[Senate Hearing 108-488]
[From the U.S. Government Publishing Office]



                                                        S. Hrg. 108-488


        FEDERAL RESERVE'S FIRST MONETARY POLICY REPORT FOR 2004

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

                                HEARING

                               before the

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

                      ONE HUNDRED EIGHTH CONGRESS

                             SECOND SESSION

                                   ON

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

                               __________

                           FEBRUARY 12, 2004

                               __________

  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

                              ----------                              

                      THURSDAY, FEBRUARY 12, 2004

                                                                   Page

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

Opening statements, comments, or prepared statements of:
    Senator Sarbanes.............................................     2
    Senator Bennett..............................................     4
    Senator Bayh.................................................     5
    Senator Allard...............................................     5
        Prepared statement.......................................    39
    Senator Stabenow.............................................     5
    Senator Bunning..............................................     6
    Senator Carper...............................................     7
    Senator Sununu...............................................     8
    Senator Schumer..............................................     8
        Prepared statement.......................................    39
    Senator Crapo................................................     9
    Senator Reed.................................................    10
        Prepared statement.......................................    40
    Senator Dole.................................................    10
    Senator Miller...............................................    33
    Senator Corzine..............................................    35

                                WITNESS

Alan Greenspan, Chairman, Board of Governors of the Federal 
  Reserve System, Washington, DC.................................    12
    Prepared statement...........................................    41
    Response to written questions of:
        Senator Shelby...........................................    46
        Senator Schumer..........................................    49
        Senator Corzine..........................................    56
        Senator Hagel............................................    58

              Additional Material Supplied for the Record

Monetary Policy Report to the Congress, February 11, 2004........    61

                                 (iii)

 
                    FEDERAL RESERVE'S FIRST MONETARY
                         POLICY REPORT FOR 2004

                              ----------                              


                      THURSDAY, FEBRUARY 12, 2004

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

    The Committee met at 10:02 a.m. in room SD-538 of the 
Dirksen Senate Office Building, Senator Richard C. Shelby 
(Chairman of the Committee) presiding.

        OPENING STATEMENT OF CHAIRMAN RICHARD C. SHELBY

    Chairman Shelby. The hearing shall 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.
    Chairman Greenspan, your testimony and your written report 
highlight the significant positive developments in our economy 
in 2003. Following a blistering 8.2 percent increase in the 
third quarter, the real GDP increased 4 percent in the fourth 
quarter of 2003. On an annual average basis, productivity rose 
4.3 percent in the business sector and 4.2 percent in the 
nonfarm business sector. Our economy is much stronger now than 
it was a year ago, and our prospects for 2004 are even 
brighter.
    The job market is also showing signs of recovery. Payroll 
employment increased by 112,000 jobs in January--the largest 
monthly gain since 2000--and the unemployment rate fell to 5.6 
percent. These improvements are certainly welcome and should 
continue at a healthy pace.
    With this improved economic environment, Congress needs to 
do its part in achieving the appropriate fiscal policy. The 
continued strength of our Nation's economy will be dependent on 
how the Congress goes about achieving this balance. We would 
certainly welcome your views, Mr. Chairman, on how to address 
some of these issues today.
    Mr. Chairman, this Committee will also have the pleasure of 
hearing your views on Government-sponsored enterprises in less 
than 2 weeks at our hearing scheduled for Tuesday, February 24, 
and we look forward to that meeting. I, and my colleagues on 
the Committee, are keenly interested in that topic and look 
forward to that discussion. The condition of the U.S. economy 
and the direction of monetary policy should provide us with 
more than enough ground to cover in the time that we have this 
morning.
    Chairman Greenspan, thank you for your appearance today. We 
look forward to hearing your remarks. I am sure it will be a 
lively and an informative exchange that will follow.
    Senator Sarbanes.

             STATEMENT OF SENATOR PAUL S. SARBANES

    Senator Sarbanes. Thank you very much, Mr. Chairman. I am 
pleased to join with you in welcoming Federal Reserve Board 
Chairman Greenspan back before the Committee on Banking, 
Housing, and Urban Affairs to testify on the Federal Reserve's 
Semi-Annual Report to Congress on Monetary Policy.
    This Committee took the lead in putting that requirement 
into the statute for these twice-a-year reports, and I think it 
has worked out very well over the years as a way of, in effect, 
educating the public, getting a timely review before the 
Congress, and it broke us out of the pattern of bringing the 
Chairman up when there seemed to be some crisis developing in 
the economy. I think it gives us a more orderly and consistent 
way of reviewing monetary policy.
    On Tuesday of this week, the Joint Economic Committee held 
a hearing on the release of the Economic Report of the 
President, prepared by the President's Council of Economic 
Advisers. I will not comment at this point on the view 
expressed in the Economic Report which has gained so much 
attention over the last few days, that the outsourcing of U.S. 
jobs to workers overseas is good for our Nation's economy. That 
is a topic, in and of itself, of some concern, but there were 
other aspects of the Economic Report that I want to mention 
because they are relevant to Chairman Greenspan's testimony 
this morning.
    The first is the Administration's continual lowering of its 
forecast for jobs over the past 3 years. The forecast of the 
number of jobs that we would have in calendar year 2004, the 
year in which we now find ourselves, was 138.3 million in the 
2002 Economic Report. That was lowered in last year's Economic 
Report to 135.2 million, and in this most recent report to 
132.7 million. This is total jobs for the country. And we have 
now learned that, based on the lower job numbers for late 2003 
and January of this year, the CEA has now lowered the forecast 
again to 132 million jobs. So, we have gone from a forecast of 
over 138 million, just 2 years ago, to 132 million now. In 
other words, in just 2 years, the forecast of jobs has been 
lowered by more than 6 million jobs. This obviously reflects 
the fact that the biggest problem in the economy today is the 
loss of over 2 million jobs in the last 3 years and the 
continued failure of jobs to grow at a satisfactory rate. In 
fact, Chairman Greenspan in his statement this morning notes 
that ``Progress in creating jobs has been limited.''
    The Chairman's statement will emphasize the role increased 
productivity has played in restraining job growth, and I think 
that is an important factor, but the Economic Report of the 
President points out that heightened uncertainties can lead to 
reduced economic growth and, in particular, to reluctance by 
business to hire.
    The Economic Report listed a number of these uncertainties 
but it left off the list the fact that for the last 3 years our 
Government has been passing tax cuts that generate large and 
unsustainable budget deficits for the foreseeable future. The 
Congressional Budget Office has forecast deficits totalling $5 
trillion over the next
10 years on the assumption that current tax cuts are continued 
and
spending growth continues. The tax cuts, which the 
Administration has trumpeted as the cause of economic recovery, 
may indeed have caused people to lose confidence that economic 
growth can be
sustained.
    We have a situation of very large deficits, a more 
difficult world environment, and a Government that refuses to 
face up to the problem of looming deficits. Any observer would 
be concerned about the long-term sustainability of the recovery 
in these circumstances.
    I cannot help but note at this point the testimony that 
Chairman Greenspan gave to the Senate Budget Committee in 
January 2001 in support of the Administration's first tax cut. 
We have had others since, of course. At that time, Chairman 
Greenspan warned about the danger of paying off the Federal 
debt too quickly, and went on to observe that a tax cut was 
needed to lower the budget surplus. Chairman Greenspan stated:

    The sequence of upward revisions to the budget surplus for 
several years now has reshaped the choices and opportunities 
before us. The most recent data significantly raise the 
probability that sufficient resources will be available to 
undertake both debt reduction and surplus lowering policy 
initiatives. The emerging key fiscal policy need is to address 
the implications of maintaining surpluses beyond the point at 
which publicly held debt is effectively eliminated. The time 
has come, in my judgment, to consider a budgetary strategy that 
is consistent with a preemptive smoothing of the glide path to 
zero Federal debt or, more realistically, to the level of 
Federal debt that is an effective, irreducible minimum.

    I was at that hearing. I remember it as though it were 
yesterday. In fact, I recall warning the Chairman that he was 
taking the lid off the punch bowl and that there would be 
severe consequences if we followed that fiscal path. 
Regrettably, we are dealing with those consequences today.
    I would like to make a final point. In his testimony today, 
Chairman Greenspan properly points out that, ``Addressing the 
Federal
budget deficit is even more important in view of the widening 
U.S. current account deficit. Given the already substantial 
accumulation of dollar-denominated debt, foreign investors, 
both private and official, may become less willing to absorb 
ever-growing claims on U.S. residents.''
    The IMF, in a recently released report, made this point 
even more forcefully:

    Against the backdrop of a record high U.S. current account 
deficit and a ballooning U.S. net foreign liability position, 
the emergence of twin fiscal and current account deficits has 
given rise to renewed concern. The United States is on course 
to increase its external liabilities to around 40 percent of 
GDP within the next
few years--an unprecedented level of external debt for a large 
industrial country. This trend is likely to continue to put 
pressure on the U.S. dollar, particularly because the current 
account deficit increasingly reflects low savings rather than 
high
investment.

    Although the dollar's adjustment could occur gradually over 
an extended period, the possible global risks of a disorderly 
exchange rate adjustment, especially to financial markets, 
cannot be ignored. Episodes of rapid dollar adjustments failed 
to inflict significant damage in the past, but with U.S. net 
external debt at record levels, an abrupt weakening of investor 
sentiments vis-a-vis the dollar could possibly lead to adverse 
consequences both domestically and abroad.''
    Mr. Chairman, I think it is clear that there are profound 
underlying problems in our domestic and international financial 
position that raise serious questions about our economic 
prospects and are contributing to the failure of our economy to 
produce jobs.
    I look forward to hearing Chairman Greenspan's testimony 
this morning and the opportunity to ask him some questions.
    Chairman Shelby. Senator Bennett.

             STATEMENT OF SENATOR ROBERT F. BENNETT

    Senator Bennett. Thank you very much, Mr. Chairman.
    I am moved to repeat what I said at the JEC hearing and 
very often elsewhere. I do not know what the number will be 5 
years from now of the various projections that are being made, 
but I do know absolutely it will not be the number that is 
currently projected. I do not know whether it will be too high 
or too low, that is, the current number, but I do know, with 
absolute certainty, that the current number is wrong. And I 
think the review of all of the projections made by CBO and OMB 
over the years of where things would be 5 years from now 
uniformly supports that. Every single one of them has been 
wrong, and we can be certain that every single one of them will 
be wrong as we go forward.
    That does not mean we should not make the projection. We do 
the best we can, but we should have a little more humility 
around here as we try to forecast what is going to happen in an 
$11 trillion economy, in a constantly changing world.
    The thing I would like to pursue with Chairman Greenspan 
during the question period, Mr. Chairman, is a careful look at 
the unemployment figures, the job creation figures because 
something is happening, and I do not know--we have tried to 
pursue it with the Bureau of Labor Statistics, they do not 
know--whether something structural is happening or whether 
there is an anomaly that will fix itself in the few months 
ahead.
    The household survey numbers and the payroll survey numbers 
are moving away from each other in a way they never have done 
historically. If you look at the payroll survey numbers, we 
have the job loss that Senator Sarbanes referred to. If you 
look at household survey numbers, more Americans are working 
today than has ever been the case in history. And as we go 
after the Bureau of Labor Statistics that does both surveys and 
say, ``Can you tell us which one is accurate or where the truth 
lies or where the methodology is faulty,'' they cannot. They 
say they are studying it, and they are looking at it. I believe 
them, that they are studying it and they are looking at it.
    At this point, we are basically looking for hunches, and I 
would like to ask Chairman Greenspan, at the appropriate time, 
what his hunch may be as to what is happening. If indeed there 
is a structural change in the way jobs are being created in 
this country, as the household survey would indicate, then both 
our measures of unemployment or employment and our measure of 
productivity both are suspect, if there is a structural change 
going on.
    I look forward to the opportunity of pursuing this with 
Chairman Greenspan. Because of all of the things that are 
important around here, the most important one is that we have 
data that are accurate when we make our policy decisions. And 
if the data are being skewed, by virtue of some structural 
change that is going on below the surface that has no historic 
basis and demonstrates something new happening in the economy, 
it is very important that we discover that as quickly as 
possible and try to get accurate data. I know of no one who has 
a better sense of smell for these kinds of structural changes 
than Chairman Greenspan, and I look forward to the opportunity 
of having that discussion with him.
    Chairman Shelby. Senator Bayh.

                 COMMENTS OF SENATOR EVAN BAYH

    Senator Bayh. At the risk of disappointing all of those who 
have gathered here today to give an opening statement, I will 
defer to Chairman Greenspan.
    Chairman Shelby. Senator Allard.

                COMMENTS OF SENATOR WAYNE ALLARD

    Senator Allard. Mr. Chairman, I think that Senator Bayh has
started a good trend here. I am going to see if I cannot make 
it follow through for the rest of the Committee. I have some 
opening remarks and would like to make them a part of the 
record.
    Chairman Shelby. They will be made part of the record 
without objection.
    Senator Allard. I will pass because I am also interested in 
hearing what Chairman Greenspan has to say.
    Chairman Shelby. Senator Stabenow.

              COMMENTS OF SENATOR DEBBIE STABENOW

    Senator Stabenow. Thank you, Mr. Chairman. I would like to 
make a couple of opening comments because of the fact that I 
will unfortunately be having to juggle and move in and out of 
the meeting this morning for multiple Committee hearings.
    I want to welcome the Chairman and thank you for your 
service. I have had an opportunity to read your written 
statement, and I am hopeful this morning that we will be able 
to have more of a discussion based on what Senator Sarbanes and 
Senator Bennett both have talked about in terms of issues 
related to employment.
    I was particularly interested in your statements that once 
again household spending was the mainstay, with real personal 
consumption spending increasing nearly 4 percent and outlays on 
residential structures rising about 10 percent. Mr. Chairman, 
my concern, is that we are losing, certainly in my State of 
Michigan, the middle-income, good-wage jobs in our country. I 
would appreciate your thoughts on the impacting on household 
spending and consumption which is such a mainstay of the 
economy, as you point out.
    I am hopeful that you will also have an opportunity to talk 
with us about the fact that employment is not increasing. As 
you have indicated, new hires and recalls from layoffs are far 
below what historical experience indicates, and I am very 
interested in your thoughts on the issues of productivity and 
employment. I have been hearing and reading more about 
outsourcing and how that relates to productivity numbers where 
there may in the past have been 100 people doing a particular 
job, as an example, there are now 80, but 20 are being 
outsourced to another country, does that show up in some way, 
and is that reflected in what we measure as productivity in 
this country? I would welcome your thoughts on that.
    I was deeply concerned about the Council of Economic 
Advisers' report earlier this week that indicated that 
outsourcing jobs to other countries is good for our economy. It 
has certainly not been good for the State of Michigan, Mr. 
Chairman.
    Thank you.
    Chairman Shelby. Senator Bunning.

                STATEMENT OF SENATOR JIM BUNNING

    Senator Bunning. Thank you, Chairman Shelby, and welcome, 
Chairman Greenspan.
    I think it is obvious to everybody by now that I have 
disagreed with some of your monetary policy decisions. 
Sometimes I think I am the only one who disagrees, but that is 
okay. Since you called the emergency meeting in January 2001, I 
think you have done a pretty good job, particularly on the 
policy. Personally, I think you should have cut the discount 
rate months before, and you and I have talked about that, but 
overall I have agreed with much of what you have done.
    However, I do not think you should have changed your 
statement after the last FMOC meeting. I know you like to have 
``wiggle room,'' but everybody knows the Fed is not going to 
raise interest rates any time soon, maybe not at all in 2004. 
There is no inflation and no reason to raise rates. But 
changing your statement brought uncertainty to the markets. You 
had to know that changing your January statement would bring 
great uncertainty, and you had to know it would create some 
havoc in the marketplace. The decision was made to go ahead and 
delete those four little words ``for a considerable period.'' I 
disagree strongly with that decision.
    Mr. Chairman, your words matter, and you know that. You 
know what happened when you used the term ``irrational 
exuberance.'' You know what happened when you used the term 
``wealth effect.'' You know how volatile the markets can be. 
You had to have known what deleting the phrase ``for a 
considerable period'' would do.
    Yesterday, your words mattered in a very positive way. Your 
outlook helped the Dow reach a two-and-a-half-year high. 
Hopefully, what you say here today will not reverse those 
gains.
    You also must be aware that your words matter when you 
comment on things that you have nothing to do with and the Fed 
has nothing to do with. I have harped about this before. The 
job of the Fed is to set monetary policy, and I believe that 
when the Fed strays from that into other areas that we get in 
trouble.
    I remember when you testified before the Energy Committee 
about natural gas prices. I just do not understand what the Fed 
has to do with the spot market for natural gas. I realize that 
you were invited to testify, and I realize that you will be 
asked to comment on a number of things that are not under your 
purview. Senators and Members of Congress like their questions 
answered, and that kind of puts you in a tight spot, but you do 
not have to answer those questions, and you do not have to 
testify on subjects that really are not part of the Fed's 
jurisdiction.
    We all know that your term as Chairman expires this summer, 
and I expect that you will be nominated to serve as Chairman 
for the remainder of your 14-year term, and you will probably 
be approved by the Senate. I am sure you will also not be 
surprised to find that I will not be able to support you. A lot 
of people ask me why I put you on the spot when you come to the 
Hill. They think that we do not get along, that there is some 
problem. And I try to explain to them that that is not true at 
all. You and I have talked many times. I remember a very nice 
luncheon we had down in your office several years ago. I will 
say to you what I say to them--it is not personal, it is just 
business.
    I think that the Fed continues to get involved in matters 
outside of its charter. I think that the Fed has made several 
awful decisions in recent years, like when you took too long to 
lower rates in the late summer and early fall of 2000. 
Decisions like these might seem like ``pie in the sky'' to some 
people, but they have real results and consequences. If the Fed 
had acted more quickly in 2000, it could have spared us a 
recession in which we lost 3 million jobs and just about $7 
trillion in stock market value. Mr. Chairman, that is not ``pie 
in the sky.'' That is ``bread and butter.''
    Thank you for your time, and for allowing me to speak.
    Chairman Shelby. Senator Carper.

              COMMENTS OF SENATOR THOMAS R. CARPER

    Senator Carper. Listening to my friend from Kentucky 
address the Chairman reminds me of why he was probably fairly 
successful as a pitcher in the American and the National 
League. And when he said it is nothing personal, looking at 
those batters in either league, in Detroit, and in Philadelphia 
and other places, I can imagine you saying, ``Well, it is 
nothing personal, but I am going to throw one high and 
inside.''
    [Laughter.]
    Mr. Chairman, I am glad you are here today. My job is not 
to lecture or to admonish you. My job is to ask you hopefully 
some good questions and maybe to learn from what you have to 
say.
    I do want to just make one brief comment with respect to 
what Senator Bennett said earlier. He said one thing we know 
for sure, the projections for 5 years down the road, whatever 
is being projected we know for sure that is not what the number 
will be, and that is probably true.
    Another thing that we know, I think for sure, is that when 
my generation begins to retire, the boomers, and we will start 
retiring about the end of this decade, the pressure on Social 
Security, and on Medicare and Medicaid are not going to get 
less. They are going to get more, and as I look at those 
numbers down the road, and the demographics that back them up, 
and I look at our budget deficit and our trade deficit, this is 
a worrisome time for me, and I think for a lot of people. I 
always look forward to your testimony here with anticipation 
and probably no more than today.
    So having said that, I will just say in the words of 
another of our colleagues ``bring it on, just bring it on.''
    Chairman Shelby. Senator Sununu.

               COMMENTS OF SENATOR JOHN E. SUNUNU

    Senator Sununu. Thank you, Chairman Shelby.
    Despite the fact that I am sorely disappointed by Senator 
Bayh's refusal to pontificate----
    [Laughter.]
    I am pleased to be here to welcome the Chairman. I look 
forward to his testimony and to the questions.
    Thank you, Mr. Chairman.
    Chairman Shelby. Senator Schumer.

