[Senate Hearing 108-281]
[From the U.S. Government Publishing Office]



                                                       S. Hrg. 108- 281


        FEDERAL RESERVE'S SECOND MONETARY POLICY REPORT FOR 2003

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

                                HEARING

                               before the

                              COMMITTEE ON
                   BANKING,HOUSING,AND URBAN AFFAIRS
                          UNITED STATES SENATE

                      ONE HUNDRED EIGHTH CONGRESS

                             FIRST SESSION

                                   ON

      OVERSIGHT ON THE MONETARY POLICY REPORT TO CONGRESS PURSU- 
       ANT TO THE FULL EMPLOYMENT AND BALANCED GROWTH ACT OF 1978

                               __________

                             JULY 16, 2003

                               __________

  Printed for the use of the Committee on Banking, Housing, and Urban 
                                Affairs



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                            WASHINGTON : 2003
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            COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

                  RICHARD C. SHELBY, Alabama, Chairman

ROBERT F. BENNETT, Utah              PAUL S. SARBANES, Maryland
WAYNE ALLARD, Colorado               CHRISTOPHER J. DODD, Connecticut
MICHAEL B. ENZI, Wyoming             TIM JOHNSON, South Dakota
CHUCK HAGEL, Nebraska                JACK REED, Rhode Island
RICK SANTORUM, Pennsylvania          CHARLES E. SCHUMER, New York
JIM BUNNING, Kentucky                EVAN BAYH, Indiana
MIKE CRAPO, Idaho                    ZELL MILLER, Georgia
JOHN E. SUNUNU, New Hampshire        THOMAS R. CARPER, Delaware
ELIZABETH DOLE, North Carolina       DEBBIE STABENOW, Michigan
LINCOLN D. CHAFEE, Rhode Island      JON S. CORZINE, New Jersey

             Kathleen L. Casey, Staff Director and Counsel

     Steven B. Harris, Democratic Staff Director and Chief Counsel

               Peggy R. Kuhn, Senior Financial Economist

             Martin J. Gruenberg, Democratic Senior Counsel

   Joseph R. Kolinski, Chief Clerk and Computer Systems Administrator

                       George E. Whittle, Editor

                                  (ii)
?

                            C O N T E N T S

                              ----------                              

                        WEDNESDAY, JULY 16, 2003

                                                                   Page

Opening statement of Chairman Shelby.............................     1

Opening statements, comments, or prepared statements of:
    Senator Johnson..............................................     2
    Senator Allard...............................................     3
    Senator Sarbanes.............................................     3
    Senator Enzi.................................................     5
        Prepared statement.......................................    45
    Senator Reed.................................................     7
    Senator Bennett..............................................     7
    Senator Bayh.................................................     8
    Senator Hagel................................................     8
    Senator Chafee...............................................     8
    Senator Corzine..............................................    22
    Senator Carper...............................................    25
    Senator Crapo................................................    27
    Senator Dodd.................................................    29
    Senator Schumer..............................................    32

                                WITNESS

Alan Greenspan, Chairman, Board of Governors of the Federal 
  Reserve System, Washington, DC.................................     8
    Prepared statement...........................................    46
    Response to written questions of:
        Senator Shelby...........................................    50
        Senator Sarbanes.........................................    53
        Senator Bunning..........................................    56
        Senator Miller...........................................    56

              Additional Material Supplied for the Record

Monetary Policy Report to the Congress, July 16, 2003............    59
Letter to Senator Tim Johnson from Alan Greenspan, dated June 25, 
  2003...........................................................    89

                                 (iii)

 
  FEDERAL RESERVE'S SECOND MONETARY POLICY REPORT TO CONGRESS FOR 2003

                              ----------                              


                        WEDNESDAY, JULY 16, 2003

                                       U.S. Senate,
          Committee on Banking, Housing, and Urban Affairs,
                                                    Washington, DC.

    The Committee met at 10:00 a.m. in room SD-538, Dirksen 
Senate Office Building, Senator Richard C. Shelby (Chairman of 
the Committee) presiding.

        OPENING STATEMENT OF CHAIRMAN RICHARD C. SHELBY

    Chairman Shelby. The hearing will come to order.
    I am very pleased this morning to welcome Chairman 
Greenspan before the Committee on Banking, Housing, and Urban 
Affairs to testify on the Federal Reserve's Semi-Annual 
Monetary Policy Report to the Congress.
    This morning, I will keep my remarks brief as we are all 
eager to hear from the Chairman on his views on the U.S. 
economy and other related issues. We also have the benefit, Mr. 
Chairman, of having read about your remarks before the House 
yesterday.
    At this time I would like to make two observations, both of 
which you highlight in your statement or in your more extensive 
report.
    First, the economy stands on the brink of, we hope, a 
strong recovery. The question is how strong will the rebound be 
and what further steps can be taken should the recovery falter. 
There is little question that we all would like to see the 
economy grow faster and to have more jobs created for the 
American people. A number of stimulative measures, including 
the tax cut enacted in May, have already been taken. We know 
from your testimony that the Federal Reserve also stands ready 
to take additional action should the economy remain sluggish.
    Second, the Congress, I believe, needs to remain focused on 
achieving the appropriate fiscal policy. Yesterday, as we all 
know, the OMB announced an update of its budget estimates, 
revising its estimates of the 2003 deficit upward to $455 
billion. The budget forecast has been adversely affected by the 
relatively weak economy and by the necessary expenditures to 
fight the war on terrorism. Over the longer term, the Congress 
needs, I believe, to renew its effort at reforming mandatory 
programs and controlling Government spending. We would 
certainly welcome, Mr. Chairman, your views of the importance 
of that goal.
    We are happy to host you and we look forward to your 
remarks and an enlightening discussion.
    Senator Johnson.

                STATEMENT OF SENATOR TIM JOHNSON

    Senator Johnson. Thank you, Chairman Shelby, for inviting 
Chairman Greenspan before this Committee to present the Second 
Monetary Report to Congress for 2003. I hope that we will find 
some good news in the report given the recent demoralizing 
headlines about an exploding budget deficit, the tax cuts 
enacted earlier this year, contrary to Chairman Greenspan's 
recommendation that any tax cuts be offset so as to minimize 
deficit.
    Once again, the Office of Management and Budget has 
adjusted its deficit estimates upward. We are now being told 
that this year's deficit will reach $455 billion, 50 percent 
higher than the Bush Administration forecast just 5 months ago. 
In fact, the deficit is $55 billion higher than many economists 
projected just last week. This represents a fiscal reversal of 
more than $680 billion since 2000 when the Treasury reported a 
surplus--a surplus--of $236 billion.
    At the same time, the unemployment rate has reached 6.4 
percent. More than 9.4 million Americans are looking for work 
and cannot find a job. Now, as much as the next person, I will 
take a glass-half-full attitude any day, but at a certain 
point, one begins to suspect that reports of an imminent 
economic recovery are assuming a bit more juice than we really 
have.
    For example, just one year ago, Chairman Greenspan 
predicted that our economy, our GDP, would grow between 3.5 and 
4 percent in 2003. Chairman Greenspan has now slashed those 
projections to 2.5 to 2.75 percent. A year ago, Chairman 
Greenspan predicted the unemployment rate would be 
approximately 5.24 to 5.5 percent by the end of 2003. We are 
now at 6.4 percent and rising steadily.
    Now, I have enormous respect for Chairman Greenspan, and I 
know that the depth of the economic malaise has taken us all by 
surprise. But I am deeply skeptical of arguments by this 
Administration that all economic ills will be cured if we give 
massive tax cuts, without offsetting them, to those at the top 
of the economic ladder in the hope that the money will somehow 
trickle down to working families.
    At this point I would also like to make note of a topic on 
which Chairman Greenspan and I do see eye to eye, and, Mr. 
Chairman, I do have a 10-page letter from Chairman Greenspan 
that I would ask unanimous consent that the letter be inserted 
into the record in its entirety.
    Chairman Shelby. Without objection, it is so ordered.
    Senator Johnson. This letter deals with the topic of the 
regulation of the industrial loan companies and the importance 
that these banks come under consolidated supervision. As many 
of you know, I have a longstanding concern about the mixing of 
banking and commerce, and I am alarmed that recent attempts to 
expand the ILC charter would undercut much of the progress we 
have made over the past few years, including closing the so-
called ``unitary thrift loophole'' a few years ago. Of even 
greater concern, I believe, is the ability of ILC's, which may 
have commercial parent companies, to escape consolidated 
supervision by the Federal Reserve.
    I would like to quote from Chairman Greenspan's letter 
about the critical importance of consolidated supervision:

    Consolidated supervision provides the Board with both the 
ability to understand the financial strength and risks of the 
overall banking organization and the authority to address 
significant management, operational, capital, and other 
deficiencies within the overall organization before these 
deficiencies pose a danger to subsidiary insured banks and the 
Federal safety net. As the Treasury Department noted in its 
1991 report and recommendations on modernizing the financial 
system, umbrella oversight of a financial company that controls 
an insured bank, ``is necessary to protect the insured 
depository [institution] from affiliate risk. Umbrella 
oversight is designed to identify problems in the holding 
company or affiliates that are likely to cause difficulties for 
the insured bank, and to apply remedial action.''

    I would like to note my great respect for FDIC Chairman 
Powell, and I do not mean in any way to impugn the supervisory 
capacity of his agency. However, ILC's which exist principally 
within large affiliated structures should not be regulated 
separate and apart from those affiliates. The Bank Holding 
Company Act provides a unique set of supervisory powers which 
are vitally important where banking and commerce are 
intertwined in a way that introduces additional risk to the 
system.
    Thank you, Mr. Chairman, for holding today's hearing. I 
apologize in advance that I will be unable to stay for 
questions due to competing and conflicting hearing obligations.
    Chairman Shelby. Senator Allard.

                COMMENTS OF SENATOR WAYNE ALLARD

    Senator Allard. Mr. Chairman, I would also like to thank 
you for holding this hearing and join my colleagues in 
welcoming Federal Reserve Board Chairman Greenspan to this 
hearing. I always look forward to the opportunity to hear from 
Chairman Greenspan concerning monetary policy and other 
economic issues.
    I was pleased to hear Chairman Greenspan's generally 
positive comments yesterday. I share his belief that the 
economy is headed in a positive direction. But the recovery is 
still preliminary, and we need to ensure that we keep the 
country headed in the right direction. Now is the time to 
address the long-term solvency of Social Security and Medicare 
and to put the Government on a plan to eliminate the deficit 
and to pay down the national debt.
    I would invite my colleagues to join me in voting to hold 
down spending excesses on the floor of the Senate. So far, 
there have just been a few that have been willing to join me in 
that effort. To balance the budget means that we need to hold 
down spending as we go through the appropriations process, and 
that is what we are beginning to address now on the floor of 
the Senate.
    By pursuing policies of low taxation, limited Federal 
regulation, free trade, and sound monetary policy, the United 
States will prosper with wealth and opportunity.
    Chairman Greenspan, again, thank you for appearing before 
the Banking Committee today, and I look forward to your 
testimony.
    Chairman Shelby. Senator Sarbanes.

             STATEMENT OF SENATOR PAUL S. SARBANES

    Senator Sarbanes. Thank you very much, Mr. Chairman. I am 
pleased to join with my colleagues in welcoming Chairman 
Greenspan to this morning's hearing on the Federal Reserve's 
Semi-
Annual Report to Congress on Monetary Policy.
    I went over Chairman Greenspan's statement this morning. As 
usual, it provided a thoughtful overview of the outlook for the 
economy and signaled the Fed's willingness ``to maintain a 
highly 
accommodative stance of policy for as long as needed to promote 
satisfactory economic performance.'' However, I found very 
little discussion in the statement of what I consider to be a 
significant concern with respect to our economy today, and that 
is an exceptionally weak labor market.
    Chairman Greenspan's statement mentions that, ``incoming 
data on employment and aggregate output remain mixed.'' In the 
context of a discussion of productivity, the statement also 
says that, ``One consequence of these improvements in 
efficiency has been an ability of many businesses to pare 
existing workforces and still meet increases in demand. Indeed, 
with the growth of real output below that of labor productivity 
for much of the period since 2000, aggregate hours and 
employment have fallen, and the unemployment rate rose last 
month to 6.4 percent of the civilian labor force.''
    Now in my perusal of the statement, this is the extent of 
the discussion about jobs in our economy. Given what I believe 
is the disturbing prospect for employment, particularly at this 
stage of a so-called recovery, Mr. Chairman, I would like to 
take a moment or two to review in a little more detail the 
employment situation.
    Since January of this year, the unemployment rate has risen 
from 5.7 percent to 6.4 percent, the highest unemployment rate 
in over 9 years, since April of 1994; 9.4 million workers are 
unemployed, the most unemployed workers since December 1992, 
more than 10 years ago. If individuals who have become too 
discouraged to look for work were included in the unemployment 
rate figure, it would be well over 7 percent.
    The economy has lost 394,000 jobs since January, losing 
jobs each of the past 5 months. Since February 2001, total jobs 
have fallen 2.6 million, and private sector employment has 
fallen more than 3.1 million. More than 3 million private 
sector jobs have been lost since February 2001, a little over 2 
years ago--2 and a half years ago. Last week, the Labor 
Department reported that an additional 439,000 workers filed 
initial unemployment insurance claims. More than 400,000 
workers have been filing initial claims now for 21 consecutive 
weeks. The last time we had such an extended streak was in 
September 1992--again, more than 10 years ago.
    Continuing claims for unemployment insurance are at a 20-
year high of 3.8 million. That is the highest level since 
February 1983--more than 20 years ago. There are over 1.1 
million Americans who have already exhausted all of their 
unemployment insurance benefits still unable to find a job. The 
average unemployed worker has been out of work 19.8 weeks. That 
is the highest duration average for unemployed workers, 19.8 
weeks, since 1948, except for a 7-month period in 1983 and 1984 
when unemployment ranged between 8 and 10 percent.
    Since GDP reached a low in the third quarter of 2001, the 
economy has lost over 2 million jobs. At the same stage of the 
early 1990's cycle--when the phrase ``a jobless recovery'' was 
coined--the economy had already generated net job gains 
totaling 482,000, and job growth had already turned positive on 
a sustained basis by the summer of 1992, just a year after the 
recession officially ended. In other words, it seems to me we 
are in a very difficult situation here, and we really need to 
lay this out and then make some judgments about how to move on 
it.
    Last week, The Washington Post reported that the National 
Bureau of Economic Research, the arbiter of when U.S. economic 
recessions begin and end, has been unable to declare an end to 
the recession that began in March 2001, because payroll 
employment has continued to decline long after the economy 
resumed growing.
    The article noted that employment has never been down so 
much this far into a post-recessionary phase. The article 
quotes a prominent Wall Street economist as saying, ``The 
current situation makes the early 1990's jobless recovery look 
like a hiring spree.''
    On Monday, The New York Times reported that, ``Teenagers 
are facing the worst summer job market in years, with the 
percentage of those holding summer jobs at its lowest in 55 
years and the unemployment rate at its highest in a decade.''
    I take note of all of this because I think there is a 
serious prospect that the employment situation may not improve 
in the coming months and unemployment may continue to rise. It 
is by no means clear that a level of economic growth can be 
achieved that will bring about a significant improvement in the 
unemployment rate.
    Taken together, it seems to me more focused attention on 
our employment situation is warranted. Unlike Chairman 
Greenspan's statement that he finds the situation mixed, I find 
it very negative with respect to the employment situation.
    Chairman Greenspan notes in his testimony the achievement 
of ``effective price stability--a long-held goal assigned to 
the Federal Reserve by the Congress.'' And it is certainly part 
of the statutory mandate of the Fed as determined by the 
Congress. But I would note another goal assigned by the 
Congress not covered in the Chairman's statement and that is 
``maximum employment.'' Mr. Chairman, I think it is important 
that we focus on this. At a minimum, it seems to me critical 
that unemployment insurance should be extended for those long-
term unemployed who have exhausted their benefits.
    Thank you very much.
    Chairman Shelby. Senator Enzi.

              STATEMENT OF SENATOR MICHAEL B. ENZI

    Senator Enzi. Thank you, Mr. Chairman.
    Everyone always looks with anticipation toward this 
presentation. Of course, there is a little more anticipation 
when it is the Senate's turn for the first presentation, but we 
thank you for all of the insight that you provide.
    The U.S. economy is still the greatest economy in the 
world, but there are certain issues that we need to address to 
ensure that we retain that position. If I had to pick a single 
issue that has the greatest impact on the financial affairs of 
Wyoming, and the rest of the Nation, I would choose the state 
of the Nation's energy development. Every sector of our economy 
relies on some form of technology that in turn relies on 
electricity and/or fossil fuels to function. And one of the 
secrets of the United States has always been low-cost energy. 
Our economy is literally driven by our ability to develop and 
maintain a steady, constant energy supply.
    Wyoming's role is much like the position held by the 
colonies during America's first years of European settlement. 
We provide the raw materials or, in other words, the feedstock 
that makes the rest of the Nation's energy economy function. In 
my home county of Campbell County, Wyoming, we would be the 
third largest coal-producing country in the world. One-third of 
our Nation's coal is produced in this county alone. We also 
produce more uranium annually than the rest of the Nation 
combined and have the greatest potential for natural gas 
development in the entire continental United States. In our 
county, we are in the process of building some 50,000 wells for 
coal-bed methane, and they just made a discovery that there is 
another coal formation below the present one. The top formation 
is 60 to 100 feet thick, and under about 60 to 100 feet of 
dirt. The other one is a little bit lower, but it is 200 feet 
thick and it has considerably more natural gas production than 
the other. In short, we have what the rest of the Nation needs 
to keep its technology fueled and running.
    Unfortunately, most of that energy is stranded in Wyoming 
and is inaccessible to other parts of the country that need it. 
Our natural gas development is being slowed down by the 
inability to get the gas out of State. We are short of 
pipelines. We are talking about some pipelines from Alaska. We 
need to talk about pipelines to get the gas that has already 
been discovered in the lower 48 to where it is needed. Our 
electricity runs into bottlenecks where the power lines outside 
the State do not have enough capacity to carry what we can 
generate, and our coal is being hit with the threat of new 
regulations and bureaucratic limitations that could eventually 
slow down exploration and development. All of these limitations 
are having an effect on the rest of the economy.
    I know that Chairman Greenspan has already visited the Hill 
on a number of occasions and has testified on this issue. I 
look forward to any additional insights he might offer on how 
we can bolster the economy by increasing energy stability, and 
I hope he could address what future role the energy-producing 
States can play in meeting our energy demands.
    I know that we have had a craze of trying to go with 
natural gas for as many things as possible. The production of 
electricity can be very efficiently done with coal, and I know 
they were making a decision in Rapid City one year on whether 
to use peaking power from natural gas. They discovered that the 
peaking power would require as much natural gas and be needed 
at the same time as gas to heat Rapid City. It was an 
equivalent amount. It took as much electricity as it would take 
to heat in winter in Rapid City. So, we are talking about some 
large quantities of gas for things that could be substituted by 
coal production. We do need to be able to get the electricity 
around. And I have mentioned the need for pipelines.
    In addition to the importance of natural gas prices on our 
Nation's economy, we must also ensure that we have a favorable 
business climate to encourage the creation and growth of our 
small businesses. And small business has been the backbone for 
the country; more than 97 percent of the businesses are small 
business. I appreciate any of the concentration that people 
have done on improving small business, and I would ask that a 
copy of my full statement be made part of the record.
    Chairman Shelby. Without objection, it is so ordered.
    Senator Reed.

