[Joint House and Senate Hearing, 109 Congress]
[From the U.S. Government Publishing Office]
S. Hrg. 109-484
THE ECONOMIC OUTLOOK
=======================================================================
HEARING
before the
JOINT ECONOMIC COMMITTEE
CONGRESS OF THE UNITED STATES
ONE HUNDRED NINTH CONGRESS
FIRST SESSION
__________
NOVEMBER 3, 2005
__________
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JOINT ECONOMIC COMMITTEE
[Created pursuant to Sec. 5(a) of Public Law 304, 79th Congress]
HOUSE OF REPRESENTATIVES SENATE
Jim Saxton, New Jersey, Chairman Robert F. Bennett, Utah, Vice
Paul Ryan, Wisconsin Chairman
Phil English, Pennsylvania Sam Brownback, Kansas
Ron Paul, Texas John E. Sununu, New Hampshire
Kevin Brady, Texas Jim DeMint, South Carolina
Thaddeus G. McCotter, Michigan Jeff Sessions, Alabama
Carolyn B. Maloney, New York John Cornyn, Texas
Maurice D. Hinchey, New York Jack Reed, Rhode Island
Loretta Sanchez, California Edward M. Kennedy, Massachusetts
Elijah E. Cummings, Maryland Paul S. Sarbanes, Maryland
Jeff Bingaman, New Mexico
Christopher J. Frenze, Executive Director
Chad Stone, Minority Staff Director
C O N T E N T S
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Opening Statement of Members
Hon. Jim Saxton, Chairman, a U.S. Representative from the State
of New Jersey.................................................. 1
Hon. Carolyn B. Maloney, a U.S. Representative from the State of
New York....................................................... 2
Witnesses
Statement of Hon. Alan Greenspan, Chairman, Board of Governors of
the Federal Reserve System..................................... 3
Submissions for the Record
Prepared statement of Representative Jim Saxton, Chairman........ 27
To Hon. Alan Greenspan from Representative Saxton............ 28
To Representative Saxton from Hon. Alan Greenspan............ 31
Prepared statement of Senator Jack Reed, Ranking Minority........ 36
Prepared statement of Representative Carolyn B. Maloney.......... 36
Prepared statement of Hon. Alan Greenspan, Chairman, Board of
Governors of the Federal Reserve System........................ 37
Letters:
To Hon. Alan Greenspan from Senator Bennett.................. 43
To Senator Bennett from Hon. Alan Greenspan.................. 44
To Representative Saxton from Senator Bennett................ 46
Responses by Hon. Alan Greenspan to questions submitted by the
Joint Economic Committee....................................... 32
Core PCE Inflation Chart......................................... 41
Yield Spread Chart............................................... 42
THE ECONOMIC OUTLOOK
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THURSDAY, NOVEMBER 3, 2005
Congress of the United States,
Joint Economic Committee,
Washington, D.C.
The Committee met, pursuant to notice, at 10 a.m., in room
2175, Rayburn House Office Building, the Honorable Jim Saxton
(Chairman of the Committee) presiding.
Present: Representatives Saxton, English, Brady, Paul,
Maloney, Hinchey, Sanchez and Cummings.
Staff Present: Chris Frenze, Robert Keleher, Colleen Healy,
John Kachtik, Emily Gigena, Brian Higginbotham, Chad Stone,
Matt Salomon, and Nan Gibson.
OPENING STATEMENT OF HON. JIM SAXTON, CHAIRMAN,
A U.S. REPRESENTATIVE FROM THE STATE OF NEW JERSEY
Representative Saxton. Good morning, I am pleased to
welcome Chairman Greenspan before the Committee once again to
testify on the economic outlook. We appreciate the many times
that you have testified before this Committee, Mr. Chairman,
and recognize your outstanding stewardship of monetary policy
during your tenure as Fed Chairman.
You have guided monetary policy through stock market
crashes, wars, terrorist attacks and natural disasters with a
steady hand. Under your tenure, price stability has been the
norm, with inflation low and stable. You have made a great
contribution to the prosperity of the United States, and the
Nation is in your debt.
A broad array of standard economic data reflect the health
of the U.S. economy. Figures released last week indicate that
the economy grew at a 3.8 percent rate last quarter despite the
massive regional destruction wrought by the hurricanes.
So far during 2005, the economy has expanded at a 3.6
percent rate, roughly in line with Federal Reserve expectations
as well as the Blue Chip indicators.
Equipment and software investment has bolstered the economy
since 2003 and continues at a healthy pace. This component of
investment responded especially sharply to the incentives
contained in the 2003 tax package. Employment has also gained
over the period with 4.2 million jobs added to the business
payrolls since May 2003, and the unemployment rate is at 5.1
percent.
Consumer spending continues to grow. Home ownership has
reached record highs. Household net worth is also at a record
level. Productivity continues at a healthy pace, and although
higher energy prices have raised business costs and imposed
hardships on many consumers, these prices have not derailed the
expansion.
As the Fed recently suggested, long-term inflation
pressures are contained. As a result, long-term interest rates,
such as mortgage rates, are still relatively low.
By its actions, the Fed has made clear its determination to
keep inflation in check.
In summary, the economy has displayed impressive
flexibility and resilience in absorbing many shocks. Monetary
policy and tax incentives for investment have made important
contributions in accelerating the expansion in recent years.
The most recent release of Fed minutes indicates that the
central bank expects this economic growth to continue through
2006.
The Blue Chip Consensus of private economic forecasters
also suggests that the economy will grow in excess of 3 percent
next year.
Current economic conditions are positive, and the outlook
for 2006 is favorable.
Mrs. Maloney, we are ready for your opening statement.
[The prepared statement of Representative Jim Saxton
appears in the Submissions for the Record on page 27.]
OPENING STATEMENT OF HON. CAROLYN B. MALONEY,
A U.S. REPRESENTATIVE FROM THE STATE OF NEW YORK
Representative Maloney. Well, thank you very much, Mr.
Chairman, and on that note I would like to place inside the
record Senator Reed's opening statement and hope that everyone
about will get a chance to see it. It is over on the desk.
[The prepared statement of Senator Jack Reed, Ranking
Minority Member, appears in the Submissions for the Record on
Page 36.]
Representative Maloney. First of all, I want to welcome
Chairman Greenspan for his appearance before the Joint Economic
Committee as Fed Chairman.
This will probably be your last appearance before us, and
first of all, I want to say that New York is so proud of you.
And we take tremendous pride in the fact that you are a born,
tried and true New Yorker. And many of my constituents have
expressed their gratitude for your service and their hope that
in retirement you will be able to spend more time back in New
York City.
You have really done a great service for this Nation. You
have pulled us through some difficult times that were outlined
by the Chairman. I would like to add to that list, 9/11. That
was a very difficult economic time. And your leadership is
greatly appreciated by New York and the entire Nation.
Over the past 18 years, Chairman Greenspan has achieved a
really remarkable record of success as the country's central
banker. He has steadfastly maintained the Fed's credibility for
keeping inflation under control while dealing flexibly with a
variety of economic challenges. The 10-year economic expansion
of the 1990's was the longest on record. One contributing
factor was Chairman Greenspan's strong sense in the middle of
that expansion that there was room for monetary policy to
accommodate further reductions in the unemployment rate, even
though the conventional wisdom at the time said otherwise.
Of course, another contributing factor was the Clinton
administration's strong commitment to deficit reduction, which
created a fiscal policy environment conducive to strong,
sustainable, non-
inflationary growth.
Unfortunately, that discipline is now a distant memory and
Chairman Greenspan's successor will face a host of problems
managing monetary policy in the face of historically large
budget deficits, largest in history, a record current account
deficit, a negative household savings rate, rising inflation
and a labor market recovery that remains very weak in many
respects.
As always, I look very much forward to hearing Chairman
Greenspan's testimony. I hope that, in addition to his views on
the economic outlook, he will share with us some reflections on
what has made his tenure at the Fed so successful and what are
the key lessons he would like to pass on to his successor. We
thank you for your many years of public service.
[The prepared statement of Representative Carolyn B.
Maloney appears in the Submissions for the Record on page 36.]
Chairman Greenspan. Thank you.
Representative Saxton. Mr. Chairman, let me just add my
personal thanks for you being here today and just say that, in
my office, there is a great picture of you with me, and as my
constituents come in and tell me whatever it is that is on
their minds, on the way out the door, I often point to that
picture and say, ``and there we are planning for this great
economy.'' And so it has been a pleasure working with you, sir,
and Mr. Chairman, we are ready for your statement.
STATEMENT OF HON. ALAN GREENSPAN, CHAIRMAN, BOARD OF GOVERNORS
OF THE FEDERAL RESERVE SYSTEM
Chairman Greenspan. First, let me thank you both for your
thoughtful and kind comments. I will be excerpting my prepared
remarks and request the full transcript be included in the
record.
Representative Saxton. Without objection. Thank you.
Chairman Greenspan. Prior to the hurricanes that severely
damaged the Gulf Coast, the economy appeared to have
considerable momentum. But pressures on inflation remained
elevated. Then Hurricane Katrina hit at the end of August,
causing widespread disruptions to oil and natural gas
production and driving the price of light sweet crude oil above
$70 per barrel. With the recovery from the first storm barely
under way, Hurricane Rita hit, causing additional destruction,
especially to the energy production and distribution systems in
the Gulf.
These events are likely to exert a drag on employment and
production in the near term and to add to the upward pressure
on the general price level. But the prices of crude oil and
refined petroleum products have now fallen significantly from
their peaks, and repair and rebuilding activities are underway
in many parts of the affected region.
Outside the areas affected by the storms, economic
fundamentals remain firm, and the U.S. economy appears to have
retained considerable forward momentum.
If allowance is taken for the effects of Katrina and Rita
and for the now-settled machinists strike at Boeing, industrial
production rose at an annual rate of 5\1/4\ percent in the
third quarter. That is up from an annual rate of 1\1/4\ percent
in the second quarter when a marked slowing of inventory
accumulation was a restraining influence on growth.
The September employment report showed a loss of 35,000
jobs. However, an upward revision to payroll gains over the
summer indicated a stronger underlying pace of hiring than
before the storms that had been previously estimated.
The Bureau of Labor Statistics estimates that employment
growth in areas not affected by the storms was in line with the
average pace over the 12 months ending in August.
Retail spending eased off in September, likely reflecting
the effects of the hurricanes and higher gasoline prices.