            STATEMENT OF SENATOR CHARLES E. SCHUMER

    Senator Schumer. Thank you, Mr. Chairman, and I would like 
my whole statement to be put in the record.
    Chairman Shelby. Without objection, so ordered.
    Senator Schumer. I would just like to make a brief point 
here, and I would like the Chairman to comment on it when he 
gets a chance, and it is the issue of outsourcing. Many of us, 
on this side of the aisle, have basically supported free trade, 
not exclusively, but basically. And I am troubled by the new 
trends. I do not think they are the same as the old trends. You 
have three factors which we have not had before:
    First, the flow of capital goes to all corners of the 
earth. Ten years ago our major companies would not have 
invested in China and India. Now, they feel confident to do it. 
That is the least important of the three.
    The second is broadband. You can have people working almost 
anywhere around the globe and have instantaneous and full 
communication with them for no cost.
    But third, and most important, for the first time in our 
history, you will have $50 to $100 million over the next 
decade, well-educated, well-motivated Chinese and Indians, who 
are PhD's, who are college graduates who can compete for high-
end jobs. The theory of free trade, since World War II at least 
as it has played out, is the lower-end jobs, the lower-paying 
jobs, the lower value-added jobs would go overseas, but the 
high-end jobs would stay here.
    But if an American company, an international company has an 
instantaneous ability to hire someone in India who is asking 
for $20,000 and does the job that an American gets $100,000 
for, we have new trouble. The head of a major securities firm 
told me that there are 800 people in New York who do the high-
end computer programming. These are the ones who do the 
programs as the derivatives, with billions of dollars sloshing 
around, things you understand, Mr. Chairman, I do not. They get 
paid $150,000 a year. He told me in 3 years none of them will 
be working for us. We will instead hire 800 Indian computer 
programmers, just as good he said, who ask for $20,000 a year.
    The former head of the American Radiological Society told 
me that we will need half the radiologists we have now 10 years 
from now because when you break a leg or need a chest X-ray, 
you will go back to the technician, and the picture will be 
beamed overseas to a Chinese doctor who will be able to read it 
just as well, but instead of charging $500 to read the picture, 
they will charge $50 to read the picture. You will still need 
radiologists because the more complicated things will be read 
by Americans, but the typical, workman-like broken arm, chest 
X-ray will go there.
    So, I think we may have something new here. Free trade 
works on comparative advantage, but if, for the first time, at 
the low end, the middle end and the high end, other countries 
have an advantage over our labor force, where are we headed? 
That is the question I would like. I do not think the classic 
theory of free trade works when the means of production can 
shift in the blink of an eye. I do not know what the answer is. 
I do not believe the old
protectionist nostrums are the answer, but I think we are 
ignoring
the question.
    Just one other point, and I will conclude. I feel strongly 
about this, and it relates a little to what my colleague from 
Michigan asked. Somehow this is related to the productivity 
numbers, I think, although again you know much more about this 
than me. This is the first time we have had such high 
productivity and no job growth. Productivity grew at 3.3 
percent between 1948 and 1973, I think it is--maybe 1977--1973, 
and there was huge job growth.
    In the last 2 years, productivity has grown a little 
higher, 4 percent, and there is no job growth, virtually no job 
growth, job loss. Could it be that the shifting of jobs 
overseas is causing this? That when IBM or Intel hires workers 
to do the same job at one-fifth the cost, somehow the way we 
measure productivity--Intel or IBM is still very productive, 
but it is not happening here.
    Nine percent productivity--I mean I know there are bumps in 
this--but overall something is different when productivity, now 
it is 2 years, and maybe you will say--and I hope you are 
right--that if there is 4 percent productivity growth over 5 
years, we will see job growth, but I think we are in a 
different world, and I think we need to look at this 
differently, and I would ask the Chairman to comment in general 
on that specific issue, which I think plagues all of us. No one 
has good solutions, but I do not think by just sticking to the 
old nostrums everything will be all right. At least I would 
like to know a trajectory, a scenario as to how we deal if our 
high-end jobs can go to India and China, as well as our low- 
and middle-end jobs, whether they be blue collar or white 
collar.
    Thank you, Mr. Chairman. I am sorry to take the time.
    Chairman Shelby. Senator Crapo.

                 COMMENTS OF SENATOR MIKE CRAPO

    Senator Crapo. Thank you very much, Chairman Shelby.
    Chairman Greenspan, welcome to the Banking Committee again. 
I am going to be very brief as well because I want to get on to 
your
comments.
    I would just say that, as with a number of the comments 
that have been made by my colleagues here, my biggest concern 
right now is our budget deficit and the trade deficits that we 
are facing and what the proper policies we must pursue are as 
we try to address them. Obviously, they have been raised a 
little bit today. On a broad scale, there are those who say, 
well, it is easy to balance the budget. Let us just get taxes 
back up where they will bring in the necessary revenue, and 
there are those of us who are fighting to keep the tax cuts 
that we have already adopted permanent.
    Then there is the other side of the question, which I know 
you addressed yesterday. I expect we will discuss today in your 
comments and in some of the questions, as to whether our focus 
should be on first trying to address this problem through 
controlling spending as opposed to first trying to address it 
through tax-rate increases and what consequences those have for 
monetary policy.
    Again, I look forward to your testimony and all of its 
aspects. If I am able to be here when the question and answer 
period comes, I will probably toss you my regular question 
about derivatives, but one way or the other we will get that on 
the record again as well because I expect we will be debating 
that issue at some point again this year.
    Thank you very much for being here.
    Chairman Shelby. Senator Reed.

                 COMMENTS OF SENATOR JACK REED

    Senator Reed. Thank you very much, Chairman Shelby, and 
welcome, Chairman Greenspan.
    The currently improving economic numbers should not 
distract us from some very disturbing trends that persist in 
the growing deficits, and the disappearing jobs, as many of my 
colleagues have pointed to, large trade deficits and a 
weakening dollar, and we might be picking up economic speed, 
but we could very well be heading over the cliff.
    And I hope that in the course of your discussion today or 
your comments that you can address these issues of the deficit, 
particularly as we approach the baby boom generation, the 
impact on, as Senator Schumer discussed so well, the structural 
changes that appear to be siphoning off jobs to places around 
the world that impact on not only our economy, but also our 
society, the trade deficit and all of these issues that are 
critical to our future.
    We appreciate your appearance here today and look forward 
to your testimony. And I would ask that my whole statement be 
put in the record.
    Chairman Shelby. Without objection, so ordered.
    Senator Dole.

              STATEMENT OF SENATOR ELIZABETH DOLE

    Senator Dole. Thank you, Mr. Chairman. As you know, I 
normally submit my statement for the record in the interest of 
time, but today, since I have----
    Chairman Shelby. It is your time, Senator Dole.
    Senator Dole. --some conflicts as well, I would like to 
make a few statements on the record.
    I want to thank you and Ranking Member Sarbanes for holding 
this hearing. Welcome, Chairman Greenspan.
    According to the payroll survey, 112,000 new jobs were 
created in January--the largest monthly increase since December 
2000. Over the past 7 months, the national unemployment rate 
has fallen from 6.3 percent in June, to 5.6 percent in January, 
the fastest steady decline in nearly a decade. That 
unemployment rate, according to the household survey, is below 
the average of the 1970's, the 1980's, and the 1990's. The 
Nation's economy is on the right track, jobs are being created 
and people are going back to work. This is a result of the 
economic growth tax relief package that was signed into law in 
June 2001, and renewed in May 2003. President Bush proposed 
bold tax relief, and its implementation has produced very 
positive results.
    Chairman Greenspan, I applaud your ability to keep interest 
rates down while the President's tax relief creates liquidity 
in our monetary system.
    The positive economic trends that the country has enjoyed 
lately are certainly a welcome relief, and I expect the 
positive progress to continue. But while there are good trends 
in national unemployment numbers, my home State of North 
Carolina continues to lag behind the national average. Indeed, 
North Carolina has areas that are severely hurting. The losses 
of manufacturing jobs, mainly in textiles and furniture, have 
been felt throughout the State. This past summer, North 
Carolina experienced the largest layoff in the State's history 
when Pillowtex, a huge textile company dating back 116 years, 
closed its doors forever. The result was 4,400 people losing 
their job in a single day.
    I was able to be on the ground in North Carolina to speak 
with displaced workers about the challenges that lay ahead, and 
it was a very emotional experience as constituents came up to 
ask what they were going to do about paying for health care to 
treat a husband's cancer or a child's illness or what was going 
to happen to my 401[k].
    Local community college officials with whom I visited 
explained the stark reality that many of these recently 
displaced workers were not able to read. They were illiterate. 
They would need the most basic of remedial education, the 
equivalency of a high school diploma before being retrained in 
a skill.
    In Eastern North Carolina, the layoffs and plant closures 
have
resulted in 2,200 layoffs since the summer, and in just the 
past 2 weeks, the Western region of North Carolina has lost 
over 1,100 jobs. These layoffs have produced ripple effects 
across communities and throughout the State. One of these 
effects is a strain on the State's community college system. 
With a vast amount of workers out of a job and in desperate 
need of retraining, community colleges have said, ``Look, we do 
not have enough space. We do not have enough instructors. We 
need new programs.''
    I visited with many of the presidents. I am passionate 
about their positive role in the State of North Carolina. In 
short, community colleges are on the front lines in a 
transitioning economy, and they must have more support.
    Today, President Bush will outline his plan entitled, 
``Jobs for the 21st Century.'' It dedicates more than $500 
million for a series of measures to better prepare current and 
future workers for jobs in the new millennium. It also includes 
a $250 million proposal to fund partnerships between community 
colleges and employers in high-demand job sectors. I want to 
express my earnest support for this plan and highlight its 
importance to my home State of North Carolina. But, first, 
Chairman Greenspan, let me quote you in testimony to the House 
yesterday: ``I must say to you that the community colleges in 
this country have been in the forefront of a major change in 
the quality of what we are doing with respect to reestablishing 
skills.'' I appreciate that support and could not agree more.
    As I mentioned, North Carolina's community college system 
has been stretched beyond its limits, and I am certain that 
that is true in many other States. I have worked very closely 
with the Administration regarding the need for community 
college funding, and it is my hope that the President's plan 
will bring timely relief where it is needed most in my State. 
This Congress will have an opportunity to increase Pell Grant 
funding and to address community college needs through Higher 
Education Reauthorization--and I look forward to working with 
my colleagues to utilize these opportunities to strengthen 
community colleges. The future of North Carolina's economy 
depends on it.
    Chairman Greenspan, I appreciate your willingness to come 
and testify today. I look forward to hearing your thoughts on 
what we must do to ensure that the benefits of a recovering 
economy can be extended to all areas of North Carolina and the 
Nation.
    Thank you.
    Chairman Shelby. Mr. Chairman, we again welcome you to the 
Committee. Your written statement will be made part of the 
record in its entirety. You proceed as you wish.