                 COMMENTS OF SENATOR JACK REED

    Senator Reed. Thank you, Mr. Chairman, and welcome, 
Chairman Greenspan. You are certainly a respected voice on 
these matters, not only here in Washington but also 
internationally.
    We are in the midst of some of the worst economic news we 
have had in a long time, particularly the unemployment numbers. 
And the Administration seems to suggest more tax cuts and it 
will get better. The Congress has passed more tax cuts, and it 
is getting worse. I do not think that is the approach that we 
should take.
    It is particularly worse when it comes to the increase in 
unemployment, and I think Senator Sarbanes' comments are very 
precise and detailed about what is happening and the fact that 
it seems in most cases to be a lag variable. So even when the 
GDP starts improving, we are likely to see further increases in 
unemployment. We are reaching a critical juncture. These are 
the real lives of our constituents.
    And right over the horizon is Social Security and Medicare, 
and rather than taking prudent steps today to strengthen those 
programs, or at least to reserve resources to do that, we have 
effectively funded the tax cuts with Social Security monies and 
other monies. I know it is incumbent upon all of us to restrain 
spending, but, frankly, in 2003, about 94 percent of the 
spending above the baseline was devoted to defense, homeland 
security, and other items as a response to September 11, plus 
Iraq and Afghanistan. It is very difficult to hold down 
spending when we are spending $4 billion a month in Iraq and $1 
billion a month in Afghanistan.
    Today, we will consider and this week we will vote on a 
defense bill that is a significant increase in spending, and, 
ironically, none of those funds will include the cost of Iraq. 
That will come later, probably in a supplemental. So, we have a 
policy that is difficult to rationalize in terms of our fiscal 
policy here: Uncontrollable expenses, or at least very-
difficult-to-predict expenses, resulting from our operations in 
Iraq, Afghanistan, and homeland security, and continued tax 
cuts which leave us, I think, not only with a poorly performing 
economy but also in no position to deal with the issues of 
Medicare and Social Security.
    I look forward to your comments, Mr. Chairman.
    Chairman Shelby. Senator Bennett.

             COMMENTS OF SENATOR ROBERT F. BENNETT

    Senator Bennett. Thank you, Mr. Chairman. I will resist the 
temptation to engage in a debate and save that for speeches on 
the floor.
    I appreciate Chairman Greenspan's being with us today and 
look forward to his testimony.
    Chairman Shelby. Senator Bayh.

                 COMMENTS OF SENATOR EVAN BAYH

    Senator Bayh. Welcome, Mr. Chairman. I look forward to your 
testimony as well. I think my colleagues have covered most of 
the relevant terrain.
    Chairman Shelby. Senator Hagel.

                COMMENTS OF SENATOR CHUCK HAGEL

    Senator Hagel. Mr. Chairman, thank you.
    I, too, welcome Chairman Greenspan. With all of this good 
news floating around today, I look forward to your comments.
    Thank you.
    Chairman Shelby. Senator Chafee.

             COMMENTS OF SENATOR LINCOLN D. CHAFEE

    Senator Chafee. Likewise, welcome, Mr. Chairman, and you 
have the back-to-back--the House yesterday, the Senate today. I 
look forward to your testimony.
    Chairman Shelby. Chairman Greenspan, your written testimony 
will be made part of the record in its entirety. You proceed as 
you wish. Welcome to the Committee again.

             STATEMENT OF ALAN GREENSPAN, CHAIRMAN

        BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM

    Chairman Greenspan. Thank you very much, Mr. Chairman and 
Members of the Committee.
    When in late April I last reviewed the economic outlook 
before the Congress, full-scale military operations in Iraq had 
concluded, and there were signs that some of the impediments to 
brisker growth in economic activity in the months leading up to 
the conflict were beginning to lift. Many, though by no means 
all, of the economic uncertainties stemming from the situation 
in Iraq had been resolved, and that reduction in uncertainty 
had left an imprint on a broad range of indicators.
    Stock prices had risen, risk spreads on corporate bonds had 
narrowed, oil prices had dropped sharply, and measures of 
consumer sentiment appeared to be on the mend. But, as I noted 
in April, hard data indicating that these favorable 
developments were quickening the pace of spending and 
production were not yet in evidence, and it was likely that the 
extent of the underlying vigor of the economy would become 
apparent only gradually.
    In the months since, some of the residual war-related 
uncer-
tainties have abated further and financial conditions have 
turned decidedly more accommodative, supported, in part, by the 
Federal Reserve's commitment to foster sustainable growth and 
to guard against a substantial further disinflation. Yields 
across a number of maturities and risk classes have posted 
declines, which together with improved profits boosted stock 
prices and household wealth. If the past is any guide, these 
domestic financial developments, apart from the heavy dose of 
fiscal stimulus now in train, should bolster economic activity 
over coming quarters.
    To be sure, industrial production does appear to have 
stabilized in recent weeks after months of declines. Consumer 
spending has held up reasonably well, and activity in housing 
markets continues strong. But incoming data on employment and 
aggregate output remain mixed. A pervasive sense of caution 
reflecting, in part, the aftermath of corporate governance 
scandals appears to have left businesses focused on 
strengthening their balance sheets and, to date, reluctant to 
ramp up significantly their hiring and spending. Continued 
global uncertainties and economic weakness abroad, particularly 
among some of our major trading partners, also have extended 
the ongoing softness in the demand for U.S. goods and services.
    When the Federal Open Market Committee met last month, with 
the economy not yet showing convincing signs of a sustained 
pickup in growth, and against the backdrop of our concerns 
about the implications of a possible substantial decline in 
inflation, we elected to ease policy another quarter-point. The 
Federal Open Market Committee stands prepared to maintain a 
highly accommodative stance of policy for as long as needed to 
promote satisfactory economic performance. In the judgment of 
the Committee, policy accommodation aimed at raising the growth 
of output, boosting the utilization of resources, and warding 
off unwelcome disinflation can be maintained for a considerable 
period without ultimately stoking inflationary pressures.
    The prospects for a resumption of strong economic growth 
have been enhanced by steps taken in the private sector over 
the past couple of years to restructure and strengthen balance 
sheets. These changes, assisted by improved prices in asset 
markets, have left households and businesses better positioned 
than they were earlier to boost outlays as their wariness about 
the economic environment abates.
    Nowhere has this process of balance sheet adjustment been 
more evident than in the household sector. On the asset side of 
the balance sheet, the decline of longer-term interest rates 
and diminished perceptions of credit risk in recent months have 
provided a substantial lift to the market value of nearly all 
major categories of household assets. Most notably, 
historically low mortgage interest rates have helped to propel 
a solid advance in the value of the owner-occupied housing 
stock. And the lowered rate at which investors discount future 
business earnings has contributed to the substantial 
appreciation in broad equity price indexes this year, 
reversing a portion of their previous declines.
    On the liability side of the balance sheet, despite the 
significant increase in debt encouraged by higher asset values, 
lower interest rates have facilitated a restructuring of 
existing debt. Households have taken advantage of new lows in 
mortgage interest rates to 
refinance debt on more favorable terms, to lengthen debt 
maturity, and, in many cases, to extract equity from their 
homes to pay down other higher-cost debt. Debt service burdens, 
accordingly, have 
declined.
    We expect both equity extraction and lower debt service to 
continue to provide support for household spending in the 
period ahead, though the strength of this support is likely to 
diminish over time.
    In addition to balance sheet improvements, the recently 
passed tax legislation will provide a considerable lift to 
disposable incomes of households in the second half of the 
year, even after accounting for some State and local offsets. 
Most mainstream economic models predict that such tax-induced 
increases in disposable income should produce a prompt and 
appreciable pickup in consumer spending. The evolution of 
spending over the next few months may provide an important test 
of the extent to which this traditional view of 
expansionary fiscal policy holds in the current environment.
    Much like households, businesses have taken advantage of 
low-interest rates to shore up their balance sheets. Most 
notably, firms have issued long-term debt and employed the 
proceeds to pay down commercial paper, bank loans, and maturing 
high-cost debt. The net effect of these trends to date has been 
a decline in the ratio of business interest payments to net 
cash flow, a significant increase in the average maturity of 
liabilities, and a rise in the ratio of current assets to 
current liabilities.
    With business balance sheets having been strengthened and 
with investors notably more receptive to risk, the overall 
climate in credit markets has become more hospitable in recent 
months. Specifically, improvements in forward-looking measures 
of default risk, a decline in actual defaults, and a moderation 
in the pace of debt-rating downgrades have prompted a marked 
narrowing of credit spreads and credit default swap premiums.
    In the past, such reductions in private yields and in the 
cost of capital faced by firms have been associated with rising 
capital spending. But as yet there is little evidence that the 
more accommodative financial environment has materially 
improved the willingness of top executives to increase capital 
investment. Corporate executives and boards of directors are 
seemingly unclear, in the wake of the recent intense focus on 
corporate behavior, about how an increase in risk-taking on 
their part would be viewed by shareholders and regulators.
    As a result, business leaders have been quite circumspect 
about embarking on major new investment projects. Moreover, 
still-ample capacity in some sectors and lingering uncertainty 
about the strength of prospective final sales have added to the 
reluctance to expand capital outlays. But should firms begin to 
perceive that the pickup in demand is durable, they doubtless 
would be more inclined to increase hiring and production, 
replenish depleted inventories, and bring new capital online. 
These actions in turn would tend to further boost incomes and 
output.
    The favorable productivity trend of recent years have 
continued, which certainly bode well for the future. Output per 
hour in the nonfarm business sector increased 2.5 percent over 
the year ending in the first quarter. It has been unusual that 
firms have been able to achieve consistently strong gains in 
productivity when the overall performance of the economy has 
been so lackluster. To some extent, companies under pressure to 
cut costs in an environment of still-tepid sales growth and an 
uncertain economic outlook might be expected to search 
aggressively for ways to employ resources more efficiently.
    However, one consequence of these improvements in 
efficiency has been an ability of many businesses to pare 
existing workforces and still meet increases in demand. Indeed, 
with the growth of real output below that of labor productivity 
for much of the period since 2000, aggregate hours and 
employment have fallen, and the unemployment rate rose last 
month to 6.4 percent of the civilian labor force.
    Inflation developments have been important in shaping the 
economic outlook and the stance of policy over the first half 
of the year. With the economy operating below its potential for 
much of the past 2 years and productivity growth proceeding 
apace, measures of core consumer prices have decelerated 
noticeably. Allowing for known measurement biases, these 
inflation indexes have been in a neighborhood that corresponds 
to effective price stability--a long-held goal assigned to the 
Federal Reserve by the Congress. But we can pause at this 
achievement only for a moment, mindful that we face new 
challenges in maintaining price stability, specifically to 
prevent inflation from falling too low.
    This is one reason the Federal Open Market Committee has 
adopted a quite accommodative stance of policy. A very low 
inflation rate increases the risk that an adverse shock to the 
economy would be more difficult to counter effectively. Indeed, 
there is an especially pernicious, albeit remote, scenario in 
which inflation turns negative against a backdrop of weak 
aggregate demand, engendering a corrosive deflationary spiral.
    It is incumbent on a central bank to anticipate such 
contingencies, however remote, and the Federal Reserve has been 
studying how to provide policy stimulus should our primary tool 
of 
adjusting the target Federal funds rate no longer be available. 

Indeed, the Federal Open Market Committee devoted considerable 
attention to this subject at its June meeting, examining 
potentially feasible policy alternatives. However, given the 
now highly stimulative stance of monetary and fiscal policy and 
well-anchored inflation expectations, the Committee concluded 
that economic fundamentals are such that situations requiring 
special policy actions are most unlikely to arise. Furthermore, 
with the target funds rate at 1 percent, substantial further 
conventional easings could be 
implemented if the Federal Open Market Committee judged such 
policy actions warranted. Doubtless, some financial firms would 

