[Senate Hearing 109-551]
[From the U.S. Government Publishing Office]

                                                        S. Hrg. 109-551

                     NOMINATION OF BEN S. BERNANKE



                               before the

                              COMMITTEE ON
                          UNITED STATES SENATE

                       ONE HUNDRED NINTH CONGRESS

                             FIRST SESSION


 the nomination of ben s. bernanke, of new jersey, to be a member and 
    chairman of the board of governors of the federal reserve system


                           NOVEMBER 15, 2005


  Printed for the use of the Committee on Banking, Housing, and Urban 

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                  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       ROBERT MENENDEZ, New Jersey

             Kathleen L. Casey, Staff Director and Counsel

     Steven B. Harris, Democratic Staff Director and Chief Counsel

               Peggy R. Kuhn, Senior Financial Economist

                  Aaron D. Klein, Democratic Economist

   Joseph R. Kolinski, Chief Clerk and Computer Systems Administrator

                       George E. Whittle, Editor


                            C O N T E N T S


                       TUESDAY, NOVEMBER 15, 2005


Opening statement of Chairman Shelby.............................     1

Opening statements, comments, or prepared statements of:
    Senator Dodd.................................................     2
    Senator Sununu...............................................     4
        Prepared statement.......................................    65
    Senator Sarbanes.............................................     4
    Senator Dole.................................................     6
    Senator Johnson..............................................     7
    Senator Martinez.............................................     8
    Senator Carper...............................................     9
    Senator Bennett..............................................    10
    Senator Reed.................................................    10
    Senator Hagel................................................    11
    Senator Stabenow.............................................    12
    Senator Allard...............................................    13
    Senator Bayh.................................................    34
    Senator Schumer..............................................    41
    Senator Menendez.............................................    66


Ben S. Bernanke, of New Jersey, to be a Member and Chairman of 
  the Board of Governors of the Federal Reserve System...........    14
    Biograhpical sketch of the nominee...........................    53
    Response to written questions of Senator Bunning.............    67


                     NOMINATION OF BEN S. BERNANKE
                   OF NEW JERSEY, TO BE A MEMBER AND
                     OF THE FEDERAL RESERVE SYSTEM


                       TUESDAY, NOVEMBER 15, 2005

                                       U.S. Senate,
          Committee on Banking, Housing, and Urban Affairs,
                                                    Washington, DC.

    The Committee met at 10 a.m., in room SD-106, Dirksen 
Senate Office Building, Senator Richard C. Shelby (Chairman of 
the Committee) presiding.


    Chairman Shelby. The hearing will come to order.
    This morning, we are meeting to consider perhaps the most 
important nomination that ever comes before this Committee, 
that of the Chairman of the Federal Reserve System. This will 
be the first time in nearly 20 years that the Congress has had 
a new nominee for its consideration. President Bush has made a 
superb appointment in naming Dr. Benjamin S. Bernanke to serve 
as a Member and as Chairman of the Board of Governors of the 
Federal Reserve System.
    The Federal Reserve would have a big enough job to do if it 
were tasked with serving only as a central bank for the United 
States. However, as the United States continues to lead the 
world economy, sound stewardship of the Federal Reserve affects 
the global marketplace. The Federal Reserve also shoulders the 
responsibility for supervising some of the world's most complex 
financial holding companies. In addition, as technology 
continues to evolve, the Federal Reserve must adapt and 
innovate to provide an effective payment system for our 
    Chairman Alan Greenspan has been the face and the voice of 
the Federal Reserve for over 18 years. During his tenure, the 
U.S. economy and the financial system withstood a number of 
significant challenges, including the stock market crash of 
1987 and the Asian debt crisis. His tenure also includes the 
1991-2001 economic expansion, the longest in American history. 
These are among the reasons Chairman Greenspan is considered by 
some to be the greatest central banker of all time.
    Stepping into Mr. Greenspan's shoes will be a tremendous 
challenge. While it may seem a daunting task to follow as 
distinguished a Chairman as Alan Greenspan, we should be 
mindful of two things. In 1987, many observers were concerned 
about whether an economist name Alan Greenspan could 
successfully follow in the wake of the vaunted Paul Volcker. We 
now know how the experiment turned out. Each person who sits in 
the Chairman's seat has the opportunity to make that position 
his own and to become a leader in his own right.
    Second, many have observed that President Bush has selected 
the best possible candidate to serve as the next Federal 
Reserve Chairman. Dr. Bernanke may well be the finest monetary 
economist of his generation. With his distinguished career as 
academic, he is eminently qualified and extremely well-versed 
in monetary policy issues.
    Furthermore, Dr. Bernanke is more than an esteemed 
academic. Dr. Bernanke served with distinction as a Member of 
the Board of Governors of the Federal Reserve System. This 
experience gives him an inside knowledge of the Federal Reserve 
and also financial markets. In speaking out on a variety of 
important economic issues, he earned tremendous respect and 
confidence from policymakers in this country and around the 
    Dr. Bernanke's other professional experiences are also 
significant here. Prior to becoming a Member of the Board of 
Governors of the Federal Reserve, Dr. Bernanke served as 
Chairman of the Economics Department at Princeton University. 
Before arriving at Princeton, Dr. Bernanke had been an 
Associate Professor of Economics and an Assistant Professor of 
Economics at the Graduate School of Business at Stanford 
University. His teaching career also included serving as 
Visiting Professor of Economics at New York University and the 
Massachusetts Institute of Technology.
    Dr. Bernanke also served as the Director of the Monetary 
Economics Program of the National Bureau of Economic Research. 
He received a B.A. in economics in 1975 from Harvard University 
summa cum laude, and a Ph.D. in economics in 1979 from the 
Massachusetts Institute of Technology.
    Dr. Bernanke, this Committee knows that you have an 
important job in front of you. We are also confident you have 
the right set of skills to lead the Federal Reserve System.
    We look forward to hearing your statement today and the 
interesting discussion that will follow.
    But I want to say at the outset that we have seven roll 
call votes scheduled beginning around 10:45, so we are going to 
continue this hearing until probably 10:55 or something like 
that, and then recess until 3 o'clock and go forward, if it is 
okay with you.
    Senator Dodd.


    Senator Dodd. Thank you very much, Mr. Chairman, and, Mr. 
Bernanke, welcome to the Committee. We had a chance to chat on 
the phone the other day, and this is a challenging opportunity 
the President has given to you. I know you must be grateful to 
him, and we are looking forward to your testimony here today.
    As my custom is, I will withhold, as I am sure most of my 
colleagues will, probably, any final judgment on your 
nomination until we have completed the process here. But I want 
to acknowledge at the outset that the President, in my view, 
has made a superb decision in nominating you. Your academic 
credentials, as the Chairman has pointed out, are tremendously 
impressive, if not unsurpassed.
    In fact, I made the comment to the nominee coming in, Mr. 
Chairman, that when overlooking the list of the number of 
publications the nominee has authored over the years, I suppose 
we should be thankful he is not a nominee for the Supreme Court 
of the United States. We would spend a year examining his 
written credentials from those publications.
    The chairmanship of the Federal Reserve, as the Chairman 
has pointed out, is not just another Government job, obviously. 
It is, arguably, the most important position in our country 
with respect to our Nation's economy. The decisions made by the 
Chairman and his colleagues on the Board affect every single 
citizen in a very profound way. The Federal Reserve is 
responsible, as we know, for setting interest rates and 
ensuring the safety and soundness of financial institutions. It 
represents U.S. interests and negotiations with foreign and 
international regulators, and its Chairman bears the 
responsibility for protecting consumers from unscrupulous, 
illegal, and predatory financial practices.
    As we have seen repeatedly over the years, the opinion of 
the Federal Reserve Chairman on economic policy matters goes 
beyond the institution's official jurisdiction and carries an 
enormous amount of weight that can have significant 
implications. One need look no further than 2001, when your 
predecessor Alan Greenspan's support for the President's tax 
cuts, however qualified it may have been, was perceived as a 
major cause for their enactment--which has led to deep budget 
deficits, I might add, and the widening inequality of wealth in 
this Nation.
    We know from previous experience that the position of the 
Federal Reserve Chairman requires several important qualities, 
such as intelligence, experience, and good judgment, most 
importantly in the face of a crisis. The markets need to know 
they can trust the Chairman of the Federal Reserve, and 
developing this trust requires an understanding of the need for 
independence from the President and the Administration, 
particularly from the one run by the President who has 
appointed the Chairman, and especially in your case, Dr. 
Bernanke, from an Administration in which you are still 
currently employed as a spokesman for a specific economic and 
political agenda.
    Successful Chairmen have also been able to balance the dual 
mission of the Federal Reserve as embodied by the Federal 
Reserve Act, ``to promote effectively the goals of maximum 
employment, stable prices, and moderate long-term interest 
    In the 1990's, we had a remarkable period of both price 
stability and high employment. Obviously, that was due in part 
to technological innovation and the development of the 
technological sector. But there is little doubt that the 
preconditions for economic growth were laid earlier in the 
decade when a newly elected Democratic President joined with 
the Republican-appointed Federal Reserve Chairman to pursue a 
commitment of fiscal responsibility and effective monetary 
policy. The result was a reduction in poverty rates, an 
increased standard of living for the middle class, and the 
first budget surplus in three decades.
    So, Dr. Bernanke, I look forward to discussing with you 
today these issues and how we can return to achieving the 
results that we had only a few years ago. And, again, I welcome 
your nomination. I congratulate you on having received it and 
look forward to working with you.
    Thank you, Mr. Chairman.
    Chairman Shelby. Senator Sununu.


    Senator Sununu. Thank you, Mr. Chairman.
    It is a pleasure to have you in front of us, Dr. Bernanke. 
I get the sense that you have put on some a charm offensive 
over these past weeks, and I imagine you received a number of 
awards in your academic career. But you probably were not voted 
the most likely to conduct a charm offensive on the U.S. 
Senate. Your reviews of the various meetings you have had with 
Members I think have been very positive, and it is just a 
credit to your professionalism, in part, because it is not an 
easy task to come before us and to be prepared to answer all 
these questions. People want you to weigh in on all kinds of 
policy issues, some of which you are probably qualified to 
comment on, some you may not be.
    As the Chairman and others have pointed out, you do come 
with very impressive credentials, a great academic and 
educational background, although I think having been educated 
at both Harvard and MIT, it is probably a sign of having a 
conflicted personality to a certain degree.
    We do not have the facts in front of us to support the 
conclusion that you are the most qualified or finest economist 
of your generation. But for the purposes of this hearing, I am 
willing to assume that and to work from there.
    I look forward to hearing from you about your approach to 
monetary policy. Price stability is absolutely critical. I 
think it is due or it has resulted in large measure to the 
great performance of our economy cited by Senator Dodd. And 
while everyone expects or hopes for a pretty smooth transition, 
there are differences in approach that you will take relative 
to Chairman Greenspan.
    Your support for greater transparency and your success in 
advocating for real changes that result in a more open Fed 
deserve great commendation and recognition. I will be 
interested to hear more about the progress that can be made 
along those lines and more about any changes that might be made 
to improve the clarity in the approach that the Fed takes to 
targeting inflation.
    So, I certainly wish you well and look forward to your 
    Thank you, Mr. Chairman.
    Chairman Shelby. Senator Sarbanes.


    Senator Sarbanes. Thank you very much, Mr. Chairman. First 
of all, I want to thank you for scheduling this hearing in a 
very timely manner. I join my colleagues in welcoming Dr. Ben 
Bernanke to the Committee. He is no stranger. He has been here 
before, both to be a Member of the Federal Reserve Board of 
Governors and then to be Chairman of the President's Council of 
Economic Advisers.
    Of course, he has now been nominated to a 14-year term as a 
Member of the Board of Governors and also nominated to be the 
Chairman of the Federal Reserve Board of Governors, a 4-year 
    As I understand it, Mr. Chairman, we are going to 
reconvene, because of this series of votes that are scheduled, 
again in the afternoon.
    Chairman Shelby. Three o'clock.
    Senator Sarbanes. Yes. The Federal Reserve Act of 1913, 
which established the Federal Reserve System, set the 14-year 
terms for the Members of the Board of Governors of the Federal 
Reserve. I think that clearly reflected the intention of 
Congress at the time in enacting this legislation to place the 
Federal Reserve Board and its individual Members beyond the 
reach of any given Administration and the political pressures 
of the moment.
    Actually, the 14-year term is the longest we give to any 
official in the Government other than the lifetime appointments 
for members of the Federal judiciary.
    I think it is fair to say or it certainly has come to be 
the case that the credibility of the Federal Reserve rests in 
large part on broad confidence in its independence in the 
judgments it makes, and obviously, if that confidence were to 
be undermined, the stature of the Board would be gravely 
diminished, and that in turn would have serious consequences, I 
think, not only for our national economy but also, indeed, for 
the world economy.
    So, obviously, we are looking forward to hearing from Dr. 
Bernanke about this important role of the independence of the 
Federal Reserve in rendering its judgments.
    My colleague Senator Dodd has made reference to the other 
major point I wanted to make, and that was the Federal Reserve 
Act provides as the goals that the Board of Governors of the 
Federal Reserve System and the Federal Open Market Committee 
shall maintain long-run growth of the monetary and credit 
aggregates commensurate with the economy's long-run potential 
to increase production so as to promote effectively the goals 
of maximum employment, stable prices, and moderate long-term 
interest rates. And this is conveniently referred to as ``the 
twin mandates of the Federal Reserve,'' addressing both maximum 
employment and stable prices. That is another issue that I look 
forward to exploring with Dr. Bernanke in the course of these 
    Actually, we had to contend for quite a while with this 
nonaccelerating inflationary rate of unemployment, something 
that Chairman Greenspan, to his credit, never accepted. That 
was the theory that if the unemployment rate got down to a 
certain level, beyond that you would inflation; and, therefore, 
as it approached that unemployment rate, the Fed would have to 
start raising interest rates to cool off the economy, even if 
we did not see manifested inflationary signs. So it was a 
preemptive strike against inflation, but it also, of course, 
ended up being a preemptive strike against employment, if it 
had been followed.
    Fortunately, that was not the case, and we have seen in 
recent years that we have been able to go down--and we are now 
at 5 percent, but we have been able to go down below that to a 
4-percent unemployment rate without an inflationary problem. 
And I am anxious to explore that with Dr. Bernanke as well, 
since I think jobs is a very important purpose of economic 
    Let me just add one other dimension which is not often 
talked about when we talk about the Fed, and that is, the Board 
has responsibility, supervisory and regulatory authorities to 
assure the safety and soundness of the Nation's banking and 
financial sector and protecting the credit rights of consumers. 
In the area of consumer protection, the Board has broad 
jurisdiction and authority to implement regulations for a whole 
host of consumer laws: The Community Reinvestment Act, Truth in 
Lending, Truth in Saving, Home Mortgage Disclosure, Home 
Ownership and Equity Protection Act, the Equal Credit 
Opportunity Act, and a number of others as well. And while 
public attention is focused on the Board's monetary policy 
responsibilities, I think it is important to recognize its 
jurisdiction and authority with respect to these regulatory 
issues. The Board can play a very significant role in improving 
consumer rights and enforcing consumer protections.
    Finally, Mr. Chairman, I notice that the papers this 
morning are already setting out an agenda. I would just quote 
one paragraph to give one example of it. ``If confirmed, 
Bernanke will take over the Fed at a moment of rising economic 
unease. The U.S. trade and budget deficits are soaring. The 
once-blistering housing market may be cooling. Rumors continue 
to rumble through Wall Street of dangerously overextended hedge 
funds ripe for collapse. The next Fed Chairman could face 
significant challenges, as Greenspan did, within months of 
taking office.''
    Welcome to the Committee this morning, Dr. Bernanke.
    Thank you, Mr. Chairman.
    Chairman Shelby. Senator Dole.


    Senator Dole. Thank you, Chairman Shelby. I also certainly 
want to extend a warm welcome to Dr. Bernanke, to his family, 
and his friends this morning.
    This is the most significant nomination this Committee will 
consider. The role of the Chairman of the Board of Governors 
holds great influence over our economy and financial system. 
The Federal Reserve is charged with conducting the Nation's 
monetary policy with the goals of maximum employment, stable 
prices, and moderate long-term interest rates. These goals can 
at time conflict, requiring a steady hand at the helm to keep 
us on a track toward long-term sustainable growth.
    Two weeks ago, the Federal Open Market Committee again 
raised its target for the Federal funds rate and the discount 
rate by 25 basis points. This was the 12th straight increase in 
the Federal funds rate. The release noted robust underlying 
growth in productivity and temporarily depressed output in 
employment due to elevated energy prices and hurricane-related 
disruptions in economic activity. These observations reflect 
how hard we were hit this hurricane season, but they also 
appear to indicate a positive track for economic expansion in 
the coming years.
    While the outlook is certainly encouraging, I continue to 
be concerned about the slow pace of job creation, particularly 
in my State of North Carolina. North Carolina continues to 
experience dramatic losses in employment, especially in the 
traditional industries of textile and furniture manufacturing. 
The national economy may be trending positively, but we must 
continue to focus special attention on the areas where people 
have lost their jobs with companies that struggle to compete 
with the dramatically lower cost structures of foreign 
    Congress continues to debate the pros and cons of free 
trade, and I believe we must work toward trade agreements that 
benefit American workers and consumers and support jobs and 
growth in our industries.
    During my confirmation hearing many years ago to serve as 
Secretary of Labor, I spoke about the gap between skilled and 
unskilled workers. In the changing economic environment, this 
gap has widened, and there are fewer and fewer opportunities 
for lower-skilled workers. We must do everything in our power 
to make sure that these people do not fall through the cracks. 
As we discussed in my office, we must focus greater attention 
on educating our less-skilled workers so they can take 
advantage of the new jobs that are being created. To this end, 
I believe that we should take steps to improve trade adjustment 
assistance and continue to make strengthening our community 
colleges a very top priority.
    I also remain concerned, of course, about high energy 
prices, the rising costs of raw materials, and the growing size 
of our trade deficit. In spite of these concerns, however, I 
have confidence that the very forces that stimulate economic 
growth--free but fair trade, ever improving global 
communications, higher education, training for our workforce, 
and, of course, hard work--these forces indeed will put us on a 
course toward great opportunity for North Carolinians and for 
all Americans.
    Dr. Bernanke, as we have all said, has a keen intellect and 
impressive credentials and comes before us, Mr. Chairman, with 
an extensive list of accomplishments, a wealth of experience, 
and a reputation for consensus building, particularly during 
his time on the Board of the Federal Reserve. And I tend to 
think that his good Carolina roots are a great strength as 
    Dr. Bernanke has my strong support, Mr. Chairman, for 
Chairman of the Board of Governors of the Federal Reserve. 
While I am sure the Committee does have many questions, I hope 
he will earn our swift approval.
    Thank you, Mr. Chairman.
    Chairman Shelby. Senator Johnson.