 STATEMENT OF ALAN GREENSPAN, CHAIRMAN, BOARD OF GOVERNORS OF 
                   THE FEDERAL RESERVE SYSTEM

    Chairman Greenspan. Thank you very much, Mr. Chairman. I am 
pleased to be here today to present the Federal Reserve's 
Monetary Policy Report to the Congress. I believe this is the 
thirty-third time I am delivering this report. I hope my 
arithmetic is right. I have not checked it with staff----
    Chairman Shelby. I bet your arithmetic is right.
    Chairman Greenspan. I know I am close, somewhere in there.
    Senator Sarbanes. Mr. Chairman, could you pull that 
microphone a little closer. I think it would be helpful to 
everybody.
    Chairman Greenspan. Is this better?
    Senator Sarbanes. Yes.
    Chairman Greenspan. When I testified before this Committee 
in July, I reported that conditions had become a good deal more 
supportive of economic expansion over the previous few months. 
Still, convincing signs of a sustained acceleration in activity 
were not yet in evidence. Since then, the picture has 
brightened. Gross domestic product expanded vigorously over the 
second half of 2003. Progress in creating jobs, however, has 
been limited.
    Looking forward, the prospects are good for sustained 
expansion of the U.S. economy. At the same time, increases in 
efficiency and a significant level of underutilized resources 
should help keep a lid on inflation.
    In retrospect, last year appeared to have marked the 
transition from an extended period of subpar economic 
performance to one of more vigorous expansion. Once again, 
household spending was the mainstay, while strengthening the 
capital spending over 2003 contributed importantly to the 
acceleration of real output.
    To a considerable degree, the gathering strength of capital 
spending reflects a substantial improvement in the financial 
condition of businesses over the past few years. Firms' profits 
rose steeply during 2003, following smaller gains in the 
previous 2 years.
    The profitability of the business sector was again 
propelled by stunning increases in productivity. The strong 
gains, however, have obviated the need for robust increases in 
business payrolls. To date, the expansion of employment has 
significantly lagged increases in output. Gross separations 
from employment, two-fifths of which have been involuntarily, 
are about what would be expected from past cyclical experience, 
given the current pace of output growth. New hires and recalls 
from layoffs, however, are far below what historical experience 
indicates. To a surprising degree, firms seem able to continue 
identifying and implementing new efficiencies in their 
production processes and thus have found it possible so far to 
meet increasing orders without stepping up hiring.
    In all likelihood, employment will begin to grow more 
quickly before long as output continues to expand. Productivity 
over the past few years probably received a boost from the 
efforts of businesses to work off the stock of inefficiencies 
that had accumulated in the boom years. As those opportunities 
to enhance efficiencies become scarcer, and as managers become 
more confident in the durability of the expansion, firms will 
surely once again add to their payrolls.
    The consequence of the rapid gains in productivity and 
slack in our labor and product markets has been sustained 
downward pressure on inflation. Inflation last year was in a 
range consistent with price stability.
    Although the prospects for the U.S. economy look quite 
favorable, we need to remind ourselves that all forecasts are 
projections into an uncertain future. We must, as a 
consequence, remain alert to risks that could threaten the 
sustainability of the expansion.
    Besides the chronic concern about a sharp spike in oil or 
natural gas prices, a number of risks can be identified. Of 
particular importance to monetary policymakers is the 
possibility that our stance could become improperly calibrated 
to evolving economic developments. But the evidence indicates 
clearly that our current policy stance will not be compatible 
indefinitely with price stability and sustainable growth. The 
real Federal funds rate will eventually need to rise toward a 
more neutral level. However, with inflation very low and 
substantial slack in the economy, the Federal Reserve can be 
patient in removing its current policy accommodation.
    The outlook for the Federal budget deficit is another very 
critical issue for policymakers. As I have noted before, the 
debate over budget priorities appears to be between those 
advocating additional tax cuts and those advocating increased 
spending. Although some stirrings in recent weeks in the 
Congress and elsewhere have been directed at actions that would 
lower forthcoming deficits, to date, no effective constituency 
has offered programs to balance the
budget.
    Our demographics, especially the retirement of the baby 
boom generation beginning in just a few years, mean that the 
ratio of workers to retirees will fall substantially. Without 
corrective action, this development will put substantial 
pressure on our ability in coming years to provide even minimal 
Government services while maintaining entitlement benefits at 
their current level, without debilitating increases in tax 
rates.
    Addressing the Federal budget deficit is even more 
important in view of the widening U.S. current account deficit. 
To date, the current account deficit has been financed with 
little difficulty.
    Nonetheless, given the already substantial accumulation of 
dollar-denominated claims, foreign investors, both private and 
official, may become less willing to absorb ever-growing claims 
on U.S. residents. Taking steps to increase our national saving 
through fiscal action to lower Federal budget deficits would 
help diminish the risks that a further reduction in the rate of 
purchase of dollar assets by foreign investors could severely 
crimp the business investment that is crucial for our long-term 
growth.
    The large current account deficits and the associated 
substantial trade deficits pose another imperative--the need to 
maintain the degree of flexibility that has been so prominent a 
force for U.S. economic stability in recent years. The greatest 
current threat to that flexibility is protectionism. 
Consequently, creeping protectionism must be thwarted and 
reversed.
    In summary, Mr. Chairman, in recent years, the U.S. economy 
has demonstrated considerable resilience to adversity. It has 
overcome significant shocks that, in the past, could have 
hobbled growth for a much longer period than they have in the 
current cycle. Looking forward, the odds of sustained robust 
growth are good, although, as always, risks remain. The 
Congress can help
foster sustainable expansion by taking steps to reduce Federal 
budget deficits and, thus, contribute to national savings and 
by continuing to pursue opportunities to open markets and 
promote trade. For our part, the Federal Reserve intends to use 
its monetary policy tools to promote our goals of economic 
growth and maximum employment of our resources in an 
environment of effective price stability.
    Thank you very much, Mr. Chairman, and I look forward to 
answering any of your questions.
    Chairman Shelby. Thank you, Chairman Greenspan.
    Chairman Greenspan, while the job numbers have improved, 
that is of little comfort to those who have been without work 
for quite some time or are still underemployed. Are there any, 
to your knowledge, any historical analogies to the present 
situation, where there has been a similar disconnect between 
strong economic growth and job creation or is this an atypical 
situation?
    Chairman Greenspan. I think this is atypical or I should 
put it more exactly, I do not recall a period even remotely 
like this. It is fairly evident what is happening. And as I 
mentioned in my prepared remarks, the gross separations, that 
is, layoffs, firings, and even voluntary job leaving, have gone 
down quite measurably and, indeed, it looks pretty much the way 
you would expect it to look given the growth rate of the 
economy.
    When you look on the other side of the equation, new hires 
from new jobs or recalls from layoffs are extremely subdued, 
and, indeed, the pattern that you see in the new hires series 
actually is a mirror reflection of the productivity growth that 
we see in our other sets of data.
    In short, what is happening is that as demand has picked 
up--and, indeed, it has picked up--businesses have been able to 
find ways in which they can increase efficiency such that they 
can meet new orders and new commitments without bringing on the 
usual new hires that in the past we would have seen under 
comparable circumstances.
    As I said in the House yesterday, it seems likely that the 
extraordinary pace of productivity is almost surely going to 
slow, largely because many of the reasons for it, as best we 
can judge, are not continuing; namely, issues that reflect the 
nature of the types of investments and the types of 
inefficiencies that arose in the boom period which are now 
being reversed. We have to eventually run out of opportunities 
to exploit all of those inefficiencies.
    So what we are seeing is something new. It is something 
different. I do not believe it is going to continue. It will 
continue, in part, because we think productivity will be above 
what it has been, while surely, over the next year or two, well 
below what we have seen in the recent quarters.
    Chairman Shelby. Is what is driving the productivity gains, 
is that the hard work of the American workers plus technology, 
among other things?
    Chairman Greenspan. Well, looking back, this extraordinary 
expansion in high-tech equipment in the 1995 to 2000 period 
probably had a rate of return on it higher than was realized at 
the time. In a sense, we have all experienced the situation 
where we get a new PC, and our initial use of it is probably 10 
percent of the capacity, and, indeed, the most generally new 
things about the PC we do not employ maybe for 6 months or 2 
years.
    And if you generalize this in the way business is adjusting 
to the new technologies, there is a long lag before the 
efficiencies actually materialize because they do not know how 
to use the stuff, and as they learn, it begins to have a 
significant impact.
    In my judgment, when we look back on this whole period and 
try to determine the rate of return off that equipment that was 
installed in the latter part of the 1990's, I suspect we are 
going to find that the real rate of return was quite a bit 
higher than we anticipated, either at the point it was being 
initiated or even 2 or 3 years after it was in place.
    Chairman Shelby. Well, in other words, it has been a 
sustained impact.
    Chairman Greenspan. Indeed, it has.
    Chairman Shelby. In light of what many perceive as job 
creation problems associated with productivity gains, could you 
just briefly elaborate on the overall and long-term importance 
of productivity for the economy. Is it, after all, absolutely 
critical for long-term economic growth and prosperity?
    Chairman Greenspan. Yes, Mr. Chairman, I think this is a 
very important point you are making. It is very evident from 
the data that the improved efficiencies are making it very 
difficult to get job growth, and, indeed, a good deal of the 
job loss that we have seen is a result of that, but we can 
scarcely be against improved efficiencies and increased 
productivity because, at root, that is where our standards of 
living ultimately come from.
    We will get through all of this problem that we are now 
engaged in, and if history is any guide, we will have 
employment expanding at a reasonably good clip within a short 
period of time. But what is very important for the longer-term 
outlook for the American economy is how productive we seem to 
have been able to become. And while it clearly has a short-term 
downside, over the long-term, it is an unequivocal positive 
factor for our country.
    Chairman Shelby. Thank you.
    Senator Sarbanes.
    Senator Sarbanes. Thank you very much, Mr. Chairman.
    Chairman Greenspan, The Wall Street Journal this morning, 
in reporting on your testimony yesterday, says, ``Mr. 
Greenspan's warnings on the budget deficit were more urgent 
than in previous remarks.''
    I note in your statement that you say, ``The imbalance in 
the Federal budgetary situation, unless addressed soon, will 
pose serious long-term fiscal difficulties.'' And then a 
paragraph later you go on to say, ``The fiscal issues that we 
face pose long-term challenges, but Federal budget deficits 
could cause difficulties even in the relatively near term.''
    Now, I also note in reading a New York Times article on 
your testimony yesterday, and I am now quoting, ``To the relief 
of the Administration, though, Mr. Greenspan did not criticize 
the President's plan to make his tax cuts permanent. That would 
increase the projected deficit by more than $1 trillion over 
the next 10 years even if the Government virtually freezes 
discretionary domestic spending. Mr. Greenspan did not 
criticize Mr. Bush's budget plan, and because neither 
Republicans nor Democrats on the House Financial Services 
Committee asked his opinion about making the tax cuts 
permanent, he did not volunteer one.''
    What is your opinion about making the tax cuts permanent?
    [Laughter.]
    Chairman Greenspan. I am glad you asked, Senator.
    [Laughter.]
    Let me put a little history in this.
    Senator Sarbanes. And as you answer it, let me just--I am 
prompted to do this by an editorial that appeared in The New 
York Times last month. ``The recent book about former Treasury 
Secretary Paul O'Neill makes it clear that Mr. Greenspan even 
had qualms about the extent of the Administration's first round 
of tax cuts in early 2001. Mr. Greenspan can no longer keep his 
worries to himself. Whether he musters the full authority of 
his office to sound the alarm and urges the President and 
Congress to reconcile Federal revenues and spending will help 
determine Mr. Greenspan's legacy as Fed Chairman.''
    Now what is your view about making tax cuts permanent?
    Chairman Greenspan. In September of 2002, I appeared before 
the House Budget Committee, strongly requesting that the about-
to-expire pay-go and discretionary caps be renewed. They were 
not. I am still in favor of pay-go and discretionary caps as a 
critical issue in budgetary processing.
    As I indicated yesterday, I think that one of the first 
orders of business of the Congress would be to restore 
discretionary caps, and especially pay-go. And if that is 
indeed the case, under current law, you would have to have a 
pay-go evaluation for any change in the tax structure. So, I am 
in favor, as I have indicated in the past, for continuing the 
tax cuts that are in dispute at this particular stage, but I 
would argue strenuously that it should be taken out on the 
expenditure side.
    And let me go further on the question of the issue----
    Senator Sarbanes. How do you take it out on the expenditure 
side if, as this points out, even if you just froze 
expenditures--and we have all of these expenditures in Iraq and 
homeland security--you would still be running up an additional 
over $1 trillion deficit?
    Chairman Greenspan. Let me get to the broader issue which 
is what concerns me. Everyone is looking at the issue only of 
the discretionary spending part of the budget, but I suspect 
that if we were to look at the arithmetic and all of the 
various alternatives that exist out there, we are going to have 
to relook at some of the entitlement spending outlays.
    In 1983, when I was in charge of the Social Security 
Commission, and we went through a whole series of evaluations 
of possible changes, I strongly advocated at the time--and I 
have done subsequently--things such as indexing the age of 
eligibility to longevity.
    I have argued, on occasion, for getting a better price 
index to index various different benefits. And I raise these 
issues largely because I think we have been looking at, we have 
constructed a good deal of the benefit structure over the last 
quarter of a century without a firm look at whether or not the 
real resources were there to meet those benefits.
    And I suggest that what we have to do, as difficult as it 
is going to be, is to relook at some of these commitments that 
were made without any advertence to what the long-term 
availability of resources is.
    I do not know where you come out on that. I do know that 
the arithmetic does not work, and I would really suggest that a 
broader view of what it means to have such a huge change in the 
number of retirees that will inexorably occur over the next 
decade, and I think that the sooner we address that the sooner 
we can assure the people who will be retiring that the benefits 
that are being promised will, indeed, be forthcoming.
    My real concern is that when the time comes to start to pay 
these benefits, we are going to find that we are in very 
serious fiscal difficulty. I am not saying we are going to 
renege on any of those benefits. We cannot, and we will not. 
But I do think it is important for the people who are retiring 
to have a sense of security that what is being promised to them 
as they retire will, indeed, be there, and I mean ``there'' in 
real resources.
    Finance is merely a means by which we exchange physical 
goods and services. And when you look at the hard issue of what 
proportions of the output that we are expected to produce over 
that period will be going to retirees, we have to make sure 
that we can do that.
    Senator Sarbanes. Mr. Chairman, let me just observe that 
that is a very large issue. In the meantime, we are faced here 
and now with the issue that is being pressed on the Congress, 
and very hard by the Administration--in fact, it is their 
number one priority to do further tax cuts by making these tax 
cuts permanent. They will undermine our future fiscal strength 
in terms of dealing with the very problem that you just spent a 
few minutes outlining for us.
    It is difficult for me to understand why you cannot state 
very simply that one way of addressing the budget deficit is to 
show restraint on both spending and tax cuts, since they both 
make up the combination that determines budget deficits.
    Chairman Greenspan. Oh, I am certainly willing to say that. 
I believe that.
    Senator Sarbanes. Thank you.
    Chairman Shelby. Senator Allard.
    Senator Allard. Mr. Chairman, I want to talk a little, and 
ask you a question about, manufacturing jobs. The loss of 
manufacturing jobs is not a particularly new phenomena. I think 
it has been going on for some time actually. I wondered if you 
would talk about that so the Committee is clear that there are 
jobs created in the small business sector and then there are 
the manufacturing jobs themselves. I wonder if you would 
comment on that and what you see happening in the United 
States, what you see happening worldwide, and perhaps in some 
of our competitor nations that have been mentioned, such as 
China and India.
    Chairman Greenspan. Well, Senator, one thing that has been 
going on in this economy for generations is a gradual shift 
from physical things and manual labor to produce our GDP to 
ideas and more conceptual-related types of output. As a 
consequence of that, the actual weight of the GDP, in other 
words, the raw materials that go into it, has gone up hardly at 
all. Virtually, all of the increase in our GDP is conceptual 
ideas, new ways of doing things.
    And so it should not be a surprise that the ratio of 
manufacturing to the GDP has been very gradually going down. It 
is going down, I must say, very gradually, not in any 
pronounced way, but because the productivity and efficiencies 
have been so extraordinary, far better than the rest of the 
economy, what happens is that with a level of production, which 
is continuing to rise quite significantly, you have such 
exceptional efficiencies that they are able to produce that 
output with ever fewer employees. As you have pointed out, it 
has been going on for a long number of years.
    Senator Allard. It seems to me that this has been the case 
at least back to 1979--I was talking with Senator Bennett here, 
and he thinks that it has been maybe even 50 years that this 
phenomena has been occurring. Can you give us kind of a range?
    Chairman Greenspan. I think you are correct. I think it 
peaked in 1980, as my recollection serves me, but that process 
has been going on for quite a good deal of time. Manufacturing 
productivity growth has outstripped the overall productivity 
quite significantly.
    Senator Allard. This is a phenomena that is going to happen 
with a more modern economy, meaning that which is happening in 
the United States. In other countries like Japan and China, for 
example, I would guess there is probably a loss of 
manufacturing jobs because they also are becoming more 
efficient. Would you make that assumption?
    Chairman Greenspan. No, that is a fact. Now, in China, it 
is a little bit difficult because, while it is true the 
manufacturing jobs have gone down quite appreciably, a lot of 
that was the excess staffing that goes on in state-owned 
enterprises. And so when they rationalized a number of them, 
their employment numbers came down. It is hard. We do not have 
enough data from them to disag-
gregate what part of it is merely extracting what was a very 
odd way of using people in some of those state-owned 
enterprises. Whereas, now they are making a lot of progress, 
but still there is still a lot of it.
    Senator Allard. I am concerned about the deficit, as are 
many other Members in the Senate and a lot of Americans. In 
your view, what is the greatest problem with our deficit? Is it 
on the spending side of Government programs or is it our tax 
cuts?
    Chairman Greenspan. I have always argued that the problem 
is on the expenditure side and that our real danger is that we 
will create longer-term commitments which are very difficult to 
finance. And one of the problems that commitments have is that 
it is very difficult, once you have made them, to reverse them.
    So as I argued yesterday and on previous occasions, I think 
that in addressing this budget issue, it is crucially important 
that we try to find, wherever we can, reductions in outlays 
before adverting to the question of revenues to fill in the 
gap.
    As I have been saying for quite a good deal of time, I 
think the budget deficit problem needs to be resolved primarily 
or fully on the expenditure side. And what I mean by that is 
that we should be looking at all of the possible changes, 
reductions we can make in expenditures before we find we have 
no other alternative but to add taxation to fill in the gap.
    The reason for that is we are reasonably certain that if we 
have a solution primarily from the expenditure side, if not 
wholly, that we have a stable fiscal output. We do not know the 
extent to which increased taxes will inhibit the growth of the 
GDP and, hence, the revenue base. And we have to be quite 
careful because it is very obvious that if you put very 
substantial tax rate increases in, you could slow the rate of 
growth enough so that the revenue base does not increase 
anywhere near the amount of expectations when you raise taxes.
    You have to be careful about being unable to close the gap. 
So, I think there are far greater risks in failure on the tax 
side than there is on the expenditure side. I am not talking 
about cutting expenditures. I am talking about slowing down the 
rate of increase.
    Senator Allard. Thank you.
    Thank you, Mr. Chairman. I see my time has expired.
    Senator Bennett [presiding]. Yes. I would like to follow 
that up very briefly here, Mr. Chairman. I have quoted you, and 
I would like to check and make sure I am quoting you correctly, 
as having said, ``Congress can set the level of expenditure 
just about anywhere it wants, but it cannot set the level of 
income wherever it wants. The level of income is a product of 
the economy, and if
the economy is damaged, you are stuck with the level of 
expenditure that you have committed, but you cannot guarantee 
the level of income.''
    Is that a fair summary of----
    Chairman Greenspan. I do not remember the words, but I 
certainly agree with them.
    [Laughter.]
    Senator Bennett. I think that is precisely what happened in
California. They had the rivers of cash that came out of the 
dot-com boom, and the instant millionaires, and all of the 
capital gains realizations, and then they built the expectation 
of that revenue into their budget and made a series of 
commitments which, when the bust came, they could not commit 
because the revenue was
not there.
    Let me go back to the issue I raised during my opening 
statement, and I realize this is always dangerous, but I will 
give you an anecdotal example to suggest what I think may be 
going on.
    On an airplane flying from Salt Lake City to Washington, I 
sat next to a woman and got into conversation, as you do on 
airplanes, and this was her story. She worked for a fairly 
large company. It was a high-tech company. The bust came. She 
was laid off as they had to downsize their employment. She and 
a group of her friends got together, organized a small firm 
that now has only eight employees. She was flying to Washington 
because this small firm was able to obtain a contract with the 
Department of the Navy. She was actually doing better 
financially than she was when she was with the big company, as 
were her associates who had formed this small group.
    Now, statistically, the job that she lost would show up as 
a lost job in the payroll survey. It would show up as a new job 
in that household survey, but as far as the payroll survey is 
concerned, her job is lost, and has never been filled and never 
will be. Is it not the payroll survey that we use as the base 
for computing productivity, and therefore would that not 
indicate that productivity is overstated if there are enough 
examples, like this woman, of people who have left the payroll 
world, gone into the self-employment or small business--in her 
case, it is a small business rather than self-employed--that, 
for one reason or another, is not plugged into the payroll 
database, and therefore productivity numbers would be 
artificially high and job numbers would be artificially low 
with the Bureau of Labor Statistics?
    That is my hunch of what might be going on, but I cannot 
put my handle on it in any way. I would be interested in the 
thoughts you might have about some structural changes that are 
going on.
    Chairman Greenspan. We have looked at that in some detail, 
Senator, and we have concluded, for reasons I will give in a 
moment, that the payroll data do look to be the correct data. 
Let me express to you why.
    If we take the household data and make all of the 
adjustments that are required to make it conceptually 
equivalent to the payroll data, we still have this very big 
difference. In other words, the addition of proprietors and 
unpaid family workers, the adjustments for multiple jobs and 
all of the various things is not the answer to this 
discrepancy. It is deep-seated in the data themselves.
    We asked ourselves what could go wrong with either series. 
We looked first at the payroll data, and we find that it is 
benchmarked every quarter to the unemployment insurance data 
system which is a full coverage of wages and salaries that are 
required for unemployment insurance calculations, so that we 
have a total number of people which is relatively full coverage 
for wage and salary workers only.
    The monthly series that we publish is merely a sample which 
works off that quarterly series, and for all practical 
purposes, the level is relatively a full count. The household 
series, however, is a sample of 60,000 households. It is a very 
big, very sophisticated sample, but what that does is merely 
take ratios of, for example, the people in the household, and 
asks are you employed, are you looking for a job, are you out 
of the labor force? And all they have is a sample of 60,000 
which have those data in them.
    They create the household employment figures by taking the 
ratio of employment to the number of people in the household, 
and they multiply it by the population, the so-called 
noninstitutional population.
    What we did is to take a look at the population 
projections. We find that the way they are made is, as you 
know, they take the base, which the last base is 2000, they add 
births, subtract deaths, and add net immigration.
    We then took a look at what the implied population number 
would be if we started with the data we had from the 
unemployment insurance benchmark system. Using the household 
ratios, we then added back the proprietors, the type of person 
that you were
referring to, and the nonlabor force people to get a synthetic, 
independent estimate of population.
    What, indeed, we get is a significantly slower pace of 
population which, since we presume that the births and the 
deaths are fairly accurate estimates, and the immigration is 
not, we then presumed that most of the difference is in 
immigration. However, we find that we overexplain the problem, 
so it is not easily that simply explainable, but it is apparent 
that a goodly part of the problem is that the household 
