[House Hearing, 110 Congress]
[From the U.S. Government Publishing Office]




 
                        MONETARY POLICY AND THE
                      STATE OF THE ECONOMY, PART I

=======================================================================

                                HEARING

                               BEFORE THE

                    COMMITTEE ON FINANCIAL SERVICES

                     U.S. HOUSE OF REPRESENTATIVES

                       ONE HUNDRED TENTH CONGRESS

                             FIRST SESSION

                               __________

                             JULY 17, 2007

                               __________

       Printed for the use of the Committee on Financial Services

                           Serial No. 110-51



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                 HOUSE COMMITTEE ON FINANCIAL SERVICES

                 BARNEY FRANK, Massachusetts, Chairman

PAUL E. KANJORSKI, Pennsylvania      SPENCER BACHUS, Alabama
MAXINE WATERS, California            RICHARD H. BAKER, Louisiana
CAROLYN B. MALONEY, New York         DEBORAH PRYCE, Ohio
LUIS V. GUTIERREZ, Illinois          MICHAEL N. CASTLE, Delaware
NYDIA M. VELAZQUEZ, New York         PETER T. KING, New York
MELVIN L. WATT, North Carolina       EDWARD R. ROYCE, California
GARY L. ACKERMAN, New York           FRANK D. LUCAS, Oklahoma
JULIA CARSON, Indiana                RON PAUL, Texas
BRAD SHERMAN, California             PAUL E. GILLMOR, Ohio
GREGORY W. MEEKS, New York           STEVEN C. LaTOURETTE, Ohio
DENNIS MOORE, Kansas                 DONALD A. MANZULLO, Illinois
MICHAEL E. CAPUANO, Massachusetts    WALTER B. JONES, Jr., North 
RUBEN HINOJOSA, Texas                    Carolina
WM. LACY CLAY, Missouri              JUDY BIGGERT, Illinois
CAROLYN McCARTHY, New York           CHRISTOPHER SHAYS, Connecticut
JOE BACA, California                 GARY G. MILLER, California
STEPHEN F. LYNCH, Massachusetts      SHELLEY MOORE CAPITO, West 
BRAD MILLER, North Carolina              Virginia
DAVID SCOTT, Georgia                 TOM FEENEY, Florida
AL GREEN, Texas                      JEB HENSARLING, Texas
EMANUEL CLEAVER, Missouri            SCOTT GARRETT, New Jersey
MELISSA L. BEAN, Illinois            GINNY BROWN-WAITE, Florida
GWEN MOORE, Wisconsin,               J. GRESHAM BARRETT, South Carolina
LINCOLN DAVIS, Tennessee             JIM GERLACH, Pennsylvania
ALBIO SIRES, New Jersey              STEVAN PEARCE, New Mexico
PAUL W. HODES, New Hampshire         RANDY NEUGEBAUER, Texas
KEITH ELLISON, Minnesota             TOM PRICE, Georgia
RON KLEIN, Florida                   GEOFF DAVIS, Kentucky
TIM MAHONEY, Florida                 PATRICK T. McHENRY, North Carolina
CHARLES WILSON, Ohio                 JOHN CAMPBELL, California
ED PERLMUTTER, Colorado              ADAM PUTNAM, Florida
CHRISTOPHER S. MURPHY, Connecticut   MICHELE BACHMANN, Minnesota
JOE DONNELLY, Indiana                PETER J. ROSKAM, Illinois
ROBERT WEXLER, Florida               KENNY MARCHANT, Texas
JIM MARSHALL, Georgia                THADDEUS G. McCOTTER, Michigan
DAN BOREN, Oklahoma

        Jeanne M. Roslanowick, Staff Director and Chief Counsel


                            C O N T E N T S

                              ----------                              
                                                                   Page
Hearing held on:
    July 17, 2007................................................     1
Appendix:
    July 17, 2007................................................    39

                               WITNESSES
                         Tuesday, July 17, 2007

Friedman, Dr. Benjamin M., William Joseph Maier Professor of 
  Economics, Department of Economics, Harvard University.........     6
Galbraith, Dr. James K., Lloyd M. Bentsen, Jurisdiction Chair in 
  Government/Business Relations, Lyndon B. Johnson School of 
  Public Affairs, The University of Texas at Austin..............     9
Meltzer, Dr. Allan H.., The Allan H. Meltzer University Professor 
  of Political Economy, Tepper School of Business, Carnegie 
  Mellon University..............................................    13

                                APPENDIX

Prepared statements:
    Paul, Hon. Ron...............................................    40
    Friedman, Dr. Benjamin M.....................................    41
    Galbraith, Dr. James K.......................................    52
    Meltzer, Dr. Allan H.........................................    60