experience difficulties in such an environment, but these 
intermediaries have exhibited considerable flexibility in the 
past to changing circumstances. More broadly, as I indicated 
earlier, the Federal Open Market Committee stands ready to 
maintain a highly accommodative stance of policy for as long as 
it takes to achieve a return to satisfactory economic 
performance.
    Thank you very much. I look forward to your questions.
    Chairman Shelby. Thank you, Mr. Chairman.
    Mr. Chairman, in response to your remarks yesterday, bond 
markets moved the yield on the benchmark 10-year Treasury up to 
3.93 percent. Was the market reaction, in your judgment, in 
line with what you anticipated would be the case? And if not, 
would you take an opportunity to redirect your thoughts or just 
tell us what your thoughts are?
    Chairman Greenspan. Well, as I indicated yesterday, 
remember that just prior to our last meeting, the financial 
markets had been split on the evaluation of whether we would 
move 25- or 50-basis-points. In the event, of course, we moved 
25-basis-points and we concluded as a consequence that when we 
announced that, interest rates would rise, as indeed they did.
    It is difficult to judge what causes market rates to move. 
There are a great number of opinions out there, and I hesitate 
to give an opinion because that is basically endeavoring to try 
to answer the question why did a large number of market 
participants do certain things?
    You can draw certain inferences. For example, Treasury rate 
yields went up significantly, as, in effect, did high-grade 
corporates. But speculative-grade bond yields actually went 
down and the exchange rate firmed up. So a number of 
commentators have concluded, looking at those data, that the 
general view of the economy which we expressed--meaning the 
Federal Reserve--was somewhat stronger than they had expected 
we would have indicated.
    There was also a general judgment that, in a sense, we took 
off the table, as I read one commentator stipulating, the 
notion that we might use so-called nontraditional means. I was 
not aware I took anything off the table at any time, but 
apparently that was the view that was taken at the time.
    Remember that the Federal Open Market Committee can make a 
judgment about policy probably with a 15-minute lead. And our 
job is to be prepared to be able to move if we have to in any 
particular case. But that requires a good deal of backup 
analysis, and that is what we have been doing, and we have been 
trying to convey what we are learning along the way to the 
American public and the markets.
    Chairman Shelby. Mr. Chairman, what is your view on the 
spread between short- and long-term rates at the moment?
    Chairman Greenspan. The market is obviously responding to 
our general view--which has been our policy and will continue 
to be our policy, as best I can judge--that we will hold rates 
until the economy achieves satisfactory performance, which 
means that we tend to anchor the short-term rate structure 
because what we are targeting, as you know, is the overnight 
rates.
    Chairman Shelby. Sure.
    Chairman Greenspan. And the longer-term rates reflect three 
things: They basically reflect inflationary expectations, the 
expectations of real economic growth, and the supply of 
securities. And in all of those cases, those markets will move 
essentially independently in many respects of what Federal 
Reserve policy is.
    Chairman Shelby. Mr. Chairman, this morning's data released 
on industrial production showed an output gain for 
manufacturing. Does this signal a potential rebound for this 
sector of the economy which has been lagging?
    Chairman Greenspan. It certainly indicates--at least, as I 
say in my prepared remarks--that industrial production has 
stabilized. But it is stabilized, as best I can judge on the 
data we are looking at, with inventories being liquidated, 
which effectively is saying that the consumption of industrial 
production, is somewhat higher than the production level, 
implying that at some point it will rise further. But short of 
that, I would just as soon not give you any projection because 
we do not have one immediately that is useful.
    Chairman Shelby. We respect that.
    Senator Sarbanes.
    Senator Sarbanes. Thank you, Mr. Chairman.
    In this July report, the Fed has downgraded its projection 
for GDP growth for 2003 for the second time. Last July, the Fed 
forecast GDP growth for 2003, the year we are in, between 3.5 
and 4 percent. In February, it lowered that forecast slightly 
to between 3.25 and 3.5 percent. And now it estimates growth 
between 2.5 and 2.75 percent for 2003.
    Regrettably, this pattern is similar to forecasts for the 
previous several years. In February 2001, the Fed projected 
economic growth of between 2 and 2.5 percent. In July, we were 
already in the midst of a recession, and the Fed significantly 
lowered its projections to between 1 and 2 percent growth. 
Growth in 2001 was barely even positive at 0.3 of a percent.
    In February 2002, the Fed projected growth of between 2.5 
and 3 percent for 2002, only to revise that projection upward 
in July to between 3.5 and 3.75 percent. Growth came in below 
projections at 2.4 percent. Those are the three most recent 
years.
    So far economic growth in the first quarter of this year 
was a meager 1.4 percent. The consensus estimate is that the 
second quarter will hardly be any better. But now we are 
hearing that next year the growth will pick right back up to 
between 3.75 and 4.75 percent, according to this report.
    It leads me, Mr. Chairman, to ask: Are the models that you 
are using at the Fed overly optimistic? Or have we all fallen 
into the trap of believing that there is a mythical recovery 
which is just around the corner? I mean, in all three of these 
years now, the Fed has really been off the mark on its 
projections, overly optimistic consistently?
    Chairman Greenspan. That is true, and I would suggest to 
you that it is not the result of a single model because what 
you are quoting is, I would put it this way, the consensus of 
the individual forecasts of the members of the Federal Open 
Market Committee. That is not the staff forecast as such, which 
we produce separately.
    But it is certainly the case that we and others--in fact, 
the general consensus--have been projecting a recovery sooner 
than it has obviously been occurring.
    Senator Sarbanes. Well, that would lend some weight to the 
view that we have a more serious economic situation on our 
hands than is being generally acknowledged or admitted to.
    Chairman Greenspan. Oh, there is no question that that is 
the case, and indeed, remember that we did have the emergence 
of 
Afghanistan and especially the Iraqi war, the big surge in oil 
prices, and a number of events which we did not forecast.
    Senator Sarbanes. Let me ask about the labor market, just 
to follow along with this line of thought. The June 25, Federal 
Open Market Committee statement said, ``Recent signs point to 
labor and product markets that are stabilizing.'' Now this was 
a shift from the FOMC meeting on May 6 in which the FOMC found, 
``Initial claims for unemployment insurance remained at an 
elevated level, suggesting further labor market weakness in 
May.'' Indeed, the labor market was quite weak in May, with the 
revised data reporting that 70,000 jobs were lost. Initial 
claims for unemployment 
remained above the 400,000 level throughout May and June.
    Since your June report, initial claims have risen to 
439,000 for the most recent week. They have been above the 
400,000 level for 21 consecutive weeks. The unemployment rate 
jumped to 6.4 percent, a 9-year high, and the economy continued 
to lose jobs in June for the fifth consecutive month. As I said 
earlier, the number of workers who were unemployed for more 
than one week has reached a 20-year high of 3.8 million.
    Would it not be more accurate now in describing the labor 
market to go back to the May formulation, an elevated level 
suggesting further labor market weakness rather than the June 
formulation, the labor markets are stabilizing?
    Chairman Greenspan. Well, Senator, my recollection--and I 
would have to look at the data--is that the reason the 
statement of stabilization was put in there is that the 
employment data historically were revised to, as I would put 
it, a more stable pattern. They then were revised again down in 
the most recent report. So what we were reflecting were the BLS 
payroll data, which, as I recall, had shown signs of stability, 
which then was erased in the next month's report.
    Senator Sarbanes. Yes, I understand that, and the point I 
was trying to get at is, given the additional data that is now 
available to us, as you come this morning, wouldn't the May 
formulation of a further labor market weakness be more apt to 
our current circumstance than the June formulation of a 
stabilizing labor market?
    Chairman Greenspan. Senator, we will not know until we get 
beyond the July initial claims figures, and let me explain to 
you what that is.
    We have very considerable difficulty during the month of 
July, especially in the first 2 weeks of July, in seasonally 
adjusting the normal retooling that goes on in the motor 
vehicle industry and seasonal shutdowns in a number of 
different industries, and they vary. And we have found that the 
variants of the seasonals are very large, and so until we get 
into August, we will not get a good reading on initial claims 
or insured unemployment.
    It is conceivable that the formulation you just suggested 
may, in fact, turn out to be the correct one. I would like to 
wait a couple of weeks before I respond to that in any 
definitive manner.
    Senator Sarbanes. Thank you, Mr. Chairman.
    Chairman Shelby. Senator Allard.
    Senator Allard. Chairman Greenspan, we just enacted a tax 
cut. Would you say that that tax cut increases the likelihood 
that our economy will recover more quickly?
    Chairman Greenspan. I have argued in the past that I did 
not view fiscal measures as being appropriate for purposes of 
short-term fiscal stimulus. I have said that over the years. I 
have indicated that in many testimonies here.
    The truth of the matter is that more, I suspect, for 
fortuitous reasons, the last two tax cuts have turned out to be 
timed in a manner which would affect the economy. And I do 
believe that the current one, as I indicated in my prepared 
remarks, by shifting a very substantial amount of monies to 
reduce taxes and increase disposable personal income in the 
third quarter has the makings of a fairly prompt impact on 
sales.
    It is too soon to judge whether that impact is going to be, 
as I put it in my prepared remarks, what standardized 
conventional models ordinarily suggest would occur. But there 
is no question that the quality of the data on sales have been 
improving. The retail sales released for the month of May, 
which is obviously prior to these data, was obviously above 
expectations. And, indeed, chain store sales in recent weeks 
have been running above expectations.
    Motor vehicle sales seem to be a shade better, but it is 
too soon to tell. And the best thing is we will probably find 
out the answer to your question of whether the tax cuts really 
made a difference I would say probably toward the end of this 
quarter.
    Senator Allard. Thank you for your response.
    As you know, you and I have had a discussion about the 
capital gains tax. In some of those hearings where you appeared 
before 
either this Committee or the Budget Committee, you have 
strongly argued for its elimination or reduction. Whenever we 
get a fiscal note on a capital gains proposal, or tax reduction 
proposal, it has a positive fiscal note; in other words, it 
shows increasing revenue to the Federal Government.
    So, I was struck by your comment yesterday when you 
acknowledged that the tax cuts have a stimulatory effect, 
although you noted that you doubted the tax cut paid for 
itself. Would you modify that comment, specifically with 
regards to capital gains?
    Chairman Greenspan. No, not really, Senator. It is 
certainly the case that if you cut the capital gains tax, you 
are likely to get fairly significant revenue initially. You 
probably will get an initial response in revenue raising as the 
turnover occurs.
    Senator Allard. Right.
    Chairman Greenspan. But over the long run, I do not think 
the data show that. In other words, you get an initial surge in 
revenues followed by a significant decline from the capital 
gains tax, and taken over the long run, you would lose revenue, 
as best I can judge.
    Senator Allard. Chairman Greenspan, this Congress is right 
now wrestling with the reauthorization of transportation bills, 
highway transportation and mass transit in particular. Members 
of Congress are struggling with how they are going to pay for 
all these transportation projects. Some have called for an 
increase of 2 cents per gallon, while others are calling for an 
increase in excess of 12 cents per gallon.
    First, I wonder if you might comment on how you think this 
tax increase could have an impact on our economy when it is 
dedicated to improving the infrastructure of this country. The 
second part of the question: In Colorado, we have a unique 
situation. We have some of the highest gas taxes in the 
country. And, our neighbor, Wyoming, has some of the lowest gas 
taxes in the country. Could you talk a little about how those 
two extremes may be impacted since they are right next to each 
other? I would appreciate it.
    Chairman Greenspan. Well, it should be apparent that if you 
increase the gasoline tax, consumption of gasoline will go 
down. That has two effects. Since a significant part of the 
crude oil and, indeed, even gasoline stocks that we consume are 
imported, it probably has the effect of reducing consumption of 
gasoline, reducing, I should say, aggregate consumption, which 
is partially offset from imports. The net effect is probably to 
weaken the economy slightly. But I would be doubtful that that 
is a big issue, and I think there are far more important other 
issues that are involved in gasoline tax, which obviously gets 
to questions of conservation, gets to questions of security of 
supply, and I would be hesitant to draw the economic impact as 
being a crucial issue in the context of the small changes that 
we tend to talk about.
    I have really nothing to say about the disparity among 
States. That has to do with your legislatures, and if you want 
to have a meeting at the border to marginalize them, that is a 
question for the States.
    Senator Allard. Let me rephrase that question. Is there 
likely to be a greater economic impact on States that have high 
gas taxes as opposed to those who have lower gas taxes?
    Chairman Greenspan. Yes.
    Senator Allard. I see my time has expired. Thank you.
    Chairman Shelby. Senator Reed.
    Senator Reed. Thank you very much, Mr. Chairman.
    Thank you, Chairman Greenspan.
    In this Monetary Report to the Congress, page 12, and I 
quote, ``With little change, on balance, in non-Federal 
domestic saving over this period, the downswing in Federal 
saving''--which I think roughly is the surplus--``showed 
through into net national saving, which was equal to less than 
1 percent of GDP in the first quarter, compared with the recent 
high of 6.5 percent of GDP in 1998. If not reversed over the 
longer haul, such low levels of national saving could 
eventually impinge on the formation of private capital that 
contributed to the improved productivity performance of the 
past half-decade.''
    Today's headlines from The Washington Post,--White House 
Foresees 5-Year Debt Increase Of $1.9 Trillion.--``The Federal 
Government will pile up $1.9 trillion in new debt over the next 
5 years and will still be running an annual deficit of $225 
billion by 2008, long after White House economists assume 
current war costs will have subsided and the economy will have 
recovered. . . .'' Those are pretty rosy predictions but, 
nevertheless, even the White House assumes we will be running 
deficits and not surpluses by 2008.
    The question is: Where is the long haul? Is it 2005, 2006, 
2007, 2008, 2009? When are we going to start seeing this 
adverse impact requiring us to do something more than just talk 
about it?
    Chairman Greenspan. Remember that the statement in that 
report is a statement of accounting and arithmetic; that is, 
the accounts of savings and investment must balance. Obviously, 
if you get an absorption of savings from the private sector by 
increased Federal deficits, that will reduce the private 
savings available to finance investment.
    But as I said yesterday in response to a related question, 
that leaves open the question of financing domestic capital 
investment by essentially borrowing savings from abroad, as one 
possibility, which we have done, obviously, quite extensively. 
And then there is a quite important question which gets to the 
issue that only roughly half of our productivity increases are 
directly attributable to the amount of capital investment that 
is employed in the economy. The rest are technological changes, 
organizational changes, things which economists call ``multi-
factor productivity.''
    There is no question that if you run substantial and 
excessive deficits over time, you are draining savings from the 
private sector, and other things equal, you do clearly undercut 
the growth rate of the economy. That is one of the reasons I 
have argued for years about getting the deficit down. So, I 
have no question that if we do not come to grips with these 
deficit issues, it will make it more difficult for us to 
maintain the type of growth rates which, to respond to Senator 
Sarbanes' concerns, will bring total employment up and bring 
the unemployment rate down.
    Senator Reed. As I understand the numbers out of the White 
House, though, they are assuming a full-employment economy by 
2008 and still deficits. Is that accurate?
    Chairman Greenspan. That is certainly economically 
consistent. It depends on the nature of the individual 
assumptions that are made with respect to a lot of different 
variables.
    Senator Reed. I still have not heard the long haul, where I 
am looking over the horizon. Where should I put my stake down 
for the long haul? Certainly that is something that you must 
think about. It is one thing, because your models and your 
presumptions all have a time base as well as other parameters.
    Chairman Greenspan. That is exactly right, Senator. Even 
though, as I indicated earlier, we can move on 15 minutes 
notice, nonetheless, unless we have a broad overview of the 
forces that are driving the economy, not only in the short run 
but also in the long run, it is difficult to make judgments as 
to what the appropriate posture of monetary policy is unless 
you have the full context of both the short term and the long 
term.
    Senator Sarbanes. Jack, would you yield for a second?
    Senator Reed. I would yield to the gentleman.
    Senator Sarbanes. Would you run large deficits at full 
employment levels? If the economy is at full employment levels, 
what is your view with respect to running large deficits in the 
Federal budget?
    Chairman Greenspan. I would be against it.
    Senator Reed. May I ask one more question? That is, the 
consumer has been one of the stalwarts in the economy. Getting 
back to the taxes, there are at least two issues with the 
taxes. One is the size and the other issue is who are the 
beneficiaries? It seems to me, and the one phrase I remember 
from college economics is that the marginal propensity to 
consume is the inverse of proportional income. So that if we 
target these tax cuts--I have exhausted all my economic 
knowledge, I will admit it.
    [Laughter.]
    Senator Reed. If we target these tax cuts to the 
wealthiest, which seems to be the case, we will not get the 
proportional benefit from consumption that we would if we had 
targeted these tax cuts to lower-income Americans.
    Chairman Greenspan. Senator, I was exposed to the same 
economic education that you were as an undergraduate.
    Senator Reed. I think it took in your case.
    [Laughter.]
    Chairman Greenspan. I would merely qualify the conclusion. 
What we have found recently is that while indeed the marginal 
propensity to consume does fall as incomes rise, that the 
extent of the decline is much less than has been our previous 
expectation, and what I also would presume to be conventional 
wisdom. So, yes, it is true that marginal propensities to spend 
fall, but it is not enough to really make a very substantial 
difference when you apply it to various different income 
distributions.
    Senator Reed. Thank you.
    Thank you, Mr. Chairman.
    Chairman Shelby. Senator Bennett.
    Senator Bennett. Thank you very much, Mr. Chairman.
    Chairman Greenspan, this is anecdotal from my own 
observation, but I want to share it with you and get your 
response. One of the areas where I have found that the recent 
recession and soft recovery has hit very, very hard is in the 
area of venture capital. VC's, as I have discussions with them 
about new ideas and new opportunities, say very flatly, ``We 
have no money. There is no VC money.'' What little VC money 
that has been available has gone not to fund new ventures but 
to follow the pattern that you outlined in your statement, to 
shore up the balance sheets of the ventures that they funded 
during the bubble of the 1990's, so that when we had the froth 
and the excitement of the late 1990's, and you could get 
venture capital for almost any idea, no matter how hare-brained 
it might have been in retrospect, the system washed out all of 
the bad investments and the venture capitalists took what money 
they did have and went back to the investments that were just 
hanging on, but surviving nonetheless, and put money that would 
have gone into new ventures and thus created new jobs into 
strengthening the balance sheets of the companies that they 
had.
    The VC's were saying to me, ``We have a liquidity crisis. 
We cannot get any money out of the banks. The banks are getting 
very, very anxious about making sure that they are not taking 
undue risks, much the way they did after the savings and loan 
crisis when banks got very, very conservative in their lending 
process. We cannot raise very much money from individuals. They 
are burned. They are being very, very cautious, and 
consequently there is a liquidity crisis in the venture capital 
world.''
    I think that may have some impact on the unemployment 
situation that Senator Sarbanes is so concerned about because 
much of our job creation comes from new business creation. 
Fortunately, we are not like Europe, and we are not like Japan 
where they do not have the VC tradition. So until we get 
venture capitalists funding new entrepreneurial activities, we 
are probably not going to make as big a dent on the 
unemployment number as we would like. The Fortune 500 cannot 
solve the unemployment problem. The Fortune 500 has always been 
lagging in job creation as opposed to the entrepreneurial side 
of the house.
    Do you have any data, or if no data, any intuition about 
what might be happening in the venture capital world and what 
we might be able to look forward to in this uniquely American 
phenomenon of a lot of private capital funding brave new 
entries into the world?
    Chairman Greenspan. Senator, the data that we have show, as 
you correctly point out, a moderate to small industry prior to 
the mid-1990's, and then with the surge of the stock market 
there is this huge increase in venture capital as a spike, and 
indeed it has come all the way back down to where it had been. 
It is not below, but clearly it was all the way up and all the 
way down. My impression is that it depends to a very large 
extent not just on the availability of capital without the 
ideas, but you need to start to get market values up first, so 
that there are presumed opportunities. Remember, that so far as 
financing is concerned, as important as venture capital is for 
these highly speculative and very imaginative projects, and as 
you pointed out, some of them perhaps a little exotic, too 
exotically imaginative in the past, far more important is the 
fact that there has been a very significant decline in what we 
call junk bond yields. Those are high-yielding bonds which are 
a large source of financing for capital investment in a number 
of lower-grade corporations whose fluctuation in capital 
expenditure is quite large. So, yes, I do think if we were to 
get increased venture capital going it would be helpful, but I 
think if the economy gets going, venture capital will follow 
along.
    I do not believe that it is a leading indicator at all, and 
it is one which really requires opportunities to arise and 
individuals looking for various different types of investments 
because they presume that other market prices have gone up too 
high.
    Senator Bennett. Thank you.
    Chairman Shelby. Senator Bayh.
    Senator Bayh. Thank you, Mr. Chairman. Time permitting, I 
have three questions, two of a short-term nature, one of a 
longer-term nature.
    My first question would be: When do you anticipate a pickup 
in capital investment, and how robust would you expect that to 
be? Particularly, Mr. Chairman, you mentioned three factors in 
your testimony. First, the increased risk aversion by corporate 
decisionmakers because of the recent scandals. I will assume 
that they will eventually become acclimated to the new rules 
and that will abate. Second, you mentioned overcapacity in some 
parts of the economy. You did not mention telecom, but some of 
those areas I assume we will just have to work their way 
through that. In particular, if you could, I would like for you 
to address the third point you mentioned, which is when do you 
think the pickup in demand will be perceived as being durable, 
thereby incenting corporate decisionmakers to increase their 
capital investments?
    Chairman Greenspan. Senator, if we knew the answer to just 
any two of those three questions, I think we would have the 
elements of an economic forecast, because that is really where 
the major uncertainties are.
    The problem in the corporate governance area is one in 
which there has been a shock to the corporate sector because 
the types of things that occurred were not presumed 
contemplatable in an earlier period, and it is going to take a 
while for that to wear off. I do not know how long it will 
take, but one way of getting some judgments, I would be looking 
to see whether mergers and acquisitions begin to pickup. That 
would give you a sense that there is lessened concern.
    Senator Bayh. There are some tentative signs of that, more 
MA activity.
    Chairman Greenspan. Well, I have heard the same, but it is 
still quite preliminary and not really evident.
    Senator Bayh. Could I ask, Chairman--forgive me for 
interrupting, but our time is unfortunately limited--if you 
might focus on the third factor, when the pickup in demand will 
be perceived as being more durable?
    Chairman Greenspan. It will depend on two things. One, on 
the issue which I was discussing with Senator Reed, what the 
propensity to consume out of these very substantial tax cuts 
concentrated in a short period of time is, and, two, whether 
the increase in demand is perceived by the business community 
as not a blip but as something which is more ongoing. I cannot 
answer that question with any degree of certainty, but at the 
moment most private forecasters have forecast for the third 
quarter which I will tell you are higher than ours.
    Senator Bayh. Well, that is encouraging.
    Chairman Greenspan. I do not know whether that makes it 
right. I am just saying it.
    [Laughter.]
    Senator Bayh. It is always nice to be encouraged, right or 
not. It seems to me though that that really lies at the crux of 
the issue, that the risk aversion because of the corporate 
scandals will eventually subside as decisionmakers acclimate 
themselves to the new rules that we have attempted to put in 
place and that some of the overcapacity, we will eventually 
work our way through that, but really the key here is the 
perception of the durability of demand going forward on a 
sustainable basis, to the increase in CapEx which has been a 
significant missing component of this tentative recovery to 
date.
    My second question I do not think I am going to get to my 
third, which is unfortunate because I wanted to ask you about 
the long-term fiscal challenges that we face when the baby 
boomer begins to retire. Perhaps that will await another time.
    We all care about the deficit here. I know when I go home 
people occasionally ask about it, but my perception is that the 
public only begins to focus on the deficit when it begins to 
bite in real rather than theoretical terms, and public 
policymakers tend to only make the difficult decisions that 
have to be made once the public has begun to focus because of 
real world consequences.
    So my question would be, and you mentioned in response to 
one of my colleagues' questions, or rather one of my colleagues 
may have mentioned the activity in the credit markets 
yesterday, and then you mentioned that the more high-yielding 
securities actually responded well, I assume because of 
perception of a reduced default risk. But the treasuries and 
high-grade corporates went the other direction. My question 
would be: When do you perceive that the adverse consequences of 
the deficit will actually begin to manifest themselves in real 
terms? It seems to me that the markets yesterday were at least 
sending a near-term signal that the answer may be now. In terms 
of the crowding out, they are anticipating both higher private 
demand, which was the reason for my first question, 
simultaneously with high ongoing deficits, and that we may see 
crowding out sooner rather than later.
    Chairman Greenspan. I think it is difficult to separate the 
issue of increased supply in the short term, and general 
notions of broad economic recovery. They are interrelated and 
very difficult to separate. We have found that the impact of 
deficits on current long-term interest rates are related to 
changes in long-term deficit expectations, not generally short-
term issues of deficits and Treasury borrowing. So it is not 
clear to me to what extent changes in yields are impacted, 
although there is no question that if you put new 
securities in the market, prices will tend to adjust. But the 
real impact on long-term interest rates which matter are really 
driven by long-term expectations of the deficit to the extent 
that interest rates are affected by deficits, which as you 
know, I am a firm believer they are.
    Senator Bayh. My time has expired, Mr. Chairman, which is 
too bad, because that led directly to my third question which 
was the long term--
    Chairman Shelby. Senator, we will have another round.
    Senator Bayh. Thank you, Mr. Chairman.
    And thank you, Chairman Greenspan.
    Chairman Shelby. Senator Hagel.
    Senator Hagel. Mr. Chairman, thank you.
    Chairman Greenspan, thank you again for appearing before 
the Committee. Actually, I would like to pick up where the 
Senator from Indiana left off, staying within the universe of 
deficits, and I think where the Senator from Indiana was going 
with this is in the unfunded entitlement liabilities direction, 
or at least that is where I want to go with the question.
    First, it has been noted here, and you have responded to 
some questions about OMB's numbers that they released yesterday 
which appeared in the papers today about a $1.9 trillion 
deficit over the next 5 years, and I think we are all familiar 
with the numbers that they have projected for this fiscal year 
as well, as higher numbers for next year. Staying in that 
universe for a moment, there was a piece in the Financial Times 
yesterday, and I do not know if you saw it. The headline was 
``The Fiscal Overstretch That Will Undermine An Empire.'' As a 
matter of fact, one of the authors of this, according to the 
story, is a senior economist at the Federal Reserve in 
Cleveland. It talks about the unfunded entitlement liabilities 
that are out there for this country. And you know the numbers 
very well on this, Mr. Chairman. In 8 years, 77 million baby 
boomers start collecting Social Security benefits.
    What they did in this study is they tried to, as best they 
could, develop a model that would tell them what kind of 
revenues we could expect within that time frame versus the 
commitments that the Government had. What they found was a $44 
trillion shortfall in revenues, and a great amount of that was 
due to the Medicare-Social Security liabilities that are 
unfunded.
    Now, in light of that, as you have been following, and you 
and I have had some discussions about this previously, both the 
House and the Senate have passed a Medicare reform bill, and 
the centerpiece of that, as you know, is a prescription drug 
plan. I would be interested in your thoughts about the entirety 
of this issue because of the kind of obligations that we are 
saddling future generations with a prescription drug plan in a 
Medicare reform bill, and any other comments you would like to 
make in this regard, because I think you just said that large 
deficits, in your words, undercut the growth rate of an 
economy.
    So with all of that, have at it. Thank you.
    Chairman Greenspan. Without discussing any particular 
programs, I do think that it is possible to get a general 
projection of what under the best conditions the revenue flows 
in this country would be to the U.S. Treasury. Wholly 
independent, the Congress passes legislation with commitments 
for the future which do not relate to the available revenues. 
It is a very difficult evaluation, and I will grant you that 
others will come to different conclusions. In recent years it 
has been my impression that the statutes that we have now 
currently in place, granted the demographics that will emerge 
in the years ahead, will create a level of spending in excess 
of our capability to finance it. It is not an issue of raising 
taxes 
because there comes a point, as everybody agrees, when you 
raise taxes, you will lose revenue eventually, so it is not an 
open-ended situation.
    As a consequence of that I do think that it is crucially 
important for us to look at the whole fiscal situation in the 
context of whether our laws are internally consistent, whether, 
in fact, the structure of obligations we have presented for the 
future are indeed capable of being financed in real terms, 
because remember, we are talking real resources. Money is 
merely an intermediary here. From the types of numbers that I 
have been looking at, when we get into the period beyond 2010, 
2011, and 2012, we are running into potentially serious 
troubles in which the claims on the aggregate GDP, in order to 
finance what is required by law for retirees, would require a 
significant reduction in the real earnings of the working 
people over and above what otherwise would be the case. In 
other words, a disproportionate amount of the GDP would have to 
be diverted, and it is not clear under those conditions whether 
we create a very major problem between generations in that 
regard. I think it is readily forecastable now because we may, 
as Senator Sarbanes says, have some trouble with our GDP 
forecasting. We do not have trouble in forecasting the age 
structure of the American population and what the demographics 
are going to impose on us as we move toward the movement of 
this very large baby boom generation from productive work into 
retirement.
    Senator Hagel. Thank you.
    Chairman Shelby. Senator Corzine.

