[Joint House and Senate Hearing, 109 Congress]
[From the U.S. Government Publishing Office]
S. Hrg. 109-164
THE ECONOMIC OUTLOOK
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HEARING
BEFORE THE
JOINT ECONOMIC COMMITTEE
CONGRESS OF THE UNITED STATES
ONE HUNDRED NINTH CONGRESS
FIRST SESSION
__________
JUNE 9, 2005
__________
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JOINT ECONOMIC COMMITTEE
[Created pursuant to Sec. 5(a) of Public Law 304, 79th Congress]
HOUSE OF REPRESENTATIVES SENATE
Jim Saxton, New Jersey, Chairman Robert F. Bennett, Utah, Vice
Paul Ryan, Wisconsin Chairman
Phil English, Pennsylvania Sam Brownback, Kansas
Ron Paul, Texas John Sununu, New Hampshire
Kevin Brady, Texas Jim DeMint, South Carolina
Thaddeus G. McCotter, Michigan Jeff Sessions, Alabama
Carolyn B. Maloney, New York John Cornyn, Texas
Maurice D. Hinchey, New York Jack Reed, Rhode Island
Loretta Sanchez, California Edward M. Kennedy, Massachusetts
Elijah E. Cummings, Maryland Paul S. Sarbanes, Maryland
Jeff Bingaman, New Mexico
Christopher J. Frenze, Executive Director
Chad Stone, Minority Staff Director
C O N T E N T S
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Opening Statement of Members
Representative Jim Saxton, Chairman, a U.S. Representative from
New Jersey..................................................... 1
Senator Jack Reed, Ranking Member, a U.S. Senator from Rhode
Island......................................................... 2
Senator Robert F. Bennett, Vice Chairman, a U.S. Senator from
Utah........................................................... 12
Representative Carolyn B. Maloney, a U.S. Representative from New
York........................................................... 14
Senator Jim DeMint, a U.S. Senator from South Carolina........... 15
Representative Maurice D. Hinchey, a U.S. Representative from New
York........................................................... 16
Representative Ron Paul, a U.S. Representative from Texas........ 17
Representative Loretta Sanchez, a U.S. Representative from
California..................................................... 20
Representative Kevin Brady, a U.S. Representative from Texas..... 22
Representative Elijah E. Cummings, a U.S. Representative from
Maryland....................................................... 24
Representative Thaddeus G. McCotter, a U.S. Representative from
Michigan....................................................... 35
Witnesses
Statement of Hon. Alan Greenspan, Chairman, Board of Governors,
Federal Reserve System......................................... 4
Submissions for the Record
Prepared statement of Representative Jim Saxton, Chairman........ 40
Letter from Chairman Saxton to Chairman Greenspan................ 41
Response of Chairman Greenspan to letter from Chairman Saxton.... 44
Prepared statement of Senator Jack Reed.......................... 50
Prepared statement of Hon. Alan Greenspan, Chairman, Board of
Governors, Federal Reserve System.............................. 52
THE ECONOMIC OUTLOOK
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THURSDAY, JUNE 9, 2005
Congress of the United States,
Joint Economic Committee,
Washington, DC.
The Committee met, pursuant to notice, at 10 a.m., in room
HR-2118, Rayburn House Office Building, the Honorable Jim
Saxton, Chairman of the Committee, presiding.
Representatives Present: Representatives Saxton, English,
Paul, Brady, McCotter, Maloney, Hinchey, Sanchez, and Cummings.
Senators Present: Senators Bennett, DeMint, and Reed.
Staff present: Chris Frenze; Colleen Healy; Bob Keleher;
Brian Higginbotham; John Kachtik; Natasha Moore; Jeff Wrase;
Chad Stone; Matt Solomon; and Nan Gibson.
OPENING STATEMENT OF HON. JIM SAXTON, CHAIRMAN,
A U.S. REPRESENTATIVE FROM NEW JERSEY
Representative Saxton. Good morning. The hearing will come
to order.
I am very pleased this morning to welcome Chairman
Greenspan before the Joint Economic Committee. Chairman
Greenspan's testimony will provide useful insights on the
current economic expansion and the potential for further
economic progress.
A broad array of standard economic data indicates that the
economic expansion is on a solid footing. The U.S. economy grew
4 percent in 2004 and advanced at a 3.5 percent rate in the
first quarter of 2005.
A rebound in business investment has played an important
role in explaining the pickup of the economy since 2003.
Equipment and software investment has also been strong over
this period.
The improvement in economic growth is reflected in other
economic figures as well. For example, over the last 4 months,
3.5 million jobs have been added to the business payrolls. The
unemployment rate stands at 5.1 percent, consumer spending
continues to grow, home ownership is at record highs and
household net worth is also at a high level.
Meanwhile, inflation pressures appear to be contained.
Interest rates remain at historically low levels with long-term
interest rates, including mortgage rates, actually declining
recently. This decline of long-term interest rates, even as the
Fed is increasing short-term interest rates, is very unusual, a
topic I would like to discuss later on.
In short, overall economic conditions remain positive. It
is clear that an accomodative monetary policy and tax
incentives for investment have made important contributions to
the improvement of the economy in recent years. Recently
released minutes from the Federal Reserve suggest that the
central bank expects this economic trend to continue. As
always, there are some aspects of the economy that should be
monitored quite closely. There appears to be pressures in some
local housing markets, but these are unlikely to pose a
significant threat to the national economic expansion.
Also, quite importantly, the increase in oil prices has had
an impact on certain sectors of the economy, but has not
severely undermined overall economic growth. A consensus of
Blue Chip forecasters projects that the economic expansion will
continue through 2005 and 2006. This is consistent with Federal
Reserve forecasts for economic growth through 2006.
In summary, the economic situation is solid and the outlook
remains favorable. That is the good news.
At this point I would like to yield to the gentleman from
Rhode Island, Senator Reed.
[The prepared statement of Hon. Jim Saxton appears in the
Submissions for the Record on page 40.]
OPENING STATEMENT OF HON. JACK REED, RANKING MEMBER, A U.S.
SENATOR FROM RHODE ISLAND
Senator Reed. Thank you, Chairman Saxton, and welcome,
Chairman Greenspan, I want to thank you for coming here to
testify today at a time when there are so many genuine puzzles
about the direction of the American economy. Chairman
Greenspan, you have been rather upbeat about the economic
outlook and let me be the first to say that I hope you're
right. However, I am concerned about what continues to be a
disappointing economic recovery for the typical American
worker. Economic insecurity for workers is widespread as a
healthy job recovery is yet to take hold, wages are failing to
keep pace with inflation, inequality is growing and private
pensions are in jeopardy.
Job growth sputtered again last month when only 78,000 jobs
were added, calling into question the strength of the labor
market recovery. We still have not seen several consecutive
months of solid job gains, which is disappointing 42 months
into a recovery.
At this point in the last recovery, the economy had created
over 4 million more jobs than we have seen in this recovery and
we regularly saw gains of 200,000 to 300,000 and sometimes even
400,000 jobs per month. Employers don't seem to have enough
confidence in this recovery to pick up their pace of hiring.
Of course the real disappointment in this recovery is how
workers have been left out of the economic growth we have seen
so far. Strong productivity growth has translated into higher
profits for businesses, not more take-home pay for workers.
Since the start of the economic recovery in late 2001,
corporate profits from current production have risen by 67
percent. By contrast, employee compensation rose by only 17
percent. Since the economy started generating jobs in June of
2003, the average hourly earnings of production workers in non-
farm industries have fallen by 1.4 percent after inflation.
The stagnation of earnings in the face of higher prices for
food and medical care is squeezing the take-home pay of
workers. I hope that the Federal Open Market Committee is
paying close attention to the labor market as they set the
direction of monetary policy. Workers have been short-changed
so far in this recovery, and I believe that the economy should
be able to accommodate some acceleration in wages to catch up
to productivity growth without generating undue fears of
inflation.
Any wage gains we have seen seem to be concentrated at the
top of the earnings distribution while the largest losses are
at the bottom. As The New York Times noted this week, the
distribution of earnings has become so unequal that even the
merely wealthy are being left behind in the dust by the small
slice of super-rich Americans.
I know, Chairman Greenspan, that you have expressed concern
about the widening inequality of income and earnings in the
American economy. So this development cannot be encouraging to
you.
Another troubling development is how unstable the private
pension system is becoming. Data released this week by the
Government's Pension Benefit Guaranty Corporation show that the
country's 1,108 weakest pension plans had an aggregate
shortfall of $353.7 billion at the end of last year, 27 percent
more than the previous year. Meanwhile, the PBGC itself is
underfunded.
Social Security does face long-term challenges, but at the
moment it looks like the strongest leg of our retirement
system. Rising national savings is the key to our economic
growth, a good way to reduce our record trade deficit and, as
your past testimony reflects, the best way to meet the fiscal
challenges posed by the retirement of the baby boom generation.
Unfortunately, the President's large Federal budget deficits
are undermining national saving and leaving us increasingly
hampered in our ability to deal with the host of challenges we
face.
The President's policy priority for large tax cuts for
those who are already well off and private retirement accounts
that add to the debt and worsen Social Security solvency would
take us in exactly the wrong direction for the future.
Finally, there are real questions about whether today's
workers can look forward to a future of economic prosperity or
one of continued risk and uncertainty about whether they will
have good jobs and the means to provide a comfortable standard
of living for their families. Indeed, it is a very real
question in the mind of all the people I represent whether they
will enjoy the same standard of living that their parents
enjoyed before them or are enjoying at this moment, and for the
first time in my lifetime there is serious concern that the
quality of life--the standard of living in the United States
will slip rather than progress forward.
Chairman Greenspan, I look forward to your testimony about
the economic outlook and exploring some of these issues with
you further in the questioning. Thank you, Mr. Chairman.
[The prepared statement of Hon. Jack Reed appears in the
Submissions for the Record on page 50.]
Representative Saxton. Mr. Chairman, thank you again for
being with us this morning, and we look forward to your
testimony.
STATEMENT OF HON. ALAN GREENSPAN, CHAIRMAN,
BOARD OF GOVERNORS, FEDERAL RESERVE SYSTEM
Mr. Greenspan. Thank you very much, Mr. Chairman, Senator
and Members of the Committee. I am pleased once again to appear
before this Committee, as I have done for many a year.
Over the past year, the pace of economic activity in the
United States has alternately paused and quickened. The most
recent data support the view that the soft readings on the
economy observed in the early spring were not presaging a more
serious slowdown in the pace of activity. Consumer spending
firmed again, and indicators of business investment became
somewhat more upbeat. Nonetheless, policymakers confront many
of the same imbalances and uncertainties that were apparent a
year ago.
Our household savings rate remains negligible. Moreover,
only modest, if any, progress is evident in addressing the
challenges associated with the pending shift of the baby boom
generation into retirement that will begin in a very few years.
And although prices of imports have accelerated, we are at best
in only the earliest stages of a stabilization of our current
account deficit, a deficit that now exceeds 6 percent of U.S.
Gross Domestic Product.
A major economic development over the past year has been
the surge in the price of oil. Sharply higher prices of oil
imports have diminished U.S. purchasing power. The value of
petroleum imports rose from 1.4 percent of nominal GDP in the
first quarter of 2004 to 1.8 percent in the first quarter of
this year. The alternating bouts of rising and falling oil
prices have doubtless been a significant contributor to the
periods of deceleration and acceleration of U.S. economic
activity over the past year.
Despite the uneven character of the expansion over the past
year, the U.S. economy has done well, on net, by most measures.
Real GDP has grown by 3.7 percent over that period, the
unemployment rate has fallen to 5.1 percent and core personal
consumption expenditures prices have risen a historically
modest 1.6 percent.
But the growth of productivity, though respectable at 2.5
percent over the year ending in the first quarter, is far less
than the extraordinary pace of 5.5 percent during 2003.
Excluding a large, but apparently transitory, surge in
bonuses and the proceeds of stock option exercises late last
year, overall hourly labor compensation has exhibited few signs
of acceleration. Thus, the rise in underlying unit labor costs
has been mainly the result of the slower growth of output per
hour. At the same time, evidence of increased pricing power can
be gleaned from the profit margins of non-financial businesses,
which have continued to press higher even outside the energy
sector. Whether that rise in unit costs will feed into the core
price level or be absorbed by a fall in profit margins remains
an open question.
Among the biggest surprises of the past year has been the
pronounced decline in long-term interest rates in U.S. Treasury
securities despite a 2 percentage point increase in the Federal
funds rate. This is clearly without recent precedent. The yield
on 10-year Treasury notes, currently at about 4 percent, is 80
basis points less than its level a year ago. Moreover, even
after the recent backup in credit risk spreads, yields for both
investment grade and less-than-investment grade corporate bonds
have declined even more than Treasuries over the same period.
