[Senate Hearing 109-54]
[From the U.S. Government Publishing Office]
S. Hrg. 109-54
FEDERAL RESERVE'S FIRST MONETARY POLICY REPORT FOR 2005
=======================================================================
HEARING
before the
COMMITTEE ON
BANKING,HOUSING,AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED NINTH CONGRESS
FIRST SESSION
ON
OVERSIGHT ON THE MONETARY POLICY REPORT TO CONGRESS PURSU-
ANT TO THE FULL EMPLOYMENT AND BALANCED GROWTH ACT OF 1978
__________
FEBRUARY 16, 2005
__________
Printed for the use of the Committee on Banking, Housing, and Urban
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COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
RICHARD C. SHELBY, Alabama, Chairman
ROBERT F. BENNETT, Utah PAUL S. SARBANES, Maryland
WAYNE ALLARD, Colorado CHRISTOPHER J. DODD, Connecticut
MICHAEL B. ENZI, Wyoming TIM JOHNSON, South Dakota
CHUCK HAGEL, Nebraska JACK REED, Rhode Island
RICK SANTORUM, Pennsylvania CHARLES E. SCHUMER, New York
JIM BUNNING, Kentucky EVAN BAYH, Indiana
MIKE CRAPO, Idaho THOMAS R. CARPER, Delaware
JOHN E. SUNUNU, New Hampshire DEBBIE STABENOW, Michigan
ELIZABETH DOLE, North Carolina JON S. CORZINE, New Jersey
MEL MARTINEZ, Florida
Kathleen L. Casey, Staff Director and Counsel
Steven B. Harris, Democratic Staff Director and Chief Counsel
Peggy R. Kuhn, Senior Financial Economist
Martin J. Gruenberg, Democratic Senior Counsel
Aaron D. Klein, Democratic Economist
Joseph R. Kolinski, Chief Clerk and Computer Systems Administrator
George E. Whittle, Editor
(ii)
C O N T E N T S
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WEDNESDAY, FEBRUARY 16, 2005
Page
Opening statement of Chairman Shelby............................. 1
Opening statements, comments, or prepared statements of:
Senator Sarbanes............................................. 1
Senator Bunning.............................................. 3
Senator Reed................................................. 4
Senator Crapo................................................ 5
Senator Schumer.............................................. 5
Senator Dole................................................. 6
Senator Stabenow............................................. 7
Senator Bennett.............................................. 8
Senator Bayh................................................. 8
Senator Martinez............................................. 8
Senator Dodd................................................. 9
Senator Corzine.............................................. 9
Senator Carper............................................... 42
Senator Allard............................................... 48
WITNESS
Alan Greenspan, Chairman, Board of Governors of the Federal
Reserve System, Washington, DC................................. 10
Prepared statement........................................... 48
Response to written questions of:
Senator Bennett.......................................... 53
Senator Santorum......................................... 53
Additional Material Supplied for the Record
Monetary Policy Report to the Congress, February 16, 2005........ 56
(iii)
FEDERAL RESERVE'S FIRST MONETARY POLICY REPORT FOR 2005
----------
WEDNESDAY, FEBRUARY 16, 2005
U.S. Senate,
Committee on Banking, Housing, and Urban Affairs,
Washington, DC.
The Committee met at 10:02 a.m., in room SD-G50, Dirksen
Senate Office Building, Senator Richard C. Shelby (Chairman of
the Committee) presiding.
OPENING STATEMENT OF CHAIRMAN RICHARD C. SHELBY
Chairman Shelby. The hearing will come to order. We are
very pleased this morning to welcome Chairman Greenspan before
the Senate Banking Committee to testify on the Federal
Reserve's Semi-Annual Monetary Policy Report to the Congress.
Chairman Greenspan, at its meeting earlier this month, the
Federal Open Market Committee, FOMC, raised its target for the
Federal funds rate by 25 basis points to 2.5 percent, the sixth
increase since June 2004, when the FOMC began raising the
target rate from a low of 1 percent. The FOMC has been
consistent in noting that its policy is one of accommodation
and that changing the accommodative stance will be done in a
``measured'' fashion.
The U.S. economy, I believe, has responded well, in turn,
with a continuing expansion. Real GDP increased 3.1 percent in
the fourth quarter of 2004. We can now also point to a strong
job growth with payroll employment increasing at an average of
181,000 jobs per month in 2004. On the unemployment front, the
unemployment rate decreased to 5.2 percent in January, falling
half a percentage point from the previous January.
This morning, we will have ample opportunity to discuss in
greater detail the Federal Reserve's performance in carrying
out monetary policy and its views on the future direction of
our Nation's economy. I look forward to raising a number of
issues during our discussion.
Mr. Chairman, again, we are pleased to have you with us,
and we look forward to discussing with you the necessary
actions we must take to ensure that our economy grows and
prospers in the coming years.
Senator Sarbanes.
STATEMENT OF SENATOR PAUL S. SARBANES
Senator Sarbanes. Thank you very much, Chairman Shelby. I
am pleased to join you in welcoming Chairman Greenspan before
the Committee on Banking, Housing, and Urban Affairs this
morning to testify on the Federal Reserve's Semi-Annual Report
to Congress on Monetary Policy.
Chairman Greenspan's testimony on the Fed's monetary policy
report is always widely anticipated by the Congress, the press,
the financial markets, and the public, as witness the large
crowd in this room this morning. In addition, I believe this is
Chairman Greenspan's first testimony this year before any
Committee of Congress. So, I suspect that that heightens the
expectation.
The Federal Reserve Act requires the Board of Governors to
submit a report to Congress by February 20 and July 20 of each
year on the conduct of monetary policy. It also requires the
Chairman of the Federal Reserve to testify before the Congress
on both of those reports.
Chairman Shelby, I would like, at the outset, to take note
of a decision announced by the Federal Open Market Committee,
on December 14, to expedite the release of the minutes of the
FOMC meetings. Beginning with the December 14 meeting, the
minutes of regularly scheduled meetings will be released 3
weeks after the date of the policy decision, as I understand
it. The previous policy was to release minutes of the FOMC
meeting after the next FOMC meeting, usually a period of 6
weeks or more.
This move is consistent with previous actions by the
Federal Open Market Committee to announce its policy decisions
immediately after its meetings to provide some explanation of
the basis for the decision in the announcement. In my view,
greater transparency in the FOMC's decisionmaking process is of
great benefit both to the operations of the market and to the
public. This is an effort which Chairman Greenspan has led
during his tenure, and I think it constitutes an important
legacy at the Federal Reserve and, Chairman Greenspan, I
commend you and your colleagues for this most recent step.
Chairman Shelby, I listened to your review of the economy,
and it all goes to show whether the glass is half-full or half-
empty and how you perceive it. Because I, actually, have
concerns about----
Chairman Shelby. We are trying to fill it up.
[Laughter.]
Senator Sarbanes. Yes. --the outlook for the U.S. economy
and, therefore, about our current monetary policy, and I want
to raise those just briefly this morning.
As you noted, the Federal Open Market Committee raised the
Federal funds rate another quarter of a point at its last
meeting. This was the sixth consecutive quarter-point increase
by the FOMC in less than 8 months. It has now gone from 1 to
2.5 percent. It seems to me that, while the Federal Open Market
Committee apparently feels that this pace can be continued, I
think there is some cause for concern. The GDP growth in the
fourth quarter actually slowed to 3.1 percent, well below the
rate most experts consider our potential growth rate.
In my view, the labor market remains relatively weak.
Employers added 146,000 payroll jobs in January, 157,000 in
December, 137,000 in November, all of which are just about
enough to keep pace with population growth.
Now, while the Labor Department reported last week that the
unemployment rate dropped in January to 5.2 percent, from 5.4
percent in December, it was mostly because of a decline in the
number of people looking for work. In fact, most of the decline
in the unemployment rate over the last year occurred because of
a decline in the share of people looking for work not because
of a higher share with jobs. Capacity utilization in our
Nation's factories remains at low levels. In fact, figures were
released this morning that capacity utilization fell to 79
percent. December's level had been reported as 79.2 percent,
but had been revised downward by a tenth of a point. Wages are
rising more slowly than inflation. The economy is still in the
situation of three-quarters of a million fewer private-sector
jobs than existed when President Bush took office over 4 years
ago. Over 20 percent of those who are unemployed are long-term
unemployed; in other words, have been unemployed for more than
26 weeks. This has been continuous now for the last 28 months,
that more than 20 percent of the unemployed are long-term
unemployed, which sets a record.
The Fed said, in its statement, ``Inflation and longer-term
inflation expectations remain well contained.'' Given this, it
seems to me that the Fed should consider now taking a pause
from its policy of interest rate increases to see how the
economy develops in the first part of this year. Some expect
that economic growth will slow and, given that, it seems to me
worth considering, and I commended to the Chairman the
possibility of pausing to survey where we are and assuring
ourselves that the economy is, indeed, strengthening and can
withstand continuing to raise interest rates. And I look
forward to pursuing that with the Chairman in the course of his
appearance here this morning.
Thank you very much, Mr. Chairman.
Chairman Shelby. Thank you, Senator Sarbanes.
Senator Bunning.
STATEMENT OF SENATOR JIM BUNNING
Senator Bunning. Thank you, Mr. Chairman. I appreciate you
coming, Chairman Greenspan, for your second-to-last Federal
Reserve Semi-Annual Monetary Report. Though some may not
believe this, I really do appreciate you coming up here. I am
sure coming up here is like going to the dentist for you, and I
am probably the dentist.
[Laughter.]
Your testimony is very important before this Committee, and
we have a lot of people waiting with bated breath to hear your
thoughts about the state of our economy. I hope I will be happy
and the people whose lives can be directly affected by your
comments are happy when this hearing concludes.
I, like most of the people in this room, will be paying
particularly close attention to any insight you may give us
about whether the FOMC will continue its current tack of
``measured accommodation'' of monetary policy. Of course, that
is the $64,000 question, and I am sure you will do your best
not to give us a hint of what the FOMC will do at its next
meeting.
Once again, I will be asking about the persistence and
presence of inflation in our economy, the same question I ask
you every time you come before us to give your report. If you
do not see any evidence of inflation, I would hope you would
take that into account, in a big way, during the next FOMC
meeting. You do not have to raise rates just because many
expect it. Low interest rates are not necessarily a bad thing.
I will take this opportunity to bring up one other pet
peeve of mine, and I do it a lot. You will be asked a number of
questions over the next 2 days that have nothing to do with
your job. I know every time you come here, you are asked every
question under the sun. Just remember, you do not have to
answer those questions. You do not have to testify on subjects
that are really not part of the Fed's jurisdiction. We will try
to suck you in, but please do not succumb.
Once again, thank you, Chairman Greenspan, for coming
before us today. I look forward to your response during the
question and answer period.
Thank you.
Chairman Shelby. Senator Reed.
STATEMENT OF SENATOR JACK REED
Senator Reed. Thank you very much, Mr. Chairman, and
welcome, Chairman Greenspan.
Four years ago, we found ourselves at a crossroads, and the
Administration chose a path that led from record surpluses to
record deficits, both in our fiscal accounts and our current
accounts, our trade balance overseas, and much of that is being
financed now by foreign central banks. And we have the
opportunity, I would suspect, the obligation to try to change
that course.
The Congressional Budget Office has estimated that the
Federal budget deficit for fiscal year 2005 will be $368
billion. That does not include an $80-billion supplemental for
Iraq and more than likely another $50-billion supplemental next
year, given the troop sizes we will have in Iraq. It does not
include cost of Social Security privatization, whatever they
may be, and it does not include other operations. We have
record deficits, stemming primarily from the tax cuts and from
the steadily increasing spending for needed defense and
homeland security measures.
Another aspect of the President's budget for 2006 is the
cutting of numerous entitlement and domestic discretionary
programs without effectively reining in the deficit. And many
of these programs go to the heart of building human capital,
the education system, and other systems that will, I think,
over time help increase our productivity. And so we are
dangerously underfunding those programs. Once again, there are
major issues left out--the war in Iraq, alternative minimum tax
reform, $1.6 trillion in extension of expiring tax cuts, and
associated debt service. So this is a rather bleak picture of
fiscal discipline.
You have reminded us already, Mr. Chairman, back in
February 2002, that to the extent that we would be owing debt
to other sovereign governments, in that respect there is a
difficulty. We have a serious difficulty at the moment. You,
also, state in April 2002, talking about current account
deficits, countries that have gone down this path have
invariably run into trouble, and so would we. Eventually, the
current account deficit will have to be restrained, and no one
is anticipating any restraint at the moment.
Now, given this context for important decisions, we are
facing critical choices about extending on a permanent basis
expiring tax cuts for wealthy Americans. We are, also,
according to the President's Social Security, rather,
contemplating borrowing trillions of dollars to create private
accounts.
I am deeply concerned about the direction the President is
taking in terms of our Nation's commitment to providing
retirement security to the elderly and income security to
disabled widows and surviving families. Many people do not
recognize that about 30 percent of the recipients of Social
Security are not the elderly, they are disabled or widows, or
surviving families.
We all acknowledge that the long-term fiscal imbalance of
the Social Security trust fund must be addressed. However, it
is equally critical to recognize that the concept of private
accounts being advanced by the President does absolutely
nothing to address this
imbalance. In fact, diverting payroll tax revenues exacerbates
insolvency and accelerates the date of trust fund imbalance.
Now, more than ever, Social Security occupies a critical role
in ensuring this retirement is secure, especially at a time
when the country is saving so little and fewer employers are
offering the security of defined benefit pension plans. Defined
benefit pension plans comprise 61 percent of all pension plans
in 1980. By 2001, that number had dropped to 25 percent, and
this trend is only further exacerbated by the solvency issues
faced by the Pension Benefit Guarantee Corporation, which has
been absorbing more failed employer-sponsored defined benefit
plans.
So, Mr. Chairman, we have a serious set of issues before us
and, as always, we look forward to your response to these
issues.
Thank you very much, Mr. Chairman.
Chairman Shelby. Senator Crapo.
COMMENTS OF SENATOR MIKE CRAPO
Senator Crapo. Thank you very much, Mr. Chairman. Chairman
Greenspan, we welcome you here again. I am not going to give a
long opening statement. I am going to listen very closely to
your comments. We are very interested in your discussion with
us about the status and the prospects of the U.S. economy and
whether it is the issue of tax policy or derivatives, as you
know, is a very critical issue to me or Social Security or
entitlement spending. I think that the issues that we are
prepared to go into with you today are those on which you can
provide us some very significant insight, and I look forward to
it.
Thank you for coming.
Chairman Shelby. Senator Schumer.
STATEMENT OF SENATOR CHARLES E. SCHUMER
Senator Schumer. Thank you very much, Mr. Chairman, and I,
too, want to welcome my friend and someone who has been just a
superlative Chairman of the Federal Reserve Board. He has a
reputation--deserved--as a straight shooter and somebody who is
really brilliant on monetary policy and economic policy. And
that is why, when he comes here, we all want to ask him a whole
lot of questions because we respect his judgment so.
My view, Mr. Chairman, is that if we left things to you,
and I think the way you have handled monetary policy in the
last few years has been excellent. I think the steps where the
market has certainty and knows exactly what you are doing is a
very good idea, provided the economy continues to move along at
this pace--Senator Sarbanes mentioned that it may not--and
then, of course, it would have to be reexamined.
Down the road, on Pennsylvania Avenue, we tend to mess
things up. And I am truly worried about the debt, and
particularly the added debt that Social Security could create
in terms of the privatization of accounts. I think they are
ideologically driven, frankly. I do not think they fall within
the rubric of fixing Social Security, of, as I would call it,
``mend it not end it.'' I think, rather, there are a group of
people who want to prove that every Government program does not
work and, therefore, they have come up with so-called
``privatization.'' That is what they want to do is privatize.
Now, they do not want to call it that because the public does
not like it, but I think the name has stuck. The junk bond
dealers tried to change the name of junk bonds for years, and
they are still referred to as junk bonds 10 years later. I know
they want them to call them high-yield bonds, but these
personal accounts, there is privatization, and private
accounts, and they are going to stick.
My view, you have been a strong voice for restraining our
fiscal policies. We have disagreed on some of the tax cuts, but
you have always talked about PAYGO, and you talked as early as
2001, I believe it was--it may have been 2000--of creating a
glide path, which reduces the debt to as close to zero as
possible. We had that under the Clinton years. We have lost it
in the Bush years. My one criticism of your nonmonetary aspects
of your policy is that you would speak out strongly, but I will
be very interested in your views of privatization and whether
the so-called ``gain of privatization,'' having Joe and Jane
Smith be able to manage a little bit of their own money in some
kind of account, is equal to the huge amount of debt that it
would throw on the shoulders of our already burdened
Government.
We are giving a birth tax to every child born in America
now of about $15,000. If we do all the things Senator Reed
mentioned, that birth tax will double to $30,000, and I do not
think that is good for the newborns. I do not think it is good
for the economy, and I am interested in your views and hope you
will give us a straightforward answer about the effects of
privatization on debt.
Thank you, Mr. Chairman.
Senator Dole.
STATEMENT OF SENATOR ELIZABETH DOLE
Senator Dole. Thank you, Mr. Chairman. Welcome, Chairman
Greenspan.
Two weeks ago, when the Federal Open Market Committee
raised its target for the Federal funds rate and the discount
rate by 25 basis points, the release noted robust underlying
growth and productivity, a gradually improving labor market and
moderate growth in output. All of these, coupled with low
inflation, appear to indicate a positive track for economic
expansion in the coming years.
While these trends certainly are pleasing, I continue to be
concerned about the slower pace of job creation. As you well
know, the State of North Carolina has experienced dramatic
losses in manufacturing employment. While the whole economy
trends positively, we continue to focus special attention on
those who lost their jobs due to the inability of their
companies to compete with foreign firms that operate with
dramatically lower-cost structures.