                        MONETARY POLICY AND THE
                      STATE OF THE ECONOMY, PART I

                              ----------                              


                         Tuesday, July 17, 2007

             U.S. House of Representatives,
                   Committee on Financial Services,
                                                   Washington, D.C.
    The committee met, pursuant to notice, at 10 a.m., in room 
2128, Rayburn House Office Building, Hon. Barney Frank 
[chairman of the committee] presiding.
    Present: Representatives Frank, Waters, Maloney, Watt, 
Scott, Green, Cleaver, Ellison, Klein, Wilson, Perlmutter; 
Castle, Paul, Manzullo, Garrett, Neugebauer, Bachmann, and 
Marchant.
    The Chairman. The hearing will come to order. As we made 
clear, we have a statutory requirement under the Humphrey-
Hawkins Act for the Chairman of the Federal Reserve to come 
twice a year to each of the relevant committees in the House 
and the Senate to make a report. That has previously been 
considered to be a unique, if not sacred occasion, in which the 
Chairman is invited to pronounce with due deference on the part 
of the listeners. We intend to continue to be polite and 
receptive to what the Chairman has to say, but we have decided 
in the current Congress that we are going to make clear that 
there are other views that are relevant, and that the 
responsibility the Federal Reserve has under the Humphrey-
Hawkins Act is one that is important enough to get a range of 
comments on the issue, so that is what we are going to be doing 
today.
    The ranking member of the subcommittee--although this is a 
full committee hearing--has also been one of those who over the 
years has argued that it is legitimate to have full and 
vigorous debate over whether what the Federal Reserve does is 
right or wrong. And so we look forward to today, leading to a 
very serious discussion tomorrow.
    We are seeing a change to some extent in the economics 
profession that the New York Times talks about. I'm glad we 
have three very distinguished economists here today, none of 
whom have ever felt constrained by academic convention. And I 
think that affects one of the key issues that the Federal 
Reserve is dealing with. There has been a lot of conversation 
about inflation targeting, about the theory that the Federal 
Reserve, in pursuit of its obligations under the Humphrey-
Hawkins Act, should focus on a maximum inflation amount and 
very explicitly conduct its policy with the goal of keeping 
inflation under that number.
    The Federal Reserve, of course, under the Humphrey-Hawkins 
Act has a dual mandate--to restrain inflation, but also to 
promote full employment. Many of us are concerned about that 
approach because we believe it would lead to an undervaluing of 
the employment issue. The Chairman believes, and he will talk 
more about this, that he can in fact serve both goals by the 
way in which he is approaching the inflation issue, and we will 
hear a lot about the anchoring of inflation expectations as the 
philosophy that the Federal Reserve is increasingly adopting, 
both the Chairman and Governor Mishkin in particular have 
spoken about this.
    What I want to talk about, though, is the real economic 
situation we find ourselves in today, which I think has an 
impact on this inflation unemployment incipient rivalry, which 
is what's there, whether people acknowledge it or not, at least 
in the emphasis, and here's the issue that I'm really sort of 
trying out in my own head, and I will talk some today and a 
little bit more tomorrow, and the issue is this:
    What we have in the Federal Reserve is the argument that, 
from the standpoint of overall economic progress, it is 
important implicitly to focus on inflation and that if you can 
keep inflation low and keep inflation expectations anchored at 
a fairly low level, that will allow them to conduct monetary 
policy in a way that will promote the fullest possible 
employment in any given set of circumstances. And it's an 
emphasis that says from the overall economic standpoint, 
inflation is really the key driver. Some deference is paid to 
employment, but it does seem to me that the emphasis goes the 
other way.
    But we have, I think, a new recognition. We had a hearing 
on it last week. The New York Times has written about it a 
couple of times, and it's this: We're at a situation in America 
today where the distribution of wealth that is generated has 
become a very significant economic issue. And implicitly, the 
view that I've been discussing downgrades that. It asserts 
essentially that the focus has to be on the overall rate of 
growth in the country. And the assumption is that if you keep 
inflation down, you can promote an appropriate rate of growth 
and therefore all will benefit.
    Increasingly, it is clear as we look at the events of the 
past couple of decades, especially the past 6 years, the 
increasing concentration of wealth in the country has now 
become a significant issue. A couple of weeks ago, the 
immigration bill blew up very noisily in the Senate. Of 
somewhat equal significance from this perspective, trade 
promotion expansion died without either a bang or even a 
whimper. It just died. People didn't even notice.
    I say that because there are many who argue for increased 
integration of the United States into the global economy, 
taking full advantage of technology and trade as wealth 
generators, who were very regretful of that, and they have been 
talking about, ``How do we resuscitate the immigration bill? 
How do we get back trade promotion authority?''
    I think it's very clear. The problems that led to the 
demise of both of those are extrinsic to both issues. You are 
not going to solve either the immigration issue for those who 
want, as I do, an immigration bill along the general lines that 
went down, or get back into the trade business simply by 
changing the terms of those two policies. There is a deep 