    Senator Johnson. Chairman Shelby, Ranking Member Sarbanes, 
I am pleased to be here this morning. And, Dr. Bernanke, 
welcome. I congratulate you on your nomination and thank you 
for meeting with me this past week.
    Today's hearing is no doubt one of the most important that 
this Committee will hold during this Congress. It is not every 
day that we consider the nomination for a new Chairman of the 
Board of Governors of the Federal Reserve. In fact, the last 
such hearing was over 18 years ago. Therefore, it is critical 
that we are thorough in our questioning and that we cover a 
broad range of relevant issues.
    The Fed is not only charged with serving as the Nation's 
central bank and lender of last resort, but it also supervises 
and regulates banks and, perhaps most importantly, formulates 
and executes monetary policy in order to promote stable 
economic growth, hopefully with an eye toward both inflation 
and employment.
    The Fed Chairman is an influential economic figure. He must 
be attuned to the U.S. economy and the world economy. He holds 
one of 12 votes and, therefore, must not only build consensus 
but also confidence. It is my expectation that the Fed Chair, 
even when he is a former White House adviser, refrains from 
being a cheerleader for White House policies of either 
political party and instead maintains the independence and 
credibility of the central bank through greater transparency in 
its decisionmaking.
    As my colleague Senator Dodd noted, your predecessor, 
although properly credited with a great many accomplishments, 
has been roundly criticized by some for intervening in a tax 
policy debate in Congress that in the end contributed 
significantly to a transition from enormous budget surpluses to 
today's massive budget deficits. It is increasingly apparent 
how important sound and complementary monetary and fiscal 
policy is to the U.S. economy as the Federal deficit increases, 
national savings falls, pensions and Social Security become 
less secure, health care costs skyrocket, and energy prices 
remain volatile.
    In addition to the formulation of monetary policy, the 
Board of Governors has a significant bank regulatory and 
supervisory responsibility, including promoting the safety and 
soundness of the banking system and ensuring compliance with 
the Nation's banking laws and regulations. This Committee 
continues to hear from our Nation's financial institutions 
about the increased and often overwhelming burden of bank 
regulations. It is the number one concern raised by both small 
and large banks in my home State, and I hope that the Fed will 
pay close attention to this issue. And while I am interested in 
your views on rising energy prices and the impact on the trade 
deficit, I would also like to hear your thoughts on the role of 
consolidated supervision and protecting the safety and 
soundness of the Nation's banking system and the longstanding 
policy of maintaining a separation of banking and commerce.
    Dr. Bernanke, your credentials, both academic and 
professional, are exemplary. I appreciate having had the 
benefit of meeting with you last week in my office, and I look 
forward to hearing from you today as we move forward in an 
expeditious fashion on the nomination process. Congratulations.
    Chairman Shelby. Senator Martinez.


    Senator Martinez. Thank you, Mr. Chairman.
    Dr. Bernanke, welcome, and it is good to see you back in 
the Committee again. I know we have had the privilege of 
confirming you on two other occasions, and I want to just 
extend my congratulations to you for the confidence the 
President has expressed in you by naming you to this very 
significant post.
    When we met last week, I expressed my concerns about the 
rising interest rate environment and its impact on our Nation's 
housing market. Florida's median housing costs have continued 
to rise, especially in cities where basic infrastructure is 
already overwhelmed by population demands. However, employee 
wages have not risen in response to the rapidly increasing cost 
of living. Additionally, the October report from the Federal 
Reserve Bank of Atlanta shows increases in fuel and building 
supply costs, all of which will continue to contribute to the 
rising costs of housing.
    We are facing a housing crisis in Florida, and I am afraid 
it may get worse before it gets any better, and I do not think 
that Florida really is unique to the Nation in this regard. 
Pockets of Florida are still recovering from the hurricane 
season of this year and last, and we are still assessing the 
damages from the recent Hurricane Wilma. According the State, 
the challenge is always the same: The lack of housing 
affordable to working families. Low interest rates over the 
past several years have created record homeownership rates on a 
national level, but have also encouraged very creative 
financing with interest-only loans and short-term ARM's. Both 
of these, and others, make monthly mortgage payments 
susceptible to increases in the Federal funds rate for 
homeowners who choose these options for financing.
    During our conversation, you indicated your commitment to 
providing more transparency and disclosure to the public to 
reduce market uncertainty and encourage investment. You also 
talked about increasing financial literacy and how that may 
help borrowers and lenders understand the implications and 
risks associated with varying mortgage products. This is 
something I worked with very intimately when I served during my 
time as Secretary of HUD. I do believe that financial literacy 
is crucial to today's consumers.
    We also discussed the need to legislate fundamental changes 
to the regulatory structure of the housing GSE's. While we 
agreed that these Enterprises play a crucial role in the 
housing market, they have strayed from their original mission, 
which is to focus on creating housing opportunity for low- and 
moderate-income families. I believe this Committee reported out 
a very good piece of legislation in July that would require 
fundamental changes in how these Enterprises are regulated.
    Before we can move a bill to the floor for full 
consideration, we need to also reach some consensus on the 
issues of portfolio limitations and the creation of an 
affordable housing fund. I would be interested in hearing your 
views on both of these two crucial issues.
    I look forward to your tenure as Chairman. I do have every 
expectation of your confirmation and look forward to working 
with you in your new capacity, and I again commend you and 
congratulate you for this fine distinction.
    Thank you, Mr. Chairman.
    Chairman Shelby. Senator Carper.


    Senator Carper. Thank you, Mr. Chairman, and, Dr. Bernanke, 
welcome today. I congratulate you on your nomination. Thank you 
for the time that you were good to spend with me earlier this 
month when you were visiting in our office.
    You are, I think, two for two before this Committee, two 
for two before the Senate, and my guess is before we are 
finished here, you will be three for three. And given your 
experience, your education, your intellect, and, frankly, your 
demeanor, I think they all combined to prepare you well for the 
challenges that lie ahead. I would not underestimate those 
challenges, and I think Senator Sarbanes has alluded to them. 
They are considerable.
    I want to return to a theme that a couple of my colleagues 
have mentioned, and then I will close, and the theme is the 
need for independence. You work for the President. You were 
chosen by him to head up his Council of Economic Advisers. You 
have been nominated by him for this post as well. But when you 
are confirmed, as I am sure you will be, it is critically 
important that you be independent, and I think you realize 
that. And we are counting on you to be that independent person.
    I thank you for your service to this country and for your 
willingness to serve, and for anyone in your family who is here 
to share you with all of us, we express our thanks as well.
    Chairman Shelby. Senator Bennett.


    Senator Bennett. Mr. Chairman, I will save my comments for 
the question period.
    I join my colleagues, Dr. Bernanke, in welcoming you here 
and congratulating you on your appointment. I think the 
President has made a superb selection and I look forward to not 
only voting for you, but also working with you in the years 
    Chairman Shelby. Senator Reed.


    Senator Reed. Thank you very much, Chairman Shelby. This is 
an important confirmation hearing because of the tremendous 
influence that the Federal Reserve Chairman has on economic 
policy in this country and indeed around the world.
    I want to welcome the President's nominee, Dr. Bernanke. 
Welcome, doctor. We look forward, obviously, to hearing your 
views on many issues. Chairman Greenspan will be a hard act to 
follow and his successor's job will not be made any easier by 
the state of the economy. Yes, GDP has grown as the economy has 
been recovering from a recession in a very protracted job 
slump, but large structural budget deficits, a record current 
account deficit, a record low personal saving rate, rising 
consumer prices, and sluggish wage growth, all pose tremendous 
challenges to setting monetary policy.
    Dr. Bernanke is an economist with strong academic and 
policy credentials, who has already pledged to maintain the 
Greenspan-era commitment to controlling inflation and providing 
market stability. And I hope that also means maintaining 
flexibility in pursuing the multiple goals of price stability, 
high employment, and sustainable growth, rather than adopting a 
rigid adherence to any predetermined policy rule in responding 
to changing economic circumstances.
    Indeed, a critical question for Dr. Bernanke will be how he 
would balance the goals of fighting inflation with allowing 
sufficient employment and wage growth. These are difficult 
economic times for many Americans who are facing stagnant 
incomes and rising costs for health care, home heating, and 
education. We need a Fed Chairman who will be committed to 
guiding the economy toward creating broadly shared prosperity. 
Strong productivity gains have shown up in the bottom lines of 
corporations but not in the paychecks of workers. The typical 
worker's earnings are not keeping up with their rising living 
expenses, and both earnings and income inequality are 
increasing in our economy.
    Both Chairman Greenspan and Dr. Bernanke have emphasized 
the importance of education and training for increasing 
opportunity and reducing inequality over the long-run. But 
rising inequality has been a problem for a long time and it is 
particularly acute now. Monetary policy alone cannot solve this 
problem, but I hope the new Fed Chairman will recognize the 
critical importance of fostering a high employment economy.
    I am also interested in Chairman Bernanke's views on 
whether the budget and trade deficits are dangerous imbalances 
that pose a risk to the economic outlook. I hope that we would 
all agree that raising our future standard of living and 
preparing adequately for the retirement of the baby boom 
generation require that we have a high level of national 
investment and that a high fraction of that investment be 
financed by our own national savings, not by foreign borrowing.
    We followed such prosperity enhancing policies under 
President Clinton, but that legacy of fiscal discipline has 
been squandered under President Bush.
    Financial markets will surely hang on the new Fed 
Chairman's words about monetary policy and interest rates, but 
the new Chairman will not automatically inherit Alan 
Greenspan's considerable influence over a broad array of 
economic policy. While Chairman Greenspan's track record 
managing monetary policy is very impressive, his role in 
justifying the 2001 tax cut is problematic and now we are 
living with the consequences.
    Dr. Bernanke was a respected independent economist long 
before taking the position as Chairman of the Council of 
Economic Advisers with the Administration. He has spent many 
years building a reputation as a politically independent 
economist, and I hope he will preserve that reputation if 
confirmed as Fed Chairman.
    One bit of advice, Dr. Bernanke, do not forget what you 
learned on the School Committee.
    Thank you, Mr. Chairman.
    Chairman Shelby. Senator Hagel.


    Senator Hagel. Mr. Chairman, thank you. I too welcome Dr. 
Bernanke to our hearing, and I look forward to voting for his 
nomination, and enthusiastically support the President's wise 
    Mr. Chairman, thank you for the hearing, and I too will 
reserve any further comments to the questions. Thank you.
    Chairman Shelby. Senator Stabenow.


    Senator Stabenow. Thank you, Mr. Chairman.
    Welcome, Dr. Bernanke. It is a pleasure to have you with 
us, and look forward to many opportunities to work with you.
    You have heard a lot of important words, transparency, 
accountability, financial literacy. As the author of the 
provision on financial literacy and the creation of the new 
Federal commission, I look forward to working with you on those 
important long-term issues of education and financial literacy.
    The position of the Federal Reserve Chairman is vital to 
the quality of life of every single American. It affects 
interest rates on credit cards, home mortgages, and 
investments. It impacts the safety and the soundness of our 
financial institutions and may lend stability or instability to 
global financial markets. It is a very, very critical position. 
There is a reason why many say the position of Federal Reserve 
Chairman is the second most powerful position in Washington, 
although some others may want to disagree with that, but it 
certainly in terms of impact affects each and every one of the 
people we represent, as well as ourselves and our country, in 
extraordinary ways.
    While Chairman Greenspan I believe has done an excellent 
job, there is no doubt that you bring an academically 
impressive record, and eminently qualified to replace him, Dr. 
Bernanke. But we have a responsibility to know your views on 
growing the economy, as a number of my colleagues have talked 
about today, about maintaining an economy that produces good-
paying jobs. All of your intellectual horsepower is going to be 
needed to revive what continues to be a struggling economy, 
particularly in the Midwest in our manufacturing economy and in 
my home State, the great State of Michigan.
    Throughout the past 6 months, Michigan has been in an 
incredible struggle. The high-profile bankruptcies at Northwest 
Airlines and Delphi have served to emphasize the lack of job 
security that Americans feel right now, and I believe what is 
happening in Michigan is very much a wake-up call for the 
entire country. Many who have devoted a career to a company are 
being told that their incomes are too high, their health 
insurance is too much, or their pensions are too costly. 
Essentially their way of life is being threatened, and the 
middle class of our country is being threatened.
    One by one each of these benefits is being cut back, and if 
the employees protest the company threatens bankruptcy and 
unveils the specter of using the judicial process to slash 
labor costs, and again, the way of life of middle class 
    A healthy economy needs to be based on more than a race to 
the bottom, and I believe that very strongly, and believe the 
Fed has an important role in whether or not this is a race up 
or a race down. A race down is a lose/lose for our country and 
for every American, and we need to change that.
    It must produce good-paying jobs. Our economy has to be 
dynamic as well to easily assimilate those who are forced from 
their old jobs into new jobs. A healthy American economy must 
be more than a service economy. We make things and grow things 
in this country. We make things and grow things in my home 
State. We do it very well. I do not believe we should concede 
in a global marketplace that we no longer make things or grow 
things. Again, I think we would lose our middle class.
    A healthy economy must be rooted in reality as well. Global 
competition is here to stay, and we must wake up to the reality 
that China, Japan, and others are competitors, and treat them 
like competitors. As the President begins his tour of Asia this 
week, I want to reemphasize the need for this country, our 
country, to insist on fair trade, a level playing field for our 
businesses and our workers. Currency manipulation and 
counterfeiting are destroying jobs in Michigan and in America. 
It can be fixed. We just simply need the political will to make 
the changes to do it.
    In 2003, Dr. Bernanke, you said the current account deficit 
cannot be sustained at its current level. I would agree, and I 
believe we have the tools to change that. No matter what the 
inflation numbers show, no matter what the job numbers show, 
the current approach that we are taking to our economy is 
destroying our way of life in Michigan, and I believe is an 
incredible threat to our country.
    As the current Chair of the Council of Economic Advisers, 
Dr. Bernanke, you are the President's point person on 
economics. It is important for me to know and for the people of 
the State of Michigan to know that as the Federal Reserve Chair 
you will be your own man, and capable of separating yourself 
from these policies. They are not working. And I welcome you to 
come to Michigan, and I can show you, sit you down with the 
faces of business people, workers, and families that can show 
you that they are not working.
    These are difficult times for average Americans. The 
position to which you have been nominated impacts all of us in 
very real ways. Your views on how we will maintain growth is of 
vital importance to our future as a Nation. I look forward to 
your testimony.
    Thank you.
    Chairman Shelby. Senator Allard.


    Senator Allard. Thank you, Mr. Chairman, for holding this 
hearing. You always make it a priority to move nominations 
promptly, and I particularly commend you for that policy today.
    The position of Federal Reserve Chairman is one of the most 
important in the country and possibly the world, and I 
appreciate that we are taking up that nomination today. I was 
pleased when President Bush announced his intention to nominate 
Ben Bernanke to Chair the Federal Reserve Board of Governors. 
Dr. Bernanke is widely respected, and will maintain continuity 
with the policies and strategies that have allowed our country 
to prosper. The reaction of Wall Street and the investment 
world would also seem to confirm the positive view of Dr. 
Bernanke's nomination.
    Dr. Bernanke brings a uniquely advantageous mix of both 
academic and practical experience. After spending 20 years at 
Princeton, including as Chairman of the Economic Department, 
Dr. Bernanke is well-respected and frequently quoted in 
academic circles. He is considered one of the world's leading 
experts on the subject of how central banks such as the Fed 
should set interest rates and cause the money supply to expand 
or contract.
    Rather than limiting himself to purely academic knowledge 
and research, Dr. Bernanke also has outstanding real world 
credentials that have allowed him a fuller understanding of the 
job for which he is nominated. His service as a Fed Governor 
can be viewed as an apprenticeship for the chairmanship. 
Through his service as a Governor he became aware of the 
challenges facing the Fed, as well as the strategies that have 
made it successful in meeting past challenges. It will allow 
him to ease the transition between Chairmen.
    Additionally, Dr. Bernanke has continued his public service 
as Chairman of the President's Council of Economic Advisers, a 
position for which I was also pleased to support his 
confirmation. I am encouraged that Dr. Bernanke has indicated 
the importance of fighting inflation and of increasing 
transparency at the Fed. I was particularly pleased in my 
discussions with him that he is going to stress improved 
    I also appreciate that Dr. Bernanke has acknowledged that 
the final determination on debts and deficits rightfully lies 
with the President and Congress.
    Dr. Bernanke, thank you for appearing here today before the 
Banking Committee. I appreciate this opportunity to once again 
discuss your views on a variety of matters. You have always 
made yourself accessible to me personally, as well as to this 
Committee, and I am pleased to support your nomination and hope 
that the Committee will be able to vote promptly.
    Thank you.
    Chairman Shelby. Dr. Bernanke, will you stand and raise 
your right hand and be sworn?
    Do you swear or affirm that the testimony that you are 
about to give is the truth, the whole truth, and nothing but 
the truth, so help you God?
    Mr. Bernanke. I do.
    Chairman Shelby. Do you agree to appear and testify before 
any duly-constituted committee of the Senate?
    Mr. Bernanke. I do.
    Chairman Shelby. Please sit. Your written testimony will be 
made part of the record in its entirety. You can sum up what 
you want to say here. Do you have anybody you want to 
introduce, any family members or anything here this morning? 
You may proceed.