employment has been overestimated largely because of what we 
perceive to be an overestimate of population.
    It is interesting, in this regard, that in January the 
population numbers were revised down by 500,000. Now, we still 
have not closed the gap, but the presumption is that with these 
types of analyses, plus the fact that 60,000 is a very large 
sample, but it still has sample variance in it, we have 
concluded that, as best we can judge, the payroll series is the 
more accurate number. And I believe that the Bureau of Labor 
Statistics has come to the same conclusion.
    Senator Bennett. Yes, they have, and I am not challenging 
that. We are aware at JEC of all of the statistical noise in 
the data that you have described, and we have tried to do our 
own adjustments on the census in the way that you have talked 
about.
    The thing that keeps nagging at me on this issue, and maybe 
I am obsessing and should forget it, but, historically, the two 
have run fairly close together. The household survey has always 
been higher than the payroll survey.
    Chairman Greenspan. Oh, in level, yes. Absolutely, yes.
    Senator Bennett. But when one moves up, the other moves up 
not in lockstep, but they have historically kind of moved in 
the same direction.
    Chairman Greenspan. That is a fair statement.
    Senator Bennett. In this particular recession and recovery 
period, that has not been the case. They have diverged in a way 
that has no historic background, and that leads to the question 
that I raised in my opening statement, and I do not want to 
beat this horse any more, but simply put it out for you to 
continue to think about. Is this sending a signal that there 
may be some structural change going on, and can we dig into it 
to the point, as I said in my opening statement, where we are 
more sure about the data?
    If you ask me which is the more reliable, I would say the 
payroll survey is the more reliable, but I am not as convinced 
that the household survey is not trying to tell us something as 
I would be if the two were moving in a historic pattern.
    Chairman Greenspan. Oh, I think that is a correct way of 
evaluating it. One thing, obviously, which clearly caught our 
attention, is the issue you raised at the very beginning; 
namely, that one way to explain these extraordinary 
productivity figures is that they are not real, and, indeed, 
they are a function of the fact that the denominator is being 
basically underestimated.
    So, we are aware that there may be something not fully 
explained here because, as I mentioned to you just a moment 
ago, our endeavor to reconcile to the population figure does 
not quite do it. It overadjusts and implies a decline in 
immigration to make them reconciled, which is just not 
credible.
    Senator Bennett. I agree with that, and we have run into 
the same problem in the JEC as we are trying to deal with this.
    I have some other questions, but Senators have returned, 
and I will wait for a second round.
    According to the sheet that we have from Chairman Shelby, I 
think, Senator Reed, you are next.
    Senator Reed. Thank you, Mr. Chairman.
    Thank you, Chairman Greenspan, for your testimony. I would 
like to follow up on the line of questioning that Senator 
Sarbanes began and understand your position on the pay-go 
rules. You would, one, favor their reinstatement?
    Chairman Greenspan. Correct.
    Senator Reed. Two, these pay-go rules would cover any 
proposed tax changes, they would have to be paid for?
    Chairman Greenspan. That is what they are there for--both 
taxes and spending.
    Senator Reed. Taxes and spending. In that context, would 
you think it appropriate that tax provisions be looked at to 
pay for other tax provisions, or would you exclusively urge 
that expenditures be cut?
    Chairman Greenspan. I do not have a strong feeling one way 
or the other. My suspicion is that the success of the pay-go 
rules--and they were successful--over the years was more that 
they locked in the requirement that the deficit be addressed. I 
obviously would prefer it be biased toward reducing outlays, 
because I think that is the area where the probability of 
success is highest in the sense of its impact on the economy. 
But I think that the focus has to be firmly on pay-go in 
general rather than how it is done.
    Senator Reed. May I assume, then, that you would at least 
conceptually oppose provisions that would only make pay-go 
applicable to expenditures and exclude or protect any of the 
tax provisions?
    Chairman Greenspan. I would like to see the pay-go rules 
that expired in September 2002, be reapplied hopefully in 
precisely the same way.
    Senator Reed. In your testimony, you did suggest that 
because of the dwindling discretionary spending, and because of 
some accounts that we frankly cannot touch--Department of 
Defense, maybe not in general, but expenditures in Iraq and 
Afghanistan--you are looking at policy options such as 
increasing the age of eligibility for Social Security, 
significant changes----
    Chairman Greenspan. I might add Medicare would be implicit 
in this.
    Senator Reed. --and Medicare--you just stole my next 
phrase--and I think you understand that these are exceedingly 
difficult choices to make.
    Chairman Greenspan. I fully understand that. However, the 
other alternative is to have legislation which repeals the laws 
of arithmetic.
    Senator Reed. Well, some of the legislation I have seen 
lately proposed by the Administration is proposing to repeal 
the laws of arithmetic, so I hope you gave them the advice, 
too, Mr. Chairman.
    One of the issues with respect to arithmetic is timing. 
These proposals would be difficult in any case, but the sooner 
we at least begin to consider them, the better off we will be. 
I have seen no leadership from the Administration suggesting 
proposals of this order. Would you urge them to begin this 
process now?
    Chairman Greenspan. Certainly.
    Senator Reed. Thank you.
    One of the other areas of concern is the time frames where 
we look at different dimensions of the budget. We have 
estimates of 5 years of expenditures and 10 years of 
expenditures. We look at Social Security in 75-year periods. Do 
you think it would be helpful if we looked at these proposed 
tax cuts in 75-year periods?
    Chairman Greenspan. I do not even think the 75-year period 
is other than an arbitrary number. I think what we should be 
looking at is the present value of all outlays and receipts. In 
other words, as you are aware, when you get to the 76th year, 
you go off the cliff, and it is very often very odd that people 
do not understand why, as you go from 1 year to the next with 
the 75-year pattern, when you drop off the most recent year and 
you add the huge deficits that you get in the longer years, the 
numbers change. I think that is an indication that you need to 
look at this in a much more conceptually appropriate way.
    The 75-year number was employed many, many years ago as a 
convenience of calculation and explanation, but it is not a 
mathematically appropriate statistic.
    Senator Reed. But it seems to give us a little longer 
perspective, obviously, than the 5 years and 10 years that we 
look at tax cuts and expenditures. I think the same phenomenon 
seems to take place if you look at these proposed tax cuts. 
Some of the deficit numbers explode beyond the 5- or 10-year 
period, yet the Administration talks only in terms of these 
shorter periods. Is that a conceptual failing?
    Chairman Greenspan. Well, I think as Senator Bennett 
pointed out earlier, our forecasts are pretty thin, but while 
that is true, it is better to have a forecast than none. You do 
reduce the risks by at least looking out into the future and 
getting some judgments.
    But the budget as it affects the economy is ever-
increasingly moving toward a more distant horizon. Remember, we 
used to have 1-year budgets, then we went to 5-year budgets, 
now we are going to 10, with supplementals on 20, 30, and 40. 
And I think that process will continue largely because of the 
increasing proportion of the budget which is essentially 
related to the state of retirement, and that is something we 
never had before. The average life expectancy was not all that 
great, and the number of retired people was not that many. But 
the incredible increase in our standards of living has enabled 
us to support very large retired populations, and I think as a 
consequence of that, in evaluating our budget process, our 
horizon has to move out, and I am not even sure that 10 years 
is enough, frankly.
    Senator Reed. Thank you, Mr. Chairman.
    Chairman Shelby. Senator Sununu.
    Senator Sununu. Thank you, Mr. Chairman.
    Chairman Greenspan, you said that one possible reason--
possible explanation--for the high rates of productivity if in 
fact they are not real would be an underestimation of the 
denominator. I presume that means the denominator is the 
payroll survey in that equation?
    Chairman Greenspan. Well, actually, only in part. The base 
is the payroll survey and the hours that are in that survey. 
But then, the Bureau of Labor Statistics adds estimates of 
hours for proprietors and other elements of the overall 
workforce of nonfarm business, which as you remember is the 
numerator. So it is not solely the payroll series, but that is 
by far the dominant factor in the
denominator.
    Senator Sununu. But in responding to Senator Bennett's 
question, I just want to make sure that was your point----
    Chairman Greenspan. Yes.
    Senator Sununu. --that you were suggesting that if the 
payroll survey were too low a number, then that would 
artificially inflate the productivity number. Is that a correct 
statement?
    Chairman Greenspan. That is correct. I do not believe that 
that is, indeed, the case.
    Senator Sununu. No. You were very clear that you thought 
the payroll survey was most accurate. I just want to make sure 
that I understood the answer that you provided to Senator 
Bennett.
    Chairman Greenspan. That is correct, Senator.
    Senator Sununu. Senator Bennett may have asked--and I 
apologize if I missed the response--about the degree to which 
issues such as the self-employed or contracted workers are 
taken into consideration in the payroll survey or the household 
survey. Could you just touch on that briefly?
    Chairman Greenspan. I will. Contracted workers will either 
be in the payroll series itself--you will remember that 
temporary employment is part of the payroll series, and the 
number of contractual types of work are there as well--but to 
the extent that they are proprietors, or they are essentially 
self-employed, they will be picked up in the denominator of the 
productivity estimate largely from the household survey data, 
which is really the sole source of self-employed.
    Senator Sununu. The household data is the only source of 
the self-employed numbers; is that what you just said?
    Chairman Greenspan. That is my recollection, yes.
    Senator Sununu. So there is no effort to, for example, look 
at IRS filings, who is filing as self-employed, doing their 
taxes, declaring that they are self-employed, to try to draw 
some correlation?
    Chairman Greenspan. Well, I have looked at those data 
myself. And it is probably a superior procedure to do what the 
BLS is doing, taking a very large sample survey and estimating 
from those data themselves.
    Senator Sununu. Excellent.
    It is my understanding that the Fed just recently announced 
a change in policy with regard to the short-term financing of 
interest payments on GSE debt. Could you talk about that a 
little bit, what the rationale for that policy is, when it 
might be implemented, and what the economic impact might be, or 
the impact to the financial markets?
    Chairman Greenspan. Yes, Senator, what you are referring to 
is what we call ``daylight overdraft'' in the Federal Reserve 
System. During the day, there are transfers in and out of 
Federal Reserve accounts, and there are a huge amount of 
payments, there are a huge amount of receipts, and over the 
years, we have endeavored to remove what has been an increasing 
problem, namely, that a number of the private payers have been 
paying later in the day, whereas the Federal Reserve pays a lot 
of the payments for, say, the U.S. Treasury and for agency and 
GSE debt at 9:15 a.m. in the morning.
    The consequence of this is that if you have an owner of a 
GSE security, whether it is a depository institution directly 
or a depository institution acting for a customer, we pay at 
9:15 a.m., and the receipts that we get from the issuer, we 
usually do not get until late in the afternoon. So what we are 
doing is we are paying the depository institution its interest 
or repayment of principal far in advance of the time during the 
day that we actually get the funds. We were doing what private 
sector transfer agents were not doing--namely, they do not pay 
out any principal or interest until the funds are deposited--
and it was a convenience for us to do that early on; it was our 
decision to do it.
    We are now getting to the point where the numbers are 
getting so large----
    Senator Sununu. How large?
    Chairman Greenspan. Well, it is $145 billion on occasion.
    Senator Sununu. So that is real money.
    Chairman Greenspan. It is real money.
    Now what we have done is to send out a request for comment 
on a rule stating that by July 2006, I believe it is, that we 
will be making payments to the depository institutions only 
when we have predeposited funds, as is done generally in the 
private sector.
    Senator Sununu. Why wait so long? Why wait until 2006?
    Chairman Greenspan. Because it is going to require the 
individual depository institutions to find alternate means of 
financing, and we do not sense any urgency of it. We think it 
is something which has developed over the years on the basis of 
a policy which we initiated. Now with the size of the numbers 
that are appearing, we decided that it is important not to be 
giving out inadvertent subsidies, which is in effect what we 
are doing, and it will require of necessity that the depository 
institutions who have been getting payments at 9:15 look for 
alternate sources of finance, as their payment desks do all day 
long. And we state in our request for comment that there is 
obviously an alternate need of how these funds are going to be 
raised, and at some point, it is going to be some form of 
permanent financing on their part.
    Senator Sununu. Thank you.
    Thank you very much, Mr. Chairman.
    Chairman Shelby. Senator Bayh.
    Senator Bayh. Thank you, Chairman Shelby, and thank you, 
Chairman Greenspan.
    I have a couple of questions. It seems to me, Mr. Chairman, 
that one of the things we have learned over the last several 
years is to keep a fair amount of humility when it comes to 
forecasting too far out into the future. We have had stock 
market collapses, unanticipated recessions, wars, terrorist 
attacks, and all these things have taken a toll upon the 
country's economy and finances. And recognizing that back when 
we addressed the issue of tax-cutting and possible entitlement 
expansion the last time, you had recom-
mended and some of us had embraced the idea of a trigger to try 
to ensure that while we were giving it our best shot, if there 
were these unanticipated contingencies, we would not go deeply 
into deficit, in debt, as has, in fact, turned out to be the 
case.
    My question is--and we favored the idea of a trigger at a 
time when we were in surplus--wouldn't it also apply to either 
further tax-cutting or entitlement expansions in time of 
deficit? Back then, the idea had been to tie it to paying down 
the debt. Perhaps now we could tie it to a steady glide path 
and reducing the amount of the deficits as the trigger, 
something like that.
    I would be interested in your thoughts about the possible 
trigger when it comes to permanency of tax cuts or expansion of 
entitlements under the current set of circumstances.
    Chairman Greenspan. Senator, because of the fact that the 
horizon over which we have to make budgetary policy is 
continuously moving out and because, as you correctly state, 
forecasters are in need of considerable humility, we have to 
have some form of mechanism which is a safety valve on the 
issue of how expenditures can be controlled--I mean by that 
when you put out a program, you at least know what the 
entitlements are or what the central estimates are in general--
--
    Senator Bayh. Although we have learned just recently that 
that is sometimes subject to variation.
    Chairman Greenspan. I was about to say in certain things 
like Social Security, you can know with some degree of 
accuracy. Our estimates of benefits over time have been pretty 
good and will continue to be. Health care is a totally 
different type of operation, as are a number of other things.
    But be that as it may, the point at issue is that unless 
you can forecast either receipts or outlays with some degree of 
accuracy, you need a fallback trigger position to protect the 
fiscal status of the system. And over the years, I have argued 
for two different types of approaches. I have argued for 
sunsetting virtually everything. My view is that if a program 
is desirable, sunsetting it will be of no problem whatsoever, 
because it will be automatically renewed, but it does subject 
the whole issue of governmental programs to an automatic 
reevaluation.
    I think we will be surprised at how many programs will 
indeed be sunsetted and not be restored, whereas today they 
just go on far beyond their original purpose, and I think there 
is just an enormous amount in our budget which has that 
characteristic.
    Over and above sunsetting, then, is the trigger issue, 
which I have in recent years advocated as another safety valve. 
There may be others, and indeed, I would be----
    Senator Bayh. I am about to run out of time, Mr. Chairman, 
forgive me. But you think it still has merit?
    Chairman Greenspan. Oh, I do indeed, yes.
    Senator Bayh. My second question--and again, I apologize, 
but I have less than a minute--deals with a question of United 
States sovereignty.
    I was restless one night this week and picked up a 
publication of the International Monetary Fund, ``U.S. Fiscal 
Policies and Priorities for Long Run Sustainability,'' and 
before the publication had its intended effect and I went back 
to sleep, I did pick up some interesting insights from it. Let 
me just read you one sentence.
    ``The United States is on course to increase its net 
external liabilities to around 40 percent of GDP within the 
next few years, an unprecedented level of external debt for a 
large industrial country.''
    There were other countries that had higher levels of debt, 
but they financed it internally through savings; we do not.
    My question is as long as we are financing our governmental 
operations by borrowing from abroad, principally from foreign 
central banks, as long as American consumers are sending wealth 
abroad through their purchases that deal with our balance of 
trade situation, in the long run, if we allow this to continue 
apace, or if it does continue apace, doesn't this really affect 
our sovereignty?
    How do we take firm negotiating stances with those to whom 
we are deeply in debt, whether it is in the trade realm or even 
events on the North Korean peninsula--just a whole raft of 
things. Is there not a concern that if we continue apace, it 
will affect our sovereignty in some other areas?
    Chairman Greenspan. To the extent that we would be owing 
debt to other sovereign governments, in that respect, there is 
a difficulty. But if it is a private negotiation, I am not sure 
it has the same type of problem which you are alluding to. That 
in no way says that building up those debts is not a problem, 
because unlike the Federal budget problem in which those 
decisions are made
essentially in the Congress, current account balances get 
adjusted by the marketplace in the sense that people accumulate 
claims against American residents because they want to. As 
wealth continues inexorably to increase, you have claims that 
represent it, and a very substantial part of the world has 
chosen to have claims against the United States as the most 
secure claims they know how to have.
    Without getting into the detail, I recently made a fairly 
broad analysis which suggests that the dispersion of current 
account deficits because of international financial 
intermediation is stretching out, meaning that there are far 
greater surpluses and deficits now than existed 20 years ago, 
and it looks as though that is going to continue, meaning that 
as overall wealth, world wealth, increases, you have to hold it 
someplace. And what is happening in part is that because of the 
nature of our society, property rights, in general, very strong 
underlying productivity, we are still the area where people 
want to invest.
    Now, I certainly can conceive of a situation where even if 
that is the case, you get so much in the way of dollar-
denominated claims, you just really want to diversify----
    Senator Bayh. You saturate the market.
    Chairman Greenspan. --so that you will get diversification, 
and you will then get pressures in the marketplace to adjust. 
But I would not be overly concerned about the issue in terms of 
delimiting our sovereign capability of acting in the world 
because of that. I think that is true only in a very limited 
sense, and I would be more concerned about the broader 
implications of our saving and investment policies at home as 
being a crucial issue.
    Senator Bayh. Thank you, Mr. Chairman.
    Chairman Shelby. Senator Carper.
    Senator Carper. Thanks, Mr. Chairman.
    There is a recurring theme, I am sure you have noticed, to 
a lot of these questions, particularly from our side of the 
aisle, and I just want to pick up where Senator Bayh has left 
off.
    When we run a deficit in Federal operations in our budget, 
we have the ability to borrow from trust funds, and we borrow 
from the Social Security trust fund, we borrow from Medicare 
trust funds and other trust funds that exist. I think we have 
pretty well exhausted all of those. When that is not enough, we 
look around the country to see if there are investors in the 
United States who are willing to loan the Federal Government 
some money and buy our securities, and there are plenty of 
people and institutions who are willing to do that.
    When we have pretty well brought in those dollars from 
potential investors with the interest rates they can yield, 
then we turn around and look around the world to see who 
outside of our borders will lend this money, and as in the 
conversation you have had with Senator Bayh, there are a lot of 
investors around the world who are willing to invest in U.S. 
securities. And so far, so good.
    My fear--and I think you touched on it right at the end--is 
that we reach a point, almost like on a seesaw, where you start 
going in the other direction, and potential investors, whether 
they are banks or individuals around the world, look at the 
United States, and they look at our securities, and they look 
at our inability to balance our Federal deficit or to even come 
close to managing our fiscal matters in a responsible way. They 
look at the exodus of jobs from this country, not just 
manufacturing jobs but good-paying technology jobs, and my 
fear--and I am by nature an optimistic person; I almost always 
see the glass as at least half-full--and I must say that 
looking down the road here a few years, especially, as I said 
earlier, when my generation starts to retire, when the boomers 
start to retire, I will be honest with you, I do not see the 
glass as half-full.
    I have a fear--and maybe it is misplaced--but a fear that 
we will reach a point where the rest of the world will say to 
us: You know, if you want us to continue to invest in your 
securities and to continue to loan money to your country, we 
will do it, but not at the interest rates that you are willing 
to pay.
    I think you and the Fed have done a masterful job in 
managing monetary policy and trying to keep interest rates low 
and to help make this recession as shallow as it has been, but 
I want to tell you that I worry that the day will come when the 
rest of the world says, No, you need to raise your interest 
rates for us to continue to make those kinds of massive 
investments. And when we are faced with that prospect, the 
effect on the economic recovery is not going to be good. Can I 
just ask you to react to that?
    Chairman Greenspan. Well, Senator, remember, the way it 
will happen is not that somebody abroad is going to say, ``You 
have to raise your interest rates,'' because the major question 
here is the private flow of funds. What will happen is that 
foreign investors, for one reason or another, will seek non-
U.S. type investments. They are not going to call us and say, 
``If you do not raise your rates, we are not going to invest 
here.'' They just will not invest.
    And what can happen and what has happened in the past is 
that you remove the demand for private securities, and with the 
same supply, interest rates of necessity start to rise. In 
other words, it is not necessarily an action of the Federal 
Reserve or anything necessarily that the Federal Government----
    Senator Carper. I have no quarrel with what you have just 
said. I agree.
    Chairman Greenspan. --so the answer is yes, that is clearly 
something we have to keep in mind.
    Senator Carper. Again looking down that road another 5 
years or so, could you just talk with us about what are the 
implications to our fiscal situation when my generation begins 
to retire?
    Chairman Greenspan. We may have humility in forecasting 
economic and financial issues; we should have none in 
forecasting that a very substantial number of people currently 
in our labor force will move into retirement starting in 2008. 
That forecast is probably one of the very few forecasts which 
we can get with a very high degree of accuracy.
    Also, we have under existing law commitments to those 
people, and when you multiply current law times the numbers, 
you get a very considerable rise in obligations of this 
Government. And as I said earlier, it is very important for us 
to recognize when and to what extent we may have overcommitted, 
and if indeed we have, it is very important for us to 
communicate to this group of people who are looking forward to 
benefits in retirement that they feel secure that what they 
have been promised, they will get. And unless and until we 
review all of these things, I do not think we really know what 
the nature of the problems are out in the longer term. What we 
do know is cause for considerable concern.
    Senator Carper. One last quick question if I could. Others 
have asked you about restoring pay-go procedures within our 
budget process. There are two ways to go pay-go. One is to say 
that if a Senator comes in with an idea for raising spending in 
a particular program, you have to come up with an offset--
either cut spending somewhere else or raise revenues to offset 
it.
    The flip side of that is to say that when a Senator comes 
in with an idea to reduce revenues, there should be an offset 
of that as well--either you find another place to cut spending 
or you find another place to raise revenues to offset the 
revenue loss that is going to come from my initiative or anyone 
else's.
    I think what the Administration has proposed is only the 
first half of that plan, pay-go only as it affects new 
spending. My question is should we just do half-a-loaf, or 
should the restoration of pay-go be consistent with what we 
have done in the past to say that if you are going to raise 
spending, you have to come up with the offset, and if you are 
going to cut revenues, you have to come up with the offset?
    Chairman Greenspan. Senator, I mentioned earlier that I, in 
testimony in September 2002, was very concerned about the 
pending expiration of pay-go, as well as discretionary caps and 
argued strenuously that they be restored. My view is that what 
seemed to work in the past, what was in the statute prior to 
September 2002 is needed, and I think just resurrecting that 
structure, which was far more successful than I ever imagined 
it could be, is an essential element in restoring fiscal sanity 
to our system.
    Senator Carper. Thank you.
    Mr. Chairman, I think he just said a mouthful there, and I 
hope we will take that one to heart.
    Chairman Shelby. Thank you.
    Senator Schumer.
    Senator Schumer. Thank you, Mr. Chairman, and thank you, 
Chairman Greenspan.
    I would like to focus on the area I mentioned at the 
beginning which I am very concerned about. When people question 
whether free trade is still the way to go, usually, economists 
and editorial boards say, ``You are being protectionist.'' But 
given the new changes, there are lots of very--not lots--there 
are a few very respected economists who are saying we should 
reexamine because the world has changed.
    Mr. Roach of Morgan Stanley calls it ``global labor 
arbitrage.''
    I would like to read you a quote from two very respected 
economists, Ralph Gomory and William Baumol, and get your 
comments on that. They are saying what the free trade theory 
is. This is from their book, ``Global Trade and Conflicting 
National Interests'':