Major chain stores report a gradual recovery over October
in the pace of spending, though light motor vehicle sales
declined sharply last month when some major incentives to
purchase expired.
The longer-term prospects for the United States' economy
remain favorable. Structural productivity continues to grow at
a firm pace, and rebuilding activity following the hurricanes
should boost real GDP growth for a while.
More uncertainty, however, surrounds the outlook for
inflation. The past decade of low inflation and solid economic
growth in the United States and in many other countries around
the world has been without precedent in recent decades.
Much of that favorable performance is attributable to the
remarkable confluence of innovations that spawned new computer,
telecommunication and networking technologies, which especially
in the United States, have elevated the growth of productive
capacity, suppressed unit labor costs and helped to contain
inflationary pressures. The result has been a virtuous cycle of
low prices and solid growth.
Contributing to the disinflationary pressures that had been
evident in the global economy of the past decade or more has
been the integration of in excess of 100 million educated
workers from the former Soviet bloc into the world's open
trading system. More recently, and of even greater
significance, has been the freeing from central planning of
large segments of China's 750-million workforce. The gradual
addition of these workers, plus workers from India, a country
which is currently undergoing a notable increase in its
participation in the world trading system, will approximately
double the overall supply of labor once all these workers
become fully engaged in competitive world markets.
Of course, at current rates of production, the half of the
world's labor force that has been newly added to the world
competitive marketplace is producing no more than one quarter
of world output. With increased education and increased
absorption of significant cutting-edge technologies, that share
will surely rise.
Over the past decade or more, the gradual assimilation of
these new entrants into the world's free market trading system
has restrained the rise of unit labor costs in much of the
world and hence has helped to contain inflation.
As this process has unfolded, inflation expectations have
decreased, and accordingly, the inflation premiums embodied in
long-term interest rates around the world have come down.
The effective augmentation of world supply and the
accompanied disinflationary pressures have made it easier for
the Federal Reserve and other central banks to achieve price
stability in an environment of genuinely solid economic growth.
But this seminal shift in the world's workforce is producing,
in effect, a level adjustment in unit labor costs.
To be sure, economic systems evolve from centrally planned
to market-based only gradually and at times in fits and starts.
Thus, this level adjustment is being spread over an extended
period. Nevertheless, the suppression of cost growth and world
inflation at some point will begin to abate and, with the
completion of this level adjustment, gradually end.
These global forces pressing inflation and interest rates
lower may well persist for some time. Nonetheless, it is the
rate at which countries are integrated into the global economic
system, not the extent of their integration, that governs the
degree to which the rise in world unit labor costs will
continue to be subdued.
Where the global economy is currently in this dynamic
process remains open to question. But going forward, these
trends will need to be monitored carefully by the world's
central banks.
Mr. Chairman, I want to conclude with a few remarks about
the Federal budget situation which, at least until Hurricanes
Katrina and Rita struck the Gulf Coast, were showing signs of
modest improvement. Indeed, tax receipts have exhibited
considerable strength of late, posting an increase of nearly 15
percent in fiscal year 2005 as a result of sizable gains in
individual and, even more, corporate income taxes.
Thus, although spending continued to rise gradually last
year, the deficit in the unified budget dropped to $319
billion, nearly $100 billion less than the figure for fiscal
year 2004 and a much smaller figure than many had anticipated
earlier in the year.
Lowering the deficit further in the near term, however,
will be difficult in light of the need to pay for post-
hurricane reconstruction and relief.
But even apart from the hurricanes, our budget position is
unlikely to improve substantially further until we restore
constraints similar to the Budget Enforcement Act of 1990,
which were allowed to lapse in 2002. Even so, the restoration
of PAYGO and discretionary caps will not address the far more
difficult choices that confront the Congress as the baby boom
generation edges toward retirement.
As I have testified on numerous occasions, current
entitlement law may have already promised to this next
generation of retirees more in real resources than our economy,
with its predictably slowing rate of labor force growth, will
be able to supply.
So long as health care costs continue to grow faster than
the economy as a whole, as seems likely, Federal spending on
health and retirement programs would rise at a rate that risks
placing the budget on an unsustainable trajectory.
Specifically, large deficits will result in rising interest
rates and an ever-growing ratio of debt service to GDP. Unless
the situation is reversed, at some point, these budget trends
will cause serious economic disruptions.
We owe it to those who will retire over the next couple of
decades to promise only what the government can deliver. The
present policy path makes current promises, at least in real
terms, highly conjectural. If fewer resources will be available
per retiree than promised under current law, those in their
later working years need sufficient time to adjust their work
and retirement decisions. Crafting a core strategy that meets
the Nation's longer-run needs will become ever more difficult
and costly the more we delay.
The one certainty is that the resolution of the Nation's
demographic challenge will require hard choices and that the
future performance of the economy will depend on those choices.
No changes will be easy, as they all will involve setting
priorities and making tradeoffs among valid alternatives.
The Congress must determine how best to address the
competing claims on our limited resources. In doing so, you
will need to consider not only the distributional effects of
policy changes, but also the broader economic effects on labor
supply, retirement behavior and private savings. The benefits
of taking sound, timely action could extend many decades into
the future.
Thank you very much.
I look forward to your questions, Mr. Chairman.
[The prepared statement of Hon. Alan Greenspan appears in
the Submissions for the Record on page 37.]
Representative Saxton. Thank you, very much, Mr. Chairman.
Mr. Chairman, let me refer first in a question to something
that you mentioned in your testimony, and that is, expectations
related to inflation. I would like to put up a chart, if I may,
that shows changes in core personal consumption expenditures,
which is a measure of inflation that the Fed likes to use. The
Fed has successfully kept this measure of inflation between 1
and 2 percent, which some refer to as the Fed's comfort zone.
By keeping inflation low and in this narrow range, it seems to
me that the Fed has reduced and helped keep long-term interest
rates lower than they would otherwise be.
We know that we have had 12 short-term increases in
interest rates brought about by monetary policy. And at the
same time, long-term rates, which often in the past have
tracked along with short-term rates, have remained relatively
low.
[The chart entitled ``Core PCE Inflation'' appears in the
Submissions for the Record on page 41.]
By lowering uncertainty, by keeping inflation controlled
and reducing the inflation premium embedded in interest rates,
it seems to me that price stability has helped promote long-
term economic growth and, in doing so, kept long-term interest
rates relatively low. Is this a policy result that was planned
by the Fed, and, if so, what is your perception of how well it
has worked?
Chairman Greenspan. Well, I go back to the earlier years
when I first joined the Federal Reserve, and our general policy
that emerged from that particular period going forward was a
recognition of our dual mandate to maintain maximum,
sustainable growth and price stability.
What we began to learn--which came as a conceptual shock to
most economists in the 1970s--is that you could get both rising
unemployment and rising inflation concurrently. We began to
recognize that, indeed, rising inflation causes unemployment
or, the reverse, that a necessary condition for maximum
sustainable growth is price stability. So what has occurred
over the years is a recognition that rather than having a dual
set of goals which are independent of one another, which indeed
was the general policy prescription in earlier decades, it is
price stability which creates economic growth, employment and
higher standards of living.
We have chosen the core PCE inflation measure as our
standard gauge largely because, as I have argued many times in
the past, there are structural problems in the consumer price
index which don't capture the inflation rate per se.
We are also aware that even though this is a superior
measure to the CPI, it nonetheless does have upward measurement
bias. And it ranges, depending on how you look at some of the
numbers, from a half a percent, to as much as a percentage
point.
Second, as you may recall, we ran into what looked to be
the beginnings of at least possible disinflationary pressures
in the summer of 2003, another surprise to economists who did
not believe that would be feasible in a world of fiat money,
but Japan proved otherwise.
We have gained from that experience a recognition that we
don't want to get close to that particular area, either. So we
have chosen effectively to perceive price stability largely as
the range which you are seeing, after making adjustment for the
statistical and economic adjustments which we learned over the
last couple of decades.
I don't want to communicate to you that somehow we had this
chart up there, and every time the inflation rate got close to
the top, we tightened it, and every time it got down to the
bottom, we eased. That is not the way policy is run because
there are long leads in various different things. But
essentially, as I indicated, fairly early on in this particular
period, I thought that we had, in fact, achieved price
stability. While it has moved up and down since then, it has
broadly stayed in that range.
And judging from the data which you have cited, Mr.
Chairman, it appears to be a range which is really quite
conducive to economic growth and prosperity that are associated
with that.
Representative Saxton. Thank you very much. Let me ask a
question that is related to inflation, as it also relates to
energy. Oil prices in particular have shot up, as every
American consumer knows, boosting increases in the major broad
price indices. Arguably, however, the additional expense of oil
might not be inflationary if it were offset by cutting back on
other expenses.
In the absence of an accommodatative monetary policy,
should oil prices necessarily be expected to lead to increases
in inflation? Would you give us your response to that?
Chairman Greenspan. Yes, Mr. Chairman. I think there are
two aspects to this. One is a technical issue which relates to
the degree to which American businesses, confronted with
increasing energy costs, institute various different actions,
either by capital equipment or changing of the structure by
which goods are produced. The extent to which they do that can
increase the efficiency of oil use. Indeed, we have been seeing
that for several decades.
The ratio of British thermal units per constant dollar of
GDP has effectively been falling progressively decade after
decade since the 1970s in this country, so that the intensity
of energy use--and indeed oil use as well--is about half of
what it was relative to the level of GDP, say, 30 years ago.
The increasing, if I may put it in these terms,
productivity of energy, gains in productivity associated with
more efficient use of energy, continues to this day. Indeed, as
best we can judge, the very sharp increases in prices, and
therefore costs to the non-financial, non-energy corporations
of this country, actually induced a fairly significant rise in
efficiency, so it all didn't pass through as cost increases.
But more important is the perception that inflation overall
will be contained.
Indeed, as you point out, inflation expectation is a
crucial variable in any market system, largely because it tends
to be a key factor in wage rates and labor costs generally.
As long as the Federal Reserve is perceived to be holding
inflation expectations in check, which means holding core
inflation in check, the pass-through of energy costs into the
underlying inflation rate will be subdued.
And indeed, the data indicate that while, prior to the
early 1980's, a goodly part of energy costs were indeed passed
through into the general price level, subsequent to then, there
is very little indication that has been the case, and we
associate it with the significant decline in inflation
expectations. One of the reasons why we are very firm in the
notion that this country should not visit the 1970s again, in
the way of inflation, is that we have managed to keep
expectations contained. As difficult as energy problems are--
there is no doubt there has been a very significant amount of
hardship, and I think people are going to be quite surprised at
their heating bills this winter--we have not had the pass-
throughs into other products in a manner which existed in the
1970s.