               COMMENTS OF SENATOR JON S. CORZINE

    Senator Corzine. Thank you, Mr. Chairman.
    I welcome Chairman Greenspan. Let me just follow on there 
just for a brief second. I think your arguments today with 
regard to structural deficits which we apparently have now in 
place due to the set of policies and the need to prepare for 
the demographic reality that you suggest, tells us that our 
imprudence at the current moment is only going to aggravate the 
problems that one could anticipate coming down the pike with 
how we deal with these obligations. We certainly put ourselves 
on a course where we may be in a position where we have no 
choices to deal with that, and we are taking those choices off 
the table as we go, and it is very troubling to me.
    We have a statement you made to this Committee in February. 
We have to be very careful in talking about structural deficits 
because there is no self-equilibrating mechanism when 
structural deficits are occurring because the rise in 
indebtedness increases the amount of interest payments which, 
in turn, increases the debt still further, and there is an 
acceleration, a pattern, till you reach a certain point of no 
return. You put that against the demographic situation, and we 
are taking off the table our ability, many of the 
options to deal with just the issue we are talking about 
suggests.
    I had a couple of micro issues. Since we are now seemingly 
going to be financing the U.S. Treasury for very significant 
amounts of dollars for a very long period in time, regardless 
of how you calculate it, including what the Budget Office let 
us know yesterday, is it not time that the Treasury reconsider 
the issuing of 30-year notes? At the time they ended the 30-
year bond, they argued that we were headed into surplus. I 
think that was 2 years ago or 2\1/2\ years ago. And a long bond 
was no longer necessary to meet Government financing needs. 
They also added at the time that the return to deficit might 
necessitate a reintroduction.
    I would also ask that, given the debate that we are now 
having about discount rates for pension policies, which are so 
important for the private sector and others, there is also a 
need for clarity with regard to what the yield curve looks 
like, using indices that may be an accurate reflection of 
longer dated markets for discount rates. It just seems there 
are a number of reasons to spread out over a longer period of 
time. I remember these arguments being made by the most 
eloquent economists in the late 1970's and early 1980's of why 
we needed a full-year curve. Is it not time to reconsider that 
point of view? I would love to hear how you feel about it 
yourself.
    And then finally, another micro issue. We see the SEC 
talking about easing voting for outside directors and other 
issues. Do you have any comments on how that might impact 
capital formation? Is that a positive? Is that a negative? And 
how would you respond?
    Chairman Greenspan. On the 30-year bond I am going to be 
interested in hearing the various debates and arguments on both 
sides of the issue, which I think will eventually materialize 
for exactly the reasons that you raise, Senator. There are pros 
and cons to the issue, as you are aware, and I do not want to 
anticipate how Treasury will come out, but I would presume we 
will be involved, as we have been over the years, in 
discussions on this issue as it affects our monetary structure. 
While to be sure the ultimate decision has to be with the 
Secretary of the Treasury, we do have input and we will 
endeavor to review the pros and cons and try to come to a 
conclusion ourselves on that issue.
    Senator Corzine. Did you have a view about whether it was 
constructive or not in the period of time? We had almost 20 
years of experience.
    Chairman Greenspan. Yes. I thought that if you took the 
projections of the surpluses seriously, and remember, we all 
were skeptical, but those were nonetheless the best judgments 
that people could make at that time, then the issue of taking 
the 30-year off the table clearly was a very reasonable one. 
Times have changed, Senator. Presumably these issues will be 
revisited as part of a broader set of questions of how Treasury 
needs to fund itself, or more exactly, how Treasury needs to 
fund the debt requirements of the Government.
    Senator Corzine. Shareholder issues?
    Chairman Greenspan. Actually, I am aware that the SEC was 
discussing that yesterday and I have not caught up to what they 
have been mentioning on the issue. I am aware that it is in the 
papers this morning, but I have not as yet had a chance to see, 
and hence to comment on anything that they have said on that 
regard.
    Senator Corzine. Thank you.
    Chairman Shelby. Senator Chafee.
    Senator Chafee. Thank you, Mr. Chairman.
    Again, welcome, Chairman Greenspan. In your written 
testimony you say there is an especially pernicious, albeit 
remote scenario, in which inflation turns negative against a 
backdrop of weak aggregate demand, engendering a corrosive 
deflationary spiral. Can you describe what might be a worst 
case scenario of this corrosive deflationary spiral?
    Chairman Greenspan. Sounds by itself as a worst case 
scenario.
    [Laughter.]
    It is an issue which economists never even thought about 
largely because, as I indicated in my prepared remarks, it was 
considered a curiosity, because with fiat money it just seemed 
noncredible that you could get too little inflation and that 
the capacity of central banks essentially to print money at 
will could not overcome any such tendency. That changed with 
the evident difficulties that Japan has been having. Even 
though there are good arguments, as I point out in my prepared 
remarks, to presume that the Japanese case of modest deflation 
is idiosyncratic, especially related to their institutions and 
specific difficulties that they have. But it still raises 
questions as to whether we are prepared as a central bank in 
the event that that happens.
    It was not an issue that concerned us when the inflation 
rate was 5 percent, 3 percent, or even 2 percent, but in the 
last 6 to 9 months the rate of inflation has fallen quite 
dramatically in this country. It has triggered a fairly 
extensive evaluation on our part as to what we would do if we 
perceived that that issue was becoming an important one. And as 
I indicated, we have spent a good deal of time on examining 
types of alternative monetary policies which we believe could 
successfully address that problem and fend it off. It is quite 
remote, in our view, because we do not see the elements of that 
occurring, but if it occurs, it is a very major event. Even 
though its probability is very small, the size of the problem, 
should it occur, is sufficiently large to have engaged our 
attention, and it will continue to engage our attention until 
it is very clear that it can be fully taken off the table.
    Senator Chafee. And as you war game for this scenario, do 
you worry about, as you said, stoking inflationary pressures on 
the other end?
    Chairman Greenspan. We certainly do, and obviously a 
central bank needs to be acutely aware of that, but as I 
indicated in my prepared remarks, the impact of a number of 
forces from the collapse of the bubble in stock prices and its 
downward pressure on asset values for a while, and the issue of 
globalization, are all working at this stage to contain 
inflationary impulses. But it is obvious that our goal is price 
stability, and it is price stability on both sides. We are 
engaged in trying to fend off both deflation and inflation, and 
hopefully we can maintain the degree of price stability that we 
have finally achieved and hopefully do so for a very 
considerable period of time.
    Senator Chafee. I do not think you mentioned in your 
testimony exactly what you would do if we went down that 
pernicious path of disinflation?
    Chairman Greenspan. Senator, we have discussed what we call 
nontraditional means, meaning the focus of central bank policy 
in this country has, for a very long period of time, been 
restricted to endeavoring to change the overnight rate of 
interest without any advertence to how we might impact longer-
term interest rates.
    The reason that issue comes up is that with the Federal 
funds rate at 1 percent, there is obviously a downside limit to 
how far we could engage in further monetary expansion which is 
the obvious remedy that a central bank would create to confront 
this type of difficult deflationary process. Obviously, with 
only 100 basis points left, we have to first conceive what we 
would do in the event, which I have indicated we consider is 
remote, of needing to go well beyond that, and we have engaged 
in a number of different issues, all of which are involved in 
expanding the balance sheet of the central bank, which 
essentially means that we buy different types of assets and we 
do different types of things including moving out on the yield 
curve well beyond the issue of overnight funding.
    That is an issue which we have been concerned about for a 
number of months. We have accordingly, not having focused on it 
before because we, as I said, thought it was an academic 
curiosity, but I think we have pretty much caught up to speed, 
so to speak, and we trust we never have to engage in such 
policies, but I think we are in a position to know what to do 
and how to do it should that necessity arise.
    Senator Chafee. Thank you.
    Chairman Shelby. Senator Carper.

             STATEMENT OF SENATOR THOMAS R. CARPER

    Senator Carper. Thanks, Mr. Chairman.
    Welcome, Chairman Greenspan. Good to see you.
    Senator Chafee and I have offered legislation, along with 
Senators Judd Gregg of New Hampshire and also Lamar Alexander 
of Tennessee, that attempts to address the need to clean our 
air further with respect to emissions of sulfur dioxide, 
nitrogen oxide, mercury, and also CO2. We have 
sought to find a middle position, if you will, between Clear 
Skies over here, the President's proposal, the competing 
proposal over here by Senator Jeffords, and we sought to put 
something right here in the middle which puts in place caps on 
emissions including carbon, but relies on market systems, such 
as cut cap and trade. For example, if you are a utility and I 
am a farmer, and you have to reduce your emissions, you can use 
technology, you can change up your mix of fuels. You can say to 
this farmer: I would like for you to put more money in and 
expand the number of trees on your land, reforestation, change 
the planting patterns on the land, change what I do on our 
animal feedlots, that kind of thing, so different ways to 
achieve the goal.
    It has been estimated over the next I guess 17 years, by 
2020, if there is no change in the law at all, just business as 
usual, the cost of generating electricity for the producers is 
about $95 billion. The cost under the President's Clear Skies 
Initiative is about $101 billion. The cost under our proposal 
is about $102 billion. So, we are trying to decide whether or 
not at a time when we want utilities to be able to create the 
electricity, we want them to reduce their sulfur dioxide, 
nitrogen oxide, and mercury, if this is also a time to come in 
and say, all right, somewhere along the line you are going to 
have to face reducing carbon dioxide, and rather than wondering 
when that is going to happen, let us just provide some 
certainty and to try to do it now. There are some, as I 
suggested, marginal costs that are involved in that, about a 
billion dollars it looks like by 2020.
    I wanted to talk with you a little bit this morning. You 
and I have talked about energy costs before, but I want to talk 
a little bit this morning about the cost of trying to regulate 
carbon dioxide, and the effect that that might have on our 
economy, and just your counsel on how we might go about it. I 
have a concern. I am a native of West Virginia and I have a lot 
of concerns about coal still in my native State. I am not 
interested in seeing a lot of change in the fuel mix. I want us 
to use coal, but use clean coal. Interestingly enough, under 
the President's proposal and in the proposal that we have made, 
by 2020 it is estimated about 45 percent of electricity 
generation will still come out of coal, in either proposal. And 
what has been suggested to us by some analysis done by people 
more objective than we are, is we can have some good outcomes 
with respect to better health outcomes, less premature deaths 
with our approach. Health care savings of about $50 billion 
under our approach. And to do so without putting huge burdens 
on utilities and on the consumer.
    That is kind of laying it out there. I do not know if there 
is a question in there or not, but I hope there might be.
    [Laughter.]
    The thought is, in regulating CO2 how might we 
go about it? Does any of that make any sense? I will not be 
offended by what you might say. Senator Chafee might be.
    [Laughter.]
    Chairman Greenspan. Senator, I think the type of analysis 
that you are discussing is probably the most complex type of 
statistical analysis which you can bring to bear on Government 
policy. First of all, we have a number of different problems 
all emerging simultaneously. We have an issue of the new 
technologies enabling the wielding of power over very 
significant areas, and hence the whole question of the nature 
of regulation of the electric power industry by itself is a 
very difficult issue, which is all the more difficult because, 
as you know, there is no way, with the exception of a minor 
situation with hydroelectric facilities, of effectively storing 
electric power. And if you do not have inventories in a 
product, the tendency for markets to spike in all different 
directions with respect to price is very high, as we observed 
in California a couple of years ago. I do not think yet we have 
come to grips with the question of exactly how to manage our 
power industries in a manner in which the efficiencies which 
are evident in the newer technologies are brought forth. 
Coupled with that is the overall issue of the fuel inputs in 
the CO2 emissions, and then of course, there is the 
Kyoto Protocol out there which is also overhanging this whole 
question.
    The trouble I see is that, because these issues are 
extremely complex, we develop very complex models and the 
conclusions of a number of these studies may be model specific 
as distinct from what economists would say robust, meaning the 
same results would come up no matter what models you tend to 
use.
    So, I am not someone who has been involved in this specific 
problem but I have spent a good deal of my life involved in 
this type of process. I would essentially suggest, if I may, 
that the resolutions of all the related issues be done 
simultaneously because you cannot, as far as I can see, make 
the judgments with respect to natural gas or coal, or various 
different emissions requirements, without having an 
understanding simultaneously of what the underlying technology 
force is, specifically the new technologies which enable a very 
large regional bridge to be created. You have to address them 
at the same time, and I think that is going to be very 
difficult, and all I suggest to you is that when you get a 
number from a specific model which has three digits in it, you 
may suggest that only two of them may be accurate, and indeed 
it is quite possible that only one is. So it is a very 
difficult issue, and I understand where you are coming from and 
I wish you well.
    Senator Carper. I will take those good wishes and run with 
them. Thank you.
    Chairman Shelby. Senator Crapo.

                 COMMENTS OF SENATOR MIKE CRAPO

    Senator Crapo. Thank you very much, Mr. Chairman.
    Chairman Greenspan, thank you for coming here and 
presenting your information about our monetary policy in the 
country.
    I want to go back to an issue you and I have discussed 
several times over the last 2 years, and that is derivatives. 
As you well know, we have for the last 2 years faced, on two or 
three occasions, efforts to change the manner in which we 
regulate derivatives. Under the Commodities Futures 
Modernization Act of 2000, the President's Working Group and 
others recommended a structure by which we approach the 
management of commodities in a number of contexts, and 
derivatives were handled in a particular way under that 
approach.
    By the way, let me interject. I want to thank you, the 
Secretary of the Treasury, the Chairman of the Securities and 
Exchange Commission, and the Chairman of the Commodities 
Futures Trading Commission for being so prompt in responding to 
our letter inquiring about this yet once again this year when 
the amendment came forward on the energy bill once again to try 
to make this change in the way that we regulate derivatives.
    The purpose of my bringing it up with you again is that 
there are again rumors that we will see another effort to try 
to in some way similar to the previous amendments change the 
Commodities Futures Modernization Act so that we create a new 
regulatory regime for derivatives, and in my opinion, create 
some confusion with regard to the regulator in terms of the 
introduction of regulation from FERC as well.
    The question I have is, has anything changed? Is there a 
reason that we should change our approach to the regulation of 
derivatives or does the Commodities Futures Modernization Act 
still represent a very solid approach to managing this issue?
    Chairman Greenspan. I am of the opinion that it was an 
excellent Act when it was passed in 2000 as I recall.
    Senator Crapo. In 2000, that is right.
    Chairman Greenspan. And as far as I can judge, I see 
nothing which would alter my view and my appraisal of it.
    Senator Crapo. I know you have done this before, but could 
you give us your understanding of why derivatives are helpful 
in our markets?
    Chairman Greenspan. We have a very complex financial system 
in which we endeavor to regulate in a manner to enable the 
system to be stable and function in a way which contributes to 
economic growth, not only in our country but also for the world 
at large. What we have found over the years in the marketplace 
is that derivatives have been an extraordinarily useful vehicle 
to transfer risk from those who should not be taking it to 
those who are willing to take it and are capable of doing so.
    Prior to the advent of derivatives on a large scale we did 
not have that capability, and we often had, for example, 
financial institutions like banks taking on undue risk and 
running into real serious problems. From 1998 to 2001, we had a 
trillion dollar increase in debt in telecommunications 
worldwide. A significant part of that debt went into 
bankruptcy, and yet no financial institution of any 
significance was caught in that, and the reason was that, in 
this case, credit derivatives were employed to transfer the 
risk from these highly leveraged financial institutions to 
other institutions and pension funds, insurance companies, 
pension funds largely, which had much more equity and could 
absorb the costs of default which they did, but they did not 
like it. But they are still around and they are still viable.
    The vast increase in the size of the over-the-counter 
derivatives markets is the result of the market finding them a 
very useful vehicle. And the question is, should these be 
regulated, well, indeed for the United States they are 
obviously regulated to the extent that banks, being the crucial 
creators of these derivatives, are regulated by the banking 
agencies, but not beyond that.
    The reason why we think it would be a mistake to go beyond 
that degree of regulation is that these derivative transactions 
are transactions amongst professionals, and the institutions 
which are involved have very considerable what we call 
counterparty surveillance, where, for example, one major bank 
will know far more about its customer, whether it is a bank or 
something else, than we could conceivably know as regulators. 
In a sense this counter-
party surveillance has become the crucial element which has 
created stability in that particular system.
    My concern and others' concerns about going in the 
direction of an increasing degree of Government regulation is 
that we will undercut counterparty surveillance and that the 
net effect will not be to enhance the stability of that overall 
structure, but undermine it, and it has become such a valuable 
tool, in my judgment, in the international financial system 
that anything that we can do to enhance its capability of 
internal stabilization, which is currently the case, we ought 
to do, and I do not believe that many of the measures that have 
been offered to introduce increased regulation are indeed 
positive in the sense that they would have a positive outcome. 
My fear is that their effect would be counterproductive and 
that is the reason I wrote the letter, the response to you on 
that occasion, and why the President's Working Group came out 
the way that it did on that issue.
    Senator Crapo. Well, thank you very much for that extended 
explanation. Each time we face this issue we pick up a little 
support and our strength grows, and I think it is because we 
are better able to explain to the Members of the Senate the 
issues as you have just done. So thank you very much.
    Chairman Shelby. Thank you, Senator Crapo.
    Senator Dodd.