    ``However, it is also true that in the time since these 
basic models of international trade were formulated, there have 
been major change in the world economy. David Ricardo's world 
of agriculture, slow-moving technology, and tiny businesses has 
been replaced by a world dominated by manufactured goods, 
rapidly evolving technology, and huge firms. This calls for 
reexamination of those classical models.''

    There is another paragraph, and then they say:

    ``However, as modified by us, the theory shows that there 
are in fact inherent conflicts in international trade. This 
means that it is often true that improvement in one country's 
productive capability is attainable only at the expense of 
another country's general welfare. An improvement in the 
productive capability of a trading partner that allows it to 
compete effectively with a home country industry, instead of 
benefitting the public as a whole, may come at the expense of 
the home country overall, and this harm is not the localized 
damage previously mentioned--loss of jobs in the immediately 
affected industry--but an adverse effect that is felt 
throughout the home country.''

    As I mentioned to you earlier, it seems to me that the 
Ricardo theory relied on factors of production that were 
staying in a country, not in a world with broadband, with an 
international labor market that is rapidly changing. And I 
think I mentioned just two examples; I have heard many. The 
head of a major insurance company said except for salespeople, 
who have to deal face-to-face, if he is doing his job, 80 
percent of his workers should be overseas within 10 years.
    Can you comment on both my opening statement and 
particularly the comments of Professor Gomory and Baumol?
    Chairman Greenspan. Certainly.
    Senator Schumer. I do not know a solution here, to be 
honest with you, but do you disagree with the view that the 
basic changes in the last 5 years perhaps should cause us to 
reexamine the classical theory of free trade, which is when 
each country specializes, everyone does better?
    Chairman Greenspan. I see no reason to do so, and let me 
tell you why. Instead of thinking in terms of trade per se, I 
think it is important to start in a different direction and 
then come back to trade.
    The real question is the question which Adam Smith 
originally raised: What causes the wealth of nations?
    We have two statistics in this country which we have to 
explain. One is that employment has moved in parallel with the 
adult population for generations. There are aberrations, but in 
general, it has happened.
    More important, real wages have gone up at all times. And I 
might say that both of those trends have occurred irrespective 
of whether we have had a trade deficit or a trade surplus, 
whether we have had high outsourcing or low outsourcing. If, 
indeed, the wealth of the Nation, meaning the United States, is 
independent of the degree or nature of trade, then the question 
is what causes the wealth of nations. And here, even though we 
do not have any recent evaluations for developed countries, 
there has been an
extraordinary amount of research on less-developed countries 
which looks to me wholly applicable to developed countries as 
well. You start off with what are the factors which seem to 
make the
difference.
    One is the skill and education level of the indigenous 
population. Two is the extent to which there is a rule of law 
which facilitates the way that populations trade internally. In 
that regard, property rights turn out to be a very critical 
issue. And the two of those are sometimes augmented by the 
degree of natural resources that are there, but that is a very 
minor question.
    This, therefore, raises the issue of why is it that the 
United States has been able to increase our per capita income 
not every year, but over a period of time. And it largely comes 
down to the fact that our skills, along with our degree of 
intelligence, is what determines what our real income is wholly 
independent of which particular job we had and what proportion 
of our total consumption was imported.
    I submit to you that if, indeed, that is the case, then the 
issue of trade is constructed in a different context. Then the 
question is how do people exchange goods and services, how do 
you create specialization of labor within an economy, within a 
city, within a company, to create maximum wealth. In a context 
of fully free trade, then, national boundaries are utterly 
irrelevant to where people move or not move.
    Yesterday, I raised the very important issue in this regard 
of education. I think our real concern should not be the 
question of whether or not trade is increasing internally or 
externally. I think we have to be very concerned about the fact 
that there are very substantial people who are obviously losing 
jobs not only because of trade but also because of internal 
productivity. That is something which is a public policy 
question we have to be very much concerned about, but it should 
not change our view of what the economic forces are which are 
moving world events in that regard.
    What I am saying here is that if we have, as I mentioned 
before, an economy which is increasingly conceptual--that is, 
the quality of the goods are more and more--it means that for 
us to function, we need a level of skills of our working 
population which is continuously becoming more conceptual to 
match the type of goods and services that consumers want--or, 
to put it another way, that workers acting as consumers 
request. And what we are observing at this stage----
    Senator Schumer. Could you comment on 100 million well-
educated people added----
    Chairman Greenspan. --I will; I will exactly do that, 
because that is where the critical issue is. In any event, what 
is happening in the United States is we are finding that the 
lesser skills are turning out to be in surplus supply, and 
therefore, the real wages of our lower-income are going 
nowhere, but the premiums for skills in the upper areas of our 
skill area have been rising for the last two decades, which is 
another way of saying that we are not moving our younger people 
through our school system from the fourth grade through 12 
sufficiently quickly to put them into college and into areas 
where their capabilities get to a point where the supply of 
skills meets the burgeoning demand, which incidentally will 
bring down the wage rate and will reduce the inequality of 
income which is involved here. And there have been very 
disturbing international studies that American students in math 
and science in the fourth grade are average, maybe even 
slightly better than average internationally; by the time they 
get to the 12th grade, they are way down below the average.
    We do something wrong which obviously, people in Singapore, 
Hong Kong, Korea, and Japan do far better than we. There is 
nothing wrong with our students--they are just as good if not 
better in the fourth grade. They are teaching in these strange, 
exotic places for some reason far better than we do it. And 
because we are not doing it, then the issue you raise, Senator, 
disturbs me, because what will ultimately determine the 
standard of living of this country is the skill of the people. 
I think we are fortunate in that we have a Constitution and a 
rule of law so that people find it sufficiently attractive to 
invest here, and that has helped us to a very considerable 
degree--but unless we somehow resolve the education problem, 
then I think the issue you raise about the 100 million Indians, 
Chinese, and the like is an issue.
    I should, however, say parenthetically remember that that 
was our concern about Japan in the 1950's and the 1960's, and 
when the demand for those so-called low-wage workers, highly-
educated workers, began to move, the Japanese wage rates just 
took off. So it is not as though Chinese and Indian software 
engineers, for example, are always going to be at a very 
significant differential. Because of the very large numbers of 
them, it will be for a while, but eventually, the gap will 
close. But whether it closes or not should not be relevant to 
us if we cannot solve our education issue.
    Senator Schumer. Thank you.
    Thank you, Mr. Chairman.
    Chairman Shelby. Senator Miller.

                STATEMENT OF SENATOR ZELL MILLER

    Senator Miller. Thank you, Mr. Chairman.
    Mr. Chairman, thank you. I know you have been at this a 
long time already this morning, and we appreciate your generous 
and your knowledgeable remarks. I do not want to continue to 
beat this horse, but I listened very carefully to what you had 
to say to Senator Schumer, and I apologize for not being here 
when Senator Allard asked you about the loss of manufacturing 
jobs.
    I really want to embrace what you are saying, and what you 
are saying about education I could not agree with more. 
However, in the interim, I get letters like this one. It is 
from a pre-K school class in Trion, Georgia. Now, obviously, 
they are an advanced class of preschoolers:

    ``Dear Senator Miller, we are a pre-K class from Trion, a 
small mill town in northwest Georgia. The main industry in our 
area is Mount Vernon Mills. The mill has been in business since 
1845 and is a main source of employment in our area. They 
employ about 1,900 people. Many of them are our parents.''
    ``We are very worried about our mill. They have been on 
short time more in the past year than at any time in the mill's 
158-year history. We are and continue to be the largest 
producer of denim in one location, but we fear this may change 
unless something is done. Back current legislation for 27.5 
percent tariffs on Chinese goods.''

    I told you they were a very advanced class; they know about 
tariffs and quotas.

    ``This company is vital to our area. They make regular 
donations to our schools, including $1 million several years 
ago to help build our new school. The old one is in a 
floodplain and badly damaged. Without this mill, our town will 
not survive, and neither will our school. Won't you please help 
save our mill and the American textile manufacturing industry 
by putting quotas on Chinese imports? Please help save
our mill.''

    ``Ms. Janice and Ms. Cathy's pre-K class, Trion pre-K.''
    Now, I know that those kids did not write that letter, but 
I can guarantee you that those kids have heard that kind of 
talk around the kitchen table back home, and they have seen 
their daddy or mamma is worried about their job, and that makes 
them worried about their future.
    Mr. Chairman, assure me again that it is not the end of the 
world to lose all these manufacturing jobs. What happens to the 
tax base when something like this happens? I know you talk a 
lot, and I agree with you on the retraining of workers, but 
will there be enough new jobs to employ all the retrained 
workers, say, in Trion, Georgia? Can America live on 
consumption alone?
    Chairman Greenspan. No, Senator Miller, we cannot, and 
indeed, I think this is an issue which requires a considerable 
amount of attention.
    I know there is a gulf between people who are advocating 
the abstraction of free trade and those confronting the letter 
that you have. It is a very difficult public policy question, 
because the way our system functions is that it is continuously 
churning--that is, as a famous Harvard professor said, it is 
called ``creative destruction'' in the sense that we are 
continuously using the resources of obsolescent technologies to 
finance cutting-edge technologies, and the difference in the 
productivity in the cutting-edge technology less that of the 
obsolescent technology is a rise in productivity that is the 
source of a rise in our standards of living.
    So, economists will tell you that the process is basically 
one in which there are lots of losers and gainers in the 
process, and indeed, if you look at the equivalent in the labor 
markets, as I have mentioned previously, we hire a million 
people every week in this country, and a million, more or less, 
are either laid off or quit. But the important issue here is 
that there is an extraordinary churning in the labor market, 
and there are a very large number of people in the wrong end of 
that churn who are in very serious straits.
    We have 2 million people who have been looking for a job 
for over a year. Now that is a relatively small percent of the 
150-odd million people who are employed, but it is a large 
number of people, and we have to be very careful to recognize 
that there are winners and losers here, and I think it is 
crucially important that we, one, as I have indicated 
previously, recognize that if you are going to get obsolescent 
technologies or ones that become obsolescent
because we have different patterns of labor and capital--but 
for example, if you go back 20 or 30 years and look at the 
textile mills in the South, and these are absolutely first-rate 
operations, world-class--I know, because a lot of them were my 
clients, and I know what they were doing--the trouble, 
unfortunately, is that a num-
ber of developing nations have evolved and copied a lot of our
technologies.
    It was an American who created the cotton gin. The cotton 
gin was the critical issue which enabled a major textile 
industry to really start in this country, and up until very 
recently, we were at the cutting edge. It was true in steel, it 
is true in motor vehicles. And we are finding that we are 
fading in those areas, and yet fairly recently, we had 4 
percent unemployment, and we have always been having a very 
significant increase in real wages.
    Human ingenuity is producing ever more useful ways of 
operating. I think it is important that we do not stop that 
process, because that is where our standard of living, that is 
where American greatness, is coming from. But on the other 
hand, we should be very careful to recognize that we are not 
dealing with averages, we are dealing with real people. And 
that is the reason I support community colleges, which are 
turning out to be by far the most useful vehicle to retrain 
people--because if they have an adequate education, you can 
retrain them.
    That is why I am worried about the school system. If you 
can retrain them, the evidence suggests that to be sure, when 
you lose a job, you usually get the next one at a lower pay, 
but ultimately, you move up. If you have that situation, you 
have to craft programs that get people retrained and, where you 
cannot get them retrained, find other ways of assuaging their 
problem, which was not of their making.
    Senator Miller. Thank you, Mr. Chairman.
    It is hard, though, to look at the big picture when you are 
one of the flesh and blood that is caught up in that little 
picture.
    Chairman Greenspan. It certainly is.
    Senator Miller. Eli Whitney was a New Englander who came to 
Georgia and invented that cotton gin, by the way.
    Thank you, sir.
    Chairman Shelby. Senator Corzine.

              STATEMENT OF SENATOR JON S. CORZINE

    Senator Corzine. Thank you, Mr. Chairman.
    I apologize for not being here today. I was listening to 
incredible minds and public servants. Secretary Powell was in 
our Foreign Relations Committee meeting.
    This discussion that you are having about the wealth of 
nations and its growth through productivity and the capacity 
expansions is both spot on given our current situation, but I 
think the piece--and you have alluded to it a couple of times, 
because you cannot talk about averages and really have this 
apply to our workforce and income distribution that we have in 
our Nation. I think one of our major problems is that we 
continue to look at averages when we look at per capita income 
and some of the metrics that you have mentioned and others have 
mentioned, but when you look at it in the way you just 
suggested--someone who loses a job, their next job is at a 
lower real wage, and you are seeing that happen more broadly in 
the economy--whether that is a trend, I think it is early, but 
there are a number of studies out that show that in the bottom 
80 percentile of American workers, there is beginning to be an 
erosion of real wages. So, we are getting that offset by what 
is going on at the top, and some of this is education, there is 
no question.
    But how long does it take for that adjustment process to 
occur, and should there be public policies that actually 
address that? Obviously, you talked about community colleges 
and the budget, and I know we had an initiative talked about in 
the State of the Union, but if you look at the real spending on 
community colleges that is going on in the other elements of 
the budget, we are cutting them.
    I just do not understand how we can continue to forecast 
2.5 million jobs when this process of growing the wealth of the 
globe as well as the Nation with the kinds of problems of 
income distribution. So, I think today's discussion is 
extraordinary, but unless it deals with the distribution of 
income and talks about something other than averages, I think 
we are missing the point with the broad base of Americans.
    Chairman Greenspan. Well, Senator, I think the income 
distribution issue is very critical because we cannot have a 
significant inequality of income and expect to have support for 
the type of institutions which have made this country great.
    A point that I am trying to make is that the nature of our 
production processes, the nature of our capital facilities, are 
requiring an ever higher degree of skill on the part of our 
working population to staff the plant and equipment. Indeed, we 
have been doing it. If you go back to the turn of the previous 
century when people were coming off farms, our education system 
was remarkably effective. We had created high schools which 
taught people how to take the skills which essentially staffed 
a major expansion in manufacturing. By World War II, we were 
far ahead of any other country in our level of general 
education.
    Since then, we have had this continuous requirement for 
increased skills, but because we have been doing it very 
slowly, too many of our people who should have been in college 
or graduate school or whatever end up not making it through 
high school. And if you just think in terms of what would 
happen if we had the same schooling that a number of East Asian 
countries are having, there would be a far larger number of 
people going into high school and a far larger number of people 
going from high school to college to graduate school. We would 
move the whole population structure up. We would reduce the 
excess supply of those in the lower-skilled areas and those who 
are still lower-skilled would find their wage rate would rise, 
but moving up the population into the higher skills would 
create excesses there and lower the wage levels in the upper-
skilled levels and thereby reduce the degree of income 
inequality very significantly.
    There is another piece of this which is, of course, 
immigration, which has an interesting effect, but the point 
that I am making is that this is a problem which is best, and I 
fear may only be, addressed through education. And if that is 
the case, it is very important that we focus on what is wrong 
with our system--why do fourth graders, who in math and science 
do as well as the rest of the world, if not better, find that 
by the time they get out of high school, they are way down at 
the bottom of the ladder? Why is that? What are we doing wrong?
    I think if we could answer that question, we would find the 
public policies which would solve a good number of problems 
that are reflected in the type of letter that Senator Miller 
just read.
    Senator Corzine. Thank you.
    Chairman Shelby. Chairman Greenspan, you have been very 
patient with us this morning. I have four questions, and I will 
submit them for the record. I am just going to touch on them 
here.
    The first has to do with the sustainability of the current 
account deficit. You have talked about that some. I will put 
that in the record and get it to you.
    The second one has to do with the possible fragility of the 
Chinese financial system, the banking system, as a lot of us 
see it.
    Then, the third one would deal with the decline of the 
dollar versus the euro, the long-term consequences and so 
forth.
    The fourth one deals with price indices and the Federal 
budget in reference to some testimony you gave one time dealing 
with income tax brackets; have they been inflated using the 
chain-weighted CPI rather than the cost and so forth.
    I will get those to you for the record.
    The last question I want to ask you is not necessarily here 
before us today, and that deals with hedging. The SEC staff 
recently issued a report recommending that hedge fund advisors 
register with the SEC. What is your perspective on the 
registration of hedge fund advisors, and how would it impact 
the industry? In other words, do you agree with that 
recommendation?
    Chairman Greenspan. No, I do not, Senator. I think that 
hedge funds, which I would define as financial institutions in 
which the investors are only of high income levels--if I get 
this wrong, Senator, please correct me--the value that these 
institutions have is to create a very significant amount of 
liquidity in our system, and I think that while they have a 
reputation of being a peculiar type of financial group, they 
have been very helpful to liquidity and hence the international 
flexibility of our financial system. We have to be very careful 
that we make sure that they do not become an investment vehicle 
for people in lower and moderate incomes, because that 
appropriately requires registration and SEC----
    Chairman Shelby. Perhaps on the retail level.
    Chairman Greenspan. --it requires SEC oversight. I grant 
you that registering advisors in and of itself is not a 
problem, but the question is what is the purpose of that unless 
you are going to go further, and therefore, I feel 
uncomfortable with that issue.
    Chairman Shelby. Thank you.
    Senator Bennett.
    Senator Bennett. Thank you, Mr. Chairman.
    I was interested in the same question as the Chairman just 
asked and appreciate your answer.
    I have no further questions other than just one last shot 
at the thing that we are talking about here. One more time, 
trade is good, even if it is trade in services as opposed to 
trade in hard goods. Trade is good for both sides. Trade is 
good for this country. Is this an overall summary that you 
would be comfortable with?
    Chairman Greenspan. I would, Senator.
    Senator Bennett. I think it is important that we remember 
that, because there are some who say, well, yes, trade in hard 
goods is okay, but when we get into services, then trade is not 
good. And I appreciated your answer to Senator Schumer when you 
talked about the historical impact of trade whether we were in 
recession or boom times, whether we were in war or otherwise--
just historically, American productivity has produced this 
benefit.
    I tell my constituents that when it comes to trading, we 
are the meanest, toughest, biggest kid on the block, and 
therefore, we want the most trade we can possibly get. We are 
not afraid of anybody as a Nation in trading if we can lower 
all of the barriers.
    So that is the last point I wanted to make, and I 
appreciate your comment. Trade is good--let us remember that.
    Chairman Greenspan. Yes, sir.
    Chairman Shelby. Senator Corzine, do you have a parting 
statement or question?
    Senator Corzine. Thank you.
    I have a couple of quick questions.
    First of all, I would just comment on the hedge fund issue. 
I think there are some questions about the ``retailization''--
bit big, crazy word--that people have seen, where you break it 
up and are selling----
    Chairman Greenspan. I think that is where the issue really 
lies.
    Senator Corzine. Yes. And there are also issues about what 
the limits are today versus when rules were promulgated, 
whether it is 200,000, and what is a sophisticated investor.
    Then there is this continuing element, no matter how you 
feel about hedge funds, like in every other walk of life, there 
is always the 5 percent or the 2 percent, and they seem to end 
up being in some of the more reckless and dangerous worlds on a 
consistent basis--but for another day.
    Let me ask a quick question. You have been an advocate of 
triggers, and I want to know, actually, if we had taken your 
advice, would the trigger have been pulled with regard to the 
current tax cuts that are being requested to be made permanent 
as we go forward now, given the changed circumstances of our--
--
    Chairman Greenspan. It depends on the way the trigger was 
constructed. It could have been, it could not have been, 
depending on what the form of the trigger----
    Senator Corzine. The way you conceived of it, though, when 
you spoke to us.
    Chairman Greenspan. As I conceived of it then, I said in 
the 2001 testimony, which Senator Sarbanes was discussing, that 
because forecasts are so difficult, and we could not be certain 
that the surpluses were going to be in place, that we would 
probably need to take a new look at whether, in fact, the 
surpluses were dissipating. If, indeed, you took the literal 
words of the testimony I gave back then, yes, I think the way 
you put it would be accurate.
    Senator Corzine. I am going to submit for the record one 
other question----
    Chairman Shelby. Without objection, it will be done.
    Senator Corzine. --with regard to the top 10 countries 
holding our national debt. I have a particular curiosity about 
the Caribbean banking centers and what its implications are 
with respect to our concern about funding of all kinds of 
miscellaneous problems that could potentially exist. I would 
love to hear an analysis of what is driving the fourth-highest 
concentration of our debt being held by Caribbean banking 
centers.
    Chairman Greenspan. I am sorry--was that a question to me?
    Senator Corzine. That is a question that we can ask, if 
there could be an analysis.
    Chairman Greenspan. You want us to look at it.
    Senator Corzine. Yes, please.
    Chairman Greenspan. In the context, as you are far more 
aware than I, that the amount of information that those 
individual institutions and those various areas produce is less 
than we would like to see. But we will take a look at it and 
see what we can find.
    Senator Corzine. I think the issue in the funding of global 
terror, one wonders why so much of the external debt of the 
United States is being housed among institutions that we have 
very little idea about.
    Chairman Greenspan. We will see what we can find, Senator.
    Senator Corzine. Thank you.
    Chairman Shelby. Thank you, Senator Corzine.
    Chairman Greenspan, again we thank you for your appearance, 
and we look forward to your next appearance in less than 2 
weeks.
    Chairman Greenspan. Thank you very much, Mr. Chairman.
    Chairman Shelby. The hearing is adjourned.
    [Whereupon, at 12:33 p.m., the hearing was adjourned.]
    [Prepared statements, response to written questions, and 
additional material supplied for the record follow:]
               PREPARED STATEMENT OF SENATOR WAYNE ALLARD
    I would like to thank Chairman Shelby very much for holding this 
hearing, and I would also like to join my colleagues in welcoming 
Federal Reserve Board Chairman Greenspan to the Committee today to 
discuss monetary policy and the state of the U.S. economy. I always 
look forward to the opportunity to hear from Chairman Greenspan on 
economic issues and those factors that are driving and hindering 
economic growth.
    I was pleased to hear in your testimony before the House yesterday 
that the picture of the U.S. economy has brightened since you last 
testified here in July. I share your views, and know the people of 
Colorado have been seeing the improving economic environment as well. I 
was also pleased to hear that the prospects are good for sustained 
expansion of the U.S. economy and look forward to finding ways to 
sustain that growth.
    Recognizing that fiscal policy is far less powerful than monetary 
policy in influencing Gross Domestic Product growth and employment, 
Congress must do its part by pursuing policies of low taxation, limited 
Federal regulation and free trade in order to see the United States 
improve and prosper with wealth and opportunity. The President's tax 
cuts have played an integral part in helping to sustain the U.S. 
economy after the mild recession and terrorist attacks in 2001. Sound 
monetary policy coupled with wise decisions on fiscal policy will allow 
Americans to benefit from the fruits of a flourishing economy.
    Chairman Greenspan, once again thank you for appearing before the 
Banking Committee today. I look forward to your testimony.

