[Joint House and Senate Hearing, 109 Congress]
[From the U.S. Government Publishing Office]


                                                        S. Hrg. 109-164
 
                          THE ECONOMIC OUTLOOK

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

                                HEARING

                               BEFORE THE

                        JOINT ECONOMIC COMMITTEE

                     CONGRESS OF THE UNITED STATES

                       ONE HUNDRED NINTH CONGRESS

                             FIRST SESSION

                               __________

                              JUNE 9, 2005

                               __________

          Printed for the use of the Joint Economic Committee






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                        JOINT ECONOMIC COMMITTEE


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


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



                              ----------                              


                      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

                              ----------                              


                         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.''
  

                                  
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