Congress. Chairman 
Greenspan, you testified again last month that you support such an 
extension, as you have in the past, ``in times like this.''
    But House Republicans have thwarted efforts by Democrats to help 
nearly three million unemployed workers and their families avoid 
financial ruin by extending temporary federal jobless benefits for the 
next six months and retroactively for the past three months. The 
Republican leadership has made this the ``do-nothing for unemployed 
workers'' Congress. The long-term jobless deserve additional 
unemployment benefits now--the President and the Republican-controlled 
Congress should just do it.
    I look forward to Chairman Greenspan's testimony today.

                               __________

       Prepared Statement of Honorable Alan Greenspan, Chairman, 
               Board of Governors, Federal Reserve System

    Mr. Chairman and members of the committee, I am pleased to be here 
today to offer my views on the outlook for the U.S. economy.
    The economy appears to have emerged around the middle of last year 
from an extended stretch of subpar growth and entered a period of more 
vigorous expansion. After having risen at an annual rate of 2\1/2\ 
percent in the first half of last year, real GDP increased at an annual 
pace of more than 6 percent in the second half. Aided by tax cuts, low 
interest rates, and rising wealth, household spending continued to post 
sizable gains last year. In addition, an upturn in business investment, 
which followed several years of lackluster performance, and a sharp 
rise in exports contributed importantly to the acceleration in real GDP 
over 2003.
    Although real GDP is not likely to continue advancing at the same 
pace as in the second half of 2003, recent data indicate that growth of 
activity has remained robust thus far this year. Household spending has 
continued to move up, and residential home sales and construction 
remain at elevated levels. In addition, the improvement in business 
activity has become more widespread. In the industrial sector, nearly 
two-thirds of the industries that make up the index of industrial 
production have experienced an increase in output over the past three 
months. More broadly, indicators of business investment point to 
increases in spending for many types of capital equipment. And 
importantly, the latest employment figures suggest that businesses are 
becoming more willing to add to their workforces, with the result that 
the labor market now appears to be gradually improving after a 
protracted period of weakness.
    Looking forward, the prospects for sustaining solid economic growth 
in the period ahead are good. Monetary policy remains quite 
accommodative, with short-term real interest rates still close to zero. 
In addition, fiscal policy will likely continue to provide considerable 
impetus to domestic spending through the end of this year.
    Importantly, the caution among business executives that had 
previously led them to limit their capital expenditures appears to be 
giving way to a growing confidence in the durability of the expansion. 
That confidence has, no doubt, been bolstered by favorable borrowing 
conditions, ongoing improvements in efficiency, and rising 
profitability, which have put many firms on a more solid financial 
footing.
    Nevertheless, some of the strains that accompanied the difficult 
business environment of the past several years apparently still linger. 
Although businesses are replacing obsolescent equipment at an 
accelerated pace, many managers continue to exhibit an unusual 
reluctance to anticipate and prepare for future orders by adding to 
their capital stock. Despite a dramatic increase in cash flow, business 
fixed and inventory investment, taken together, have risen only 
moderately. Indeed, internal corporate funds exceeded investment over 
the course of last year for the first time since 1975.
    Similar cautious behavior has also been evident in the hiring 
decisions of U.S. firms, during the past several years. Rather than 
seeking profit opportunities in expanding markets, business managers 
hunkered down and focused on repairing severely depleted profitability 
predominately by cutting costs and restricting their hiring. Firms 
succeeded in that endeavor largely by taking advantage of the untapped 
potential for increased efficiencies that had built up during the rapid 
capital accumulation of the latter part of the 1990s. That process has 
not yet played out completely. Many firms seem to be continuing to find 
new ways to exploit the technological opportunities embodied in the 
substantial investments in high-tech equipment that they had made over 
the past decade.
    When aggregate demand accelerated in the second half of 2003, the 
pace of job cuts slowed. But because of the newfound improvements in 
the efficiency of their operations, firms were able to meet increasing 
demand without adding many new workers.
    As the opportunities to enhance efficiency from the capital 
investments of the late 1990s inevitably become scarcer, productivity 
growth will doubtless slow from its recent phenomenal pace. And, if 
demand continues to firm, companies will ultimately find that they have 
no choice but to increase their workforces if they are to address 
growing backlogs of orders. In such an environment, the pace of hiring 
should pick up on a more sustained basis, bringing with it larger 
persistent increases in net employment than those prevailing until 
recently.
    Still, the anxiety that many in our workforce feel will not subside 
quickly. In March of this year, about 85,000 jobless individuals per 
week exhausted their unemployment insurance benefits--more than double 
the 35,000 per week in September 2000. Moreover, the average duration 
of unemployment increased from twelve weeks in September 2000 to twenty 
weeks in March of this year. These developments have led to a notable 
rise in insecurity among workers.
    Most of the recent increases in productivity have been reflected in 
a sharp rise in the pretax profits of nonfinancial corporations from a 
very low 7 percent share of that sector's gross value added in the 
third quarter of 2001 to a high 12 percent share in the fourth quarter 
of last year. The increase in real hourly compensation was quite modest 
over that period. The consequence was a marked fall in the ratio of 
employee compensation to gross nonfinancial corporate income to a very 
low level by the standards of the past three decades.
    If history is any guide, competitive pressures, at some point, will 
shift in favor of real hourly compensation at the expense of corporate 
profits. That shift, coupled with further gains in employment, should 
cause labor's share of income to begin to rise toward historical norms.
    Such a process need not add to inflation pressures. Although labor 
costs, which compose nearly two-thirds of consolidated costs, no longer 
seem to be falling at the pace that prevailed in the second half of 
last year, those costs have yet to post a decisive upturn. And even if 
they do, the current high level of profit margins suggests that firms 
may come under competitive pressure to absorb some acceleration of 
labor costs. Should such an acceleration of costs persist, however, 
higher price inflation would inevitably follow.
    The pace of economic expansion here and abroad is evidently 
contributing to some price pressures at earlier stages of the 
production process and in energy markets, and the decline in the 
dollar's exchange rate has fostered a modest firming of core import 
prices. More broadly, however, although the recent data suggest that 
the worrisome trend of disinflation presumably has come to an end, 
still-significant productivity growth and a sizable margin of 
underutilized resources, to date, have checked any sustained 
acceleration of the general price level and should continue to do so 
for a time. Moreover, the initial effect of a slowing of productivity 
growth is more likely to be an easing of profit margins than an 
acceleration of prices.
    As I have noted previously, the federal funds rate must rise at 
some point to prevent pressures on price inflation from eventually 
emerging. As yet, the protracted period of monetary accommodation has 
not fostered an environment in which broad-based inflation pressures 
appear to be building. But the Federal Reserve recognizes that 
sustained prosperity requires the maintenance of price stability and 
will act, as necessary, to ensure that outcome.

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