                              ------------
            PREPARED STATEMENT OF SENATOR CHARLES E. SCHUMER

    Thank you, Chairman Shelby and Ranking Member Sarbanes, and thank 
you, Chairman Greenspan, for being here today.
    As I travel all across my State I hear one question, one fear, one 
concern--jobs. People who do not have them want them. People who have 
them are just waiting for the shoe to drop and their job to go overseas 
in the relentless pursuit for the cheapest labor.
    Who can blame them? Despite historically low interest rates, large 
tax cuts, record spending and record deficit levels, our highly 
stimulated economy again missed expectations in January with a weaker 
number of mainly low-paying service jobs. According to the Bureau of 
Labor Statistics after the first 10 recessions, jobs always hit their 
low point around the end of the recession and never more than 3 months 
after the recession ended. But this time, the low point in jobs came in 
August 2003--21 months after the last recession ended.
    After the first 10 recessions, there was a complete recovery in the 
number of jobs within 2 years after the end of the recession. But this 
time, the recession has been over for 26 months and we still have 2.3 
million fewer payroll jobs than when the recession started.
    Mr. Chairman, at times it seems some believe we have discovered 
productivity for the first time. But the United States has a history of 
strong productivity--in fact, productivity has been the key to our 
strength and high standards of living.
    It is true that over the last 8 years, from 1996-2003, productivity 
growth has averaged 2.9 percent. And during the preceding 20 years, 
1974-1995, productivity growth was much lower, averaging only 1.5 
percent growth per year. But during the period 1948-1973, productivity 
growth was much stronger on average, stronger even than what we have 
experienced since 1995, averaged 3.3 percent growth per year.
    Yet the recessions during the previous high-productivity growth 
period were not marked by the continual job losses and jobless recovery 
that we are in the midst of today. During those recession and 
recoveries, jobs returned quickly. In fact, the two times that the 
unemployment rate was below 4.0 percent were during the high 
productivity periods of the late 1990's and the late 1960's.
    So to me productivity is not an answer. We have been a highly 
productive economy for a long time that should not be news to anyone. 
And in fact, our economic team should have factored in strong 
productivity in our stimulus--high productivity cannot be used as an 
excuse for the failure to produce jobs.
    What is news is that we are now having high productivity but no 
wage growth. That is the real story. That is what is puzzling with this 
economy. And I think that fact signals the bigger change. I believe 
what we are seeing is something brand new, the first stage of a new 
economic era--a seismic shift--characterized by massive global labor 
competition for every job.
    It is not simply an issue of white collar service jobs moving 
offshore. That is only one manifestation of a larger phenomenon.
    The real concern is that any job that does not require daily face-
to-face interaction will be moved from high-wage countries like the 
United States to low-wage countries like India and China where huge 
amounts of skilled labor is available at a fraction of the cost.
    The proper term for this new era is ``Global Labor Arbitrage,'' a 
phrase recently coined by Morgan Stanley's Chief Economist, Stephen 
Roach. In this arbitrage, multinational companies--often U.S 
companies--source labor from wherever it is most advantageous to them 
and shift operations to wherever is most accommodating to their needs.
    In manufacturing industries, factories, plants, and jobs are moved 
overseas for the extra margin earned by substituting in skilled, cheap 
foreign labor for U.S. workers. In services industries, skilled, 
foreign, low-cost labor is virtually imported into the country via the 
Internet and employees here are left to look for new work. The result 
of this arbitrage is enormous pressure on U.S. jobs and wages.
    In this new age of global labor arbitrage the United States is 
handicapped by our past success. Over many years we have fought hard to 
build industries and create a system where our citizens enjoy high 
wages and a high standard of living, as well as some basic social 
benefits and worker protections. Now suddenly, United States workers 
are being forced to compete with hundreds of millions of skilled Indian 
and Chinese workers who are ready, willing, and able to work for a 
fraction of the cost, and largely without regulatory controls.
    What makes the experience of this new age particularly jarring for 
U.S. workers is that it is their own companies who are leading the 
charge to move jobs overseas. These businesses are even asking United 
States workers to train their foreign replacements.
    While some argue that the high productivity of the U.S. worker will 
save the day by keeping good jobs here and wages high, the facts to 
date do not support that case. While labor productivity is, in fact 
high, wages have been stagnant and job growth is far behind schedule. 
Yet corporate profits are near records. In the past, U.S. workers' 
productivity was a result of good training coupled with the ability to 
work with the best equipment and technology. But today, armed with 
United States technology and capital, and trained by United States 
workers, a Chinese or Indian professional can be just as productive as 
his or her United States counterpart, but at a fraction of the cost. 
The company gains efficiency, while the Nation loses productive 
capacity.
    So in my view, the emergence of a new era of global labor arbitrage 
needs to be addressed for what it is--a new phenomenon in our economy. 
We need to face up to the new reality.
    Thank you.

                               ----------
                PREPARED STATEMENT OF SENATOR JACK REED

    Thank you, Mr. Chairman. The Federal Reserve's mission is to 
conduct monetary policy. But monetary policy doesn't operate in a 
vacuum. Sound fiscal policies, like those we pursued in the 1990's, 
complement monetary policy in creating an environment of economic 
growth and job creation in the United States not abroad. In contrast, 
large budget deficits like those we experienced from the early 1980's 
to the early 1990's are a drain on national saving that is harmful to 
long-term growth.
    I am afraid that fiscal discipline has become a fading memory and 
more tax cuts for the upper income have become the trend. We now have 
large deficits and debt as far as the eye can see. The President's 
budget includes $521 billion in deficit spending just in 2005, a 
complete reversal from just 3 years ago. At least in the 1980's, the 
pressures on the budget from the retirement of the baby boomers were 
off in the distant future and there was time to restore fiscal 
discipline. This time, however, the biggest tax cuts will be kicking in 
at just about the same time that the baby boom starts retiring.
    We used to get a clear signal from the Federal Reserve about the 
importance of fiscal discipline and the preeminence of deficit 
reduction and paying down the public debt over tax cuts as the way to 
stimulate investment and growth. But that signal has gotten a little 
garbled in the past couple of years. I hope that in addition to 
discussing his views on the economic outlook, Chairman Greenspan will 
spend some time talking about how the choices we make in the coming 
year about taxes and other fiscal priorities will affect that outlook.
    Mr. Chairman, I look forward to your testimony.

                  PREPARED STATEMENT OF ALAN GREENSPAN
       Chairman, Board of Governors of the Federal Reserve System
                           February 12, 2004

    Mr. Chairman and Members of the Committee, I am pleased to be here 
today to present the Federal Reserve's Monetary Policy Report to the 
Congress.
    When I testified before this Committee in July, I reported that 
conditions had become a good deal more supportive of economic expansion 
over the previous few months. A notable reduction in geopolitical 
concerns, strengthening confidence in economic prospects, and an 
improvement in financial conditions boded well for spending and 
production over the second half of the year. Still, convincing signs of 
a sustained acceleration in activity were not yet in evidence. Since 
then, the picture has brightened. The gross domestic product expanded 
vigorously over the second half of 2003 while productivity surged, 
prices remained stable, and financial conditions improved further. 
Overall, the economy has made impressive gains in output and real 
incomes; however, progress in creating jobs has been limited.
    Looking forward, the prospects are good for sustained expansion of 
the U.S. economy. The household sector's financial condition is 
stronger, and the business sector has made substantial strides in 
bolstering balance sheets. Narrowing credit risk spreads and a 
considerable rally in equity prices have reduced financing costs and 
increased household wealth, which should provide substantial support 
for spending by businesses and households. With short-term real 
interest rates close to zero, monetary policy remains highly 
accommodative. And it appears that the impetus from fiscal policy will 
stay expansionary, on net, through this year. These circumstances all 
should spur the expansion of aggregate demand in 2004. At the same 
time, increases in efficiency and a significant level of underutilized 
resources should help keep a lid on inflation.
    In retrospect, last year appears to have marked a transition from 
an extended
period of subpar economic performance to one of more vigorous 
expansion. Once again, household spending was the mainstay, with real 
personal consumption spending increasing nearly 4 percent and real 
outlays on residential structures rising about 10 percent. Last year's 
reductions in personal income tax rates and the advance of rebates to 
those households that were eligible for the expanded child tax credit 
boosted the growth of real disposable personal income. The very low 
level of interest rates also encouraged household spending through a 
variety of channels. Automakers took advantage of low interest rates to 
offer attractive incentive deals, buoying the purchase of new vehicles. 
The lowest home mortgage rates in decades were a major contributor to 
record sales of existing residences, engendering a large extraction of 
cash from home equity. A significant part of that cash supported 
personal consumption expenditures and home improvement. In addition, 
many households took out cash in the process of refinancing, often 
using the proceeds to substitute for higher-cost consumer debt. That 
refinancing also permitted some households to lower the monthly 
carrying costs for their homes and thus freed up funds for other 
expenditures. Not least, the low mortgage rates spurred sales and 
starts of new homes to very high levels.
    These developments were reflected in household financing patterns. 
Home mortgage debt increased about 13 percent last year, while consumer 
credit expanded much more slowly. Even though the ratio of overall 
household debt to income continued to increase, as it has for more than 
a half-century, the rise in home and equity prices enabled the ratio of 
household net worth to disposable income to recover to a little above 
its long-term average. The low level of interest rates and the large 
volume of mortgage refinancing activity helped reduce households' debt-
service and financial-obligation ratios a bit. And many measures of 
consumer credit quality improved over the year, with delinquency rates 
on consumer loans and home mortgages declining.
    A strengthening in capital spending over 2003 contributed 
importantly to the acceleration of real output. In the first quarter of 
the year, business fixed investment extended the downtrend that began 
in early 2001. Capital spending, however, ramped up considerably over 
the final three quarters of 2003, reflecting a pickup in expenditures 
for equipment and software. Outlays for high-tech equipment showed 
particular vigor last year. Even spending on communications equipment, 
which had been quite soft in the previous 2 years, accelerated. A 
growing confidence of business executives in the durability of the 
expansion, strong final sales, the desire to renew capital stocks after 
replacements had been postponed, and favorable financial conditions all 
contributed to the turnaround in equipment spending.
    By contrast, expenditures on nonresidential structures continued to 
contract on balance, albeit less rapidly than in 2001 and 2002. High 
vacancy rates for office buildings and low rates of capacity 
utilization in manufacturing evidently limited the demand for new 
structures. Inventory investment likewise failed to pick up much 
momentum over the year, as managers remained cautious. Firms finished 
2003 with lean inventories relative to sales, an encouraging sign for 
the expansion of production going forward.
    To a considerable degree, the gathering strength of capital 
spending reflects a substantial improvement in the financial condition 
of businesses over the past few years. Firms' profits rose steeply 
during 2003 following smaller gains in the previous 2 years. The 
significantly stronger cashflow generated by profits and depreciation 
allowances was more than adequate to cover rising capital expenditures 
in the aggregate. As a result, businesses had little need to borrow 
during 2003. For the nonfinancial business sector as a whole, debt is 
estimated to have grown just 3\1/2\ percent.
    Firms encountered very receptive conditions in longer-term credit 
markets in 2003. Interest rate spreads on both investment-grade and 
speculative-grade bond issues narrowed substantially over the year, as 
investors apparently became more confident about the economic expansion 
and saw less risk of adverse shocks from accounting and other corporate 
scandals. Corporate treasurers took advantage of the attractive market 
conditions by issuing long-term debt to lengthen the maturities of 
corporate liabilities.
    As a consequence, net short-term financing was extremely weak. The 
stock of business loans extended by banks and commercial paper issued 
by nonfinancial firms declined more than $100 billion over the year, 
apparently owing to slack
demand for short-term credit rather than to a constriction in supply. 
Interest-rate spreads on commercial paper, like those on corporate 
bonds, were quite narrow. And although a Federal Reserve survey 
indicates that banks had continued to tighten lending conditions early 
in the year, by the second half, terms and standards were being eased 
noticeably. Moreover, responses to that survey pointed to a lack of 
demand for business loans until late in the year.
    Partly as a result of the balance-sheet restructuring, business 
credit quality appears to have recuperated considerably over the past 
few years. Last year, the default rate on bonds fell sharply, recovery 
rates on defaulted issues rose, the number of rating downgrades 
moderated substantially, and delinquencies on business loans continued 
to decline. The improved balance sheets and strong profits of business 
firms, together with attractive terms for financing in open markets and 
from banks, suggest that financial conditions remain quite supportive 
of further gains in capital spending in coming quarters.
    The profitability of the business sector was again propelled by 
stunning increases in productivity. The advance in output per hour in 
the nonfarm business sector picked up to 5\1/4\ percent in 2003 after 
unusually brisk gains in the previous 2 years. The productivity 
performance of the past few years has been particularly striking in 
that these increases occurred in a period of relatively sluggish output 
growth. The vigorous advance in efficiency represents a notable 
extension of the pickup that started around the mid-1990's. Apparently, 
businesses are still reaping the benefits of the marked acceleration in 
technology.
    The strong gains in productivity, however, have obviated robust 
increases in business payrolls. To date, the expansion of employment 
has significantly lagged increases in output. Gross separations from 
employment, two-fifths of which have been involuntary, are about what 
would be expected from past cyclical experience, given the current pace 
of output growth. New hires and recalls from layoffs, however, are far 
below what historical experience indicates. To a surprising degree, 
firms seem able to continue identifying and implementing new 
efficiencies in their production processes and thus have found it 
possible so far to meet increasing
orders without stepping up hiring.
    In all likelihood, employment will begin to grow more quickly 
before long as output continues to expand. Productivity over the past 
few years has probably received a boost from the efforts of businesses 
to work off the stock of inefficiencies that had accumulated in the 
boom years. As those opportunities to enhance efficiency become scarcer 
and as managers become more confident in the durability of the 
expansion, firms will surely once again add to their payrolls.
    A consequence of the rapid gains in productivity and slack in our 
labor and product markets has been sustained downward pressure on 
inflation. As measured by the chain-weighted price index for personal 
consumption expenditures excluding food and energy, prices rose less 
than 1 percent in 2003. Given the biases in such indexes, this 
performance puts measured inflation in a range consistent with price 
stability--a statutory objective of the Federal Reserve and a key goal 
of all central banks because it is perceived as a prerequisite for 
maximum sustainable economic growth.
    The recent performance of inflation has been especially notable in 
view of the substantial depreciation of the dollar in 2003. Against a 
broad basket of currencies of our trading partners, the foreign 
exchange value of the U.S. dollar has declined about 13 percent from 
its peak in early 2002. Ordinarily, currency depreciation is 
accompanied by a rise in dollar prices of imported goods and services, 
because foreign exporters endeavor to avoid experiencing price declines 
in their own currencies, which would otherwise result from the fall in 
the foreign exchange value of the
dollar. Reflecting the swing from dollar appreciation to dollar 
depreciation, the dollar prices of goods and services imported into the 
United States have begun to rise after declining on balance for several 
years, but the turnaround to date has been mild. Apparently, foreign 
exporters have been willing to absorb some of the price decline 
measured in their own currencies and the consequent squeeze on profit 
margins it entails.
    Part of exporters' losses, however, have apparently been offset by 
short forward positions against the dollar in foreign exchange markets. 
A marked increase in foreign exchange derivative trading, especially in 
dollar-euro, is consistent with sig-
nificant hedging of exports to the United States and to other markets 
that use
currencies tied to the U.S. dollar. However, most contracts are short-
term because long-term hedging is expensive. Thus, although hedging may 
delay the adjustment, it cannot eliminate the consequences of exchange 
rate change. Accordingly, the currency depreciation that we have 
experienced of late should eventually help to contain our current 
account deficit as foreign producers export less to the United States. 
On the other side of the ledger, the current account should improve as 
U.S. firms find the export market more receptive.
                                 * * *
    Although the prospects for the U.S. economy look quite favorable, 
we need to remind ourselves that all forecasts are projections into an 
uncertain future. The fact that most professional forecasters perceive 
much the same benign short-term outlook that is our most likely 
expectation provides scant comfort. When the future surprises, history 
tells us, it often surprises us all. We must, as a consequence, remain 
alert to risks that could threaten the sustainability of the expansion.
    Besides the chronic concern about a sharp spike in oil or natural 
gas prices, a number of risks can be identified. Of particular 
importance to monetary policymakers is the possibility that our stance 
could become improperly calibrated to evolving economic developments. 
To be sure, the Federal Open Market Committee's current judgment is 
that its accommodative posture is appropriate to foster sustainable 
expansion of economic activity. But the evidence indicates clearly that 
such a policy stance will not be compatible indefinitely with price 
stability and sustainable growth; the real Federal funds rate will 
eventually need to rise toward a more neutral level. However, with 
inflation very low and substantial slack in the economy, the Federal 
Reserve can be patient in removing its current policy accommodation.
    In the process of assessing risk, we monitor a broad range of 
economic and financial indicators. Included in this group are a number 
of measures of liquidity and credit creation in the economy. By most 
standard measures, aggregate liquidity does not appear excessive. The 
monetary aggregate M2 expanded only 5\1/4\ percent during 2003, 
somewhat less than nominal GDP, and actually contracted during the 
fourth quarter. The growth of non-Federal debt, at 7\3/4\ percent, was 
relatively brisk in 2003. However, a significant portion of that growth 
was associated with the record turnover of existing homes and the high 
level of cash-out refinancing, which are not expected to continue at 
their recent pace. A narrower measure, that of credit held by banks, 
also grew only moderately in 2003. All told, our accommodative monetary 
policy stance to date does not seem to have generated excessive volumes 
of liquidity or credit.
    That said, as we evaluate the risks to the economy, we also assess 
developments in financial markets. Broad measures of equity prices rose 
25 percent in 2003, and technology stocks increased twice as quickly. 
The rally has extended into this year. And as I noted previously, 
credit spreads on corporate bonds have narrowed con-
siderably, particularly for speculative-grade issues. This performance 
of financial
markets importantly reflects investors' response to robust earnings 
growth and the repair of business balance sheets over the past few 
years. However, history shows that pricing financial assets 
appropriately in real time can be extremely difficult and that, even in 
a seemingly benign economic environment, risks remain.
    The outlook for the Federal budget deficit is another critical 
issue for policymakers in assessing our intermediate- and long-run 
growth prospects and the risks to those prospects. As you are well 
aware, after a brief period of unified budget
surpluses around the beginning of this decade, the Federal budget has 
reverted to
deficits. The unified deficit swelled to $375 billion in fiscal 2003 
and appears to be widening considerably further in the current fiscal 
year. In part, these deficits are a result of the economic downturn and 
the period of slower growth that we recently experienced, as well as 
the earlier decline in equity prices. The deficits also reflect fiscal 
actions specifically intended to provide stimulus to the economy, a 
significant step-up in spending for national security, and a tendency 
toward diminished restraint on discretionary spending. Of course, as 
economic activity continues to expand, tax revenues should strengthen 
and the deficit will tend to narrow, all else being equal. But even 
budget projections that attempt to take such business-cycle influences 
into account, such as those from the Congressional Budget Office and 
the Office of Management and Budget, indicate that very sizable 
deficits are in prospect in the years to come.
    As I have noted before, the debate over budget priorities appears 
to be between those advocating additional tax cuts and those advocating 
increased spending. Although some stirrings in recent weeks in the 
Congress and elsewhere have been directed at actions that would lower 
forthcoming deficits, to date no effective constituency has offered 
programs to balance the budget. One critical element--present in the 
1990's but now absent--is a framework of procedural rules to help 
fiscal policy makers make the difficult decisions that are required to 
forge a better fiscal balance.
    The imbalance in the Federal budgetary situation, unless addressed 
soon, will pose serious longer-term fiscal difficulties. Our 
demographics--especially the retirement of the baby-boom generation 
beginning in just a few years--mean that the ratio of workers to 
retirees will fall substantially. Without corrective action, this
development will put substantial pressure on our ability in coming 
years to provide even minimal Government services while maintaining 
entitlement benefits at their current level, without debilitating 
increases in tax rates. The longer we wait before addressing these 
imbalances, the more wrenching the fiscal adjustment ultimately will 
be.
    The fiscal issues that we face pose long-term challenges, but 
Federal budget deficits could cause difficulties even in the relatively 
near term. Long-term interest rates reflect not only the balance 
between the current demand for, and current supply of, credit, but they 
also incorporate markets' expectations of those balances in the future. 
As a consequence, should investors become significantly more doubtful 
that the Congress will take the necessary fiscal measures, an 
appreciable backup in long-term interest rates is possible as prospects 
for outsized Federal demands on national saving become more apparent. 
Such a development could constrain investment and other interest-
sensitive spending and thus undermine the private capital formation 
that is a key element in our economy's growth prospects.
    Addressing the Federal budget deficit is even more important in 
view of the widening U.S. current account deficit. In 2003, the current 
account deficit reached $550 billion--about 5 percent of nominal Gross 
Domestic Product. The current account deficit and the Federal budget 
deficit are related because the large Federal dissaving represented by 
the budget deficit, together with relatively low rates of U.S. private 
saving, implies a need to attract saving from abroad to finance 
domestic private investment spending.
    To date, the U.S. current account deficit has been financed with 
little difficulty. Although the foreign exchange value of the dollar 
has fallen over the past year, the decline generally has been gradual, 
and no material adverse side effects have been visible in U.S. capital 
markets. While demands for dollar-denominated assets by foreign private 
investors are off their record pace of mid-2003, such investors 
evidently continue to perceive the United States as an excellent place 
to invest, no doubt owing, in large part, to our vibrant market system 
and our economy's very strong productivity performance. Moreover, some 
governments have accumulated large amounts of dollar-denominated debt 
as a byproduct of resisting upward exchange rate adjustment.
    Nonetheless, given the already-substantial accumulation of dollar-
denominated debt, foreign investors, both private and official, may 
become less willing to absorb ever-growing claims on U.S. residents. 
Taking steps to increase our national saving through fiscal action to 
lower Federal budget deficits would help diminish the risks that a 
further reduction in the rate of purchase of dollar assets by foreign 
investors could severely crimp the business investment that is crucial 
for our long-term growth.
    The large current account deficits and the associated substantial 
trade deficits pose another imperative--the need to maintain the degree 
of flexibility that has been so prominent a force for U.S. economic 
stability in recent years. The greatest current threat to that 
flexibility is protectionism, a danger that has become increasingly 
visible on today's landscape. Over the years, protected interests have 
often
endeavored to stop in its tracks the process of unsettling economic 
change. Pitted against the powerful forces of market competition, 
virtually all such efforts have failed. The costs of any new 
protectionist initiatives, in the context of wide current account 
imbalances, could significantly erode the flexibility of the global 
economy. Consequently, creeping protectionism must be thwarted and 
reversed.
                                 * * *
    In summary, in recent years the U.S. economy has demonstrated 
considerable resilience to adversity. It has overcome significant 
shocks that, in the past, could have hobbled growth for a much longer 
period than they have in the current cycle. As I have noted previously, 
the U.S. economy has become far more flexible over the past two 
decades, and associated improvements have played a key role in 
lessening the effects of the recent adverse developments on our 
economy. Looking forward, the odds of sustained robust growth are good, 
although, as always, risks remain. The Congress can help foster 
sustainable expansion by taking steps to reduce Federal budget deficits 
and thus contribute to national saving and by continuing to pursue 
opportunities to open markets and promote trade. For our part, the 
Federal Reserve intends to use its monetary tools to promote our goals 
of economic growth and maximum employment of our resources in an 
environment of effective price stability.
        RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY 
                      FROM ALAN GREENSPAN

Q.1. Chairman Greenspan, the U.S. current account deficit and 
the offsetting financial holdings of foreign country residents 
have sparked concerns among some economists and others. They 
question how long foreign country residents will sustain the 
deficit
by increasing their holdings of dollar-denominated assets in 
their
portfolios.
    What factors do you believe are the most important in 
determining how long such capital flows can be sustained?
    What do you believe is the most serious long-term cost to 
the U.S. economy that arises from the current account deficit?