            STATEMENT OF SENATOR CHRISTOPHER J. DODD

    Senator Dodd. Thank you very much, Mr. Chairman.
    Mr. Chairman, thank you once again for being here. I 
apologize, I was not here for your opening comments. We had a 
briefing by Secretary Powell, so a lot of us, about half the 
Members of the Senate were up there for about an hour or so.
    Let me preface, I gather others have raised a number of 
questions about the deficits and your thoughts about them. I 
thank you again.
    Your comments earlier this year about the tax cuts and 
their being revenue neutral I think were tremendously helpful 
to many of us. Unfortunately, they were not heeded by many, 
nonetheless I think your cautionary note about the importance 
of the revenue neutrality of those proposals was worthwhile to 
be heard. Clearly, and obviously, I join with those who are 
deeply worried about the overall condition of the economy. I 
know you struck a more optimistic note, and I appreciate that, 
but as I look at these numbers, with more than 3 million 
private sector jobs having been lost over the last couple of 
years and business investment is down by 12 percent. Consumer 
confidence is down by 28 percent. This is the only 
Administration in 70 years that has seen a decline in private 
sector jobs. I find that deeply, deeply troubling. When you add 
the fact that the Administration's solution to the Nation's 
economic woes has been more tax cuts, and if you add them up 
over the next few years, you get in excess of $3 trillion, not 
to mention of course the cost of the war in Iraq and elsewhere.
    In fact, the Administration's own estimate is that more 
than half of the changes in the Federal deficit, changes which 
total over $4 trillion, according to them between the years 
2004 and 2008, are a result of the President's domestic 
policies, which include three tax cuts and international 
policies including the war with Iraq. So there is a real 
concern here.
    I would like to focus on the trade deficit and the loss in 
manufacturing jobs. I spent some time over the last several 
weeks, as all my colleagues have, in my State, I attended 
meetings in my business community and labor community 
separately. If I had been taken into both of them blindfolded 
and not told which group was which, I could not have 
distinguished them in terms of their concerns about job loss 
and what is happening to the manufacturing sector in our 
society and the growing trade deficits.
    I was stunned, like many were, to read where Japan bought 
up more than $42 billion in May, a record number. If you take 
Japan, Taiwan, Korea, and China, there is a trillion dollars 
that countries have accumulated in reserves. Now many would 
argue that this amounts to manipulation, that this was not just 
coincidental. I agree with you that these values ought to be 
determined by the international marketplace, but nonetheless 
there are provisions in the International Monetary Fund and 
other organizations that require that when you have 
manipulation of currencies, particularly when it affects jobs 
to the extent that it appears to be doing in our own country, 
than others have to step up.
    I was disappointed. I know, Mr. Chairman, you have asked 
the Secretary of the Treasury to be here before the Committee. 
He was due to be here tomorrow, I think, or the next day, and 
he turned us down. Of course under the Trade Act of 1988, the 
Secretary of the Treasury is required to report to this 
Committee and to submit a report twice a year. So, I am hopeful 
that before this year is out he will be here to respond to 
these questions about the trade deficit that now is going to, 
based on a quarterly report, exceed $540 billion this year.
    I know it is not the Fed's job to get into this 
specifically, but this is such a growing concern to me about 
what is happening here, when you look at the job loss, the 
businesses that are going out of business. I see it in my own 
State to an alarming degree. Someone has to respond to this. We 
need some ideas on how to respond to this. If, in fact, we are 
seeing currency manipulation going on by some of our partners, 
particularly in the Pacific Rim, then I think it is critically 
important that we answer this in some way, and I would be very 
curious what your thoughts might be as to how we might respond 
to this. First of all, is it a matter of concern to you? And if 
so, what can the Fed do or what can we do to begin to try and 
stem this tide?
    Chairman Greenspan. Well, I think, Senator, it is important 
to understand the causes of the problem before we try to 
address them. On the import side, as I think I have indicated 
to this Committee on many occasions, we observe in our 
international accounts a fairly significant difference between 
the propensity to import goods and services relative to our 
incomes in the United States compared with our trading 
partners, which is another way of saying, if everybody's GDP 
were increasing at the same pace, we would have a trade deficit 
which is ever increasing, and indeed there would be a 
counterpart increase of surpluses elsewhere. So, we do have 
this imbalance in the system which at some point is going to 
adjust, and there is some evidence that it is in the process of 
adjusting, but clearly, the proportion of the consumption of 
goods in this country that is imported has been rising for 
quite a long 
period of time.
    In addition, the productivity in manufacturing has been 
exceptionally impressive, more so than for the economy as a 
whole, and obviously if you have a very rapid rate of increase 
in productivity, any particular increase in industrial output 
will have a lower requirement for workers than one when 
productivity were growing less. So it is the combination of 
these two factors which has been decreasing the level of 
employment in the manufacturing area, coupled with the fact 
that there has been a gradual reduction in manufacturing 
relative to the economy as a whole over and above these other 
factors.
    The question you raise with respect to currency 
manipulation is a tricky issue because it would be desirable 
and has evidently been desirable for emerging countries to have 
reasonably high reserves because what has happened is that in 
crisis conditions when their reserves are high there has been 
less in the way of underlying world instability, say, as we had 
in 1998. Now, having said that, there is no question that the 
motives of some of the accumulation of reserves has been to 
stabilize exchange rate against the dollar on the part of a 
number of countries, and that process obviously means that you 
will accumulate dollar denominated assets as indeed a large 
number of them have, and the figures you cite are related to 
this particular question.
    This is not, however, an activity which a central bank can 
engage in indefinitely because as you buy dollars, as indeed 
you used to buy gold under the gold standard, the asset side of 
the balance sheet of the central bank expands unless, as we 
say, it has been sterilized, and it is increasingly more 
difficult to sell off other non-U.S. dollar assets to 
effectively neutralize the effect of accumulating these 
dollars.
    The consequence of the big rise in the asset side of the 
central bank is to create a major increase in money supply 
growth, and that cannot continue indefinitely. So this is not a 
process which central banks can engage in indefinitely. 
Something has to give. But there is no question that the motive 
here in many respects at least as I judge it, is to suppress 
the value of their currency. They cannot do it indefinitely, 
and I think a number of my colleagues, the Secretary of the 
Treasury, for example, have indicated that they would like to 
see less of that going on.
    Senator Dodd. I appreciate that, and I would hope that, Mr. 
Chairman, he would be here. I do not know what his motivations 
were for not coming tomorrow, but obviously there is a growing 
concern.
    Chairman Shelby. I understand he is going to be with the 
President tomorrow, but Secretary Snow has indicated on many 
occasions, that he will appear before the Banking Committee.
    Senator Dodd. I hope so. Again, I appreciate the Chairman 
of the Fed's response, and obviously, I am fully aware that the 
Central Bank's responsibility in this regard is very different, 
but as I hear from my own constituencies and others--and a lot 
of it is unemployment, but going out of business too. I mean 
their produc-
tivities are rising but they are finding it more and more 
difficult to compete in the marketplace. I have been supportive 
in the past on free trade agreements and so forth for all the 
obvious reasons, but that free trade is always conditioned on 
fair trade as well, and when you have what you and I suspect is 
currency manipulation going on simultaneously, then it makes it 
very, very difficult for us. As I sat in a room the other day, 
one fellow got up and he said: ``I am the CEO of a company. I 
am the only one in this room that still makes anything.'' There 
is a growing concern in the United States about the fact that 
we are making fewer and fewer things.
    Chairman Greenspan. Just remember that the nature of the 
economy is becoming increasingly conceptual as distinct from 
physical, in the sense that ideas are becoming increasingly the 
predominant means by which we create wealth. The consequence of 
that is that there is less physical stuff around. I think that 
is good, not bad for the economy as a whole, but if you are a 
maker of stuff, it is not.
    Senator Dodd. If your job depends upon being a maker of 
stuff, it is more than just a conceptual kind of problem you 
have. It is a real problem.
    As I saw the other day in Wal-Mart, they had a sale on and 
they sold $1 billion in one day of television sets made in 
China. One day, $1 billion. Not a single one of them made in 
the United States. Now there is something fundamentally wrong 
if we cannot do a better job of at least creating an atmosphere 
where there is an opportunity for U.S. manufacturers to have 
the same kind of opportunity. I worry about that, and I know 
you do as well.
    Thank you, Mr. Chairman.
    Chairman Shelby. Senator Schumer.