We must equip our Nation's poorest citizens with the
necessary tools to take advantage of new jobs created by the
expanding economy. To this end, I continue to make
strengthening our community colleges a top priority.
I have spoken before about the work that Senators Enzi,
Alexander, and I undertook last year. In addition to the
President's $125-million proposal to establish a new community
college access grant program, our bill provides increased
assistance to our community colleges and other institutions of
higher learning for training and retraining of students in
high-growth job markets. I look forward to working again on
this legislation with my colleagues in this session of
Congress.
I, also, remained concerned about high energy prices, the
rise in steel prices and the size of our trade deficit. In
December, leaders in the City of Charlotte, North Carolina, and
I were shocked to discover that the contracts for the South
Corridor Light Rail construction came in at $30 million over
estimates due to the increases in steel and concrete prices. It
was explained that this dramatic rise in price was caused by
China's growing demand for steel and concrete. Despite these
concerns, though, I am confident that through increased trade,
hard work, global communications, and continuing education of
our workforce, we will achieve new levels of opportunity and
global security for all Americans. I look forward to hearing
from you on these and other matters, Chairman Greenspan.
Thank you for joining us today.
Chairman Shelby. Senator Stabenow.
STATEMENT OF SENATOR DEBBIE STABENOW
Senator Stabenow. Thank you, Mr. Chairman, and welcome, Mr.
Chairman. It is wonderful to see you, again, and I want to join
my colleagues in thanking you for your leadership and service
over the last 16 years. We truly have appreciated and relied on
your judgments and your thoughts, and I have appreciated, also,
the opportunity to talk with you both privately in my office,
as well as on other occasions, about what we are facing in
terms of out-of-control deficits.
I know you have warned us, since I was in the House of
Representatives, and, by the way, I was very proud of the fact,
coming into the U.S. House in 1997, that we balanced the budget
for the first time in 30 years. We, unfortunately, now have
gone from the largest surpluses in the history of the country
projected in 2001 to the largest deficits, and that is deeply,
deeply disturbing, and I am very interested in your current
thinking as it relates to our economic environment with the
deficit and the sustainability of that and, in fact, the ethic
and responsibility that we all have to address that. I view
that as a major moral issue.
The President would have us believe that Social Security,
in 13 years, is going bankrupt even though we know that is not
accurate. We do know that there is a gap, 40 or 50 years down
the road, and I am confident that working with my colleagues
that we will address that.
But what we are hearing from the President is that his
suggestion as a way to fix it is to hoist an additional $5
trillion of national debt on American families over the next 20
years, and he calls it an ownership society. I would argue that
what every man, woman and child will own is an additional
$17,000 in debt, on top of what we already have as a birth tax
right now of $15,000. Every time a child is born, that is our
gift to them, in terms of the current national debt. So, I am
extremely concerned about where we are going and the
sustainability of that.
Right now, it will require decades for this debt to be
fully offset, and the projected savings being talked about in
terms of the savings and the market growth, in terms of
privatization of Social Security, ironically, is the same
growth that would take care of the Social Security gap if, in
fact, it materialized. And so I would be interested in your
thoughts about that as well.
I am very interested in your discussion in terms of the
national debt, our chronic deficit and, also, what has been
raised by my colleagues as troubling trade deficits, which are
exploding, and particularly when we look at China and what is
happening in terms of our inability to enforce trade laws and
to address the trade imbalances that we have that are causing
great havoc in my home State with manufacturers and others that
are asking us for a level playing field so that they can keep
and create more jobs.
So, I thank you, Mr. Chairman.
Chairman Shelby. Senator Bennett.
COMMENTS OF SENATOR ROBERT F. BENNETT
Senator Bennett. Thank you, Mr. Chairman. I am going to
resist the urge to continue the debate that probably should
take place on the floor and during morning business. But I
think, perhaps, the opening statements are not the place to do
that. So, I will simply pass and look forward to Chairman
Greenspan's testimony.
Senator Bayh.
COMMENTS OF SENATOR EVAN BAYH
Senator Bayh. Thank you, Chairman Shelby. I was interested
in Senator Bunning's dentist analogy. And not wanting to apply
anesthetic to the patient, I will take a pass on my own
remarks.
Mr. Chairman, I look forward to your comments about the
critical issues that face us, and thank you for joining us
today.
Chairman Shelby. Senator Martinez.
COMMENTS OF SENATOR MEL MARTINEZ
Senator Martinez. Mr. Chairman, thank you very much and,
Mr. Chairman, thank you for coming this morning. It is great to
see you, and I look forward to your remarks as well.
I do recall that we worked together on issues in my prior
role, and I look forward to any comments you might make that
would give encouragement to the housing market in America. I
think that in spite of what any might say of all Committees in
this Senate, this Committee should be particularly keen on
ownership, private investment and homeownership opportunities,
all of which I think are seeing tremendous record successes in
recent days.
And so I would look forward to hearing your comments,
particularly with an eye toward those issues that might have
impact on my home State of Florida, as well as something I care
deeply about, which is homeownership, mortgage rates, and
things of that nature.
So thank you, Mr. Chairman, for coming this morning.
Chairman Shelby. Senator Dodd.
STATEMENT OF SENATOR CHRISTOPHER J. DODD
Senator Dodd. Thank you, Mr. Chairman, and I will join my
colleagues in welcoming you, Mr. Chairman. It is a pleasure to
have you before this Committee again.
In the words of Morris Udall, ``Everything has been said,
but not everyone has said it,'' here this morning. So let me
just associate my remarks, briefly, with those of Senator Reed,
Senator Schumer, and Senator Stabenow. I know you are here to
talk about monetary policy, but, obviously, because of the high
regard in which we hold you and the tremendous respect we have
for your knowledge about broader economic issues, while the
subject matter is of monetary policy, obviously, these other
issues are of keen interest to all of us here. I can recall
only 4 years ago talking about we have not had hearings about
the dangers of too steep a glide path on retiring the national
debt. It sounds difficult to believe that only 4 years ago we
had that hearing to talk about those issues.
Senator Sarbanes. I remember it as though it was yesterday.
[Laughter.]
Senator Dodd. But here we are in a very different
situation, obviously. With estimates now, we have had to raise
the debt ceiling twice in the last 3 years in excess of $8
trillion. I am worried, as well, about the amount of resources,
the amount of this debt being held off-shore. And I know you
have talked about that in the past, but the numbers seem to be
going up. And the concern I see with some of these countries
purchasing assets, not dollar-denominated assets, but looking
more to the euro and whether or not we should be worried about
that as a country, and so I will be looking forward to your
comments on these matters that have been raised by others, and
thank you again for your service.
Chairman Shelby. Senator Corzine.
STATEMENT OF SENATOR JON S. CORZINE
Senator Corzine. Thank you, Mr. Chairman, and I will join
my colleagues in welcoming Chairman Greenspan. I truly want to
congratulate and thank him for his service.
That said, we all have questions that most have already
been talked about--the twin deficits, and I am anxious to hear
your remarks and how and whether you believe we can have a
smooth adjustment to dealing with them, particularly the trade
deficit, which is shockingly large, at least from my
perspective.
There are, also, some issues though that have not been
mentioned, which I am personally quite concerned about. We have
had a stagnation of real wages in the country at least in the
last 7 years, slow, absolute growth and what I believe will
ultimately be a real problem for the country, a growing
concentration of wealth and income disparity as revealed by
statistics and share of population that is actually working is
declining. There are a number of issues that deal with the
health of our labor force and, ultimately, our broader economy
that sometimes get pushed off of the discussion for good and
proper reasons with regard to some of the major issues that we
debate every day--trade and fiscal deficits and, God willing,
some discussion on rational reform of Social Security.
So, I hope that we cannot forget that these underlying
economic conditions have real impact on people's lives and the
income disparity is growing in this country, and I am certainly
anxious to hear the Chairman's views and suggestions on what
maybe they need to do to try to at least moderate some of those
trends.
Thank you, Mr. Chairman.
Chairman Shelby. Chairman Greenspan, you proceed as you
wish. Welcome, again, to the Committee.
STATEMENT OF ALAN GREENSPAN, CHAIRMAN
BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM
Chairman Greenspan. Thank you very much, Mr. Chairman and
Members of the Committee.
I am, as always, pleased to be here today to present----
Chairman Shelby. Would you bring the mike just a little
closer to you. We have a huge audience here.
Chairman Greenspan. As usual, despite the fact that there
is a DDS sign in front of the Committee, I, nonetheless, feel
that it is a privilege to be here, as always, because I do find
this an extraordinarily interesting discussion vehicle, and I
trust that many of the issues will get clarified or, if not
that, at least, the level of discussion will get heated
sufficiently to engage us in considerable discussion, which I
have a suspicion it may well.
In the 7 months since I last testified before this
Committee, the U.S. economic expansion has firmed, overall
inflation has subsided, and core inflation has remained low.
Over the first half of 2004, the available information
increasingly suggested that the economic expansion was becoming
less fragile and that the risk of undesirable decline in
inflation had greatly diminished. Toward mid-year, the Federal
Reserve came to the judgment that the extraordinary degree of
policy accommodation that had been in place since the middle of
2003 was no longer warranted and, in the announcement released
at the conclusion of our May meeting, signalled that a firming
policy was likely. The Federal Open Market Committee began to
raise the Federal funds rate at its June meeting, and the
announcement following that meeting indicated the need for
further, albeit gradual, withdrawal of monetary policy
stimulus.
Around the same time, incoming data suggested a lull in
activity as the economy absorbed the impact of higher energy
prices. Much as had been expected, this soft patch proved to be
short-lived. Accordingly, the Federal Reserve has followed the
June policy move with similar actions at each meeting since
then, including our most recent meeting earlier this month. The
cumulative removal of policy accommodation to date has
significantly raised measures of the real Federal funds rate,
but by most measures, it remains fairly low.
The evidence broadly supports the view that economic
fundamentals have steadied. Consumer spending has been well
maintained over recent months and buoyed by continued growth in
disposable personal income, gains in net worth, and the
accommodative conditions in credit markets. Households have
recorded a modest
improvement in their financial position over this period, to
the betterment of many indicators of credit quality.
The sizable gains in consumer spending of recent years have
been accompanied by a drop in the personal savings rate to an
average of only 1 percent over 2004, a very low figure relative
to the nearly 7-percent rate averaged over the previous 3
decades. Among the factors contributing to the strength of
spending and the decline in saving have been the developments
in housing markets and home finance that have spurred rising
household wealth and allowed greater access to that wealth. The
rapid rise in home prices over the past several years has
provided households with considerable capital gains. Moreover,
a significant increase in the rate of single-family home
turnover has meant that many consumers have been able to
realize gains from the sale of their homes. To be sure, such
capital gains, largely realized through an increase in mortgage
debt on the home, do not increase the pool of national savings
available to finance new capital investment. But from the
perspective of an individual household, cash realized from
capital gains has the same spending power as cash from any
other source.
More broadly, rising home prices, along with higher equity
prices, have outpaced the rise in household, largely mortgage,
debt and have pushed up household net worth to about 5.5 times
disposable income by the end of last year. Although the ratio
of net worth to income is well below the peak attained in 1999,
it remains above the long-term historical average. These gains
in net worth help to explain why households, in the aggregate,
do not appear uncomfortable with their financial position even
though their reported personal savings rate is negligible.
For their part, business executives apparently have become
somewhat more optimistic in recent months. Capital spending and
corporate borrowing have firmed noticeably, but some of the
latter may have been directed to finance the recent backup in
inventories. Mergers and acquisitions, though, have clearly
perked up.
Even in the current much-improved environment, however,
some caution among business executives remains. Although
capital investment has been advancing at a reasonably good
pace, it has nonetheless lagged the exceptional rise in profits
and internal cashflow. This is most unusual. It took a deep
recession to produce the last such configuration in 1975. The
lingering caution evident in capital spending decisions has
also been manifested in less-aggressive hiring by businesses.
In contrast to the typical pattern early in the previous
business-cycle recoveries, firms have appeared reluctant to
take on new workers and have remained focused on cost
containment.
As opposed to lingering hesitancy among business
executives, participants in financial markets seem very
confident about the future and, judging by the exceptionally
low level of risk spreads and credit markets, quite willing to
bear risk. This apparent disparity in sentiment between
business people and market participants could reflect the
heightened additional concerns of business executives about
potential legal liabilities rather than a fundamentally
different assessment of macroeconomic risks.
Turning to the outlook for costs and prices, productivity
developments will likely play a key role. The growth of output
per hour slowed over the past half-year, giving a boost to unit
labor costs after 2 years of declines. Going forward, the
implications for inflation will be influenced by the extent and
persistence of any slowdown in productivity. A lower rate of
productivity growth in the context of relatively stable
increases in average hourly compensation has led to slightly
more rapid growth in unit labor costs. Whether inflation
actually rises in the wake of slowing productivity growth,
however, will depend on the rate of growth of labor
compensation and the ability and willingness of firms to pass
on higher costs to their customers. That, in turn, will depend
on the degree of utilization of resources and how monetary
policymakers respond. To date, with profit margins already
high, competitive pressures have tended to limit the extent to
which cost pressures have been reflected in higher prices.
The inflation outlook will also be shaped by developments
affecting the exchange rate of the dollar and oil prices.
Although the dollar has been declining since early 2002,
exporters to the United States apparently have held dollar
prices relatively steady to preserve their market share,
effectively choosing to absorb the decline in the dollar by
accepting a reduction in their profit margins. However, the
recent, somewhat quickened, pace of increase in U.S. import
prices suggests that profit margins of exporters to the United
States have contracted to the point where the foreign shippers
may exhibit only limited tolerance for additional reductions in
margins should the dollar decline further.
The sharp rise in oil prices over the past year has no
doubt boosted firms' costs and may have weighed on production,
particularly, given the sizable permanent component of oil
price increases suggested by distant-horizon oil futures
contracts. However, the share of total business expenses
attributable to energy costs has declined appreciably over the
past 30 years, which has helped to buffer profits and the
economy more generally from the adverse effect of high oil and
natural gas prices. Still, although the aggregate effect may be
modest, we must recognize that some sectors of the economy and
regions of the country have been hit hard by the increase in
energy costs, especially over the past year.
Despite the combination of somewhat slower growth of
productivity in recent quarters, higher energy prices, and a
decline in the exchange rate for the dollar, core measures of
consumer prices have registered only modest increases. The core
PCE and CPI measures, for example, climbed about 1.25 to 2
percent, respectively, at an annual rate over the second half
of last year.
All told, the economy seems to have entered 2005, expanding
at a reasonably good pace, with inflation and inflation
expectations well-anchored. On the whole, financial markets
appear to share this view. In particular, a broad array of
financial indicators convey a pervasive sense of confidence
among investors and associated greater willingness to bear risk
than is yet evident among business managers.
Over the past 2 decades, the industrial world has fended
off two severe stock market corrections, a major financial
crisis in developing nations, corporate scandals, and, of
course, the tragedy of September 11, 2001. Yet overall economic
activity experienced only modest difficulties. In the United
States, only five quarters in the past 20 years exhibited
declines in GDP, and those declines were small. Thus, it is not
altogether unexpected or irrational that participants in the
world marketplace would project more of the same going forward.
Yet history cautions that people experiencing long periods
of relative stability are prone to excess. We must, thus,
remain vigilant against complacency, especially since several
important economic challenges confront policymakers in the
years ahead.
Prominent among these challenges in the United States is
the pressing need to maintain the flexibility of our economic
and financial system. This will be essential if we are to
address our current account deficit without significant
disruption. Besides market pressures, which appear poised to
stabilize and over the longer-run possibly to decrease the U.S.
current account deficit and its attendant financing
requirements, some forces in the domestic U.S. economy seem
about to head in the same direction. Central to that adjustment
must be an increase in net national savings. This serves to
underscore the imperative to restore fiscal discipline.
Beyond the near-term, benefits promised to a burgeoning
retirement-age population, under mandatory entitlement
programs, most notably Social Security and Medicare, threaten
to strain the resources of the working-age population in the
years ahead. Real progress on these issues will unavoidably
entail many difficult choices. But the demographics are
inexorable, and call for action before the leading edge of baby
boomer retirement becomes evident in 2008. This is especially
the case because longer-term problems, if not addressed, could
begin to affect longer-dated debt issues, the value of which is
based partly on expectations of developments many years in the
future.
Another critical long-term economic challenge facing the
United States is the need to ensure that our workforce is
equipped with the requisite skills to compete effectively in an
environment of rapid technological progress and global
competition. Technological advances are continually altering
the shape, nature, and complexity of our economic processes.
But technology and, more recently, competition from abroad have
grown to a point at which
demand for the least-skilled workers in the United States and
other developed countries is diminishing, placing downward
pressure on their wages. These workers will need to acquire the
skills required to compete effectively for the new jobs our
economy will create.
Although the long-run challenges confronting the U.S.
economy are significant, I fully anticipate that they will
ultimately be met and resolved. In recent decades, our Nation
has demonstrated remarkable resilience and flexibility when
tested by events, and we have every reason to be confident that
it will weather future challenges as well. For our part, the
Federal Reserve will pursue its statutory objectives of price
stability and maximum sustainable employment, the latter of
which we have learned can best be achieved in the long-run by
maintaining price stability. This is the surest contribution
the Federal Reserve can make in fostering the economic
prosperity and well-being of our Nation and its people.
Mr. Chairman, I request that my full statement be included
for the record, and I look forward to your questions.
Chairman Shelby. Without objection, your complete statement
will be made part of the record.
