[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

                               __________

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                                Affairs












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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

                              ----------                              

                      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.










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