unhappiness within the American electorate over the 
maldistribution of income.
    The recent report put out by the Financial Services Forum--
which is headed by Don Evans, a close friend of the President, 
and the first Secretary of Commerce in this Administration--a 
three-member panel which consists of: Matthew Slaughter, an 
immediate past member of the Council of Economic Advisors, whom 
Mr. Bernanke says he selected for that job; Grant Aldonis, who 
is a high-ranking Commerce Department official with trade 
responsibilities in this Administration; and Robert Lawrence of 
Harvard. What they put out is a report which documents the 
extraordinary maldistribution of income recently.
    The fact under their--the most striking chart was the one 
that shows, since 2000 I believe was the period they picked, if 
you look at segments of the economy, real income rose for 3.8 
percent of the economy, of the people, and was either stagnant 
or eroded for 96.2 percent. The political effects of that are 
serious. Professor Friedman has written about inequality and 
the impact of it.
    And we are now seeing, in very vigorous form, that the 
connection between the two is this: If we do not address this 
problem of the excessive inequality--obviously, inequality is 
essential to a capitalist system. No one's trying to get rid of 
it, at least no one rational. But it can reach a point where it 
becomes clearly politically distorting, and it may also become 
economically distorting in terms of consumption, in terms of 
the savings rate.
    But if we are not able to alleviate the understandable 
anger that Americans feel at the real maldistribution of income 
and the fact that as wealth has increased, they get little of 
it, then people should understand that we will not be making 
progress in some of these other areas. It makes no sense to 
tell people that trade and other economic policies will help 
promote national wealth if the overwhelming majority of 
citizens don't think that they benefit when the national wealth 
increases.
    And that is why--and that seems to become a constraint on 
the Federal Reserve. That gets to the tradeoff of inflation and 
unemployment to the extent that there is one. It does mean that 
the social and eventually the economic cost of increased 
unemployment is even greater than it may have been in people's 
minds. The anger that will be generated if the Federal Reserve 
were to decide that because of excessive inflation, and that 
it's slowed down the economy with the resulting increase in 
unemployment and the obvious further retardation of real wage 
growth, then the economic consequences and political 
consequences become worse.
    So I think we are in a somewhat new era in this regard in 
which this--it is no longer sufficient to look at the overall 
economic performance. Distribution questions have become prime 
questions for the future of the economy, and they've become 
more than just distribution questions because they control 
whether or not the economy can in fact continue to grow in ways 
that people would find satisfactory.
    I now recognize the gentleman from Texas.
    Dr. Paul. Thank you, Mr. Chairman. I appreciate very much 
you holding these hearings because, like you, I've had an 
intense interest in monetary policy and think it's very 
significant.
    It's interesting to note that over the years since we've 
been holding these Humphrey-Hawkins hearings, money supply had 
been in the past emphasized to a large degree, and yet 
recently, it's been deemphasized to the point where in these 
reports they've barely even referred to money supply. Likewise, 
a year ago, they even stopped reporting M3, as if it were 
totally unimportant. But the definition of certain words, I 
think, is very important. Most people talk about inflation, but 
almost everybody wants others to think that inflation is 
measured by prices as recorded in the CPI or the PPI. And yet 
for others, inflation is merely the increase in the supply of 
money and credit, it's the excess of credit that is inflated, 
which leads to higher prices in certain categories.
    So often what is neglected today with current understanding 
of monetary policy is that as long as we can bring about a 
government statistic that claims that the prices are relatively 
stable or rising at a lower level than that which would cause 
worry, then everything is okay. What is ignored is the fact 
that even if prices are stable as measured by the CPI, you 
still have other conditions to be concerned about such as 
malinvestment, excessive debt, and bubble formations.
    And indeed, this is the case in recent years where 
inflation of prices seem to be relatively stable, and yet we 
still had NASDAQ bubbles developing, housing bubbles develop, 
and various areas of the economy where prices go up 
excessively. The one thing characteristic about monetary 
inflation is that price inflation is not even. It's never even, 
and it's never fair, and I think this should help explain the 
concerns that the chairman has regarding the maldistribution of 
wealth. I'm deeply concerned about that, too, but I see it so 
often as a monetary phenomenon because the characteristics of a 
fiat currency, the characteristics of a devaluation of money, 
mean that the middle class and the poor hurt the most, and 
there are certain categories that benefit the most, the people 
who get to use the money first; the politicians, the 
government, and the military-industrial complex. These 
individuals benefit. When that money circulates, somebody else 
gets hit with a high inflation rate.
    Quite frankly, if we were measuring the CPI today the way 
we used to measure the CPI, it's rising at over 10 percent, so 
it becomes convenient for governments to change their 
calculation and make it sound like we are controlling prices 
and everybody is supposed to be satisfied with this.
    But what has happened, I believe, over these many years, 
especially since 1971, is that we have deferred to the central 