Representative Saxton. Let me ask you just one final
question. According to a FOMC statement of last Tuesday, ``core
inflation has been relatively low in recent months and longer-
term inflation expectations remain contained.''
Given the need for the Fed to preempt inflation, to what
extent is the Fed now addressing inflationary expectations or
fears that may not be fully evident in the current available
data?
Chairman Greenspan. Inflationary expectations are
reasonably well measured concurrently and in real time in the
sense that we pick them up from a variety of different sources,
but mostly from the structure of interest rates: very
specifically, the differences between interest rates, which are
defined in real terms, such as Treasury TIPS, and what we call
additional compensation required for inflation. That pretty
much picks up what we are looking at.
Although we measure the same phenomena in a number of
different ways--in other words, we have a whole series of
measures which relate to inflation expectation, essentially
picking up the same general attitude that is embodied in the
marketplace--they all very much show the same sort of pattern,
which is that inflation expectations are contained.
Representative Saxton. Thank you, Mr. Chairman.
We are going to move now to Mrs. Maloney for her questions.
Representative Maloney. Thank you, Chairman Greenspan. The
question that my constituents ask me, I am going to ask you: If
the economy is so good and inflation is so well behaved and
there is price stability, then why does everything cost so much
more when you go to buy something? They are feeling pressured
in their lives.
The question that I hear from my neighbors and friends and
constituents is, when we have so many economic indicators that
are unhealthy, how are we having a healthy economy? We have a
costly war, the largest deficit in history, the largest trade
deficit in history, high energy costs, a weak dollar, huge
investment from foreign countries. All of these patterns are
very troubling to people, yet the economy appears, according to
your testimony, strong and moving forward.
They question, how can it be strong when there are so many
concrete problems out there that are unhealthy for the economy?
And I would like to frame the question in terms of your career
at the Fed. When you first came in the 1970s, your first job
was with President Ford as the head of his Council of Economic
Advisors. And when you took that job, the country was going
through a great deal of what we are going through now, possibly
less shocked than we are now, you had the high energy price
shock, but not the huge deficits in history, and you didn't
have a war. But inflation in 1974 shot up to double-digit
territory, and by 1975, the economy was in a serious recession
with the unemployment rate rising from under 6 percent in 1974
to 8.5 percent in 1975.
Now we are experiencing yet another energy price shock. But
your testimony is very optimistic. And you are saying that we
will not see any inflation, that we will not see any recession.
You are very optimistic.
I want to know how are you confident that we will not--that
we will be able to avoid the same type of economic outcomes now
that we had in the 1970s? Has the economy fundamentally
changed? Are we more competitive? Is it the world economy? Is
it Fed policy? What has changed so that the economy has not
experienced the really dramatic problems that we had in the
1970s?
I guess a part of it is, what are the key changes over the
past 30 years in our economy and in the way that we are
conducting monetary policy that have put us in a better
position to withstand energy supply shocks or price shocks?
Chairman Greenspan. Well, Congresswoman, that is a very
important question, because it is the experience that we had in
the 1970's that gave us a far better understanding of how the
post-World War II American economy functions.
First, let me say that we have a very complex, huge economy
which is churning. There are winners, and there are losers, and
there are pockets in the economy where things are exceptionally
weak, areas where they are strong.
The best way of summarizing why I say things are doing well
is that I would suspect that, on average, I worry about 20
different problems which seem insurmountable out there. Today,
there are only 12 or thereabouts. So, they are still out there.
And you know, I have mentioned on innumerable occasions,
despite the fact that the economy overall is growing, there is
a definite bimodal labor market in the sense that for the 80
percent of the labor force which are production workers, wages
are growing far less quickly than the skilled workers. This is,
as I have mentioned before you on numerous occasions,
essentially an educational problem which we need to adjust
because it is creating a skewing of economic distribution in
this country, which I think is a very unsettling trend for a
democracy.
That, to me, is where I think the major problems are.
But what I should also point out the reason people are
seeing prices rising is that they are. They are seeing them,
however, for a lot of petroleum-related products. The one
statistic that I think almost everybody is able to audit
clearly every day, every week, is the price of gasoline. It is
a homogeneous product, and it is listed on the signs in the
service stations all the time, and needless to say, the price
has been fluctuating all over the place.
But the Bureau of Labor Statistics does an excellent job in
trying to truly get what is the structure of price change in
this country. Those data, which essentially come from the BLS
and in detail, are the best we can do. So I think that it is
mainly a selective view, when you look at the total, which
people often see in a period like this. But when you look at
all the data, it doesn't show the concern of acceleration that
I often hear, as you do.
What has changed since the 1970s with respect to oil is, as
I mentioned before, we are using only half as much as we used
to relative to the GDP in the 1970s. As a consequence of that--
and also because of the fact that the underlying inflation rate
is now much lower--we are able to absorb a remarkable amount of
that increase because we have an extraordinarily more flexible
economy than we had in the mid-70s.
Indeed, that very flexibility itself is one of the reasons
we have gotten through a whole series of shocks that the
Chairman mentioned early on. It is the development of that
flexibility, coupled with the fact that the use of energy is
much less than it was, that has enabled us to absorb the energy
shock with nowhere near the consequences that we confronted in
the earlier period.
Representative Maloney. Thank you.
In your testimony today, Chairman Greenspan, you stress the
long-term core pressures that we face with the retiring baby
boomers. And we have very little flexibility in our core. Most
of it is entitlements. We have very little discretionary
spending now in our Federal core. So this is a huge challenge.
But weren't those pressures also there in 2001? And wouldn't it
have been better if we had focused on that challenge in 2001,
instead of enacting tax cuts that lost revenue and reduced our
national savings? And I want to read the following quote from a
story that was in the New York Times on Monday:
``Mr. Greenspan is widely perceived as having given an
agreement to President Bush's plans for a big tax cut in 2001
and thus to have helped set the stage for the huge deficits
that followed.''
And do you have any regrets about the way you expressed
yourself in 2001? And were you surprised that your testimony
was interpreted as having given a green light of support for
these policies that have added to this extremely large core
deficit?
Chairman Greenspan. Let me review what was going on then
and what I actually testified to with respect to the budget at
that particular point.
We, as you know, then had very large surpluses, which all
of the technical experts projected further, and indeed, the
Congressional Budget Office projected them further. The Office
of Management and Budget projected them further. The staff at
the Federal Reserve projected them further. We were all trying
to get as full detailed an analysis as we could on something
which we found very surprising, namely, chronic surpluses,
which we never believed we would ever see, and we could not
find any technical reasons to say that those data were
incorrect.
Indeed, the Federal Reserve embarked upon a study of what
we would do when the actual supplies of U.S. Treasury issues
would become inadequate for purposes of open market operations,
meaning that the level of debt outstanding would approach de
minimis levels.
The problem, if you get to that point and still have
surpluses, is that you have to accumulate technically private
assets plus State and local assets.
I have always argued that that is potentially very
destabilizing where large claims on American businesses would
be held by the U.S. Government.
As a consequence, I argued at that time that we ought to
cut taxes before the debt would get to such levels that we
couldn't reduce it any more and would therefore have to
accumulate assets. Were I confronted with the same data today
as I was then, I would have given exactly the same testimony.
I must tell you, however, that in that whole evaluation I
did recognize, in the testimony, that even though we couldn't
find anything wrong with the forecasts of surpluses should
they, in fact, dissipate, we ought to have procedures which
would follow up any changes in budgetary policies, whether for
tax cuts or expenditure increases, and essentially have
triggers or other means of review that would reverse the
actions that would be taken at that particular point in time.
So, I have gone back and I have reviewed that testimony.
And I must tell you that, aside from the fact that the
probability that we all perceived of the deficit reemerging was
small and that was clearly a forecast gone wrong--not that the
probability was small, but that we would maintain the
surpluses. Aside from that, I must say, I would reproduce the
testimony word for word.
Representative Maloney. Well, former Treasury Secretary
O'Neill reports that when he expressed concern about the
possible impact of the proposed tax cuts on the deficit and he
said that Vice President Cheney said, ``Reagan proved that
deficits don't matter.'' And did you have any idea when you
gave that testimony in 2001 that the Administration was not
serious about containing deficits, was not serious about
enforcement rules to help turn record deficits into surpluses
and to control the core?
Chairman Greenspan. I think the ``deficits don't matter''
was a reference that they don't have an impact on interest
rates. And I disagree with that. I disagreed with it then; I
disagree with it now. And I disagree with it because the facts
prove otherwise.
Representative Maloney. My time is up, and as always, it is
a great pleasure to listen and learn from you. Thank you.
Chairman Greenspan. Thank you.
Representative Saxton. Thank you, Mrs. Maloney.
Mr. Paul.
Representative Paul. Thank you, Mr. Chairman.
And welcome, Mr. Greenspan.
Looking at your last three paragraphs, I certainly would
agree with your concern about the concerns for the future, the
future financing of the medical care system as well as the
retirement programs, as well as financing the debt. And to me,
I read that as a rather dire warning of what we should be
dealing with in the Congress. And you make a suggestion that
the entitlement laws should be looked at because we cannot much
sustain this.
And yet I think that is only part of the problem, because
the entitlement system is certainly one reason why we spend a
lot of money. I don't think we can do this without addressing
the subject of what we do with our foreign policy as we spend
hundreds of billions of dollars overseas destroying countries
and then rebuilding countries.
I cannot see how we can adjust our ways here unless we talk
about that as well. But I also think that we should tie in this
deficit spending and this commitment to the future to overall
monetary policy because I think the system of money that we
have had helped create the problems that we have. And we can't
separate the two because it certainly makes it a lot easier for
Congress to spend if there is some way of creating new money to
accommodate these deficits.
Just in the time that you have been at the Fed, we have had
a lot of monetary inflation. We have had a lot of new money
pumped into the system. As a matter of fact--over $600 trillion
as measured by M3--it is all new money. It is three times as
much money as we had in 1987. But interestingly enough, the
total debt, government debt, corporate debt and personal debt,
has done the same thing. It has tripled. It was approximately
$8 trillion in 1987, and now it is like $25 trillion. So a lot
of new money was created. And we have a lot of new debt in the
system. But we also suffered a consequence, our dollar now is
worth 55 cents. So that to me seems unfair because if I had
saved money in 1987, I am only going to get 55 cents back on my
dollar.