The unusual behavior of long-term interest rates first
became apparent almost a year ago. In May and June of last year
market participants were behaving as expected. With a firming
of monetary policy by the Federal Reserve widely expected, they
built large short positions in long-term debt instruments in
anticipation of the increase in bond yields that has been
historically associated with a rising Federal funds rate. But
by summer, pressures emerged in the marketplace that drove
long-term rates back down. And in March of this year, market
participants once again bid up long-term rates, but as occurred
last year, forces came into play to make those increases short
lived. There remains considerable conjecture amongst analysts
as to the nature of those market forces.
That said, there can be little doubt that exceptionally low
interest rates on 10-year Treasury notes, and hence on home
mortgages, have been a major factor in the recent surge of home
building and home turnover and especially in the steep climb in
home prices. Although a bubbling in home prices for the Nation
as a whole does not appear likely, there do appear to be at a
minimum signs of froth in some local markets where home prices
seem to have risen to unsustainable levels.
The housing market in the United States is quite
heterogeneous, and it does not have the capacity to move
excesses easily from one area to another. Instead, we have a
collection of only loosely connected local markets. Thus, while
investors can arbitrage the price of a commodity such as
aluminum between Portland, Maine and Portland, Oregon, they
cannot do that with home prices because they cannot move the
houses. As a consequence, unlike the behavior of commodity
prices, which varies little from place to place, the behavior
of home prices varies widely across the Nation.
Speculation in homes is largely local, especially for
owner-occupied residences. For homeowners to realize
accumulated capital gains on a residence, a precondition of a
speculative market, they must move. Another formidable barrier
to emergence of speculative activity in housing markets is that
home sales involve significant commissions and closing costs,
which average in the neighborhood of 10 percent of the sales
price. Where homeowner sales predominate, speculative turnover
of homes is difficult.
But in recent years, the pace of turnover of existing homes
has quickened. It appears that a substantial part of the
acceleration in turnover reflects the purchase of second homes,
either for investment or vacation purposes. Transactions in
second homes of course are not restrained by the same forces
that restrict the purchases or sales of primary residences. An
individual can sell without having to move. This suggests that
speculative activity may have had a greater role in generating
the recent price increases than it has customarily had in the
past.
The apparent froth in housing markets may have spilled over
into mortgage markets. The dramatic increase in the prevalence
of interest-only loans, as well as the introduction of other
relatively exotic forms of adjustable rate mortgages, are
developments of particular concern. To be sure, these financing
vehicles have their appropriate uses. But to the extent that
some households may be employing these instruments to purchase
a home that would otherwise be unaffordable, their use is
beginning to add to the pressures in the marketplace.
The U.S. economy has weathered such episodes before without
experiencing significant declines in the national average level
of home prices. In part, this is explained by an underlying
uptrend in home prices. Because of the degree of customization
of homes, it is difficult to achieve significant productivity
gains in residential building despite the ongoing technological
advances in other areas of our economy. As a result, productive
gains in residential construction have lagged behind the
average productivity increases in the United States for many
decades. This shortfall has been one of the reasons that house
prices have consistently outpaced the general price level for
many decades.
Although we certainly cannot rule out home price declines,
especially in some local markets, these declines, were they to
occur, likely would not have substantial macro-economic
implications. Nationwide banking and widespread securitization
of mortgages make it less likely that financial intermediation
would be impaired than was the case in prior episodes of
regional house price corrections. Moreover, a substantial rise
in bankruptcies would require a quite significant overall
reduction in the national average housing price level because
the vast majority of homeowners have built up substantial
equity in their homes despite large home equity withdrawals in
recent years financed by the mortgage market.
In conclusion, Mr. Chairman, despite some of the risks that
I have highlighted, the U.S. economy seems to be on a
reasonably firm footing and underlying inflation remains
contained. Accordingly, the Federal Open Market Committee in
its May meeting reaffirmed that it ``believes that policy
accommodations can be removed at a pace that is likely to be
measured. Nonetheless, the Committee will respond to changes in
economic prospects as needed to fulfill its obligation to
maintain price stability.''
Thank you very much. I look forward to your questions.
[The prepared statement of Hon. Alan Greenspan appears in
the Submissions for the Record on page 52.]
Representative Saxton. Mr. Chairman, thank you very much
for that very thorough statement. I would like to lead off with
a question that relates to something that you mentioned early
in your testimony, and that is the unusual set of circumstances
that we see in the relationship between short-term and long-
term interest rates.
Over the last year or so, the Fed has increased short-term
interest rates by a quarter point 8 times. And long-term rates,
as you pointed out in your testimony, have come down.
There is a chart displayed there that shows the increase in
short-term rates and that historically during a period of time
such as this, long-term rates would be expected to follow an
upward path. However, as the blue line shows, that has not
happened. In this case, and as a matter of fact I don't know
what the Fed policy is going to be going forward, but if this
trend continues those two lines could actually meet at some
point. So I have essentially three questions.
In your opinion, what has caused this unusual set of
circumstances in the relationship between short-term and long-
term rates? Second, what do you think might be the potential
effects of it on the economy going forward? Third, does this
relationship suggest any negative impact on prices and in our
ability to control inflation? Is there anything that from a
policy point of view we should begin to look at to correct the
situation, if in fact it needs to be corrected? And I would be
interested in your thoughts on those questions.
Mr. Greenspan. Well, Mr. Chairman, with respect to your
first question, as I have indicated previously in various
commentaries, this particular configuration is unprecedented in
recent experience. Indeed, it is even more exaggerated than it
appears on the chart for a very important reason; namely, that
the 10-year note which is I believe what you have plotted up
there----
Representative Saxton. Is that correct?
Mr. Greenspan [continuing]. Is actually an average, both of
long-term rates, meaning, say, a combination of 1-year
maturities, 9 and 10 years out, and comparable 1-year short-
term rates. If you average them out, you get the 10-year yield.
But it means that when the Federal Reserve is raising the
Federal funds rate, the short end of the market goes up, and
the elements that go into the construction of the 10-year
average automatically go up solely because the short-term rates
have gone up, which means that the longer term rates--that is,
say, from the 5-year maturities--the 1-year maturities 5 years
out and longer, have actually gone down more. And if you
actually plot those data it is the fastest decline that we have
seen in that longer term set of patterns in many decades.
So something unusual is clearly at play here. We have
concluded that it is not a U.S. phenomenon because all one
needs to do is look abroad and you get very much the same
patterns that we see here in the United States. So it is
clearly of international origin. There are numbers of
hypotheses, frankly all of which are credible to one degree or
extent, which people have put forth to explain this. They run
anywhere from that the world economy is slowing down to the
fact that the degree of and pace of global integration is such
as to open up very significant areas of educated, low-cost
employment pools in China, India, and in the former Soviet
Union. There are vast numbers of people who are skilled,
educated, and have a very significant interest in working hard,
and they have all come on the market at the same time and have
had the effect, as best we can judge, in bringing the cost
structure in the world down, which obviously would be reflected
in inflation premiums in the low end of the market, which
clearly have gone down. I might say both inflation premiums and
the real risk premiums as well.
All of these in one way or another probably are part of the
explanation. We don't know yet which are the really important
ones and probably will not know except in retrospect. But it is
a profoundly important phenomenon and really quite different
from what one would expect. Its effect on the United States is
very clear in the sense that, as I pointed out in my prepared
remarks, mortgage rates are lower than they would ordinarily be
in a regular cyclical pattern in the United States, and the
consequence of that is we have had a very strong housing
market, as I am sure you are all aware.
But certain elements of froth are clearly developing in
local markets as a consequence. The low long-term interest
rates have also obviously affected other asset values, stock
prices, and asset prices elsewhere and has undoubtedly been a
factor in the expansion of the economy. How this will all turn
out and how we integrate it into the basic underlying monetary
policy structure is something we are spending a very
considerable amount of time on, making certain we understand
this process that is going on as best we can.
Obviously, as you point out in your third question, what
may be quite critical here with these lower long-term rates
than we ordinarily expect, is to be sure it isn't potentially
engendering inflationary forces, and that is something which,
needless to say, we are focusing on very extensively,
endeavoring to get as much data as we can.
At the moment we are finding little evidence of
inflationary pressures on the product side, but it is certainly
the case that underlying unit labor costs are rising. There is
some evidence, as I indicated in my prepared remarks, that
passing through of costs has been easier, but in any event, the
overall inflation rate does at this stage remain modest. But we
will remain vigilant.
Representative Saxton. Thank you. Let me just follow up,
Mr. Chairman. During this period of time when we have seen
increased short-term rates and falling long-term rates, the
economy, as you note in your statement, seems to be doing
reasonably well. You note that the economy has done well on net
by most measures as a matter of fact, and you cite standard
data on GDP growth, unemployment, and inflation that reflect
the ongoing economic expansion.
In addition, Fed projections of economic growth for 2005
and 2006 are generally consistent with the Blue Chip consensus,
are they not?
Mr. Greenspan. I believe they are, Mr. Chairman.
Representative Saxton. And your statement also suggests
that despite risks to the economic outlook, the economic
expansion currently appears to be strong enough to absorb
additional tightening of monetary policy without serious
damage. Is this a reasonable reference to your remarks? Am I
right in saying that?
Mr. Greenspan. I don't wish to go beyond the statements
that the Federal Open Market Committee have agreed upon, and
the way we have formulated it is basically the way I
communicated in the very tail end of my prepared statement.
Representative Saxton. One final item and then we will turn
to Senator Reed. In this morning's Wall Street Journal there is
an article which credits past Fed policy for curbing the
effects of the collapse of the stock market and the tech
investment bubble in 2000. At the same time, the article
suggests that an accommodative Fed policy has instead
contributed to a housing bubble.
It seems to me that given the enormous shocks to the
economy from the collapse of the stock market and technology
bubbles in 2000, that the Fed did the right thing in relaxing
monetary policy and in retrospect perhaps could have done that
even sooner. The thrust of Fed policy seems to have averted
what could have been a much more serious economic fallout from
the popping of the bubbles in 2000.
Looking back, do you believe that the Fed relaxation of
monetary policy after the busting of the bubble in 2000 was the
best course given the risky conditions at the time?
Mr. Greenspan. I do, Mr. Chairman. We couldn't draw that
conclusion at the point we were implementing the policy,
because we knew that what we were doing--that is, addressing
the consequence of a very severe deflation of a bubble--carried
with it potential side effects.
As best we can judge, things have turned out reasonably as
we had expected, both positively and negatively. But in our
judgment, the positive effects of the policy far exceeded the
negative ones. And we decided at that time it was the
appropriate policy to initiate, and while it is too soon to
judge the final conclusions of how all of this comes out, I
think that given the same facts under the same conditions we
would have implemented the same policy.
Representative Saxton. I thank you very much, Mr. Chairman.
Senator Reed.
Senator Reed. Thank you very much, Chairman Saxton, and
thank you, Chairman Greenspan. Let me for a moment focus on
several aspects of your testimony, first your very useful
comments about the recent spike in employee compensation for
the past two quarters. As I understand your testimony, this was
attributable generally to a surge in bonuses and stock option
exercises that are transitory, is that correct?
Mr. Greenspan. As best we can judge. We don't have actual
official data. All we get are the data that are reported under
the unemployment insurance system, which accounts for almost
100 percent coverage of wages and salaries. What we do not get
is a breakdown in any form which tells us where it is. We have
other data which gives us the level of employment by supervised
workers and non-supervisory workers and payroll data for non-
supervisory workers, so we can infer certain things. And as you
pointed out in your earlier remarks, there really is a very
substantial difference in the labor market where the 80 percent
of the non-supervisory workers' wage increases have been
relatively modest, and indeed if you deflate by the Consumer
Price Index it is actually negative. I don't like the Consumer
Price Index, but you do you get the numbers you are suggesting.
What happens, however, is that the 20 percent, which is an
issue of the supervisory, skilled and other workers, is
reflecting a problem which we have discussed in the past;
namely, we have a very significant divergence in our labor
market which has consequences we need to address soon rather
than later.
Senator Reed. As a follow-up point, Mr. Chairman, so wage
compensation is not a significant factor in driving inflation,
as you pointed out. If you use the Consumer Price Index
deflator it is almost negative. Is that a fair statement?
Mr. Greenspan. That would not be true if you included 100
percent of workers. In other words, wages and salaries per hour
overall, even excluding bonuses and stock option realizations,
are rising at a reasonably good clip, because the rate of
increase in the supervisory, skilled worker categories is far
faster than the numbers you were quoting.
Senator Reed. But essentially what we are seeing, I think
unfortunately, is a divergence between highly-skilled, highly-
compensated individuals and the rest of the work force. And we
have had this discussion before, and I know we all like to
think about the better education and better training, et
cetera, but in the short run, in the immediate run, what policy
options should we pursue to enhance the incomes of most of the
workers of America?