                  STATEMENT OF BEN S. BERNANKE




    Mr. Bernanke. No, Chairman. I would like to briefly read 
testimony if I may?
    Chairman Shelby. Yes.
    Mr. Bernanke. Thank you.
    Chairman Shelby, Senator Sarbanes and Members of the 
Committee, I thank you for the opportunity to appear before you 
today and for the expeditious scheduling of this hearing. I 
would also like to express my gratitude to President Bush for 
nominating me to be a Member and Chairman of the Board of 
Governors of the Federal Reserve System. If I am confirmed, I 
will work to the utmost of my abilities to fulfill the 
important responsibilities of this office.
    I recently testified before this Committee in my capacity 
as Chairman of the President's Council of Economic Advisers. 
Today, however, I appear before this Committee in a different 
capacity, as the President's nominee to lead the Federal 
Reserve System. In this prospective new role, I would bear the 
critical responsibility of preserving the independent and 
nonpartisan status of the Federal Reserve, a status that, in my 
view, is essential to that institution's ability to function 
effectively and achieve its mandated objectives. I assure this 
Committee that, if I am confirmed, I will be strictly 
independent of all political influences and will be guided 
solely by the Federal Reserve's mandate from Congress and by 
the public interest.
    With respect to monetary policy, I will make continuity 
with the policies and policy strategies of the Greenspan Fed a 
top priority. Several aspects of the policy strategy that has 
evolved under Chairman Greenspan, and under Chairman Volcker 
before him, deserve special note.
    First, central bankers in the United States and around the 
world have come to understand that ensuring long-run price 
stability is essential for achieving maximum employment and 
overall economic stability. In recent decades, the variability 
of output and employment has decreased markedly, and recessions 
have become less frequent and less severe. I believe that the 
Federal Reserve's success in reducing and stabilizing inflation 
and inflation expectations is a major reason for this improved 
economic performance. If I am confirmed, I am confident that my 
colleagues on the Federal Open Market Committee and I will 
maintain our focus on long-term price stability as monetary 
policy's greatest contribution to general economic prosperity 
and maximum employment.
    Second, monetary policy at the Fed has been executed with 
both careful judgment and flexibility. To cite one prominent 
example, Chairman Greenspan's risk-management policy approach 
attempts to take into account the possible consequences of not 
only the most likely forecast outcomes, but also of a range of 
lower probability outcomes. Implementing this approach requires 
sophisticated judgments about possible risks to the economy, as 
well as the flexibility to respond quickly to new information 
or unexpected developments. Risk analysis of this type is a 
necessary component of successful monetary policymaking. To be 
sure, the need for flexibility does not imply that a good 
policy is undisciplined, as Chairman Greenspan himself has 
emphasized. Monetary policy is most effective when it is as 
coherent, consistent and predictable as possible, while at all 
times leaving full scope for flexibility and the use of 
judgment as conditions may require.
    Finally, under Chairman Greenspan, monetary policy has 
become increasingly transparent to the public and the financial 
markets, a trend that I strongly support. A more transparent 
policy process increases democratic accountability, promotes 
constructive dialogue between policymakers and informed 
outsiders, reduces uncertainty in financial markets, and helps 
to anchor the public's expectations of long-run inflation, 
which, as I have argued already, promotes economic growth and 
    One possible step toward greater transparency would be for 
the FOMC to state explicitly the numerical inflation rate or 
range of inflation rates it considers to be consistent with the 
goal of long-term price stability, a practice currently 
employed by many of the world's central banks. I have supported 
this idea in my academic writings and in speeches as a Board 
    Providing quantitative guidance about the meaning of 
``long-term price stability'' could have several advantages, 
including further reducing public uncertainty about monetary 
policy and anchoring long-term inflation expectations even more 
    I view the explicit statement of a long-run inflation 
objective as fully consistent with the Federal Reserve's 
current policy approach, including its appropriate emphasis on 
the role of judgment and flexibility in policymaking. Most 
important, this step would in no way reduce the importance of 
maximum employment as a policy goal. Indeed, a key 
justification for this action is its potential to contribute to 
stronger and more stable employment growth by further 
stabilizing inflation and inflation expectations. In any case, 
I assure this Committee that if I am confirmed, I will take no 
precipitate steps in the direction of quantifying the 
definition of long-term price stability. This matter requires 
further study at the Federal Reserve, as well as extensive 
discussion and consultation. I would propose further action 
only if a consensus can be developed that taking such a step 
would further enhance the ability of the FOMC to satisfy its 
dual mandate of achieving both stable prices and maximum 
sustainable employment.
    My comments so far today have focused on monetary policy. 
Of course, the Federal Reserve's responsibilities extend well 
beyond this area. Since its founding, the Federal Reserve has 
been given substantial responsibility for protecting the 
stability of the Nation's financial system, which is a 
precondition for stability of the broader economy. For example, 
the Fed works closely with other regulators to ensure the 
safety and soundness of the U.S. banking system, and over the 
years it has played a constructive role in managing and 
mitigating diverse types of financial crises. If I am 
confirmed, I will work to enhance the stability of the 
financial system and to ensure that the resources, procedures, 
and expertise are in place as needed to respond to any threats 
to stability that may emerge.
    The Federal Reserve, along with other regulators, is also 
engaged in trying to ensure that consumers are treated fairly 
in their financial dealings: That their privacy is protected, 
that they receive clear and understandable information about 
the terms of financial agreements, and that they are not 
subject to discriminatory or abusive lending practices. The Fed 
also enhances consumer welfare through programs to promote 
financial literacy and community economic development. These 
are important responsibilities, and if I am confirmed, I will 
give them my close attention and support.
    I have emphasized this morning the importance of 
intellectual continuity in policymaking. A more fundamental 
source of continuity, however, is the superb staff and 
leadership of the Federal Reserve System. If I am confirmed, I 
will have the privilege of drawing on the great strengths of 
this institution to ensure a continuity of the policy process 
that transcends any single person. I very much look forward to 
this opportunity.
    Let me conclude by offering special thanks to Chairman 
Greenspan for his collegiality and support when I served on the 
Board of Governors and for his exemplary leadership of the 
Federal Reserve System. One may aspire to succeed Chairman 
Greenspan, but it will not be possible to replace him.
    Thank you. I would be happy to take your questions.
    Chairman Shelby. Thank you, Dr. Bernanke. It is well known 
that you have been a proponent of inflation targeting, which is 
pleasing to this Senator. Have your views on inflation 
targeting, Dr. Bernanke, as an academic, been tempered by your 
more recent experience as a policymaker, both at the Board of 
Governors of the Federal Reserve and in your present job as the 
top economic adviser to the President of the United States?
    Mr. Bernanke. Chairman Shelby, my views on inflation 
targeting now are that it represents continuity with the 
existing approach of the Federal Reserve System, which focuses 
on maintaining medium- and long-term inflation stability as the 
primary contribution that the Fed can make to maintaining 
stability of the general economy. We see, for example, in the 
last 20 years, that the economy has become more stable, that 
employment growth and output growth have been stronger and more 
stable, that recessions have been less frequent. I attribute 
that to the maintenance of stable inflation and inflation 
    So, in that respect, the inflation targeting ideas that I 
had espoused simply are an attempt to perhaps codify or 
strengthen this important commitment of this Federal Reserve to 
maintaining low inflation.
    I also think of this as a continuation of the Fed's recent 
progress toward greater transparency in policymaking. Over the 
past 10 years, the Fed has become increasingly more open about 
its processes, about its decisionmaking, and I believe this is 
just a single step and indeed just an incremental step that 
would add to that transparency.
    But, in particular, I would like to emphasize to those who 
may be concerned that, in no way, do I intend to make any 
significant change in the overall approach to monetary policy 
that has been developed under Chairman Greenspan.
    Chairman Shelby. Dr. Bernanke, do you believe an inflation 
targeting regime is consistent with the Federal Reserve's other 
goals, that is, of long-term sustainable growth and full 
employment, or full as we can get?
    Mr. Bernanke. Chairman Shelby, I subscribe entirely and 
wholeheartedly to the dual mandate. I believe the Federal 
Reserve has an important responsibility to maintain strong and 
sustained employment growth. I believe, though, that the best 
way that the Fed can do that, or one of the best ways, is to 
maintain, in the medium- and long-term, low and stable 
inflation and inflation expectations. To the extent that the 
inflation targeting approach, which may not be a good name for 
the process, but to the extent that naming a long-term 
inflation objective can help to stabilize those expectations, 
keep inflation under control, I think it actually significantly 
advances our ability to meet the dual mandate and to increase 
employment growth.
    Chairman Shelby. Is it your view that price stability is 
very important to all Americans?
    Mr. Bernanke. I certainly agree with that, Chairman.
    Chairman Shelby. Thank you. When your nomination was 
announced by President Bush, you indicated, ``My first priority 
will be to maintain continuity with the policies and policy 
strategies established during the Greenspan years.'' But when 
you are confirmed, as I predict you will be soon as Chairman of 
the Federal Reserve, it will be the Bernanke-led Federal 
Reserve. Could you elaborate on your statement for the 
Committee here today? Specifically, can you discuss your views 
on the importance of price stability that I just referenced, 
and do you view the pursuit of inflation targeting regime, 
which we have been talking about, as being consistent with the 
policy strategies of the Greenspan era?
    Mr. Bernanke. Yes, Chairman. In my statement, I emphasized 
three elements of the Greenspan strategy. They are, first of 
all, maintaining low and stable inflation in the medium-term; 
second, using flexibility and judgment in making monetary 
policy--I do not subscribe to any rigid or mechanical rule in 
policymaking--and the third, using transparency to inform the 
public and the markets about policy and its intentions. In all 
these respects, I intend to be continuous with Chairman 
Greenspan. I expect also, though not to be static and to evolve 
over time. In the case of Chairman Greenspan, transparency 
changed over time, evolving into a greater degree of 
transparency. I expect going forward, to look for other 
opportunities to increase the transparency of the Federal 
Reserve. Naming the long-term inflation objective, which I 
again emphasize would be done only if there is a broad 
consensus that it is appropriate, would be one potential step 
for increasing that transparency.
    So good monetary policymaking evolves over time, as we 
learned from the experience of other countries and from our own 
experience. I intend to be flexible and to learn from 
experience, but I believe the right starting point is where we 
currently are, that Chairman Greenspan has demonstrated in his 
    Chairman Shelby. Dr. Bernanke, you have spoken before of 
transparency at the Fed and so forth. Do you believe that there 
would be a point at which transparency would be or could be 
counterproductive to effective implementation of monetary 
    Mr. Bernanke. Yes, Chairman Shelby, I do. Transparency has 
an important role in helping the public understand policy 
intentions and policy goals. However, transparency should not 
be allowed to interfere with the decisionmaking process itself. 
To the 
extent that, for example, some have suggested that the FOMC 
meetings be televised.
    Chairman Shelby. FOMC, tell the public what that is. We 
    Mr. Bernanke. I do not think that, for example----
    Chairman Shelby. Open Market Committee?
    Mr. Bernanke. I am sorry. The FOMC, the Federal Open Market 
Committee, that is the decisionmaking body that determines 
monetary policy. One extreme form of transparency would be 
simply to televise the meeting at which the discussion takes 
place. My concern about that suggestion is that it would 
inhibit discussion, that it would affect the decision process, 
that it would create volatility in financial markets. I believe 
that is an example of a transparency which might be a step too 
far in terms of affecting the decision process itself.
    Chairman Shelby. Thank you.
    Senator Sarbanes.
    Senator Sarbanes. Thank you very much, Mr. Chairman.
    Let me continue on the inflation targeting issue since it 
has been put into play here right at the outset.
    In 2000, you and several colleagues wrote an opinion piece 
in The Wall Street Journal entitled ``What Happens When 
Greenspan is Gone?'' You were certainly looking ahead, I must 
    In that article you stated, ``We think the best bet lies in 
a framework known as inflation targeting, which has been 
employed with great success in recent years by most of the 
world's biggest economies, except for Japan.'' The European 
Central Bank uses inflation targeting, and they set the target 
at 2 percent. But most observers see their experience has been 
one of slower economic growth and higher unemployment, and 
usually, actually, although not always, higher inflation.
    What we have achieved in the United States without an 
inflation target--and I just want to show three charts in that 
regard. One is GDP growth in the United States versus Europe. 
Our GDP growth as a general proposition has done better. The 
next inflation, United States versus Europe. And except for 
this period here--and we are on the way back down--we have done 
a better job. And then the final chart is the unemployment 
rate, United States versus Europe. There, as we see, the United 
States has consistently had a substantially lower unemployment 
rate than the Europeans have.
    So on unemployment rate, inflation, and GDP growth, we are 
doing better than the leading practitioner I would guess of 
inflation targeting.
    David Wyss, Standard and Poor's Chief Economist, summarized 
the lesson of these charts this way: The experience of the 
European Central Bank does not give people a lot of confidence 
about inflation targeting. That was in a BNA report just a few 
weeks ago.
    If inflation targeting works so poorly in Europe compared 
to our performance, why should we go down that path here?
    Mr. Bernanke. Senator, just as a preliminary remark, it is 
certainly the case the U.S. economy has outperformed the 
industrial economies of Europe in the last decade or so, and I 
would ascribe that primarily to a set of structural 
differences: The flexibility of our labor markets, for example, 
compared to European labor markets, regulatory tax policies, 
and other policies. So, I do not ascribe the very real 
differences that you point to as being primarily related to 
monetary policy.
    Having said that, I think it is important to note that the 
European Central Bank itself does not describe its own policy 
as inflation targeting, and its policies are very distinct from 
the ones I would advocate in one very important sense, that the 
mandate of the European Central Bank is for price stability and 
price stability only, with other considerations to be taken 
account of only insofar as price stability is met.
    Senator Sarbanes. And what do you think of that?
    Mr. Bernanke. I disagree with it entirely.
    Senator Sarbanes. All right. Now, let me ask you the next 
follow-on--and I am hurrying along because we get limited in 
the time we have to ask questions.
    Of course, Chairman Greenspan publicly opposed inflation 
targeting. In the book on inflation targeting that you edited 
several years ago, some academics recommended that the Federal 
Open Market Committee unilaterally establish inflation targets. 
Former Fed Governor Ned Gramlich has argued that any move 
toward inflation targeting would require the approval of the 
Congress, and he made this statement: ``The question of whether 
the United States does or does not adopt a formal inflation-
targeting regime is not up to the Federal Reserve. The Federal 
Reserve Act now requires the Fed to strive for maximum 
employment and balanced growth, along with price stability and 
moderate long-term interest rates. Until the Congress changes 
these guidelines, the Fed will continue to pursue these 
    Do you agree with Governor Gramlich?
    Mr. Bernanke. I disagree somewhat with his premise, 
Senator. Inflation targeting comes in many flavors. Some 
countries have taken a more hawkish stance in terms of putting 
inflation first among equals or even first among the objectives 
of policy. As I said, I subscribe entirely to the Humphrey-
Hawkins mandate, which puts employment growth and output growth 
on a fully equal footing with inflation in terms of the Federal 
Reserve's objectives.
    I believe in the types of changes that I am proposing--
which are not major changes--in the way policy is conducted or 
any change in objectives; are modest bit of additional 
transparency, which I believe would help the Federal Reserve 
achieve the stated, mandated objectives the Federal Reserve 
    Since this is not a change in objectives or a change in 
fundamental operating procedure, in my view the kinds of 
suggestions I am making would not require a change in the law. 
If I thought they did, I would not follow them through because 
I am not interested in changing the mandate of the Federal 
    Senator Sarbanes. Well, you certainly could not do it 
unilaterally. You would have to come to the Congress in order 
to do that, would you not?
    Mr. Bernanke. To change the law, certainly.
    Senator Sarbanes. Yes.
    Mr. Bernanke. Of course. So, I would not be interested in 
pursuing that matter with Congress if I thought that it 
involved changing the mandate of the Federal Reserve.
    Senator Sarbanes. E.J. Dionne wrote just a few weeks ago, 
``A Fed Chairman who beats inflation at the cost of middle-
income living standards will not be regarded as a success.''
    What do you think about that observation?
    Mr. Bernanke. Senator, I think it is a false dichotomy. 
Middle-income living standards, and poverty, for that matter, 
are best addressed through strong, stable employment growth. It 
is low-income people who suffer most from recessions. It is 
low-income people who suffer most from high levels of 
inflation. The understanding that central banks currently have 
is that by maintaining inflation at a low and stable level, 
avoiding a situation where inflation gets out of control--as it 
did, for example, in the 1970's--you can create more stable, 
more solid, and more substantial growth in employment.
    I am entirely in favor of maximum employment. I believe 
this is a method to achieve it. If I did not think it was, I 
would not pursue it.
    Senator Sarbanes. My time has expired. I just want to leave 
you with the impression of these two charts again.
    This is the unemployment rate in the United States versus 
Europe, and, of course, the Europeans Central Bank is the one 
that is cited for using inflation targeting. They set a 2-
percent figure. This is the unemployment rate. This is 4 
percent here. This is 6 percent there.
    In the United States, substantially and consistently below 
the unemployment rate in Europe.
    Mr. Bernanke. Senator, it was below that rate 20 years ago 
before ECB was even created. I believe there are other factors 
that contribute to that difference.
    Senator Sarbanes. We will have to separate them out, but a 
number of people think that the European Central Bank focus on 
inflation targeting as its only objective, which is what it has 
been given, has led to a loss of economic growth, GDP growth, 
and the unemployment situation, without getting a particularly 
better performance on the inflation front compared to the 
United States.
    Mr. Bernanke. Senator, I disagree with that objective. I 
think the dual objective is the correct one.
    Senator Sarbanes. Okay.
    Thank you, Mr. Chairman.
    Chairman Shelby. Senator Sununu.
    Senator Sununu. Thank you, Mr. Chairman.
    Let me begin with an observation about your concern with 
regard to having cameras in Open Market Committee proceedings. 
We have had televised Senate debate for some time now, and I 
think you will find political posturing for the benefit of the 
cameras is practically unheard of.
    Let me engage you in a modest hypothetical. It is the end 
of December 2007, and we are into the second year of the 
Bernanke Fed. The charm offensive has continued. The titans on 
Wall Street are wearing tan socks in deference to the 
intelligent but very plain-spoken Chairman of the Fed.
    For the past 6 months, the announced target rate has been 
1.5- to 2.5-percent inflation as a target for the Fed, but for 
the final quarter of 2007, inflation has been running at an 
average of 4.2 percent.
    What do you say? What do you do? And how do the markets 
    Mr. Bernanke. Senator, a little bit depends on the 
circumstances and where the inflation came from and the like. 
The inflation objective is explicitly a long-term or medium-
term objective. It focuses, for example, on core inflation to 
avoid getting involved in short-term fluctuations in energy 
prices and the like.
    My principal concern at that point would not be that 
inflation had temporarily risen above its normal range. For 
example, currently inflation is above the range that in the 
long-run would be desirable. But the concern would be that 
expectations about inflation going a year or two in the future 
had become unhinged or unanchored so that the public was losing 
its confidence in the Federal Reserve to maintain low and 
stable inflation.
    I believe that maintaining that confidence is extremely 
important. It is important whether you have an explicit target 
or whether you do not have an explicit target. Under Chairman 
Greenspan, talk and action were combined to assure the markets 
that over a period of time--not necessarily within a quarter or 
two quarters, but over a period of time, perhaps lasting 
several years--the Fed would stabilize inflation in a region 
consistent with the objective of price stability.
    So that is the approach I would take. I would certainly not 
try to return inflation to a target within a short period of 
time. I would simply try to assure the markets that over a long 
period of time the Federal Reserve was committed to price 
stability as a central part of its monetary strategy.
    Senator Sununu. What can you do to provide that long-run, 
longer-term assurance? And do you think that markets are 
sophisticated enough, rational enough, intelligent enough to 
recognize this difference between the longer-term objective 
with regard to core inflation and what you might perceive in 
your capacity as Fed Chairman as being a shorter-term anomaly?
    Mr. Bernanke. I think the markets are quite able to 
distinguish. They pay a lot of attention now to core measures 
because they understand that the Fed is interested not in 
short-term inflation fluctuations but, rather, in the long-term 
trend of inflation and making sure that it stays under good 
    Again, I think the primary means of winning inflation 
credibility is by demonstrating, over a long period of time, 
that the Fed is committed to maintaining price stability by 
doing that. By naming a potential range, which I emphasize is 
no fait accompli, is something that is going to be discussed 
and will be consulted with Members of Congress, but naming such 
a range does not change the 
underlying dynamic. It is only an attempt to provide a bit of 
additional confidence, a bit of additional assurance, or a bit 
of additional certainty to the markets about the Federal 
Reserve's long-term objective.
    Senator Sununu. Has there been any attempt or any success 
at measuring improvements or the beneficial impact on stability 
or volatility in those central banks that have used targeting?
    Mr. Bernanke. Yes, Senator, there is an extensive 
literature. I could talk about it for quite a while.
    Senator Sununu. You have 22 seconds.
    Mr. Bernanke. It is not quite definitive because, of 
course, every country is different. But there is recent 
evidence by Board research, for example, from the United 
Kingdom and Sweden, which shows greater stability in their 
long-term interest rates after they became inflation targeters 
because the market has more confidence that inflation and long-
term interest rates will remain stable and less concern about 
short-term fluctuations.
    Senator Sununu. Thank you very much.
    Thank you, Mr. Chairman.
    Chairman Shelby. Thank you.
    Senator Dodd.
    Senator Dodd. Thanks, Mr. Chairman, very much, and let me 
thank our witness again for his presence here this morning.
    Let me not go quite as far in advance as my colleague from 
New Hampshire has, going a couple of years, but let me talk 
about something that is looming, I think maybe in the next few 
weeks or months, and that is an energy shock which we may 
witness here. I do not know whether you would agree or not, but 
I suspect you might agree that handling an energy shock is one 
of the most difficult problems that the Federal Reserve has to 
respond to.
    Last year, as a Member of the Board, you gave a speech in 
which you said, ``Monetary policy cannot offset the 
recessionary and inflationary effects of increased oil prices 
at the same time. If the central bank lowers interest rates in 
an effort to stimulate growth, it risks adding to inflationary 
pressure. But if it raises rates enough to choke off the 
inflationary effect of the increase in oil prices, it may 
exacerbate the slowdown in economic growth. Whether monetary 
policy eases or tightens following an increase in energy prices 
ultimately depends on how policymakers balance the risks they 
perceive to their employment and price stability objectives.''
    I bring up this dilemma because a piece this morning, The 
New York Times ran an article about the potential threat of an 
energy price shock to our Nation's economy, and the article 
reads, ``Unexpectedly warm weather has bathed much of the 
United States in recent weeks, but fears persist that a classic 
energy shock may be unfolding as the Nation heads into 
    The article goes on to quote the owner of a business whose 
monthly natural gas price--and it is in the natural gas price 
here I think we are looking at the major problem here. But they 
cite a business that doubled its natural gas bill from $700,000 
to $1.4 million as an example of the threat posed by high 
energy prices to our larger economy. I might point in my State, 
51 percent of my consumers use natural gas, and they are 
looking at about a $276 increase, or a 27-percent increase this 
    After the last major price shock hit our Nation's economy 
in the 1970's, it took a painful recession that had deep and 
lasting consequences for many people to bring inflation back 
under control. Given the soaring prices of oil and gas over the 
past few months and the possibility of further supply 
disruptions, what type of monetary policy prescription would 
you apply? I mean, I appreciate your article in which you cite 
the balancing things here, but then you were writing an 
article. Now you are going to become the Chairman of the 
Federal Reserve. You do not have the luxury of telling us on 
the one hand and on the other. We want Harry Truman's economist 
here, and that is, a one-armed economist here. What is the 
answer of the Chairman of the Federal Reserve if we face this 
type of a shock?
    Mr. Bernanke. Senator, as I also discussed in that 
particular speech, the oil price impacts on the economy and the 
monetary policy response is an excellent illustration of the 
importance of having low, stable, and well-anchored inflation 
expectations. The contrast between the 1970's and now, with an 
energy price shock of a similar magnitude, is very instructive. 
During the 1970's, inflation expectations were very poorly 
anchored. There was very little confidence that the Fed would 
keep inflation low and stable. When oil prices rose, those 
price increases fed through quickly into other prices and began 
to raise the general rate of inflation quite quickly. The Fed 
responded in a panicked way, by raising interest rates 
enormously, which then contributed to the deep recessions of 
1975 and 1981-1982.
    In a more recent episode, we have had extensive increases 
in energy prices, but outside of the energy sector, if we look 
at core inflation, core inflation remains very well-controlled, 
and as a result, the Federal Reserve has been able to raise 
interest rates from its low accommodative level, but to only 4 
percent at this point, and the economy is growing strongly.
    So, I think this is an enormously good illustration of why 
keeping inflation low, stable, and keeping expectations well-
anchored is of tremendous benefit, not just on the inflation 
side but also on the employment and growth side.
    Senator Dodd. So you would not anticipate taking any 
precipitous action here in light of these price increases?
    Mr. Bernanke. I believe that inflation expectations remain 