I think there is a moral element to this, too, as well as
an economic argument. Why save? And we don't save. And if we
need more money to take care of our entitlements or fight a war
or accommodate the debt, we just literally are able to go and
depend on the Federal Reserve to make sure interest rates don't
go up.
And then I think another problem we have is we look at the
wrong things when we are looking at our problems. It has been
said that the government tells us there is really no inflation.
But you know we could use what we strike out. We could look at
medical care costs. We could look at food. We could look at
energy. We could look at the cost of government, taxes. And who
knows, the inflation rate might be 12 percent or 14 percent. So
sometimes I think we deceive ourselves with the system of money
that we have today by looking at the wrong things.
Because of globalization and productivity, prices have in
some respect been held in check. But I cannot see how we can
continuously reassure ourselves that that is good, because it
doesn't deal with the problem of the malinvestment, the
overinvestment, the bubbles that develop, as well as the debt
that builds up.
And this could not be done other than with someone being
able to create credit out of thin air.
I think it should be held in check.
So, in order to get this into a question, isn't there--
isn't there something unfair about the system? How can we
justify stealing value from people who save, cheat the people
who are on retirement and then they get so little on their
interest earned as well? Is this a wise thing to do
economically? Because you have expressed the concerns that I
have. But I cannot see how you can separate that from the
overall monetary system that we have been dealing with a lot
longer than you have been in charge of the Fed.
Chairman Greenspan. Well, Congressman, the first thing that
we have to recognize is that the inflation rate, properly
measured, at this particular stage has been very close to zero
for a very long period of time.
In other words, as I said earlier, those numbers are biased
upwards because of the way we calculate it. So while that is
true about a number of the statistics you quote, those
statistics go back well before the inflation rate stabilized
and are reflecting very substantial inflation pressures which
existed, especially during the 1970s when the inflation rate
was double-digit.
But the level of nominal GDP has gone up basically roughly
the same after certain types of adjustments, with what the real
underlying GDP properly measured would have done. That tells me
that we are not unduly inflating the system.
Representative Paul. Well, I don't think that reconciles
the facts that I can get from the Federal Reserve that show
that our dollar is worth 55 cents compared to 1987. If that is
not the reverse of what you see in rising price and inflation,
my dollar just doesn't buy as much any more. And the trend is
continuous since 1914. It is worth 5 cents. So I don't see how
you can say there is no inflation.
Chairman Greenspan. Well, you and I have discussed this
issue at length many times over the years. And I agree with you
in part, and I disagree with you on the other part.
Representative Paul. Can you say anything favorable about
gold today?
Representative Saxton. The gentleman's time has expired. We
are going to go now to Mr. Hinchey.
Representative Hinchey. Thank you very much, Mr. Chairman.
Mr. Greenspan, I just want to say that we are going to miss
you, really miss you.
I think that you have probably been one of the most
effective chairmen of the board in the history of the Federal
Reserve.
Chairman Greenspan. Thank you.
Representative Hinchey. And also I think one of the most
interesting and instructive. And I think that that instruction
has come on a variety of levels, so you have done one heck of a
job. I won't say, Brownie, but you have done one heck of a job.
And I think we are going to miss you a great deal, and I want
to thank you, take this opportunity to thank you very much for
your service and to share the things that were said by my
friend and colleague, Mrs. Maloney, a few moments ago. As a New
Yorker, I am very proud of you, too.
The economic circumstances that we are experiencing today,
growth in the economy, is a result of a variety of things, not
the least of which, the most of which, frankly, I think is the
conflux of some extraordinary circumstances of economic
stimulation. We have had record low interest rates,
extraordinary amount of Federal spending and record tax cuts,
all coming at the same time. And if you don't have economic
stimulation and a growing, creating-new-money economy when you
are pouring all that money in, both in terms of monetary and
fiscal policy, then you are in deep, deep trouble.
So I am frankly very concerned about what is going to
happen when the conflux of circumstances wears out. And it
certainly will in the not-too-distant future.
So that would be my first question to you. What is going to
happen when all of this stimulation starts to decline?
Chairman Greenspan. Congressman, it depends on what is
going on in the world generally, because you can remove all of
that stimulation, but if the underlying incentives in the
private system are increasing--and I think they are, at the
moment, especially coming out of the hurricanes--you can more
than offset the stimulation, if you want to put it that way,
from the private sector.
Representative Hinchey. That is true. And if that happens,
that may be the case----
Chairman Greenspan. Well, the history of stimulating a
market economy is mixed. There are innumerable occasions in the
past when we have engaged in very significant stimulation--in
other words, large deficits, large expansions of the monetary
base--and we found that real GDP barely grew, and often fell
into recession because of the inflation which was engendered by
the excess stimulant. I think we have to be careful about
defining what type of stimulus, what part of the economy it is
imposed on or injected into and what is going on mainly in the
private sector, because that is where most of the job
generation occurs.
Representative Hinchey. Well, the job generation in the
private sector----
Chairman Greenspan. Let me just follow up. I recognize that
and agree with you. I think that there is going to be
significant pulling back in the overall degree of stimulus. At
least I hope there is, because if we engage in fiscal policy
that I was concerned about, that was in the latter part of my
testimony, then we are going to get exceptionally large amounts
of fiscal stimulus which we are not going to want.
Representative Hinchey. Well, Mr. Chairman, I know that is
a very vague and ambiguous answer. And it is probably the best
you can do in the context. But the fact of the matter is that I
think we are going to be facing some very serious problems when
we begin to pull back. And we will have to pull back. In terms
of the job production in the private sector, this economy has
lost substantially more than a million manufacturing jobs in
the last 5 years. And those are the best paying jobs.
One of the scholars at the American Enterprise Institute
very recently made the observation that the benefits in the
economy--and these are his words--the benefits of the economy
are not filtering down, that the creating-new-money benefits
are going to capital and not to workers.
And we see that very, very clearly. The median pre-tax
income is now $44,389. That is the lowest it has been since
1997.
We have a situation here in our country where the average,
the median income of the average American family has been flat
for 5 years. The biggest problem that we are going to face, in
addition to maintaining the growth of the economy, assuming
that we can do that, even as we have to withdraw all of this
stimulation that we have been pouring into it because growing
core deficits and a national debt now that exceeds $8
trillion--the biggest problem that we are going to face, is how
to engage in some more equitable distribution of the benefits
of the creating-new-money growth in the context of a democratic
society.
How are we going to do that?
Chairman Greenspan. Well, first of all, let me just say
that there is a question about what the real median income
level has been, and it gets to different types of price
deflation and which types of data are employed.
Representative Hinchey. That number takes into
consideration inflation.
Chairman Greenspan. I don't disagree with the conclusion
that you raised as a consequence of that.
The issue is most vividly reflected in the fact that, in
the last period, 20 percent of the workforce, which is largely
supervisory by definition, has had hourly wage increases
approaching 10 percent, whereas the increase for those in the
80 percent, who are perceived to be production workers, is
under 4 percent.
That is essentially creating a type of bimodal
distribution.
The argument that seems most convincing to me as to the
cause of this problem, indeed it is almost necessary, is that
we have clearly observed a major increase in the need for
skilled workers to basically staff our ever-increasingly
complex technological capital stock.
On the other hand, we have seen a relative decrease in
those who are required to do less skilled work. Our educational
system, however, has, as best we can judge, been falling short
in pushing our students, from fourth grade to high school and
from high school into the universities relative to the rest of
the world. As a consequence, we are left with a shortage of
skilled workers who go through this whole educational process,
and with a lot of more lesser-skilled people than are needed to
staff our capital structure. The result is that wages are
rising rapidly among the skilled and at a very subdued level
for the lesser skilled, creating a very marked change in the
distribution of income. And it is showing up in the capital as
well.
Representative Saxton. Thank you very much, Mr. Hinchey.
Representative Hinchey. Wish we had more opportunity to
follow up, Mr. Chairman.
Chairman Greenspan. I agree with you. I think this is a
very important question for the United States.
Representative Saxton. Thank you, Mr. Chairman, and Mr.
Hinchey.
We are going to go to the gentleman from northwestern
Pennsylvania, a Member of the Ways and Means Committee, Mr.
English.
Representative English. Thank you, Mr. Chairman.
Chairman Greenspan, let me first say I would also like to
thank you for your long years of testimony before this and
other committees up here on the Hill and your willingness to
speak truth to power and present some powerful economic
realities to us whether they are politically comfortable at the
moment or not.
I am particularly grateful in this testimony that you have
focused on the nuances of the problems that you see in our
fiscal policy, and particularly the fact that we have an
ongoing challenge in dealing with the deficit. I was
particularly grateful for how your testimony also focused on
the fact that prior to Katrina, we had, in effect, seen a
lowering of the deficit by a little under $100 billion for the
previous year, the result at least in large part of economic
growth interacting with the Tax Code to produce additional
revenues. To me, that points the way for at least partially
digging out from under this problem even though we now have
huge additional obligations, as some of the other Members have
noted.
To me, through all of this you have made the case for
strong policies to continue to encourage economic growth, and I
am concerned that we have, in effect, in the Tax Code scheduled
under current law a tax increase in a couple of the provisions
that directly impact on our growth rate, and here I am noting
for the record that in 2008 under current law, the capital
gains tax rate will go back up, and the reforms in dividends
will be phased out. And I wonder if you would comment on
whether you think that that is sound policy, or whether
Congress should move now while we have the opportunity to make
the current rates permanent before the market begins to
anticipate that we might allow those tax increases to go into
law. Do you share my concern, Mr. Chairman?
Chairman Greenspan. I think there are two issues here,
Congressman, and I thank you, incidentally, for your kind
remarks. The first is, I have testified previously that the
partial elimination of the double taxation of dividends has
been a major contribution to the structure of our tax system,
and I should very much like to see it continued.
Secondly, however, I would like to see it continued in the
context of PAYGO, in the sense that we should not be cutting
taxes by borrowing, we should be cutting taxes by reducing the
level of spending, and that is an issue which I think is
critical.
We do not have the capability of having both productive tax
cuts and large expenditure increases and presume that the
deficit doesn't matter, because it will create very serious
backlashes in the system. So I would like to see the extension
of that provision in the tax law, but I would insist that it be
done in the context of a PAYGO, which is not currently on the
books. As I indicated in my testimony, one of the very first
things that we ought to recognize is that if we are going to
come to grips with the long, very difficult budget problems
that exist as the baby boomers start to retire, we have to put
in place a structure which will enable the Congress to make
rational choices. I don't believe this is realistically
possible unless something like the Budget Enforcement Act of
1990 is on the books, and if that is the case, then I would say
let's confront the question of the tradeoffs, of what the
advantages are of keeping or even increasing the reduction of
the double taxation on dividends with the context of what other
priorities there are.