Mr. Greenspan. Well, Senator, I don't think there are
short-term policies other than the ones we typically use to
assuage those who fall into unemployment or policies in the tax
area which we endeavor to redistribute income.
The basic problem, as we have discussed previously, as best
I can judge, goes back to the education system. We do not seem
to be pushing through our schools our student body at a
sufficiently quick rate to create a sufficient supply of
skilled workers to meet the ever-rising demand for skilled
workers, which means that wage rates are accelerating. But the
very people who have not been able to move up into the
education categories where they become skilled overload the
lesser skilled market and cause wages to be moving up, well
below average. The consequence, of course, is a divergence and
an increased concentration of income.
And as I have often said, this is not the type of thing
which a democratic society, a capitalist democratic society can
really accept without addressing, and as far as I am concerned
the cause is very largely education. It is not the children,
because at the 4th grade they are above world average. Whatever
it is we do between the 4th grade and the 12th grade is
obviously not as good as what our competitors abroad do because
we, our children, fall below, well below, the median in the
world, which suggests we have to do something to prevent that
from happening. And I suspect were we able to do that we will
indeed move children through high school and into college and
beyond in adequate numbers, as indeed we did in the early post-
World War II period, such that we do not get the divergence in
income which is so pronounced in the data we currently look at.
Senator Reed. I have other questions, but this argument can
be looked at from a different perspective. Back in the 1950s
and the 1960s, we had jobs that were producing incomes for
families. We had college education costs which were reasonable.
We had in some respects better access to health care at more
affordable prices so that families could, in fact, save and
provide for their children in a way that they can't do today.
But let me move forward. This is a debate that will go
forth, I think, further.
You mentioned in response to Chairman Saxton's question
this conundrum about interest rates, the yield curve, short-
term and long-term rates. But there are some that might see the
lack of movement in the long-term rates as a justification for
deficits; i.e., deficits don't make a difference, but I think,
Mr. Chairman, you have also insisted that deficits do make a
difference ultimately for interest rates. Is that true?
Mr. Greenspan. It is, Senator.
Senator Reed. And essentially we have choices before us
with respect to these budget deficits. They will, if we don't
respond to them, continue to impair national savings and thus
our ability to invest in the economy. Is that correct also?
Mr. Greenspan. I believe so.
Senator Reed. And it seems to me at a time where we have to
deal with the interest rates to further compound our problems
by further reducing taxes, such as the estate tax, would be
exactly the wrong direction to pursue. What is your view, Mr.
Chairman?
Mr. Greenspan. Well, all I can say is that I have argued
before the relevant committees that fiscal policy as it moves
into the early part of the next decade is going to run into
very severe problems unless we restore PAYGO and other means of
restraint on the system. And so I don't want to get involved in
any particular policy configurations, but I do think that we
have to recognize that something very unusual is about to
happen to this country in that we are going to get a huge
exodus from the labor force. And remember, the baby boom
generation was followed by the baby bust generation, which
means that we have relatively fewer workers, on average, ever
increasingly as we move into the next decade and beyond to
produce the goods and services required, not only for the
workers and their families, but for the huge increase in
retirees. So we have a very important task out there of
creating a level of savings and investment which will make sure
that the replacement rate in real terms of retirees enables
them to maintain a reasonably adequate standard of living
without encroaching on the growth in standard of living of the
American work force.
Senator Reed. Just a final point, Mr. Chairman. It seems
that we have positioned ourselves adversely to deal with that
challenge as we have gone from a surplus to a significant
deficit, and that the proposal of the Administration is to
further exacerbate the deficit by tax policies. Again that New
York Times article to me was extraordinarily revealing. It has
been estimated that if the President's tax cuts are made
permanent, Americans making between $100,000 and $200,000, the
new middle class in America if you will, will be paying 5 to 9
percent more in taxes than those making over $1,000,000 a year.
That doesn't seem to me to be either good economic policy or
good social policy.
Mr. Greenspan. Well, Senator----
Senator Reed. We have to deal with these issues.
Mr. Greenspan. I don't want to comment on individual
policies. I have stated before to you--and other committees, on
occasion--that I do think that there are parts of the existing
recent tax changes, especially with respect to eliminating part
of the double taxation of dividends, which I think enhance
economic growth, enhance the tax base and increase tax
revenues. And that is good economic policy. Having said that, I
would argue that all tax and all spending policy should be
under PAYGO, which therefore makes them, theoretically at
least, hopefully deficit neutral.
Senator Reed. Thank you, Mr. Chairman.
Representative Saxton. I would like to thank Senator Reed
for asking the question about the educational component. I
think that is extremely important, and I am going to ask my
staff to perhaps get with your staff, Mr. Chairman, to explore
the details of the studies that you have referred to, and I
thank you for your input on that.
Now that the Ranking Member has completed his questions, we
are going to move to Senator Bennett and, as we do, we are
going to implement the 5-minute rule in the interest of making
sure that all Members have an opportunity to ask questions as
well.
Senator Bennett.
Senator Bennett. Thank you, Mr. Chairman.
Chairman Greenspan, I agree with you that we don't really
know what is behind the anomaly indicated by the chart that the
Chairman put up and there are a number of theories.
I want to suggest another one to you, because I know you
believe in the power of markets, that markets send us messages,
that many times those of us who are policymakers want to ignore
and think we are smarter than the markets. The market is saying
something interesting here, and I have heard the various
explanations. The one that I want you to consider and perhaps
comment on, maybe the markets are being very complimentary to
you and the Open Market Committee by saying: we like the way
you are handling the challenge of inflation and we like the
measured pace, to use your phrase, with which you have adopted
the overnight rate increases. And the reason the long-term
rates are as low as they are is because we have confidence that
inflation is under control.
If that is indeed what the combined wisdom of the market is
saying here, it might suggest that when you got to 3.5 in June
you stop. Or August, I guess, would be the time that the
anticipation is. I know you are far too cagey to respond to the
number here because the television cameras are running, but
would you comment on the idea that there may be a different
kind of message here coming from the marketplace in terms of
the way the interest rates are reacting to what the Fed is
doing and talking about where you think the ideal overnight
rate should be, whether 3 percent, 5 percent, 4 percent,
something of that kind in an ideal set of economic
circumstances, the target that you could live with?
Mr. Greenspan. Well, Senator, I have commented that it is
very difficult to know where that so-called neutral rate is,
but we probably will know it when we are there, because we will
observe a certain degree of balance which we had not perceived
before, which would suggest to us that we are very close to
where that rate is. We don't have the statistical ability to
forecast where it is or to judge it other than being in place
at a certain time and looking at what the specific events are,
because that means we don't have to forecast what happens, we
just can observe. But if you have to forecast and then observe,
it makes it exceptionally difficult.
On the broader question of whether it is a Fed correction
or, as it is more generally stated, credibility of central
banks throughout the world, we obviously would like to believe
it, but the problem with it is, it doesn't give us any
information that is useful to us. In other words, if we said
that is true, it doesn't tell us what to do. And so, that is
for others to judge. My own suspicion is there is less there
than meets the eye. But even if I am mistaken on it, it does
not help in knowing what to do next.
Senator Bennett. I accept that. My only comment would be
that this anomaly, this extraordinary circumstance, might
suggest that the golden mean, if I can use that term, is lower
than we may have thought in the previous analysis with respect
to this.
I would like to focus on one other issue, and that is long-
term savings. The savings rate in this country, as you have
told us and as we recognized, is lower than it ought to be.
That has entered into the debate with respect to how we might
deal with the Social Security crisis that we are facing. I
agree with you that we are going to have an extraordinary,
indeed unprecedented, historical event in the next 20 years.
The percentage of Americans of retirement age is going to
double in a 20-year period. It has also gone up in an
incremental fashion, but it is going to go up in a very sharp
upward fashion that has never happened before.
What can we do to stimulate increased savings? Well, I have
some suggestions as to what we could do to stimulate increased
savings, and one of them is a form of payroll deduction
separate and apart from the payroll deduction that goes into
Social Security, called the Save For Tomorrow accounts. I think
you may be familiar with those.
Have you any feel, or any opinion, as to what would happen
if there was a more formal kind of payroll deduction across the
economy aimed at increased personal savings? And if that was
successful, Save For Tomorrow has been successful in the firms
that have used it. If that was successful across the economy
would that have a beneficial effect if we saw the savings rate
of everybody start to go up?
Mr. Greenspan. Well, Senator, the only new evidence we
have, if I can put it that way, with respect to savings
concerns the suggestion that if right now an employee has to
opt in on a 401(k), for example, there is some evidence to
suggest that if the 401(k) is automatic unless the employee
opts out, that we may find that there is a significantly larger
amount of savings that is being created.
Senator Bennett. That is an aspect of the Save For Tomorrow
account.
Mr. Greenspan. Yes, I understand that, so there is some
evidence to suggest that there is something valid in that
general proposition. I am a little gun-shy on the issue of
inducing savings in this country because I have seen just too
many vehicles promising to do something important, and as you
know we have ended up with a very low savings rate.
So it is clearly the market that is generating the vast
amount of the savings flows, the expansion and contraction, and
I am reasonably certain that if we get a significant increase
in savings, in household savings for example, it is more likely
to be reflective of a slowdown in the rate of mortgage
increases rather than any of the other variables that we are
using. But I would say that anything which does promise to
increase savings is a very worthwhile endeavor because, as I
said before, the slow growth that is implicit in the labor
force starting 2006, 2010, and thereafter, if it is going to
produce enough goods to meet all the retirees' needs as well as
those of workers themselves, has got to have a significant
pickup in output per hour growth. And that historically has
been associated with increased capital investment, which in
turn requires mainly domestic savings to finance it since we
cannot count indefinitely on foreign savings doing that.
Therefore, anything which increases domestic savings has a
double effect in one respect on the longer term outlook,
because it will displace the potential loss of foreign savings
and contribute to a level of savings that will be required to
maintain a viable society with a very large number of retirees.
Representative Saxton. Senator Bennett, thank you for
bringing up that extremely important subject of savings. It is
something that is on all of our mind, and thank you for
bringing that up.
Mrs. Maloney.
Representative Maloney. Thank you, Mr. Chairman, Ranking
Member, and welcome, Mr. Greenspan. As you indicated in your
testimony, the American economy is resilient and I expect that
we will continue to experience a cyclical recovery in the
economy. But I did not hear much in your statement about the
longer run imbalances associated with our failure to address
the problem with the large Federal deficits, the largest trade
deficit in our history and the largest debt ever in our
history, over $7.6 trillion, and like Senator Bennett, I am
concerned about our national savings. And, as you both
indicated, our national savings is quite low as a share of our
national income. And aren't large Federal budget deficits one
of the main reasons why?
Mr. Greenspan. They are, Congresswoman.
Representative Maloney. We are financing an increasing
share of our net national investment with foreign borrowing
rather than our own saving, and as you indicate we can only
depend on our own domestic savings and not on more foreign
borrowing, but aren't we financing an increasing share of our
net national investment with foreign borrowing rather than our
own saving?
Mr. Greenspan. Well, the significant increase in foreign
borrowing or, to be more exact, the significant increase in the
amount of financing of our domestic consumption that is coming
from abroad, a very considerable amount of it is not debt, but
when it is not United States debt, when it is not the United
States that is borrowing, it is foreigners who want to invest
here. So it is a mixed issue, but however you look at it, it is
not something on which we can depend indefinitely.
Indeed, our net debt on foreign income is rising quite
significantly year after year and the service cost, that is of
course quite substantial. So we can't count on that going on
indefinitely and if we are going to cite the level of capital
stock that is necessary to meet the requirement of, say, 2020,
2030, we are going to have to get a much higher level of
savings than we have and in the process we are going to have to
create capital assets which induce a very significant rise in
productivity growth.
Representative Maloney. Doesn't that mean, this increasing
share of net national investment with foreign money--doesn't
that mean that most of the benefits from that investment will
accrue to our foreign creditors rather than increasing
standards of living here in the United States for our citizens?
Mr. Greenspan. Congresswoman, it will depend wholly on
what, of course, are net claims on U.S. residents, because
obviously to the extent that we borrow or even get equity
capital from abroad, we have got to pay the servicing costs of
that. When you have a very large net foreign debt, a
significant amount of domestic production is essentially owned
by foreigners. Indeed the income from production goes abroad
and is not available to domestic residents of the United
States, so that the issue is essentially what is the level of
net claims against U.S. residents as a share of GDP, that being
the best measure, as I can see, to measure the type of problem
you are raising.
Representative Maloney. Can you talk with the Committee
about what would happen to interest rates and investment if
foreigners were no longer willing to accept our IOUs?