well-anchored. It is important to ensure they remain well-
anchored. But as long as they remain well tied down and low and 
stable, I imagine that the economy will be much better able to 
absorb any further increases in energy prices than they were 30 
years ago.
    Senator Dodd. Any indications you have as a result of your 
present employment that the anecdote cited here in The New York 
Times article about the business that virtually is doubling its 
energy costs as a result of price increases is more than just 
    Mr. Bernanke. There are real problems in the energy sector; 
in natural gas, in particular, there have been substantial 
increases in prices, largely because the United States is 
somewhat isolated in terms of natural gas. We do not have the 
capacity to import large amounts, and, therefore, when we lose 
domestic production, as we did following Katrina, the shortage 
of supply drives up prices.
    Natural gas prices have been rising for some time, and this 
has proved a very heavy burden to chemical manufacturers, 
Alumina, other manufacturers in the United States. That is a 
real problem. I do not want to understate that problem at all. 
But, obviously, monetary policy per se can only try to avoid 
having those price increases spread into general inflation. 
Monetary policy cannot create more energy. It cannot really 
solve the energy problem.
    Senator Dodd. Let me jump quickly, because time is short 
here, to another area of questioning, if I can, although that 
is obviously a looming problem here. And if you are confirmed, 
we are going to want to talk with you about this potential 
energy shock.
    Let me address the issue of fiscal responsibility and 
deficit-financed tax cuts. You wrote in your macroeconomic 
textbook that you co-authored with Andrew Abel, you discussed 
the negative effect of budget deficits, and I thought a rather 
good paragraph here, you said, ``The tendency of government 
budget deficits to reduce investment spending is called 
crowding out.'' You have used that line many times in your 
book. ``Reduced investment spending implies lower capital 
formation and, thus, lower economic growth. The adverse effect 
of budget deficits on economic growth is probably the most 
important cost of deficits and a major reason why economists 
advise governments to minimize their deficits.''
    Because of the negative effect of budget deficits, which 
you so eloquently describe, is it not possible that the cost of 
running a budget deficit could outweigh any benefit to be 
gained by a tax cut?
    Mr. Bernanke. Senator, I agree that budget deficits are a 
problem. I think it is important to continue to reduce budget 
deficits. I am going to begin now, I think, a practice of not 
making recommendations on specific tax or spending proposals--
    Senator Dodd. I did not ask for that here. I am just asking 
whether or not the negative implications of a budget deficit 
could outweigh any benefits--without getting very specific. We 
won't talk about any specific tax cut, just as a general 
    Mr. Bernanke. As a general proposition, it is possible. It 
depends on the scale of spending, the size of the deficit, and 
whether or not the debt-to-GDP ratio is thought to be stable or 
    Senator Dodd. So it could be more damaging to our----
    Mr. Bernanke. It is possible.
    Senator Dodd. Let me ask you quickly as well, are you 
concerned at all about the record levels of debt being held by 
foreign creditors? We are now talking numbers that are getting 
close to $1 trillion, I think it is. Does that worry you at all 
as the potential Chairman of the Federal Reserve?
    Mr. Bernanke. Well, Senator, given that we have a large 
current account deficit--a complex issue which I am sure I will 
be asked to address and will be glad to address and given that 
that deficit needs to be financed, we are fortunate that 
foreigners, including foreign central banks, seem quite willing 
to hold U.S. Treasury debt and other financial instruments. So 
it is like asking how it feels to be very old. You consider the 
alternative. It is better to have willingness to hold our 
financial assets than not, given that we have a large current 
account deficit.
    Senator Dodd. But certainly better off if we did not have 
to have them hold it at all. Better to be young.
    Mr. Bernanke. The issue is what to do about the current 
account deficit, and I would argue that we need over a period 
of time, to reduce the current account deficit. I believe that 
is possible to do. Once the current account deficit comes down, 
then the need to have foreign financing will, therefore, be 
    Senator Dodd. So you are not alarmed about this at all.
    Mr. Bernanke. I believe that the current account deficit 
needs to come down over a period of time.
    Senator Dodd. But you are not alarmed about foreign 
creditors holding this debt?
    Mr. Bernanke. I think that it is an essential implication 
of the fact that we have a current account deficit, that it 
needs to be financed, that we are better off with willing 
lenders than we are with unwilling lenders. If they were not 
willing to hold our obligations, interest rates would be higher 
the economy would not be as strong.
    Senator Dodd. Thank you.
    Thank you, Mr. Chairman.
    Chairman Shelby. Senator Bennett.
    Senator Bennett. Thank you, Mr. Chairman.
    Back to your comments to Senator Sununu, Dr. Bernanke, both 
of you talk about inflation here or inflation there and you use 
numbers. That assumes that we know what inflation is. That 
assumes that our measuring device is accurate. And I am not 
sure that is true. Do we use CPI? Do we used chained CPI? Do we 
use the PCE price index, the CPI-U? Various measures of 
    Then the Tax Code has provisions that are indexed to CPI-U, 
and let me ask you, do you believe that CPI-U is the 
appropriate measure or would you rather move to something like 
the chained CPI or the PCE price index? Your predecessor always 
insisted that the CPI was overstated, and I would like your 
reaction to that, because we are talking about pegging to a 
number or trying to find a number or trying to hit a goal. But 
if the goal is measured improperly, we need X number of 
touchdowns, and the touchdown are only worth 4 points, and we 
are counting them at 6, why, we end up with the wrong kind of 
    A very bad analogy. I apologize for it.
    Mr. Bernanke. That is a very good question, Senator.
    As you know, Senator, there was a commission some years ago 
headed by Michael Boskin with a number of other distinguished 
academics that reviewed the Consumer Price Index as a 
measurement of inflation, and it found for a number of reasons 
that it overstated inflation. Quality adjustment bias, 
substitution bias, and other technical matters were involved.
    For that reason, for purposes of thinking about inflation 
and for purposes possibly even of indexing in the Government, I 
think consideration should be given to measures of inflation 
which adjust for some of these concerns. For example, chain-
weighted measures of inflation tend to reduce the substitution 
bias that the Boskin Commission pointed to.
    With respect to choosing an inflation objective in the 
medium-term, there are many considerations one would want to 
take into account--familiarity by the public, for example. I 
think that would need to be discussed by the Federal Open 
Market Committee and in our general consultations. To the 
extent that, say, the CPI overstates inflation by an 
approximately known amount, one could simply adjust the range 
of inflation rates that define price stability to allow for 
that bias.
    So there are many considerations to be taken into account 
there, and I do not want to prejudge that issue.
    Senator Bennett. Okay. As I said, the Tax Code has 
provisions that are tied to CPI. Would you recommend that we 
change the Tax Code if we come to the conclusion that it is 
overstated--which Chairman Greenspan believes--and, thus, 
affect bracket creep and all of the other things that occur 
    Mr. Bernanke. Senator, of course, this is ultimately 
Congress' decision, but from a purely technical perspective, I 
believe there are better measures of inflation than the CPI-U, 
and in that respect, one might want to consider alternatives.
    Senator Bennett. That was at the heart of my proposal with 
respect to Social Security, looking at the way the inflation is 
    Let us go to tax reform. Two versions of tax reform were 
forwarded by the President's tax reform commission to the 
Department of the Treasury for review. Frankly, I was a little 
disappointed. I was hoping for a clean sheet of paper approach, 
and I feel that they were nibbling around the edges. I think 
the current Tax Code, which has its philosophical basis in the 
1930's, is no longer applicable to the 21st century. I have a 
novel and radical idea that the purpose of taxes should be to 
raise money to run the Government and not to direct economic 
activity toward or against any particular bias.
    We then run into the question of how much money does the 
Government need, and, historically, I have felt comfortable 
with 20 percent of GDP as the absolute top ceiling, and we have 
gotten by, 
regardless of where the Tax Code is. A combination of payroll 
taxes and income taxes have produced revenues somewhere in a 
band of 18.5 to 19.5 percent of GDP, with the river of revenue 
that came in when we changed the capital gains tax rate as part 
of the agreement made between Congress and President Clinton 
following the 1996 election, where the capital gains 
realizations were 5 times as much as CBO had projected that 
they would be. The Federal revenue went up to 22, 22.5 percent 
of GDP, and that was one of the figures that caused some of us 
to feel we could support a reduction in tax burden to come down 
to the 20 percent--below 20-percent ceiling.
    Then we had September 11, we had the recession, we had the 
war, and the economy went into the tank, so that we fell down 
to about 16.5 percent of GDP. We are now rising comfortably 
back toward the 18.5 to 19.5 percent band where last year tax 
revenues were up 14 percent over the previous year, showing 
that these policies were working.
    Where would you put the ceiling, regardless of what the tax 
structure is? Are you comfortable with saying 20 percent of GDP 
is all the Federal Government should be taking out of the 
economy? Or would you go with some of our friends who say no, 
it should be as high as 25 or 28, 29 percent of GDP and then we 
can pay for all of the wonderful things Congress wants to 
enact? Do you have an opinion as to where that number should 
    Mr. Bernanke. Senator, I just note that as an empirical 
fact, over the last 40 years, the share of GDP collected as 
Federal taxes has been pretty stable at about 18.2 percent, 
something in that range. And you are right, we are not much 
below that at this point.
    No, I would not be inclined to pick a specific number other 
than to observe that historically we have been stable around 
this 18-percent rate. The choices that Congress will face are 
really cost-benefit choices. Looking at individual programs, do 
they meet the cost-benefit test when you include in the cost 
the fact that the higher the share of GDP that you collect in 
taxes, the greater are the so-called deadweight losses or 
excess burdens associated with the inefficiencies of high 
taxes? I do not think that one can necessarily point to a 
single number, but I do believe that a rigid, rigorous cost-
benefit analysis should be applied to different programs.
    I would point out a concern, which may be what you are 
alluding to, that on current plans the three major entitlement 
programs--Medicare, Medicaid, and Social Security--are slated 
to take up about 16 percent of the GDP as of 2045. Together 
with the interest on the national debt, that would be pretty 
much the entire share of GDP that we are currently spending on 
the Government.
    Senator Bennett. It would be higher than that, according to 
the projections I have seen.
    Mr. Bernanke. So, in any case, it would involve either 
radical increases in taxes, radical cuts in other spending 
programs, or some combination. So, I do believe, if that is 
what you are alluding to, that certainly is a looming issue 
that needs to be addressed sooner rather than later.
    Senator Bennett. Thank you.
    Chairman Shelby. Senator Bennett, thank you.
    We have about 3 minutes left on this series of votes. Dr. 
Bernanke, we will recess until 3 o'clock.
    The hearing is in recess.
    Chairman Shelby. The hearing will come back to order.
    The Chair recognizes Senator Carper.
    Senator Carper. Thank you, Mr. Chairman. You have a memory 
like an elephant, so thanks for letting me lead off here.
    Chairman Shelby. It is your time.
    Senator Carper. Yes, it is.
    Dr. Bernanke, thank you for coming back and for 
accommodating our schedule. We apologize for all those votes 
and that you had to truncate your day.
    Just a couple of press interviews right around our lunch 
hour, and people were asking me, like some TV people and radio 
people wanted to know how things were going so far, and I 
described the hearings; I described a day-night double header 
in baseball: We did the day part of the game, and now, we are 
about to move into the twilight portion of the game.
    I would like to just start by again thanking you for being 
here, for your willingness to serve our country. And I am just 
going to ask you to take a couple of minutes, if you will, and 
just describe what you see when you look at our economy: How we 
are doing, where we are strong, where we are not so strong and 
any thoughts you might have toward what we can do better. I 
would like to say that everything we do, we can do better, and 
how do you assess the situation, and how might we do better?
    Mr. Bernanke. Thank you, Senator.
    That is a large question. I think in the near-term, the 
economy is in a strong recovery. The economy has been growing 
quickly for the last couple of years. Employment has been 
improving. The labor market is improving, and I am looking 
forward to that growth continuing next year despite the 
obviously serious impacts of the hurricanes.
    One good feature of this growth has been the increase in 
productivity, which we saw again in the third quarter. The 
ability of this economy to continue to improve output per hour 
is remarkable and speaks very well for the innovativeness and 
the industry of the American people and speaks well for the 
future of the economy.
    With respect to inflation, I think the main issue has to do 
with energy prices. The economy has withstood 3 years of 
increasing energy prices. So far, both growth and inflation 
have not been very badly affected; in particular, core 
inflation remains low, and I think an important consideration 
for the Federal Reserve going forward is that should energy 
price increases continue, they not feed into second round 
effects; they not become part of the baseline inflation rate.
    So, I think the near-term situation is strong. There are 
certainly risks. We can get into many of them. Housing prices 
will probably stabilize. Energy prices are an issue. So there 
are some risks in the near-term, but I think the baseline looks 
reasonably strong.
    As some of our earlier conversations alluded to, I think 
the United States economy faces some very serious long-term 
issues, and just to tick them off for future discussion: First, 
fiscal, particularly over the next few decades, we have 
increasing obligations with respect to entitlements. We will 
need to find ways to restructure those entitlement programs or 
else pay for them. They represent a very serious challenge to 
our economy.
    Second, education will come up in many of our discussions 
here, because in our world today--with enormous amounts of 
dynamism, openness, international trade, change--people need to 
be able to have lifetime learning to change, to be able to 
respond to new conditions. Education and training are going to 
be a crucial part of that.
    Third, I would mention technological leadership. We need to 
maintain that leadership here in the United States. There have 
been a number of reports here addressing that subject.
    And finally, just this laundry list; perhaps more than you 
asked for.
    Senator Carper. No, it is a good list.
    Mr. Bernanke. We need to address the health care sector. 
There are many pockets of excellence, of course, in our health 
care system, but the costs are high, and they are rising. They 
have fiscal implications--for wages, for competitiveness--and I 
would put that along with these other long-term issues at the 
very top of the things we need to address.
    Senator Carper. Thanks. On the last point you mentioned 
with respect to health care, I mentioned to the people back in 
Delaware on Veterans Day, we had a number of assemblies around 
the State of veterans, and I mentioned that an unlikely model 
for us to consider emulating, at least with respect to 
harnessing information technology in the provision of health 
care actually comes out of the VA, a place which was a 
backwater just years ago but today is really setting the model.
    You did not mention savings. We are lousy savers, as you 
know. In fact, the last couple of months, I think we have 
actually seen negative net savings. And I would just ask, is 
that a source of concern to you? Should it be for us? What 
should we do?
    Mr. Bernanke. I think it is an issue, Senator. I think part 
of the reason for the low savings rate in the last few years is 
that our wealth has risen for a variety of reasons. Our housing 
wealth has increased. The stock market has recovered somewhat. 
So, with their homes doing their savings for them, for example, 
people are less inclined to put aside something from their 
    That has implications for our current account, for other 
issues. I suspect as we go forward that the savings rate will, 
of its own accord, begin to rebound somewhat, but it is an 
important issue. The fiscal situation contributes to the saving 
issue, so I agree that is something we need to look to over the 
long period.
    Senator Carper. Good. My time has expired. I would just say 
to my colleagues, Mr. Chairman, and to others, if you look at 
homeownership in this country, it is now up close to 70 
percent. It is about 75 percent in my State. But there are some 
people, low- or middle-income people, who should be homeowners, 
would like to be homeowners. They have the ability to make a 
mortgage payment, but they just are not able to get there. They 
do not think they can get there.
    And for a lot of those people, the ability to accumulate 
savings has passed them by. And one of the things I hope we can 
do is figure out better to help them. Thank you.
    Thanks, Dr. Bernanke, and good luck. I look forward to 
working with you.
    Mr. Bernanke. Thank you.
    Chairman Shelby. Senator Reed.
    Senator Reed. Thank you very much, Mr. Chairman, and once 
again, welcome, Dr. Bernanke.
    One of the ways we were able to instill fiscal discipline 
during the 1990's was adherence to PAYGO rules. And I just 
wondered, do you agree that PAYGO rules should apply to taxes 
as well as to expenditures?
    Mr. Bernanke. Senator, I think it is important for Congress 
to have well-developed structures, practices, and procedures 
for managing its budget, but I am not going to make a 
recommendation on that. I think that is outside of my realm of 
authority, and I think I would leave that to the Senate, and to 
Congress, to make up their own minds.
    Senator Reed. Well, your predecessor was not equally 
inhibited. He seemed to suggest that PAYGO was an appropriate 
mechanism to deal with fiscal discipline, and frankly, 
sometimes, we need a little help on these issues, Dr. Bernanke. 
So, I appreciate your ceding us the ground, but this is a very 
serious issue, and it seems to me that we will not be able to 
restore the discipline here in terms of an orderly budget 
process unless we do something like that.
    Let me ask the question again. You are an economist; I am a 
lawyer, so I keep asking questions. If we do not subject tax 
cuts to PAYGO, then, essentially, in this economy, we are 
borrowing the money for these tax cuts. Is that accurate?
    Mr. Bernanke. It depends on both the spending side and the 
tax side. To respond to your question in just a general 
economic way, I think there are several things to look at when 
you are examining a fiscal policy. One of them is deficits. 
Deficits are important, because they represent debt which is 
being accumulated and being passed on to future generations. 
But the share of the economy being devoted to Government 
spending is another important criterion. In particular, a 
balanced budget with Government spending at 25 percent of GDP 
is a very different proposition than a balanced budget with 
Government spending at 15 percent of GDP.
    So, I am a little bit reluctant--both for the reasons I 
mentioned in terms of my prerogatives but also in terms of the 
economics--to put specific rules like that. I think that the 
Congress has to make judgments about the overall arc of the 
budget and make tradeoffs.
    Senator Reed. Well, then, let me ask this a final way. 
Assuming you are consistent in your viewpoint, you would not 
render an opinion if we increased expenditures without 
offsetting it.
    Mr. Bernanke. I believe that it is within my purview to 
discuss broad issues of the share of Government spending and 
GDP, the share of taxes and GDP, deficits, fiscal stability, 
those issues. What I would like to do is refrain from making 
recommendations on specific matters of taxes and spending or 
specific approaches to pay-go and the similar methods.
    Senator Reed. And we can assume that is going to be a 
policy after you are confirmed as Chairman?
    Mr. Bernanke. That is my intention.
    Senator Reed. Thank you, Doctor.
    Let me ask another question: Chairman Greenspan has 
explained as recently as last fall that it is, in his words, 
``Very rare and very few economists believe that you can cut 
taxes, and you will get the same amount of revenues. When you 
cut taxes, you gain some revenue back. We do not know exactly 
this is, but it is not small. But it is also not 70 percent or 
anything like that.'' You do not subscribe to the view that tax 
cuts pay for themselves, do you?
    Mr. Bernanke. Senator, the revenue cost of a tax cut 
depends on the structure of the tax cut, whether it is one that 
improves economic growth or not, and so on. I think that 
generally, tax cuts, if they are well-designed, do increase 
growth and therefore do partially offset the revenue loss. But 
I think it is unusual for a tax cut to completely offset the 
revenue loss.
    Senator Reed. Thank you, Dr. Bernanke.
    One other area of concern, and that is although interest 
rates have not gone--excuse me, we have had, over the last 
several quarters, increases by the Federal Reserve with respect 
to interest rates, but the long-term interest rates have hardly 
moved at all, and that is, I think, an issue that is beginning 
to draw a lot of professional attention as to why that might 
    Although these long-term interest rates have not gone up, 
the large Federal budget deficits we have seen recently have 
substantially reduced our national savings. I think that is 
correct, also, and the increase in national savings, I would 
assume, and I hope you do also, does harm our future prosperity 
and economy; is that accurate?
    Mr. Bernanke. It does increase the debt that we pass on to 
our children; that is correct.
    Senator Reed. Now, just recently, I think Chairman 
Greenspan has talked about the potential for foreign lenders to 
become disenchanted. Will interest rates not have to rise 
substantially in our current posture if foreign lenders are not 
forthcoming? Is that almost axiomatic?
    Mr. Bernanke. I do not expect to see foreign lenders change 
their holdings very significantly. The foreign holders are not 
doing us a favor. What they are doing is choosing a set of 
assets which they consider to be highly liquid, highly safe, 
from a country with a safe, strong legal system. So it is for 
that reason that American assets make up the bulk of 
international reserves.
    I do not expect to see major changes in that. Moreover, 
there is broad interest in holding U.S. assets both by 
Americans, of course, but also by foreign, nonofficial sources 
as well, so I do not expect to see any such shift in demand for 
U.S. assets.
    Senator Reed. Thank you, Dr. Bernanke.
    Thank you, Mr. Chairman.
    Chairman Shelby. Senator Stabenow.
    Senator Stabenow. Thank you, Mr. Chairman and welcome. 
Welcome back.
    Mr. Bernanke. Thank you.
    Senator Stabenow. Dr. Bernanke, I wanted to talk a little 
bit more about this whole question of our U.S. assets, 
financial assets and other assets being held by foreign 
investors. We are told that about $9 trillion in all, if you 
look at financial assets, large portions of which are easily 
sold and highly susceptible to shifts in the market sentiment, 
to interest rates, to other variables, even a modest slowdown 
in the net new inflows from private and official foreign 
sources could have a negative impact on an economy where 
foreign investment is about 25 percent of our gross national 
product, very alarming. And I would argue that since a large 
part of that is China and Japan, that it unduly impacts our 
ability to enforce trade laws and to address other issues with 
them, whether we want to acknowledge that or not. I have a hard 
time believing it does not have some impact there.
    But it would appear to many of us that our trade deficits 
are leading us down an incredibly alarming path as well as our 
budget deficits. When you are looking back, do you see any 
instances where alternative monetary policy choices by the Fed 
could have moderated the buildup of these imbalances or had an 
impact on what is happening in terms of deficits?
    Mr. Bernanke. No, I do not think that the Federal Reserve, 
whose mandate, after all, is domestic price stability and 
employment, has much role in terms of the current account 
deficit. The current account deficit is a very complex 
phenomenon. I believe it arises from essentially a global 
imbalance of saving and investment. Countries outside the 
United States have a lot of savings that they want to put into 
international capital markets and insufficient investment to 
make use of those savings.
    The United States has been the recipient of those savings, 
and that is, in some sense, a good thing, because the United 
States is a very attractive destination for foreign capital 
flows. But it has also created this imbalance that we call the 
current account deficit.
    I do believe the current account deficit needs to come down 
over a period of time. I think there are a number of elements 
needed to do that. Part of it would be to increase U.S. 
national savings through both private savings and public 
savings. It would also be useful for our trading partners to do 
a number of things, including allowing their exchange rates to 
float freely and be determined by the market and relying less 
on exports as a source of demand for their economies.
    So we need to rebalance the global international system. I 
believe that can be done over a period of time, but it will not 
happen overnight. And I think the Federal Reserve's main 
objective should be to maintain domestic employment and price 
stability and to allow other factors to be predominant in 
curing the current account situation.
    Senator Stabenow. Let us talk for a moment; you mentioned 
floating currencies. Currency manipulation is of great concern 
to me and many of my colleagues. We had a very strong vote; I 
believe it was 67 Members of the Senate, both parties, a year 
ago that sent a very strong message about how we want that to 
stop, particularly with China; China, and Japan is also a 
concern, whether it be as aggressive or an open process in 
    We have a process where the Treasury Secretary comes in 
every 6 months, gives us a report. This past summer, he issued 
his semiannual report and was not able to bring himself to 
recognize that China is, in fact, manipulating their currency. 
We all know it is happening. Everybody in my State knows; any 
businessperson knows that is happening.
    But once again, we have in November, now, this month, we 
will have access to another report. I fear that it will be the 
same as other reports, technically indicating that currency 
manipulation is not happening. Do you believe the Federal 
Reserve has a role to play in ensuring that economies around 
the world allow market forces to determine the value of their 
    Mr. Bernanke. Senator, let me begin by saying that I think 
it is very much in China's own interest to allow their currency 
to float freely and be determined by the market. They are a 
very large country. They need to have independent monetary 
policy. It is difficult for them to continue sterilizing their 
interventions the way they have been doing, so I believe that 
they will come to the recognition, and I hope they do, that it 
is in their interest to allow their currency to be determined 
by market forces.
    With respect to the Federal Reserve's role, the Treasury 
usually takes the lead in matters of currency negotiation and 
the like, but the Federal Reserve is active in providing advice 
and assisting in whatever way possible, and I would certainly 
do that.
    Senator Stabenow. I would just comment that when you are 
talking about China's best interests, I would just note that we 
have lost over 1.5 million manufacturing jobs in America, which 
is where my focus is, and our focus is on America, American 
businesses, and American jobs. We have lost over 1.5 million 
jobs because of currency manipulation.
    And while I appreciate that we can hope that someday, China 
will get there, because it is in their interests, it has been 
long in our interests to have stopped this along with 
counterfeiting and a number of other issues that have created 
an unlevel playing field for our businesses and our workers.
    So, I realize that is not directly under your purview, but 
I would hope that your knowledge and leadership would be used 
as we talk about the broad economic factors that allow us to 
create those good paying jobs that we desperately need to keep 
and expand upon in this country, and certainly, what we are 
doing to enforce, or in this case, not enforce trade laws has a 
tremendous impact on that, and certainly, currency manipulation 
is one of those things.
    Thank you very much, Mr. Chairman.
    Chairman Shelby. Senator Bayh.