bank to be the central economic planners, that they are in 
charge of the economy and they can achieve this merely by 
manipulating interest rates. So there's a large consensus of 
people and groups that like low interest rates. The stock 
market likes low interest rates. The banks like low interest 
rates. Everybody seems to like low interest rates, and people 
call for low interest rates. Consumers, when they're borrowing 
money, like low interest rates. But it just happens to injure a 
lot of other people. Some individuals still believe that saving 
is worthwhile, and yet the interest that they earn is below 
market rate, and it hurts them. People on fixed incomes suffer 
from this.
    But this whole notion that a central bank somehow has the 
wisdom to know what interest rates should be is to me rather 
bizarre, and also the source of so much mischief that has gone 
on. If our goal is to have stable prices to a degree, if you 
look at monetary history, you will find out that if you have an 
asset-backed currency, prices will remain pretty stable for 100 
or 200 years as long as you have an asset-backed currency.
    It's only when there's nothing behind that currency, and 
banks, the central banks that inflate the currency that you 
have this radical increase in prices, and all you have to do is 
study the price increases since 1971, and it's a disastrous 
record for that.
    I believe also the idea that ought to be challenged is the 
notion that somehow or another if we just increase the money 
supply, which is the inflation, that we will increase 
employment, and yet this was virtually disproven and to a 
degree rejected in the 1970's, because it did eventually lead 
to stagflation. And today, I believe we are facing the very 
same conditions. This is the first time in over 30 years that 
every currency is going down in value in terms of traditional 
money, which is gold. And in the 1970's, it led to very bad 
times for us, and I think we should beware of this.
    But ultimately, monetary policy is key. Most economists 
will accept the notion that inflation, when they think of 
inflation, of course, prices, is a monetary phenomenon. At the 
same time, they falsely assume that if we can hide the 
inflation, change the way we record it, don't look at inflation 
for one group versus another, that we have nothing to worry 
about. That was virtually the major error they made in the 
1920's, believing there was no inflation, no malinvestment; but 
there was, and there had to be a correction.
    So the malinvestment and the misdirected economy and the 
excessive debt comes from the excessive credit created by the 
Federal Reserve Bank. Unless we address that and really hold 
their feet to the fire so that we have more transparency, the 
fact now that we get less transparency, although they talk 
about more transparency, means to me that they're trying to 
hide the ill effects of what's happening with the monetary 
system.
    So once again, I want to thank the chairman for these 
particular hearings that we're having, the extra effort to try 
to emphasize the importance of the Federal Reserve. But I will 
argue strongly that we need more transparency. The Congress 
needs to assume more responsibility for the very important 
issue of maintaining the value of the currency. And I yield 
back.
    The Chairman. The gentlewoman from New York is recognized 
for 5 minutes.
    Mrs. Maloney. Thank you, Chairman Frank, and I want to 
welcome our distinguished panel of experts and thank them for 
testifying today.
    These next 2 days of hearings come at an important time, 
because monetary policy remains at a critical juncture. Risks 
in the housing market have not yet subsided, and rising 
mortgage delinquencies on subprime home loans could level a 
serious blow to the overall economy. Personal bankruptcies will 
undoubtedly rise as the many families who have fallen prey to 
these risky mortgages run out of options, and the ability of 
American consumers to keep spending may be flagging with the 
cooling housing market.
    Last month retail sales experienced the sharpest decline in 
nearly 2 years, with housing-related sales contributing to the 
fall. Meanwhile, core inflation has tended to be higher than 
the Fed is comfortable with over the long term, which seems to 
have contributed to the Fed maintaining an anti-inflation tilt.
    Dr. Galbraith's testimony challenges the Fed's view that 
the relatively low unemployment we currently have poses an 
inflation risk. Even more compelling is the evidence he 
presents that earnings inequality is, ``A direct product of 
monetary policy choices.'' How American families are faring 
should be an important part of the Fed's policymaking 
decisions, because most workers have not shared in the gains 
from the economic growth we have seen so far.
    Setting the right course for monetary policy is further 
complicated by our huge budget deficits, our record debt, and 
international trade imbalances. Our challenge is to return to 
the legacy of fiscal discipline that President Bush inherited 
but squandered over the past 6 years. Democrats in Congress 
have a realistic budget plan that adheres to the PAYGO 
principles for controlling the deficit and bringing revenues 
into line with what we need to spend to defend our country and 
take care of our citizens.
    I thank the chairman for holding these hearings, and I look 
forward to the discussion and the testimony from our 
distinguished panel.
    Thank you. I yield back my time.
    The Chairman. The gentleman from Texas had a unanimous 
consent request.
    Dr. Paul. Thank you, Mr. Chairman. I'd ask unanimous 
consent to insert a printed statement into the record.
    The Chairman. Is there any objection?
    There being none, it will be put in the record.
    And we will now proceed to the witnesses. We appreciate 
your coming. This is a procedural innovation which we think 
people will be building on, so we thank you for participating. 
Professor Friedman, let's begin with you.