Mr. Greenspan. Well, I don't think that is going to be an
issue anywhere of significance, because there is always a
question, what do they do with their other resources? But
having said that, we at the Federal Reserve have looked at a
very special part of that problem, which is the large
accumulation of U.S. Treasury issues in foreign accounts.
What we have concluded is that because of the extraordinary
depth of the U.S. Treasury market, even as large as the
holdings are of those abroad, their impact on the Treasury
interest rate level is still rather modest. The reason why is
that U.S. Treasuries complete with a huge block of other debt
instruments throughout the world--both dollar dominated
instruments, and of course a very large block of foreign
currency denominated issues.
As a consequence, even were the net accretion of U.S.
Treasuries on foreign accounts to cease, its impact, I think,
would be evident, but not serious.
Representative Saxton. I thank the gentlelady for the
questions.
We will move now to Senator DeMint.
Senator DeMint. Thank you, Mr. Chairman.
Thank you, Mr. Chairman for being here today. I appreciate
very much the confidence that your steady hand has given to our
economy over many years.
Today you have described a short-term economic situation as
steady, as sound. But reading between the lines, and I think
about what you have said about a long-term scenario, I think if
we contemplated that for a few moments, it seems very alarming.
You have described a situation in which over the next 10 or
20 years, we will have the largest decrease in workforce and
increase in retirement that we have ever faced as a Nation. You
have also said at the same time that the workforce that we are
leaving behind is well below an ability to compete in the
international market as we are training them today.
As I look at where we are headed, it seems very close to
Europe; a little older society, moving toward heavy social
benefits, raising taxes to pay for it; a real burden on the
economy. I mean, is it fair to say that there should be a
greater sense of urgency on this panel and in Congress in
dealing with our education situation, our entitlements?
With this massive change in front of us, it seems to me
there should be a greater sense of urgency on how to deal with
this and avoid the situation that many European nations are in.
I know that is a very broad question to answer, but if you
could give us any direction there, I would appreciate it.
Mr. Greenspan. As I have testified previously, before a
number of committees in the House and the Senate, as best I can
judge, especially with respect to Medicare, because of the huge
prospective increase in the number of beneficiaries, which will
invariably occur and our inability to have any real particular
judgment of what the trend in healthcare per beneficiary is
going to be in the years out into the future, there is a not
insignificant probability that we have already committed under
existing law and presumed demographics far more in real
resources than we can actually deliver without significantly
undermining the very base of the economic system.
I think that unless we start to address this issue sooner
rather than later, the markets will force it on us, and that is
usually an unhappy circumstance. So I think that the extent of
entitlements that have been created in the system have not been
properly evaluated with respect to whether, in fact, the
implicit real resources, which those commitments require, fit
into a reasonable expectation of what the structure of the
American economy is able to produce, especially as you put it
in the context of a labor force, which may not have the skills
that are required to create a level of goods and services
output that will be necessary to maintain reasonable standards
of living, not only of the working population, but of this huge
increase in retirees.
Senator DeMint. Thank you.
Representative Saxton. Thank you.
Mr. Hinchey.
Representative Hinchey. Mr. Chairman, thank you very much.
Good morning, Chairman Greenspan, it is a pleasure to see you
and thank you for being here. I just wanted to make an
observation about the baby boom generation and the retirement
of that baby boom generation and the maintenance of those
programs. It seems to me that there are more children in
secondary schools in America today than ever before in history.
Our job is to create and maintain fiscal and monetary
policies that are going to insure that when they get out into
the workforce, they will have an abundance of good-paying jobs
in order for programs like Social Security and Medicare to be
sustained. That is really what our job is, isn't it, Mr.
Chairman?
Mr. Greenspan. I would say that if we all are successful in
doing that, it is a job well done.
Representative Hinchey. You pointed out in your testimony
and in your response to questions that we are at a moment of
conflicting economic circumstances, kind of a convergence of
those conflicting circumstances. Since June, the Central Bank
has reduced short-term interest rates by 2 points.
Mr. Greenspan. Increased.
Representative Hinchey. Increased, rather, right. Thank
you. Increased short-term interest rates by 2 points, but at
the same time, the 10-year Federal Reserve bond has gone down
by roughly about 80 basis points, now, under 4 percent.
So the economic and financial world, as you pointed out, I
think very, very correctly, is indeed changing. My question is,
does the unusual behavior of the global bond market signal
economic weakness, because that is what we are hearing from
other predictors, from Wall Street, particularly?
Mr. Greenspan. Well, it is one of the possible hypotheses.
There is no question that growth is slowing in a goodly part of
the world. But this has been a characteristic of the world
economy ever since we started to seriously proceed toward
advanced globalization, which is what I would say occurs when
you begin to get not only trade imports and exports, expanding
relative to the GDP which has been occurring for the last 50
years, but, more importantly, in addition, get savers willing
to reach beyond their natural borders to invest abroad, which
is a phenomenon which has arisen in a material way only in the
past decade.
What that has done is to alter the way the world's economy
functions. In so doing, I think we are getting a goodly part of
backing and filling and adjustments of all sorts in which you
find that instead of the economy going very smoothly forward,
it goes in little cycles.
Hence it is often misread as though we are about to tilt
into a recession. I think in that respect, it is important to
try to cut through some of this. If that is the case, then the
hypothesis that it is a weak world economy, which has been
driving down long-term interest rates, is probably not correct.
Indeed, it can't explain the fact that rates were going down in
2004 when we had the fastest growth worldwide in a very long
period of time.
The idea of weakness--there is a certain credible ring to
it. But when you begin to look at the details of the argument,
it becomes less persuasive.
Representative Saxton. Mr. Hinchey, thank you very much for
the questions.
We are going to move now to Mr. Paul.
Representative Paul. Thank you, Mr. Chairman.
Mr. Greenspan, I have a short question, hopefully, and then
a follow-up. You talked frequently about the conundrum that was
mentioned already today about the interest rates not being as
low as one would anticipate. I am wondering why this is such a
conundrum in the sense that this could well represent just the
flattening of a yield curve, which is well-known and
established and generally presages a recession, and the fact
that you have mentioned that this is different in that it is
worldwide. Could this not be a bad omen, that it is just a
flattening of a yield curve and presages a coming recession?
Mr. Greenspan. Well, the flattening of the yield curves
which get engendered as a consequence of ever-tightening
monetary policy are usually in the context of rising short-term
rates and rising long-term rates.
Most importantly, in the context of where they are
perceived to be precursors of economic decline, it essentially
commercial banks, which are the main forces of intermediation
in the economy. Because obviously, if short-term rates are
rising and long-term rates are holding steady or falling, and
because the maturity of annual bank assets is somewhat longer
than the maturity of their liabilities, if you raise short-term
interest rates and lower long-term interest rates, you get a
squeeze in the commercial banking system and a pulling back of
loans, which has usually been in the past a precursor of a
significant decline in economic activity.
Representative Paul. Thank you. My second question has to
do with debt. You have frequently talked about us having too
much debt and too many deficits here in the Congress. But I am
really concerned about it when you look at the unfunded
liabilities of Medicare, the problems we face with Social
Security, and now we have evidence that our private pension
funds backed up by the U.S. Government probably have the
characteristics of a Ponzi scheme similar to Social Security
and that their reporting requirements have not required that
they report their true assets, but just their cash-flow.
But we have a current deficit which you talk about
frequently, and also a foreign debt that is into the trillions
of dollars. I just wonder if we might not be fooling ourselves
about our prosperity. Because if I could borrow a lot of money,
if I could borrow $1 million every year, I would have pretty
good prosperity and eventually it would come to an end.
So a Nation probably has an end point as well. I think this
has been magnified by the fact that the efficiency of the
central banker, which you have explained that you have gotten
fiat money to act as if it is gold, and in some ways, I think
that is true, that people do accept our money, and that this
encourages us to have more deficit, it encourages us to buy
more than we pay for, buy more than we save, and contribute to
the current account deficit.
So it is the combination of the monetary system and the
acceptance of our money that has contributed this huge debt.
But most people say, most economists recognize that there is a
limit to how far we can go on the accumulation of this debt.
It is almost a Catch 22. The more efficient we are in
convincing the world to take our money, the worse the problem
gets, and the bigger the bubble. Instead of borrowing that
money to build our manufacturing base, which we are not,
everybody knows that is dwindling, we are using it for
consumption. So why is it that we should be reassured that our
prosperity is sound and we don't have to worry about paying
this debt back?
Mr. Greenspan. Well, I think we have learned very early-on
in economic history that debt in modest quantities does enhance
the rate of growth of an economy and does create higher
standards of living, but in excess, creates very serious
problems.
First of all, I would think that one way to address the
question you are raising with respect to unfunded liabilities
is that we need to do a good deal more of accrual accounting in
the Federal Government, which will automatically pick that up
and get a realistic size of what we are dealing with. But there
is no question that the amount of debt that is out there has to
be serviced, and so that debt per se can not grow indefinitely.
But if we can grow indefinitely and sustainably, if we
assure a means of servicing that debt, which is essentially
what we try to do, but we may not be doing it as well as we
should and have in the past, we have not always done it well.
Let me just make one final remark, because I didn't want to
leave the implication with respect to the yield curve as though
I am concerned that the potential tilting of the yield curve is
precursing a significant economic weakness.
What is different, in the past when commercial banking was
our key form of financial intermediation, is we have created
many more means of intermediation, so that even if the
commercial banks pull away, as they did indeed in the very
early 1990s, like 1990-1991, we have alternate means of
financing. Indeed, with the increase of technologies and the
broader globalization, I would hesitate to read into an actual
downward tilt of the yield curve as meaning necessarily what it
invariably meant 30, 40 years ago.
Representative Saxton. Thank you very much, Mr. Chairman.
We are going to return to Mr. Hinchey. I think I may have
shorted him on his time. Mr. Hinchey. You are recognized for 2
additional minutes.
Representative Hinchey. Well, thank you very much, Mr.
Chairman.
Mr. Greenspan, I think you are absolutely correct, a modest
amount or reasonable amount of debt carefully applied and
intelligently invested does lead to strong growth.
But the question is, how can it be carefully applied and
intelligently invested? I think that part of the Federal debt
that we hold, which is approaching $8 trillion, is neither of
those things.
You said a few moments ago that you continue to support the
President's tax cuts. But the President's tax cuts have not
only contributed to the huge debt and the annual budget
deficits that we are experiencing, but they are also making it
very difficult for us to meet other obligations.
In your testimony and in response to questions, you
emphasized the importance of education and we all, I am sure,
agree with you on that. If we are going to be competitive in
the future, we have to have the best educational system
training the best people in the world.
But because of this debt and because of these huge budget
deficits, the Federal Government is defunding education, all
across the board, and that is particularly true of higher
education, making it much more expensive and much more
difficult for people to go to college. The cutbacks in Medicare
and Medicaid are causing problems for local and State
governments, thereby causing them to raise the price of
education. In my State, for example, the Governor has increased
the cost of public education at the New York State University
system by enormous amounts over the course of the last several
years.
Aren't we in some kind of a conflict here that we need to
resolve? Do you still support the tax cuts and do you believe
that those tax cuts should be made permanent?
Mr. Greenspan. Mr. Hinchey, I have said on numerous
occasions that I support the tax cuts in the context of PAYGO.
I support a lot of programs directly and indirectly, but only
if they don't affect the deficit. The only way that is true is
if they are passed under PAYGO.
Now the problem is that I--and I suspect all--the Members
of Congress who have a vote, which I don't have, have a lot of
priorities. There is a physical amount of resources which is
available to make them real. We have to choose between a whole
series of things we all perceive to be of value. Indeed,
numbers of bills that have come up in the Congress would not
have come up if a large number of the House or the Senate
didn't believe it was a worthy cause. But if you put them all
together, it is very obvious that you have a large number of
worthy causes, but not enough resources to meet them.
Representative Hinchey. But we have cut our resources, we
have cut our resources dramatically, and this Government has
abandoned PAYGO. Since the Government has abandoned PAYGO,
should we make the tax cuts permanent?
Mr. Greenspan. All I will say is I will repeat what I have
said. I have always approved of and have always made fiscal
policy choices and recommendations only in the context of
PAYGO.
Representative Saxton. Thank you very much, Mr. Chairman.
We are now going to move to Ms. Sanchez.
Representative Sanchez. Thank you very much, Mr. Chairman,
thank you very much for being here today. I am a Blue Dog
Democrat. As you know, one of our policies is to try to
institute PAYGO as much as possible here in the Congress. You
know, I live my life under PAYGO, I have only one outstanding
loan and that would be a mortgage.
I don't owe anybody any money--and I think that is a good
way. I think the biggest problem that the United States has is
a large debt and a large deficit situation going on, a
structural problem that is going to be very difficult to get
ourselves out of. So I have a question with respect to PAYGO,
because you keep coming back to it. I think we should switch to
PAYGO.