There are no easy choices. The easy choices are long gone.
These choices are between things which a majority of the
Congress has previously said are good and another one which the
majority of Congress has said are good, but both can't exist at
the same time.
Representative English. Thank you, Mr. Chairman, and thank
you, Mr. Chairman.
Representative Saxton. Thank you, Mr. English.
Ms. Sanchez.
Representative Sanchez. Thank you, Mr. Chairman, and thank
you, Chairman Greenspan, for your service to our country. I
think most of my colleagues have already spoken about your
service, and I would associate myself with their words.
I have a couple of questions. One has to do with the
capital markets and our budget situation here in Washington,
D.C., and the other has to do with something in your testimony
on page 5 with respect to the result of 100 million educated
workers from the former Soviet bloc entering into the world's
trading system, China's 750 million people workforce, and India
are also engaging in it.
Let me go first with this one, because basically what you
have said in here is the economy, the world's economy, has been
able to absorb much of this workforce. You have also said in
there, or you alluded to the fact, that they are educated
workers, and my biggest fear for this country's future,
competitively speaking, is that we are doing such a poor job in
education. When I go to the universities, the teachers in the
graduate departments of science and math tend to be foreigners,
and probably three-quarters of the classes are.
So I guess my question to you is with this disparity that
we continue to see growing between no growth or actually a
decrease in the real income of unskilled workers in the United
States versus the high-skilled workers, what do you think we do
as a Nation to address that?
Chairman Greenspan. Let me address the issue, because I
think this is a critical question that we will be confronted
with as the years go on. The global world is changing in a way
which is that an ever-higher proportion of value added in the
world, goods and services produced--meaning value which the
world consumers view as value--is becoming increasingly
conceptual and less physical, more services and less physical
goods.
We have recently done an analysis of 136 countries in the
world which indicates that there is a very high correlation
between the proportion of services to GDP and the relative real
per capita income in that country, reflecting that those
countries with an above-average amount of services relative to
goods being produced tend to have the higher standard of
living.
What we in the United States are going through is a very
difficult transition. Our standard of living continues to
increase, our per capita real GDP continues to be increasing
amongst the major countries; we are obviously well ahead even
considering the problem I was discussing with Congressman
Hinchey previously. On the average we are well ahead, which
essentially says that we are going through a period which is
extremely stressful for those people who are producing goods.
Indeed we have had an extraordinary decline--not in industrial
production, which has held up--but in employment involved in
industrial production. The job loss has been horrendous, and in
certain areas of the country it has really been a very serious
and stressful problem.
It does say to us, however, that our standard of living is
dependent on our ability to create services, conceptual
services, ever more as an increasing ratio to goods, and this
is where our educational system is going to be critical. While
we will find that both China and India have a huge number of
educated people, they still are missing one thing which we
have, which in addition to our fairly wide but, as I said
previously, less than numerous skilled workers, we have a
really very imaginative workforce and a very productive
workforce.
We also have what the others don't have, namely the
Constitution of the United States. What that has done, in my
judgment, is to create a rule of law which enables individuals
both in this country and those investing from abroad--in other
words, those who invest in the United States--to know and trust
the course of this country to protect their rights. That is
true both of citizens of the United States and foreigners, and
I believe that has been a very major factor in why we do as
well as we do, and indeed a lot of the so-called development
research which endeavors to determine why certain economies
prosper and others don't would subscribe to that.
But unless we get our educational system in check, even our
Constitution is not likely to protect us over the very long
run. But we do have an awful lot going for us, and if we can
resolve our educational problems, we will maintain the very
extraordinary position the United States holds in the world at
large.
Representative Sanchez. I see my time has expired, Mr.
Chairman.
Representative Saxton. Thank you very much, Ms. Sanchez.
Mr. Brady.
Representative Brady. Thank you, Mr. Chairman, for this
hearing and, Mr. Chairman, like others, I want to thank you for
your service. It has been famously said you make a living by
what you get; you make a life by what you give. You have given
back so much through your guidance of our economy and the Fed
to the prosperity of this Nation. I just want to join others in
thanking you for your leadership.
I want to ask two questions, one related to foreign
holdings of U.S. debt and the other to the account deficit the
United States is running. In your view, what do you see as the
real world risk to the large amount of foreign holdings of our
U.S. debt? In the account deficit, while we mostly look at that
as a function of what we purchase and what we export, there is
a savings component in that trade deficit that I think is often
ignored. Can you give your views to us on what impact we can
have, what role that plays long term for us?
Chairman Greenspan. I think it is part of the globalization
process which has been accelerating over recent years,
especially since 1995. In other words, the last decade has been
a remarkable period of expanding trade, movement of capital,
and all the various measures which we use to say that
globalization has increased. You can compare, for example, the
U.S. economy 150 years ago--where we had a lot of interstate
movement of goods and services and trade deficits between the
States, but very little outside of our borders--as we expanded
into a national market, all of that activity that is going on
between peoples in different geographical areas--which creates
deficits and creates debts and all the variety of other
elements--spills over our sovereign borders, and now we look at
it in somewhat a different way, but it really is not.
I grant you that there is exchange-rate risk and legal risk
with respect to whose jurisdiction you are in, but a lot of
what we are observing is economic process, which is adjusted.
The markets are gradually adjusting.
The big puzzle to everybody is how is it possible for the
United States to have a current account deficit of more than 6
percent of the GDP. It is one of the major puzzles, and the
reason why I believe it exists is that it is a market
phenomenon which is reflecting globalization. It can't go on
indefinitely, as I indicated previously, but a lot of these
variables--that is, the big increase in debt holdings or U.S.
Treasury holdings by foreign central banks or the even larger
holdings of American debt by foreign citizens--all of this is a
buildup which is characteristic of the global markets.
At some point globalization will slow down, but we are in a
period where it has been undergoing extraordinary expansion and
has had effects we have yet to fully understand. Indeed, one of
the problems that we have run into, which was a great surprise
to us, is how apparently globalization forces have affected the
long-term interest rates when we started tightening our
monetary policy in June 2004. Long-term interest rates did not
rise because of these extraordinary forces, which we are just
now beginning to understand.
So, yes, we ought to be looking at these various different
increases. A very significant part of our Federal debt is held
outside of this country. It is close to half, depending on what
the denominator is. But that is part and parcel of the
globalization process, and I think the presumption that when it
stops, the whole world is going to collapse is not correct,
unless we fall back on a degree of protectionism which has not
existed in the world in the post-World War II period.
Representative Brady. Thank you.
Would your advice to Congress be to not overreact to those
elements until we see further how it is working out? And what
the impact is in this?
Chairman Greenspan. Yes. Most certainly, Congressman, and
indeed I have argued in other recent testimony that the best
way we can address this type of problem is to make certain that
our economy overall is sufficiently flexible so that adverse
events--the unforecastable events that occur as a part of this
globalization--will not have a significant negative impact on
production or employment in this country. As far as policy is
concerned, that is a policy issue, and I think we ought to move
as best we can to create as much flexibility as we can in our
system.
Representative Brady. Thank you, Mr. Chairman.
Representative Saxton. Mr. Chairman, let me just ask a
quick question here. We have talked about various stimuli that
have occurred in recent years, and one of the by-products of
the easing of monetary policy which began in 2001 was to give
homeowners whose properties had increased in value the
opportunity to refinance at lower rates of interest. And as
people did that, we found them not only refinancing to the
balance of their higher rate mortgage, but also taking out more
of their equity, which supported consumer spending.
I am just curious to know whether the Fed anticipated that
this would happen and your thoughts on--just generally on this
matter.
Chairman Greenspan. Well, in the early stages we didn't,
largely because the proportion of cash-outs that were
associated with refinancing were relatively small. But as
refinancing became ever easier, as the costs of refinancing
declined, and as the home equity loans became a major
instrument for household debt accumulation--or, more exactly,
an ability to extract equity from homes, plus the automatic
extraction of equity that occurs when homes are sold and the
realized capital gains for all practical purposes come out as
cash--these have turned out to be extraordinarily large amounts
relative to disposable income. Ten years ago we would not have
been able to forecast them because we would not have been able
to foresee the extraordinary changes that would emerge in the
mortgage markets, in the secondary mortgage market, in the
whole structure of asset-based securities generally, and the
willingness on the part of households and their ability to
extract very substantial amounts of equity as the capital gains
built up.
We have been observing that phenomenon very closely.
Indeed, my colleagues at the Fed and I have put together a
fairly detailed series trying to trace the issue of cash-outs
and the effects of equity extraction from home turnover and
home equity loans, and trying to determine to what extent that
has been a factor in the decline in the savings rate in this
country. We are still examining it. There are conflicts in the
data, and it is very clear a good part of the decline in the
savings rate is directly attributable to the extraction of
equity.
Representative Saxton. Mr. Chairman, one of my great
staffers and I have had ongoing conversations about the so-
called flattening of the yield curve, which essentially means
that short-term rates have gone up, while long-term rates have
stabilized, creating a very small gap between short-term and
long-term rates. What, in your opinion, is the effect of this
on the economy in the future?
Chairman Greenspan. Mr. Chairman, that used to be one of
the most accurate measures we had to indicate when a recession
was about to occur and when a recovery was about to occur. It
has lost its capability of doing so in recent years. The
markets have become far more complex, and the simple
relationships that that yield curve slope indicated no longer
work. For example, remember we used to have Reg Q a number of
years ago, which essentially limited the extent to which you
could increase interest rates, short-term deposit rates, and
that created all sorts of imbalances in the system and was an
indicator which induced the change in the structure of the
yield curves, which did anticipate fairly accurately what was
going to happen to financial markets and to the economy.
The effectiveness of that relationship to where the economy
is going has virtually disappeared, and while it has
significant financial impacts, it's no longer useful as a
leading indicator to the extent that it was.
Representative Saxton. I thank you for that.
I just want to refer to the chart that we put up. The red
line, of course, refers to short-term rates, which have gone up
12 times. The darker gray line indicates the level of long-term
rates. My question is: If banks are forced to pay interest at
relatively high rates on short-term loans, what is the
encouragement to loan with long-term rates when there is such a
small difference in the spread?