    Senator Bayh. Welcome, Doctor, and I want to thank you for 
the visit you were kind enough to pay on me a week ago. I 
enjoyed our discussion. As I told you at the time, I look 
forward to supporting your nomination and was impressed by your 
combination of both theoretical and practical concerns, which 
is the combination that I think we need in a Fed Chairman.
    Doctor, let me begin by asking a stylistic question, if I 
might. And I would like to quote from an article in today's New 
York Times, which concludes by saying, ``As an academic 
economist and as a Fed Governor, Mr. Bernanke prided himself on 
speaking clearly and sometimes even bluntly.'' It then goes on 
to say that perhaps to satisfy the concerns of Members of 
Congress but also the bond market said to satisfy both 
constituencies, he may have to sacrifice his plain speaking.
    Is that true? I, for one, am hoping that you can continue 
to speak your mind in a language the American people can 
    Mr. Bernanke. I will certainly try to speak clearly on all 
occasions, Senator.
    Senator Bayh. Good. I guess we will have to be the judge of 
that as we go forward, but I hope you will endeavor to do that. 
Clarity and transparency, I think, are normally better than the 
alternatives, so I hope you will stick to your stylistic guns.
    Mr. Bernanke. Thank you.
    Senator Bayh. Let me ask you about current account 
balances, if I might. And let me follow up on something that I 
think both Senators Reed and Stabenow were asking and also 
quote from today's New York Times. It says of the more than $30 
trillion in foreign investment tracked by the Bank of 
International Settlements in the first 3 months of 2005, 42.5 
percent were in dollars, 39.3 percent were in euros. The dollar 
share was down 4 percentage points from around 3 years earlier, 
while the euro share was up by 5 percentage points.
    The reason these statistics were cited by Chairman 
Greenspan was in furtherance of the notion that perhaps in 
accordance with portfolio theory, some countries had reached 
the tipping point in terms of their level of dollar-denominated 
assets. What is your take on that?
    Mr. Bernanke. Senator, it is an open question. There is 
still what Chairman Greenspan calls the home bias, the fact 
that most countries still own a smaller share of dollar-
denominated assets than the U.S. share in the world economy. 
And so, it is a question of judgment about how much more dollar 
assets foreign investors will want to hold. My sense is that 
there is still a broad appetite for dollar assets, both 
domestically and abroad, and as I indicated, I do not expect to 
see any major shifts in that appetite. Clearly, we will need to 
monitor the situation. We will need to watch the behavior of 
interest rates, the dollar, and other financial variables, but 
I see no indication of any major shift in these flows in the 
    Senator Bayh. Let me ask a question that I posed to you in 
our meeting in my office, and that is the most likely course of 
events is that there may be an orderly readjustment of the 
imbalances that currently exist, but from time to time, events 
happen that lead to disorderly movements. What should the 
appropriate policy response of our Government be if there were 
to be a precipitous decline in our currency, and what do we do 
about the conundrum where, if you raise interest rates in the 
short-run to defend our currency, it could have a stifling 
effect on the economy which, then, in the longer-term, could 
have a depressing effect on our currency? How do you strike the 
right balance there?
    Mr. Bernanke. Senator, in answering the question, first, we 
are talking hypothetically.
    Senator Bayh. I understand that.
    Mr. Bernanke. So, I want to be sure everyone understands 
    Senator Bayh. And by the way, forgive me for interrupting, 
but as a Member of this body and admonishing you to speak 
bluntly and clearly, perhaps we should look in the mirror. I 
want to just put that on the record, too.
    Mr. Bernanke. Thank you, Senator.
    The Federal Reserve has important responsibilities for 
maintaining financial stability that involves ensuring ex ante 
that banks, for example, are managing their portfolios safely; 
that the clearing and settlement systems are well-designed and 
secure; that there are good arrangements in place for dealing 
with some kind of financial crisis no matter what its source 
should be; and ex post, should there be a problem that there be 
plenty of liquidity provided to the banking system and that the 
Fed would make sure that whatever problems arise be brought to 
some venue where they can be unwound, discussed, and assistance 
be given.
    So broadly speaking, the Federal Reserve must deal with 
financial crises of all different kinds. There have been a 
variety of them. Should an untoward movement in dollars and 
interest rates cause financial stress, the same approach that 
the Federal Reserve has taken in other circumstances would be 
applied in this case.
    With respect to the macroeconomic implications, it would 
depend on the overall impact on the economy. Again, the Federal 
Reserve's responsibility is maximum employment and price 
stability. So the impact of the change in the dollar, interest 
rates, asset prices, however those things would occur, there 
would have to be an evaluation about what the net change would 
have to be in order to make sure that the domestic economy is 
stabilized and is insulated from the impact of these changes.
    Senator Bayh. I have exceeded my time, but it would be a 
sticky problem, would it not?
    Mr. Bernanke. Surely, it would be a sticky problem, and 
that is why it is good to have an experienced staff and lots of 
experience in the institution for dealing with these crises.
    Senator Bayh. I am going to defer to my colleagues and 
stick around for a few moments, but my concern in this regard 
is that if, in fact, other countries have reached the point at 
which they are not seeking to increase the percentage of 
dollar-denominated assets, then perhaps that increases the risk 
of an exogenous event of some kind leading to a precipitous 
readjustment of the currency, thereby presenting you with this 
possible hypothetical.
    Mr. Bernanke. Senator, if I may, there is demand for dollar 
assets not simply by foreigners but by Americans as well. And 
American household wealth, for example, is about $50 trillion. 
There is an enormous demand for dollar-denominated assets, and 
so, I do not expect that that demand would drop precipitously.
    Senator Bayh. Let us hope.
    Thank you, Mr. Chairman.
    Chairman Shelby. Thank you, Senator Bayh.
    Dr. Bernanke, last week, the Banking Committee, as you 
probably knew, heard from the banking regulators, including the 
Federal Reserve, and several industry experts regarding the 
proposed Basel II capital standards. While the regulators 
basically supported moving forward, some with a little caution 
in the wind, the outside experts, a lot of them former 
regulators, advised caution, raising concerns about lower 
capital ratios and failure to factor in all risks faced by 
    What is your assessment of the Basel II proposal? I know 
you have been on the Fed as a Member. And if you are confirmed 
as Chairman, which I hope you will shortly, what will the 
Federal Reserve do to address the unanswered questions? And 
there are a lot of unanswered questions and concerns raised 
regarding Basel II.
    Mr. Bernanke. Well, Chairman Shelby, Basel II or something 
like it appears necessary. The banking system has become 
extraordinarily sophisticated financially. Basel I is no longer 
sufficient as a means of determining adequate regulatory 
capital for the banking system. The Federal Reserve, the other 
banking regulators, and international counterparties have 
worked for a number of years trying to determine an appropriate 
system that would appropriately account for the complexity of 
the banking system.
    Basel II tries to embody the notion that the amount of 
regulatory capital should be based on modern risk management 
techniques, which try to evaluate the risks associated with 
different kinds of investments. It is true that there have been 
various concerns and disagreements along the way. My sense is 
that the banking regulators are proceeding in a very cautious 
and slow way. In particular, as you know, they have delayed the 
implementation following the QIS-IV results, and moreover, 
there is going to be a series of safeguards, including, for 
example, a slow transition parallel run where both Basel I and 
Basel II capital standards will be calculated, and there will 
be a floor based on the Basel I standards. There will be a 
continual process of evaluation, of feedback, and of comment.
    There are various other safeguards as well, including the 
Pillar II, which allows regulators to make additional 
assessments of capital, depending on their evaluation. And 
finally, I should just mention, among many other elements, both 
prompt corrective action and the leverage ratio, which are two 
other ``belts and suspenders'' provisions, will remain in place 
to ensure that banks have sufficient capital.
    So while I am not involved personally in all of the details 
at this point, I expect I will be if I am confirmed. My sense 
is that regulators are moving very cautiously and very slowly 
to make sure that the regulatory capital is going to be 
sufficient to make the banking system safe and sound.
    Chairman Shelby. Thank you.
    I want to touch on the Fed's role in crisis management, and 
I hope you will not be confronted with crisis management, but I 
know you will be. Over the past 20 years, the United States and 
world economies have benefitted when the Federal Reserve took 
swift and appropriate action to respond to various financial 
disturbances. Some now question whether the Federal Reserve 
will have a more difficult time in the event of a future crisis 
because of the large trade deficit and the large foreign 
official holdings of U.S. Treasury debt we have been talking 
    Do you agree or disagree with the assessment that the Fed 
may not have, may not have the same flexibility as it had in 
the past? And what measures, if any, would you, as Fed 
Chairman, lead the Federal Reserve in taking to prepare for its 
role in crisis management, which will come sooner or later?
    Mr. Bernanke. Chairman Shelby, it is certainly true that 
the economy has become much more open, that capital flows are 
much more important, that the current account is a much bigger 
issue, and that certainly makes more complicated the Federal 
Reserve's objectives, both macro objectives and financial 
crisis management.
    Nevertheless, I do not believe that the ability of the 
Federal Reserve to respond, to meet its objectives has been 
substantially compromised by this opening. It just makes the 
problem more complicated, requiring more expertise. I think, in 
fact, that the financial system has benefitted over the years 
from the meeting of a variety of financial crises, including, 
for example, September 11, which has led to hardening and 
providing additional backup facilities.
    The depth, liquidity, and flexibility of the financial 
markets have increased greatly. The strength of the clearing 
systems of the major financial centers has been improved. So 
certainly, I agree that we can never be complacent about 
financial crisis, and I will certainly make every effort to be 
prepared for whatever may come my way. But I do believe that 
progress has been made in strengthening the system to be more 
resilient in the face of shocks.
    Chairman Shelby. Senator Sarbanes, would you like to ask 
any questions?
    Senator Sarbanes. Yes, I do indeed. Thank you very much, 
Mr. Chairman.
    Dr. Bernanke, I have a number of questions I want to run 
through as quickly as I can. Before I do that, though, I do 
want to observe that--let me start, and then, I will come back 
to that.
    On Basel II, which you just responded to the Chairman 
about, it seems to me you are being much too sanguine. They did 
the quantitative impact study. They found that more than half 
of the participating institutions would show a capital 
reduction of 25 percent or more; in some instances, up to 50 
percent, which, of course raised a lot of red flags about the 
safety and soundness of the system and the adequate capital. Do 
you think that prompt corrective action and the leverage 
capital requirements could be maintained if risk-based capital 
levels fell significantly below the leverage ratio?
    Mr. Bernanke. Senator, I guess the good news about QIS-IV 
is that it led the regulators to stop, take stock, and to try 
to understand the results.
    Senator Sarbanes. Which only raises the question, how did 
we get so far down this path that when they ran it through the 
models, it brought this absolutely show-stopping result? How 
did that happen? I mean, we keep holding these hearings; 
Chairman Shelby, to his credit, has really exercised a lot of 
oversight over this repeatedly. Everyone says, well, we are 
working it all out. It is going to be good, you know; and then, 
all of a sudden, they do a quantitative run on the thing, and 
everyone says wow, how did we get to this posture?
    How did that happen?
    Mr. Bernanke. Senator, various issues have been identified 
that will help explain the results. I do not have to go through 
all of them; to give one example, some of the results were 
based on relatively good times and did not include some weak 
periods of the economy that give a higher loss rate. But what 
it does emphasize--and here, I agree with you, Senator--is that 
it is very important that this be done right, and we need to 
learn from these exercises. If they were purely mechanical, 
they would not be worth doing.
    So we need to go slowly and cautiously and learn from these 
exercises and make sure that capital is adequate, and I agree 
with that 100 percent.
    Senator Sarbanes. Well, I want to commend to you--I will 
not pursue this question, because there are a number of others 
to ask, that there was a panel after we heard from the 
regulators, including former FDIC Chairman William Isaac and 
former FDIC Chairman William Seidman, and Isaac said a number 
of things, but I quote him: He says ``Basel II will be used to 
reduce large bank capital ratios and either place small banks 
at a competitive disadvantage or force regulators to lower bank 
capital ratios.'' Neither option is acceptable public policy.
    And Seidman, and these are two experienced people, said the 
original intent of Basel II was to more closely align minimum 
regulatory capital with actual risk, not to materially reduce 
overall capital levels within the banking system. And I 
strongly commend the testimony of that second panel to you as 
you move ahead to examine this question.
    Let me ask you about remittances. I know this is an issue 
you have been interested in. A recent study by the Inter-
American Development Bank said Latin American immigrants will 
send over $50 billion in remittances to their family and 
friends in their countries of origin, the vast majority of 
which is from the United States.
    We have been concerned about the state of the remittance 
market, especially that individuals are using methods of 
transmitting remittances that are outside the financial 
mainstream and therefore often subject to high fees and often 
to hidden charges in the form of unfavorable exchange rates.
    You have studied this issue. You have said typical nonbank 
fees for remittances remain high on an absolute basis, and 
consumers who deal with the less scrupulous providers of 
remittance services may bear a significant financial cost. I 
think we have an opportunity here to get immigrants into the 
financial mainstream, using the remittance issue in order to do 
    Would it be your intention to work on this issue as 
Chairman of the Fed, and do you think there is a role that the 
Fed can play in helping to achieve this goal of greater 
fairness for the immigrants who are doing the remittances and 
their inclusion in the financial system?
    Mr. Bernanke. Senator, yes, I do. As my same speech that 
you are alluding to discussed, I think this is an excellent 
opportunity for mainstream financial institutions to bring 
immigrant communities into their organizations, to give them 
not only remittance services but also other services, savings, 
borrowing, and the like. And it is an opportunity that many of 
these organizations are already undertaking.
    The Federal Reserve is involved in this in numerous ways, 
through bank supervision and regulation but also through, for 
example, the Fed ACH system, which has been set up with Mexico 
to permit easier remittance payments, through financial 
education and in managing the risks that are involved in these 
    So, I think it is an important issue. It is very important, 
obviously, for the immigrants themselves and for the countries 
that are receiving the remittances, and I will continue to be 
interested in that.
    Senator Sarbanes. Mr. Chairman, I see my time is up. I have 
a few more.
    Chairman Shelby. You go ahead.
    Senator Sarbanes. Well, you have people who have not had 
their first round. And Bob Bennett is here, too.
    Chairman Shelby. Senator Bennett.
    Senator Sarbanes. And Senator Schumer is here.
    Senator Bennett. Thank you, Mr. Chairman, Senator Sarbanes, 
and I listened to this conversation about the current account 
and foreign ownership, and I have a fundamental question: Where 
else are they going to go?
    Mr. Bernanke. Senator, that was part of my response.
    Senator Bennett. Yes.
    Mr. Bernanke. American assets are very attractive assets, 
and they will be an important part of any international 
portfolio and, of course, of Americans' portfolios as well.
    Senator Bennett. Sure; I mean, I would not want to invest a 
lot of my retirement money anyplace else but in the American 
economy, and it is a logical place. Where else are they going 
to go?
    I would like to pursue a little bit another question. We 
talked about inflation. We talked about price stability and 
price stability being the target and the old idea that 
inflation and employment are tied together, and you cannot have 
high employment without overheating the economy. And so you 
have to make a choice, and I think we have broken that link and 
decided you can have price stability and tight labor markets at 
the same time, because we have seen some of that before the 
recent recession.
    What causes inflation? That becomes the fundamental 
question here, and there are some who would suggest that 
inflation is caused by too much growth, and the way to control 
inflation is to control growth. But we have had low inflation, 
and we have had growth in excess of 3 percent of GDP, sometimes 
up to 4 percent of GDP without the sense that the economy was 
    Could you just explain that in your best professorial 
manner to a graduate student here who wants to know how you are 
feeling about this whole question of whether or not inflation 
is caused by too much growth, and if not, by what?
    Mr. Bernanke. Senator, growth itself and growth capacity 
are ultimately determined by productivity, which again, depends 
on issues like regulation, taxation, innovation, technology, 
and the like, and also by employment growth--the number of 
workers available and the increase in their labor supply. So 
those are the fundamental factors that determine growth.
    The amount of available growth varies over time according 
to economic conditions. It can be high. The United States has 
had good economic policies and good technologies that have 
promoted growth in recent years. So, in that sense, strong 
growth does not create inflation.
    If financial conditions are such, though, that aggregate 
demand, aggregate spending is greater than even the growth that 
underlying conditions can permit, then, there can be increased 
pricing power, excess demand, and pricing pressures can 
increase. In that case, you can get some inflation.
    I agree with your original statement, though, that in the 
long-run, the most important relationship is between low 
inflation and high growth. That is, when inflation is kept low 
and stable, and expectations are kept low and stable, then the 
economy will be more stable, and more growth will be possible. 
So, I think that is the most fundamental relationship between 
the two variables.
    Senator Bennett. Well, I have always said wealth is created 
by two things: One is accumulated capital, and the other is 
risk taking and that we need policies, both fiscal policy and 
monetary policy, that encourage both the accumulation of 
capital and the willingness to take risks. I realize tax policy 
comes into that, because if you tax accumulated capital and 
thereby make it less attractive, or if you tax the rewards so 
that I take a risk, but I am not going to get that much of a 
reward out of it; but taking those two, the role of accumulated 
capital and risk taking in creating growth, talk about the 
Fed's role with respect to that, because you do not control 
    Mr. Bernanke. No, the Fed's role is to keep inflation low 
and stable, and that makes markets work better. It reduces 
risks in the market, causes people to spend less time worrying 
about the value of money and more time about businesses and 
innovations and changes that will make the economy better. So 
that is, I think, the main contribution the Fed can make is to 
ensure long-run price stability. In the short-run, the Fed can 
respond to various shocks to the economy and try and keep 
things on an even keel, but all that works best when inflation 
is kept low and stable.
    Senator Bennett. Thank you, Mr. Chairman.
    Chairman Shelby. Senator Schumer. This will be your first 