I mean, if you were in Congress, what sort of--how would
you get to PAYGO? We have entitlements. We had a Medicare part
D plan that was passed that was supposed to be $400 billion
over 10 years. It is $1 trillion and growing, who knows how
that is going? We had tax cuts, which the President's own
comptroller said that the tax cuts are responsible for 70
percent of the deficit that is going on. What that means is
there is less revenue coming in.
Some had thought if we did tax cuts somehow we would get
more revenue, because people would invest more--and it doesn't
seem like that really happened. We have defense spending going
up, $1.5 billion a week in Iraq alone. You know, we don't know
how long we are going to be there.
Then we have discretionary spending, education,
transportation, research, healthcare. You know I like to spend
on investment. I took out loans to go to college, as did the
rest of my family members. I think that is a good place, if you
are going to be spending.
You are concerned about the haves and have-not problem and
the gap growing wider. You are concerned about education, as
you told us. Yet the President's policies have been to cut Head
Start, to shortchange No Child Left Behind by $9 billion, to
cut funds at the community college level, to cut student loans.
Where would you go to PAYGO? What would you do? What tax
cuts would you keep--I know you don't like to get into
individual policies. But, you know, when you say you have got
to get back to PAYGO Congress, what do you mean by that?
Mr. Greenspan. Well, let me try to be as explicit as I
dare.
We have passed a large number of bills on the outlay side,
and we have instituted a tax structure on the receipt side.
They don't balance. But it is very clear that a majority of
both Houses and the President of the United States, whoever it
was at the particular time, thought that all of these items on
both sides of the ledger were things that were of value to the
American people, but that some of them are not possible, which
means that choices must be made between very goods and only
lesser goods.
In other words, what is missing in the process is choosing
between things that people think are of value. I have seen very
little in the way of interest in curtailing anything. There is
a constituency out there for tax cuts. There is a constituency
out there for expenditure increases, and very little
constituency for balancing the budget--although I must say the
Blue Dogs come as close as any part of the Congress to being in
that particular area.
But as I recall, when I first came to Washington in the
1970s, there was at least an awareness that balancing the
budget was a critical issue. Indeed, we have carried out of the
1974 Act, from which PAYGO--actually, PAYGO comes out of the
combination of the 1974 and the 1990 Acts. But we constructed a
system which essentially seemed to work. We have abandoned it,
and I think that we have got to find a way to construct a
system which enforces the issue of choosing between A and B.
Right now, everybody wants A and B. Unless you repeal the
laws of arithmetic, it won't work.
Representative Sanchez. Let me ask you another question.
This is with respect to housing, because I represent Orange
County, California, probably the hottest housing market right
now, where the mean value of a resale 1,500-square-foot 40-
year-old home is running about $600,000.
You say in your testimony that you do not think--you say
these declines, were they to occur, would not likely have
substantial macro-economic implications. You are talking about
maybe a decline in housing in certain markets.
You know, when I look at what is going on in Orange County,
I see interest-rate only loans, lots of them. I see ARMs that
people are just beginning to understand are going to choke them
in the next year or two. I see a lot of people who took equity
out of homes that grew with the housing boom, but which they
are not--if housing stops--they are not going to be able to
recover out of that.
How can you say, when the brightest spot in the economy has
been housing and refinance, how can you say that you don't
believe that if there is a slowdown, even in some of these
markets, that it will have substantial macro--it will not have
substantial macro-economic implications?
Mr. Greenspan. It really gets to the question of what I
mean by ``substantial.'' Clearly, if you get a flattening out
of prices, not even a decline, and you gradually reduce the
realized capital gains and the unrealized capital gains on
homes, equity extraction, which is a very significant
contributor to personal consumption expenditures, will go down.
I have no doubt that as this boom begins to basically diffuse,
we will see the rate of increase in mortgage debt largely
driven by equity extraction, slow down.
Since a significant part of personal consumption
expenditures--and I might say home modernization--are financed
by equity extraction, one would presume one will also be
observing a slowing in consumption expenditures. Higher
savings, but slower economic growth, at least as far as the
consumer is concerned.
The reason I don't suspect that there will be substantial
macro-economic effects is that I envisage, as it is occurring,
capital investment will begin to take up the slack and growth
will continue to a greater or lesser extent.
So I am really not saying that it has no local effect. I
mean, remember what happened to Silicon Valley, which is just
up the State from you. It had a really severe local effect. But
it was not a national macro-economic effect.
What I was referring to was basically not that it would
have no effect, but I don't perceive it on net to be a major
macro-economic effect.
Representative Saxton. Thank you very much, Ms. Sanchez.
We will go now to Mr. Brady.
Representative Brady. Thank you, Mr. Chairman, I thank
Chairman Greenspan. I would like to ask two questions related
to the deficit, one trade and one our Federal financial
deficit. You have spoken frequently about the growing role of
international trade in the U.S. economy, about the savings to
consumers, the opportunity to raise the standards of living,
and a repeated note of caution about the trade deficit.
We have a relatively open economy, yet we find when our
companies try to compete around the world, we often run into
strong tariff barriers and non-tariff barriers around the
world. How important is it that we pursue a trade agenda and
trade agreements, like with Central America, that lower those
trade barriers for U.S. producers of goods and services?
Mr. Greenspan. Congressman, I think it is exceptionally
important. The major reason is that a very substantial amount
of American prosperity is the consequence of an opening up of
the world trading system over the last 50 years. Everybody has
benefited from the increasing globalization, net--and I mean
net. I do not deny that as you get globalization and the churn
of the economy, there are winners and losers. But the number of
winners are far in excess of the number of losers. The
resources that are created in the process can help take care of
those who are on the wrong side of the tradeoff.
However, a very major part of our current standard of
living rests on our position in the global markets. If we start
to retreat from that, I think we will find that we are very
significantly impaired with respect to living standards.
Competition is not something anybody likes.
I didn't like it when I was in the business community. I
thought my competitors were always unfair, and I wished they
would go elsewhere. But at the end of the day, I realized that
they made me work harder, do better and be more successful. It
is a tough thing to think in terms of, but that is what our
problem is.
The facts are, the more we liberalize trade, the more we
expand it, the higher are our standards of living. While we
might prefer to be quiescent and not engage in so much
competition, we can do that. But there is a cost. That cost
could be very significant.
Representative Brady. Thank you, Chairman. I will just
thank you. That was very revealing.
On our Federal deficit, I am convinced after 9 years in
Congress, if Congress were a manufacturing plant, we would
manufacture spending, that is what we are good at doing. If we
want to manufacture savings and efficiency, we have to retool
the plant, change the process that we go about reaching our
budget each year and controlling spending.
In the past you have supported a sunset process where at
the Federal level we require agencies and programs to justify
their existence or face consolidation, streamlining or, in some
cases, elimination--the goal being to eliminate the duplication
of services, to eliminate obsolete agencies, to find a more
thoughtful way really of getting the bang for the buck up here.
Do you still support a sunset mechanism of some type, as a
tool, one tool, to help reach that efficiency?
Mr. Greenspan. I certainly do, Congressman. One of the
reasons is, as you point out, it is exceptionally effective
mechanism to force a review of an ongoing program, whether it
is an entitlement or any other form of program. I think we
would find, that even though there is a general, conventional
wisdom, that this country is extraordinarily split 50/50, we
would find that the vast majority of programs that are now on
the books would very readily be renewed without any question.
But enough of them would not be, and that could create
fairly considerable avenues of budget savings which we don't
seem to be able to create these days. As you say, it is only
one tool. I mean, there are triggers, there are sunsets, there
are a variety of other things, along with PAYGO, which, as far
as budget process is concerned, I think would give us a far
more sensible structure. But I have always envisaged sunset as
being the crucial issue because every agency, every program
should be reviewed.
Another Member of your Committee, Senator Sarbanes, many
years ago, asked me when I was raising this issue, does that
include the Federal Reserve? I said absolutely, Senator. If we
cannot convince the Congress that we should still be here, we
shouldn't be.
Representative Brady. Thank you, Chairman, very much. Thank
you, Chairman Saxton.
Representative Saxton. Thank you. We will move now to my
friend, Mr. Cummings.
Representative Cummings. Thank you, Mr. Chairman.
Chairman Greenspan, you know they say that when you speak,
to paraphrase the investment commercial, everybody listens. I
am hoping that they listen to some of the most powerful words I
have heard from you. Those were your comments on education and
how important education is and how we need to bring our
children and our young people up so that they can take on these
jobs that you talked about.
I am just wondering, if we have a situation where in many
parts of our country where 50 percent, sometimes as much as 60
percent, of young people are dropping out of school, then you
have a number of students who will get a diploma, but can
barely read the diploma itself. Even though we may--let us
assume that the things that we are doing now to try to help
these young people become all that God meant for them to be,
taking into account all that you said about the people retiring
and the problems that we have with our public education system,
looking into your crystal ball--what do you see for our future?
In other words, you are talking about something that is
going to take a little while to reverse, I mean, to get back on
track. So those kids who may be in the--we saw in the State of
Maryland some good great developments with our recent test
scores. But we are talking about kids in elementary school.
So I am just wondering what do you see?
Mr. Greenspan. Well, I wish my crystal ball were as clear
as I would like it to be. But let me just put a little
perspective on this issue. I have been dealing on a day-by-day
basis with the American economy and the American institution
since 1948.
Every decade or so we look forward and it looks awful.
There is no way that the United States is going to continue to
survive in the state that we have been in. We, somehow by some
means, seem to recreate ourselves. I think it is one of the
extraordinary aspects of our country that the Constitution and
the culture that derived from it is creating a dynamism that we
seem to have which one way or the other we seem, when
confronted with problems, to get them resolved.
With all of that experience of that happening all of these
years, my inclination is just to assume. I don't know how it is
going to happen, but we will do it. The trouble I have is that
we only seem to do it when we are forced into a crisis.
I trust that we have the capability of being able to see
something in the future, which is reasonably certain to happen,
namely the demographic shifts in retirement and the problems
that are now emerging in our schools. We know what will happen
if we don't address both of those questions.
I should hope that instead of waiting till we are at the
edge where we have to really get to work to resolve them, we
can do them in advance where less effort and less resources and
less angst would be required. I trust we will be able to
address what we see as real problems in the next decade, in
this decade, rather than waiting for them to come right up to
our door.
Representative Cummings. Just, very quickly, on the pension
situation, Chairman Greenspan, with companies turning to the
Pension Benefits Guarantee Corporation, and it seems like many
anticipate there will be a stream of companies coming, not
having sufficient funds to pay off these pensions. How do you
suggest that problem be addressed?
Mr. Greenspan. It is. Let me just start off with what an
economist or an accountant would say about how you can fund,
with no risk, a pension fund at relatively little risk.
Since you can project the liabilities, really the amounts
of payout that your workforce when they retire will require,
you know that cash-flow needs on a yearly basis, going out 30,
40, sometimes 50 years.
If you invested on the asset side of your balance sheet in
U.S. Treasuries, which matured in the periods when you knew you
would have your cash-flow, you would have a riskless system.
But that is very expensive in the sense that you don't get the
interest rates or the dividends that most private pension funds
get.
So what we are dealing with here is that to the extent that
pension funds are invested in other than risk-free instruments,
risks are being taken. It is perfectly sensible to do that,
when you realize, for example, stocks over the very long term
yield more than U.S. Treasuries with a reasonable degree of
accuracy. There is a tendency to have not all U.S. Treasuries
in your portfolio.
However, it is important to recognize that all of that is
risk, and the question is somebody has to bear that risk in the
event of failure. It is either the employees, corporate
shareholders, or now with the Pension Benefit Guarantee
Corporation, the American taxpayer. I think we have to
recognize what it is we are doing when we are setting up a
pension fund.
If there are risks involved, they should be identified, and
the question is in the event of a problem, who bears the cost?
Historically, it was always either the shareholders of the
corporation or the beneficiaries. Now that we have got a very
big slug of possibilities that the American taxpayer is going
to have to pay for it. The Congress will have to judge how far
you want to carry this.
Representative Cummings. Thank you.
Representative Saxton. Thank you very much, Mr. Cummings.
Mr. McCotter, would you have a question at this point?
Representative McCotter. No, thank you.
Representative Saxton. Thank you. Let me just say where we
are in terms of time. We have been informed we will have a vote
on the House floor sometime between 11:40 and 12:00 or a little
bit after. So if it is all right with you, Mr. Chairman, we
will begin a second round and try to do it quickly. When the
time comes for us to go to vote, we will go to vote, and we
will adjourn the hearing at that point.
Mr. Chairman, you have pointed out some good news. Real GDP
growth is paced over 3 percent, and that is expected to
continue into 2006. Housing and real estate remains strong--and
as a matter of fact, at near record levels. Payroll employment
is up 3.5 million jobs over the last 24 months. The
unemployment rate is at 5.1 percent, which is a historic low,
particularly when compared to the averages of the 1970s, 1980s
and 1990s and inflationary pressures appear to be contained.