Thank you, Chairman Greenspan. Thank you for your wisdom
that you shared with us, some of it, at times.
Mr. Chairman, President Bush, I believe, has shown a lot of
courage and leadership in highlighting the need to deal with
Social Security. The President has proposed establishing, as
you well know, personal accounts with a portion of payroll
taxes as a means of reducing long-term Government liabilities.
Some observers, however, have noted that up to $2 trillion--I
do not know if that figure is right--in new Federal borrowing
would be needed to make such a transition.
If that figure is a valid representation of transition
costs, if so, how do you believe financial markets would react
to such borrowings and so forth?
Chairman Greenspan. Mr. Chairman, if I may, I would like to
just take a minute to put context around this whole problem.
Chairman Shelby. Go ahead. Absolutely.
Chairman Greenspan. We have to really ask ourselves what
the problem we are trying to solve is. The problem essentially
is that we have an unprecedented potential increase in the
number of people leaving the workforce and going into
retirement over the next 25 years. Indeed, those age 65 and
over will increase according to the Bureau of Census by more
than 30 million, and that is an inexorable move as we all age
and retire.
The problem that creates is that unless productivity growth
increases significantly, the per capita GDP must significantly
slow. That means either the retirees or active workers, say, in
the year 2030, must experience a significant slow-down in their
standard of living. And my concern is that we are putting
forward, in a number of different programs, commitments to be
fulfilled in the year 2030, for which the real resources are
not being made available.
And the way real resources are made available in such a
context is for savings to be put aside to be invested in
capital assets, and those capital assets, by increasing
relative to the labor force, tend to create increased output
per hour. The correlation for that is very close.
So that unless we develop the savings to invest or
significantly increase our borrowing from abroad, we are not
going to be able to create the capital assets, to create the
amount of goods that are required. Our problem, with respect to
retirement, has got nothing to do with finance. It has to do
with real assets, real physical resources, and goods and
services that people consume.
What the test in this context of our individual financial
systems should be is do they or do they not create savings to
create the capital assets or put it another way, are they fully
funded or not? For example, Social Security, as a pay-as-you-go
system worked remarkably well for 50, 60, 70 years, largely
because a pay-as-you-go system works if population is growing
sufficiently quickly and longevity is growing only modestly.
Now, we have had, in recent years, some slowing down in
population growth, but a remarkable increase in life expectancy
after age 65. That has created a very major problem for a pay-
as-you-go system. And the reason, essentially, is, by its
nature, in the purest form, pay-as-you-go creates no savings.
It merely transfers from taxpayers, in any particular period,
to beneficiaries.
Now, to be sure, there are some savings involved in the
OASI fund in the sense of we have built up a trust fund, which
is now approximately $1.5 trillion, but a fully funded OASI
would require more than $10 trillion. So we are very far short,
and we have very great difficulty in fully funding the existing
system, and that is the reason why I think we have the problems
that we are running into.
Not to take too much more time, let me just say very
specifically, in response to your question, there are basically
two models that we are confronting. One is the pay-as-you-go
model which, if we can fully fund it, will work, but it has
shown very considerable difficulty in doing that.
The other is the forced savings model which, in the current
context privatization, is not increasing savings because you
are switching from Federal Government savings to a forced
savings account. But as a general model, it has in it the seeds
of developing full funding by its very nature, and therefore I
have always supported moves to full funding in the context of a
private account, and I will respond in more detail in response
to a number of questions that I am sure you and your colleagues
have.
The issue with respect to the financing the transition is a
difficult one to answer because there are things we do not
know. There are two things which we do not know which are
important, and if we knew them, we could answer it very
explicitly.
First, we do not know the extent to which the financial
markets at this stage, specifically, those trading in long-term
bonds, are discounting the $10-trillion contingent liability
that we have. Actually, it is more than $10 trillion now. It
was $10 trillion a while back. If, indeed, the financial
markets do not discount that $10-trillion-plus, and say it is
just as much of a debt as the $4-odd-trillion that is a debt to
the public, then, one would say, well, if you wanted to go to a
private system, you could go fully to a private system without
any response in interest rates because, obviously, you are not
changing the liabilities that are involved. You are just merely
switching assets to the private sector. But we do not know
that.
And if we were to go forward in a large way, and we were
wrong, it would be creating more difficulties than I would
imagine. So, if you are going to move to private accounts,
which I approve of, I think you have to do it in a cautious,
gradual way and recognize that there is yet another problem
involved, which is this: Unlike almost all of the other
programs with which we deal, moving to a forced savings account
technically does not materially affect net national savings. It
merely moves savings from the Government account to a private
account. One can argue at the margin as to whether or not that
induces some change in personal behavior, but it is at the
margin.
So the question really is if it does not affect national
savings, it should not affect the supply and demand for funds,
but, again, we do not know how the markets respond to that. It
is one thing to say it as an economist. It is another thing to
say how the market is responding.
All in all, I am glad that if we are going to move in that
direction, we are going to move slowly and test the waters
because I think it is a good thing to do over the longer-run
and, eventually, because the pay-as-you-go system, in my
judgment, is going to be very difficult to manage, we are going
to need an alternative.
Chairman Shelby. Mr. Chairman, just to follow up, could we
create the personal accounts without any substantial borrowing
for the transition? And, if so, how?
Chairman Greenspan. Obviously, if you raise taxes, you
could.
Chairman Shelby. What about cutting benefits?
Chairman Greenspan. You could certainly do it that way,
too.
Chairman Shelby. One of those two.
Chairman Greenspan. Yes.
Chairman Shelby. If one of the goals of reform that you
alluded to is to increase real savings in this country, would
it be desirable to pursue personal accounts as an add-on rather
than as a replacement?
Chairman Greenspan. Well, it depends on how you finance it.
We have add-ons. It is called a 401(k) at this stage.
Chairman Shelby. That is right.
Chairman Greenspan. It is not clear to me what you want to
do other than perhaps expand the 401(k)s, which I think become
a very popular and very useful adjunct to our financial system.
Chairman Shelby. Senator Sarbanes.
Senator Sarbanes. Thank you very much, Mr. Chairman. I
presume we are going to do multiple rounds here this morning.
Chairman Greenspan, the first thing I want to make clear or
try to get clear is you said the increase in net national
savings is a very important objective; is that correct?
Chairman Greenspan. Yes, sir.
Senator Sarbanes. Is a reduction of the Federal deficit,
does that translate into an increase in net national savings?
Chairman Greenspan. It does, Senator.
Senator Sarbanes. So that eliminating the deficit or even
running a surplus constitutes a contribution toward raising net
national savings; is that correct?
Chairman Greenspan. It may be the most significant vehicle
we have.
Senator Sarbanes. I take it from that, that anything that
markedly increases the deficit runs directly counter to the
objective of increasing the net national savings.
Chairman Greenspan. That is correct.
Senator Sarbanes. Because I recall 4 years ago you came
before us--Senator Dodd alluded to that--and you told us, and I
am quoting you now--this was when we were projecting, over a
10-year period, a $5.6-trillion surplus in the Federal budget,
a $5.6-trillion surplus projected over 10 years, and now we are
projecting a $3.7-trillion deficit. That is a rather staggering
turnaround of $9.3 trillion, almost $10 trillion. You told us,
then, and that is why I am really concerned here, ``The time
has come, in my judgment, to consider a budgetary strategy that
is consistent with a preemptive smoothing of the glide path to
zero Federal debt or, more realistically, to the level of
Federal debt that is an effective, irreducible minimum.''
Now, that was taken I think by all as a view on your part
that we were paying down the debt too quickly, and we had to
alter the glide path and the payment down of the debt.
I remember saying to you at the time you have just taken
the lid off the punch bowl because, at that time, of course, we
were debating whether to do these extensive tax cuts. They were
done. They were done the following year. Even more were done
the year after, and now we have managed to transpose our
economic outlook from this projection of over $5 trillion in
surplus to almost $4 trillion in deficits, which I would take
it you would agree constitutes a major setback to the goal of
increasing net national savings.
Chairman Greenspan. I do, Senator.
Senator Sarbanes. In view of that, would you say anything
that markedly increases the deficit is the wrong path to go
down?
Chairman Greenspan. In general, but let us remember that
the basic issue is net national savings. Ordinarily, any
increase in spending or reduction in taxes which is funded by
marketable securities clearly increases the deficit and lowers
national savings. The only reason I raise it at the moment is
that we are discussing these private accounts, and this is one
of the very rare cases in which you can increase the deficit,
but not decrease the national savings.
Senator Sarbanes. So you do not support through borrowing,
sustaining the existing benefit levels to cover monies diverted
from the trust fund into private accounts?
Chairman Greenspan. I think the issue is something which I
am still puzzling about in the sense I am trying to get a sense
as to whether the markets read this as no change in national
savings, and therefore it is not a problem.
I do say, as I said previously, that I would be very
careful about very large increases in debt, but I do believe
that relatively small increases are not something that would
concern me.
Senator Sarbanes. Do you regard increases of $1 trillion or
$2 trillion or $3 trillion as large?
Chairman Greenspan. I would say over a trillion is large.
Senator Sarbanes. Mr. Chairman, if I have time. I am sure
we will revisit this issue, but I want to come back to another
issue. You stated that inflation and inflation expectations are
under control in your testimony here this morning.
Chairman Greenspan. I said they were contained, I believe.
Senator Sarbanes. What factors warrant raising interest
rates if inflation and inflationary expectations are contained
and if there remains a jobs problem. In other words, the
Federal has obviously set out on this constant escalator now of
taking up the interest rates. Why would we continue to do that
if we do not have an inflation problem that we have to
confront? Why would we not, as I suggested, pause and take a
look at and see how the economy strengthens and how we pick up
on the job side? What is the factor that drives raising these
interest rates inexorably, meeting after meeting after meeting,
and where will it stop, or what factor would determine when it
stops?
Chairman Greenspan. Senator, I will not comment about the
future because that is up to the Federal Open Market Committee
in its meetings, but I will address the issue as to why we have
moved from 1 percent----
Senator Sarbanes. I am told you are primus inter pares in
those Federal Open Market Committee meetings.
Chairman Greenspan. I am sorry?
Senator Sarbanes. Primus inter pares, that you speak for
the group.
Chairman Greenspan. I have one vote.
[Laughter.]
But let me address why it is that we have moved from 1 to
2.5. We very purposefully moved the Federal funds rate down
quite sharply in the context of the set of financial
deflationary pressures which occurred as the stock market came
down, and capital investment went down, and capital goods
spending went down. And so we very purposefully decided to
drive the Federal funds rate well below what we considered a
long-term sustainable rate, and we got down to 1 percent. We
had no notion as to how far we would have to go down, but we
decided that we went down, when we got down to 1 percent we
could hold it there for a while.
When it became clear that the excessive accommodation which
we purposefully injected into the financial system was no
longer necessary, we then proceeded to withdraw it. We are
withdrawing purposefully injected excess accommodation into the
system. Had we left it there indefinitely, in our judgment, it
would have engendered significant inflationary imbalances. So
we embarked on, as we discussed, what we called a measured pace
of increase.
As you know, the response in the marketplace has not been
one of significantly rising long-term rates, difficulties in
the housing market, and other problems which we had run into in
the past in previous increases in rates. So that I would not
look at this as a pattern that we were involved in for purposes
of addressing what was then going on within the economy, but
rather, as removing something which we knew had to be
temporary. And one tries to remove it as rapidly as possible
with the obvious caveat, that should the economy show signs of
weakening, clearly we would respond, and we have made that
statement every time we have issued one following a Federal
Open Market Committee meeting.
We are not oblivious as to what is going on in the economy.
Our judgment, as I indicated in my prepared remarks, at the
moment is that the economy is moving forward at a reasonably
good pace.
Senator Sarbanes. Does this analysis assume that there is
some normal rate of interest, I mean a figure that you are
trying to get to that you say, well, this is what the normal
rate of interest should be? Is there a premise of that sort in
this analysis?
Chairman Greenspan. There is, Senator. We do not know what
the actual number is, but it is that interest rate which
creates a degree of stability in the economy and removes any
excess which would create inflationary pressures.
Senator Sarbanes. Is it possible that that rate would
change as circumstances develop? I thought it was commendable
that you did not buy the national accelerating rate of
unemployment analysis, which said at a certain unemployment
figure, if we go below it, we are going to drive inflation up,
and therefore we start constraining the economy, and that costs
us jobs, and we do not get back to our full potential, but we
are prepared to go against that dogma at the time and move on
down the interest rates, give the economy a boost and bring
down the unemployment rate well below what had previously been
seen as normal.
I guess the question I am asking is whether we need to
think in those terms again with respect to this normal interest
rate. I mean what may be a normal interest rate in changing
circumstances may be lower than what previously was a normal
interest rate. And of course a lower interest rates stimulates
the economy. Presumably it makes carrying this debt less costly
rather than more costly, and has a lot I think of other
benefits for the workings of our economic system. So that is
why I am suggesting that we need to reexamine.
Chairman Greenspan. We believe that so-called ``normative
rate'' or whatever you want to call it, is not stable. It does
move around, and that is the reason I say I do not know where
it is. I do know that we have the capacity to examine how the
market is behaving in all of its myriad manifestations so as to
be able as a committee, I hope and believe, to judge where we
are at all times. We may not be able to forecast it, but I do
think we have enough analytical technology to be able to make a
judgment as to where we are at any particular point in time. I
am almost certain that that rate does move around, and we are
constantly trying to get the appropriate fix because that is
implicit, as you point out, in the strategy that we started to
pursue last year.
Senator Sarbanes. Thank you, Mr. Chairman.
Chairman Shelby. Senator Bunning.
Senator Bunning. Thank you, Mr. Chairman.
I am not going to ask you the obvious question about
inflation. You already have answered it. In the past it is my
recollection you were not as concerned with the current account
deficits as you were with other economic figures. Back in
November, when the current account deficit reached record
levels you did express concern. But in February, your concern
eased as the current account deficits decreased. Would you
comment on the current account deficit and your concern or lack
thereof ?
Chairman Greenspan. Senator, it is an extraordinary part of
a phenomenon which has been going on for the last decade
worldwide. Prior to 1995, there was a very major grossing up of
exports and imports around the world, leaving as a consequence
on average imports as a percent of GDP growing every year
virtually. We nonetheless did not find that there was any
evident consistent increase in the dispersion of trade or
current account surpluses and deficits. In other words, there
was what economists call a very considerable amount of home
bias, meaning that countries tended to use their domestic
savings to very largely finance their domestic investment. But
since 1995, there has been a very pronounced change in which
cross-border use of savings to invest in foreign countries all
over the world has increased dramatically, which has meant that
the dispersion of current account balances, both as surpluses
on the one hand and deficits on the other, with the United
States as the largest deficit, has increased.
That phenomenon has given us the capacity to create a very
large deficit, and indeed it has been a major source of
financing to our domestic investment. But as I also said, and I
think you pointed out, over the longer-run it is just not
credible that it could go on without change because you will
get an undue concentration of dollar claims on U.S. residents,
which even though they are considered a highly valuable, and
have high rates of return and the like, they lack the
diversification of a good portfolio, and foreign investors
would therefore start to ease off. And if you cannot finance a
current account deficit, it will not exist. So that is surely
the case. But I have also said that the degree of flexibility,
owing to deregulation, owing to technology, owing to lots of
innovation, has created a degree of flexibility and therefore
resilience in this economy that has in the past and is very
likely in the future to defuse this large current account
balance without undue negative economic effects on the American
economy.
So what I said in the last several weeks is, one, this is a
problem; we are approaching it and I think coming to grips with
it in the marketplace, and the evidence is that for the first
time we are beginning to see the impact of stable margins of
foreign exporters at very low levels now beginning to produce
increases in import prices in the United States, which is the
first stage in the adjustment process.
Senator Bunning. As you know, the SEC has proposed a new
Regulation B to Section 2 of the Gramm-Leach-Bliley Act. The
Fed, along with the FDIC and the OCC, wrote a very strong
letter to the SEC opposing their proposed regulation. Would you
comment on how this proposed regulation could affect the
bankers?
Chairman Greenspan. I am sorry. I do not remember what the
specific nature of the regulation was.
Senator Bunning. You do not remember what you wrote?
Chairman Greenspan. No, no, I do not remember the specific
SEC regulation to which you refer. I know I write a lot of
things, but I am just basically saying I do not--one of my
staff will know exactly what I wrote. They will tell me.
Senator Bunning. So will my staff there.
Chairman Greenspan. Okay.
[Laughter.]
Senator Bunning. How you would regulate new bank products?
Chairman Greenspan. I remember it now. I did not remember
the name, but I now remember the issue, which is a significant
issue.
Senator Bunning. Our bankers think it is very significant.
Chairman Greenspan. It is. In fact, I think we are
concerned about that as well, and I think that the resolution
of this question is clearly going to have to be completed
because the brokerage operations within the banks as such are
integral parts of a process which we perceive to be important
to banks overall, and we will get it resolved I hope sooner
rather than later.
Senator Bunning. Then you still oppose, along with the
other people who have written SEC?
Chairman Greenspan. Yes, sir.
Senator Bunning. Thank you very much, Mr. Chairman.
Chairman Shelby. Senator Reed.
Senator Reed. Thank you very much, Mr. Chairman.
Just for context, Chairman Greenspan, you referred to a $10
trillion shortfall in the Social Security trust fund. Over what
time period is that?
Chairman Shelby. This is the present value of the benefits
earned by those currently in the labor force over the years as
of right now, plus the benefits of those who are retired and
receiving benefits which they had earned previously. So it is
the discounted value of all of the benefits which are to be
received by the total labor force and retirees over essentially
indefinite period in time.
Senator Reed. Longer than the 75-year planning phase?