    Senator Schumer. Thank you, Mr. Chairman, and thank you for 
holding these hearings. I want to thank you, Mr. Bernanke, for 
being here. I apologize I could not be here earlier. I was over 
on the House side.
    And we have had some extensive discussions, and you have 
answered most of my questions satisfactorily; a few I would 
like to go over even though we talked about them when we met: 
China; now, in May of this year, you told this Committee, I am 
quoting you, ``For large economies like China and the United 
States, it is preferable to have a market-determined, flexible 
exchange rate. And China should move as expeditiously as 
possible toward loosening up its exchange rate. They are now 
ready to go to a more flexible rate regime, and I would 
encourage them to do that.''
    That states your views correctly and without any 
    Mr. Bernanke. Yes, Senator.
    Senator Schumer. Okay; let me ask you a couple of questions 
about that. First, do you believe that our current account 
deficit is sustainable?
    Mr. Bernanke. I believe we need to bring it down over a 
period of time, yes.
    Senator Schumer. Okay; do you think that China and its 
particular inability or unwillingness to let the currency float 
is contributing to that current account deficit?
    Mr. Bernanke. It is a contribution, but there are many 
other factors as well.
    Senator Schumer. Right.
    Mr. Bernanke. Including the very high savings rate around 
the world and the export-led strategies of some other 
    Senator Schumer. Right; do you believe the Chinese engage 
in mercantilist policies? You had said you did when we talked. 
Could you just elaborate a little bit?
    Mr. Bernanke. They have adopted a development strategy, 
which other countries have also adopted which focuses on 
export-led growth; that is, that they are looking to export in 
order to help their economy grow. They see advantages in being 
able to sell to a global market, one that is more 
technologically sophisticated, and it has been proved a method 
that has helped them in their rapid growth process.
    Senator Schumer. But they try to maximize imports and 
minimize imports; would that be fair to say?
    Mr. Bernanke. I am not sure about imports. In some cases, 
the imports are quite important; for example, China is a 
platform, and they bring in goods and services, bring in goods 
from other parts of Asia and reproduce them.
    Senator Schumer. Right. But their goal is to increase their 
overall wealth. That is what a mercantilist policy would be.
    Mr. Bernanke. They have focused on exports as a way of 
trying to increase their growth, yes.
    Senator Schumer. Now, second question is China did promise 
to allow market forces to affect the value of the yuan, and 
yet, the currency has moved as much in nearly 4 months as they 
said they would allow it to move in a day; in other words, the 
total amount of movement. Is it your view that China has kept 
its promise to allow the yuan to move with market forces?
    Mr. Bernanke. I think they need to do more to allow their 
exchange rate to become more flexible and more market-driven.
    Senator Schumer. Obviously, it would not move so little if 
they were not intervening, and it would be better if they did 
not or at least gradually moved away from it; I assume you 
assume that is correct.
    Mr. Bernanke. Yes.
    Senator Schumer. Okay; could you just talk a little bit 
about a reasonable timetable for China to allow its currency to 
float freely? Are they ready to do it immediately? That would 
be one extreme. Should it take 10 years? That might be another 
extreme. Could you talk a little bit about what you think is a 
reasonable timetable for them? I am not going to pin you down 
to 2 years, 6 months, but just talk to us a little about that.
    Mr. Bernanke. Senator, I think that they will go somewhat 
slowly. They want to make sure that their economy is ready for 
the flexible exchange rate. They are looking at the 
institutional factors involved in trading, the exchange rate, 
and the like. I would be very reluctant to give a timetable.
    Senator Schumer. Are they moving too slowly now?
    Mr. Bernanke. I would like to see them make further 
progress on this issue.
    Senator Schumer. Okay; thank you, Mr. Chairman. Time is up.
    Chairman Shelby. I believe it comes back--no, it comes back 
to you, does it not?
    Senator Bayh. I would be on my second round.
    Chairman Shelby. Yes, sir.
    Senator Bayh.
    Senator Bayh. Doctor, I would just observe I am a little 
concerned about a cavalier attitude with regard--not on your 
part, just in general--about the current account imbalance and 
the attitude of, well, where else are they going to go? I can 
see the Chancellor of the Exchequer having made a comment like 
that in the 1930's or the 1940's, and in fact, history evolved 
in a way that there was an alternative, and that is where the 
global currency flows went.
    It is also possible that other countries might choose to 
make decisions that we would view as suboptimal in terms of the 
return on their investments for other reasons of state; for 
example, to pressure us on national security issues of some 
kind involving, just to pick at random, the issue of Taiwan, 
for example. There are occasionally nationalist issues that 
trump economic interests. And that is one of the reasons that I 
am somewhat concerned about just saying, well, the current 
account deficit can run forever at, what, 6 percent now and 
maybe larger. Eventually, this has to unwind in some way or 
other, and it had best be orderly rather than disorderly, so 
that is the nature of my questioning.
    I would like to shift and ask about the budget imbalances, 
the different imbalances that we are running. I think in our 
conversation, we both agreed that there was some level at which 
an internal momentum begins to take hold when a deficit gets to 
a certain size and the interest payments begin to build and the 
snowball effect, for lack of a better term, and as I recall, 
that was around 2 percent or thereabouts; is that correct in 
your opinion?
    Mr. Bernanke. Not precisely. A 2 percent deficit is about 
consistent with a stable ratio of debt-to-GDP. So maintaining a 
deficit at that level, while not optimal, it would be better to 
get it lower, at least does not have the property of raising 
the debt-to-GDP ratio. There can be periods of higher deficits. 
I expect we will see one with the costs of Katrina, for 
    Senator Bayh. Well, indeed, we are already in one. I think 
our current deficit-to-GDP is about 2.7 percent, excluding 
    Mr. Bernanke. So as long as the deficit returns to a 
sustainable level over a period of time, then the debt-to-GDP 
ratio also will stabilize. But I am not disagreeing in the 
sense that I think it is very important, and here, my main 
concern is the long-run entitlement issues, which I have 
already alluded to, which are going to put very heavy burdens 
on the fisc. In order to prepare for those heavy burdens, I 
think we do need to begin to try to reduce the deficit, try to 
reduce spending, try to bring the budget closer to balance so 
that we will be prepared to deal with those long-term 
    Senator Bayh. Here is the reason for my question: If we are 
already at 2.7, then, we agree that we are above the rate at 
which the debt level-to-GDP begins to increase. Therefore, any 
decision, be it spending or on the tax side that increases the 
deficit only exacerbates that situation; I think by definition, 
that is correct, is it not?
    Mr. Bernanke. If you take as a baseline the midsummer, 
midsession review earlier this year----
    Senator Bayh. Remember my admonition from the Times about 
speaking bluntly.
    Mr. Bernanke. I will speak bluntly.
    Senator Bayh. I am teasing.
    Mr. Bernanke. That baseline had a declining deficit-to-GDP 
ratio over the next few years.
    Senator Bayh. Which timeline was that, Doctor?
    Mr. Bernanke. Over the next 5 years, the midsession review 
shows the deficit as a share of GDP declining over time. 
However, there are important risks to that projection. 
Obviously, since the summer, we have had Katrina, which will 
have a near-term impact. Another concern I would raise for you 
is the reliance for revenue on the alternative minimum tax, 
which the Congress is not willing to allow to actually take 
    So it is, I think, important for Congress to consider 
whether either to allow the alternative minimum tax to actually 
take effect or alternatively to undertake a tax reform or other 
measures that replace that revenue with some other form of 
    Senator Bayh. Let me ask you one final question: I am 
occasionally asked this, and it is always a little hard for me. 
But I find that a certain amount of reflection and 
introspection sometimes is--I can learn more sometimes from 
things that maybe did not go quite as I expected as much as I 
can from things that went as I expected.
    Looking back in the different public policy pronouncements 
that you have made and situations that you thought you had 
analyzed correctly at the time, can you point to anything that 
just did not turn out quite the way you expected and what you 
learned from that instance?
    Mr. Bernanke. Well, in 2003, there was an episode where 
there was clearly a miscommunication between the Federal 
Reserve and the bond markets, and it caused a significant 
fluctuation in the bond markets. This was over the issue of 
whether there was some risk of deflation going forward. And 
clearly, there was a misunderstanding about that risk. It 
impressed on me the importance of speaking clearly and 
communicating clearly and making sure that there is 
understanding on both sides about what the Fed is saying and 
what the Fed is intending to do.
    Senator Bayh. Thank you very much, Doctor. I wish you the 
    Mr. Bernanke. Thank you.
    Chairman Shelby. I believe it is back to me, Dr. Bernanke. 
In your previous tenure, Dr. Bernanke, when you were a Member 
of the Board of Governors of the Federal Reserve, you spoke 
regarding, ``a global savings glut.'' Others have, too. Would 
you elaborate just for the record further on the potential 
causes of this behavior and whether our Nation's economy has 
ever experienced similar circumstances? And should this 
situation persist, how would this affect the Federal Reserve's 
economic projections if it would? We realize that there is 
capital in the world, which is money, I guess, savings.
    Mr. Bernanke. The global savings glut idea attempts to 
point out that the current account deficit of the United States 
is not simply or entirely a product of U.S. economic policies. 
It is a global phenomenon created by global forces; in 
particular, I argued in the speech that over the last 10 years 
or so, the amount of savings around the world has exceeded 
desired investment in those same countries, for various 
reasons, including the aging of some industrial economies, the 
oil revenues of crude producers, and most importantly, the fact 
that emerging market economies over the last 10 years have gone 
from being significant borrowers in international capital 
markets to large lenders, to having large current account 
    As a result, there have been enormous amounts of capital 
dumped into international capital markets, which helps to 
account for the fact that global interest rates are at record 
lows or, at least, at very low levels. The inflows of that 
capital into the United States, which is an attractive 
destination for this capital, and the resulting impact on asset 
pricing in the United States is, in my view, part of the reason 
why Americans have increased their consumption and reduced 
their savings, which has resulted in this current account 
    Now, as I have argued already today, I do not view the 
current account deficit as desirable. I think there are a 
number of reasons to try to end it, but in order to end it or 
at least to wind it down over a period of time, it is going to 
require action both within the United States and also within 
our trading partners. On the part of the United States, we need 
to increase our own savings relative to investment.
    With respect to our trading partners, there needs to be, 
first, increased reliance on flexible exchange rates, as we 
already discussed, and also, more willingness on the part of 
our trading partners to rely on domestic spending--domestic 
government purchases or consumption--to drive their economies 
as opposed purely to an export-led strategy.
    Chairman Shelby. Is it basically true that in a global 
economy where you have market forces working that capital would 
know no boundaries? It would look for its best investment, 
would it not?
    Mr. Bernanke. That is correct, but at this point, some of 
the savings which is coming to the United States might well be 
served by going, say, to emerging market economies, which are, 
because they have perhaps inadequate infrastructures or 
insufficient transparency, are not receiving as much capital 
as, in some sense, would be ideal. I think a more balanced 
global situation will be one where there is a closer balance 
between saving and investment both in the United States and 
    Chairman Shelby. Senator Sarbanes.
    Senator Sarbanes. Just to follow up on the Chairman's point 
quickly, is some of that capital not coming from emerging 
market countries or developing economies?
    Mr. Bernanke. Yes, Senator, a great deal of it.
    Senator Sarbanes. And what is the rationale for that? Why 
should they be sending capital into the world's most advanced 
economy? Is not something--at least what economics I learned, 
that is the wrong way for the flows to be going in terms of 
building up worldwide prosperity.
    Mr. Bernanke. Senator, your basic point is right. Normally, 
you would expect to see capital flowing into emerging market 
economies rather than out of emerging market economies. The 
proximate cause of this switch, I would argue, were the 
financial crises of the late 1990's, which occurred in a 
variety of emerging market economies in East Asia, Latin 
America, and elsewhere and led them to be much more cautious 
about accepting capital inflows and to focus more on building 
up their reserves, building up their current accounts and 
looking more to an export-oriented strategy.
    So, I think it is the effects of the financial crises, 
which, over a period of time, I expect will wane, but that was 
the main impetus, I believe, for this shift in strategy on the 
part of the emerging market countries.
    Senator Sarbanes. Yes, but I take it you regard it as 
undesirable; I know in a speech, you said in the longer-term, 
however, the current pattern of international capital flows, 
should it persist, could prove counterproductive. Most 
important, for the developing world to be lending large sums on 
net to the mature industrial economies is quite undesirable as 
a long-run proposition.
    Mr. Bernanke. That is correct.
    Senator Sarbanes. You still agree with that statement, do 
you not?
    Mr. Bernanke. In the short-run, and I agree with Senator 
Bennett, given that these countries have high savings, and they 
are unable to make full use of those savings domestically, it 
is understandable that they would send capital to the United 
States, which has very deep, liquid, and strong capital 
markets. Over a period of time--not immediately but over a long 
period of time--a greater balance, which would involve more of 
these funds going into emerging markets, I think, would be 
    Senator Sarbanes. You are on record as opposing the use of 
monetary policy to control asset bubbles, as I understand it, 
whether in the stock market or the housing market. Instead, you 
have stated a far better approach is to use micro-level 
policies to reduce the incidence of bubbles, to protect the 
financial system against their effects.
    The Wall Street Journal ran an article recently entitled 
``Concerns Mount About Mortgage Risks,'' which reported, ``In 
the latest sign of how frothy the housing market has become, 
new data show the degree to which people are stretching to buy 
homes in a hot housing market. The data from the Mortgage 
Bankers Association show that adjustable rate and interest only 
mortgages accounted for nearly two-thirds of mortgage 
originations in the second half of last year.''
    Alan Fishbein, the Director of Housing and Credit Policy at 
the Consumer Federation of America, called it a game of musical 
chairs. Somebody is going to have the chair pulled out from 
under them when they find prices have leveled out and then try 
to sell, only to find they cannot sell for what they paid for 
    Are you concerned about the potential for a bubble in the 
housing market? And specifically, does the drastic increase in 
the use of risky financing schemes, including interest only and 
even negative amortization mortgages, concern you?
    Mr. Bernanke. Senator, as I understand, the Federal Reserve 
is reviewing these practices with the idea of issuing guidance 
about so-called ``nontraditional mortgages.'' I think it is 
important to make sure that mortgages of the nontraditional 
type--whether they are interest only, option ARM's, or other 
similar types of mortgages--that first, they are consistent 
with safety and soundness on the part of the lenders, and 
second, that consumers who are using these mortgages fully 
understand the implications of holding these mortgages should, 
for example, housing prices decline or interest rates rise.
    I think it is very important to look at these instruments, 
and I believe that doing so would have, on the margin, some 
beneficial effects in reducing speculative activity in some 
local markets. However, overall, I think the main reason to 
look at these instruments is to make sure that banks are 
protected and that the consumers are protected against the 
potential risks of these instruments.
    Senator Sarbanes. Chairman Shelby and this Committee, and I 
have joined with him on it in expressing our concern that the 
Federal banking agencies are not taking a sufficiently 
aggressive and sophisticated attitude toward examining 
institutions with respect to money laundering. There have been 
some very bad examples.
    What will you do to evaluate and improve the strength of 
the Fed's consolidated supervisory activity in this area? I am 
getting into the dimension of your responsibilities that 
involve your regulatory function, which does not always draw, I 
think, the attention that it warrants or requires.
    Mr. Bernanke. Senator, the Bank Secrecy Act and the 
antimoney laundering rules are very important. Obviously, they 
bear on terrorist finance and money laundering by criminal 
organizations, and the Congress has passed a set of rules which 
require banks to be very careful to try to prevent such 
activities from occurring.
    It is an important responsibility of the Federal Reserve to 
enforce those laws. I will certainly be interested in those 
activities. As I understand, the Federal Reserve's approach to 
enforcing so-called ``BSA/AML provisions'' is a risk-focused 
approach, which means that the Federal Reserve attempts to 
evaluate whether the banks' or other financial institutions' 
procedures and processes are sufficiently good to ensure 
compliance with the law rather than trying to evaluate every 
individual transaction.
    I think that is a good approach. It is one that allows the 
Federal Reserve to evaluate the overall ability of the 
institution to meet the law without incurring the heavy costs 
and the heavy regulatory burden of checking each and every 
individual submission.
    Senator Sarbanes. Well, I know I am intruding on Senator 
Bennett's time. If I could just close out this question.
    I have this concern: In some instances, the money 
laundering violation, which, of course, have an antiterrorism 
financing important dimension to them as well, have been, as it 
were, found and corrective action taken by the Federal Reserve 
System or State banking systems. But in other situations, and a 
number of large banks are involved in that, the violations have 
reached such a level of seriousness that they warranted 
criminal investigation by the Department of Justice, which, of 
course raises a question of how do you explain situations in 
which senior officials of major financial institutions are 
found to have come sufficiently close to the line that criminal 
investigations of their conduct, and of their institution, are 
    In other words, where were the gatekeepers or the watchmen, 
which are the banking regulatory agencies, where were they at 
an earlier stage in this process instead of it having gone to 
the level or deteriorated to the level that criminal action by 
the Department of Justice was called for? It seems to me that 
is a fairly clear call for the financial institution regulators 
to be more active in meeting their responsibilities.
    Mr. Bernanke. I agree with that, Senator.
    Senator Sarbanes. Okay; thank you.
    Chairman Shelby. Senator Bennett.
    Senator Bennett. Thank you, Mr. Chairman.
    One last area I would like to explore with you, Dr. 
Bernanke, is your attitude toward commodity prices as an 
indicator of inflation. I remember many years ago the standard 
position was well, when the stock market is going up, you buy 
stocks. When the stock market is going down, you buy gold. And 
it is just very simple. You take the cyclical nature of things, 
and your hedge against everything going to pot is gold. And 
then, once the bottom has been reached, you sell your gold, and 
you start with stocks.
    I do not know that anybody is that simplistic anymore 
except maybe on the advertising pages of some magazines where 
the people are trying to sell gold. But what about other 
commodities? I know an economist whom you know very well and 
whom I respect very tremendously, Wayne Angel, is always 
looking at a basket of commodities, not necessarily gold by 
itself but commodities generally, foreign exchange rates, 
indicators of where we should be in policy; you get an 
individual commodity like natural gas that is an anomaly 
because of the tremendous demand that has been created by 
natural gas. So maybe you take that out of the basket.
    But just talk to us about your attitude toward commodities 
in general, some of these other basket issues, gold, foreign 
exchange rates, and so on in terms of what you see as their 
value as indicators of where the economy is really going.
    Mr. Bernanke. Senator, there is no perfect forecaster, no 
perfect indicator of inflation. Each of the variables you 
mention has an inflation component, so to speak. It reflects 
inflationary pressures. It may reflect other things as well. As 
you mentioned, natural gas or other energy commodities reflect 
supply and demand conditions arising from international 
pressures in international markets, for example. Exchange rates 
reflect inflation pressures. They may also reflect the balance 
of trade and other factors.
    So there is no single, optimal indicator of inflation. My 
personal strategy, therefore, is to be very eclectic and to 
look at a wide range of indicators, and among those is 
commodities, gold, exchange rates, the whole list. I think 
interest rates, real side indicators, surveys, expectations--
there is a whole list of variables which can be useful in 
forecasting inflation--and I think one has to be very open-
minded about using whatever information one has.
    Senator Bennett. Let us talk about productivity in the same 
way. Bob Woodward's book about Chairman Greenspan indicates a 
situation where he challenged existing data points on 
productivity and ended up forcing the Fed to restructure the 
way they monitored it. And he proved by saying, and I have 
heard him say this, and I am sure you have, too, well, this 
violates the laws of arithmetic. By taking an equation and 
putting in various pieces of the equation, he said the 
remaining piece, productivity, has to be higher than your 
measurement of productivity.
    Obviously, an understanding of productivity fits into this 
whole discussion that we are having. Do you have any view as to 
the various measures of productivity and how it should be 
    Mr. Bernanke. I draw two lessons from that late 1990's 
experience that Bob Woodward was referring to. The first is 
that you do not just look at the conventional measures. You 
look at the data quite deeply and try to understand how the 
data are constructed and how they relate to each other, because 
there may be anomalies that will be instructive, and that was 
the case in the late 1990's.
    The other is that published Government data is not the only 
source of information. It is also important to talk to people 
in the marketplace, to talk to businesspeople. I think in the 
case of Chairman Greenspan, he had indications from 
businesspeople that they were making extraordinary gains in 
productivity based on new information and communications 
    So by putting together those clues, I think one tries to 
make an inference about the general state of the economy and 
productivity being one of the major variables to look at.
    Senator Bennett. I have the sense that our failure to 
understand the impact of productivity in the information age is 
one of the reasons why we feel as confused as we do in some 
areas. We have industrial age mentality in the information age 
reality. And that can be a problem. Just one last quick 
comment: You do not need to answer this. This is just an 
    One of my major focuses in the Senate has to do with cyber 
security. And I have raised this with Chairman Greenspan in the 
past. If I were someone who wished this country ill, I would be 
more anxious to find a way to hack into the computer system and 
shut down the Fed wire than I would to try to find a way to get 
a suitcase nuclear device into lower Manhattan, because the 
damage to the economy of shutting down the Fed wire would be 
greater than the damage by a nuclear explosion from a suitcase 
bomb virtually anywhere, whether it was lower Manhattan or 
Pennsylvania Avenue or whatever it might be.
    I hope in your stewardship as the Chairman of the Fed, you 
pay attention to cyber terrorism and the vulnerability that we 
have to those who might break in, and hack in. The more time I 
spend on this, the more concerned I become, and I know the 
financial community generally with its various firewalls and 
ways of trying to hang onto the data is moving ahead, but every 
time I look at it, the next generation of attackers is 
substantially more sophisticated than the one that was there 
just 18 months ago, and our ability to private security must 
always be working ahead on that. So among the other things you 
have to do, do not neglect that particular morsel as it gets 
put on your plate.
    Mr. Bernanke. Thank you, Senator.
    Chairman Shelby. Senator Sarbanes.
    Senator Sarbanes. I want to follow up Senator Bennett's 
point, but I want to not go as--because he is dealing with 
people who are very calculatingly trying to do this thing, but 
this year, several financial institutions as well as private 
companies, government agencies, universities, and other 
entities have reported breaches of Social Security numbers, 
credit and debit numbers, security codes, bank account 
information, and other sensitive information. In fact, The 
Washington Post had a story; they said, ``American corporations 
that eat your personal information for breakfast have suffered 
troubling data breaches over the past year or so, making the 
data on more than 50 million consumers vulnerable.''
    Now, there is a coalition of 12 consumer groups concerned 
about privacy who have expressed very deep concerns about this. 
As Chairman of the Fed, would you work with the financial 
institutions that you regulate to reduce the likelihood of 
future data breaches? And further, would you be prepared to 
meet with these interested groups, this coalition of consumer 
groups concerned about financial privacy to review with them 
and to discuss this important issue?
    Mr. Bernanke. Senator, I believe the banking regulators 
have already at least issued guidance, or perhaps a regulation, 
about data breaches that applies to financial institutions, 
which is the group that they regulate. And I believe the 
Congress is considering similar legislation for other entities. 
It is a very important issue. I think the Federal Reserve and 
the other banking regulators have already taken some steps in 
this direction about providing rules about how to protect data 
and how to react to data breaches.
    To answer the second part of your question, I hope to meet 
broadly with a large number of people, including the groups 
that you referred to. I think it is important for the Federal 
Reserve Chairman not to confine himself to Wall Street analysts 
but to speak to a wide range of people in the economy with 
different interests and different viewpoints, and I intend to 
do that.
    Senator Sarbanes. Warren Buffett has warned us that 
derivatives are time bombs, both for the parties that deal in 
them and the economic system. The Financial Times has said so 
far, there has been no explosion, but the risks of this fast 
growing market remain real. How do you respond to these 
    Mr. Bernanke. I am more sanguine about derivatives than the 
position you have just suggested. I think, generally speaking, 
they are very valuable. They provide methods by which risks can 
be shared, sliced, and diced, and given to those most willing 
to bear them. They add, I believe, to the flexibility of the 
financial system in many different ways.
    With respect to their safety, derivatives, for the most 
part, are traded among very sophisticated financial 
institutions and individuals who have considerable incentive to 
understand them and to use them properly. The Federal Reserve's 
responsibility is to make sure that the institutions it 
regulates have good systems and good procedures for ensuring 
that their derivatives portfolios are well-managed and do not 
create excessive risk in their institutions.
    Senator Sarbanes. In a recent article in The New York 
Times, they stated, ``Seven years ago, Wall Street's top 
bankers were caught off guard by the near collapse of the Long 
Term Capital hedge fund. Since then, the number and influence 
of hedge funds have ballooned. The hedge fund explosion has 
prompted concerns that if a big bet goes wrong, regulators and 
banks will again be caught up in a collapse.'' My recollection 
is that the Federal Reserve Bank of New York was convening all 
night, all weekend meetings at the time of Long Term Capital 
Management, putting enormous pressure on financial institutions 
to pick up on it in order to prevent the very collapse that is 
mentioned here. How do you respond to this concern? Equally 
    Mr. Bernanke. I think it is important not to be complacent.
    Senator Sarbanes. Not----
    Mr. Bernanke. Not to be complacent. It is important for the 
Federal Reserve to be aware of what is going on in the market, 
particularly working through the banks, which are the 
counterparties of a lot of hedge funds, to understand their 
strategies and their positions.
    Nevertheless, broadly speaking, my understanding is that 
the hedge fund industry has become more sophisticated, more 
diverse, less leveraged, and more flexible in the years since 
LTCM. So again, while it is very important to understand that 
industry, and particularly to make sure that the banks, are 
dealing in appropriate ways with hedge funds, my sense on that 
is that they are a positive force in the American financial 
    Senator Sarbanes. Do you think these issues contain a 
sufficient danger in them that it would warrant the Fed 
undertaking a special examination of these questions if you 
were to become the Chairman? Because if this went bad on your 
watch, I mean, there could be tremendous consequences, 
    Mr. Bernanke. I think it is useful to have informal 
contacts to try to understand what is going on in the market, 
and the Federal Reserve has various mechanisms for learning 
about this market; in particular, working through the various 
counterparties that deal with hedge funds.
    Senator Sarbanes. Well, I commend this area to you as one 
that should have some focus of your attention. Otherwise, it 
may well come back to haunt you.
    Could I ask you about HMDA and the Home Mortgage Disclosure 
Act? The data released in September showed that African-
Americans and Hispanics pay more for home loans and face higher 
denial rates than similarly situated White Americans. I 
understand the Board has reviewed the HMDA data and flagged 
approximately 200 lenders for further scrutiny. And in fact, 
Governor Olson at the Fed says anytime a lender differentiates, 
the burden of proof shifts to the lender to demonstrate that 
the pricing differentials are based on empirical analysis.
    Would you agree with that, and how important do you think 
this issue is that is revealed by the HMDA data?
    Mr. Bernanke. Senator, the facts you point out are correct. 
They were revealed because the Federal Reserve asked for 
disclosures of pricing information, as well as quantity and 
denial information. I think fair lending is extremely 
important. The Federal Reserve is going to follow up on these 
results. It is going to share the results, or has already 
shared the results, with other bank regulators, and the 
intention is to find out why these discrepancies exist.
    Senator Sarbanes. Mr. Chairman, I just want to close with a 
couple of observations.
    Chairman Shelby. Go ahead. You take your time.
    Senator Sarbanes. We discussed this morning the inflation 
targeting, and I do not want to close out without referring 
back to it. And I want to commend to you for your own thinking 
the danger that if you had a numerical figure for inflation but 
not for unemployment, that there would be a shift in focus of 
policymaking and debate toward whether the Fed was achieving 
its inflation target and away from whether the Fed was 
achieving maximum employment through stabilizing output, 
whether you intended that to happen or not. I think it is easy 
enough to assert that it is not your intention, that you are 
keeping the dual mandate in mind and so forth.
    But I think in the real world of the dynamics and 
particularly in the way the media would cover such a question, 
the constant focus is going to be have you hit the numbers 
target on your inflation goal and that it would, in effect, 
draw attention away from the dual mandate and the emphasis we 
are placing on trying to balance the two.
    I take some encouragement from your statement that if 
confirmed, you will take no precipitous steps in the direction 
of quantifying the definition of long-run price stability; that 
the matter requires further study at the Fed as well as 
extensive discussion and consultation. I would propose further 
action only if a consensus can be developed and that taking 
such a step would further enhance the ability of the FOMC to 
satisfy its dual mandate of achieving both stable prices and 
maximum sustainable employment.
    I do not think this is fully consistent with the Fed's 
current policy approach, which is an assertion you make in your 
statement, and obviously, there have been fellow Members of the 
Board who have resisted inflation targeting for this very 
reason amongst other reasons. So, I mean, you make that 
assertion, but there are a number of very thoughtful people who 
disagree with it very strongly.
    Further, I refer back to earlier. I do not think you can 
change the Fed's mandate except by statute from the Congress, 
and I know you are laying out a rationale where you interpret 
it in such a way that it is encompassed within the mandate, but 
I think you have to be extremely careful, and I particularly 
think, as I just said, that if you have a figure for inflation 
and not for unemployment, the public focus is going to be drawn 
to the inflation figure, and that is going to become the 
overriding concern.
    Finally, Mr. Chairman, I do welcome in Dr. Bernanke's 
statement right at the outset where he talks about this 
prospective new role and says, and I want to quote this, 
because I think it is very important to underline it and again 
put it on the record: ``I would bear the critical 
responsibility of preserving the independent and nonpartisan 
status of the Federal Reserve, a status that in my view is 
essential to that institution's ability to function effectively 
and achieve its mandated objectives, in the plural, I might 
add. I assure this Committee that if confirmed, I will be 
strictly independent of all political influences and will be 
guided solely by the Federal Reserve's mandate from Congress 
and by the public interest.''
    Thank you very much, Mr. Chairman.
    Chairman Shelby. Dr. Bernanke, we appreciate your 
appearance here today at your hearing and especially when we 
had a bifurcated hearing with the votes in the Senate. We 
appreciate your candor and your ability. I do not know of a 
Federal Reserve nominee, Chairman, that has as many 
publications under their belt as you do. And I am not going to 
tell you that I have read all of them, but they are interesting 
to go with.
    But we will try to move your nomination as soon as 
possible. I think it is a good nomination. I have said this 
from the beginning. And I will be consulting with Senator 
Sarbanes and see what we can do. Thank you for your time today.
    Mr. Bernanke. Thank you.
    Chairman Shelby. The hearing is adjourned.
    [Whereupon, at 4:28 p.m., the hearing was adjourned.]
    [Prepared statements, biographical sketch of nominee, 
response to written questions, and additional material supplied 
for the record follow:]