All of this has happened and continues to be a good
picture, in spite of the fact that we today see oil prices well
over $50 a barrel. If someone had told me in 2003, when oil
prices were at $30 a barrel, that the economy would have
continued to expand with oil prices at $50 a barrel, I would
have had great doubts. In spite of this, we have continued to
see good growth.
I would just ask you, in spite of the fact that oil prices
are in nominal dollars, far in excess of what they were in the
late 1970s and early 1980s, adjusted for inflation, today oil
prices are significantly below what they were in the late 1970s
and 1980s. Can you expand on this and help us understand what
is happening here in the economy, in spite of the fact that we
have historically high oil prices in today's dollars, measured
in nominal terms?
Mr. Greenspan. I think one of the important issues to focus
on is the fact that when oil prices go up or, more exactly,
when gasoline and oil prices, for example, in the United States
go up, we don't curtail consumption in any measurable way.
However, as time goes on, you get a change in the motor vehicle
stocks, use of gasoline, so that while people don't curtail the
amount of miles they travel, over the longer run, as prices
stay high they start to buy increasingly fuel-efficient cars.
So while the consumption levels don't get impacted right
away with a rise in oil prices, whether it is gasoline or in
the case of home heating oil whether insulation is put in the
home--over the longer run it does. What we find is that there
is a fairly significant response in consumption, both in the
United States and worldwide, over the longer run when oil
prices go up.
So that the effect has been over the years, as we have
moved from, for example, the late 1960s, early 1970s, when oil
prices really began to move, we have seen a very dramatic
decline over the long run in the ratio of oil consumption to
real GDP, indicating that the structure of the American
economy, its capital assets that consume energy and
specifically petroleum-based products, that capital structure
becomes ever more energy efficient, because it turns over
toward more energy efficient-type capital, whether it be
passenger cars or capital equipment.
We are now confronted with an issue where presumptions have
changed. The earlier presumption was that the longer-term price
will go back to what used to be termed normal, which was $20 a
barrel. We no longer perceive that that is going to occur, even
though the evidence of a long-term decline in the ratio of oil
to GDP continues and the evidence of increasing fuel efficiency
in cars is occurring.
I think that the significant increase in the long-term
futures prices for crude oil 6, 7 years out, in recent years,
is suggestive of the fact that the markets do not believe that
after we go through a price bulge, which then ultimately gets
reversed because consumption settles down, that is not going to
happen now.
Future prices have gone up for the year, to the year 2011,
for example, they are up quite significantly from what they
were. The reason why that has happened, as best I can judge, is
more political than economic. The reserves of crude oil, as you
know, are largely concentrated in OPEC countries where to a
very substantial extent, national oil companies have evolved
and have become monopolies in their countries and are having
considerable difficulty in choosing whether the cash revenues
go for domestic uses and the budgets in those countries, or are
plowed back into drilling, not just to increase the oil
reserves, but the capacity to produce oil from those reserves.
We are having significant shortages in the growth of long-
term crude oil capacity availability, which seems to be falling
short of what our projections of oil use over the longer run
will be, and that has created an increase in expectations of
shortages in the long run, and it is the reason why prices are
up. We also have significant problems, I might add, with
capital expenditures and capital availability for world
refining as well.
So the international oil system is changing. We are able to
function and be able to grow economically, especially in the
United States, because we find ever more sophisticated ways to
remove petroleum and energy as a cost in our production
structures.
As a consequence, we have managed to find ways around these
ever higher increases in prices. I think we will continue to do
so. But there is no question that if the real price of oil were
what it was back in the early 1970s, our rate of growth and our
current standard of living in the United States would clearly
be lower today than it currently is.
Representative Saxton. Thank you, Mr. Chairman.
Senator Reed.
Senator Reed. Thank you, Mr. Chairman.
Chairman Greenspan, you have identified two contemporary
challenges to our economy, principally the housing bubble and
also the trade deficit, which has to be financed. With respect
to the housing bubble, you suggest that it is really a froth.
By the way, I have this image of thousands of Ph.D.
students in economics running to a thesis advisor and changing
the topic from exuberance, irrational exuberance, to housing
froth. So that is happening as we speak.
But the housing bubble may be something because of the
nature of housing and the localized implications. That is not
serious. But financing our deficits, and dependence upon
foreign central banks, could be the most significant challenge
we face, given the fact that if there is a moment's lack of
confidence in our economy or our decisionmaking, if they feel
that our deficit projections would continue to be unremitting
and without any type of break, there would be a tendency,
obviously, to move out of dollars.
In fact, there was a stutter in the market several weeks or
months ago when the South Koreans seemed to be moving. Is that
to you a most significant challenge, and how long do we
maintain this co-dependency?
I mean, we are hooked on their central bank money. They are
seeing it as a way to continue to give us money to buy their
products. How long can we maintain this, in my view, unstable
co-dependency?
Mr. Greenspan. The expanding dispersion of current account
balances which, as you know, are a big chunk of the deficit
side, is a function of the degree of globalization.
The increasing tendency of domestic savers to invest
outside of their country necessarily implies that the
dispersion of current account balances will increase. The
dispersion of current account balances is not necessarily a
problem, provided that you do not, as a consequence, build up
very significant levels of debt is a consequence of chronic
deficits.
If you move between a surplus and a deficit, it is no real
problem. But what our concern has got to be, especially in the
United States, is if we continue to build up net claims against
U.S. residents, which must be serviced.
That, I suspect, will get resolved, because the markets
will not allow that to happen. The prices will change, terms of
trade will change, interest rates will change. At the end of
the day, exchange rates will change one way or the other, which
will effectively create changes in these balances.
But the thing which should concern us is more that which
the markets cannot adjust, which is the Federal budget deficit.
There is a policy question. I would focus on that as being the
major issue which I think we have to worry about, because I
believe that if we maintain the degree of flexibility in our
economy that we have achieved in recent years, and which
enabled us to absorb 9/11's economic impact, the bubble of the
markets in 2000, the corporate scandals and their aftermath, it
is the flexibility of the American economy, which has enabled
us to do that.
I do think that so long as we continue that, and avoid
protectionism, which would undermine it, I am not worried about
how the international system will restructure itself. But we
cannot count on the international system or the markets as such
to solve our budget deficit problem. That is an issue of choice
and an issue which is quite difficult, and I think must be
addressed.
Senator Reed. Well, I agree with you, Mr. Chairman, we made
those choices in the early 1990s, we raised taxes and we cut
expenditures. Do you think there is any other way we can deal
with this deficit other than by pursuit of those two courses?
Mr. Greenspan. Not that I am aware of.
Senator Reed. Thank you very much.
Representative Saxton. Thank you, Mr. Chairman and Senator
Reed.
Senator Bennett.
Senator Bennett. Thank you very much, Mr. Chairman.
As I look around the world, I become more discouraged than
I am about the United States. Japan seems to be unable to come
out of their now decade-long recession. I spend time with
Europeans now to a greater degree than I used to, and any
country in Europe would kill to have our numbers, our
productivity numbers, our GDP growth numbers, our unemployment
numbers; they are behind us in every category. And their
demographic challenge is greater than ours.
We, at least, have immigration to help us deal with the
challenge. The retirement end. They don't, to the extent that
we have, they are below replacement level. Their population is
shrinking. One statistic that struck me: in the Second World
War, Germany had 70 million population, today they have 80
million, whereas we had what--140 million in the Second World
War, and we are now closing in on 290 million. The European
Union in the next 30 years will become smaller than the United
States populationwise. We will grow, they will not.
Basically, we are carrying the rest of the world on our
shoulders in this situation.
We can talk about our deficit problem, we can talk about
the foreign money we depend on, but as you indicated in an
answer to a previous question, a large part of the reason the
foreign money is coming here is because it feels safer here
than any other place. You can you address this whole question
of what we have to do in the overall context of dealing with
globalization, it is a reality. It cannot be repealed. I agree
were you absolutely, that we must pass CAFTA, and we must pass
other free trade agreements in an effort to get the greatest
efficiency and benefit out of globalization that we can.
Protectionism would be a disaster. But other than that,
comment on the overall international situation that we face in
the next 10 to 15 years.
Mr. Greenspan. Well, Senator, a while back, I had to
deliver a memorial lecture on Adam Smith and was required as a
consequence to read The Wealth of Nations again, which I must
say, I hadn't read for 50 years. And it was obviously
different. Somebody came in and rewrote it one way or another
because it seemed so modern in so many of its insights. The
major insight is, I think, the serious question of what does
create the wealth of nations? What is it about the United
States that which gives us a special status? And, I think the
way I would put it is first, it is not our real resources as
such, although we, over the generations, have had a
considerable amount of oil, copper, ore, iron ore and the like.
But it is fundamentally our Constitution, because the
Constitution is structured in a manner which protects property
rights better than anywhere else in the world. And one of the
reasons why businesses have flocked here, why they have
invested here, is that they know that in the event of
adjudication they get a fair trial. And that our Constitution
protects them.
The second major issue that has always been relevant to the
United States is the nature of the people and their education
and what they have in their heads. And we have managed, up
until very recently, to maintain a very high level of skills.
It became obviously most manifest in World War II when the kids
who came out of the war were able to put together an automotive
engine in 20 minutes where the rest of the world had not yet
even gotten close. And we maintained that all the way through
the 1960s, the 1970s. We are running into problems now. They
are not overwhelming yet.
But I am concerned about the quality of our workforce that
we have got to make certain can have the skills that will be
required of us in the next generation. As I said to your
Congressman colleague from Maryland, I have been around long
enough to have considerable expectation that we will figure it
out at some point. Over the years, I have been through too many
hanging-over-the-edge-of-cliffs scenarios about whether we
would do it or not, but we managed to. I think it would be very
useful to anticipate sometime in the future what we are going
to have to do and do it sooner rather than later.
Representative Saxton. Thank you very much.
Mrs. Maloney.
Representative Maloney. Thank you, Chairman Greenspan, for
your truly insightful testimony today. You mentioned you just
read Adam Smith. Well, have you read The World Is Flat by
Thomas Friedman? And do you have any comments.
Mr. Greenspan. Well, the picture on the cover of his book
is so revealing. I don't know if you remember what it is. It is
the galleons going off the cliff and falling off the region of
the earth. I found it sufficiently riveting to go find out what
is in the book. And I think it is an interesting book and I
think I haven't read it in full detail, but I have read parts
of it.
There are big issues out here, which I think we are all
trying to come to grips with. This is a different world. I
mean, it is a world in which we all are economically related.
When I first started in business and had to forecast the
American economy, I did not have to avert to what was going on
in the rest of the world because it didn't matter that much to
what the GDP--or then the GNP--would be for the United States.
But now, unless you start with what is going on in the rest of
the world, you don't have a clue with what is going to happen
here. And I think books like Tom Friedman's and others trying
to delve into this have got good things and bad things in them,
but I think we are all learning a great deal about how the
world works. And I think it is helpful.
Representative Maloney. You commented to Senator Reed's
focus on the deficits that it is a tremendous problem, and I
would like to ask, wouldn't we see a sharp increase in interest
rates and a decline in investment if we continued to run large
Federal budget deficits?
Mr. Greenspan. Well, Congresswoman, the real problem that I
have is that if you take what I perceive is likely increases in
outlays, as you move into the next decade and beyond, you begin
to create potentially unstable deficit situations in which
deficits increase, the debt increases, the interest on that
debt increases, both because interest rates go up and because
the debt itself goes up, and that increases the deficit still
more, and a number of the econometric scenarios that we run in
that context do not reach equilibrium very easily so that we
have a major task in front of us.
Representative Maloney. Thank you. You also mentioned today
several times and advocated as for a pay-as-you-go policy for
all of our Federal budget decisions. And that would also
include budget decisions concerning tax cuts becoming
permanent, would it not?
Mr. Greenspan. It would.
Representative Maloney. It would. OK. And currently that is
not the policy of the Administration, and have you talked to
members of the Administration and tried to persuade them of the
need for pay-as-you-go rules for all of our budget decisions?
Mr. Greenspan. I have tried to persuade lots of people in
this town, sometimes with success, more often than not, lesser
success.
Representative Maloney. But we always listen to you, Mr.
Chairman, we may not agree, but we always listen to you with
great attention. And I really need more evidence to be
convinced that we have a robust economic recovery, particularly
for the typical American worker. And how would you characterize
the behavior of payroll employment over the most recent cycle?
Wouldn't you say that it took an unusually long time just to
erase the jobs deficit created by the 2001 recession and that
we are still well behind the pace of job creation typically
seen in past economic recoveries? And, related to that, how
would you characterize the unemployment? I know that it has
edged down to 5.1 percent in May. But aren't we still waiting
for labor force partnership participation to bounce back from
the effect of the recession?