  STATEMENT OF DR. BENJAMIN M. FRIEDMAN, WILLIAM JOSEPH MAIER 
   PROFESSOR OF ECONOMICS, DEPARTMENT OF ECONOMICS, HARVARD 
                           UNIVERSITY

    Mr. Friedman. Thank you, Mr. Chairman. I'm delighted to be 
here this morning to address this distinguished committee. As 
you mentioned, I do indeed have views on the role of inequality 
in our economy today, and I also have views on the issues that 
Congressman Paul raised in his earlier remarks. The remarks in 
my prepared statement focus on two issues. The first is the 
dual mandate and the second is inflation targeting. What I'll 
do, with your permission, and in the interest of time, is to 
only present parts of my prepared remarks.
    The Chairman. Without objection, all of the written 
material that any of the witnesses wish to present will be made 
part of the record.
    Mr. Friedman. Thank you. I appreciate that. Our country's 
central bank is unusual today in two respects. First, under the 
prevailing legislation, Congress has instructed the Federal 
Reserve to conduct monetary policy so as to promote both 
maximum employment and stable prices. This dual mandate, as 
it's often called, stands in contrast to the charge given to 
many other countries' central banks to focus primarily or even 
exclusively on maintaining stable prices.
    Second, the Federal Reserve System has stood apart from the 
movement among many other central banks to organize monetary 
policy around the pursuit of a specific publicly announced rate 
of inflation, what's commonly called inflation targeting.
    I believe our country is well served by both of these 
differences. The Congress is right to assign the Federal 
Reserve a dual mandate, and given that dual mandate, it would 
be harmful for the Federal Reserve to organize its monetary 
policy within an inflation-targeting rubric. I will address 
both of these issues.
    First, the dual mandate: The purpose of any nation's 
economic policy is clearly to advance its economic wellbeing, 
meaning the prosperity of its citizens and the vitality of the 
institutions through which they participate in economic 
activity.
    Whether working men and women are able to make a living, 
whether the businesses that they own and at which they work and 
earn a profit and invest for future growth, and whether the 
banks and other financial institutions on which they rely can 
survive, are all fundamental aspects of that wellbeing. 
Individual citizens are, and they have a right to be, concerned 
with many facets of the economic environment in which they 
live; their incomes, their employment prospects, their ability 
to start a business, or to borrow to purchase a new home, just 
to name a few.
    Experience shows that rising prices, or for that matter, 
falling prices, can and sometimes do undermine the efficient 
functioning of economic activity, so that price stability is a 
key desideratum in all of these regards. But price stability is 
instrumental. We value it not for itself but for how it 
enhances the economy's capacity to achieve those goals that, 
even if they are not genuinely primary from the perspective of 
basic human concerns, at least instrumental on a higher level.
    The idea that economic policy should pursue price stability 
as a means of promoting more fundamental economic wellbeing, 
either currently or in the future, is not grounds for pursuing 
price stability at the expense, much less to the exclusion, of 
that more fundamental wellbeing.
    I go on, in my prepared remarks, to contemplate an 
imaginary situation in which the economy is in deep depression, 
banks are failing, corporations are in bankruptcy, home 
mortgage foreclosures are accelerating, and then to imagine 
that the Chairman of the Board of Governors of the Federal 
Reserve System were to appear at the equivalent of tomorrow 
morning's hearing and greet you, ladies and gentlemen, by 
saying, ``I'm pleased to report that during the past year, U.S. 
monetary policy has been outstandingly successful. Overall 
inflation has again been just 1 percent, and prices other than 
for food and energy have risen by .9 percent. My colleagues are 
here to accept your congratulations.''
    Now, such a situation is of course unthinkable. But the 
relevant question for this committee is what makes it 
unthinkable. The Federal Reserve System is a part of our 
Federal Government, to which the Congress has--importantly, 
under instruction and with oversight--delegated its 
constitutional power to make monetary policy. The substantive 
content of that instruction is essential, and the existing dual 
mandate is a crucial component of it.
    I turn now to inflation targeting.
    The Chairman. I'm going to--we'll do 7 minutes for each of 
the witnesses, so, please keep going.
    Mr. Friedman. Thank you, Mr. Chairman. Advocates of 
inflation targeting, both within central banks and elsewhere, 
frequently ground the argument in favor of this way of 
conducting monetary policy on considerations of transparency, 
which Mr. Paul mentioned in his remarks, though in a very 
different way, and accountability. Telling the public which 
single variable to associate with monetary policy and also the 
numerical target at which the central bank is aiming, makes 
clear what policymakers are trying to achieve. When the 
objective is low and stable inflation, transparency also helps 
to anchor the public's expectations. Furthermore, 
accountability of policymakers for the efficacy of their 
actions is plainly part of what constitutes effective 
democracy.
    I believe, however, that under circumstances like those 
under which our Federal Reserve System operates, the argument 
for the transparency of inflation targeting fails, and with it 
the argument for the resulting greater accountability. 
Describing the intended trajectory of monetary policy in terms 
of inflation alone need not imply that policymakers have no 
objectives apart from inflation, but nor does it preclude their 
having such a single goal for monetary policy. The essential 
question is whether policymakers have objectives for output and 
employment or not. If they do, then inflation targeting is more 
likely to undermine the transparency of their policy than to 
promote it. The chief reason is that under inflation targeting, 
policymakers reveal to the public only one aspect of their 
multiple objectives. They have a numerically specific and 
publicly announced target for inflation, but not for the real 
component.
    Indeed, many inflation targeting central banks--and I give 
some examples in my prepared remarks--appear to go to some 
effort not to reveal targets that they have, or even objectives 
that they have, for the real aspects of the economy. In light 
of the favorable effect on short-run output--inflation 
tradeoffs that some people argue ensues from keeping 
expectations of future inflation anchored at a low level, the 
incentive for policymakers to downplay or even conceal their 
objectives for real outcomes is of course clear enough. But 
their doing so hardly contributes to the transparency of their 
policy, nor does it contribute to making their policy 
accountable.
    Indeed, one interpretation of the movement toward inflation 
targeting among so many of the world's central banks, is that 
this is precisely the state of policymaking that inflation 
targeting is intended to bring about over time. A plausible 
consequence of constraining the discussion of monetary policy 
to be carried out entirely in terms of a specified numerical 
inflation trajectory is that, in time, objectives for output 
and employment will atrophy or even disappear from 
policymakers' purview altogether.
    This eventuality would ensue in part simply because the 
language and analytical framework within which discussion takes 
place inevitably shapes what is discussed. The 18th century 
Scottish philosopher and economist David Hume, writing about 
the central political issue in the Britain of his day, which 
was monarchy versus republic, observed that, and here I quote 
Dr. Hume, ``The Tories''--that is, the pro-monarchy party--
``The Tories have been obliged for so long to talk in the 
republican style that they have at length embraced the 
sentiments as well as the language of their adversaries.'' We 
are all familiar with instances of the same phenomenon in our 
own day.
    In addition, exactly as the argument for accountability 
implies, policymakers inevitably take more seriously those 
aspects of their responsibilities for which they expect to be 
held accountable. Disclosing a numerical target for only the 
inflation objective, when in fact policymakers are charged by 
the Congress to have objectives for inflation as well as for 
output and employment, biases the relative importance that 
policymakers will attach to these respective objectives by 
fostering their accountability for inflation and not for real 
outcomes. In time, the objectives for output and employment 
specified in the Congress's instruction to the Federal Reserve, 
would simply devolve into a rhetorical fiction.
    The United States is today well-served by the dual mandate 
that the Congress has assigned to our Nation's central bank. It 
is worth preserving. Inflation targeting would instead 
undermine it. Thank you, Mr. Chairman.
    [The prepared statement of Dr. Friedman can be found on 
page 41 of the appendix.]
    The Chairman. Thank you, Mr. Friedman.
    Mr. Galbraith.