Chairman Greenspan. Oh, yes, yes. I think if you cut it off
at 75, I think it is $3.7 trillion.
Senator Reed. And that is generally the norm in terms of--
--
Chairman Greenspan. Yes, but I think that it is an
artificial norm, and most pension fund accounting thinks in the
full context of the actual liabilities one has, and a 75-year
period is a convenience that relates largely to a pay-as-you-go
system, but it is not consistent with the general notion of how
one runs a defined benefit program. Were pay-as-you-go a fully
funded defined benefit, I think many of the objections I raised
earlier on would disappear.
Senator Reed. Let me ask you another question, Mr.
Chairman. Various Administration spokespersons, somewhat
reluctantly have admitted that the private accounts plan that
has been announced will by itself alone do nothing to improve
the long-term solvency of the Social Security system. Do you
agree with that?
Chairman Greenspan. I do, Senator.
Senator Reed. Thank you. Would you also agree--and I think
this is a follow up really to your discussion with Senator
Sarbanes--is that the private accounts will basically leave
national savings unchanged since the Government has borrowed
money to give to individual citizens to invest in the market.
Do you agree with that also?
Chairman Greenspan. Yes, I do.
Senator Reed. Looking at the system, there are various
means to make it essentially a pay-as-you-go system. One would
be to take a portion of the proposed extension of the taxes the
President is talking about and putting that into the Social
Security Trust Fund. Just on a--that would establish a pay-as-
you-go system; is that correct?
Chairman Greenspan. It depends. If in the full context of
accounting it increases national savings, then the answer is
yes, but the test has to be how it effects the private sector
and the public sector, and if net on balance is constructed in
a manner to do that, then yes.
Senator Reed. Thank you. In 1983, Chairman Greenspan, you
were the Chairman of the Commission that rescued Social
Security from the brink. If this is a crisis, that was a
catastrophe back in 1983. Your colleagues and yourself joined
in saying that in the words of the report, that Congress should
not alter the fundamental structure of the Social Security
programs or undermine its fundamental principles. Part of the
fundamental principle of Social Security is it is an insurance
program, not just an investment vehicle. One of the most
obvious manifestations of that is that many of the
beneficiaries are not retirees at all, but they are disabled
Americans. They are children who do not have parents or they
are widows.
Proposals that are being assessed today could alter those
principles fundamentally. I understand also in 1983 you did
consider the changes that would transform it from a defined
contribution plan into something else, at least you thought
about those things. But do you still believe that we should
maintain the fundamental principles of Social Security as you
did in 1983?
Chairman Greenspan. I think we should maintain the
principles of Social Security, but I think the existing
structure is not working, and that until we can construct a
system which creates the savings that are required to build the
real assets so that the retirees have real goods and services,
we do not have a system that is working. We have one that
basically moves cash around, and we can guarantee cash benefits
as far out and at whatever size you like, but we cannot
guarantee their purchasing power. This is why the issue
ultimately has to be resolved in terms of do we have the
material goods and services that people will need to consume,
not whether or not we pass some hurdle with respect to how
financing occurs, because the financing is a secondary issue,
and it is the means to create the real wealth, not an end in
itself.
Senator Reed. That goes back to your fundamental point that
unless you increase national savings, you will not have these
resources.
Chairman Greenspan. Yes, sir.
Senator Reed. And just to follow up on your point before,
as the Administration has admitted, and as you concur today,
that the present proposed private accounts will not add to
those national savings?
Chairman Greenspan. It does not add, but it does not
subtract either, that is correct.
Senator Reed. So it is a zero?
Chairman Greenspan. Let me just say that in any move which
we endeavor to create full funding, there is a huge transition
cost because we have not built the stock of assets required,
and that is the shortfall of the difference between the $1.5
trillion and the $10 trillion plus in funding assets. Actually,
if you go further and you put Medicare in here, we are talking
another $60 trillion. So the problem that we have is there is a
huge transition cost to get us to a point where we are building
the savings adequate to produce the assets. We are not doing
that, and any scheme cannot get around the fact that there is a
huge hole in the system, and we have no choice but to find a
way to fill it.
Senator Reed. I am recalling reading the book, Secretary
O'Neill's book, in which if you believe it is accurate, and I
do, is that you have discussions with him about solving some of
these issues with the surplus, which at that time we could fund
transition costs, but at this point, running a deficit, we have
squandered the opportunity to make a serious transition in
terms of both Social Security, Medicare, Medicaid, and other
programs, and that to me is one of the casualties of the
Administration's policies.
And I thank you, Mr. Chairman.
Chairman Shelby. Senator Crapo.
Senator Crapo. Thank you very much, Mr. Chairman.
Chairman Greenspan, I want to continue on this same line of
questioning. We are hearing a tremendous amount of discussion
in the public today, both among the political leadership here
in the U.S. Congress and in the Administration as well as out
in the public about these transition costs that are related to
the proposal to move to personal accounts with a portion of the
taxes paid in payroll.
And as you have discussed today, I believe I understand
your testimony to be that with regard to national savings--and
I assume that means governmental savings.
Chairman Greenspan. National savings is another word for
domestic savings to differentiate it from the fact that we do
not include the current account deficit or foreign savings that
we borrow in that total.
Senator Crapo. All of this is a discussion of the
Government's posture and the Government's savings, is that not
correct?
Chairman Greenspan. Government savings, both State and
local and Federal, is part of national savings. Maybe that is a
bad term. Probably domestic savings should be used.
Senator Crapo. Does it include the personal savings of the
individuals across the country?
Chairman Greenspan. Yes. The way to think about this is
that the aggregate of domestic savings includes the savings of
households, businesses, and governments, and that is the part
which we call domestic savings.
Senator Crapo. If we move then to a system of personal
accounts, where individuals were able to save a portion of
their payroll taxes, can I correctly assume that the reason you
say that does not increase national savings is because it is
putting money in individual accounts that would otherwise be in
a different savings account?
Chairman Greenspan. No. Let me see if I can come back at
this. If in its original form we did not have anything other
than a requirement that we had 12.4 percent tax which was put
into a private account, in other words, that particular fund
coming off the person's income and the employer's income would
go into a forced savings account. In a sense private savings
would increase by that amount, and the part that the
corporation contributed which would have reduced its
undistributed earnings, which would have been savings, would be
a negative. But net it would, except under a certain number of
distant conditions, it would be a net increase.
Senator Crapo. So the employer's savings would be reduced
but the employee's savings would have gone up, and there would
be a net zero balance?
Chairman Greenspan. Yes. In order to get savings, remember
you have to get consumption declining relative to income.
Senator Crapo. I appreciate that because I think that there
is a lot of misunderstanding about that fact, as we discuss
this issue. And when we discuss the cost, there is a lot of
discussion about the transition cost being--I have heard the
number of $2 trillion. The Administration says the number in
terms of its proposal is more in the neighborhood of the $7 to
$8 hundred billion over 10 years. Is the same not true about
that transition cost in the sense that those costs are actually
related to debt in out-years or obligations in out-years of the
Social Security system that are being borrowed to take care of
in earlier years?
Chairman Greenspan. Well, the President has not made a
formal proposal.
Senator Crapo. I understand.
Chairman Greenspan. But I gather what he has in mind is in
a sense that the amounts that go into the private account are
offset after discount with benefits that would have been paid
with those monies in the Social Security system.
Senator Crapo. And making that assumption, is it not
correct to say then that the transition costs, although they
would be incurred now, and would require some borrowing to pay
for them now, are actually relieving an obligation of the
Social Security system in out-years?
Chairman Greenspan. The problem is that you cannot commit
future Congresses to stay with that.
Senator Crapo. Unfortunately, I understand that.
Chairman Greenspan. And as a result, the markets will not
discount as though that were the case, even though it is the
intention and that is what the law would say, and if you could
put it in the Constitution I suspect you may be right.
But I think the relevant issue here is that how the markets
interpret it is really in a sense the important issue because
if the markets correctly or incorrectly make a judgment as to
what they think the potential outcome is, we can get interest
rates going up or going down, and we would have significant
effects that we would prefer probably did not occur. So my
caution here is based on not knowing and not knowing how to
know in advance how markets will respond.
I do know that asking people in the marketplace is of no
value at all, because they do not know. They will tell you they
know, but I have not found that a very useful forecast.
Senator Crapo. I appreciate your encouragement that we move
cautiously in terms of this proposal, but I also appreciate
that you have said that you believe that we should look at a
personal account.
Chairman Greenspan. Oh, indeed I do.
Senator Crapo. Could you give us just quickly your reasons
for that?
Chairman Greenspan. Well, basically it has to do with the
issue of personal accounts have far greater probability,
indeed, almost it is built into their nature, of being fully
funded. And the simple form of pay-as-you-go by construction
saves nothing. And unless you save, merely basically creating
dollar commitments in the future without the corresponding real
resources to accommodate the claim, you will get more claims on
a fixed amount of goods than is good for the inflationary
balance of the system. So it is strictly a question of where
can we create a system which we get full funding. It did not
matter 20, 30, 40 years ago because the ratio of workers to
retirees was quite high and that therefore the implicit tax per
worker for each retiree was very small. But now we have 3.3
workers for every retiree, and that number is falling quickly.
So the current system is ill-suited to the demographics
that we are expecting to evolve in the future. And while a pay-
as-you-go system worked very well, I thought, surprisingly
well, through decades, that was because of the special case of
the demographics of the society at that point. It is not a
general system in the sense of a defined benefit or defined
contributions system, which very explicitly indicates what type
of replacement rate to expect meaning the amount of income you
expect in retirement to get relative to the amount of income
you are making in the last years of work.
Senator Crapo. Thank you very much.
Chairman Shelby. Senator Schumer.
Senator Schumer. Well, once again, Mr. Chairman, thank you
for your erudition on this, which leaves us all better educated
and maybe more confused, too.
I would like to go back to these accounts and Senator
Sarbanes's questions. You said you cannot really tell if net
savings will increase or decrease with a private account system
that draws money from the existing Social Security system
because you do not know how much the markets have discounted,
if at all, the future obligations that we have.
Chairman Greenspan. If I may, whether it actually increases
savings or not is a fact independent of what people's opinions
are.
Senator Schumer. I agree.
Chairman Greenspan. So it is not the market. I think the
problem here is that we have a system in which, starting from
scratch, forced savings will be pay-as-you-go all the time.
Senator Schumer. Right. But a transfer, which is proposed
now, is a different issue, and we do not know how the markets
will regard that transfer.
Chairman Greenspan. Exactly. Yes.
Senator Schumer. Okay. Now I want to take two cases. One,
they have discounted for it; the other, they have not. If they
have not, and we go forward with this system that we hear
about, where you transfer some money from the existing Social
Security system to private accounts, that would create a real
problem, particularly, as you have mentioned to Senator
Sarbanes, if the amount is $1 trillion or $2 trillion or
whatever. That is indisputable, I presume.
Chairman Greenspan. It is a trillion dollars over 10 years
we are talking about.
Senator Schumer. Yes. Yes.
Chairman Greenspan. Two trillion is indisputable. A
trillion dollars, I think, is right at the margin. I should not
say I know that. That is my assumption.
Senator Schumer. Yes. Understood. And we are all guessing
here.
Chairman Greenspan. Yes.
Senator Schumer. But that could be bad. Let us make no
mistake about that.
Chairman Greenspan. It could be bad and it could be very
good. I mean, my judgment is we have a problem in that the
existing pay-as-you-go system is not working and we have to
change it.
Senator Schumer. Well, nobody disputes that.
Chairman Greenspan. We have to change it. The question is
how.
Senator Schumer. Yes. Well, nobody disputes that we need
some change. But it seems to me if the markets have discounted
all of this, then it does not do any harm, but it does not do
any good, because net savings is not increasing, as you said
before. If the market has not discounted a rather large amount
of debt being added to the existing debt--obviously, 15 or 20
years ago this would not have been a problem--then we have real
trouble.
Chairman Greenspan. Well, but if you move----
Senator Schumer. So it is not win versus lose, it is either
lose or stay static.
Chairman Greenspan. No, because if you begin to move
significant parts of the existing social insurance system into
accounts which begin to create full funding, whereas left where
they were, they won't, then you do increase national savings
over time.
Senator Schumer. But that is a huge ``if.''
Chairman Greenspan. Well, no, it----
Senator Schumer. Because it will only increase full funding
if you dramatically cut a benefit. You have to do other changes
than simply move one to the other. What we are trying to get at
here is not the overall change that is needed, and I do not
think anyone disputes what you say, but whether setting up a
private account--under current conditions, not starting from
scratch--does anything to alleviate the problem.
Chairman Greenspan. In and of itself it surely does not
alleviate the current problem. Actions have to be taken.
Senator Schumer. Exactly.
Chairman Greenspan. I am merely saying that if you move to
private accounts and----
Senator Schumer. And.
Chairman Greenspan. --the financial markets have at least
partially discounted the contingent liabilities, then you are a
net plus, because then you have----
Senator Schumer. Right. Understood. Okay. But if they
haven't, you are not.
Chairman Greenspan. That is correct.
Senator Schumer. Okay. So it seems to me that what you
really are advocating here without saying it, which would truly
increase net savings, is what is called around here Social
Security Plus. Fix Social Security on its own and if you want
to do private accounts and increase net savings over the
present system, you do those in addition, whether it is for
savings or greater incentives, which 401(k)'s or whatever
mention; in other words, fix the present system and then do the
private accounts, not in replacement but in addition--do more
for net savings?
Chairman Greenspan. It depends on how you finance them. In
other words, the question here is if you are going to expand
401(k)'s, I think that is a desirable thing, too.
Senator Schumer. Exactly.
Chairman Greenspan. If you are going to set up another
program which is an entitlement, which----
Senator Schumer. No, no, no. I am just saying a 401(k) the
first. I am saying the first. That will do more to increase net
savings than simply shifting some money from the present system
to a so-called ``private account.'' I think that is
indisputable.
Chairman Greenspan. Well, 401(k)'s are private accounts,
so----
Senator Schumer. I understand. But in addition, as opposed
to replacement. Because you will have more net savings.
Chairman Greenspan. Yeah. No, no, I am not disagreeing with
you. I say that that is correct. I just want to make sure that
you are not talking about a new entitlement.
Senator Schumer. No, I am not. And furthermore, we would
have an easier time fixing Social Security if our debt went
down. It would have been easier to fix it 6 years ago or in
1983 than it is today because one of the great problems is all
the debt we have right now. Is that not fair to say, too?
Chairman Greenspan. I think that is fair to say.
Senator Schumer. Okay. Let me tell you just--I know my time
is up--it seems to me that what you are saying here is that
moving to the system that is outlined, that the President may
propose, is risky. It is risky because we do not know what the
markets will do if they see it, and at the same time it does
not increase overall net savings in and of itself. And I know
you do not want to say that, but it seems to me it is
inevitable and inexorable from what you have outlined here in
terms of those two parts. Where am I wrong there?
Chairman Greenspan. Senator, it is risky. Doing nothing is
risky. Doing any other solution to this is risky. We have this
huge hole in our long-term funding problem, and I know of no
way to resolve it without some risk. It is a question of which
risks are more likely to be----
Senator Schumer. Right. It seems to me what you are saying
is, just on the way the privatization accounts are proposed,
the risks far outweigh the benefits unless we do something else
with it.
Chairman Greenspan. That is the reason why I think that
starting slowly and finding out how it works is a very good
idea. Because if it turns out to be something which creates
problems, or if people do not like the thing--remember, it is a
voluntary issue and they may just choose not to take it. My own
judgment is when you have assets which you own, which you can
bequeath to your children, and which have your name on them
that is a highly desirable thing because you give wealth
basically to people in the lower- and middle-income groups who
have not had it before. Because remember, these private
accounts, even though they are forced savings, are indeed owned
by the people and they have wealth which they probably would
not have had before. So that I can conceive of these being
extraordinarily popular accounts. And if they are, I think it
is a very important addition to our society, because as you
know, I have been concerned about the concentration of income
and wealth in this Nation, as indeed your colleague has been as
well, and this in my judgment is one way in which you can
address this particular question.
Chairman Shelby. Senator Dole.
Senator Dole. I would like to ask you to discuss the issue
of rising health care costs and the impact on businesses. I
have heard from a number of North Carolina businesses that
rising costs are directly affecting their hiring decisions.
Could you give us your views on this area and whether or not
you believe it is having a negative effect on wage rates and
employment?
Chairman Greenspan. Senator, I think it is a very difficult
issue. And I think that to the extent we see that benefits are
going up and wages have flattened out, relatively speaking, a
goodly part of this is the fact that individuals are willing to
take health benefits in lieu of wages and salaries, but only in
part. So overall, there is no question that the net effect on
cost to businesses is rising.
My own judgment is that the Medicare problem is, of course,
several multiples more difficult than is Social Security. But I
am also of the belief that we probably ought not to address the
medical issue quite yet, until we get much further down the
road in the advance in information technology in the medical
area, which a number of individuals are looking into, and
indeed there are Members of this body on both sides of the
aisle who are focused on this issue, and I think, to the extent
that we can begin to get major advances in information
technology at an encrypted individual level, I think that best
clinical practice is going to change. And it is going to change
because we are going to see things that we already suspect, on
the basis of certain different types of surveys, namely, that
there are all different types of practices for specific
diseases across this country with very varying outcomes, and it
is largely the unavailability of all of the information which
has made the improvement in clinical practice difficult. And in
my judgment, we have to get to the point where the medical
profession, following from the information technology, creates
a best clinical practice, at which point I think that an
endeavor to address the problems that you are concerned with
and, in the broader sense, the medical profession generally is
concerned with, would be appropiate. If we were to do it now or
even next year, I am fearful we would be restructuring an
obsolete model and have to come back and undo it.