Mr. Greenspan. Well, remember, one way of looking at the
fact that employment significantly lagged the recovery in the
economy earlier in this decade is we had an extraordinary rise
in productivity growth. Indeed, looking back at the figures,
even though the economy was relatively weak very early-on in
the decade, productivity started to pick up, which was very
unusual and as we moved through 2002 and 2003, as I pointed out
in my prepared remarks, productivity growth continued to
expand, and hence raised the overall standard of living of the
American economy. And that therefore, is the source of the
delayed recovery in employment.
But employment, obviously, is coming back. The unemployment
rate is down to quite low levels historically. It is certainly
the case that the participation rate of the labor force has
been moving down, although it's flattened out very recently. A
goodly part of that is merely the demographics that as you move
through cohorts which generally have lower labor force
participation, the average comes down and that is one of the
things that we are looking at.
But even making adjustment for the demographic shifts,
there is a tendency for people to desire to work less than they
did historically. A lot of them are going to school. And it is
not only the kids. I mean, there is a very significant increase
in enrolment at community colleges which have average ages of
enrollments, 30, 35 and more.
Representative Maloney. My time is up, thank you very much.
Representative Saxton. I thank the Gentlelady. I just would
remind the Gentlelady that today's unemployment rate is 5.1
percent, which is, as the Chairman has just pointed out, is
historically low. To be more specific, during the 1970s, the
average unemployment rate was 6.2 percent. During the 1980s, it
was averaged at 7.3 percent. During the 1990s, it averaged 5.8
percent. And so 5.1 percent doesn't appear to me to be too bad.
And I think we need to look at this in that context, and
hopefully, it will be reduced even more. But in terms of the
last three decades, we are doing pretty well.
Representative Maloney. Well, I thank the Chairman for
pointing that out to me and would like to comment that it was
lower in 2000. Thank you so much.
Representative Saxton. Again during the 1990s, the
unemployment rate averaged 5.8 percent. Historical facts will
bear that out.
Mr. Paul.
Representative Paul. Thank you, Mr. Chairman, I would like
to follow up on Chairman Saxton's question about the oil
prices. You said that the discounting of future high oil prices
is probably more political than economic, and I would like to
suggest that possibly there are some economic factors. You know
in the 1970s, we faced a somewhat similar problem. We had a lot
of inflation, and yet we had political turmoil which helped
push oil prices up. But we were also living after the decade of
the 1960s where we were financing the Vietnam War as well as
the Great Society programs and that led to a whole decade of
stagflation and significant inflation.
And most individuals now recognize that general price
inflation simply is a reflex of money policy and it is not a
result of political turmoil, although, the political turmoil
can contribute to higher prices. And today certainly we have
political turmoil in the Middle East. We see oil pipelines
being burned almost on a daily basis, and that, I would agree,
certainly contributes to this anticipation that there will be
future price increases in oil.
But, it also, we talk a lot of about increase and demand
and I would recognize that that has something to do with the
demand coming from China and other far eastern countries that
would put pressure on the oil prices. But that the one factor
that we essentially never talk about nor recognize is the
monetary factor that maybe we still have some old fashioned
inflation around. We have some house pricing inflation. We have
medical care cost inflation. And we have educational cost
inflation. And we also know that one true characteristic of
monetary inflation when it translates into price inflation, it
is never uniform. Some prices go down. Some prices go up, but
you still can have inflation; you can have prices of houses
going up with computer prices and TV pricing going down.
So I am suggesting that quite possibly the markets are
saying to us in the Congress that we are discounting Congress's
inability to handle the deficit, and therefore putting more
pressure on the monetary authorities to do what they do. And
that is, accommodate deficits and eventually inflate just as we
do to accommodate the deficits of the 1960s, and contributed to
the 1970s. Why couldn't a case be made that there is a monetary
factor in here or would you still stick to the argument that
you will say no, there is no economic factor, it is all
political factor that anticipates higher prices of oil in the
next decade or so?
Mr. Greenspan. Well, with regard to the political factors I
was referring to, I am not sure I made myself clear. It was not
so much the violence and terrorism that is involved, but the
fact that very few of these nationalized oil companies will
allow foreign oil companies to come in and drill and increase
their productive capacity. In Mexico, for example, its
constitution prohibits foreign involvement in its underlying
crude oil reserves.
The issue of monetary policy is potentially a significant
inflationary force as we have discussed before on numerous
occasions. The history of fiat monies, which is what we have,
tends to be chronically inflationary. At the current time,
money supply growth is really quite modest. And I think it is
modest around the world, and I think the reason is that a large
number of us recognize that the inflation is a very deleterious
force in a market economy, and that if we feed inflationary
forces, we ultimately undermine the economy. The argument that
we at the Fed make is that our statutory requirement is to
maintain maximum sustainable growth, but we perceive the
necessary condition of that to be a non-inflationary monetary
policy.
Representative Paul. Thank you.
Representative Saxton. Thank you very much.
Mr. Hinchey.
Representative Hinchey. Thank you very much, Mr. Chairman,
Chairman Greenspan it is always more than a pleasure and also
always instructive to listen to you. I very much appreciate the
opportunity to be here with you today.
Mr. Greenspan. Thank you.
Representative Hinchey. As you point out, whenever you put
into place a program or a policy, it is always prudent to
periodically review that policy or program to see that it still
makes sense and that it is performing as you anticipated it
might.
We have an economic policy in place today which has been in
place now for about 4\1/2\ years, and we have an opportunity to
evaluate the outcomes and to see what it is doing for us. We
talk about growth in the economy and that seems pretty
significant. Unquestionably, that growth seems strong and
solid. But it doesn't seem to be affecting everyone. For
example, in the last 4\1/2\ years, there are now 4 million more
Americans without health insurance. That number is up to 45
million now, and there are tens of millions more who have
inadequate health insurance. There are about 1.3 million more
Americans living in poverty than there were 4\1/2\ years ago.
And the median annual income of middle class families is down
by $1,400 over the course of that period.
In the private sector, we still have not produced the
number of private sector jobs that would bring us back to the
number of private sector jobs that we had 4\1/2\ years ago. The
benefits of our economy are increasingly flowing to a smaller
number of people. In fact, a recent analysis by The New York
Times, for example, indicates that about less than \1/10\th of
1 percent of the population are getting not just the lion's
share of the benefits, but most of the entire pride's share of
the benefits.
If we are going to maintain a kind of social equality, or
the social opportunities at least that we have had throughout
our history, don't you think that we need to re-examine this
policy and begin to do something different so that more people
can begin to benefit from the enormous opportunities that exist
in this country? Instead of having just a tiny fraction of
people get all the benefits, shouldn't we be trying to share
them more equitably? Aren't there things we need to be doing
better?
Mr. Greenspan. I didn't read The New York Times article in
detail, but it is a fact that the concentration of income has
increased for reasons I discussed before. I do think it is
important to recognize that to the extent that that occurs, it
is not helpful for a democratic society, especially one of the
breadth and heterogeneity of this type of society.
I have looked at the various different things that can be
done. And I have concluded that with education reforms
necessary, whatever that means, because I don't know enough
about how to teach children in a way that would prevent them
from falling to the bottom of the barrel by the time they go
from 4th grade to 12th grade.
But I do know that that is both the necessary and
sufficient condition to solving the problem that you are most
concerned about. I am not sure what a whole series of other
programs would succeed in doing. I am reasonably certain if we
don't solve the education problem, whatever else we do isn't
going to help very much.
Representative Hinchey. I am really talking now about the
monetary and fiscal policies that we are pursuing. For example
the huge tax cuts.
Mr. Greenspan. The problem I am concerned about is on a
pretax level. You will get the same numbers.
Representative Hinchey. The ones I am concerned about are
at a post-tax level.
Mr. Greenspan. I understand that. What I am trying to say--
--
Representative Hinchey. Because if you have these huge tax
cuts, which take enormous amounts of money out of the Treasury,
put them into the hands of just a tiny fraction of the American
people, and just let them do with it what they want, they will
not invest that money into society. If you had a tax cut, for
example, that was more equitable, that was distributed more
equitably among the middle class, then you would see more
investment going back into the society. You talk about
education. Because of the fact that we are running these huge
budget deficits now as a result of the tax cuts and other
actions--the war in Iraq, for example--we can't afford to
invest more in education. Now the Administration is arguing
that we can't afford Social Security. We can't afford Medicare,
we can't afford education. They are cutting back on Pell
Grants. They are cutting back on other means of funding
education.
So if we are not putting enough money into education then
you have classrooms that are overcrowded. You have educational
conditions that are actually depriving young people of the
education that they should have. We are not using our resources
equitably, intelligently, we are using them in ways that are
reckless and radical and putting them into the hands of a tiny
fraction of the American people rather than having those
resources spread in a more, not just egalitarian, but at least
more democratic way.
Mr. Greenspan. Well, it is a factual issue here that
leaving aside the question of equity, those monies come back
into investment. In other words, unless you consume your
income, it is going back into financing investment.
Representative Hinchey. But Mr. Chairman, the investments
are going to buy an island in the South Pacific or buy a
factory in China or buy some kind of information distribution
system in India. That is where they're going. They are not
coming back into our economy.
Mr. Greenspan. I think you would find if you actually had
the full detail, those would be extraordinarily small
proportions of what actually gets invested. Look, the truth of
the matter is, I don't want to argue the other side of the
question of equity, because I don't necessarily disagree with
that. But there is no question that this standard of living is
unmatched. And it is unmatched for everybody. Everybody has got
a car. And the cars that people have today are so superior to
what they were 50 years ago it is unimaginable.
So, you can look at the system and say it has got a lot of
problems. And sure it does. It always has. But, you can't get
around the fact that this is the most extraordinarily
successful economy in history. And while we may not distribute
the resources in the way that you or maybe I would think is
necessarily appropriate, the fact is it is still a very
successful economic system. And what we are going to find is
that over the years, if we resolve the education problems, I
think we will find that everybody is getting very significant
advances.
If we were in such poor shape why do so many people want to
come to this country?
Coming to this country, taking the lowest paying jobs which
are several multiples of what they can make at home. We have
got to be doing something which is not bad.
Representative Saxton. Thank you very much, Mr. Greenspan.
Mr. McCotter has joined us and we are going to move to him
for a question.
Representative McCotter. Thank you, Mr. Chairman. You had
spoken about having to dust off your Adam Smith. I guess I have
to dust off my civics book when I get home, because it was
always my understanding that taxation occurred with the consent
of the governed. The tax cuts are not taken from the Treasury
and placed in the hands of the few unless at first they are
taken from the hands of the people who earned them and then
stuffed into the Federal Treasury. And it can only be done with
their consent. So maybe we have a difference of opinion. I will
go check and see whether I am right or not.
Speaking of the consent of the governed, in economic models
as you rightly pointed out, in the past we only had to focus on
the United States of America, what is good for GM is good for
the country, and so forth.
At this point in time, given the globalization of much of
the economic sectors, do any economic models take into account
the different natures of the governments involved in global
trade?
Mr. Greenspan. Different what?
Representative McCotter. The different type of government.
For example, let's use two examples. The United States of
America is a free republic. It has an entrepreneurial system
and, say, somebody like the People's Republic of China, which
is a communist government, it is a totalitarian state.
Do economic models anywhere account for the different
natures of the governments? For example, we can discuss where
we would rightly or wrongly invest, in education or elsewhere,
but we have to do it through the consent of the governed and
through consensus in the Congress and then express incentivize.
We cannot command and control an economic sector or our
economic decisions. We have a free market. We can help. We can
hurt. We cannot command and control.
How does a free republic with the entrepreneurial free
market system engage with a communist country which is a
totalitarian state which has a command and control structure
which we cannot follow? Do economic models take these into
account? My concern is that over time, as we look at this, is
that economists tend to look at market forces. Not the
aberrations in market forces that can be caused by a
totalitarian government, whereby an economic policy will not be
determined by an aggregation of individual decisions made
throughout a free market, but at the behest and the command of
a dictatorial government.
Do any economic models take this into account or do we
simply assume that perhaps these totalitarian states can be
treated as a dichotomy between their government and perhaps a
system that they are employing economically at a given time?
Mr. Greenspan. Econometric models don't. In fact, they
presuppose a market economy and are not sufficiently
sophisticated in their mathematical constructions to say they
differentiate between differing types of market capitalism.
There are huge differences in economic development, depending
on whether or not you have a rule of law, whether you have
property rights, what type of government you have, is it
representative, is it republic, is it democratic in its nature?
That is a part of economics which I wouldn't call modeling, but
it is called development economics, and what they try to figure
out is, as did Adam Smith, what causes the wealth of nations?