    STATEMENT OF DR. JAMES K. GALBRAITH, LLOYD M. BENTSEN, 
JURISDICTION CHAIR IN GOVERNMENT/BUSINESS RELATIONS, LYNDON B. 
 JOHNSON SCHOOL OF PUBLIC AFFAIRS, THE UNIVERSITY OF TEXAS AT 
                             AUSTIN

    Mr. Galbraith. Thank you, Mr. Chairman, Congressman Paul, 
and members of the committee. It is a particular honor for me 
to be here today, as someone who worked for this committee from 
1976 until the early 1980's, and who helped--with Congressman 
Hawkins, and under the leadership of Chairman Reuss--to draft 
what became the Full Employment and Balanced Growth Act, under 
which these hearings are being held, and who worked on these 
hearings for the first 5 or 6 years of their existence. So I am 
delighted and honored and very privileged to be back.
    As this title suggests, the Full Employment and Balanced 
Growth Act set into law goals for the economic policy of the 
United States, including for the Federal Reserve. Those goals 
included full employment and reasonable price stability, a 
precise statement of what is now often called the dual mandate.
    Like Professor Friedman, I strongly subscribe to the wisdom 
that Congress showed in specifying multiple goals for our 
Nation's Central Bank. The question I would like to address 
today is, has the Federal Reserve particularly over the last 
several decades, observed that mandate?
    I would like to make a number of closely related points, 
some of them about the condition of the economy and some of 
them about the actual conduct of monetary policy.
    It is widely believed in the economics profession that the 
dual mandate is inconsistent: that low unemployment and 
particularly full employment is, per se, an inflation risk. If 
you read, for example, ``The Wall Street Journal'' of just this 
past June 21st, you find the headline, ``Fed policy makers are 
likely to continue to highlight risks that low unemployment 
could push inflation higher when they meet next week.''
    The study that I and my co-authors have done, and that we 
present to this committee, contradicts the connection between 
inflation and unemployment for the period after 1983. And 
especially the natural rate or NAIRU hypothesis that was first 
formulated back in 1968, and which has been accepted as a 
matter of faith by a great many economists ever since.
    This alleged connection has been proffered to justify 
persistently high unemployment rates and to rationalize raising 
interest rates when unemployment falls too low. But since 1983, 
let me repeat, there is simply no evidence that violating this 
supposed threshold produces rising inflation.
    A perfect example of that came in the late 1990's when 
those thresholds were violated persistently for a period of 3 
years or more with sustained full employment. Contrary to the 
fears of many, inflation simply did not rise. It was a very 
good time and a lesson in the wisdom of the Congress in having 
specified that both full employment and reasonable price 
stability could and should be policy goals.
    A second point that is often made is that inequality lies 
outside the scope of monetary policy. In testimony before this 
committee in 1997, Chairman Greenspan said he was uncomfortable 
with inequality but, ``There is nothing monetary policy can do 
to address that. And it is outside the scope so far as I am 
concerned of the issues with which we deal.''
    Chairman Bernanke holds a similar view. He gave a speech 
recently in Omaha where he discussed inequality with concern, 
but didn't mention the role of monetary policy.
    This belief is incorrect. We find that inequality--
specifically in pay or earnings, that is to say the inequality 
in the labor market, experienced by working people--does react 
to the rate-setting decisions of the Federal Reserve. 
Inequality has always been the recipient of shocks, among them 
the effects of unemployment and inflation. What we show is that 
it is also in part a direct product of monetary policy choices.
    I should say, having said that in the good period that I 
just referred to in the late 1990's, inequality of this type 
declined. And so I believe the Federal Reserve's relatively 
permissive monetary policy in that period should get some of 
the credit.
    Let me turn to the conduct of monetary policy. It is, of 
course, widely believed and often stated that monetary policy 
in recent years has been aimed at fighting inflation. And for 
an earlier period, 1969 to 1983, there is some evidence of 
that. But that evidence has as a statistical matter largely 
disappeared in the period since.
    Part of the reason may be that since 1983, the economy has 
transmitted very few clear signals of high or even rising 
inflation to the Federal Reserve. And with no inflation, 
logically there can be no reaction to inflation. But this 
raises two questions. Why did inflation so largely disappear? 
And why did the Federal Reserve undertake numerous periods of 
tighter policy in spite of the absence of rising inflation?
    Now there is an argument that the Federal Reserve was 
engaged in the management of inflation expectations, but I 
would suggest that there is very little direct evidence of what 
those expectations are. And it is a very nebulous kind of 
argument.
    Our belief on the contrary is that the economy really did 
change in the early 1980's as a result of the high dollar de-
industrialization and, frankly, globalization. And that 
inflation was permanently or for the long term reduced as a 
result of the changed position of the United States in the 
world economy. Since then, fighting inflation has been a 