So, I agree with people who are saying we should do
Medicare first before Social Security because it is a much
bigger problem. I agree it is a hugely much more difficult
problem. But I am not sure I would agree with the issue of the
sequence, wholly because of what is now occurring in medicine.
Senator Dole. And let me ask you about manufacturing. As I
mentioned in my opening statement, and we all know, North
Carolina and a number of other States have been hit hard by the
loss of manufacturing jobs since 1998. According to the Bureau
of Labor Statistics, manufacturing employment has remained
level in the last year. Do you see growth in manufacturing in
this next year?
Chairman Greenspan. Senator, it is hard to tell. And the
reason is that it is very difficult to judge how fast
productivity is going to advance. As you know, productivity in
manufacturing has really been very impressive. The downside,
obviously, is it has created fewer job opportunities. And we
can reasonably assume that the economy is going forward at a
fairly good clip and that therefore the demand for manufactured
goods will continue reasonably significant. But it depends on
productivity growth, or I should say the extent to which
manufacturing jobs change one way or the other depends on
whether productivity growth goes up or slows down. It is very
tough to judge. So, I could not give you an answer, because I
have tried to forecast manufacturing employment and, I must
tell you, my record is not altogether terrific.
Senator Dole. Thank you, Mr. Chairman. My time has expired.
Chairman Shelby. Senator Stabenow.
Senator Stabenow. Thank you, Mr. Chairman. And welcome
again, thank you for your service and for your being with us
today.
I want to follow up on Senator Dole's questions on
manufacturing. I share her concerns. Michigan has had the same
type of, certainly, challenges as it relates to manufacturing.
But I first want to thank you for some insights in your
statement that you expand upon in your written statement more
than you are able to do as you spoke today, as it relates to
education. Because I think this is critically important, and I
appreciate your wisdom of your comments here and I think they
are comments that we should take very, very seriously. You talk
about, ``The failure of society to enhance the skills of a
significant segment of our workforce has left a
disproportionate share with less skills. The effect is a
widening wage gap between the skilled and the less-skilled.''
And then you go on to talk about ``In a democratic society,
such a stark bifurcation of wealth and income trends among
large segments of the population can fuel resentment and
political polarization,'' which I believe is happening today.
And I share your concern about the concentration of wealth and,
really, what I view as splitting of the middle class in this
country due to a host of issues.
But I think it is important to emphasize that you said that
strengthening elementary and secondary schooling in the United
States, especially in the core disciplines of math, science,
and written and verbal communications, is one crucial element
in avoiding such outcomes. I would not expect you to comment on
this, but I would just say for my colleagues, putting my budget
hat on, this is of deep concern to me when I see that one-third
of what has been proposed in the President's budget in terms of
cuts are in education. And I think that goes right to the heart
of what you speak about here. I would not necessarily expect
you to comment on the President's budget, but I think we should
be listening to you because we have huge wage and skill gaps
that will affect us for decades to come and we need to be
investing in skills and education.
Turning to a different subject, in terms of our debt, and
this actually goes back to my concerns on manufacturing, but it
relates indirectly to manufacturing when we look at our
dependency on in-flows of foreign capital to finance economic
activity. And then I would argue on the other hand our
difficulty in enforcing trade agreements against those who own
so much of our foreign debt. I think this is going to be making
it more and more difficult for us. I would welcome your
thoughts on that.
But when we look at the fact that--and I just have a small
chart, but in the last 4 years, foreign holdings of U.S.
Treasury debt has gone from basically a trillion to $1.85
trillion, and about half of that is owned by China and Japan.
People would be shocked to know who else owns our foreign debt,
as we are talking about financing private accounts through
Social Security or other privatization efforts or anything else
that we are doing for that matter--the war or anything else.
That South Korea, Taiwan, Germany, Hong Kong, OPEC,
Switzerland--we have a lot of foreign entities that hold
portions of our debt right now. And I am wondering at what
point, particularly when we are looking at $2 trillion, or we
are hearing now that 20 years down the road, two decades,
potentially $5 trillion in new debt added if in fact
privatization in some part goes into effect, of Social
Security, at what point do you believe that we should be
concerned that our foreign financing of our national debt is
becoming too great?
Chairman Greenspan. Senator, we have the difficult problem
that people find U.S. Treasury securities the safest in the
world. And it is not as though we are forcing them to go buy
our securities, nor do I believe we have any legal mechanism to
prevent them from buying them in the open market, which is what
they do. So, I am not sure how to address this issue because I
am not sure what we can do about it. The notion, however, which
came out, I think, a couple of weeks ago, that there was a
significant move toward selling off U.S. dollar instruments by
foreign central banks, that actually was not accurate. The
extent of holdings remains very heavy for dollars as a share of
their aggregate holdings. And part of the decline, very small,
is the very fact that if you take a portfolio with dollars and,
say, euros, and a dollar's price falls relative to the euro,
then the value of euros in dollar equivalents rises and that
therefore it looks as though the dollar has gone down as a
share of total outstanding portfolios, when indeed it has not.
That is basically what the case is.
But on the broader issue you are raising, I am not sure how
to handle that because I am not sure what the longer-term
implications are. You are quite correct at the moment,
excluding the U.S. Treasury debt held by the Federal Reserve,
half of our debt is owned abroad. And I would assume at some
point it has consequences, but I cannot tell you what they are.
Senator Stabenow. Mr. Chairman, is it not reasonable to
assume, though, that every time we are adding national debt, we
are adding opportunities for foreign investors to purchase
those bonds, so that one way to stop the foreign holdings
increasing would be to stop the national debt from increasing?
Chairman Greenspan. Well, we had believed we were going to
run the debt down to zero not that many years ago. That would
have solved the problem.
Senator Stabenow. I remember your being here with us in
2001, when we were talking about the wonderful problem of
having too large of a surplus and the question of what we do
about that.
I wonder if I might ask one further question. I know my
time has expired.
Chairman Shelby. Go ahead.
Senator Stabenow. Thank you, Mr. Chairman. One further
question. It is similar in terms of what is happening abroad
for us. Would it be your position that free-floating currency
is an essential element of efficient capital markets? And to
that end, would you be supportive of mechanisms whose goals are
to ensure that nations allow for floating currencies?
Chairman Greenspan. Well, in general I would say
flexibility, which is an extraordinarily valuable asset to the
world financial system, is clearly advanced by having
essentially a free-floating rate system--which is largely what
we have. The difficulty is that numbers of nations find dealing
with fluctuating or variable currencies difficult to handle for
lots of different reasons, and they choose on their own to lock
in against the euro or the dollar or a basket of something, and
accumulate or decumulate their foreign assets to sustain it. So
it is largely actions taken by foreigners, not something which
can be mandated by anybody. In other words, I am not sure of
the mechanism that, for example, the IMF would be involved in
to induce somebody to go from a fixed to a flexible rate. They
could suggest to them that it is in their interest. And indeed,
we do on numerous occasions. But there is no legal mechanism to
require it because they always have the capacity of purchasing
or selling dollar, yen, or euro, or Sterling assets in the
marketplace and thereby create a nonfloating currency.
Senator Stabenow. One mechanism--and I will close, Mr.
Chairman; thank you for your patience--but we do have in the
Banking Committee, I am sure we will be hearing from Secretary
Snow in his yearly report that he is required to give about
countries that may be pegging their currency. And certainly
many of us on both sides of the aisle have expressed concern,
particularly about China and what the impact of pegging their
currency has done in terms of the costs of goods and services
in our country as well as selling into their country. And so
there is a mechanism. If in fact the Treasury Secretary would
just simply certify that it is happening, at least
internationally, we would have the opportunity to make our
case. And I am hopeful the Secretary will do that before the
Committee later this spring.
Chairman Shelby. Thank you, Senator.
Senator Bennett.
Senator Bennett. Thank you, Mr. Chairman.
It has been a most illuminating morning, Mr. Greenspan, and
you have helped focus a lot of issues on this debate. The
debate, of course, has been primarily on Social Security. I had
some questions on the band of interest rates similar to Senator
Sarbanes, but I think you exhausted those with Senator Sarbanes
with your stating that the band of normal keeps changing, and
normal keeps changing. I would just hope in the Federal Open
Market Committee you might think that around a 3-percent band
has become normal in the present economy and not feel the need
to go to higher levels, which may have greater historic
patterns to them. And I am encouraged by your comment on that.
But the Social Security debate has dominated the morning,
so I will get into it as well and make the general statement
that I always make. There is no such thing as repetition in the
Senate, I have discovered, so you just keep saying it. Any
economic forecast that goes out more than 6 months is wrong. I
do not know whether it is wrong on the high side or the low
side. I just know that the way the economy works and all of the
changes that go in, if you get beyond 6 months you are getting
into difficult territory.
I believed that about the $5 trillion surplus. I knew that
number was wrong. I believed that about the projections of a $4
trillion deficit. I think now that number is wrong. It will be
different.
The one thing that is not wrong, that is much more
inexorable than an economic forecast is the demographic
forecast. The demographics are destiny, and they change very
slowly and over long periods of time. So, I am delighted to
have you in your presentation here and in your written
statement say that the demographic pressure on Social Security
is going to begin in 2008, not 2018, not 2042, not 2052 or
whatever, because that is the date when the demographics kick
in and say that we are going to have a 30-year period of
dramatic increase in the percentage of Americans who are over
65.
I am delighted to hear Senator Schumer, as you talk about
the fact that the present system is not working, say nobody
disputes that. I can quote some statements on the floor during
morning business where there are a lot of people who dispute
that and say this present system is working beautifully and we
do not need to do anything about it. And I am also delighted to
have Senator Schumer say in your dialogue that we should have
started on doing something about Social Security 10 years ago,
and it would be easier if we had started then instead of
waiting this long.
With that, let me get, however, to the point once again
that you were debating with Senator Schumer as to whether or
not a personal account would increase national savings. Your
point here is a block of tax money, 12.4 percent of payroll,
and you are saying if that portion which is currently coming
out of the employer's side goes to a personal account, it
produces no net increase in savings because the employer would
save that if he did not have to pay it and presumably would
invest it in capital stock, whatever, that would increase the
productivity and, therefore, the reason you want national
savings. So you could increase the national savings by saying
to the employer do not pay that anymore, invest it.
But that portion that comes out of the individual's side
gets invested in capital assets, which is different than how it
is being invested now. So doesn't that shift in the investment
strategy to capital assets as opposed to an accounting number
somewhere in the unified budget mean that you will, in fact,
get some increase in capital investment and, therefore, make a
contribution toward increasing the productivity of the economy?
Chairman Greenspan. Yes, Senator, I agree with that. Let me
just reiterate that what obscures the discussion is how to
handle the transition costs, which are the equivalent in one
form of a huge unfunded liability. But if you set that aside as
a consequence of the past and you merely ask which type of
vehicle has the greater probability of adding to national
savings in the example that you gave, clearly one which is
forced savings and, therefore, reduced consumption will add to
household or personal savings and, therefore, to national
savings.
If, however, you put it into the existing system and for
the moment leave aside the question of changes in the trust
fund, it is essentially a pay-as-you-go system, which does not
create national savings. And, therefore, the two models are
fundamentally different, and the complexity is how you go from
here to a differing system, and to a very large extent, one's
capacity to do that does rest with that issue of to what extent
of the financial markets taking the $10 trillion-plus
contingent liability and assumed its a cost or debt of the
Government and have set long-term U.S. Treasury interest rates
in the context that that is their target of what the supply of
debt is and, hence, that which moves the price and not the $4
trillion, which is the debt to the public, which is what
changes with the unified budget balance.
Senator Bennett. Well, I run a business, and you focus on
cashflow. And I remember very clearly the speech by the
President of the United States who said we are going to include
surpluses in the Social Security account as part of the overall
cashflow. His name was Lyndon Johnson, and it was during the
time he was discussing the Great Society. And Republicans were
claiming that he was running a budget deficit, and he said, No,
we are not running a budget deficit because we have this extra
money coming into Social Security. I remember that speech very
clearly because I was in town and involved in that at the time.
And ever since we went to a unified budget, on a cashflow basis
the surpluses in Social Security have reduced the cash needs of
the Government to meet its obligations.
Starting in 2008, that will begin to stop as the Social
Security surplus will begin to fall in the face of the
demographic arrival of the baby-boomers.
Chairman Greenspan. I think that what happens, however, is
that the rate of increase falls and, indeed, at 2018 is the
issue of when--
Senator Bennett. That is right.
Chairman Greenspan. --taxes fall below benefits. But you
are quite right. When you get into 2008, you begin to see the
leading edges effect, but because we still have--I think it is
$150 billion per year additions to the OASI surplus, that first
has to go to zero.
Senator Bennett. Yes, sure. That is right. But in terms of
the unified budget, the amount that we can get--``we'' being
the Government as a whole--from Social Security to deal with
the unified budget deficit begins to decrease in 2008.
Chairman Greenspan. That is correct.
Senator Bennett. And it becomes--when it gets to 2018 or
2020--again, economic forecasts are never exactly accurate.
When it gets to that point, we will already on a unified budget
point of view have had to raise our external borrowing, whether
it be Senator Stabenow's concern of China or whatever, to make
up the amount that we were not getting from the Social
Security. It will begin to produce a cashflow problem.
When it crosses the line, we will have to borrow that much
more because at that point the Social Security trust fund will
come to the Government and say redeem this bond, and the
Government will have to redeem the bond. It is a legitimate
claim on the Government. And then the Government says, in order
to redeem that bond, we will sell a bond to the Japanese or the
Europeans, or whoever, so that we can have the money to redeem
that bond. At that point the interest on the bond to the
Japanese or the Europeans will hit the unified budget pressure,
cashflow pressure, differently than the interest on the Social
Security bond. Isn't that true?
Chairman Greenspan. It depends on how the accounting goes.
Remember, what is going to happen in 2008, I believe, is you
begin to get the extent of the Social Security surplus, which
is part of the unified surplus. That begins to decline.
Senator Bennett. Right.
Chairman Greenspan. And you are quite correct, it means
that less and less is being added to the fund which reduces the
amount of borrowing that would be required. At 2018, if you
believe the numbers, what happens is that the Social Security
nonmarketable issues have to be converted to marketable, and
they are sold.
The issue of interest payment, remember, refers to interest
outside the intragovernmental transfers, and I do not think
that you get a significant interest rate effect there, but you
do get the issue that you are pointing out.
Senator Bennett. You do not get a significant rate
difference, but you get a significant cashflow difference,
because the intragovernment transfers--the interest obligation
is an intragovernment transfer, and you do not have to come up
with the cash for it. But once you have sold a bond on the
public market to replace the bond that is an intragovernment
transfer, that interest payment has to be met in cash rather
than the intragovernment transfer.
Chairman Greenspan. That is part of the whole issue of the
Social Security system going from accumulating surpluses to
then creating deficits.
Senator Bennett. Sure.
Chairman Greenspan. But the point that I think is a more
important and critical issue is that even those accumulations
of surpluses are far short of anything that requires the full
funding and that while you can be concerned about the
mechanics, I think quite properly, of what is happening, let us
not lose sight of the fact that the real problem is not that we
are going from a $150 billion annual OASI surplus. The problem
is that the number is not hugely larger and building up the----
Senator Bennett. My time is up, Mr. Chairman. The only
point I want to leave us with is that if we do nothing, as some
are suggesting, we have still got to find several trillion
dollars of additional cash. So when we say, gee, if we do the
private accounts, we are going to have to find some cash, that
is a transition cost. The point is if we do not do anything, we
have to find some cash.
Chairman Greenspan. It is the same cash.
Senator Bennett. Yes. Thank you.
Chairman Shelby. Senator Bayh.
Senator Bayh. Chairman Greenspan, thank you for your
patience today and your testimony. I apologize for shuttling in
and out. We are having a simultaneous hearing in the
Intelligence Committee on global threats to the Nation's
national security. So we are trying to deal with both our
physical security as well as our economic prosperity and
security today. And I appreciate your contributions to the
latter. And I might ask at the end of my questioning about the
intersection between these two things.
My first question deals with the deficit, and some comments
that you made recently, I think at a foreign forum of some
kind, about the voices of fiscal responsibility stirring here
in our Nation's capital. When I read those comments, I was
inclined to think it might be the triumph of hope over
experience, but I was interested to see you say it,
nonetheless.
So my question involves this: There are, as you know,
skeptics who have not heard those voices yet. One, in fact,
referred to the budget proposal as a Swiss cheese, more
interesting for its holes than anything else. And so I would
like to ask you, when we look back on this year and we can
quantify the size of the deficit for this year, what number
would tell you that it was something more than a siren song,
that, in fact, it is true fiscal harmony stirring? I think the
budget deficit this last year was $412 billion. When we look
back, you know, a year or so from now, what figure would you
look at and you would conclude those voices were more than just
rhetoric but, in fact, had been put into effect?
Chairman Greenspan. There are two aspects to this. One is
the short term, going out to, say, 2008 and then there is the
post-2008 issue. The most important thing would be to look at--
--
Senator Bayh. I am just looking for accountability to hold
all of us, the executive branch, the legislative branch, to
some benchmark of performance.
Chairman Greenspan. I have been traumatized by Senator
Bennett saying forecasts do not work out for 6 months, so I am
trying to avoid making a forecast out beyond 6 months.
I think that, first of all, if the deficit as a percent of
GDP does not go down, I think we are going into the 2008 are
forward period poorly positioned.
Senator Bayh. Do you have a figure in terms of percentage
of GDP you would look at to----
Chairman Greenspan. I would just as soon not put a number
because it depends on so many different things, and that number
in and of itself is----
Senator Bayh. Unlike the rest of us, Mr. Chairman, you will
have the luxury of reentering the private sector by that time.