And there the conclusions come out fairly clearly. Namely that
when you have, if you want to call it a model, you actually had
an experiment in central planning versus market forces for 40
years with East Germany and West Germany in which they came out
of the same culture, language, everything similarly. The only
thing that was fundamentally different was their political
structure. And when the end of the 40 years, the experiment
came to an end and we looked. East Germany's standard of living
was a third of West Germany's.
So you can, in a sense, get a model, if you want to call it
that, to produce those results. But, it is very rare that that
occurs. And the only time I know they would use models in
central planning was the Gosplan in the Soviet Union which was
very sophisticated and didn't work.
Representative McCotter. And bring this up to my concern
over time whether or not there is a lot of faith in the
permanent normalization in trade relations with the People's
Republic of China has been that you will get democracy
following economic opportunity if we continue to trade with
China on this basis, if we drop human rights as a criteria, if
we allow them access to our markets and we go back and forth is
that somehow they will magically realize that the vanguard of
the proletariat is no longer needed to run the lives of their
people.
My concern is not that we have soon a past model, such as
the Soviet Union or East Germany. My concern is that we may be
seeing a different hybrid of a totalitarian government. We may
be seeing a totalitarian government that will allow a limited
amount of economic opportunity without any political freedom
whatsoever, without any real democracy whatsoever. And as a
resident of the United States, I asked the question because my
concern is that we tend to think that what we have here in the
free republic through democracy and through an entrepreneurial
economy is somehow entitled to us rather than simply an
experiment in democracy which, as some of us know, did not work
out too well in the ancient Athenian city-state very long. And
that as Russia goes backwards with their economic models and
China continues down the path, we are basically, as an article
of faith, hoping that China does the right thing and becomes
more like us in the next 20 years, rather than even bother to
entertain the notion if we continue to trade with them in the
manner that we are trading with them and dealing with them,
that somehow in the next 20 years, we might start looking a lot
more like them. So that is why I asked the question, but as
always, I enjoy engaging with you, Mr. Chairman.
Mr. Greenspan. Thank you.
Representative Saxton. Thank you very much.
Ms. Sanchez.
Representative Sanchez. Thank you, Mr. Chairman.
Mr. Chairman, what I want to go back to, what I see over
time, your concern of this, I hate to call it as the haves and
have-nots, but the widening and disparity of what is going on,
and to a large extent, you talked today at length about how
education may be one of those big issues that makes the
widening, or the gap that is occurring.
I ask because I come from the fifth wealthiest county in
the Nation, Orange County, California. And yet, the Rockefeller
Foundation about 5 months ago issued a report that said that
the city that was the worst place to be poor is Santa Ana,
California. That is the county seat of Orange County. And then
when I look at the percent of giving rates, charitable giving,
county-by-county in the Nation, Orange County is pretty low on
the list as a percent. And when we see where it gives, a lot of
the giving that we are seeing in my area goes to the arts.
So I am looking at the policy or what is it that is
creating this disparity and one of the issues that comes up is
this whole issue of the estate tax. And to tell the truth, that
has come up in different forms, I have voted one way or the
other depending on whether or not I think this will work.
As a Blue Dog, we tried to put in a proposal that would
basically have no tax all the way up to 97 percent of all
households in the United States. But that didn't go through.
The House recently passed an estate tax that said there will be
no estate tax. I want to ask you because one of the arguments
that people used in trying to sway some of us to vote one way
or the other was this other whole issue of if you don't tax
with an estate tax, then people will not put their monies into
charitable types of institutions. They won't make the Carnegie
Foundation. They won't make these foundations that in turn come
back and do education on a more broad base, or invest in
research on a more broad base.
What do you think about eliminating completely the estate
tax versus something of, you know, trying to eliminate it from
most, but not the very top 2 percent of estate tax estates?
What is your opinion on that?
Mr. Greenspan. I don't have a view on that particularly. I
think that there is a great deal of literature as to whether or
not Americans contribute to charities because of the graduated
income tax or not at all. I mean, obviously, through very
significant charitable contributions and bequeathing of very
large trusts for charitable distributions, before the income
tax, we obviously had Carnegie and Rockefeller, and a variety
of other major contributors. But it is an analytical question
as to the impact of the estate tax or indeed the income taxes
on charitable giving, and I am not sufficiently familiar with
the conclusions of that. I don't really have a position on it.
Representative Sanchez. Aside from this education gap, what
do you think might be other policies that we, the Federal
Government, have instituted that are creating this widening of
the gap between those who have the low paying service jobs and
those who have the creative, technological-type jobs?
Mr. Greenspan. Congresswoman, I don't think we need to do
anything else. If we succeed in solving the education issue, I
think we have got it solved. Remember, we came out of World War
II with the GI Bill of Rights, and a lot of technological
capability, what the technologies were back at the end of World
War II. And we had, for several decades, a very rapidly growing
economy and, no increasing concentration of income. In other
words, all wage levels moved the same. You are not going to
eliminate the differential wage levels because those are skill-
based.
But what we need to eliminate is the ever gradual spreading
of those wages which we now see and there are lots of ways you
can come out at it, but all I can say is that if you can solve
the education problem you don't have to do anything else. And
if you don't solve it, nothing else is going to matter all that
much.
Representative Sanchez. Thank you Mr. Chairman. Thank you.
Representative Saxton. Thank you, Ms. Sanchez.
Mr. Chairman, we have got to go vote, and we want to thank
you for being here with us this morning. We are pleased with
the news that you bring us today. And, I want to thank you also
for emphasizing the concern that you have with regard to the
educational issues in our society. I think that is extremely
important. I sit here in this room, actually on the Armed
Services Committee, and one of the things that we are reminded
about from time to time is the shortage of engineers that work
in various capacities that provide for expertise in the area of
defense, national security. These are important issues and I
agree with you that we need to recognize them and work on them.
Thank you again for being here with us this morning and we look
forward to seeing you again in the future.
Mr. Greenspan. Thank you, Mr. Chairman.
[Whereupon, at 12:30 p.m., the hearing was adjourned.]
Submissions for the Record
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Prepared Statement of Hon. Alan Greenspan, Chairman,
Board of Governors, Federal Reserve System
Chairman Saxton, Vice Chairman Bennett, and Members of the
Committee, I am pleased to appear once again before the Joint Economic
Committee.
Over the past year, the pace of economic activity in the United
States has alternately paused and quickened. The most recent data
support the view that the soft readings on the economy observed in the
early spring were not presaging a more-serious slowdown in the pace of
activity. Consumer spending firmed again, and indicators of business
investment became somewhat more upbeat. Nonetheless, policymakers
confront many of the same imbalances and uncertainties that were
apparent a year ago.
Our household saving rate remains negligible. Moreover, modest, if
any, progress is evident in addressing the challenges associated with
the pending shift of the baby-boom generation into retirement that will
begin in a very few years. And although prices of imports have
accelerated, we are, at best, in only the earliest stages of a
stabilization of our current account deficit--a deficit that now
exceeds 6 percent of U.S. Gross Domestic Product (GDP).
A major economic development over the past year has been the surge
in the price of oil. Sharply higher prices of oil imports have
diminished U.S. purchasing power. The value of petroleum imports rose
from 1.4 percent of nominal GDP in the first quarter of 2004 to 1.8
percent in the first quarter of this year. The alternating bouts of
rising and falling oil prices have doubtless been a significant
contributor to the periods of deceleration and acceleration of U.S.
economic activity over the past year.
Despite the uneven character of the expansion over the past year,
the U.S. economy has done well, on net, by most measures. Real GDP has
grown by 3.7 percent over that period, the unemployment rate has fallen
to 5.1 percent, and core personal consumption expenditure prices have
risen a historically modest 1.6 percent. But the growth of
productivity, though respectable at 2\1/2\ percent over the year ending
in the first quarter, is far less than the extraordinary pace of 5\1/2\
percent during 2003. Excluding a large but apparently transitory surge
in bonuses and the proceeds of stock option exercises late last year,
overall hourly labor compensation has exhibited few signs of
acceleration. Thus, the rise in underlying unit labor costs has been
mainly the result of the slower growth of output per hour. At the same
time, evidence of increased pricing power can be gleaned from the
profit margins of nonfinancial businesses, which have continued to
press higher even outside the energy sector. Whether that rise in unit
costs will feed into the core price level or will be absorbed by a fall
in profit margins remains an open question.
Among the biggest surprises of the past year has been the
pronounced decline in long-term interest rates on U.S. Treasury
securities despite a 2-percentage-point increase in the Federal funds
rate. This is clearly without recent precedent. The yield on ten-year
Treasury notes, currently at about 4 percent, is 80 basis points less
than its level of a year ago. Moreover, even after the recent backup in
credit risk spreads, yields for both investment-grade and less-than-
investment-grade corporate bonds have declined even more than
Treasuries over the same period.
The unusual behavior of long-term interest rates first became
apparent almost a year ago. In May and June of last year, market
participants were behaving as expected. With a firming of monetary
policy by the Federal Reserve widely expected, they built large short
positions in long-term debt instruments in anticipation of the increase
in bond yields that has been historically associated with a rising
Federal funds rate. But by summer, pressures emerged in the marketplace
that drove long-term rates back down. In March of this year, market
participants once again bid up long-term rates, but as occurred last
year, forces came into play to make those increases short lived. There
remains considerable conjecture among analysts as to the nature of
those market forces.
That said, there can be little doubt that exceptionally low
interest rates on ten-year Treasury notes, and hence on home mortgages,
have been a major factor in the recent surge of homebuilding and home
turnover, and especially in the steep climb in home prices. Although a
``bubble'' in home prices for the Nation as a whole does not appear
likely, there do appear to be, at a minimum, signs of froth in some
local markets where home prices seem to have risen to unsustainable
levels.
The housing market in the United States is quite heterogeneous, and
it does not have the capacity to move excesses easily from one area to
another. Instead, we have a collection of only loosely connected local
markets. Thus, while investors can arbitrage the price of a commodity
such as aluminum between Portland, Maine, and Portland, Oregon, they
cannot do that with home prices because they cannot move the houses. As
a consequence, unlike the behavior of commodity prices, which varies
little from place to place, the behavior of home prices varies widely
across the Nation.
Speculation in homes is largely local, especially for owner-
occupied residences. For homeowners to realize accumulated capital
gains on a residence--a precondition of a speculative market--they must
move. Another formidable barrier to the emergence of speculative
activity in housing markets is that home sales involve significant
commissions and closing costs, which average in the neighborhood of 10
percent of the sales price. Where homeowner sales predominate,
speculative turnover of homes is difficult.
But in recent years, the pace of turnover of existing homes has
quickened. It appears that a substantial part of the acceleration in
turnover reflects the purchase of second homes--either for investment
or vacation purposes. Transactions in second homes, of course, are not
restrained by the same forces that restrict the purchases or sales of
primary residences--an individual can sell without having to move. This
suggests that speculative activity may have had a greater role in
generating the recent price increases than it has customarily had in
the past.
The apparent froth in housing markets may have spilled over into
mortgage markets. The dramatic increase in the prevalence of interest-
only loans, as well as the introduction of other relatively exotic
forms of adjustable-rate mortgages, are developments of particular
concern. To be sure, these financing vehicles have their appropriate
uses. But to the extent that some households may be employing these
instruments to purchase a home that would otherwise be unaffordable,
their use is beginning to add to the pressures in the marketplace.
The U.S. economy has weathered such episodes before without
experiencing significant declines in the national average level of home
prices. In part, this is explained by an underlying uptrend in home
prices. Because of the degree of customization of homes, it is
difficult to achieve significant productivity gains in residential
building despite the ongoing technological advances in other areas of
our economy. As a result, productivity gains in residential
construction have lagged behind the average productivity increases in
the United States for many decades. This shortfall has been one of the
reasons that house prices have consistently outpaced the general price
level for many decades.
Although we certainly cannot rule out home price declines,
especially in some local markets, these declines, were they to occur,
likely would not have substantial macro-economic implications.
Nationwide banking and widespread securitization of mortgages make it
less likely that financial intermediation would be impaired than was
the case in prior episodes of regional house price corrections.
Moreover, a substantial rise in bankruptcies would require a quite-
significant overall reduction in the national housing price level
because the vast majority of homeowners have built up substantial
equity in their homes despite large home equity withdrawals in recent
years financed by the mortgage market.
In conclusion, Mr. Chairman, despite some of the risks that I have
highlighted, the U.S. economy seems to be on a reasonably firm footing,
and underlying inflation remains contained. Accordingly, the Federal
Open Market Committee in its May meeting reaffirmed that it ``. . .
believes that policy accommodation can be removed at a pace that is
likely to be measured. Nonetheless, the Committee will respond to
changes in economic prospects as needed to fulfill its obligation to
maintain price stability.''