[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

                               __________

          Printed for the use of the Joint Economic Committee




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                        JOINT ECONOMIC COMMITTEE

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

HOUSE OF REPRESENTATIVES             SENATE
Jim Saxton, New Jersey, Chairman     Robert F. Bennett, Utah, Vice 
Paul Ryan, Wisconsin                     Chairman
Phil English, Pennsylvania           Sam Brownback, Kansas
Ron Paul, Texas                      John 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

                              ----------                              

                      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

                              ----------                              


                       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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