So you perhaps have some more liberty to try and quantify these
things.
Chairman Greenspan. I would say that whatever it is we do
in the short-run, unless we start getting serious about the
longer-run problems, I think we are going to run into them and
be poorly positioned to effectively handle them without very
significant problems.
Senator Bayh. At some point when you feel comfortable, in
some forum, it really would help us to try and have some
benchmarks of performance against which we can judge all of
ourselves, both sides of the aisle, all branches of Government.
As you know, it is easy to talk about these things. It is a lot
more difficult to implement them and then hold ourselves to
some kind of standard.
Chairman Greenspan. Well, let me tell you one of the
reasons I hesitate: It is that the unified budget is not the
be-all and end-all of a measure of what Government is doing
because it is ultimately supposed to give us a judgment of the
allocation of real resources essentially preempted by the
Federal Government or, in fact, added if there is a surplus.
And the trouble is there are other ways in which Government can
preempt resources, either by regulation, by guarantees, which
are not fully accounted for in the budget, by any of a number
of different legal forms of preemption of property and the
like. So you cannot take only that as a measure of what the
overall issue is or its impact on interest rates.
At the end of the day, the standard of how well we are
doing really gets to the question of how have we financed this
and what are we doing. The financial markets will tell you very
quickly whether there is something wrong with the budget
processes, and rather than, say, get somebody to forecast and
say this is the standard, I will assure you the far more useful
standard is watching what is happening to long-term U.S.
Treasury rates. If long-term U.S. Treasury rates are behaving
well, it is saying you do not have a significant problem over
the maturity of Treasury instruments, most of the maturity. If
they start to behave poorly, the markets are sending a signal
which I think it is very crucial that the Congress be aware of.
Senator Bayh. I agree. This is a longer discussion. I am
afraid that if we wait--many observers, including myself, have
been surprised the markets have not reacted more than they have
to date. And I am afraid, as you know, market psychology being
what it is, if we reach that tipping point, it may require more
difficult steps to turn around than would be necessitated if we
act sooner rather than later.
But let me get to a second question, Mr. Chairman. I think
you know what I am driving at here. I am looking for some
benchmarks of performance against which to try and hold the
Government accountable when it comes to the deficit,
understanding that regulatory policy and other things also
contribute to economic performance.
Chairman Greenspan. One standard is if the unified budget
deficit is 2 percent of GDP or less, it stabilizes the ratio of
debt to GDP. So if you are looking at a straightforward
numerical type, that is not a bad one. But, again, I want to
caution you that it is a little simplistic, and I would not
want to press it too far.
Senator Bayh. We should be so fortunate as to get to 2
percent of GDP, and we could argue about the other factors that
might come into play. But thank you.
My second question, Chairman, perhaps you can help me--and
I again apologize I missed some of the discussion because I had
to attend the other hearing, and I am going to have to return
to the other hearing--with some cognitive dissonance I am
having over some of the debate here in Washington where, as
many of my colleagues and I think you alluded to, quite
rightly, we have this tremendous demographic challenge that is
going to affect our fiscal position coming along. We have the
underlying--the current budget problem, both of which are going
to--the latter of which necessitates borrowing in the short-
run, the latter of which is going to necessitate perhaps, if
nothing is done, large and ongoing borrowing in the long-run.
So we have that message that we have, you know, serious fiscal
challenges that we have to face that may necessitate large
amounts of borrowing.
At the same time, in the President's budget proposal we
have additional tax cuts included. So apparently we are in such
good fiscal condition that we can afford additional tax cuts,
and as you have convinced me in the past, there is no such
thing as a self-financing tax cut. We can argue about the
percentage of growth that is occasioned by that, but, you know,
there is a loss of revenue.
How do we reconcile these two positions? On the one hand,
we are facing large and perhaps ongoing needs to borrow, but,
on the other hand, we are flush enough with cash we can
continue with additional tax cuts at the same time.
Chairman Greenspan. The way I would do it is there are
certain of the tax cuts which I view as enhancing economic
growth and, therefore, enhancing the revenue base. I have been
arguing, since the PAYGO has been dropped in September 2002,
that we should restore it as quickly as possible. The way I
would reconcile my own position is that I think maintaining the
reduction in taxes on dividends, which essentially partially
integrates the individual and corporate taxes, eliminating part
of the double taxation on dividends, I think is a good thing.
But because I hold to the position that we should be adhering
to PAYGO, I think it is necessary to offset it by other means
as required by the law were PAYGO still in effect.
But I do not think you can essentially eliminate all tax
cuts or increased spending because you are endeavoring to get
the budget deficit down. You would probably argue, as I would,
that there are a number of things which should be done even if
we have this type of problem, but that does not mean that we
should not be focusing on the goal of getting the deficit down,
especially as quickly as we can before we begin to run into the
really serious problems maybe in 2012, 2014. We do not have a
great deal of time to do it.
Senator Bayh. Mr. Chairman, do I have time for just one
more?
Chairman Shelby. Hurry.
Senator Bayh. Very quickly. I want to ask you about our
comparative advantage looking forward, Mr. Chairman. You have
been a long-time observer of our economy. Here shortly you are
going to be liberated from the burdens of public responsibility
and might have a chance to reflect at greater length. But I was
struck in December when my wife and I were in India, in
Bangalore, and visited General Electric, who employs 6,000
people in our State. One of their worldwide innovation centers
was located in Bangalore. There is a biotech company there that
heretofore has been only engaged in generic production but is
now getting into proprietary discover.
Our economy--and my State is a good example. A hundred
years ago, most people were employed in agriculture. We
transitioned into manufacturing, which peaked in the 1950's. We
then transitioned into a service sector economy.
As succinctly as you can, how would you define, looking
forward, our comparative advantage in a world in which our
competitors--India, China, and the others--are rapidly moving
up the innovation curve?
Chairman Greenspan. I think, Senator, the question you are
asking is what creates the wealth of nations. And as best I can
judge, our comparative advantage has been a combination of our
Constitution and the skills of our workforce. It is not raw
materials. It is not anything other than what is in people's
heads and the laws of the land, the rule of law, the protection
of property rights, and a general view on the part of the rest
of the world that this is a wonderful place in which to invest
because property rights are sacrosanct to as extent that they
are not elsewhere.
Remember, there is an awful lot of investment that has come
into the United States. We have moved a lot of our investment
abroad, but a lot of investment has been moving here as well.
But the bottom line is that the only thing that we have which
maintains our standard of living, that which creates
essentially our ability to have a level of income which is a
claim against the rest of the world, the reason we are able to
do that is we create things, the ideas that we have. And we
have an economic system which capitalizes on the way those
ideas function, which most of the rest of the world, indeed
perhaps all of it, cannot match.
That is the reason why I have argued that our education
problems are serious because it is right at the root of where
our, as you put it, comparative advantage is.
Senator Bayh. So our comparative advantage lies in the rule
of law that we have and in the quality of our people.
I would just conclude by thanking you again, Mr. Chairman,
and observe, Chairman Shelby, I well recall Chairman Greenspan
in my previous incarnation, and I think, Corzine, this gets to
your point, and perhaps Tom Carper was there. I well recall
your addressing a meeting of the National Governors Association
many years ago on the issue of productivity growth and
mentioning that one of the most important things we could do to
increase productivity was to enhance the skill level of our
people, and that would help us close the increasing gap between
the haves and have-nots in our society and, indeed, improve the
comparative advantage of our society as a whole.
Thank you for your words, and the indulgence of my
colleagues.
Chairman Shelby. Thank you, Senator Bayh.
Senator Corzine, thank you for being so patient.
Senator Corzine. Thank you, Mr. Chairman.
I want to get to the integration of this issue of wealth
disparities or income disparities and the Social Security
question. First of all, I have a couple of just housekeeping
things.
Do you recall what the 1983 Commission used as far as a
time horizon to figure out its suggestions on solving the then
Social Security crisis? Was it an indefinite one, or was it an
actuarial----
Chairman Greenspan. No, it was 75 years, through 2058.
Senator Corzine. As I recall, and so you are now suggesting
that that was the wrong----
Chairman Greenspan. No, I am saying that it was wrong back
then, but the real problems which would be confronted as a
consequence of that were still 25 years off.
Senator Corzine. There is a huge difference between 3.7 and
10 whatever and----
Chairman Greenspan. The 3.7, let us put it this way, any
defined benefit program goes to perpetuity of necessity, so
that the 75-year is an artifice. I am not sure what it means.
We knew that back in 1983, but that was the historical
conventional----
Senator Corzine. Well, it does allow for thinking about
financing mechanisms that are within the mind-set of most of
the people who are in that workforce today, and a whole bunch
of them that are not even born yet. And so it strikes me that
one could reasonably--and I think actuarials often do--think in
some finite timeframe so that you are not actually trying to
solve some problem that is----
Chairman Greenspan. But Senator, I think it works fine for
the cash pay-as-you-go system, but it does nothing to create
the savings which creates the capital investment which creates
the goods and services that----
Senator Corzine. I could not agree more. I just wanted to
know whether in 1983 we were using 75.
Senator Sarbanes. Will you yield for a question?
Senator Corzine. Sure.
Senator Sarbanes. In 1983, did you say that in a few
months' time, the money being paid into the Social Security
trust fund would not be sufficient to pay the benefits?
Chairman Greenspan. Correct. What happened would be that
the trust fund was essentially running down to zero, which
statutorily required that we pay benefits only to the extent
that revenues came in.
Senator Sarbanes. So that is a situation comparable to what
is now forecast to happen in 2050, correct?
Chairman Greenspan. Well, 2042 or 2052, yes.
Senator Sarbanes. Okay.
Senator Corzine. I just want to reiterate, and this won't
take a second, but one is not arguing that the financing
structure that is being suggested by the President with private
accounts is dealing with that solvency issue, whether you use
75 years or you use infinity?
Chairman Greenspan. No. You mean the private accounts by
themselves, the personal accounts?
Senator Corzine. When we were dealing with this problem in
1983--and I think Senator Reed quoted, ``should not alter the
fundamental structure of the Social Security program or
undermine its fundamental principles,'' the fundamental
principles being guaranteed benefits for the disabled, child
and survivor benefits, and retirement.
I want to get at this because the fundamental principle is
a social insurance program, not an investment program, not a
defined benefit or a defined contribution program.
Chairman Greenspan. No. The question that you have to
answer is whether or not you want to commit to that,
irrespective of the source of revenue. Indeed, you know, we
have actually done that. I cannot believe, and did not believe
in 1983, that somehow or some way we would cut benefits. That
was not something which, in my judgment, seemed credible at
all. Nor do I believe that if the world were to emerge--and I
think that Senator Bennett is right. The one thing we are sure
of is it won't happen the way we are saying.
Senator Corzine. I think all of us accept that.
Chairman Greenspan. But if it did, the chances of cutting
benefits in 2042, for example, because we run out--I put that
probability close to zero, if I could not find a lower number.
Senator Corzine. It all depends on how you define that. I
mean, I think in 1983 you talked about changing the timeframe
in which people--we go on to extending the timeframe before
benefits would be received. One person would look at that and
say it is a benefit cut.
What I would like to get to is that the fundamental
financing structure still has variables that you could adjust
to deal with even the $10 trillion gap.
Chairman Greenspan. Oh, absolutely.
Senator Corzine. So there are solutions and they are easier
to implement if we do them sooner rather than later, which is
what was done in 1983, which was to build up these surpluses.
Unfortunately, we turned around and spent them for current
expenses on the cashflow basis that Senator Bennett talked
about, but there was a desire to prefund liabilities that was
embedded in the recommendations.
We have prefunded them, but because of the reality of the
unified budget, we have taken payroll taxes to pay for tax cuts
or wars or whatever the expenditure or reduction of revenues
has been. If I am not mistaken, just on an accounting basis,
payroll taxes come in, they go out for some other purpose with
a bunch of borrowing going on.
My real question is, because I think the fundamental
principles are still sound, that there is need for social
insurance on disability, child and survivor benefits, and for
seniors. My own view is we may have to deal with the financing
structure, and you have had great ideas in the past.
This is going to be hard for you to see, but actually the
only thing that really counts--and I worry about this very
deeply--is that because of a lot of the reasons you have talked
about, skill sets and others, real earnings for the bottom
decile in our country have actually declined in the last 4
years. They are flat for the 25th percentile. They are up a
measly two-tenths of 1 percent for the median percentile, and
they are a little bit better for the 75th percentile and the
90th percentile. I wonder what they are for the 1 percent. We
did not have it on this chart. I suspect real earnings have
gone up pretty well for the most skilled in our society.
But aren't we setting up a situation, if we take away
guaranteed benefits, that the vast majority of people in this
society are going to end up with less savings? Maybe we can
have broad changes in our educational skill levels development
in our society, but otherwise we are going to end up with a
society that has less ability to save and we are talking about
the guaranteed benefit.
Chairman Greenspan. Well, the guaranteed benefits are, I
think, unrelated to this question which you raise with which I
would agree, namely obviously the lower the level of income,
the less capability----
Senator Corzine. If the individuals do not have the
capacity to save, then we get back to a situation that we have
had in other periods in history where those most vulnerable in
society do not have the ability to maintain an above-poverty
standard of living, which is where we came from before Social
Security was implemented both for children and the disabled.
Chairman Greenspan. But Social Security--it depends on
whether you are discussing the Social Security for retirees. In
other words, that is different. What I am trying to get at is
the issue that you are raising with respect to the shortfall of
incomes of those below the median or just above the median is--
--
Senator Corzine. Fifty percent of the workforce.
Chairman Greenspan. Yes, it is the active workforce. To the
extent that real wages fall in that area, one would presume
that their savings rates fall as well because that is what
people do when their incomes go down. I think the question of
Social Security and the guarantees and the like is a somewhat
different issue. But I think there is also a very interesting
question here.
Senator Corzine. Well, that was the fundamental principle
of Social Security, though, was to provide guaranteed benefits
for all. That was the contract.
Chairman Greenspan. Well, it was mainly for retirees. We
now, because we have DI, disability, which is a different
program, we have a lot of people under OASI who are below the
so-called retirement age. But the basic purpose is a retirement
program.
Senator Sarbanes. And survivorship, too.
Senator Corzine. And survivorship.
Chairman Greenspan. That is the basic purpose of it. The
problem here is I think we have to make some decisions on
whether we want to make programs as social insurance or means-
test programs and make them essentially for people who are in
really serious difficulty.
Senator Corzine. That is getting at a financial structural
solution which you could put into any suggestion that would be
independent of whether you had personal accounts.
Chairman Greenspan. I agree with that.
Senator Corzine. Finally, I know my time is up, but you
have, and I think appropriately so, said forced savings as you
have described the private accounts.
Chairman Greenspan. It is forced in the sense that they
should not be available for other than retirement purposes.
Senator Corzine. Forced savings is not unlike forced
savings at a national level with regard to taxes, I suppose. I
mean, they are roughly the same equivalent with regard to
getting to whether we have increased savings. If we run
deficits and the Government is spending more than it is taking
in, you end up with this declining savings rate or hole in our
savings function.
But you do have choices and we have avoided those choices
pretty clearly as we have built up these deficits in the last 4
years. And it strikes me that along the lines of what Senator
Bayh was talking about you may not know what the right number
is, but if you look at 2009 and beyond--and this is the point
that I want to make--I hear this described as a $743 billion
hole in the first 10 years in this transition to private
accounts.
The fact is that allows for the fact that we are not doing
anything between 2005 and 2009, and then we will get to 2009
and find out it is $1.4 trillion, like we found out on
Medicare. We need to have some truth or precision in what it is
we are comparing and contrasting when we are comparing these
numbers. I am afraid that we are using multiple sets of books
under the rubric of a unified budget.
I guess that is more of a statement than it is a question,
but the fact is that somebody is going to say $735 billion
doesn't meet the Greenspanian test of serious borrowing when,
in fact, we are just avoiding the first 4 years and then we are
going to start it in 2009. I just want to make sure we get that
clear.
Chairman Greenspan. I think the issue essentially is that
savings, as you know as well as I, doesn't create investment.
Implicit in all of this is that the incentives for investment
are there and that when you think in terms of taxation and how
one creates the savings, it is conceivable that you can create
the savings, but regrettably at the same time so diffuse the
incentives to invest that we will not get the capital assets we
need to essentially produce the goods and services.
So proper balance here, I think, is quite important, and I
think that it is an extraordinarily complex and difficult
issue. We have known about the demographics for quite a long
time, but we have never really addressed them. And it is only
now that we are beginning to see the significance of how big
the size of the hole is.
Senator Corzine. Mr. Chairman, I----
Chairman Shelby. Go ahead.
Senator Corzine. That is true, but we have a Medicare
problem, a Medicaid problem, a pension benefit guarantee
problem. These figures, when you use the 75-year horizon, which
I tend to do, I think an estimate we heard in the Budget
Committee of something like $43 trillion. Even using a 75-year
horizon, Social Security is 3.7 of that.
Chairman Greenspan. In fact, actually, I believe I have
that number.
Senator Corzine. We need to really make sure that we are
looking at where the problem really is if we are going to be
intellectually honest about getting at these issues.
Senator Sarbanes. In fact, Chairman Greenspan, you said
before this Committee in February, 2 years ago, ``The really
major fiscal problem is not Social Security. It is Medicare.''
Chairman Greenspan. I agree with that.
Chairman Shelby. Senator Carper.
STATEMENT OF SENATOR THOMAS R. CARPER
Senator Carper. Thank you, Mr. Chairman.
Chairman Greenspan, welcome. Sometimes, when I speak to a
group back in Delaware and I am the last speaker before they
have a meal, I will say to them I am all that stands between
you and your meal.
Chairman Shelby. Maybe not. You have the two of us left
here again.