relatively easy task because there has been virtually no 
inflation and certainly no wage inflation to combat.
    The second claim is that the Federal Reserve does respect 
the dual mandate. But we find that over the period from 1984 
through 2006, the Federal Reserve has not in practice generally 
accepted the strictures of the Full Employment Act. Instead, it 
has behaved as if it believed that unemployment rates below a 
range between 5 and 6 percent are dangerous in and of 
themselves. It has behaved as if it believed that low 
unemployment poses high risks of inflation, although the 
evidence that I have just mentioned refutes that view. It is 
perhaps not surprising since, as I said before, a large number 
of economists hold this belief, but it is contrary to the 
evidence. It is contrary to what one should expect in an open 
economy--which the United States has become--where prices are 
largely set globally and not in the home labor market. And in 
addition to that, it is contrary to the mandate of the 
Congress.
    A final point about monetary policy--and here I tread on 
somewhat delicate territory--has to do with the question of 
whether the Federal Reserve has stood entirely apart from 
politics over this period.
    The Federal Reserve has a reputation of being an apolitical 
agency. Still scholars have raised the question: Does there 
exist a presidential election cycle in monetary policy? And we 
thought it reasonable to examine that possibility. We find, and 
in the paper which the committee was presented, rather strong 
evidence that such a cycle has existed.
    We find that in the year before presidential elections, the 
term structure of interest rates, a measure of monetary stance, 
deviates sharply from what was otherwise normal. Moreover, the 
direction of variation depends on who is on power. The Federal 
Reserve has had a tendency to ease in election cycles when 
Republican Administrations are in office, and a tendency to 
tighten in election cycles when Democratic Administrations are 
in office.
    These are historical findings that do not necessarily 
predict the conduct of policy under Chairman Bernanke, but they 
raise an issue in our view that this committee would be well-
advised to take into consideration as we approach future 
elections.
    I would like very briefly to second what Professor Friedman 
just said about an inflation target. An inflation target alone 
would indicate that the Federal Reserve gives priority to price 
stability over full employment.
    Congress should not accept that.
    Further, the more one examines the making of an inflation 
target, the more technical difficulties appear. Should one 
target core or headline inflation? If the former, you run the 
risk that non-core inflation will become ingrained before any 
reaction occurs. And if the latter, you run the risk of 
compounding supply shocks with demand shocks adding interest 
rate insult to oil price injury.
    These are technical issues with no easy answers. And that 
suggests that in some situations, constructive ambiguity may be 
preferable to complete clarity. This is something that, of 
course, Chairman Greenspan was famous for knowing.
    And, if I am right, finally, that inflation was in fact 
killed by the opening of the economy in the early 1980's, then 
setting an inflation target is a little bit like putting up a 
cross over the grave. It is perhaps not a bad thing. It may 
make us feel better. But one would not be justified in 
crediting the cross for keeping the ghost in the ground.
    The fact that the inflation of the 1970's died out in the 
1980's does not mean that we face no inflation risks. Inflation 
accompanies war. The Iraq War had some inflationary impact 
mainly through its affect on the price of oil. Inflation may 
also recur if the international monetary system enters a crisis 
causing a further fall in the value of the dollar. That is the 
risk of any unipolar currency system. It's a great privilege to 
issue the world's reserve currency but only so long as it 
lasts. These are issues for the future. They are issues, 
however, that the Federal Reserve will not be able to handle on 
its own. They require a broader perspective than one that would 
simply be served by an inflation target.
    Mr. Chairman, in conclusion, my research has pointed to 
several somewhat disturbing patterns in the actual conduct of 
monetary policy over the past quarter century. We have, in 
particular, the evidence that the Federal Reserve has a habit 
of reacting adversely to low unemployment even though full 
employment does not by itself pose an inflation risk.
    On these and other matters, I believe Chairman Bernanke 
should be asked to provide assurances that these patterns will 
not be repeated. He should be asked, I think, to reexamine any 
models which tie predicted inflation to the unemployment rate 
and to report in detail on that review and to examine in 
particular the evidence that the world did change as much as 25 
years ago, breaking previous linkages between inflation and 
unemployment.
    He should be asked to reexamine the view that the Federal 
Reserve does not have any effect on inequality and he should be 
asked, of course, to assure Congress that interest rates will 
not be cut or raised solely in anticipation of an election.
    Mr. Chairman, thank you for your time, and again for this 
opportunity, and I look forward to answering any questions you 
may have.
    [The prepared statement of Dr. Galbraith can be found on 
page 52 of the appendix.]
    The Chairman. And now, Professor Meltzer.