    I join my colleagues in welcoming Dr. Ben Bernanke to the 
Committee. He is no stranger. He has been here before, both to be a 
Member of the Federal Reserve Board of Governors and then to be 
Chairman of the President's Council of Economic Advisers.
    Of course, he has now been nominated to a 14-year term as a Member 
of the Board of Governors and also nominated to be the Chairman of the 
Federal Reserve Board of Governors, a 4-year term.
    The Federal Reserve Act of 1913, which established the Federal 
Reserve System, set the 14-year terms for the Members of the Board of 
Governors of the Federal Reserve. I think that clearly reflected the 
intention of Congress, at the time, in enacting this legislation to 
place the Federal Reserve Board and its individual Members beyond the 
reach of any given Administration and the political pressures of the 
moment. Actually, the 14-year term is the longest we give to any 
official in the Government other than the lifetime appointments for 
members of the Federal judiciary.
    I think it is fair to say, or certainly it has come to be the case, 
that the credibility of the Federal Reserve rests in large part on 
broad confidence in its independence in the judgments it makes. And, 
obviously, if that confidence were to be undermined, the stature of the 
Board would be gravely diminished. And that, in turn, would have 
serious consequences, I think, not only for our National economy but 
also, indeed, for the world economy.
    So we are looking forward to hearing from Dr. Bernanke about this 
important role of the independence of the Federal Reserve in rendering 
its judgments.
    And my colleague, Senator Dodd, has made reference to the other 
major point I wanted to make. And that was that the Federal Reserve Act 
provides as its goals that, ``The Board of Governors of the Federal 
Reserve system and the Federal Open Market Committee shall maintain 
long-run growth of the monetary and credit aggregates commensurate with 
the economy's long-run potential to increase production so as to 
promote effectively the goals of maximum employment, stable prices, and 
moderate long-term interest rates.''
    And this is conveniently referred to as the twin mandates of the 
Federal Reserve, addressing both maximum employment and stable prices.
    That is another issue that I look forward to exploring with Dr. 
Bernanke in the course of these hearings.
    Actually, we had to contend for quite a while with this non-
accelerating inflationary rate of unemployment, something that Chairman 
Greenspan, to his credit, never accepted. That was the theory that if 
the unemployment rate got down to a certain level, beyond that you 
would have inflation. And therefore, as it approached that unemployment 
rate, the Fed would have to start raising interest rates to cool off 
the economy, even if we did not see manifested inflationary signs.
    So it was a preemptive strike against inflation, but it also, of 
course, ended up being a preemptive strike against employment, if it 
had been followed.
    Fortunately, that was not the case. And we have seen in recent 
years that we have been able to go down--and we are now at 5 percent, 
but we have been able to go down below that to a 4 percent unemployment 
rate without an inflationary problem.
    And I am anxious to explore that with Dr. Bernanke as well, since I 
think jobs is a very important purpose of economic policy.
    Let me just add one other dimension, which is not often talked 
about when we talk about the Fed, and that is that the Board has 
responsibility, supervisory and regulatory authorities to assure the 
safety and soundness of the Nation's banking and financial systems and 
protecting the credit rights of consumers.
    In the area of consumer protection, the board has broad 
jurisdiction and authority to implement regulations for a whole host of 
consumer laws: The Community Reinvestment Act, Truth in Lending Act, 
Truth in Saving Act, Home Mortgage Disclosure, the Home Owners Equity 
Protection Act, the Equal Credit Opportunity Act, and a number of 
others as well.
    And while public attention is focused on the Board's monetary 
policy responsibilities, I think it is important to recognize its 
jurisdiction and authority with respect to these regulatory issues. The 
Board can play a very significant role in improving consumer rights and 
enforcing consumer protections.
    Finally, Mr. Chairman, I noticed that the papers this morning are 
already setting out an agenda. I just quote one paragraph to give one 
example of it:

        If confirmed, Bernanke will take over the Fed at a moment of 
        rising economic unease. The U.S. trade and budget deficits are 
        soaring. The once-blistering housing market may be cooling. 
        Rumors continue to rumble through Wall Street of dangerously 
        overextended hedge funds ripe for collapse. The next Fed 
        Chairman could face significant challenge, as Greenspan did, 
        within months of taking office.

    Welcome to the committee this morning, Dr. Bernanke.
    Mr. Chairman, thank you for holding this hearing. I am very pleased 
to again welcome my fellow New Jerseyan, Dr. Bernanke, before the 
Committee, and to support his nomination to be the next Chairman of the 
Federal Reserve.
     Dr. Bernanke has a remarkable record of service and scholarship at 
the Council of Economic Advisers, the Federal Reserve, and before that, 
Princeton University. He has served in these roles with distinction as 
one of our Nation's preeminent economists, both in policymaking and in 
academia. Moreover, Dr. Bernanke has earned great respect among 
lawmakers and economists from all points on the political spectrum who 
recognize the quality of his work regardless of whether they agree with 
him on specific economic questions.
     I have been concerned throughout the last few years that too many 
of this Administration's high profile economic officials seem to be 
salesmen for predetermined, ideologically-driven policies. Dr. 
Bernanke, however, has defied this stereotype during his time with the 
Council of Economic Advisors, and I trust he will continue this pattern 
of basing his decisions on sound economics, rather than ideology and 
     Needless to say, Dr. Bernanke has large shoes to fill as Chairman. 
Alan Greenspan has been one of the most active and significant Chairmen 
in the history of the Federal Reserve System. While I have not always 
seen eye-to-eye with Chairman Greenspan on economic issues, I thank and 
salute him for his economic stewardship through difficult times, and 
for more than 18 years of distinguished service to our country.
     I look forward to working with Dr. Bernanke in the future to 
strengthen our financial markets and to ensure economic opportunity for 
all Americans.
     Thank you, Mr. Chairman.
                      FROM BEN S. BERNANKE

Q.1. As you know, I feel that Chairman Greenspan too often 
talked publicly about things that had nothing to do with 
monetary policy. Do you believe a Fed Chairman should discuss 
things outside the Fed's jurisdiction?

A.1. I believe that it is essential to maintain the 
independence and nonpartisan status of the Federal Reserve. As 
I discussed in my testimony, if confirmed, I will be strictly 
independent of all political influences and will be guided 
solely by the Federal Reserve's mandate from Congress and the 
public interest.
    The scope of the Federal Reserve's mandate is broad and 
includes matters related to the implementation of monetary 
policy, general financial stability, supervision of financial 
institutions, administration of the payments system and 
consumer issues, among other areas. In addressing these 
matters, I pledge always to give Congress my best advice from 
the perspective of an independent and nonpartisan Federal 
Reserve. I also intend to decline to address issues that are 
not related to the Federal Reserve's broad mandate.
    Let me address specifically the area of fiscal policy. 
Because of the Federal Reserve's responsibilities for 
macroeconomic and financial stability, I believe it would be 
appropriate at times for me to comment on broad fiscal issues 
such as the sustainability of Government spending or deficits. 
However, as I indicated during my testimony, I will not 
advocate for or against specific tax or spending proposals that 
come before the Congress.

Q.2. As I am sure you read last week, The Wall Street Journal 
asked a number of economists what questions they would like to 
be able to ask you. I am going to steal a few from them. What 
is the principal reason for the existence of the Federal 

A.2. The Federal Reserve System was created by the Congress in 
1913 to provide the Nation with a safer, more flexible, and 
more stable monetary and financial system. Today, the main 
duties of the Nation's central bank fall into four general 

 Conducting the Nation's monetary policy by influencing 
    the monetary and credit conditions in the economy in 
    pursuit of the statutory objectives of maximum employment, 
    stable prices, and moderate long-term interest rates;
 Supervising and regulating banking institutions to 
    promote the safety and soundness of the Nation's banking 
    and financial system and helping to protect the rights of 
    consumers in credit markets;
 Fostering the stability of the financial system and 
    containing systemic risk that may arise in financial 
    markets; and
 Providing financial services to depository 
    institutions, the U.S. Government, and foreign official 
    institutions, including playing a major role in operating 
    the Nation's payments system.

     Each of these areas of responsibility reflects specific 
authority granted by the Congress; and each, in my view, is 
essential for the economic health of the country.

Q.3. What is currently the most significant threat to our 
economic expansion?

A.3. The U.S. economy is currently enjoying a strong and stable 
expansion. Over the past four quarters, real gross domestic 
product (GDP) has grown more than 3\1/2\ percent, extending the 
economic upturn that began in late 2001. And the current 
consensus among economists is that the expansion will be 
sustained next year.
    However, this favorable outlook is ringed with a number of 
risks. Energy prices have risen steeply in the past 3 years, 
and although the economy has accommodated these rises 
remarkably well thus far, continuing increases in the price of 
energy would pose difficult challenges for households and 
businesses. The proximate cause of the energy price increases 
is a rapidly growing global demand for energy, coupled with 
insufficient investment in new energy supplies to meet this 
growth. In the long-run, high prices will curb energy demand 
and call forth new energy supplies. In the near-term, however, 
energy price increases have the potential to spill over into 
general inflation, sap consumer spending power, and damp 
overall activity. A further jump in energy prices or a more 
pronounced reaction to those increases in prices that have 
already occurred could test the strength of the expansion. With 
respect to inflation, the Fed, thus far, has been largely 
successful in limiting the effects of higher energy prices on 
the broader rate of price inflation. But further energy price 
increases would also pose upside risks to the outlook for 
    Developments in housing markets also bear close monitoring. 
Housing prices have risen rapidly in recent years, and concerns 
have been expressed in many quarters about whether the current 
high level of prices will be sustained. It is intrinsically 
very difficult to assess whether the value the market assigns 
to any asset is fundamentally justified, and housing is no 
exception to this rule. Certainly, some powerful fundamental 
forces have contributed to the run-up in housing prices, 
including growth in jobs and incomes, demographic trends, low 
mortgage rates, and limited supplies of buildable land in some 
areas. However, it is also true that exceptionally rapid price 
appreciation and what appears to be speculative buying have 
been observed in some local markets, suggesting that prices may 
exceed fundamental values in some areas. Whatever the sources, 
house price increases will surely moderate at some point, if 
they have not begun to do so already. If that moderation is not 
too sharp, then the slowing of consumption and residential 
investment that might result should be consistent with the 
modest cooling of growth that many forecasters expect over the 
next year or so. A sharper slowdown, less likely but possible, 
would have a larger effect on the growth of real output, 
particularly if it were to occur in the context of continued 
adverse developments in energy markets.

Q.4. Are you concerned that the Basel II QIS-4 study showed 
there would be a decline in capital standards for U.S. banks? 
Given the fact that Congress has recently voted (to) increase 
FDIC coverage, are you concerned about the safety and soundness 
of the banking system with coverage increasing and capital 
possibly decreasing?

A.4. The Federal Reserve and the other Federal banking agencies 
were certainly concerned about the large drop in minimum 
regulatory capital observed in the QIS-4 study for some banks. 
Also, the average decline in minimum regulatory capital for the 
participating banks collectively was larger than observed in 
the previous QIS. Both the decline and the wider-than-expected 
dispersion among the banks participating in QIS-4 caused the 
agencies in April to take additional time to understand the 
QIS-4 results. After conducting extensive additional analysis, 
the agencies announced on September 30 that they would be 
taking additional prudential measures, including an extended 
timeline for Basel II implementation and the addition of an 
extra year of capital floors beyond those already in the 
    I am sure that the Federal Reserve and the other agencies 
will not countenance declines in capital of the amount that 
QIS-4 found for some banks. Indeed, the motivation for 
conducting this and other quantitative impact studies was to 
assess the potential effects of the framework in advance, so 
problems (such as an excessive decline in regulatory capital in 
some banks) could be identified and mitigated. In addition, 
before any banks are permitted to operate under Basel II, they 
will go through a rigorous process of review and analysis by 
the supervisors to ensure that their internal processes meet 
high standards. Importantly, there was no supervisory 
validation of the methods used by the banks in the QIS-4 
exercise; the banks in the study participated on a best-efforts 
basis without any supervisory oversight. Thus, some of the QIS-
4 results likely arose from the fact that banks were not fully 
prepared to operate under the Basel II framework and (in good 
faith) may have used methods that would not be approved by 
regulators under a ``live'' application of the framework.
    Besides the measures announced on September 30, supervisors 
have a suite of regulatory tools to prevent excessive drops in 
regulatory capital, including the leverage ratio, prudential 
measures under Pillar II of the Basel II framework, and the 
ongoing requirement of prompt corrective action. It is 
important to move to a more sophisticated system that better 
links regulatory capital to the actual risks of banks' lending 
books, trading books, and operations; that is the purpose of 
Basel II. However, the transition needs to be accomplished in a 
deliberate and careful manner, with many checks and feedback 
mechanisms, in order to ensure that capital is adequate and 
safety and soundness are ensured at all times.
    The increase in FDIC deposit coverage would affect the 
entire banking system, of course, not just the banks included 
in the QIS-4 or that will ultimately adopt the Basel II 
framework. Most banks covered by the FDIC will be subject to 
the agencies' proposed amended Basel I minimum regulatory 
capital framework, for which an Advance Notice of Proposed 
Rulemaking (ANPR) has only recently been released. I assure 
you, as the process of rulemaking proceeds, the capital impacts 
of these proposed amendments will also be carefully analyzed to 
ensure that they are consistent with a high level of safety and 
soundness and the protection of the deposit insurance fund.

Q.5. Are you concerned about the amount of U.S. debt the 
People's Republic of China holds?

A.5. The United States is running a current account deficit, 
which of necessity must be financed by net capital inflows from 
the rest of the world. These inflows have allowed the United 
States to increase its capital stock at a rate faster than 
would have been possible had we relied solely on domestic 
savings, and the resulting larger capital stock has increased 
the competitiveness of the U.S. economy. Accordingly, the 
willingness of foreign investors, including China, to hold U.S. 
liabilities has conferred important benefits on our economy.
    Concerns have been raised that the quantities of U.S. 
Treasury securities held by China and other foreign investors, 
both private and official, have become so large as to increase 
the vulnerability of the U.S. economy to changes in the 
portfolio allocations of those investors. However, many of the 
reasons that investors hold these securities--their 
unparalleled safety and liquidity, together with the dollar's 
traditional role as a reserve currency--are unlikely to 
disappear any time soon. Moreover, markets for dollar-
denominated financial assets are extraordinarily deep; for 
example, foreign official holdings of U.S. Treasuries, of which 
holdings by China represent only a part, collectively account 
for only 3 percent of total U.S. credit market debt 
outstanding. Accordingly, U.S. financial markets would likely 
be able to absorb a significant shift in foreign official 
demands for U.S. debt, including by China.

Q.6. In November 2002, you gave a speech on deflation. After 
the speech, many in the pundit class started referring to you 
as ``helicopter Ben.'' Would you like to elaborate on your 
comments on deflation?

A.6. My November 2002 speech (``Deflation: Making Sure `It' 
Doesn't Happen Here'') was a discussion of the causes and 
effects of deflation, as well as of some possible policy tools 
to address deflation. In that speech, I noted that one possible 
tool for combating deflation, a money-financed tax cut, was 
essentially equivalent to a theoretical construct used by 
Professor Milton Friedman, a ``helicopter drop'' of money. Of 
course, the ``helicopter drop'' metaphor is purely a pedagogic 
device to help explain money's role in the economy, not a 
practical policy tool. A key message of my speech was that, 
contrary to some views that were being expressed at the time, 
the central bank still has tools to address deflation even if 
the short-term interest rate reaches zero. I believe the speech 
made that point effectively and helped to relieve concerns 
about the potential effectiveness of monetary policy against 
    I would add that I believe that ``stable prices'' means 
avoiding both deflation and inflation. My November 2002 speech 
stressed the importance of avoiding deflation, at a time when 
inflation had reached an historically low level. I am equally 
committed to avoiding inflation; as I noted in my testimony, I 
believe that keeping inflation low and stable is a critical 
contribution that monetary policy can make to enhancing 
prosperity and growth.

Q.7. It is my understanding that the Federal Reserve has 
decided to halt disclosure to the public of its M3 findings and 
report. The findings of the M3 report provide pertinent 
information to the public--from economists to investors and to 
industries which all use M3 report findings for economic 
forecasting, investing, and business decisions. You have 
advocated a ``more open'' Federal Reserve under your command. 
Will you work to reverse this policy and commit to keeping the 
M3 report and its findings available and open to the public? 
What is the rationale and reasoning by the Federal Reserve to 
keep the M3's information from the public?

A.7. My understanding is that the Federal Reserve decided to 
discontinue publication of the monetary aggregate M3 because 
the costs of collecting and processing the underlying data were 
judged to exceed the benefits. The Federal Reserve will not 
withhold the M3 data from the public; rather, it will no longer 
collect and assemble that information. The Federal Reserve will 
continue to collect data for and publish the monetary 
aggregates M1 and M2 and their components.
    The benefits of continuing to publish M3 appear to be 
minimal, because M3 has not been actively used in the 
formulation of U.S. monetary policy and, at least within the 
Federal Reserve, has not been found to have much value for 
economic forecasting. Discontinuing publication of M3 will 
allow the Federal Reserve to terminate certain reporting forms 
that currently must be filled out by depository institutions, 
lowering the costs of such institutions. Costs at the Federal 
Reserve Banks and the Board will similarly be reduced as these 
particular reports will no longer need to be processed and 
    I view the periodic reappraisal of the costs and benefits 
of reports as a useful discipline to ensure that the reporting 
burden on financial institutions is kept to a minimum.

Q.8. The Fed has been on the record with their fears of Fannie 
Mae and Freddie Mac being systemic risks to our financial 
system. Are you worried about other large financial 
institutions with portfolios similar to the GSE's being 
systemic risks?

A.8. Market discipline is typically the governing mechanism 
that constrains leverage and ensures that firms do not 
undertake excessive risks. The market system generally relies 
on the vigilance of creditors and investors in financial 
transactions to assure themselves of their counterparties' 
current condition and the soundness of their risk management 
    Because of the availability of deposit insurance, market 
discipline is not by itself sufficient to control risk-taking 
in the banking system; for this reason, the Federal Reserve and 
the other banking agencies supervise and regulate banks. I 
believe that the tools available to the banking agencies, 
including the ability to require adequate capital and an 
effective bank receivership process are sufficient to allow the 
agencies to minimize the systemic risks associated with large 
banks. Moreover, the agencies have made clear that no bank is 
too-big-too-fail, so that bank management, shareholders, and 
uninsured debtholders understand that they will not escape the 
consequences of excessive risk-taking. In short, although 
vigilance is necessary, I believe the systemic risk inherent in 
the banking system is well-managed and well-controlled.
    In the case of the GSE's, market discipline is problematic. 
Market participants recognize that the GSE's are closely tied 
to the Federal Government and such ties create a view among 
market participants that the GSE's are implicitly backed by the 
Federal Government, thereby weakening market discipline. 
Consequently, strong regulatory authority and controls on GSE 
risk-taking are needed to ensure that they do not create 
systemic risks. Unfortunately, the GSE regulator's constrained 
capital authority, the ineffective receivership process, and 
other limitations weaken regulatory oversight of GSE's. Capping 
the size of GSE portfolios, which beyond a certain size do not 
contribute to the GSEs' housing mission, is also important for 
controlling potential systemic risk.