Senator Carper. Is that right?
When I have a witness who has been sitting for hours and
hours testifying without a break and I am the last person to
ask a question, I will say I am all that stands between you and
a chance to visit the nearest restroom. I won't say that today,
but I might say it on another occasion.
We have talked a lot about Social Security today, and I
want to beat a dead horse--well, actually, a live horse. I want
to ask you to go back in time with me about 23 or 24 years. I
sit on another Committee called Governmental Affairs and
Homeland Security. Last August, among our witnesses were
Governor Kean and former Congressmen Lee Hamilton, and they had
come to us that day to present the recommendations of a
bipartisan commission, 10 members, five appointed by the
President and five appointed by the Democratic leadership of
the Congress.
They recommended to us unanimously that we take 44
different steps as a follow-up to the attacks of September 11.
I remember saying to Governor Kean and Congressman Hamilton,
how did you do this? In a politically charged time and arena,
with a diverse group of people on your commission, how did you
fashion a bipartisan consensus on all these issues? There were
literally 10 to zero votes on all of them.
They said in response what happened is that the two of
them, the Chair and the Vice Chair, one appointed by the
President, the other appointed by Senator Daschle and
Congresswoman Pelosi--they said we spent a lot of time together
over the last 2 years and we got to know each other and
developed a sense of trust for each, and friendship. And out of
that bond came an environment for the rest of the commission to
band together and to join together, setting aside their
partisan differences, just to work to try to do what was right
for the country.
I was elected to the House in 1982 and joined a young Mr.
Shelby down there. I like to say I knew him when he was a
Democrat. We were both on the House Banking Committee. We used
to work out in the House gym together. Now, we work out in the
Senate gym together.
When I joined him, I found out on January 3, 1983, which
was the day I was sworn into the House, that we had a crisis
with respect to Social Security and that we needed to do
something about it. I had always heard talk about it. I talked
a little bit about it when I ran in 1982 for the House, but I
found that in 1983 this was real and there was a real crisis
and we faced the possibility of running out of money.
Fortunately, you and a number of other people had been, I
think, appointed by President Reagan and I think by Tip
O'Neill, and maybe by Robert Byrd. Whoever was the Democratic
Leader of the Senate, I think, made appointments to another
bipartisan commission that worked, I believe, throughout 1982
and came to us in 1983 with a host of recommendations.
The way I like to describe it is we joined hands, the House
and Senate Democrats and Republicans, and we either jumped off
the bridge or we drank the Kool-Aid together, and end up
adopting lock, stock, and barrel all your recommendations. We
passed them and set Social Security on a more sound footing for
several more decades.
What I want to ask you is really the same question I asked
Lee Hamilton and to Kean. I think you were the Chair or the
Vice Chair or the Co-Chair of the commission, as I recall. How
were you able to create at that time a unanimity across party
lines on a politically charged, difficult issue to be able to
present to us a consensus perspective and recommendations that
we adopted?
Chairman Greenspan. Well, I would hope so. It was done
actually in two ways. The first was that one of the senior
commissioners was an expert and appointee of Tip O'Neill, Bob
Ball, who is still around.
Senator Carper. Yes.
Chairman Greenspan. He and I merged in the sense that he
would represent the Speaker and report back to him about what
the various choices were, and I would report back to Jim Baker
and President Reagan. And so we kept a line going between the
decisionmakers in the White House and the Congress as the
commission moved forward from position to position, and in a
sense worked concurrently both within the commission and in the
Congress and in the White House so that we did not find that at
the end of the day the commission came out one place and there
was no support back with the Speaker or the President.
So that occurred, and then at the end we came up with a
report, and Bob Ball and I went up to the Ways and Means
Committee to testify on the report and we indicated that it is
an up-or-down vote. I said to Ball, when the Republicans ask
you a question, I will answer it and I hope you will answer the
questions that the Democrats ask me.
It worked remarkably well, and the reason it did is,
similar to the Kean-Hamilton relationship. Remember, we had Pat
Moynihan and Claude Pepper and Bob Dole, and I do not know
whether Jack Heinz was on that.
Senator Carper. He was.
Chairman Greenspan. It was a pretty formidable group of
people and what we eventually decided was that the commission
report was a compromise, and that it was up or down. In other
words, we argued that this should not be subject to amendment
because if it were, it would unwind the whole compromise. And
with very minor exceptions, the Senate and the House both
agreed with that, and what came out was essentially the
commission report preagreed to by the Speaker of the House--and
I think Jake Pickle was at Ways and Means at that time--and
President Reagan. So, essentially, the agreement did not occur
as a commission report and then it went to the Congress. I
suspect that rarely, if ever, works.
Senator Carper. Would you just refresh my memory. My
recollection is that President Reagan appointed some of the
members, that Tip O'Neill appointed some of the members, and
that perhaps the Democratic Leader of the Senate appointed some
of the members. Do you recall?
Chairman Greenspan. I think that is correct. It was a
national commission which would be presented in the form that
you suggest, Senator.
Senator Carper. And my recollection is the commission was
created maybe in the second half of 1981, and that you worked
through 1982 and presented your recommendations to us in 1983.
Chairman Greenspan. I think that is probably correct. I do
not remember the actual date it began.
Senator Carper. Do you think that the way that the
commission members were selected--that is, some by the
President and the Republicans, and some by some of the
Congressional leaders who in that case were Democrats--do you
think that had maybe some bearing on the fact that you were
able to bring a consensus proposal to us?
Chairman Greenspan. You know as well as I, there was a far
greater degree of comity back then, and I think that what we
need is a good deal more of that. But primarily what you need
is a bipartisan group of people getting together who have the
capacity not only to reach a compromise agreement, which means
that there are parts of that agreement with which everyone in
the room disagrees and present it as an up-or-down type of
issue. You need a mechanism in which that occurs because you
cannot have a particular commission report subject to
continuous revision.
I remember on another commission that I was on, one of the
members said I would like to agree with you at this particular
stage, but since this is not the final negotiation, I do not
want to state my position at this particular point. And it was
a perfectly sensible operation, and indeed we did not get very
far basically because of that problem.
So you have to figure a way in which the final decisions
are made concurrently with the commission and the Congress,
because if you leave those types of results, especially things
which are compromises, they get amended to death and it unwinds
the whole agreement.
Senator Carper. Mr. Chairman, thanks very, very much.
Chairman Shelby. Thank you for bringing that up. Chairman
Greenspan, we need to find another Chairman Greenspan in the
making out there somewhere to put this type of thing together.
I have a couple of questions and I will try to be quick.
One of the Social Security reform options--and there are
many out there and there will probably be many more--that has
been mentioned is changing the way that benefits are adjusted
over time, or indexing. Today, it is my understanding that the
indexing is based on wages, mainly, as opposed to an inflation-
based index.
What impact would such a change to an inflation-based index
have on the financial soundness of the Social Security program
in the years to come?
Chairman Greenspan. Well, Senator, currently we index the
initial benefit.
Chairman Shelby. Explain how that works.
Chairman Greenspan. Well, what they do is they effectively
take an average of wages over a long period of time and they
construct effectively a specific benefit that is the initial
benefit.
Chairman Shelby. For an individual.
Chairman Greenspan. For the individual.
Chairman Shelby. Okay.
Chairman Greenspan. The intial benifit is thereafter
indexed by inflation, so that the real benefit doesn't change
after retirement, whether it is at 62 or 65. And trying to get
the average wage as the index creates a much higher initial
benefit than were you to use prices retrospectively and the
reason is that wages will reflect productivity increases,
whereas prices will not.
If you, however, now substitute prices for wages in
creating the initial benefit, you will have essentially a
benefit which, whereas now its ratio to your previous income
has been stable, will begin to fall through time. And if you
make a full adjustment going from a so-called wage-adjusted
initial benefit to a price-adjusted initial benefit----
Chairman Shelby. Initial benefit is what you are talking
about?
Chairman Greenspan. I am sorry?
Chairman Shelby. You are talking about initial benefit.
Chairman Greenspan. Initial benefit. You effectively wipe
out all of that $10 trillion that I have been mentioning.
Chairman Shelby. Over many years?
Chairman Greenspan. Yes, but as a number of people have
mentioned, the replacement ratio, which is not around 40
percent, as I recall, starts to go down materially. One of the
issues that is involved here is that with the demographics that
we are looking at, in most of the scenarios the replacement
rate would go down in any event.
Chairman Shelby. Any event.
Chairman Greenspan. And the only issue is to what extent.
So it is not a question of being capable of holding that 40
percent indefinitely without causing problems in the standards
of living of the active working population at that time.
Chairman Shelby. Chairman Greenspan, what about if you are
55 years of age and you have just retired? If they were to go
to the inflation-based index for the future, what would that do
to the retirees? Or let's say you are drawing Social Security
now and you are 70 years of age. Let's say you are drawing
Social Security now. What would that do to the future?
Chairman Greenspan. It would have no effect.
Chairman Shelby. No effect on the people that are retired?
Chairman Greenspan. It is the initial benefit.
Chairman Shelby. Initial when you retired, isn't it?
Chairman Greenspan. I am sorry?
Chairman Shelby. When you initially start computing it?
Chairman Greenspan. Yes. Once you are retired and you are
getting a benefit, that is indexed by the Consumer Price Index
and that is not involved in this change, as I understand it.
Chairman Shelby. But it is something that as things are put
on the table we all should maybe consider anyway. Is that
correct?
Chairman Greenspan. I think that it is one of the most
effective ways to come to grips at closing the actual gap
between expected revenues and expected benefits. There are a
lot of other things you can do, but the impact is fairly
substantial from that change.
Chairman Shelby. I want to touch on one last thing. Your
written testimony Mr. Chairman, notes that the low national
savings rate could eventually slow the rise in living standards
either by increasing the burden of servicing U.S. foreign debt
or by impinging on domestic capital formation.
To what extent will the anticipated further increases in
interest rates affect this possibility?
Chairman Greenspan. Well, it has two effects, in a sense.
One, if real interest rates rise, one would presume that the
incentives to invest would fall. It will concurrently
presumably attract funds into the United States because of the
rates of return. I do not think you could make a judgment as to
what the overall impact is, but it is one of the issues.
Far more important, for example, is the differential growth
rates between the trading partners. Clearly, the exchange rate
has an impact. Interest rates have a number of different
effects, but they are rarely critical in the issue of
determination of the current account balance.
Chairman Shelby. Mr. Chairman, last week Atlanta Federal
Reserve President Jack Gwynn, in an interview with The Wall
Street Journal, said, as I understand it, that the central bank
could soon remove the word ``measured'' and the word
``accommodation'' from the official statement.
What is your view as to whether such a change in the FOMC's
message is likely, and what would such an action tell us about
the likely course of action in the future as far as interest
rate increases or movement?
Chairman Greenspan. Well, I think what President Gwynn was
saying was obvious. We are not going to have the same statement
in perpetuity. At some point, it is going to change. I cannot
really comment on when and under what conditions because that
is a decision that the Federal Open Market Committee has to
make.
Chairman Shelby. Mr. Chairman, thank you for your
appearance here today and we will see you a lot probably before
the year is over. Thank you very much.
Chairman Shelby. The hearing is adjourned.
[Whereupon, at 1:01 p.m., the hearing was adjourned.]
[Prepared statement, response to written questions, and
additional material supplied for the record follow:]
PREPARED STATEMENT OF SENATOR WAYNE ALLARD
Thank you, Chairman Greenspan for coming to the Senate today to
share the Federal Reserve's Semi-Annual Monetary Policy Report to the
Congress. This Committee and the Congress greatly benefit from your
reports and visits, and the expertise that you offer to us and the
Country.
The economy is healthy and expanding, with GDP having increased in
both the third and fourth quarters of 2004. Productivity and output
both increased as well during the last months of 2004. We have even
seen recent increases in exports and a decrease in the U.S. current
account deficit.
The Federal Reserve Board has done a good job at monitoring
monetary policy and economic indicators in order to see that policy
remains accommodative to the ebbs and flows of the U.S. economy. Their
steadfastness in recognizing the immediate monetary needs and adjusting
policy accordingly is to be commended. Dr. Greenspan, I appreciate your
commitment to this Committee, the Congress, and this country. I look
forward to hearing your evaluation and insights on monetary policy, the
condition of the economy, and your forecast for the next several
months. Thank you, Chairman Greenspan for coming to the Senate today to
share the Federal Reserve's Semi-Annual Monetary Policy Report to the
Congress. This Committee and the Congress greatly benefit from your
reports and visits, and the expertise that you offer to us and the
Country. The economy is healthy and expanding, with GDP having
increased in both the third and fourth quarters of 2004. Productivity
and output both increased! as well during the last months of 2004. We
have even seen recent increases in exports and a decrease in the U.S.
current account deficit. The Federal Reserve Board has done a good job
at monitoring monetary policy and economic indicators in order to see
that policy remains accommodative to the ebbs and flows of the U.S.
economy. Their steadfastness in recognizing the immediate monetary
needs and adjusting policy accordingly is to be commended.
Dr. Greenspan, I appreciate your commitment to this Committee, the
Congress, and this country. I look forward to hearing your evaluation
and insights on monetary policy, the condition of the economy, and your
forecast for the next several months.
----------
PREPARED STATEMENT OF ALAN GREENSPAN
Chairman, Board of Governors of the Federal Reserve System
February 16, 2005
Mr. Chairman and Members of the Committee, I am pleased to be here
today to present the Federal Reserve's Monetary Policy Report to the
Congress. In the 7 months since I last testified before this Committee,
the U.S. economic expansion has firmed, overall inflation has subsided,
and core inflation has remained low.
Over the first half of 2004, the available information increasingly
suggested that the economic expansion was becoming less fragile and
that the risk of an undesirable decline in inflation had greatly
diminished. Toward mid-year, the Federal Reserve came to the judgment
that the extraordinary degree of policy accommodation that had been in
place since the middle of 2003 was no longer warranted and, in the
announcement released at the conclusion of our May meeting, signaled
that a firming of policy was likely. The Federal Open Market Committee
began to raise the Federal funds rate at its June meeting, and the
announcement following that meeting indicated the need for further,
albeit gradual, withdrawal of monetary policy stimulus.
Around the same time, incoming data suggested a lull in activity as
the economy absorbed the impact of higher energy prices. Much as had
been expected, this soft patch proved to be short-lived. Accordingly,
the Federal Reserve has followed the June policy move with similar
actions at each meeting since then, including our most recent meeting
earlier this month. The cumulative removal of policy accommodation to
date has significantly raised measures of the real Federal funds rate,
but by most measures, it remains fairly low.
The evidence broadly supports the view that economic fundamentals
have steadied. Consumer spending has been well-maintained over recent
months, buoyed by continued growth in disposable personal income, gains
in net worth, and accommodative conditions in credit markets.
Households have recorded a modest improvement in their financial
position over this period, to the betterment of many indicators of
credit quality. Low interest rates and rising incomes have contributed
to a decline in the aggregate household financial obligation ratio, and
delinquency and charge-off rates on various categories of consumer
loans have stayed at low levels.
The sizable gains in consumer spending of recent years have been
accompanied by a drop in the personal saving rate to an average of only
1 percent over 2004--a very low figure relative to the nearly 7 percent
rate averaged over the previous three decades. Among the factors
contributing to the strength of spending and the decline in saving have
been developments in housing markets and home finance that have spurred
rising household wealth and allowed greater access to that wealth. The
rapid rise in home prices over the past several years has provided
households with considerable capital gains. Moreover, a significant
increase in the rate of single-family home turnover has meant that many
consumers have been able to realize gains from the sale of their homes.
To be sure, such capital gains, largely realized through an increase in
mortgage debt on the home, do not increase the pool of national savings
available to finance new capital investment. But from the perspective
of a! n individual household, cash realized from capital gains has the
same spending power as cash from any other source.
More broadly, rising home prices along with higher equity prices
have outpaced the rise in household, largely mortgage, debt and have
pushed up household net worth to about 5\1/2\ times disposable income
by the end of last year. Although the ratio of net worth to income is
well below the peak attained in 1999, it remains above the long-term
historical average. These gains in net worth help to explain why
households in the aggregate do not appear uncomfortable with their
financial position even though their reported personal saving rate is
negligible.
Of course, household net worth may not continue to rise relative to
income, and some reversal in that ratio is not out of the question. If
that were to occur, households would probably perceive the need to save
more out of current income; the personal saving rate would accordingly
rise, and consumer spending would slow.
But while household spending may well play a smaller role in the
expansion going forward, business executives apparently have become
somewhat more optimistic in recent months. Capital spending and
corporate borrowing have firmed noticeably, but some of the latter may
have been directed to finance the recent backup in inventories. Mergers
and acquisitions, though, have clearly perked up.
Even in the current much-improved environment, however, some
caution among business executives remains. Although capital investment
has been advancing at a reasonably good pace, it has nonetheless lagged
the exceptional rise in profits and internal cashflow. This is most
unusual; it took a deep recession to produce the last such
configuration in 1975. The lingering caution evident in capital
spending decisions has also been manifest in less-aggressive hiring by
businesses. In contrast to the typical pattern early in previous
business-cycle recoveries, firms have appeared reluctant to take on new
workers and have remained focused on cost containment.
As opposed to the lingering hesitancy among business executives,
participants in financial markets seem very confident about the future
and, judging by the exceptionally low level of risk spreads in credit
markets, quite willing to bear risk. This apparent disparity in
sentiment between business people and market participants could reflect
the heightened additional concerns of business executives about
potential legal liabilities rather than a fundamentally different
assessment of macroeconomic risks.