[The chart entitled ``Yield Spread'' appears in the
Submissions for the Record on page 42.]
Chairman Greenspan. Well, what is happening is that, for
example, in the mortgage market where we used to find that
rates were low, say, back closer to June 2004, adjustable-rate
mortgages became an extraordinarily important instrument. They
are obviously undergoing significant contraction now, as rates
go up, even though a very substantial number of those loans are
so-called hybrids, they are half short-term, half long-term
mortgages. But consumers are changing their behavior, and we
would have clearly expected that to happen, and we don't think
that's bad. We think that is good.
Representative Saxton. Thank you.
Mrs. Maloney.
Representative Maloney. Thank you, Mr. Greenspan.
When you say that inflation causes recession, are you
saying that the private economy on its own collapses, or are
you saying that inflation leads to a monetary policy response
of higher interest rates that slows the economic activity?
Chairman Greenspan. I think the problem is that it is the
inflation process itself that creates the difficulty, and to
the extent that monetary policy is inappropriate, the central
bank can contribute to that, or it can actually reduce the
probability. But there are broader inflationary processes in
the private economy as well, so it is a combination of a number
of forces.
Representative Maloney. What caused the 1981 recession?
Chairman Greenspan. Essentially a recognition on the part
of government generally that the acceleration of inflation that
was building for the latter part of the 1970s was creating such
huge distortions that unless and until we confronted it, this
country could get into very serious trouble. As a consequence,
my predecessor in October 1979 withdrew a huge amount of
liquidity from the system in order to bring down the inflation
rate. That process, while it ultimately was clearly successful
and importantly successful to the economy longer term, had
short-term consequences, which was a very severe recession.
I would in a sense debit the recession to the earlier
policies that created the inflationary pressures which
necessitated the reaction that we had rather than to the
Federal Reserve's action in 1979. We had no choice, and indeed
had that action not been done, had that action not been
implemented, I fear for the stability of our system, therefore,
going forward.
Representative Maloney. You have spoken very eloquently
today about the growing--and expressed concern about the
growing gap between the haves and the have-nots, the inequality
that is growing in our country, which is a very bad trend, and
the solutions that you have talked about are all long term.
I want to pick up on one of the points that you made about
the effects of integrating China and India into the world
economy, and you described that as helping to keep labor costs
contained and helpful in restraining inflation, but doesn't it
also contribute to inequality by putting a downward pressure on
the wages of U.S. workers and the competition that they feel
internationally?
Chairman Greenspan. It hasn't put downward pressure
overall. What it has done is tended to put downward pressure
mainly in the goods area of the American economy, because that
is where their capabilities at this particular stage of the
development are most evident, and the impact has been fairly
pronounced in a number of areas of this country, especially in
the manufacturing area.
Representative Maloney. I would like to bring up a point
that Dr. Alan Blinder brought up at a Democratic forum we had
on the economy, and he argued that continuing advances in
telecommunications technology are going to make global
outsourcing of jobs a much larger problem in the future. He
says we have a challenge now, but in the future it is going to
be absolutely huge, and that in the coming years the highly-
skilled educated workers could be just as vulnerable as the
less-skilled workers. And doesn't that imply that education and
training are at the least a very incomplete answer to the
challenge that we confront with the outsourcing of jobs and the
growing middle-class job insecurity that I hear every day in my
office?
Chairman Greenspan. As globalization proceeds and very
clearly creates an average higher level of standard of living
in this country, it also, because it rests upon what we call
creative destruction, induces a greater degree of insecurity in
the system. This is manifested by the fact that today half a
million people lose their jobs every week, and another half a
million quit, and we hire a million people, plus or minus,
every week. The churning is extraordinary. It basically means
that the old view of job security which we tended to have, or
the way we viewed what it was in earlier generations, is
disappearing.
We are now finding that education is not wholly constrained
to our earlier years; it is basically becoming a lifelong
proposition. Community colleges, for example, are becoming a
major part of our education system, and the average age of the
people in community colleges is quite high. So people are
recognizing that they are going to have more than one job--
indeed, they may have more than one profession--in their
lifetime.
This is the choice that we must make. In other words, if we
want the benefits of the huge amount of interaction, division
of labor and specialization that is implicit in an ever-growing
world economy, that implies a huge amount of both insourcing
and outsourcing of all goods. We at the moment, of course, are
the recipient of more insourcing than we send out. We have a
net surplus of services.
I don't know whether that will continue to exist or not,
but I do agree that the amount of exchange of services across
national borders is almost surely going to increase, and as a
consequence, standards of living will increase. But in the
process there are winners and losers, and if you have creative
destruction--which essentially means you move the obsolescent
capital, less productive capital, to cutting-edge
technologies--it necessarily means that the workforce which is
involved in the growingly obsolescent technology has to move to
another part of the economy.
That is happening. It is happening in the vast, vast
majority of cases. But there is a small and very pronounced
segment of the world economy which is creating problems which
are difficult to reverse.
Representative Maloney. My time is up. Thank you very much.
Representative Saxton. Mr. Paul.
Representative Paul. Thank you, Mr. Chairman.
You mentioned earlier that we have been debating the
monetary issue for a long time, and I guess that will go on. I
am quite confident that what I say here or whatever we say
together probably won't determine whether paper wins over gold
or vice versa, because I think the market will determine that.
I think the only thing that I have on my side is history,
because paper currencies don't have a very good history. They
usually end up in the waste can, and gold survives the many
thousands of years it has been used. So time will tell.
But a question I have relating to gold is currently,
especially since the early 1980s, 25 years, the last time there
was ever any serious talk about gold, today it is inappropriate
to talk about it, but since that time, of course, the dollar
has lost a lot of value. But during that time essentially paper
has won out, intellectually speaking. Nobody speaks of gold,
but the question I have is why does our Government--why does
policy still mean that we should hold the gold?
And I don't have any problems with this. I would think that
if we trust paper, we ought to just get rid of the gold and
spend the money. We are in big deficits; we could get a lot of
money for it. So if gold is so out of place, and we will never
have to use it again, why couldn't we make the case for just
getting rid of it, as well as the IMF?
Representative Saxton. Mr. Chairman, before you answer, if
I may just ask my colleagues, Mr. Hinchey and, I think, Ms.
Sanchez also have a question. We are in the beginning of a
series of votes, so if we could get through this question
rather expeditiously and go to Mr. Hinchey and then Ms.
Sanchez, and then we will vote, and we won't have to ask you to
wait for us to come back from this series.
Go ahead and respond to this question, if you would.
Chairman Greenspan. The question is what do we do with the
gold supply?
Representative Paul. If we don't believe in gold, why don't
we just get rid of it?
Chairman Greenspan. It is a very interesting question and a
question debated at length on rare occasions within government.
The bottom line is that in periods of extreme chaos, it has
turned out that gold has been the ultimate means by which
transactions have been consummated. It occurred, for example,
during World War II when you could only negotiate transactions
with gold.
I must say, however, there was a vigorous debate in the
Ford administration as to whether it made any sense to hold
gold stock at all, and the debate ended up with leaving it as
it is. I would suspect the same psychology exists around the
world, and that is the reason why the IMF basically holds the
gold that it does and is also the reason that other central
banks are holding the gold that they do. You might be aware,
for example, that the Europeans have sold off significant
amounts of their gold, but they still hold quite a good deal.
Representative Paul. Thank you.
Representative Saxton. Thank you, Mr. Paul.
Mr. Hinchey.
Representative Hinchey. Thank you, Mr. Chairman.
Mr. Chairman, in response to one of the questions that I
was asking earlier with regard to this growing inequality in
income, you were drawing attention to the inequality between
supervisory personnel and nonsupervisory personnel. I
understand that, and that is fine, but that isn't the real
issue. The real issue is the huge growing inequality between
people at the top of the income ladder and those down at the
middle.
As I pointed out, even a very conservative scholar at the
very conservative American Enterprise Institute pointed out the
benefits of the tax cuts are going to capital and not to
workers. That is a problem that we face.
Now, you, of course, looking at these growing surpluses
back in the beginning of this decade, were very supportive of
the ideological tax cuts that came out of this Administration
which were designed to benefit people at the upper income of
the ladder.
Now, at the same time, this country for several decades now
has been facing some very serious infrastructure deterioration,
everything from energy to transportation, to environmental
protection, health care, general quality of life. All of that
has been declining for decades in the public sector. Wouldn't
it have been wiser to take some of that money in those
surpluses, rather than just give almost all of it to the
wealthiest people in the country, to use some of it to build up
the basic infrastructure of the country rather than continuing
to witness this serious deterioration?
The final aspect of my question is we have another tax cut
coming up next year, 2006. That tax cut comes about at a time
when the median income is just over $44,000, meaning half of
the people in the country make less than that. This tax cut is
going to benefit people making over $182,000 and couples making
more than $326,000. Aren't we on the wrong track here, Mr.
Chairman?
Chairman Greenspan. Congressman, I think that a large
number of economists, perhaps most, view the issue of tax
policy in two ways: one, how does it impact on the growth of
the economy and the increase in the tax base that is associated
with the growth. My argument in favor of a number of the tax
cuts which have been offered in recent years, especially the
one which I thought was the most structurally desirable--namely
the elimination of the double taxation of dividends for lots of
reasons--is essentially because I believed they would enhance
economic growth. Similarly, I was a strong supporter of the
1986 Tax Reform Act, which, as you know, eliminated many of the
loopholes, expanded the tax base and improved the system
materially.
As I said there are two schools with respect to taxation.
One is what does it do to the economy and to the tax base; and
two, what does it do to the distribution of income. In
considering the issue you have to look at both, and I think
that there is a tendency for one side of this aisle to look one
way, the other side to look at the other. Perhaps we ought to
be aware that there is double-entry bookkeeping involved here,
as in many other things.
Representative Saxton. Thank you, Mr. Chairman.
Representative Hinchey. That is not an answer, Mr.
Chairman, but I thank you very much for it, and I wish you the
very best in the future.
Chairman Greenspan. Thank you very much, Congressman.
Representative Sanchez. Thank you, Mr. Chairman.
Mr. Chairman, before I came to the Congress, I was involved
in the capital markets, and so I have a question for you, just
an overall question that has been bothering me for a while. And
I asked my friends on Wall Street, and most of the time they
just shrug their shoulders and don't have a good answer for
this. Maybe I thought as a parting--since this will be the last
time you are before our Committee, maybe you could give me some
advice on this.