             COMMENTS OF SENATOR CHARLES E. SCHUMER

    Senator Schumer. Thank you, Mr. Chairman. I want to thank 
you again for the job you do.
    I have a few questions. One is a little bit related to 
Chris Dodd's but somewhat different. One of the reasons we lose 
manufacturing jobs is trade with China, and there are the 
classic free trade arguments about why businesses would go to 
China. But there is something else that has been happening, and 
I would like your comment on that, and that is that the Chinese 
have tightly pegged their currency--it is a fixed rate. The 
yuan has been, since 1994, at 8.3 yuan per dollar.
    Now if you let that currency float, almost every economist 
says it would be valued higher. Goldman Sachs says 15 percent; 
some say 25 to 40 percent. And the natural reason that we all 
went to floating currencies among the major currencies is, it 
is a self-correcting mechanism that you and Chris Dodd were 
talking about.
    Why wouldn't it be a good idea for our President to jawbone 
the Chinese, or our Treasury Secretary, to let their currency 
float? You know, the Chinese seem in a lot of ways to want to 
be part of the family of nations when it benefits them, you 
know, the bigger, more productive nations, but not when it 
doesn't. Why wouldn't it help everybody to let the yuan float? 
And why wouldn't it be a good idea for our Government to urge 
the Chinese to make it happen?
    Chairman Greenspan. Well, the Secretary of the Treasury has 
indicated that.
    Senator Schumer. I have not heard any public pronouncements 
about that.
    Chairman Greenspan. No, indeed, there has been a public 
statement.
    Senator Schumer. Why do the Chinese resist? Well, we know 
why but----
    Chairman Greenspan. Let me just say this----
    Senator Schumer. If you could comment in general on that.
    Chairman Greenspan. Yes. There is an issue here, but 
remember that it is very much to the advantage of the United 
States to have China involved in world trade interrelated to 
all the various institutions with which we are involved. They 
had and indeed still have the centrally planned economy, which 
has considerable rigid-
ities in it, and they have been endeavoring, and with some 
success, to open it up, creating property rights, creating 
markets, which seems to be contradictory to their political 
system. But, so far, it is working and they are increasingly 
engaging on trade throughout the world. I happen to think that 
is very good. Most economists would say that is good.
    In the process of doing that, because of the structure of 
the rigidities of their system, they tended for purposes of 
stability to fix the yuan to the dollar. And to date----
    Senator Schumer. They have not changed it----
    Chairman Greenspan. No, they have not, exactly. And that 
obviously from their point of view has created a degree of 
stability, but it has required them, in order to hold that 
rate, to be very heavy purchasers of U.S. dollar-denominated 
assets. And they have accumulated a very large store of assets, 
as has been indicated in various different fora.
    At some point they will no longer be able to do that 
because it will create an inability of their monetary system to 
function well. How one approaches the issue of getting the 
exchange rates better balanced is partially an economic issue, 
partially a political issue.
    Senator Schumer. You are good at both.
    Chairman Greenspan. My tools are limited.
    Senator Schumer. But would it be, all things being equal, 
better to have either a revaluation of the yuan or at least to 
let it float? Aren't they a big enough economy now? It is not 
1994. Do you think they should be letting it float?
    Chairman Greenspan. I think that from an economic point of 
view it is going to become increasingly evident that that is 
what is going to have to happen if the existing cost structures 
around the world remain as they are. And I think the Chinese 
economists are sufficiently sophisticated to understand that.
    Senator Schumer. When you hear--and we are all hearing what 
Senator Dodd talked about--that manufacturing is just shrinking 
and shrinking, and you are right, you said once before, 
something I have repeated often, high value is added more by 
thinking things than by making things these days. That is 
correct. But you still have a large manufacturing base. I do 
not know if the same is happening in agriculture as in 
manufacturing; in other words, there is more production with 
fewer workers, or is it less production?
    Chairman Greenspan. Oh, no, in fact, if anything, it may be 
more impressive.
    Senator Schumer. More than agriculture.
    Chairman Greenspan. Remember, crop yields are incredible.
    Senator Schumer. Okay, so I understand that. Let me ask you 
one other question, if I might, Mr. Chairman. We are in this 
period now where the economy moves along at not a terribly 
rapid pace, but a decent pace, 1 percent, 2 percent, maybe 3 
percent growth. Because productivity outstrips that growth, the 
number of jobs declines, and I am sure my colleagues have 
talked about that. This is the first Administration since 
Herbert Hoover's where the absolute number of jobs has 
declined, even though growth has occurred.
    How long can this continue? Now, I understand that incomes 
are going up. But if incomes continue to go up and jobs 
continue to 
decline, it means that wealth, almost by definition, is being 
more concentrated.
    Is this bad for the economy? Can we just continue to go 
along at this pace? And doesn't the job loss--if it does 
matter--help drag the economy and instead of creating an upward 
cycle, which we had in the 1990's where productivity and job 
growth went hand-in-hand, really provide a drag on the economy 
where productivity goes up and jobs go down?
    Chairman Greenspan. It has certainly been our experience, 
Senator, that you cannot have the situation with productivity 
growth growing faster than the economy as a whole; in other 
words, essentially rising output, falling employment. The 
reason basically is that one must presume that the consequence 
of that is an opening up of profit margins as one 
characteristic and historically increased capital investment.
    Over time, that situation is unstable and eventually 
adjusts to a higher level of economic growth and, hence, 
increasing employment, or productivity growth slowing down. 
Obviously, if you continue GDP growing and employment 
declining, at the end of the day everything is being produced 
by nobody.
    Senator Schumer. Right. Or another country. See, that is 
what may change this, the interrelatedness of the world 
economy.
    Chairman Greenspan. But then the question is: Where do we 
get the purchasing power, meaning the goods and services we 
produce, to be able to buy it from others? So it is an 
internally long-term inconsistent framework, and our 
expectation is that what will occur as a consequence is that 
the GDP growth will move above the productivity rate and 
employment will start to turn up accordingly.
    Senator Schumer. Thank you, Mr. Chairman.
    Chairman Shelby. Chairman Greenspan, could you just briefly 
highlight for the Committee the nature of your concerns 
regarding the industrial loan corporations and the extent to 
which your concerns are based on safety and soundness 
consideration?
    Second, could you provide commentary as to the deficiencies 
in the current regulation, if any, of industrial loan 
corporations that lead you to these concerns, if you have them?
    Chairman Greenspan. Mr. Chairman, my major concern is the 
fact that under Gramm-Leach-Bliley, we significantly increased 
the powers of our financial system, and in very important ways, 
in my judgment. But with the advent of these increased powers 
and the new technologies and products--for example, 
derivatives, as I mentioned before--we have a whole new array 
of types of regulatory issues which confront us.
    I believe, as I have stated previously, that in the future 
it is going to be impossible to distinguish between commerce 
and banking, and ultimately we are going to be in a position 
where we are not going to try to make that distinction.
    But, it is important, in my judgment, to move in that 
direction in a calibrated way and to understand first what the 
consequences from a regulatory point of view have been as a 
consequence of the significant changes that have occurred in 
regulation in the last decade. It is not only Gramm-Leach-
Bliley. It is a whole series of other regulatory changes.
    If we eventually get to the point where we fully understand 
and are comfortable with the issue that we have imposed a new 
set of regulations on the system, then I think we can start to 
think about the issue of moving further. However, I do not 
believe we are there at this point.
    My concern is that the vehicle of the industrial loan 
company, as it is being currently constituted and expanded 
under existing proposals, will, for all practical purposes, 
create an institution which will be very attractive for 
commercial enterprises, irrespective of their size, and will 
have a functioning commercial bank with Federal deposit 
insurance, and that will effectively create a melding of 
commerce and banking inadvertently--if I may put it that way, 
because that is not the purpose, obviously, of this----
    Chairman Shelby. But we are not there yet, are we?
    Chairman Greenspan. We are not there yet, but I would 
suggest that it is very important, before we move to 
effectively convert 
industrial loan corporations into commercial banks without 
overriding supervision, that the issue of whether we wish to 
move more broadly in this direction come before this Committee 
and your counterparts in House Financial Services, because 
there is a very major policy question here which, in my 
judgment, is not being addressed. And I think prior to moving 
forward and changing the structure, as indeed it will change 
under certain proposed legislation, it is important that the 
Congress come to a policy conclusion of a much broader 
dimension.
    Chairman Shelby. Mr. Chairman, tomorrow this Committee will 
hold a hearing focused on the oversight of Government-sponsored 
enterprises with an eye toward the accounting issues that have 
recently surfaced at Freddie Mac. Some people have criticized 
OFHEO, the regulator, noting that it lacks many of the powers 
that the bank regulatory agencies possess.
    Without getting into this morning who the GSE regulator 
should be or where the regulator should be situated, what 
additional authorities, if any, in your judgment, should the 
GSE regulator have?
    Chairman Greenspan. It is difficult to say because I think 
the broader issue, as I have indicated in public testimony 
previously, is the question of the subsidy which the financial 
markets grant to the GSE's on the presumption that they will be 
bailed out in the event of difficulty by the Federal 
Government.
    Their debentures, as they point out quite correctly, are 
not guaranteed by the full faith and credit of the United 
States, and there is no statute under which there is 
effectively a Government guarantee or subsidy issue.
    Chairman Shelby. It is all perception, isn't it?
    Chairman Greenspan. There is a strong perception, and I do 
think that, in considering the issue of where the focal point 
of supervision and regulation is, it be in the context of 
understanding how that particular subsidy impacts on the 
financial structure of those institutions and the various 
markets they are involved in.
    As I have said previously, these are very well-run 
companies, leaving aside the most recent problems with regard 
to accounting, and it is not an issue of them having, for 
example, techniques in derivative employment that are not the 
very finest in risk management. They do very well in that 
regard.
    The problem has to do with a much broader question, and I 
think what you need is a regulatory supervisor which has the 
capability of viewing the GSE's in total, not only Fannie and 
Freddie, but also I will include the Federal Home Loan Banks in 
this as well. You need to construct a regulator which has the 
reach to fully grasp the very major questions which were 
involved in these now very important institutions in our 
financial system.
    Chairman Shelby. They would need the reach and the depth, 
wouldn't they, to get into real regulation?
    Chairman Greenspan. It is going to be an interesting 
transition, I believe.
    Chairman Shelby. Senator Sarbanes.
    Senator Sarbanes. Thank you, Mr. Chairman. I will be very 
quick. I have just a few points on this second round.
    First of all, Chairman Greenspan, I have to say I think we 
are being much too sanguine about this trade deficit and 
foreign indebtedness. As recently as 1982, just over 20 years 
ago, we had a net asset position worth 7 percent of our GDP. 
Our liabilities to foreigners now exceed our assets abroad by 
$2.6 trillion, equal to 25 percent of the GDP. We ran a current 
account deficit in the first quarter of $544 billion, a record 
5.1 percent of GDP. That deficit that is financed by more 
foreign borrowing will raise our indebtedness another 3 to 4 
percent, depending on the growth of GDP. Japan bought more than 
$40 billion in dollar assets in the month of May alone. And the 
governments of China, Korea, and Taiwan have been actively 
intervening to keep their currencies low relative to a market-
determined price for their currencies.
    We are becoming increasingly dependent on the kindness of 
strangers and, in particular, on foreign government lenders. In 
fact, the Fed pointed out in its report, ``The U.S. current 
account deficit continued to be financed in large part by 
private flows into U.S. bonds and by foreign official inflows. 
Private foreign purchases of U.S. securities, which slowed in 
the latter part of 2002, stepped down a bit more in the first 
quarter of 2003. In contrast, inflows into the United States 
from official sources, which surged in 2002, picked up further 
in the first half of 2003.''
    I mean, we are obviously, it seems to me, being taken 
advantage of in the international marketplace because others 
are not playing by the rules of international trade, and it is 
working very much to their advantage, and we continue to get 
deeper and deeper into the hole. And it seems to me we need to 
move this up on the priority list of our concerns, and 
certainly that is one of the matters we will focus on when 
Secretary Snow comes.
    I do not really have a question. I just want to put that to 
you and hope you will take it under advisement in terms of the 
need to really start thinking seriously about this issue. 
Otherwise, one of these days things may just snap, and we will 
find ourselves in a difficult situation.
    Let me ask you, just as kind of an aside: Do you think that 
the responsibilities of the presidents of the Federal Reserve 
branch banks are equal to or perhaps greater than the 
responsibilities of the presidents of Federal Home Loan Banks?
    Chairman Greenspan. I would certainly think so. At least it 
is my judgment. I am sure that they have a different view. I 
mean the Federal Home Loan Bank presidents.
    Senator Sarbanes. I am not putting a question--I mean, that 
is the question I want to ask. Mr. Chairman, Chairman Shelby, I 
just want to note for the record this is not the hearing to 
explore that, but these salaries and compensation of the 
presidents of the Federal Home Loan Banks are going through the 
roof. In most instances, they have doubled or tripled over the 
last 3 years. They far exceed, again, by a factor of 2 to 3 
times, what Federal Reserve branch bank presidents are making. 
They are now up counting their other benefits in excess of $1 
million in some of these Federal Home Loan Banks. It is a 
bonanza.
    Now, you know, we need to address that when we have the 
Federal Home Loan Bank people here.
    Chairman Shelby. Proper hearing, absolutely.
    Senator Sarbanes. But I have been looking at some of these 
figures, and they just leap off the page at you in terms of 
what is taking place.
    Now, Chairman Greenspan, you said in your statement, ``The 
Federal Reserve has been studying how to provide policy 
stimulus should our primary tool of adjusting the target 
Federal funds rate no longer be available. Indeed, the FOMC 
devoted considerable attention to this subject at its June 
meeting.''
    I think the Fed has done a good job in increasing 
transparency in recent years, and I think that is a very 
important contribution to enabling people to know where the Fed 
is going with respect to its policy.
    If you have to shift off the Federal funds rate, what will 
you go to in terms of assuring transparency out there for the 
public? How will you signal policy for longer-term rates? Would 
you choose a specific maturity, or set some sort of time frame? 
You know, your policy has been widely acclaimed on 
transparency, but if you shift the focus, how will you do that?
    Chairman Greenspan. There are a large number of variations, 
any one of which could be usable. Remember, the major issue 
that we are confronted with is expanding the balance sheet of 
the Federal Reserve in total.
    Now what that means is we, as I indicated previously, could 
move out on the maturity schedule and buy longer-term bonds. 
There has been a big discussion of whether you try to peg the 
rates or not peg the rates.
    Remember, we did peg the rates from 1942 to 1951. That was 
a wholly different world, of course, and markets were 
different. But we have examined a number of different issues 
and, needless to say, discarded a large number of them as 
impractical or inappropriate. But all I can say to you is that, 
for what we would have to do in the remote event that those 
conditions arose, it is not that we have inadequate choices. We 
have more than we need. And we would then have to choose 
amongst them. Because we can create what we need to create in 
any of a number of different ways----
    Senator Sarbanes. Yes, but the thrust of my question is not 
whether you have these tools, but whether you will depart from, 
I think, the welcome trend toward greater transparency in the 
Fed's decisionmaking and go to a more opaque approach so that 
people perceive----
    Chairman Greenspan. No, no. Remember, Senator, we publish 
our balance sheets every week, and it is in sufficient detail 
to be able to very quickly understand exactly what it is the 12 
operating central banks are doing.
    Chairman Shelby. Senator Bennett----
    Chairman Greenspan. I will say to you that if we do things 
which are somewhat different, we will alter our reporting in a 
manner to make clear what it is we are doing.
    Senator Sarbanes. Will your policy statement make this 
clear? Or will we have to get a whole new breed of Fed watchers 
or----
    Chairman Greenspan. No, if we go in this direction--I just 
want to emphasize this is a remote contingency. It will be 
clear what we are doing, and there will be no purpose in being 
obscure or unclear. It will not serve the purposes of monetary 
policy to do that.
    Senator Sarbanes. Thank you.
    Chairman Shelby. Senator Bennett.
    Senator Bennett. Thank you, Mr. Chairman.
    Chairman Greenspan, listening to this whole conversation 
this morning, first, I share your sense of optimism about the 
economy near term. I think we are rebounding. We are coming 
back. And as we come back, Federal revenues as a percent of GDP 
will go up, and we will see, as we always see, revisions in the 
projections as to what the deficit or the surplus will be. I 
have said before and repeat here, the only thing I know about 
the figures we are seeing for the future is that they are 
wrong. I do not know whether they are too high or too low, but 
I know that they are wrong.
    Chairman Greenspan. I think that is a sound judgment, 
Senator Bennett.
    Senator Bennett. Okay. Now, I would like to go where some 
of the conversation here has gone, which is beyond the near 
term, beyond this recovery and how long will it take and how 
good will it be, on into those dreaded years of 2012 and 
beyond. And I think we have a model--imperfect, of course, but 
a model of what might very well happen to us as we look at 
contemporary Germany.
    In Germany, if they had an unemployment rate of 6.4 percent 
right now, they would rejoice and think that was absolutely 
wonderful. If they had a deficit at our percentage of GDP, they 
would rejoice. If they had a national debt at our percent of 
GDP, they would rejoice.
    They have over the years built into their entire culture a 
welfare state mentality of the things that they will take care 
of and the things that they will fund, and now they are hitting 
the demographic wall that we are facing, much more rapidly than 
we. And because they do not have the level of immigration that 
we do, it is going to be far worse. That is, the overall 
population is shrinking; ours will continue to grow. Even in 
the face of the retiring baby boomers, we will still continue 
to have new workers coming into the country by virtue of 
immigration, and our population will grow. Their people are 
stagnant, if not, in fact, scheduled to shrink. And they are 
faced with the systematic dismantling of many of the social 
services that they have built into their culture over the 
previous decades.
    We have held hearings in the Joint Economic Committee about 
medical costs, and there is a perverse and counterintuitive 
circumstance going on in that the more technology we bring into 
health care, the more it costs. This is exactly different from 
the way things work in other parts of the economy. The more 
technology you apply, the lower the cost becomes. And as we 
have tried to pursue why we have the opposite trend in health 
care, it is because you keep people alive longer. If you were 
aimed at cost control only, you would let them die and thereby 
save the cost of their medical care in their later years. But 
we get technology coming along that solves some of the health 
care problems, keeps them alive longer, but in terms of the 
impact on Medicare, raises the overall cost. So the more 
technological innovation we have and the more breakthroughs we 
have, from an economic point of view the more expensive 
Medicare is going to get.
    Can we look at Germany and some of the other countries that 
are seeing this demographic impact more rapidly than we see it, 
that is, it is coming 10 years or 15 years before it will hit 
us, and learn anything, or do we just look at them and say: 
Gee, there is where we will be and we have no choice but to 
start to lower benefits and dismantle services later on if we 
are going to afford it?
    Chairman Greenspan. Senator, I certainly hope that we can 
learn. Indeed, I think the Germans are learning from us in the 
sense that they are aware that their labor market, which has 
become exceptionally rigid, has been a major factor in the 
sluggish growth in their country, and they are endeavoring to 
change it, and the model they are moving toward, not fully but 
at least in the direction, is the one that we have, which does 
work in a remarkably flexible way, at least certainly 
considering all others.
    I think we learn from each other and I do agree that it is 
an unusual phenomenon of watching an economy essentially 
decline as population declines, even though standards of living 
per capita can be rising, the aggregate economy can be 
declining. That will change the structure of how production is 
organized, and it has a very major impact obviously on the 
relationship of retirees to workers, especially, as you point 
out, if the medical technology increases life expectancy.
    We are all going to be learning from each other, but you 
are quite correct in saying that Germany, Italy, Japan, 
specifically, and maybe Europe in general, are clearly well 
ahead of us in that regard, and so we will be observing what 
can happen to an economy in which population is stable or 
declining, and while that is not on the horizon directly for 
the United States, remember, our fertility rates are higher 
than theirs. I notice we had a surprisingly low birth rate the 
last year, but our fertility rates generally have been up at 
least to replacement levels, and immigration has increased the 
population. So, we are not confronting the same problems they 
do, but the underlying pressures are there and it is important 
that we recognize the implications of what it means to have an 
increasing retirement-to-working age population even if your 
population in itself is not slowing.
    Senator Bennett. That is my point. Their situation is worse 
than ours, but the underlying pressures are basically the same.
    Chairman Greenspan. Indeed they are.
    Senator Bennett. Thank you.
    Chairman Shelby. Senator Corzine.
    Senator Corzine. Thank you, Mr. Chairman.
    I appreciate this wide-ranging discussion and find it 
highly informative, and I am going to say all the positive 
things and then come back to an overview.
    Chairman Greenspan. Mr. Chairman, may I have a 5-minute 
break at this moment?
    Chairman Shelby. You can. The Committee will stand in 
recess.
    [Recess.]
    Chairman Shelby. The Committee will come to order.
    Senator Corzine.
    Senator Corzine. Thank you. I knew my questions were going 
to scare him to death.
    Chairman Shelby. I do not believe that now.
    Senator Corzine. I do not either.
    [Laughter.]
    As I was beginning, Mr. Chairman, I want to preface what I 
say by saying I have great respect for you and all you have 
done, and the Federal Reserve as an institution, which I think 
is terrific. I have listened both to recaps of yesterday's 
hearing and today's hearing, and frankly, one individual. I do 
not come away as sanguine as I think the tone of the discussion 
has been.
    My colleagues have talked about the straight deficit and 
its translation into the loss of manufacturing jobs, which 
there was a response yesterday that did not seem as serious to 
me as it is in the lives of the people that I see in New 
Jersey. Federal budget deficits, a $4 trillion negative cash 
swing in 2\1/2\ years by projections, is by anybody's standards 
an incredible change in fiscal circumstances. The demographic 
problem that we know we face. Our State and local governments, 
we see $100 billion, give or take a little bit, at the State 
level in the fiscal time frame. It is much larger at the State 
level. Property taxes are going up to offset in many places all 
of the Federal tax cuts we have had. There is 8 out of 9 
quarters we have under this Administration, we have seen a 
decline in business investment by the GDP numbers, not a long-
run formulation for a long-term increase in productivity, even 
though I understand we are in a conceptual economy as opposed 
to a physical economy, accept that. But it is not a statement 
of confidence if nothing else. And the job deficit is real. We 
have used the headline, used the 21 weeks of initial claims, 
and set aside the seasonal adjustment issues. These are real 
problems. The unemployment rate for African-Americans has gone 
up 3\1/2\ percent while for white Americans it is 1.7. We are 
up at something like 11.5 percent. Minorities are suffering a 
disproportionate burden, and as I think Senator Sarbanes 
indicated in his first question, that there have been 
projection errors, not only by the Federal Reserve but also by 
private sector and a broad set of economists. We have not 
really changed the policy mix.
    I am going to read a quote from Mr. Rosenberg from a firm 
that I know well, but did not work at one that I worked with. 
``This is the third round of Bush tax cuts, the thirteenth 
round of Fed rate relief and about the sixth mortgage 
refinancing wave so far this cycle,'' Mr. Rosenberg from 
Merrill Lynch said in a report commenting on the latest rate 
cut. ``And what do we have to show for it except an economy 
struggling at a 1 or 2 percent rate.''
    Now maybe that is changing, but I do not understand what is 
different in the policy mix we have today versus what we had 
2\1/2\ years ago, a year and a half ago, and now, that gives us 
so great a confidence that this is all going to work as well as 
everybody projects it is, and I could not agree more, that the 
one thing that is for certain, projections are likely not to be 
met. We do not know whether they are going to be under or over, 
but we seem sanguine about a state of occurrence in our economy 
where there is real job loss, it is making a real difference, 
the income distribution is more than likely widening, given the 
kinds of nature of where tax cuts and job cuts and 
manufacturing are going in this country. I am troubled more 
than what the tone of the discussion is about.
    Chairman Greenspan. I think the best way to confront the 
issue is that there is a good deal more to how an economy 
evolves than what policy is. Policy is at the margins of what 
an economy is doing. I think that we have to go back to how the 
economy evolved subsequent to the big stock market break, the 
sharp decline in 
capital investment, and indeed the shocks to our economy that 
occurred subsequent to that.
    I have testified on numerous occasions that in spite of 
those, we have hung in there. The economy has not grown 
particularly, but it has not receded. This is a very unusual 
cycle, and as you well know, the recession has been very 
shallow, and as a consequence of that, you cannot have a 
kickback from a nonsignificant recession. There is no bounce in 
the structure of the economy.
    What strikes me about the degree of flexibility which is 
broad, is it has been able to absorb a very surprisingly large 
number of the types of shocks that in my historical experience 
would have created real serious problems to this economy, and 
they did not. What it did do, however, is it took all of the 
buoyancy out of the economy. That is, rather than have 
significant negative GDP numbers, what we have had is absorbing 
a whole series of negative forces and essentially stand still, 
so to speak, or grow very gradually. That is far superior in my 
judgment.
    Senator Corzine. I would say though we have had 13 rate 
cuts and something that is approaching, depending on how you 
count the numbers, $1.8 to $3 trillion in tax cuts. I mean 
these are not light stimulants to an economy.
    Chairman Greenspan. No. And I would go further. I would say 
that it has required all of this to essentially be able to come 
off a very substantial collapse of a bubble and yet have an 
economy which is at least gradually growing, which it has been. 
And one has to presume that if that is the correct analysis of 
what it is we are observing, at some point we absorb the full 
negative shocks and the underlying flexibility shows through.
    Now, I am fully aware of the fact that out there 
everybody's forecasts, including those of your old firm and all 
of its competitors, have fairly significant acceleration in the 
current quarter and in the fourth quarter, and the reason is 
they all have the standard basic models which we all employed 
to forecast the economy, and the general presumption is, if 
even a modest part of the big tax cut is spent in retail, the 
GDP will go up. That is what is causing these forecasts to be 
what they are.
    I try to indicate within the context of my prepared remarks 
that there is a distinction between what is occurring and what 
the forecasts are. Now the data that had been coming in are not 
inconsistent with this economy picking up. I do not know 
whether they can meet the particular forecasts of some of the 
forecasters, but we are seeing gradual changes, all which are 
consistent with that process happening. Are we far along in 
that process? We are not. We first had to stop eroding, because 
remember, in April and May this economy was weakened, or I 
should say more exactly in March and April. May stabilized, and 
as best we can judge, June has come back a bit. The crucial 
issue is going to be whether, in fact, capital investment comes 
back because that is the key link to this system, and right at 
the moment it is a forecast, and we will be watching it very 
closely. If it fails to materialize we will continue to be 
going up and going down, but not carrying through in a way 
which one would call a vibrant economy. I happen to be 
optimistic about how this process is going, but I must tell you 
I do recognize the difference between economic reality and a 
forecast, and all I will say to you is that we are not quite up 
to where we are getting clear indications that the forecast is 
coming up, but we are moving in that direction. Statistic by 
statistic tends to be coming in somewhat better than we expect, 
and that is usually a sign that things are changing.
    Senator Corzine. Thank you.
    Chairman Shelby. Senator Schumer.
    Senator Schumer. Thank you.
    I want to thank you for staying and answering these 
questions. It is a great discussion. I just want to go back to 
the yuan for a minute. My staff, who is usually right, although 
not infallible, says that while Secretary Snow has talked in 
general about floating rates, he has never specifically and 
publicly talked about devaluing the yuan, and it just seems to 
me that China should be stepping up to the plate here, and we 
should not wait until they can no longer buy any United States 
Treasuries and then let it unravel at that point in time.
    Chairman Greenspan. Senator, unless I am mistaken, the 
Secretary did raise the issue enough so that the Chinese 
officially said it was false. Now if they did not, my memory 
may be faulty in this regard, but I suggest that----
    Senator Schumer. Do you not think a little more of this 
would be helpful? I mean, here is something that is not against 
free trade principles. In fact, the fixed income rate probably 
is. We have a huge problem with China. That is going to be a 
problem because of discombobulations of the economy, no matter 
what the yuan is pegged at, but it is artificially low, and it 
is being kept that way by the Chinese for their own advantage.
    Chairman Greenspan. You know, a number of trading partners 
with China have raised this issue. I think the question is 
whether or not public discussion moves the ball further down 
the road than private discussion.
    Senator Schumer. Right. You have now answered my question. 
I appreciate it. Next question I have is, just related to your 
last interchange with Senator Corzine. It is a very interesting 
perspective. I think it helps us understand things, and that is 
that with all this stimulus and which is very significant. I 
cannot remember interest rates being low and taxes being cut as 
much in my lifetime as now. You needed this to shield the 
economy or at least temper, cushion the economy from the bubble 
bursting and all the effects there, not only stock market but 
also I guess over investment in certain sectors as well. It 
would seem to me that if you are right and we have overcome 
these bumps, then something we have not worried about in a long 
time, which is the dangers of inflation, might rear its head 
back. It just strikes me as, you know, your assurance yesterday 
that interest rates are going to stay low for a long period of 
time, do not quite fit into the puzzle of dramatic stimulus of 
the economy, shocks that obviously should be receding as we 
move on in time from them, we are 2 years and 3 years away 
rather than 1 year. Could you comment on that?
    Chairman Greenspan. Certainly. It is our judgment that the 
extent of the downward pressures on the price level that are 
coming not only from the aftermath of the bubble, but also 
increasing globalization are significantly greater than the 
inflationary forces that are emerging in various different 
areas of the world economy. Remember, it is not only the United 
States who has had a significant reduction in the inflation 
rate, but also it is pretty much around the world, including a 
number of emerging countries whose problems were chronic 
inflation of a most destabilizing form. This is a world 
phenomenon, and in that sense it is larger than the United 
States as such. It has been the conclusion of the Federal 
Reserve that while we obviously over the years have been 
extraordinarily sensitive to the issue of inflation, and indeed 
our policies were fundamentally to get to price stability, we 
have recognized that the world has changed in a way which 
requires us to alter our policy mix, but I do not deny that 
some time down the road, that the situation will turn again, 
and I trust we will have a very long lead time to anticipate 
that.
    Senator Schumer. One final question, Mr. Chairman. There 
has been a recent discussion between two of my fellow New 
Yorkers, your colleague and a man I supported for the SEC, Mr. 
Donaldson, our New York Attorney General in the last while, 
about--and I have not made up my mind on this one, so I would 
like your guidance--basically on whether legislation in 
Congress or some attempt to say that State regulators, they can 
prosecute wrongdoers under their local security laws but not 
sort of set agreements, change the basic tableau, that that 
ought to stay national. And obviously, the Donaldson argument 
is this is a national function, we have national markets and to 
have 50 regulators go willy-nilly creates a nearly impossible 
situation. Spitzer's counter argument is we had that, and when 
you have one regulator, the chance of that regulator being 
asleep at the switch is greater than if you had 50, and he did 
a good job stepping into this.
    Would you comment, if not on the specific legislation that 
is approaching, if you want to do that, great, but on the 
general conflict between those two ideas?
    Chairman Greenspan. I think the argument that you have 
national markets and you should have a single regulator is the 
correct position. If you are worried about a single regulator 
having problems, that is a legitimate concern. It does not 
follow that that is solved by having 50 additional regulators, 
but it does suggest that there needs to be oversight of all 
regulatory agencies. I think that it is important that the 
Federal Reserve has Congressional oversight. The oversight of 
the SEC is this Committee. And indeed, it is important that 
they have the authority to do what they need to do, but there 
is always the danger that monopoly regulators can begin to 
become very inefficient and very disturbing.
    I, for example, have argued in the past that we should not 
have a single regulator for American banking because I am 
worried about monopoly regulation. But the answer is not an 
indefinite proliferation of alternate regulators.
    Senator Schumer. So, you would be sympathetic to the 
legislation the House just passed?
    Chairman Greenspan. I am.
    Senator Schumer. Thank you, Mr. Chairman.
    Chairman Shelby. Mr. Chairman, we appreciate your staying 
with us all morning and into the early afternoon. We appreciate 
always your appearance here and your insightful views. Thank 
you.
    Chairman Greenspan. Thank you, Mr. Chairman.
    Chairman Shelby. The hearing is adjourned.
    [Whereupon, at 12:55 p.m., the hearing was adjourned.]
    [Prepared statements, response to written questions, and 
additional material supplied for the record follow:]

             PREPARED STATEMENT OF SENATOR MICHAEL B. ENZI

    The U.S. economy is still the greatest economy in the world. 
However, there are certain issues that we need to address to ensure 
that we retain that position. If I had to pick the one single issue 
that has the greatest impact on the financial affairs of Wyoming, and 
the rest of our Nation for that matter, I would have choose the state 
of our Nation's energy development. Every sector of our economy relies 
on some form of technology that, in turn, relies on electricity and/or 
fossil fuels to function. Our economy is literally driven, therefore, 
by our ability to develop and maintain a steady, constant energy 
supply.
    Wyoming's role in this situation is much like the position held by 
the colonies during America's first years of European settlement. We 
provide the raw materials, or in other words the feedstock, that makes 
the rest of our Nation's energy economy function. If my home county, 
Campbell County, Wyoming, were its own country we would be the third 
largest coal producing Nation in the world. One-third of our 
Nation's coal is produced in this one county alone. We also produce 
more uranium annually than the rest of the Nation combined and have the 
greatest potential for natural gas development in the entire 
continental United States. In short, we have what the rest of the 
Nation needs to keep its technology fueled and running.
    Unfortunately, however, most of that energy is now stranded in 
Wyoming and is inaccessible to the parts of the country that need it. 
Our natural gas development is being slowed down by the inability to 
get the gas out of the State. Our electricity runs into bottlenecks 
where the power lines outside the State do not have enough capacity to 
carry what we can generate and our coal is being hit with the threat of 
new regulations and bureaucratic limitations that could eventually slow 
down exploration and development. All of these limitations are having 
an effect on the rest of the economy.
    I understand Chairman Greenspan has already visited the Hill on a 
number of occasions and has testified on this issue. I look forward to 
any additional insights he might offer on how we can bolster our 
economy by increasing energy stability, and I hope he could address 
what future role Wyoming can play in meeting our 
energy demands.
    In addition to the importance of natural gas prices on our Nation's 
economy, we also must ensure that we have a favorable business climate 
to encourage the creation and growth of our small businesses. For many 
industries, small businesses represent more than 97 percent of the 
number of businesses in the industries and the vast majority of them 
are critically reliant upon access to credit from our financial 
institutions.
    Recently, the Office of Advocacy of the Small Business 
Administration released an independently conducted study that showed 
that small businesses are disproportionately affected by a tight 
Federal monetary policy. Specifically, the study showed that the vital 
link between small businesses and small community banks can be worsened 
when community banks have difficulty adjusting to tighter monetary 
policies and to adverse banking developments and lending conditions. 
The study also found that community bank capital was capable of 
stimulating employment about three times compared to large bank 
capital. While the study cited the importance of SBA loan programs to 
stabilize lending to small business in tight monetary policy times, I 
believe that it is more important to keep in mind the effects on small 
business as the Federal monetary policy is being developed.
    Another critical issue for small businesses and our economy is the 
state of our initial public offering (IPO) market. Recently, news 
articles cited statistics that China has gained the crown for the IPO 
market and that Singapore has the fastest growing IPO market. In the 
first 6 months of this year, each of those countries had more IPO's 
than the U.S. markets. Last year, Congress took great pains to pass the 
Sarbanes-Oxley Act to help restore investor confidence in our financial 
markets, however, it is clear that the IPO market has failed to 
materialize. I am very concerned that our overall business climate may 
not be sufficient to encourage the 
creation and growth of our small businesses.
    In addition, recent news articles cite that many of our high-
technology jobs may be heading overseas. The combination of the loss of 
high-technology jobs and of the rise in the overseas IPO markets, is 
troublesome at best. I would like to hear Chairman Greenspan's 
perspective on how we can remedy this situation.
    Mr. Chairman, thank you again for holding this hearing. I look 
forward to hearing from Chairman Greenspan.