A.2. As noted in your question, the U.S. current account 
deficit is also, by definition, a measure of the portion of 
U.S. net investment in domestic plant and equipment that is 
financed with foreign funds, both debt and equity. The 
impressive productivity performance of the U.S. economy during 
this period of the widening of the U.S. current account deficit 
has motivated global investors (both U.S. and foreign) to place 
their funds disproportionately in U.S. assets because of the 
expectation of higher returns, adjusted for risk, on these 
relatively more productive assets.
    It is difficult to predict how long global investors will 
continue to place their funds disproportionately in U.S. 
assets. To date, the U.S. current account deficit has been 
financed with little difficulty. Although the foreign exchange 
value of the dollar has fallen over the past year, the decline 
generally has been gradual, and no material adverse side 
effects have been visible in U.S. capital markets. While 
demands for dollar-denominated assets by private foreign 
investors are off their record pace of mid-2003, such investors 
evidently continue to perceive the United States as an 
excellent place to invest, no doubt owing, in large part, to 
our vibrant market system and our economy's very strong 
productivity performance. In addition, some governments have 
added to their official holdings of dollar-denominated debt as 
a by-product of resisting upward pressure on their exchange 
rates.
    But the current account deficit, as you state in your 
question, is also a measure of the increase in the level of 
claims that foreigners have on U.S. assets. As the stock of 
such claims grows, foreign investors, both private and 
official, may become less willing to absorb ever-growing claims 
on U.S. residents. Taking steps to increase our national saving 
through fiscal action to lower Federal budget deficits would 
help diminish the risks that a reduction in the rate of 
purchase of dollar assets by foreign investors could severely 
crimp the business investment that is crucial for our long-term 
growth.
    The U.S. economy is best served by following policies that 
provide the basis for maximum long-term growth with stable 
prices in an environment characterized by private, flexible 
markets. Probably the most serious long-term costs that could 
arise from the U.S. current account deficit would come if we 
followed policies aimed at reducing this deficit that are 
inconsistent with our fundamental policy objectives, in 
particular, protectionist trade policies that interfere with 
the degree of flexibility that has been so positive a force for 
U.S. economic performance in recent years. Over the years, 
protected interests have often endeavored to stop in its tracks 
the process of unsettling economic change. Pitted against the 
powerful forces of market competition, virtually all such 
efforts are counterproductive and have failed. Creeping 
protectionism must be thwarted and reversed.

Q.2. Chairman Greenspan, in your speech before the Dallas World 
Affairs Council last December, you noted that, even if China's 
currency were allowed to float freely and consequently rose 
against the dollar, that U.S. employment rates would be 
unlikely to rise on account of a shift away from China toward 
increased imports from other, low-cost manufacturing countries.
    In your speech, you also referred to the potential 
difficulties the Chinese banking system would have in the event 
the currency peg were precipitously removed.
    Could you expand on how instability in China's financial 
markets and banking system caused by the removal of the 
currency peg would adversely affect the United States?
    What reforms does the Chinese government need to undertake 
before removal of the peg is possible? Are they moving in that 
direction?

A.2. The condition of the Chinese banking system is currently 
quite weak. Chinese banks officially reported having bad debts 
that amounted to 15 percent of their loans, but market analysts 
estimate that the true level of nonperforming loans among 
Chinese banks is in the range of 40 to 50 percent of all loans. 
Even the officially reported figure suggests that the banking 
system's liabilities may exceed the value of its assets. 
Banking systems can operate in such a weakened state only if 
depositors, perhaps because they are content with an implicit 
government guarantee on bank liabilities, leave their money in 
their banks. Many in China fear that removal of capital 
controls that restrict the ability of domestic investors to 
invest abroad and to sell or to purchase foreign currency--
which is a necessary step to allow a currency to float freely--
could cause an outflow of deposits from Chinese banks, 
destabilizing the system.
    U.S. residents do not have substantial claims on Chinese 
banks, but financial instability in a major emerging market 
economy such as China would present a risk to the global 
economic outlook.
    The Chinese government needs to take a number of steps--
some of which are already underway--to strengthen its banking 
system. It needs to strengthen accounting and bank supervisory 
systems, in order to assess accurately the size of the problem. 
Problem loans that are uncovered will need to be reserved 
against, and this will likely require government capital 
injections (because the alternative is losses for bank 
depositors and a possible loss of confidence in the banking 
system). More important, however, are steps that eliminate 
state interference in bank lending decisions and that create 
the financial discipline and incentives that are a crucial part 
of a viable credit system. Banks need to improve their lending 
decisions, internal controls, and risk management systems. 
Before this will happen, bank managers need to be given the 
training, incentives, and authority to evaluate credit risk and 
to make loans based on those evaluations, as well as the 
authority to take steps to cut costs. In addition, bankruptcy 
laws and foreclosure policies need to be strengthened.
    As mentioned, the Chinese government seems to be moving to 
strengthen the banking system. For example, they have recently 
imposed more stringent accounting rules on nonperforming loans. 
In addition, several of the largest state-owned banks recently 
received capital injections from the government, and some 
reports suggest that the authorities are encouraging the banks 
to modernize their operations.

Q.3. Many of our trading partners are concerned about the 
decline in the relative value of the dollar and that decline's 
implications for economies dependent upon exports to the 
American market. For the past year, the euro has been 
consistently stronger than the dollar. Yet, our trade deficit 
with Western Europe for 2003 exceeded that for 2002. Much has 
been made of the growth in American exports during the final 
quarter of 2003, but the trade balance hasn't changed because 
of the continued high level of imports.
    If the rise of the euro against the dollar hasn't resulted 
in the kind of shift in trade balance we might have 
anticipated, what does this tell us about conventional beliefs 
regarding the relationship between exchange rates and trade?

A.3. Trade balances are determined mainly by countries' 
relative incomes, by relative prices, including exchange rates, 
and by comparative advantage. These determinants are inherently 
multilateral; the movement of the dollar vs. the euro not only 
influences our trade with Western Europe but also influences 
both U.S. and European trade with third countries, such as 
those in Asia. Some adjustment in our multilateral trade 
balance has begun to take place; our trade and current account 
deficits have narrowed as a share of GDP during 2003, after 
widening steadily since 1997, even though the U.S. economy 
continues to expand at a faster rate than our trading partners.
    Some analysts might have expected the deficit to narrow 
more rapidly, although such adjustment most often occurs over 2 
to 3 years. Ordinarily, currency depreciation is accompanied by 
a rise in dollar prices of imported goods and services, because 
foreign exporters endeavor to avoid experiencing price declines 
in their own currencies, which would otherwise result from the 
fall in the foreign exchange value of the dollar. Reflecting 
the swing from dollar appreciation to dollar depreciation, the 
dollar prices of goods and services imported by the United 
States have begun to rise after declining on balance for 
several years, but the turnaround to date has been mild. 
Apparently, to date, foreign exporters have been willing to 
absorb much of the price decline measured in their own 
currencies and the consequent squeeze on profit margins it 
entails.
    The currency depreciation that we have experienced of late 
should eventually help to contain our current account deficit 
as foreigners export less to the United States. On the other 
side of the ledger, the current account should improve as U.S. 
firms find the export market more receptive.

Q.4. In your written testimony to the Committee last year, you 
noted that the fiscal year 2002 budget deficit would have been 
$40 billion smaller if entitlement benefits and individual 
income tax brackets had been inflated using the chain weighted 
CPI rather than the existing cost of living adjustment.
    Do you still feel that the cost of living adjustment 
underlying OMB and CBO's budget projections overstates 
inflation? If so, how much do you think Congress could have 
saved had we used the chain weighted CPI?

A.4. Although the Bureau of Labor Statistics has made 
significant changes and very materially improved the cost of 
living indexes currently used to adjust taxes and spending, I 
believe that these indexes still overstate inflation. One major 
issue is substitution bias, which the BLS's new chain weighted 
CPI index largely corrects. The other major issue that remains 
is the incomplete adjustment of quality change in the existing 
cost of living indexes; it may be quantitatively more important 
than the substitution bias.
    If, over the past decade, the chain weighted CPI had been 
used instead of the current official indexes, the cumulative 
unified budget deficit and the level of Federal debt would have 
been reduced about $200 billion. About 40 percent of these 
savings are attributable to reductions in indexed spending 
programs and the remaining 60 percent are attributable to 
higher taxes (including debt service).

       RESPONSE TO WRITTEN QUESTIONS OF SENATOR SCHUMER 
                      FROM ALAN GREENSPAN

Q.1. The President has stated that his tax cuts are leading to 
job creation. As I look at the data, that does not seem to be 
the case. The record of job creation under his leadership is 
much worse than we have ever seen in any past recession/
recovery cycle since WWII.
    It is startling to me that this recession was shorter than 
many but, in fact, has taken much, much longer than any other 
post-war period to create jobs. And we still have 716,000 fewer 
jobs 26 months after the official end of the recession than we 
had when the ``recovery'' began. What few jobs have been 
created are low end service jobs--restaurant work, temporary 
work, etc.--not the jobs that we continue to lose to this day 
that contribute to an expanding middle class.
    Given that past recoveries--following much steeper 
recessions--have been so much stronger than under this 
President is there any evidence that his policies have made 
things better than they otherwise would have been?
    Mr. Chairman, do you believe that the President's tax cut 
policies have created any net jobs to date in this country?

A.1. As I have stated publicly before, there can be little 
doubt that the tax cuts of 2001 and 2003 helped shore up a weak 
economy, raising the level of economic activity and employment 
above what it otherwise would have been. Of course, quantifying 
the exact magnitude of that effect is extremely difficult 
because of the many other events that have affected the economy 
during the past 3 years, among them the terrorist attacks of 
September 11, 2001, the corporate governance scandals, and the 
war with Iraq. Moreover, it would appear that a larger share of 
the boost to output was achieved through productivity gains 
than typically has occurred in previous instances of 
expansionary fiscal policy, with a concomitant damping 
influence on employment.

Q.2. There has been a great deal of credit for the positives 
and negatives in the economy given to productivity. However, I 
believe the data shows that productivity has also, in fact, 
been quite high in past periods. So while I agree with those 
who argue that productivity is a factor, productivity alone 
does not seem to fully explain what is happening in today's 
economy.
    Specifically, according to the Bureau of Labor Statistics, 
looking at the last 10 recessions, jobs hit their low point 
around the end of the recession and never more than 3 months 
after the recession ended. But this time the low point in jobs 
came in August 2003--21 months after the last recession ended.
    In the last 10 recessions, there was a complete recovery in 
the number of jobs within 2 years after the end of the 
recession. But this time the recession has been over for 26 
months and we still have 2.3 million fewer payroll jobs than 
when the recession started.
    It is true that over the last 8 years, from 1996-2003, 
productivity growth has averaged 2.9 percent. And during the 
preceding 20 years, 1974-1995, productivity growth was much 
lower, averaging only 1.5 percent growth per year. But during 
the period 1948-1973, productivity growth was much stronger, 
stronger even than what we have experienced since 1995, 
averaging 3.3 percent growth per year.
    Yet, as above, the recessions during the previous high 
productivity growth period were not marked by the continual job 
losses and jobless recovery that we are in the midst of today. 
During those recession and recoveries, jobs returned quickly.
    In fact, the two times that the unemployment rate was below 
4.0 percent were during the high productivity periods of the 
late 1990's and the late 1960's.
    So, again, productivity alone does not appear to be the 
answer. We have been a highly productive economy for a long 
time. And in fact, our economic team should have factored in 
strong productivity in our stimulus--high productivity cannot 
be used as an excuse for the failure to produce jobs.
    Mr. Chairman, do you agree with the data above? What 
factors other than productivity should we be considering to 
explain the differences between this ``recovery'' and past 
recoveries?

A.2. The explanations for the surge in productivity over the 
past 2 years are wide-ranging. One hypothesis is that some of 
the increase represents a temporary rise in the level of 
productivity,
reflecting a view that an unusual amount of caution is leading 
businesses to press workers and facilities to a greater degree 
than can be sustained over the longer haul. By this hypothesis, 
as that caution dissipates, employment growth will pick up and 
the level of output per hour will drop back.
    Another hypothesis is that the level of productivity has 
undergone a one-time permanent upward shift. This hypothesis 
builds on the idea that the heavy emphasis on exploiting new 
and expanding markets in the second half of the 1990's may have 
diverted management attention from the hard work of controlling 
costs. The extent to which businesses have succeeded in 
boosting output with less labor over the past 2 years or so 
points up the possibility that a considerable stock of 
inefficiencies accumulated in the boom years and that this 
stock is still being worked off.
    Finally, yet another hypothesis stresses a more-lasting 
increase in the growth of output per hour. This notion focuses 
on the considerable lag between the introduction of new 
technologies and their full integration into production 
processes and business practices. To reap the full benefits of 
technological innovation takes much learning time, especially 
if there are large synergies through network
effects.
    Of course, given the exceptionally high rate of growth in 
output per hour recently, some combination of short-term and 
longer-term productivity-enhancing forces seems likely to have 
been at work. In any event, one consequence of these 
improvements in efficiency has been a temporary ability of many 
businesses to meet increases in demand without expanding 
payrolls. Over longer periods of time, however, productivity 
should not raise the unemployment rate. And, I am confident 
that the same will be true going forward.

Q.3. Mr. Chairman, what is news is that we are now having high 
productivity but only meager wage growth. How do you explain 
that productivity is going up but wages are almost flat--why 
aren't Americans getting paid for their higher output? Have 
workers suddenly become worse negotiators on their own behalf 
for better wages or is there another factor at work, and if so 
what is it?

A.3. Employee remuneration has not been flat. During 2003, 
wages, as measured by the Bureau of Labor Statistics (BLS) 
employment cost index, rose 3 percent for workers in private 
industry; the hourly compensation, which includes employee 
benefits, rose 4
percent. An alternative measure of employee remuneration--
compensation per hour from the BLS data on productivity and on 
costs--increased 3.6 percent during 2003 for workers in the 
private nonfarm business sector.
    More generally, over the long sweep of time real hourly 
compensation and productivity tend to track each other. This 
tendency is reflected in one of the most well-documented 
empirical reg-
ularities of macroeconomics: The long-run relative stability of 
the compensation share of national income. Although the 
compensation share of income fluctuates over the course of the 
business cycle--typically rising in the latter part of 
expansion and initial phase of contraction and then falling 
during the early part of expansions--the share shows no 
distinct trend. It averaged around 61 percent during the 1950's 
and 1960's and has averaged around 65 percent since then. This 
indicates that over time both labor and capital share the 
fruits of productivity growth.

Q.4. Mr. Chairman, given our world of free trade and mobile 
factors of production, some argue that the extraordinary 
productivity of the U.S. worker will save the day by keeping 
good jobs here and wages high. But the facts to date do not 
support that case. While labor productivity is, in fact high, 
wages have been stagnant and job growth is far behind schedule. 
Yet corporate profits are near records.
    In the past, U.S. workers' productivity was a result of 
good education and training coupled with the ability to work 
with the best equipment and technology.
    Given your comments on the strong educational systems in 
East Asia, do you agree that it is possible that, armed with 
United States technology, management, and capital, and trained 
by United States workers, a Chinese or Indian professional can 
be just as productive as his or her United States counterpart, 
but at a fraction of the cost? Or do you think that one United 
States worker based in Rochester, for example, can compete with 
4 or 6 or even 10 workers available for the same price in 
Bangalore?

A.4. As you note in your question, concerns have been expressed 
about an increasing number of better paying white collar jobs 
that have been lost to foreign outsourcing. There is a sense of 
unease that this development potentially will have significant 
adverse long run implications for unemployment and the standard 
of living of the average American. It is instructive to put the 
current developments in historical context. Jobs in the United 
States were perceived as migrating to low-wage Japan in the 
1950's and 1960's, to low-wage Mexico in the 1990's, and most 
recently to low-wage China. Japan, of course, is no longer 
characterized by a low-wage workforce, and many in Mexico are 
now complaining of job losses to low-wage China. That said, 
however, over the long sweep of time, the United States has not 
experienced a net drain of jobs to other nations. For more than 
half a century, the unemployment rate has averaged less than 6 
percent with no evident trend, and the real earnings of the 
average worker have continued to rise. History clearly shows 
that our economy is best served by a full and vigorous 
engagement in the global economy.

Q.5. Mr. Chairman, I have heard a case made that the 
President's policies have hindered job creation in two ways.
    First, some executives tell me there is little confidence 
in the President's fiscal management. People fear the economy 
could be driven into a double-dip recession triggered by a 
currency crisis in turn driven by a crisis in confidence by 
foreign purchasers of our debt and other factors. Deficits and 
debt are the direct result of the high spending we have seen 
under this Administration.
    Second, I have been told the major factor weighing on the 
economy last year was not, in fact, September 11 as some argue, 
it was the decision to go to war with Iraq. That process 
introduced an enormous amount of uncertainty into the economy 
which slowed the natural recovery we were in.
    Can you comment on these two points? Are there grounds for 
pointing out that the President's fiscal policies and war 
policies may have, in fact, slowed down the recovery? Is it 
reasonable to conclude that his policies are holding back the 
natural recovery cycle that we have seen in every previous 
recovery except this one?

A.5. As I have indicated above, several hypotheses have been 
put forward to explain the unusual performance of the labor 
market recently; but the available evidence to date does not 
provide sufficient guidance on their relative importance.

Q.6. Chairman Greenspan, do you think it is time for a ``budget 
summit'' where we bring in leaders from both parties and we put 
everything on the table--tax cuts, spending programs--not just 
one side or another. The goal would be to come up with a plan 
in the best interests of the country.
    I recall you were part of such an effort related to Social 
Security two decades ago. Would you support a bi-partisan 
budget summit?

A.6. A decision of whether to have a ``budget summit'' is, of 
course, entirely up to the President and the Members of 
Congress. Nevertheless, the Nation faces enormous fiscal 
challenges in the coming years that must be dealt with. As I 
noted in my testimony before the House Budget Committee on 
February 25, 2004, the resolution of this situation will 
require difficult choices. One important first step would be 
the restoration of the budget enforcement mechanisms. None of 
the options for resolving the challenge will be easy, as they 
all will involve lowering claims on resources or raising 
financial obligations. It falls on the Congress and the 
President to determine how best to address the competing 
claims. But history has shown that, when faced with major 
challenges, the Congress has risen to the occasion.