I am worried that we have an $8 trillion debt, and from my
calculation, even though you brought up today that you thought
the unified budget was at a deficit of $319 billion right now,
I sometimes, when I look at it, truly look at it, I look at us
spending between $400 and $800 billion more every year, at
least in the last 5 years of this Congress, because I think--
and I believe there is a lot of things that don't get taken
into account; supplementals that we do here, supplemental
appropriation bills, the two Louisiana Senators asking for $250
billion just for Louisiana; a Medicare Part D package that was
supposed to be $400 billion spending over 10 years, now it is
calculated at at least $1.3 trillion, probably will get to $2
trillion by the time we finish with that. We spend $1.55
billion a week in Iraq, with no end in sight in that place, and
that doesn't include the reinvestment we are going to need to
do in our vehicles and everything that is wasting away in that
desert right now. I have in Congress a lot of colleagues who
want to increase our Army by 100,000 new troops and don't
really know what the cost is to that or the capacity that we
currently have and how that is going to affect our troops. So
we have all these big spending plans out there.
My question is why haven't the capital markets told
Congress and Washington, D.C., to get their act together? Why
are they ignoring what is happening here?
Chairman Greenspan. That is an excellent question,
Congresswoman, and let me explain to you what I think the
answer is, but I don't know for certain. As part of this
globalization trend, not only have we had the major
disinflationary forces that are occurring because of the
educated workers of the former Soviet Union, China and India
coming in, but we also have had the issue of, as I think I
testified before the House Banking Committee, an excess of
saving over investment and a general set of forces suppressing
long-term interest rates.
So the question really is why is it that with what has to
be rising expectations of very heavy borrowing as we move out,
say, into the early part of the next decade, why isn't that
beginning to reflect itself in, say, 10-year notes, because it
has to be out there for 10 years.
I think the answer--I don't really fully feel comfortable
with it, it is one of the issues that I think is on the table
and has to be understood--is that the disinflationary
pressures, the excess savings pressures, have more than offset
the expectational concerns that rising supplies of U.S.
Treasury debt have out there. I think that is going to change.
I think, as I tried to indicate in my prepared remarks, that is
a gradually changing process, but I find it utterly
inconceivable, frankly, that we can have the type of potential
fiscal outlook which now confronts us over the next 15, 20
years without having a significant impact on long-term interest
rates.
So I guess the answer to your question is there are other
forces involved offsetting it, or, to put it another way, that
the impact has been delayed.
Representative Saxton. Mr. Chairman, just let me add to the
chorus of appreciation for the many appearances that you have
made here before the Joint Economic Committee over the years.
We have benefited greatly from your wisdom, and we thank you.
And in conclusion I would just like to offer my wishes for the
best of everything in the future. Thanks for being with us.
Chairman Greenspan. Thank you very much, Mr. Chairman, and
I thank the Committee. I have always enjoyed being here, and I
must say I get questions at this Committee which I don't hear
elsewhere, and they are most interesting. Thank you.
Representative Saxton. Thank you, sir.
[Whereupon, at 11:48 a.m., the Committee was adjourned.]
Submissions for the Record
=======================================================================
Prepared Statement of Representative Jim Saxton, Chairman
I am pleased to welcome Chairman Greenspan before the Committee
once again to testify on the economic outlook. We appreciate the many
times you have testified before this Committee, and recognize your
outstanding stewardship of monetary policy during your tenure as Fed
chairman.
You have guided monetary policy through stock market crashes, wars,
terrorist attacks and natural disasters with a steady hand. Under your
tenure price stability has been the norm, with inflation low and
stable. You have made a great contribution to the prosperity of the
U.S., and the Nation is in your debt.
A broad array of standard economic data reflects the health of the
U.S. economy. Figures released last week indicate that the economy grew
at a 3.8 percent rate last quarter, despite the massive regional
destruction wrought by the hurricanes. So far during 2005, the economy
has expanded at a 3.6 percent rate, roughly in line with Federal
Reserve expectations as well as the Blue Chip Consensus.
Equipment and software investment, which has bolstered the economy
since 2003, continues at a healthy pace. This component of investment
responded especially sharply to the incentives contained in the 2003
tax legislation. Employment has also gained over this period, with 4.2
million jobs added to business payrolls since May of 2003. The
unemployment rate is 5.1 percent.
Consumer spending continues to grow. Homeownership has reached
record highs. Household net worth is also at a record level.
Productivity growth continues at a healthy pace.
Although higher energy prices have raised business costs and
imposed hardship on many consumers, these prices have not derailed the
expansion.
As the Fed recently suggested, long-term inflation pressures are
contained. As a result, long-term interest rates, such as mortgage
rates, are still relatively low. By its actions the Fed has made clear
its determination to keep inflation in check.
In summary, the economy has displayed impressive flexibility and
resilience in absorbing many shocks. Monetary policy and tax incentives
for investment have made important contributions in accelerating the
expansion in recent years. The most recent release of Fed minutes
indicates that the central bank expects this economic growth to
continue through 2006. The Blue Chip Consensus of private economic
forecasters also suggests that the economy will grow in excess of 3
percent next year.
Current economic conditions are positive, and the outlook for 2006
is favorable.
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Prepared Statement of Senator Jack Reed, Ranking Minority
Thank you, Chairman Saxton. I want to welcome Chairman Greenspan
for his last appearance before the Joint Economic Committee as Fed
Chairman. As always, I look forward to his perspectives on the economic
outlook, but I'm also interested in any reflections he may have on his
tenure as Fed chairman.
Some have called Chairman Greenspan the most successful central
banker in history. On his watch, inflation was kept under tight control
and we enjoyed the longest economic expansion on record from March 1991
to March 2001.
While the Chairman's track record managing monetary policy is very
impressive, his role in justifying the 2001 tax cuts is more
problematic. I know that Chairman Greenspan will point to his caveats
about the need for triggers and other cautions, but in the real world
of politics, he was seen as giving the green light to President Bush's
tax cuts, and now we are living with the consequences.
President Bush's tax cuts were poorly designed to stimulate broadly
shared prosperity and have produced a legacy of large budget deficits
that leave us increasingly hampered in our ability to deal with the
host of challenges we face. Large and persistent budget deficits are
undermining national saving, and they have contributed to an ever-
widening trade deficit. Our vast borrowing from abroad puts us at risk
of a major financial collapse if foreign lenders suddenly stop
accepting our IOU's.
Raising national saving is the key to our economic growth, a good
way to reduce our record trade deficit, and, as the Chairman's past
testimony reflects, the best way to meet the fiscal challenges posed by
the retirement of the baby boom generation. But what has the President
offered us? A plan to replace part of Social Security with private
accounts that would increase the deficit without raising national
saving and a proposal to make his tax cuts permanent that is simply
incompatible with reducing the deficit.
Sound policies for the long run are clearly very important, but I
am also deeply concerned about what continues to be a disappointing
economic recovery for the typical American worker. Strong productivity
gains have shown up in the bottom lines of shareholders but not in the
paychecks of workers. The typical worker's earnings are not keeping up
with their rising living expenses, including soaring energy prices. And
both earnings and income inequality are increasing.
Chairman Greenspan has regularly expressed concern about the
widening inequality of income and earnings in the American economy, but
his solutions are always focused on the long term. While I too
acknowledge the importance of education and training, we face an
immediate problem.
The flooding of New Orleans forced America to confront the
existence of poverty. A new report shows that hunger in America has
risen dramatically over the last 5 years, with more than 38 million
people living in households that suffer directly from hunger and food
insecurity, including nearly 14 million children. The minimum wage has
been losing purchasing power steadily, and low- and moderate-income
households face crushing energy bills this winter.
Of course, many of these problems in the American economy lie
outside the purview of the Federal Reserve, where Chairman Greenspan
has carried out his official monetary policy responsibilities well. He
has shown flexibility rather than a rigid adherence to any
predetermined policy rule in responding to changing economic
circumstances, in order to pursue the multiple policy goals of price
stability, high employment, and sustainable growth.
I hope the next Fed chairman observes that precedent when he takes
up his duties in the face of historically large budget deficits, a
record current account deficit, a negative household saving rate,
rising inflation, and a labor market recovery that remains tepid in
many respects.
Chairman Greenspan will be a hard act to follow. The impending
``Greenspan deficit'' is but the latest addition to our concerns about
the economic outlook. Chairman Greenspan, I want to thank you for your
public service and I look forward to your testimony today.
______
Prepared Statement of Representative Carolyn B. Maloney
Thank you, Chairman Saxton. Senator Reed will not be able to be
here because of votes in the Senate, so I request that his opening
statement be entered into the record, and I would like to make a few
brief remarks.
I want to welcome Chairman Greenspan for his last appearance before
the Joint Economic Committee as Fed Chairman. Over the past 18 years,
Chairman Greenspan has achieved a remarkable record of success as the
country's central banker. He has steadfastly maintained the Fed's
credibility for keeping inflation under control while dealing flexibly
with a variety of economic challenges.
The 10-year economic expansion of the 1990s was the longest on
record. One contributing factor was Chairman Greenspan's strong sense
in the middle of that expansion that there was room for monetary policy
to accommodate further reductions in the unemployment rate, even though
the conventional wisdom at the time said otherwise. Of course, another
contributing factor was the Clinton administration's strong commitment
to deficit reduction, which created a fiscal policy environment
conducive to strong, sustainable, non-inflationary growth.
Unfortunately, that fiscal discipline is now a distant memory, and
Chairman Greenspan's successor will face a host of problems managing
monetary policy in the face of historically large budget deficits, a
record current account deficit, a negative household saving rate,
rising inflation, and a labor market recovery that remains tepid in
many respects.
I look forward to Chairman Greenspan's testimony. I hope that, in
addition to his views on the economic outlook, he will share with us
some reflections on what made his tenure at the Fed so successful and
what are the key lessons he would want to pass on to his successor.
______
Prepared Statement of Hon. Alan Greenspan, Chairman,
Board of Governors of the Federal Reserve System
Mr. Chairman, when I last appeared before the Joint Economic
Committee in early June, economic activity appeared to be
reaccelerating after a slowdown in the spring. The economy had
weathered a further run-up in energy prices over the winter, and
aggregate demand was again strengthening. Real gross domestic product
(GDP) growth averaged 3\1/2\ percent at an annual rate over the first
half of the year, and subsequent readings on activity over the summer
were positive. By early August, the economy appeared to have
considerable momentum, despite a further ratcheting up of crude oil
prices; pressures on inflation remained elevated.