                  PREPARED STATEMENT OF ALAN GREENSPAN

       Chairman, Board of Governors of the Federal Reserve System
                             July 16, 2003

    Mr. Chairman and Members of the Committee, I am pleased to present 
the Federal Reserve's Semi-Annual Monetary Policy Report to the 
Congress. When in late April I last reviewed the economic outlook 
before this Committee, full-scale military operations in Iraq had 
concluded, and there were signs that some of the impediments to brisker 
growth in economic activity in the months leading up to the 
conflict were beginning to lift. Many, though by no means all, of the 
economic uncertainties stemming from the situation in Iraq had been 
resolved, and that reduction in uncertainty had left an imprint on a 
broad range of indicators.
    Stock prices had risen, risk spreads on corporate bonds had 
narrowed, oil prices had dropped sharply, and measures of consumer 
sentiment appeared to be on the mend. But, as I noted in April, hard 
data indicating that these favorable developments were quickening the 
pace of spending and production were not yet in evidence, and it was 
likely that the extent of the underlying vigor of the economy would 
become apparent only gradually.
    In the months since, some of the residual war-related uncertainties 
have abated further and financial conditions have turned decidedly more 
accommodative, supported, in part, by the Federal Reserve's commitment 
to foster sustainable growth and to guard against a substantial further 
disinflation. Yields across maturities and risk classes have posted 
marked declines, which together with improved profits boosted stock 
prices and household wealth. If the past is any guide, these domestic 
financial developments, apart from the heavy dose of fiscal stimulus 
now in train, should bolster economic activity over coming quarters.
    To be sure, industrial production does appear to have stabilized in 
recent weeks after months of declines. Consumer spending has held up 
reasonably well, and activity in housing markets continues strong. But 
incoming data on employment and aggregate output remain mixed. A 
pervasive sense of caution reflecting, in part, the aftermath of 
corporate governance scandals appears to have left businesses focused 
on strengthening their balance sheets and, to date, reluctant to ramp 
up significantly their hiring and spending. Continued global 
uncertainties and economic weakness abroad, particularly among some of 
our major trading partners, also have extended the ongoing softness in 
the demand for U.S. goods and services.
    When the Federal Open Market Committee (FOMC) met last month, with 
the economy not yet showing convincing signs of a sustained pickup in 
growth, and against the backdrop of our concerns about the implications 
of a possible substantial decline in inflation, we elected to ease 
policy another quarter-point. The FOMC stands prepared to maintain a 
highly accommodative stance of policy for as long as needed to promote 
satisfactory economic performance. In the judgment of the Committee, 
policy accommodation aimed at raising the growth of output, boosting 
the utilization of resources, and warding off unwelcome disinflation 
can be maintained for a considerable period without ultimately stoking 
inflationary pressures.
                                 * * *
    The prospects for a resumption of strong economic growth have been 
enhanced by steps taken in the private sector over the past couple of 
years to restructure and strengthen balance sheets. These changes, 
assisted by improved prices in asset markets, have left households and 
businesses better positioned than they were earlier to boost outlays as 
their wariness about the economic environment abates.
    Nowhere has this process of balance sheet adjustment been more 
evident than in the household sector. On the asset side of the balance 
sheet, the decline in longer-term interest rates and diminished 
perceptions of credit risk in recent months have provided a substantial 
lift to the market value of nearly all major categories of household 
assets. Most notably, historically low mortgage interest rates have 
helped to propel a solid advance in the value of the owner-occupied 
housing stock. And the lowered rate at which investors discount future 
business earnings has contributed to the substantial appreciation in 
broad equity price indexes this year, reversing a portion of their 
previous declines.
    In addition, reflecting growing confidence, households have been 
shifting the composition of their portfolios in favor of riskier 
assets. In recent months, equity mutual funds attracted sizable inflows 
following the redemptions recorded over much of the last year. 
Moreover, strong inflows to corporate bond funds, particularly those 
specializing in speculative-grade securities, have provided further 
evidence of a 
renewed appetite for risk-taking among retail investors.
    On the liability side of the balance sheet, despite the significant 
increase in debt encouraged by higher asset values, lower interest 
rates have facilitated a restructuring of existing debt. Households 
have taken advantage of new lows in mortgage interest rates to 
refinance debt on more favorable terms, to lengthen debt maturity, and, 
in many cases, to extract equity from their homes to pay down other 
higher-cost debt. Debt service burdens, accordingly, have declined.
    Overall, during the first half of 2003, the net worth of households 
is estimated to have risen 4\1/2\ percent--somewhat faster than the 
rise in nominal disposable personal income. Only 15 percent of that 
increase in wealth represented the accumulated personal saving of 
households. Additions to net worth have largely reflected capital gains 
both from financial investments and from home price appreciation. Net 
additions to home equity, despite very large extractions, remained 
positive in the first half.
    Significant balance-sheet restructuring in an environment of low 
interest rates has gone far beyond that experienced in the past. In 
large measure, this reflects changes in technology and mortgage markets 
that have dramatically transformed accumulated home equity from a very 
illiquid asset into one that is now an integral part of households' 
ongoing balance-sheet management and spending decisions. This enhanced 
capacity doubtless added significant support to consumer markets during 
the past 3 years as numerous shocks--a stock price fall, September 11, 
and the Iraq war--pummeled consumer sentiment.
    Households have been able to extract home equity by drawing on home 
equity loan lines, by realizing capital gains through the sale of 
existing homes, and by 
extracting cash as part of the refinancing of existing mortgages, so-
called cash-outs. Although all three of these vehicles have been 
employed extensively by homeowners in recent years, home turnover has 
accounted for most equity extraction.
    Since originations to purchase existing homes tend to be roughly 
twice as large as repayments of the remaining balances on outstanding 
mortgages of home sellers, the very high levels of existing home 
turnover have resulted in substantial equity extraction, largely 
realized capital gains. Indeed, of the estimated net increase of $1.1 
trillion in home mortgage debt during the past year and a half, 
approximately half resulted from existing home turnover.
    The huge wave of refinancings this year and last has been 
impressive. Owing chiefly to the decline in mortgage rates to their 
lowest levels in more than three decades, estimated mortgage 
refinancings net of cash-outs last year rose to a record high of more 
than $1.6 trillion. With mortgage rates declining further in recent 
months, the pace of refinancing surged even higher over the first half 
of this year. Cash-outs also increased, but at a slowed pace. Net of 
duplicate refinancings, approximately half of the dollar value of 
outstanding regular mortgages has been refinanced during the past year 
and a half. Moreover, applications to refinance existing mortgages 
jumped to record levels last month. Given that refinance applications 
lead originations by about 5 weeks and that current mortgage rates 
remain significantly below those on existing mortgages, refinance 
originations likely will remain at an elevated level well into the 
current quarter.
    We expect both equity extraction and lower debt service to continue 
to provide support for household spending in the period ahead, though 
the strength of this support is likely to diminish over time. In recent 
quarters, low mortgage rates have carried new home sales and 
construction to elevated levels. Sales of new single-family homes 
through the first 5 months of this year are well ahead of last year's 
record pace. And declines in financing rates on new auto loans to the 
lowest levels in many years have spurred purchases of new motor 
vehicles.
                                 * * *
    In addition to balance sheet improvements, the recently passed tax 
legislation will provide a considerable lift to disposable incomes of 
households in the second half of the year, even after accounting for 
some State and local offsets. At this point, most firms have likely 
implemented the lower withholding schedules that have been released by 
the Treasury, and advance rebates of child tax credits are being mailed 
beginning later this month. The Joint Committee on Taxation estimates 
that these and other tax changes should increase households' cashflow 
in the third quarter by $35 billion. Most mainstream economic models 
predict that such tax-induced increases in disposable income should 
produce a prompt and appreciable pickup in consumer spending. Moreover, 
most models would also project positive follow-on 
effects on capital spending. The evolution of spending over the next 
few months may provide an important test of the extent to which this 
traditional view of expansionary fiscal policy holds in the current 
environment.
                                 * * *
    Much like households, businesses have taken advantage of low 
interest rates to shore up their balance sheets. Most notably, firms 
have issued long-term debt and employed the proceeds to pay down 
commercial paper, bank loans, and other short-term debt. Although rates 
on commercial paper and bank loans are well below yields on new long-
term bonds, firms have evidently judged that now is an opportune time 
to lock in long-term funding and avoid the liquidity risks that can be 
associated with heavy reliance on short-term funding. At the same time, 
the average coupon on outstanding corporate bonds remains considerably 
above rates on new debt issues, suggesting that firms are well 
positioned to cut their debt service burdens still further as 
outstanding bonds mature or are called. The net effect of these trends 
to date has been a decline in the ratio of business interest payments 
to net cashflow, a significant increase in the average maturity of 
liabilities, and a rise in the ratio of current assets to current 
liabilities.
    With business balance sheets having been strengthened and with 
investors notably more receptive to risk, the overall climate in credit 
markets has become more hospitable in recent months. Specifically, 
improvements in forward-looking measures of default risk, a decline in 
actual defaults, and a moderation in the pace of debt-rating downgrades 
have prompted a marked narrowing of credit spreads and credit default 
swap premiums. That change in sentiment has extended even to the 
speculative-grade bond market, where issuance has revived considerably, 
even by lower-tier issuers that would have been hard-pressed to tap the 
capital markets over much of the last few years. Banks, for their part, 
remain well-capitalized and willing lenders.
    In the past, such reductions in private yields and in the cost of 
capital faced by firms have been associated with rising capital 
spending. But, as yet there is little evidence that the more 
accommodative financial environment has materially improved the 
willingness of top executives to increase capital investment. Corporate 
executives and boards of directors are seemingly unclear, in the wake 
of the recent intense focus on corporate behavior, about how an 
increase in risk-taking on their part would be viewed by shareholders 
and regulators.
    As a result, business leaders have been quite circumspect about 
embarking on major new investment projects. Moreover, still-ample 
capacity in some sectors and lingering uncertainty about the strength 
of prospective final sales have added to the reluctance to expand 
capital outlays. But should firms begin to perceive that the pickup in 
demand is durable, they doubtless would be more inclined to increase 
hiring and production, replenish depleted inventories, and bring new 
capital online. These actions in turn would tend to further boost 
incomes and output.
    Tentative signs suggest that this favorable dynamic may be 
beginning to take hold. Industrial production, as I indicated earlier, 
seems to have stabilized, and various regional and national business 
surveys point to a recent firming in new orders. Indeed, the backlog of 
unfilled orders for nondefense capital goods, excluding aircraft, 
increased, on net, over the first 5 months of this year. Investment in 
structures, however, continues to weaken.
    The outlook for business profits is, of course, a key factor that 
will help determine whether the stirrings we currently observe in new 
orders presage a sustained pickup in production and new capital 
spending. Investors' outlook for near-term earnings has seemed a little 
brighter of late.
    The favorable productivity trend of recent years, if continued, 
would certainly bode well for future profitability. Output per hour in 
the nonfarm business sector increased 2\1/2\ percent over the year 
ending in the first quarter. It has been unusual that firms have been 
able to achieve consistently strong gains in productivity when the 
overall performance of the economy has been so lackluster. To some 
extent, companies under pressure to cut costs in an environment of 
still-tepid sales growth and an uncertain economic outlook might be 
expected to search aggressively for ways to employ resources more 
efficiently. That they have succeeded, in general, over a number of 
quarters suggests that a prior accumulation of inefficiencies was 
available to be eliminated. One potential source is that from 1995 to 
2000 heavy emphasis on new and expanding markets likely diverted 
corporate management from tight cost controls whose payoffs doubtless 
seemed small relative to big-picture expansion.
    However, one consequence of these improvements in efficiency has 
been an ability of many businesses to pare existing workforces and 
still meet increases in demand. Indeed, with the growth of real output 
below that of labor productivity for much of the period since 2000, 
aggregate hours and employment have fallen, and the unemployment rate 
rose last month to 6.4 percent of the civilian labor force.
                                 * * *
    Although forward-looking indicators are mostly positive, downside 
risks to the business outlook are also apparent, including the partial 
rebound in energy costs and some recent signs that aggregate demand may 
be flagging among some of our important trading partners. Oil prices, 
after dropping sharply in March on news that the Iraqi oil fields had 
been secured, have climbed back above $30 per barrel as market 
expectations for a quick return of Iraqi production appear to have been 
overly optimistic given the current security situation.
    Also worrisome is the rise in natural gas prices. Natural gas 
accounts for a 
substantial portion of total unit energy costs of production among 
nonfinancial, nonenergy-producing firms. And as I noted in testimony 
last week, futures markets anticipate that the current shortage in 
natural gas will persist well into the future. Although they project a 
near-term modest decline from highly elevated levels, 
contracts written for delivery in 2009 in excess of $4.50 per million 
Btu are still at double the levels that had been contemplated when much 
of our existing gas-using capital stock was put in place.
    The timing and extent of the pickup in economic activity in the 
United States will also depend on global developments. Lethargic growth 
among many of our important global trading partners is posing some 
downside risk to the U.S. economic outlook. As has been true for some 
time, Japan's economy remains in difficult straits, burdened by a weak 
banking sector and an ongoing deflation, although recent data have 
seemed somewhat less negative. Economic activity in many European 
countries--especially Germany--has been soft of late and has been 
accompanied by a 
decline in inflation to quite low levels. While Japan and Europe should 
benefit from global economic recovery, the near-term weakness remains a 
concern.
                                 * * *
    Inflation developments have been important in shaping the economic 
outlook and the stance of policy over the first half of the year. With 
the economy operating below its potential for much of the past 2 years 
and productivity growth proceeding apace, measures of core consumer 
prices have decelerated noticeably. Allowing for known measurement 
biases, these inflation indexes have been in a neighborhood that 
corresponds to effective price stability--a long-held goal assigned to 
the Federal Reserve by the Congress. But we can pause at this 
achievement only for a moment, mindful that we face new challenges in 
maintaining price stability, specifically to prevent inflation from 
falling too low.
    This is one reason the FOMC has adopted a quite accommodative 
stance of policy. A very low inflation rate increases the risk that an 
adverse shock to the economy would be more difficult to counter 
effectively. Indeed, there is an especially pernicious, albeit remote, 
scenario in which inflation turns negative against a backdrop of weak 
aggregate demand, engendering a corrosive deflationary spiral.
    Until recently, this topic was often regarded as an academic 
curiosity. Indeed, a decade ago, most economists would have dismissed 
the possibility that a government issuing a fiat currency would ever 
produce too little inflation. However, the recent record in Japan has 
reopened serious discussion of this issue. To be sure, there are 
credible arguments that the Japanese experience is idiosyncratic. But 
there are important lessons to be learned, and it is incumbent on a 
central bank to anticipate any contingency, however remote, if 
significant economic costs could be associated with that contingency.
    The Federal Reserve has been studying how to provide policy 
stimulus should our primary tool of adjusting the target Federal funds 
rate no longer be available. Indeed, the FOMC devoted considerable 
attention to this subject at its June meeting, examining potentially 
feasible policy alternatives. However, given the now highly stimulative 
stance of monetary and fiscal policy and well-anchored inflation 
expectations, the Committee concluded that economic fundamentals are 
such that situations requiring special policy actions are most unlikely 
to arise. Furthermore, with the target funds rate at 1 percent, 
substantial further conventional easings could be implemented if the 
FOMC judged such policy actions warranted. Doubtless, some financial 
firms would experience difficulties in such an environment, but these 
intermediaries have exhibited considerable flexibility in the past to 
changing circumstances. More broadly, as I indicated earlier, the FOMC 
stands ready to maintain a highly accommodative stance of policy for as 
long as it takes to achieve a 
return to satisfactory economic performance.

        RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY 
                      FROM ALAN GREENSPAN

Accuracy of Credit Reports
Q.1. The Banking Committee is currently considering whether to 
reauthorize the preemption provisions of the Fair Credit 
Reporting Act. An issue that has emerged from our hearings is 
the fundamental importance of the accuracy of the information 
contained in credit reports.

A.1. The information gathered by credit reporting companies on 
the borrowing and payment experiences of consumers is a 
cornerstone of the consumer credit system in this country. 
Experience indicates that the information assembled and 
provided by these companies enables our consumer credit and 
mortgage markets to function much more efficiently than would 
otherwise be possible. Moreover, automated credit evaluation 
systems based on that information have improved the overall 
quality and reduced the cost of credit decisions while 
expanding the availability of credit. These benefits of the 
credit reporting system are evident both from comparison with 
other countries that have less developed information sharing 
structures, and from statistical analyses demonstrating the 
usefulness of credit history information for predicting an 
individual's future performance with new credit.

Q.1.a. Would you agree that accurate reports are essential for 
the efficient operation of our economy considering the 
prevalence of their usage and the manner in which risk-based 
pricing calibrates credit risk to credit price?