Q.7. The papers are reporting that economists at the Fed are 
``puzzled'' by the labor market. It does not square with past 
recoveries, as the data shows. I know you believe productivity 
is a key factor in that difference. But, as you know, we have 
had strong productivity in the past, and the labor market 
recovered more strongly and quickly than now.
    My question is whether you think there could be something 
else going on, reflected in the ability of companies to so 
easily source cheap and very skilled labor offshore--either by 
moving plants overseas or by virtually importing that labor via 
the Internet?
    Could we, in fact, be seeing lots of new jobs being 
created, just not here in the United States? Is this new 
offshoring phenomenon something worth spending more time on? 
Could it partially explain the strange quality of this 
recovery? Could it explain this strange disconnect where 
profits and productivity are up but wages are flat and jobs are 
down?

A.7. As I indicated above, over the long sweep of time, the 
United States has not experienced a net drain of jobs to other 
nations. For more than half a century, the unemployment rate 
has averaged less than 6 percent with no evident trend. 
Moreover, real earnings of the average worker have continued to 
rise. Over the past century, per capita real income has risen 
at an average rate of more than 2 percent per year, declining 
notably only during the Great Depression of the 1930's and 
immediately following World War II. Incomes trended higher 
whether international outsourcing was large or small. The 
reason for this positive long run trend in living standards 
appears to be that more fundamental economic forces determine 
real incomes, irrespective of the specific jobs in which they 
are earned and irrespective of the proportion of domestic 
consumption met by imports.

Q.8. Some have argued that ``protectionist'' trade policies 
have a long history of failure. However, as I have reviewed the 
recent studies, that statement appears to be incorrect and 
contrary to our own history of development. In short, the 
United States had a history of protecting what some call 
``infant industries'' as did Britain--until we had captured 
enough scale that we were ready to open them up to global 
competition.
    In fact, according to some recent works, protectionist 
policies were the case for much of our history and much of 
Britain's history and that protection, according to some, 
helped to create great national wealth. I am referring to data 
presented in a recent World Bank Paper and a book called, 
``Kicking Away the Ladder,'' by Ha-Joon Chang. In other words, 
the stories of the success of free trade policies do not square 
with the historical data. Is the analysis presented in 
Professor Chang's book incorrect? If it is, where is it flawed? 
And if it is not factually incorrect, could the United States 
be guilty of advocating trade policies to the current 
developing world different than we ourselves followed in our 
own developing years? Advocating a double standard, so to 
speak.
    How do you reconcile the data presented in his book--and 
other studies--that show a heavy use of tariffs during our most 
productive and highest growth years with those who argue that 
our history shows that tariffs do not work?
    Given that Professor Chang and others provide strong data 
and specific cases where protectionism has led to economic 
success for different industries, can you help provide 
comparable historical examples--not theory but real history--
and comparable data where protectionism has failed?

A.8. Professor Ha-Joon Chang's book provides an interesting 
description of the history of government policies, 
institutions, and economic growth in a range of countries. As 
Professor Chang points out, history provides important lessons 
for current policy decisions.
    However, Professor Chang's work does not prove that 
protection-
ism enhances growth, for two main reasons. First, although 
there have been historical periods during which protectionism 
and robust economic growth have occurred simultaneously, such a 
contemporaneous occurrence does not necessarily imply 
causality. In other words, just because some countries have had 
high tariffs and, at the same time, have experienced strong 
economic growth does not mean that the high tariffs caused the 
high growth. Second, as Professor Chang himself points out, a 
wide range of policies support economic development, so that 
even his own analysis does not demonstrate that protectionism 
in and of itself leads to high growth. In fact, in a number of 
the cases highlighted by Professor Chang, supportive policies 
(such as infrastructure development and support of an 
educational system) other than protectionism affected growth.
    Research has found a positive correlation between tariffs 
and growth in the late 19th Century.\1\ However, a number of 
studies, that is, Irwin (2002b), show that simultaneous 
occurrence of protectionism and growth does not necessarily 
imply that tariffs promote growth. In some cases, tariffs were 
put in place to raise revenue rather than to protect domestic 
industry from foreign competition.\2\
---------------------------------------------------------------------------
    \1\ For example, see O'Rourke (2000).
    \2\ See Irwin (2002b).
---------------------------------------------------------------------------
    In addition, history provides a number of examples in which 
inward-looking development policies actually hindered growth. 
First, consider the case of Latin America, where some countries 
followed development strategies incorporating ``import-
substituting industrialization,'' beginning in the 1930's. 
Taylor (1998) argues that these inward-looking development 
strategies hindered growth. Taylor (1994) examines the specific 
case of Argentina, which followed such an inward-looking import 
substitution policy. Import restrictions from the 1930's to the 
1950's led to an increase in the price of imported capital 
goods, thereby dampening incentives for investment. He notes 
that, ``With this quantitative support, the argument that 
Argentina's retreat into import-substitution policies cost her 
dearly in terms of slow growth remains as cogent as ever.'' \3\
---------------------------------------------------------------------------
    \3\ Taylor (1994), p. 14.
---------------------------------------------------------------------------
    India also provides an example in which inward-looking 
protectionist policies were associated with adverse effects on 
growth. Bhagwati (1993) claims that India's overall inward-
looking policies through the 1970's (and, to a lesser extent, 
in the 1980's) adversely affected private-sector efficiency and 
contributed to poor performance in terms of export activity, 
industrialization, and growth. Srinivasan and Tendulkar (2003) 
also discuss the adverse effects of inward-oriented policies 
during periods of India's recent history.
    Finally, our own country's history provides an example of 
the adverse effects of protectionism. The notorious Smoot-
Hawley tariff of 1930 likely contributed to at least some 
extent to the subsequent deterioration in U.S. trade flows and 
economic performance.\4\
---------------------------------------------------------------------------
    \4\ For example, see Irwin (2002a), Irwin (1998), p. 151, and 
Crucini and Kahn (1996).
---------------------------------------------------------------------------
    More broadly, a number of studies have found a positive 
relationship between economic openness and growth, including 
Dollar and Kraay (2001) and Edwards (1998).
    Thus, Professor Chang's analysis does not show that 
protectionism spurs growth. In fact, other evidence indicates 
that, to the contrary, inward-looking policies may well impede 
growth. In addition, his analysis does not clearly distinguish 
between the effects of protectionism and the effects of pro-
growth policies such as infrastructure development and support 
of a strong educational system. It could even be argued that 
because of these other supportive policies some countries 
experienced growth despite their protectionist policies.

References

Bhagwati, Jagdish. (1993) India in Transition: Freeing the 
    Economy. Oxford, England: Clarendon Press.
Chang, Ha-Joon. (2002a) Kicking Away the Ladder: Development 
    Strategy in Historical Perspective. London: Anthem Press.
Chang, Ha-Joon. (2002b) ``Kicking Away the Ladder: `Good 
    Policies' and `Good Institutions' in Historical 
    Perspective,'' in Papers from the First Inequality and Pro-
    Poor Growth Conference, Topic: Globalization and 
    Inequality, Washington, DC, June 18, 2002, available at 
    http://www.worldbank.org/research/inequality/
    0618RTPapers.htm.
Crucini, Mario J. and Kahn, James. (1996) ``Tariffs and 
    Aggregate Economic Activity: Lessons from the Great 
    Depression.'' Journal of Monetary Economics. 38(3) 
    (December): 427- 467.
Dollar, David and Kraay, Aart. (2001) ``Trade, Growth, and 
    Poverty.'' Manuscript. Edwards, Sebastian. (1998) 
    ``Openness, Productivity, and Growth: What Do We Really 
    Know? The Economic Journal. 108(447) (March): 383-398.
Irwin, Douglas. (1998) ``The Smoot-Hawley Tariff: A 
    Quantitative Assessment.'' The Review of Economics and 
    Statistics. 80(2) (May): 326-334.
Irwin, Douglas. (2002a) Free Trade Under Fire. Princeton, NJ: 
    Princeton University Press.
Irwin, Douglas. (2002b) ``Interpreting the Tariff-Growth 
    Correlation of the Late Nineteenth Century.'' American 
    Economic Review. 92(2) (May): 165 -169.
O'Rourke, Kevin. (2000) ``Tariffs and Growth in the Late 19th 
    Century.'' The Economic Journal. 110 (April): 456-483.
Srinivasan, T.N. and Tendulkar, Suresh D. (2003) Reintegrating 
    India with the World Economy. Washington, DC: Institute for 
    International Economics.
Taylor, Alan M. (1994) ``Three Phases of Argentine Economic 
    Growth.'' National Bureau of Economic Research Working 
    Paper Series on Historical Factors in Long Run Growth.'' 
    Historical Paper No. 60. (October). Cambridge, MA: National 
    Bureau of Economic Research.
Taylor, Alan M. (1998) ``On the Costs of Inward-Looking 
    Development: Price Distortions, Growth, and Divergence in 
    Latin America.'' The Journal of Economic History. 58(l) 
    (March): 1-28.

Q.9. I agree with your comments on the importance of education 
to our national competitiveness and strength. However, that is, 
realistically, a long-term fix and the job losses are happening 
each day. What do we do in the near term to reduce the human 
toll of lost jobs to competition from lower wage, skilled 
offshore labor? As you said, the problems may not lie with the 
workers but on our educational system, how do we make sure they 
do not pay too severe a price for a systemic failure?

A.9. As I have indicated, we need to increase our efforts to 
ensure that as many of our citizens as possible have the 
opportunity to capture the benefits that flow from free and 
open trade. One critical element is to provide ongoing training 
and education to displaced workers. As you point out, 
retraining and upgrading skills take time. Over the shorter 
term, as I noted in my appearance on March 11 before the House 
Committee on Education and the Workforce, a continuation of 
unemployment insurance benefits deserves consideration. 
Moreover, trade adjustment assistance and other income support 
programs are available to ease the adjustment faced by some 
workers.

        RESPONSE TO WRITTEN QUESTION OF SENATOR CORZINE 
                      FROM ALAN GREENSPAN

Q.1. With regard to the top 10 countries holding our national 
debt. I have a particular curiosity about the Caribbean banking 
centers and what its implications are with respect to our 
concern about funding of all kinds of miscellaneous problems 
that could potentially exist. I would love to hear an analysis 
of what is driving the fourth highest concentration of our debt 
being held by Caribbean banking centers.

A.1. According to the most recently published estimates, as of 
end-December 2003, entities located in Caribbean banking 
centers held $69 billion in U.S. Treasury securities, making 
them the fourth largest holder of U.S. Treasury securities--
behind the holdings of Japan ($545 billion), China ($149 
billion), and the United Kingdom ($113 billion), and ahead of 
Hong Kong ($58 billion). Securities reporting systems 
worldwide, including that of the United States, have well-known 
and significant shortcomings in accurately attributing ultimate 
beneficial ownership of cross-border liabilities. These 
shortcomings are especially severe vis-a-vis financial centers 
with large custodial operations and tax havens where conduit 
investment vehicles are established. Thus, a significant 
portion of the Treasuries attributed to the Caribbean are 
undoubtedly held for the benefit of residents elsewhere. 
Although the custodial issue present in reporting against other 
financial centers is likely less
severe in the case of the Caribbean, the prevalence of conduit 
vehicles there significantly obscures ultimate beneficial 
ownership.
    An examination of reports filed with U.S. regulators 
indicates that between $7 billion and $18 billion of the 
Treasuries attributed to the Caribbean are held directly on the 
balance sheets of banks within the Federal Reserve/FFIEC 
reporting systems. As such, the direct holders of these 
securities are familiar to U.S. regulators. Moreover, because 
the United States ``Know Your Customer'' (KYC) requirements 
extend to the consolidated entity, those people or entities who 
hold the claims that form the counterpart liabilities to these 
Treasury holdings are subject to the KYC screening. The 
remaining Treasuries are likely held at banks managed and 
controlled by non-U.S. residents or other investment vehicles, 
such as hedge funds.
    The reporting requirements of hedge fund managers/advisors 
can be extensive, although they vary considerably with the size 
and the nature of the investment. However, the reporting 
requirements are almost exclusively related to positions in 
equities, futures, and options on futures and are generally at 
the level of the manager/advisor, which can aggregate 
investments for both domestic and foreign funds. Thus, the 
current reporting by hedge funds sheds little light on the 
geographic attribution of their Treasury positions.
    Of late, Treasury holdings in the Caribbean have not been 
growing as rapidly as those attributed to most of the other top 
holders. Between March 2003 and December 2003, Treasuries 
attributed to the Caribbean increased $7.6 billion (12 
percent), compared with increases of $146 billion (36 percent) 
for Japan, $16 billion (12 percent) for China, $30 billion (36 
percent) for the United Kingdom, and $8 billion (17 percent) 
for Hong Kong. The increase in Caribbean holdings is similar to 
that registered by Switzerland (the tenth largest holder and 
another prominent financial center) which increased its 
holdings of Treasuries $4.2 billion (12 percent) over the 
period.
    According to the Financial Stability Forum's ``Report of 
the Working Group on Offshore Centres,'' offshore financial 
centers (OFC's) are used by a variety of firms and individuals 
for a variety of reasons, some legitimate and benign, some not. 
In particular, the report states that OFC's are used by:

 International companies, to maximise profits in low 
    tax regimes.
 International companies, to issue securitised products 
    through special purpose vehicles.
 Individuals and companies, to protect assets from 
    potential claimants.
 Investors (individuals, investment funds, trusts, 
    etc.), to minimise income and withholding taxes and to 
    avoid disclosing investment positions.
 Financial institutions with affiliates in OFC's, to 
    minimise income and withholding tax and to avoid regulatory 
    requirements in the ``onshore'' jurisdictions in which they 
    operate.
 Financial institutions, to assist customers in 
    minimising income and withholding tax.
 Insurance companies, to accumulate reserves in low tax 
    jurisdictions and to conduct business in responsive 
    regulatory environments.
 Criminals and others, to launder proceeds from crime 
    through banking systems without appropriate checks on the 
    sources of such funds and to use local secrecy legislation 
    as a means of protection against enquiries from law 
    enforcement and supervisory authorities (including foreign 
    authorities), and/or to commit financial fraud.

    Some of these activities also happen in other jurisdictions 
and the fact that they take place does not necessarily mean 
that the OFC authorities approve of such practices (for 
example, money laundering, financial fraud). (Financial 
Stability Forum, ``Report of the Working Group on Offshore 
Centres,'' April 5, 2000, p. 10.)

        RESPONSE TO WRITTEN QUESTIONS OF SENATOR HAGEL 
                      FROM ALAN GREENSPAN

Q.1. Could you discuss how the U.S. labor pool will be impacted 
by the increasing retirement of the baby boomers? What 
initiatives should policymakers be considering to address this 
issue?

A.1. The baby-boom generation has had a large effect on the 
labor force. The growth rate of the labor force was boosted 
considerably when the baby boomers began working, and the 
growth rate is
likely to fall considerably as they retire. Over the next 30 
years, the growth rate of the working-age population in the 
United States is projected to fall from about 1 percent per 
year today to about \1/2\ percent per year in 2030. One upshot 
of this slowdown in labor force growth is that the ratio of 
working age to total population will decrease. Increases in 
life expectancy, while undeniably desirable, also decrease the 
ratio of working age to total population. By 2030, the ratio of 
working age to total population is projected to be about 6 
percent below the level it is today.
    In its simplest terms, economic output is determined by the 
size of the labor force multiplied by the productivity of that 
labor. As the ratio of workers to population declines, then 
holding all else constant, per capita output will fall. Of 
course, everything else may not be constant. For example, as 
life expectancy and health status continue to improve, and as 
the demand for labor increases, older workers may choose to 
delay retirement. Increased work effort by older workers could 
have a significant impact on the labor force; however, the 
experience to date suggests that, despite the increasing 
feasibility of work, Americans have not delayed retirement. 
Indeed, there has been a long-term trend toward earlier and 
earlier retirement. While some analysts believe this trend has 
slowed, few anticipate a rapid turnaround, even given the 
increase in retirement age for Social Security from 65 to 67 
that will be fully phased in by 2027. Nonetheless, the 
potential for increased work effort by the elderly should not 
be discounted, particularly if policies to encourage such 
behavior are enacted.
    The rate of productivity growth also may be affected by the 
slowdown in labor force growth. While still quite uncertain, 
some
research has suggested that by increasing the incentives for 
labor-saving technologies, an aging workforce may actually spur 
technological development. Although it is unclear what direct 
effect policy can or should have on technological innovation, 
it is clear that maintaining the flexibility of our labor and 
capital markets is key to our ability to translate improved 
technology into greater economic output.

Q.2. In addition, does your research suggest that foreigners 
improve our ability to fund the health and retirement benefits 
of baby boomers?

A.2. Immigration is another potential source of labor growth. 
The official population projections assume that the current 
level of immigration will continue indefinitely, and on net, 
immigration represents about half of the growth of the labor 
force projected for the United States. Fully offsetting the 
effects of demographic change on elderly dependency by 
increasing immigration would require a much larger change in 
immigration than is currently anticipated. But as the influx of 
foreign workers in response to the tight labor markets of the 
1990's showed, immigration does respond to labor shortages. The 
assumption under the intermediate projections of the Social 
Security actuaries--that immigration will decline somewhat from 
today's level--may prove to be overly conservative.

Q.3. What level of concern do you have for the long-term 
effects on the Nation's economy due to the trillions of dollars 
of underfunded obligations that we face? How is the rest of the 
world perceiving
this risk?

A.3. The aging of the population in the United States will have 
significant effects on our fiscal situation and our economy. In 
particular, it makes our pay-as-you-go Social Security and 
Medicare programs, as currently constituted, unsustainable in 
the long run. The effects on the economy will depend, in large 
part, on how long we wait before we make changes to our 
retirement programs. As I noted in my February testimony, the 
budget scenarios considered by the CBO in its December 
assessment of the long-term budget outlook offer a sobering 
illustration of the potential effects on the economy of not 
reforming Social Security and Medicare in anticipation of the 
baby boomers' retirement. These scenarios suggest that, under a 
range of reasonably plausible assumptions, we could be in a 
situation in the decades ahead in which rapid increases in the 
unified budget deficit set in motion an unsustainable dynamic 
in which large deficits result in ever-growing interest 
payments leading to ever-growing deficits in future years.

Q.4. Is it not true that the global trend with all industrial 
countries, including China, has been a loss of manufacturing 
jobs in large part due to advancements in productivity and 
improvements in information technology and communications?

A.4. For the industrial economies and many emerging market 
economies, manufacturing employment as a share of total 
employment has been trending down for decades. A primary factor 
behind this downward trend has been improvement in productivity 
supported, in part, by advancements in technology and 
communication. Such gains underlie advances in living standards 
everywhere.
    In terms of the number of manufacturing jobs, however, the 
pattern is less clear. In Canada, Italy, and Mexico, for 
example, the number of manufacturing jobs has remained fairly 
stable or risen over the past one to two decades. The 
experience of other countries is more varied. In the United 
Kingdom and in Germany after reunification, manufacturing 
employment has fallen relatively continuously. In Japan, 
manufacturing employment rose through the early 1990's but has 
dropped off sharply subsequently. Manufacturing employment in 
China rose through the mid-1990's but has since declined, in 
part reflecting government efforts to reform state-owned 
enterprises. For the United States, the number of manufacturing 
jobs generally hovered between 20 and 21 million from 1980 to 
2000. It has only been in the most recent downturn that the 
number of U.S. manufacturing jobs has fallen significantly 
below 20 million.

Q.5. The Argentine debt default, the largest sovereign default 
in history, caused billions in losses for United States 
financial institutions, not to mention the losses throughout 
Canada and Europe. How will this influence emerging market 
investments and risk selection among banks in the future?

A.5. Argentina is still in the process of restructuring its 
debt so the final extent of creditor losses has yet to be 
determined. It seems clear, however, that the Argentine debt 
default will invoke significant losses on the holders of 
Argentine sovereign debt. In addition, foreign financial 
institutions operating in Argentina, including several United 
States banks, sustained losses as a result of the actions the 
Argentine government took toward the financial system in the 
wake of the default.
    To date, other than cutting off capital flows to Argentina, 
the Argentine default appears to have had little lasting effect 
on overall performance in the market for emerging market 
sovereign debt. However, foreign direct investment flows to 
Latin America have been weaker recently. The events in 
Argentina appear to have reminded lenders and investors of the 
potential risks of investing in emerging markets.



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