As you know, the economy suffered significant shocks in late summer
and early autumn. Crude oil prices moved sharply higher in August, bid
up by growth in world demand that continued to outpace the growth of
supply. Then Hurricane Katrina hit the Gulf Coast at the end of August,
causing widespread disruptions to oil and natural gas production and
driving the price of West Texas Intermediate crude oil above $70 per
barrel. Because of a lack of ready access to foreign supplies, natural
gas prices rose even more sharply. At the end of September, with the
recovery from the first storm barely under way, Hurricane Rita hit,
causing additional damage and destruction--especially to the energy
production and distribution systems in the Gulf. Most recently,
Hurricane Wilma caused widespread power outages and property damage
across the State of Florida. These events are likely to exert a drag on
employment and production in the near term and to add to the upward
pressures on the general price level. But the economic fundamentals
remain firm, and the U.S. economy appears to retain important forward
momentum.
Of course, the higher energy prices caused by the hurricanes are
being felt well beyond the Gulf Coast region. Those higher prices
resulted from the substantial damage that occurred to our nation's
energy production and distribution systems. Of the more than 3,000 oil
and gas production platforms in the paths of Katrina and Rita, more
than 100 were destroyed, and an additional 50 suffered extensive
damage. Of the 134 manned drilling rigs operating in the Gulf, 8 were
lost, and an additional 38 were either set adrift by the storms or were
badly damaged. At present, both oil and natural gas production in the
Gulf are operating at less than 50 percent of pre-Katrina levels. Since
the first evacuations of oil and gas facilities were ordered before
Katrina, cumulative shortfalls represented almost 4 percent of the
nation's annual production of crude oil and 2 percent of our output of
natural gas.
The combination of flooding, wind damage, and a lack of electric
power also forced many crude oil refineries and natural gas processing
plants to shut down. The restoration of production at the affected
natural gas processing facilities has proceeded particularly slowly, in
part because of the lack of natural gas feedstocks and infrastructure
problems. Most refineries, however, will be back on line within the
next month or so, though a few may take longer.
In the interim, a greater output of refined petroleum products in
other areas of the country and much higher imports, especially of
gasoline, are making up for the production shortfalls in Gulf refining.
The temporary lifting of some environmental regulations and the
suspension of the Jones Act facilitated those adjustments. In addition,
refiners have shifted the mix of production toward more gasoline and
less heating oil and jet fuel. That shift has had benefits in the short
run, though the longer it continues, the greater the possibility of
upward pressure on distillate fuel oil prices during the winter heating
season.
Releases from the nation's Strategic Petroleum Reserve relieved
much of the upward pressure on crude oil prices, and imports of refined
products responded rapidly to ease the price pressures stemming from
the loss of refinery production in the Gulf. As a consequence, the
nationwide retail price of gasoline for all grades has declined 60
cents per gallon from its peak of $3.12 per gallon in the week of
September 5. Motorists appear to have economized on their driving, and
gasoline demand appears to be off a bit. However, it will take time and
an appreciable increase in the fuel economy of our stock of motor
vehicles to fundamentally change the amount of motor fuel used on our
nation's highways.
The far more severe reaction of natural gas prices to the
production setbacks that have occurred in the Gulf highlights again the
need to expand our nation's ability to import natural gas. In contrast
to the fall in crude oil prices and the sharp narrowing of refinery
margins during the past 2 months, natural gas prices have remained
high. Moreover, judging from elevated distant futures prices, traders
expect natural gas prices to edge lower but to stay high for the
foreseeable future. This expectation largely reflects a natural gas
industry in North America that is already operating at close to
capacity and our inability to import large quantities of far cheaper,
liquefied natural gas (LNG) from other parts of the world. At present,
natural gas supplies appear to be sufficient to meet the near-term
demands--even with some ongoing shortfall in Gulf production. However,
a colder-than-average winter would stress this market, and prices will
likely remain vulnerable to spikes until the spring.
U.S. imports of LNG have been constrained by inadequate global
capacity for liquefaction, as well as by environmental and safety
concerns that have restricted the construction of new LNG import
terminals in the United States. In 2002, such imports accounted for
only 1 percent of U.S. gas consumption. Despite the major effort to
expand imports, the Department of Energy forecasts LNG imports this
year at only 3 percent of gas consumption. Canada, which has recently
supplied one-sixth of our consumption, cannot expand its pipeline
exports significantly in the near term, in part because of the role
that Canadian natural gas plays in supporting increasing oil production
from tar sands.
The disruptions to energy production have noticeably affected
economic activity. We estimate that the storms held down the increase
in industrial production 0.4 percentage point in August and an
additional 1.7 percentage point in September.
Except for the hurricane effects, readings on the economy indicate
a continued solid expansion of aggregate demand and production. If
allowance is taken for the effects of Katrina and Rita and for the now-
settled machinist strike at Boeing, industrial production rose at an
annual rate of 5\1/4\ percent in the third quarter. That's up from an
annual pace of 1\1/4\ percent in the second quarter, when a marked
slowing of inventory accumulation was a restraining influence on
growth.
The September employment report showed a loss of 35,000 jobs.
However, an upward revision to payroll gains over the summer indicated
a stronger underlying pace of hiring before the storms than had been
previously estimated. The Bureau of Labor Statistics estimates that
employment growth in areas not affected by the storms was in line with
the average pace over the twelbe months ending in August.
Retail spending eased off in September, likely reflecting the
effects of the hurricanes and higher gasoline prices. Major chain
stores report a gradual recovery over October in the pace of spending,
though light motor vehicle sales declined sharply last month, when some
major incentives to purchase expired.
The longer-term prospects for the U.S. economy remain favorable.
Structural productivity continues to grow at a firm pace, and
rebuilding activity following the hurricanes should boost real GDP
growth for a while. More uncertainty, however, surrounds the outlook
for inflation.
The past decade of low inflation and solid economic growth in the
United States and in many other countries around the world has been
without precedent in recent decades. Much of that favorable performance
is attributable to the remarkable confluence of innovations that
spawned new computer, telecommunication, and networking technologies,
which, especially in the United States, have elevated the growth of
productivity, suppressed unit labor costs, and helped to contain
inflationary pressures. The result has been a virtuous cycle of low
prices and solid growth.
Contributing to the disinflationary pressures that have been
evident in the global economy over the past decade or more has been the
integration of in excess of 100 million educated workers from the
former Soviet bloc into the world's open trading system. More recently,
and of even greater significance, has been the freeing from central
planning of large segments of China's 750 million workforce. The
gradual addition of these workers plus workers from India--a country
which is also currently undergoing a notable increase in its
participation in the world trading system--would approximately double
the overall supply of labor once all these workers become fully engaged
in competitive world markets. Of course, at current rates of
productivity, the half of the world's labor force that has been newly
added to the world competitive marketplace is producing no more than
one quarter of world output. With increased education and increased
absorption of significant cutting-edge technologies, that share will
surely rise.
Over the past decade or more, the gradual assimilation of these new
entrants into the world's free-market trading system has restrained the
rise of unit labor costs in much of the world and hence has helped to
contain inflation.
As this process has unfolded, inflation expectations have
decreased, and accordingly, the inflation premiums embodied in long-
term interest rates around the world have come down. The effective
augmentation of world supply and the accompanying disinflationary
pressures have made it easier for the Federal Reserve and other central
banks to achieve price stability in an environment of generally solid
economic growth.
But this seminal shift in the world's workforce is producing, in
effect, a level adjustment in unit labor costs. To be sure, economic
systems evolve from centrally planned to market-based only gradually
and, at times, in fits and starts. Thus, this level adjustment is being
spread over an extended period. Nevertheless, the suppression of cost
growth and world inflation, at some point, will begin to abate and,
with the completion of this level adjustment, gradually end.
These global forces pressing inflation and interest rates lower may
well persist for some time. Nonetheless, it is the rate at which
countries are integrated into the global economic system, not the
extent of their integration, that governs the degree to which the rise
in world unit labor costs will continue to be subdued. Where the global
economy is currently in this dynamic process remains open to question.
But going forward, these trends will need to be monitored carefully by
the world's central banks.
I want to conclude with a few remarks about the Federal budget
situation, which--at least until Hurricanes Katrina and Rita struck the
Gulf Coast--was showing signs of modest improvement. Indeed, tax
receipts have exhibited considerable strength of late, posting an
increase of nearly 15 percent in fiscal 2005 as a result of sizable
gains in individual and, even more, corporate income taxes. Thus,
although spending continued to rise rapidly last year, the deficit in
the unified budget dropped to $319 billion, nearly $100 billion less
than the figure for fiscal year 2004 and a much smaller figure than
many had anticipated earlier in the year. Lowering the deficit further
in the near term, however, will be difficult in light of the need to
pay for post-hurricane reconstruction and relief.
But even apart from the hurricanes, our budget position is unlikely
to improve substantially further until we restore constraints similar
to the Budget Enforcement Act of 1990, which were allowed to lapse in
2002. Even so, the restoration of PAYGO and discretionary caps will not
address the far more difficult choices that confront the Congress as
the baby-boom generation edges toward retirement. As I have testified
on numerous occasions, current entitlement law may have already
promised to this next generation of retirees more in real resources
than our economy, with its predictably slowing rate of labor force
growth, will be able to supply.
So long as health-care costs continue to grow faster than the
economy as a whole, as seems likely, Federal spending on health and
retirement programs would rise at a rate that risks placing the budget
on an unsustainable trajectory. Specifically, large deficits will
result in rising interest rates and an ever-growing ratio of debt
service to GDP. Unless the situation is reversed, at some point these
budget trends will cause serious economic disruptions.
We owe it to those who will retire over the next couple of decades
to promise only what the government can deliver. The present policy
path makes current promises, at least in real terms, highly
conjectural. If fewer resources will be available per retiree than
promised under current law, those in their later working years need
sufficient time to adjust their work and retirement decisions.
Crafting a budget strategy that meets the nation's longer-run needs
will become ever more difficult and costly the more we delay. The one
certainty is that the resolution of the nation's demographic challenge
will require hard choices and that the future performance of the
economy will depend on those choices. No changes will be easy, as they
all will involve setting priorities and making tradeoffs among valued
alternatives. The Congress must determine how best to address the
competing claims on our limited resources. In doing so, you will need
to consider not only the distributional effects of policy changes but
also the broader economic effects on labor supply, retirement behavior,
and private saving. The benefits of taking sound, timely action could
extend many decades into the future.
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