Turning to the outlook for costs and prices, productivity
developments will likely play a key role. The growth of output per hour
slowed over the past half year, giving a boost to unit labor costs
after 2 years of declines. Going forward, the implications for
inflation will be influenced by the extent and persistence of any
slowdown in productivity. A lower rate of productivity growth in the
context of relatively stable increases in average hourly compensation
has led to slightly more rapid growth in unit labor costs. Whether
inflation actually rises in the wake of slowing productivity growth,
however, will depend on the rate of growth of labor compensation and
the ability and willingness of firms to pass on higher costs to their
customers. That, in turn, will depend on the degree of utilization of
resources and how monetary policymakers respond. To date, with profit
margins already high, competitive pressures have tended to limit the
extent to which cost pressures have ! been reflected in higher prices.
Productivity is notoriously difficult to predict. Neither the large
surge in output per hour from the first quarter of 2003 to the second
quarter of 2004, nor the more recent moderation was easy to anticipate.
It seems likely that these swings reflected delayed efficiency gains
from the capital goods boom of the 1990's. Throughout the first half of
last year, businesses were able to meet increasing orders with
management efficiencies rather than new hires. But conceivably the
backlog of untapped total efficiencies has run low, requiring new
hires. Indeed, new hires as a percent of employment rose in the fourth
quarter of last year to the highest level since the second quarter of
2001.
There is little question that the potential remains for large
advances in productivity from further applications of existing
knowledge, and insights into applications not even now contemplated
doubtless will emerge in the years ahead. However, we have scant
ability to infer the pace at which such gains will play out and,
therefore, their implications for the growth of productivity over the
longer-run. It is, of course, the rate of change of productivity over
time, and not its level, that influences the persistent changes in unit
labor costs and hence the rate of inflation.
The inflation outlook will also be shaped by developments affecting
the exchange value of the dollar and oil prices. Although the dollar
has been declining since early 2002, exporters to the United States
apparently have held dollar prices relatively steady to preserve their
market share, effectively choosing to absorb the decline in the dollar
by accepting a reduction in their profit margins. However, the recent
somewhat quickened pace of increases in U.S. import prices suggests
that profit margins of exporters to the United States have contracted
to the point where the foreign shippers may exhibit only limited
tolerance for additional reductions in margins should the dollar
decline further.
The sharp rise in oil prices over the past year has no doubt
boosted firms' costs and may have weighed on production, particularly
given the sizable permanent component of oil price increases suggested
by distant-horizon oil futures contracts. However, the share of total
business expenses attributable to energy costs has declined appreciably
over the past 30 years, which has helped to buffer profits and the
economy more generally from the adverse effect of high oil and natural
gas prices. Still, although the aggregate effect may be modest, we must
recognize that some sectors of the economy and regions of the country
have been hit hard by the increase in energy costs, especially over the
past year.
Despite the combination of somewhat slower growth of productivity
in recent quarters, higher energy prices, and a decline in the exchange
rate for the dollar, core measures of consumer prices have registered
only modest increases. The core PCE and CPI measures, for example,
climbed about 1\1/4\ and 2 percent, respectively, at an annual rate
over the second half of last year.
All told, the economy seems to have entered 2005 expanding at a
reasonably good pace, with inflation and inflation expectations well
anchored. On the whole, financial markets appear to share this view. In
particular, a broad array of financial indicators convey a pervasive
sense of confidence among investors and an associated greater
willingness to bear risk than is yet evident among business managers.
Both realized and option-implied measures of uncertainty in equity
and fixed-income markets have declined markedly over recent months to
quite low levels. Credit spreads, read from corporate bond yields and
credit default swap premiums, have continued to narrow amid widespread
signs of an improvement in corporate credit quality, including notable
drops in corporate bond defaults and debt ratings downgrades. Moreover,
recent surveys suggest that bank lending officers have further eased
standards and terms on business loans, and anecdotal reports suggest
that securities dealers and other market-makers appear quite willing to
commit capital in providing market liquidity.
In this environment, long-term interest rates have trended lower in
recent months even as the Federal Reserve has raised the level of the
target Federal funds rate by 150 basis points. This development
contrasts with most experience, which suggests that, other things being
equal, increasing short-term interest rates are normally accompanied by
a rise in longer-term yields. The simple mathematics of the yield curve
governs the relationship between short- and long-term interest rates.
Ten-year yields, for example, can be thought of as an average of 10
consecutive 1 year forward rates. A rise in the first-year forward
rate, which correlates closely with the Federal funds rate, would
increase the yield on 10-year U.S. Treasury notes even if the more-
distant forward rates remain unchanged. Historically, though, even
these distant forward rates have tended to rise in association with
monetary policy tightening.
In the current episode, however, the more-distant forward rates
declined at the same time that short-term rates were rising. Indeed,
the tenth-year tranche, which yielded 6\1/2\ percent last June, is now
at about 5\1/4\ percent. During the same period, comparable real
forward rates derived from quotes on Treasury inflation-indexed debt
fell significantly as well, suggesting that only a portion of the
decline in nominal forward rates in distant tranches is attributable to
a drop in long-term inflation expectations.
Some analysts have worried that the dip in forward real interest
rates since last June may indicate that market participants have marked
down their view of economic growth going forward, perhaps because of
the rise in oil prices. But this interpretation does not mesh
seamlessly with the rise in stock prices and the narrowing of credit
spreads observed over the same interval. Others have emphasized the
subdued overall business demand for credit in the United States and the
apparent eagerness of lenders, including foreign investors, to provide
financing. In particular, heavy purchases of longer-term Treasury
securities by foreign central banks have often been cited as a factor
boosting bond prices and pulling down longer-term yields. Thirty-year,
fixed-rate mortgage rates have dropped to a level only a little higher
than the record lows touched in 2003 and, as a consequence, the
estimated average duration of outstanding mortgage-backed securities
has shortened appreciably ! over recent months. Attempts by mortgage
investors to offset this decline in duration by purchasing longer-term
securities may be yet another contributor to the recent downward
pressure on longer-term yields.
But we should be careful in endeavoring to account for the decline
in long-term interest rates by adverting to technical factors in the
United States alone because yields and risk spreads have narrowed
globally. The German 10-year Bund rate, for example, has declined from
4\1/4\ percent last June to current levels of 3\1/2\ percent. And
spreads of yields on bonds issued by emerging-market nations over U.S.
Treasury yields have declined to very low levels.
There is little doubt that, with the breakup of the Soviet Union
and the integration of China and India into the global trading market,
more of the world's productive capacity is being tapped to satisfy
global demands for goods and services.
Concurrently, greater integration of financial markets has meant that a
larger share of the world's pool of savings is being deployed in cross-
border financing of investment. The favorable inflation performance
across a broad range of countries resulting from enlarged global goods,
services, and financial capacity has doubtless contributed to
expectations of lower inflation in the years ahead and lower inflation
risk premiums. But none of this is new and hence it is difficult to
attribute the long-term interest rate declines of the last 9 months to
glacially increasing globalization. For the moment, the broadly
unanticipated behavior of world bond markets remains a conundrum. Bond
price movements may be a short-term aberration, but ! it will be some
time before we are able to better judge the forces underlying recent
experience.
This is but one of many uncertainties that will confront world
policymakers. Over the past two decades, the industrial world has
fended off two severe stock market corrections, a major financial
crisis in developing nations, corporate scandals, and, of course, the
tragedy of September 11, 2001. Yet overall economic activity
experienced only modest difficulties. In the United States, only five
quarters in the past 20 years exhibited declines in GDP, and those
declines were small. Thus, it is not altogether unexpected or
irrational that participants in the world marketplace would project
more of the same going forward.
Yet history cautions that people experiencing long periods of
relative stability are prone to excess. We must thus remain vigilant
against complacency, especially since several important economic
challenges confront policymakers in the years ahead.
Prominent among these challenges in the United States is the
pressing need to maintain the flexibility of our economic and financial
system. This will be essential if we are to address our current account
deficit without significant disruption. Besides market pressures, which
appear poised to stabilize and over the longer-run possibly to decrease
the U.S. current account deficit and its attendant financing
requirements, some forces in the domestic U.S. economy seem about to
head in the same direction. Central to that adjustment must be an
increase in net national saving. This serves to underscore the
imperative to restore fiscal discipline.
Beyond the near-term, benefits promised to a burgeoning retirement-
age population under mandatory entitlement programs, most notably
Social Security and Medicare, threaten to strain the resources of the
working-age population in the years ahead. Real progress on these
issues will unavoidably entail many difficult choices. But the
demographics are inexorable, and call for action before the leading
edge of baby boomer retirement becomes evident in 2008. This is
especially the case because longer-term problems, if not addressed,
could begin to affect longer-dated debt issues, the value of which is
based partly on expectations of developments many years in the future.
Another critical long-run economic challenge facing the United
States is the need to ensure that our workforce is equipped with the
requisite skills to compete effectively in an environment of rapid
technological progress and global competition. Technological advance is
continually altering the shape, nature, and complexity of our economic
processes. But technology and, more recently, competition from abroad
have grown to a point at which demand for the least-skilled workers in
the United States and other developed countries is diminishing, placing
downward pressure on their wages. These workers will need to acquire
the skills required to compete effectively for the new jobs that our
economy will create.
At the risk of some oversimplification, if the skill composition of
our workforce meshed fully with the needs of our increasingly complex
capital stock, wage-skill differentials would be stable, and percentage
changes in wage rates would be the same for all job grades. But for the
past 20 years, the supply of skilled, particularly highly skilled,
workers has failed to keep up with a persistent rise in the demand for
such skills. Conversely, the demand for lesser-skilled workers has
declined, especially in response to growing international competition.
The failure of our society to enhance the skills of a significant
segment of our workforce has left a disproportionate share with lesser
skills. The effect, of course, is to widen the wage gap between the
skilled and the lesser skilled.
In a democratic society, such a stark bifurcation of wealth and
income trends among large segments of the population can fuel
resentment and political polarization. These social developments can
lead to political clashes and misguided economic policies that work to
the detriment of the economy and society as a whole. As I have noted on
previous occasions, strengthening elementary and secondary schooling in
the United States--especially in the core disciplines of math, science,
and written and verbal communications--is one crucial element in
avoiding such outcomes. We need to reduce the relative excess of
lesser-skilled workers and enhance the number of skilled workers by
expediting the acquisition of skills by all students, both through
formal education and on-the-job training.
Although the long-run challenges confronting the U.S. economy are
significant, I fully anticipate that they will ultimately be met and
resolved. In recent decades our Nation has demonstrated remarkable
resilience and flexibility when tested by events, and we have every
reason to be confident that it will weather future challenges as well.
For our part, the Federal Reserve will pursue its statutory objectives
of price stability and maximum sustainable employment--the latter of
which we have learned can best be achieved in the long-run by
maintaining price stability. This is the surest contribution that the
Federal Reserve can make in fostering the economic prosperity and well-
being of our Nation and its people.
RESPONSE TO A WRITTEN QUESTION OF SENATOR BENNETT
FROM ALAN GREENSPAN
Q.1. In 2002, the Home Mortgage Disclosure Act (HMDA)
regulations were revised to allow for additional data
collection from the lending industry. On March 1, 2005, banks
and other covered lenders will be required to submit data to
the Federal Reserve that will include more loan-pricing data
and new ethnicity data. Concerns have been raised that this new
HMDA data, if taken out of context, might allow for
misinterpretation. Can you explain what the intent of the new
HMDA data is, the context of the data, and what some of the key
limitations of that data are, that is, what the data might show
and might not show?
A.1. The new public disclosure of price information under HMDA
is intended to ensure that the HMDA data set continues to be a
useful tool to improve market efficiency and legal compliance
with the fair lending laws. Since HMDA was last amended by the
Congress, technological advances have made it possible for
lenders to more accurately gauge credit risk. Lenders will lend
to higher-risk individuals whom they previously would have
denied credit, albeit at higher prices commensurate with the
higher risk. Broader access to credit has been a largely
positive development, expanding opportunities for homeownership
and allowing previously credit-constrained individuals to tap
the equity in their homes. However,
expansion of the higher-priced lending market also has been
associated with concerns about the fairness of pricing in the
market.
The price data newly required to be disclosed under HMDA
can be used as a screen that identifies aspects of the higher-
priced end of the mortgage market that warrant a closer look.
Conclusive judgments about the fairness of pricing, however,
must consider all of the legitimate factors that underlie
pricing decisions, including risk-related factors. Risk-related
factors include measures such as the borrower's credit history
and debt-to-income ratio, and the loan-to-value ratio of the
specific transaction. The expanded HMDA data do not include
these factors, or many others that are potentially relevant to
a pricing decision. Absent information about all relevant
pricing factors, one cannot draw definitive conclusions about
whether particular lenders discriminate unlawfully or take
unfair advantage of consumers. Thus, any price disparities by
race or ethnicity revealed in the HMDA data will not, by
themselves, prove unlawful discrimination. Such disparities
will, however, need closer scrutiny. In the case of depository
institutions, for example, that scrutiny will be supplied by
bank examiners, who will have access to information about all
of the relevant variables.
RESPONSE TO A WRITTEN QUESTION OF SENATOR SANTORUM
FROM ALAN GREENSPAN
Q.1. The final version of Basel II was, as I understand, agreed
to last summer. How final is the Accord? Are there issues that
still need to be addressed? How will U.S. regulators work to
mitigate possible negative competitive impacts of the Accord on
U.S. banks? Particularly regarding the operational risk sector:
(1) Could Pillar 1 treatment actually increase risk as more
money goes to meet regulatory capital demands and less is
therefore potentially available to apply to risk avoidance, and
(2) Could there be increasing competitive concerns for U.S.
banks, particularly in business lines for which we are world
leaders, such as credit cards and asset management? What is
being done to ensure that we continue to maintain our
leadership and are not competitively disadvantaged?
A.1. The participating countries in the Basel Committee on
Banking Supervision reached an ``Agreement in Principle'' in
mid-2004 and each country is now following its national
procedures for review. As you know, in the United States, that
procedure requires, among other things, a Notice of Proposed
Rulemaking (NPR), followed by a comment period, the adoption of
a final rule, and a delayed effective date. The U.S. banking
agencies have made it clear to the Basel Committee that there
is no final agreement until we once again have reviewed and
evaluated public comments on our NPR. We published in 2003 an
Advance Notice of Proposed Rulemaking (ANPR), reviewed comments
on the ANPR, and we are now in the process of preparing an NPR
that reflects those comments. The mid-2004 Basel II text issued
by the Basel Committee followed several years of industry
consultation in the late 1990's and early in the current
decade, resulting in modifications to the proposal. The U.S.
ban! king agencies expect to issue a final rule implementing
Basel II in the United States in mid-2006 but every provision
is still subject to public comment and review by the agencies.
The Basel Committee is still working on some important
issues, at the request of the U.S. agencies, and under their
leadership. These are (1) the capital rules for certain
guaranteed obligations, where both the borrower and the
guarantor would have to default (double default) before the
lender faces losses, (2) issues involving capital charges for
certain trading account assets, and (3) the development of
measures of Loss Given Default under conditions of stress.
In the ANPR, the U.S. banking agencies proposed a
bifurcated application of Basel II in the United States; that
is, we proposed that certain large banks would be required to
be under Basel II, any bank that meets the infrastructure
requirements and wished to do so could opt in to Basel II, and
all other banks would remain under the current Basel I-based
capital rules. Federal Reserve staff has conducted and
published several studies on the competitive implications of
the proposed bifurcated application of Basel II in the United
States. These studies were of mergers and acquisitions, loans
to small- and medium-sized businesses, and operational risk.
Early in April, Federal Reserve staff plans to release a
residential mortgage study and before mid-year a consumer
credit card study. The studies published so far suggest that
the proposed U.S. implementation of Basel II would have at most
modest competitive
impacts, although the studies do indicate that there may be
some po! tential effects on regional banks in the market for
loans to small- and medium-sized firms. The U.S. banking
agencies also have recently conducted their fourth Basel II
quantitative impact study (QIS 4), and the results of this
study (which should be available in the coming months) should
shed additional light on the potential competitive impact of
Basel II on the U.S. banking system.
The U.S. banking agencies have announced their intention to
propose changes in either the application of Basel II in this
country or in the current U.S. capital rules that would
continue to apply to non-Basel II banks in order to address
potential competitive distortions, as well as to make the
current capital regime more risk-sensitive. Proposed changes to
the current capital rules would be included in an ANPR to be
published shortly after the Basel II NPR.
Many banks that have been preparing for Pillar 1 treatment
of operational risk, using the Advanced Measurement Approach
(AMA), which allows banks great flexibility, continue to tell
us that they perceive that the process has spawned risk
management benefits for their organization that go beyond
regulatory compliance. In addition, we as supervisors--and
increasingly rating agencies and counterparties--believe that
such mechanisms are necessary in well-managed organizations
that seek to play a role in global financial markets, in
extending credit, trading in large volume, and managing and
processing financial assets for a significant share of the
global financial system. In effect, the market--independently
of Basel II--is requiring that banks establish and maintain an
operational risk management infrastructure that is similar in
nature and cost to the infrastructure that would be required
under Basel II. Moreover, we do not expect that Basel II will
impede banks' efforts to m! itigate their operational risk; in
fact, Basel II allows banks to reduce substantially their
capital requirements for operational risk to the extent the
bank has taken action to control or hedge its operational risk.
U.S. banks would be stronger, safer, and less vulnerable to
shock--and thus the preferred entities for global
counterparties--because of having the strong risk measurement
and management systems that Basel II requires. This proposition
holds true in credit cards, asset management, and across the
full range of bank activities. A bank is not competitively
disadvantaged if it has strong risk and capital management
systems vis-a-vis its rivals here and abroad. In any event,
foreign rivals will be subject to the Basel II rules, and
securities firms in this country will be subject to similar
rules.