A.1.a. Clearly, some minimum degree of accuracy of credit 
reports is required for such benefits to be realized. Moreover, 
the more accurate the information assembled by credit reporting 
companies, the greater the potential to enhance efficiency in 
the credit granting process, reducing costs to the advantage of 
both the consumers and creditors.
    Although inaccuracy can limit the potential efficiency 
benefits from a well-developed credit reporting system as well 
as disadvantage individual consumers who have errors in their 
credit reports, there are limits to the degree of accuracy that 
can be obtained without undue costs. Some inadvertent errors 
inevitably will arise in a system comprising millions of 
account records and billions of transactions yearly. The fact 
of some degree of inaccuracy does not necessarily argue that 
the system is not functioning well, or for strong measures to 
make changes in the system. Ultimately, the question is the 
frequency with which errors in credit files actually lead to 
improper credit-granting decisions.
    At present it appears that the system is functioning 
reasonably well and it is not obvious there are easy ways to 
improve accuracy substantially without also raising costs. It 
is always useful to keep in mind the importance of maintaining 
a system that serves its 
intended purposes without onerous requirements that inflate 
costs with only limited benefit.
    More important, the FCRA itself has long contained a 
mechanism whereby consumers are able to review their credit 
reports without cost in the case of an adverse action based 
upon a credit report. More recently, many consumers have 
availed themselves of opportunities provided by credit 
reporting companies to review their own reports as frequently 
as they desire at nominal cost. Over time, both mechanisms 
should continue to lead to improvements in the quality of 
information held by the credit reporting companies.

Q.1.b. Does the Federal reserve have any definitive statistics 
regarding the current level accuracy of credit reports?

A.1.b. The information the Federal Reserve has concerning the 
accuracy of credit reports was reported in the Federal Reserve 
Bulletin earlier this year. This information was based on a 
nationwide sample of credit records drawn as of June 1999, and 
as such may not be representative of the information currently 
in credit reporting files. These data supported an assessment 
of the degree to which credit files contain missing and 
``stale'' (nonupdated) information, but did not permit an 
assessment of the degree to which wrong information is present 
in credit files. The Federal Reserve does not have any 
definitive statistics concerning the current level of accuracy 
of credit reports. A copy of the article in the Federal Reserve 
Bulletin is attached. *
---------------------------------------------------------------------------
    * Held in the Senate Banking Committee files or available at http:/
/www.federalreserve.gov/pubs/bulletin/2003/0203lead.pdf.

Q.1.c. In light of the significance of this matter, do you 
believe there should be an effort to obtain information 
---------------------------------------------------------------------------
regarding the level of accuracy?

A.1.c. There has been little direct analysis of the degree of 
accuracy of credit reports; to the extent that studies have 
been done, they are limited in scope or lacking in statistical 
rigor. On the other hand, the credit reporting system is 
operating quite well at present, despite some degree of 
inaccuracy in credit reporting. It is not clear that the 
usefulness of an effort to obtain fuller information regarding 
the level of accuracy would justify the substantial costs such 
an effort would require.

Potential Weaknesses in the Housing Market
Q.2. The housing market continues to prosper with low interest 
rates spurring home purchases and refinancings. However, a 
recent report from the Harvard University Joint Center for 
Housing Studies cited two concerns. First, the growing number 
of loans to borrowers with weak credit histories. Second, the number of 
homeowners who have spent more than 50 percent of their incomes 
on housing has increased significantly. To the extent these 
borrowers are concentrated in particular markets or 
neighborhoods, any economic downturn could lead to an 
increasing number of late payments, and even foreclosures. Do 
you share these concerns and how significant are they?

A.2. Recent developments in mortgage markets have provided 
broader access to mortgage financing for borrowers with lower 
incomes and less-established credentials for borrowing. As you 
noted from the report from the Joint Center for Housing 
Studies, expanding the availability of mortgage credit entails 
some risks. However, the overall impact of this additional risk 
on the mortgage market and the economy as a whole is likely to 
be rather small. Data from the Federal Housing Finance Board 
indicate that the average loan-to-value ratio for mortgages 
excluding refinancings has decreased from a touch below 80 
percent in the mid-1990's to an average of 73 percent so far 
this year. In addition, mortgages with loan-to-value ratios of 
90 percent or more have declined from 27 percent of total 
mortgages in 1995 to less than 20 percent so far this year. 
Moreover, house prices generally have risen fairly rapidly in 
recent years, providing an equity cushion for many mortgagors.
Bank Capital and Credit Extension
Q.3. You mentioned in your testimony that the banks remain well 
capitalized. How does this compare to previous recessions? Did 
banks largely manage to avoid overextending credit during the 
1990's expansion?

A.3. Bank capital ratios by virtually all measures (including 
equity relative to problem assets) are significantly higher now 
than in the prior economic cycle, that is, in the early 1990's. 
Moreover, 98.4 percent of all insured commercial banks meet the 
regulatory criteria to be considered ``well capitalized,'' 
which is the highest percentage in more than a decade of 
calculating the statistic. As stated in my testimony, this 
depth and breadth of capitalization leaves banks well-
positioned to support economic growth through sound lending.
    It appears that banks have largely avoided the temptation 
to overextend credit in the more recent period. Increases in 
problem assets and credit losses over the past few years, while 
significant, have been modest relative to those seen in the 
last recession. Nonperforming assets represent only about 5 
percent of the capital and reserves in place to absorb them 
compared with more than 27 percent at the end of 1991. Indeed, 
despite somewhat elevated levels of nonaccrual loans, capital 
ratios have risen significantly during the recent cycle, 
reflecting both record industry earnings and continuing 
supervisory attention to capital adequacy. Early indications 
suggest that credit quality problems may have reached their 
peak in the fall of last year and have receded gradually since 
then.

Basel II Capital Accord
Q.4. On July 11, 2003, the banking regulators released proposed 
rules and guidance relating to the Basel II Capital Accord. It 
appeared from these releases that the bank regulators are not 
in total agreement about these standards. What is the process 
for resolving any disagreements between the regulators 
regarding the application of these standards?

A.4. Because the Basel II Capital Accord revisions encompass a 
number of significant and complex issues, interagency 
differences of opinion are to be expected. In our experience, 
these differences and the interagency process in place that 
allows, as a matter of course, for them to be fully aired and 
discussed, almost invariably result in a better outcome from 
both a supervisory and industry perspective than would be the 
case if a single agency was the sole decisionmaker. Each agency 
has unique insights and experiences it brings to particular 
issues and it is the agencies' collective belief that it is 
crucial to the success and the effectiveness of the final 
outcome that these be thoroughly considered and debated before 
a final consensus is achieved.
    The agencies have well-established interagency mechanisms 
for communication and decisionmaking at all levels within the 
agencies. In particular, for the Basel revision process several 
chains of communication are in place to develop U.S. views and 
communicate them consistently to the Basel Supervisors 
Committee, the industry as a whole, and to other interested 
parties. For example, interagency staff meetings and conference 
calls are held almost daily on one or more of the substantive 
issues raised by the proposed new framework. Senior staff 
regularly schedules interagency meetings prior to significant 
Basel meetings (most notably the Basel Supervisors Committee or 
the Capital Task Force). The agency principal representatives 
also have scheduled meetings prior to significant international 
meetings. Through these discussions, the U.S. views on 
particular issues are formulated. In addition, as is always the 
case, bilateral discussions on individual issues on an as-
needed basis are conducted so that concerns and objectives are 
appropriately addressed and achieved.
    At the current stage of development of the revised Basel 
Capital Accord, we expect that the agencies will have different 
views on a number of issues. We are confident that, as we work 
through these differences, the end result will be the best 
product for U.S. banking organizations.

       RESPONSE TO WRITTEN QUESTIONS OF SENATOR SARBANES 
                      FROM ALAN GREENSPAN

Q.1. There are many questions as to how the Federal Reserve 
would conduct monetary policy if it should decide that further 
easing was appropriate but that further reductions in the Fed 
funds rate was not appropriate. In testimony before the Joint 
Economic Committee in May, you stated that the Fed: ``do[es] 
have the capability, should that be necessary, of clearly 
moving out on the yield curve, essentially moving longer-term 
rates down and in the process expanding the monetary base and 
the degree of monetary stimulus.''
    In your written testimony at this hearing you also raised 
that point: ``The Federal Reserve has been studying how to 
provide policy stimulus should our primary tool of adjusting 
the target Federal funds rate no longer be available. Indeed, 
the FOMC devoted considerable attention to this subject at its 
June meeting, examining potentially feasible policy 
alternatives.''
    Chairman Greenspan could you describe in some detail what 
conclusions have been drawn from your research and conversation 
during the June meeting? In addition, could you also answer the 
following specific questions regarding the use of nonprimary 
tools to provide economic stimulus:

    Will the Fed set a target rate at a single point or range 
along the yield curve as it currently does with the Fed funds 
rate?

        If so:

          What point or range along the yield curve will the 
        FOMC target? Will the FOMC announce the target point or 
        range along the yield curve? Will the FOMC announce the 
        target interest rate for that point or range?

        If not:

          Will the FOMC specify some other policy variable 
        related to longer term interest rates? If so, what 
        would that policy variable be?

    Will the FOMC communicate its decisions in a manner similar 
to its announcements regarding the Federal funds target rate or 
will another method of communication be used? If you are 
contemplating additional or alternative methods of 
communication, could you please describe how you envision they 
would operate?

A.1. The Federal Open Market Committee recently released the 
minutes of its June 24-25, 2003, meeting, at which the issue of 
unconventional monetary policy tools was discussed. I have 
attached the relevant section of those minutes for your 
convenient reference. As that section makes clear, the FOMC 
believed that the probability that unconventional tools would 
be needed was quite low. Consequently, the Committee's 
discussion of unconventional policies was very general. Apart 
from agreeing that it would not be appropriate to establish an 
artificial floor below which the Federal funds rate could not 
be lowered, the FOMC reached no decisions on specific 
approaches to unconventional policies. As stated in those 
minutes, ``[t]he members did not see the need at this time to 
reach a consensus on the desirability of any specific 
nontraditional approach to the implementation of monetary 
policy, particularly given the low probability of its near-term 
use. As experience had shown, at times of economic and 
financial market stress the specific policy tools used would 
depend on circumstances. For now, however, they believed that 
arriving at an understanding of the various options that might 
be employed prepared them to respond more flexibly and 
effectively to unanticipated developments.'' Consequently, it 
is not possible to answer your specific questions at present. 
However, as I indicated at the July hearing, the Federal 
Reserve will communicate the relevant information to the public 
in a timely fashion in the event that the adoption of 
unconventional policies ever proves necessary.

Q.2. The President's Fiscal Year 2004 Budget includes an 
increase for the Bureau of Economic Analysis to launch several 
initiatives: (1) purchase of more real-time data now collected 
by the private sector, particularly scanner data; (2) 
collection of missing information on derivatives; (3) meeting 
international commitments for the collection and presentation 
of information on international transactions and asset 
positions; and (4) acceleration of the processing and release 
of balance of payments data. The BEA also continued to purse 
its plan to accelerate the production of input-output tables 
based on the 2002 economic census. What is your evaluation of 
these initiatives?

A.2. The Fiscal Year 2003-2007 Strategic Plan prepared by the 
BEA lays out a well-designed plan for improving the national 
economic accounts as well as the international accounts. The 
plan 
reflects the input of many facets of the BEA's user community, 
including the Federal Reserve. The initiatives presented in the 
President's Fiscal Year 2004 Budget reflect the BEA's 
requirements for carrying out its strategic plan. The specific 
initiatives you mention in your question will help BEA achieve 
two laudable objectives: (1) improve the reliability and 
timeliness of GDP and related measures, and (2) meet the 
commitments of the United States to the International Monetary 
Fund to increase the transparency, time-
liness, and accuracy of data on our international investment 
position. Achieving these objectives will provide important 
benefits to the formulation and the implementation of monetary 
and financial policy at the Federal Reserve.

       Excerpt from Minutes of the Federal Open Market Committee

                            June 24-25, 2003

    The Committee discussed at length alternative means of 
providing monetary stimulus should the target Federal funds 
rate be reduced to a point where there was little or no 
latitude for additional easing through this conventional policy 
instrument. The members agreed that current economic conditions 
and the prevailing stances of monetary and fiscal policy made 
the need to use unusual monetary policy tools a quite remote 
possibility. Even so, they believed it was useful to discuss 
that possibility because of the implications for financial 
markets and institutions and for the conduct of monetary policy 
of reducing short-term interest rates to very low levels. An 
environment involving such interest rates could have adverse 
repercussions on the functioning of some sectors of the money 
market, but the members agreed that the potential 
extent of such disruptions would not be sufficient to prevent 
the Committee from taking advantage of the full scope of 
conventional easing of the Federal funds rate, should that 
become necessary. Beyond that, a variety of nonconventional 
measures for further easing was available. In this regard, the 
members discussed the advantages and disadvantages of various 
approaches that, possibly employed in some combination, would 
alter the size and composition of the System's balance sheet. 
They also considered aspects of the Committee's communications 
as a means of underscoring to the public its willingness to 
follow a sufficiently accommodative path of monetary policy for 
as long as necessary to foster improved economic performance. 
The members did not see the need at this time to reach a 
consensus on the desirability of any specific nontraditional 
approach to the implementation of monetary policy, particularly 
given the low probability of its near-term use. As experience 
had shown, at times of economic and financial market stress the 
specific policy tools used would depend on circumstances. For 
now, however, they believed that arriving at an understanding 
of the various options that might be employed prepared them to 
respond more flexibly and effectively to unanticipated 
developments. While considerable uncertainty surrounded each 
individual policy option, the members agreed that the 
effectiveness of these alternative tools, along with the 125 
basis points of conventional easing still available, would 
allow monetary policy to combat economic weakness and forestall 
any unexpected tendency for a pernicious deflation to develop.

       RESPONSE TO WRITTEN QUESTIONS OF SENATOR BUNNING 
                      FROM ALAN GREENSPAN

Q.1. The last time the FOMC met, you cut the Fed funds rate by 
25-basis-points. The markets did not react well because they 
were expecting a 50-basis-point cut. Yesterday, you indicated 
that more cuts will be made in the near future. Why didn't you 
just cut the rate by 50-basis-points last time the FOMC met?

A.1. The Federal Open Market Committee judged at the time of 
the June FOMC meeting that a 25-basis-point reduction in the 
Federal funds rate, in the context of a substantial previous 
easing of monetary policy, a stimulative fiscal policy, and 
strong growth in productivity, would be sufficient to foster 
satisfactory growth in economic activity. The economic data 
that have since come in hand have tended to confirm that 
judgment.
    I did not indicate that more rate cuts will be made in the 
future. Rather, my point was that they could be made if 
circumstances warrant.

Q.2. I want to get back to your testimony of last week on 
Natural Gas Prices. Do you feel the high prices that we have 
had and expect in the future are largely because of past 
Federal Government policies? Specifically, do you agree that in 
the past we have encouraged demand for natural gas by giving 
incentives to use it for electricity generation and for other 
uses without increasing supply by allowing for new drilling?

A.2. We cannot on the one hand encourage the use of 
environmentally desirable natural gas in this country while 
being conflicted on larger imports of liquefied natural gas 
(LNG) and new wells. Such contradictions are resolved only by 
debilitating spikes in price.

Q.3. Would opening up the Artic National Wildlife Refuge (ANWR) 
help the demand side?

A.3. Unquestionably, the more oil and gas that we get down into 
the lower 48 the better for meeting our energy needs. I realize 
that there is a very difficult tradeoff between maintaining the 
pristine nature of the wilderness in the ANWR and the economic 
value of producing the oil and natural gas that is located 
there. The tradeoff is a value judgment that is up to Congress 
to make on behalf of the American people.

        RESPONSE TO WRITTEN QUESTIONS OF SENATOR MILLER 
                      FROM ALAN GREENSPAN

Manufacturing
Q.1. Many small manufacturing companies in my State feel that 
they are under assault (principally from China) and if the 
trend continues there will be few, if any, manufacturing 
(mostly textile manufacturing) jobs left in America. On the 
other hand, large manufacturing companies like the fact that 
they can do more business in China. How do we balance out the 
needs of both the large and small manufacturing concerns? What 
should I tell my constituent companies?

A.1. Economists generally believe that the extent of a 
country's openness to trade and its integration with the rest 
of the world exert positive influences on its economic growth 
and standard of living. Among other things, international trade 
allows the United States to purchase goods abroad at lower cost 
than we could produce them at home. This raises our standard of 
living both directly, by reducing costs, and indirectly, by 
allowing us to specialize in products in which we are most 
competitive. In some cases, the opportunity to buy raw 
materials and intermediate inputs at lowest global cost is the 
key to success for both large and small U.S. manufacturing 
concerns. Moreover, less competitive operations shrink while 
capital investment contributes to the expansion of competitive 
enterprises that embody cutting-edge technologies; this process 
of ``creative destruction'' leads to higher productivity and 
higher incomes. International trade, it should be added, is not 
a one-way street: Not only does an open global trading system 
allow us to import more and at lower cost, but it also allows 
us to access foreign markets and sell more of our product 
abroad.
    It is certainly the case that as the adjustment engendered 
by international trade proceeds, some industries that were once 
thriving but are now less competitive will experience distress. 
This may lead to factories being shut down and workers being 
laid off. However, the proper response to the distress of 
particular sectors is not to inhibit international competition, 
thereby limiting the growth potential of the economy as a 
whole. Rather, we should focus our response on enhancing job 
skills and retraining workers. If necessary, selective income 
maintenance programs could also be employed for those workers 
for whom retraining is problematic. More generally, 
establishing the conditions for sustained economic growth--
macroeconomic stability, a strong financial system, and 
institutions that support market-driven private investment--
should allow the U.S. economy to fully exploit the benefits of 
international trade while easing any associated transitional 
difficulties.

Q.2. I understand that in an answer yesterday to Representative 
Mark Green, you said you had visited textile factories in the 
1970's and also recently. Based upon this recent visit, you 
said you had noticed how technology had become an integral part 
of manufacturing. I think you also said that as long as we have 
technology we could be self-sufficient, and that ``one pound of 
technology versus one ton of raw materials,'' means we have 
shifted resources to our most effective parts. Am I quoting you 
correctly and what is your overall view of what is happening to 
the manufacturing sector?

A.2. Modern technology has become an integral part of U.S. 
manufacturing in two ways. First, all products that we 
manufacture are now produced with far more technology and 
appropriately different infrastructure than used to be the 
case. Second, the composition of U.S. manufacturing has been 
shifting toward goods that make greater use of high technology 
in their manufacture. However, I would not argue that 
technology makes the United States self-sufficient. Self-
sufficiency is not, in itself, a valuable goal. Rather, the 
specialization that goes with globalization has been extremely 
valuable to our economy and living standards. Where national 
security is a concern, producing particular goods here rather 
than importing them from abroad may be essential. In other 
cases, the key objective is to raise the productivity of 
American workers in whatever they are producing.
Effects of State Budget Deficits
Q.3. Just yesterday, in The Washington Post a lead story 
entitled ``Budget Woes Trickle Down'' discussed a lady who said 
``her taxes are going up so much that, at 70, she may have to 
sell her house to pay them.'' The article goes on to say that 
State and local governments, to meet their Federal 
responsibilities in education, health care, and homeland 
security obligations, are either having to make cuts or raise 
taxes. In February, the National Conference of State 
Legislatures said States' current budget gaps have grown to a 
total of nearly $26 billion [for this year]. What is more, the 
shortfall projected for fiscal 2004, the budget year that 
States are now planning for, is forecast to be at least $68.5 
billion--and probably will rise significantly since 11 States 
had no projections.'' Chairman Greenspan, what impact will the 
State and local governments decisions to either cut programs or 
raise taxes have on an economic recovery?

A.3. In the short-run, State and local government decisions to 
cut spending or raise taxes would tend to reduce aggregate 
demand and slow (other things held constant) the growth of 
output a bit. However, in comparison to other factors that 
recently have had a positive effect on aggregate demand and the 
economy (such as the recent Federal tax cut and added spending 
for the Iraq war and homeland security), the adjustments that 
States and localities will need to make to restore budget 
balance are small. Indeed, the effects of an improving economy 
on State and local tax receipts likely will produce a 
significant portion of the required adjustment.
    Moreover, in the longer run, improved State and local 
budget balances also have a positive effect on national saving 
and the economy. In particular, the increased saving will set 
the stage for 
future productivity gains by keeping long-term interest rates 
low and encouraging investment.
















































































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