    STATEMENT OF DR. ALLAN H. MELTZER, THE ALLAN H. MELTZER 
  UNIVERSITY PROFESSOR OF POLITICAL ECONOMY, TEPPER SCHOOL OF 
              BUSINESS, CARNEGIE MELLON UNIVERSITY

    Mr. Meltzer. Thank you, Mr. Chairman.
    I am going to start by responding to the comments that you, 
Congressman Paul and Congresswoman Maloney, made at the 
beginning. It is a pleasure to be here again, yet again, before 
this committee.
    I would like to say on the issue of distribution, one may 
think that the issue of distribution is very important or think 
that the poverty problem is very important and the distribution 
of income is something that should be left. But if the public 
thinks the distribution of income is important then for the 
Congress it becomes important. But what is the problem?
    First, we should note that the problem arises not just in 
the United States and Canada; it arises pretty much generally 
around the world. That is, it is happening in China, perhaps 
even more extreme than here. It is happening in the U.K. It is 
really a reflection of something which is very basic and going 
on all over the world, and that is productivity change.
    As the great Frederick Hayek pointed out, the first effects 
of productivity change are going to be felt by those who are 
able to master it, and their incomes go up relative to other 
people.
    Our failure, to the extent that we have a failure on the 
problem, lies in the poverty of the educational system that we 
have for those people who are most victims of the distribution 
of income that you are concerned with. Congress, along with 
various Administrations have been discussing that problem since 
the 1960's without making significant progress. It is really 
seriously time to look at why that is, and to ask the question, 
why is it that we cannot train a large fraction of the 
population to do the jobs and have the skills that are 
necessary?
    In my experience as a corporate director, if you go to a 
factory, it is hard to see a job of any major importance to a 
company, including line jobs, where the worker does not have to 
be literate and numerate. He has to be able to read the 
computer and take his instructions from the computer and 
transfer that into an action on his line. And if we do not 
train people do that, we cannot expect them to get jobs that 
require that.
    Second, to Mr. Paul, I think one of the great advantages of 
Humphrey Hawkins has been that it eventually led to greater 
transparency for the Federal Reserve. And this committee by 
scheduling regular hearings, even though they are not always 
successful, they at least require the Chairman to answer your 
questions and to be responsive. It is a long distance from the 
1930's when the Federal Reserve said, ``We do what we want and 
it is none of your business.'' That just does not fly in the 
present system.
    On the inflation target, I think the discussion so far has 
been incorrect. We have an inflation target. It is a loose 
inflation target. We go to the marketplace and ask anybody, 
what is the Fed's objective, and they will tell you to get the 
inflation rate, the core inflation rate, down to 1 to 2 
percent. They say it all the time. It is published in the 
newspapers. It is a generally agreed upon thing.
    Now, does that violate the dual mandate? Of course not. If 
the unemployment rate were 8 percent now, instead of somewhere 
around 4.5 percent, the Fed would be behaving differently. It 
would be responding as it is required to do under the dual 
mandate.
    So the issue about the inflation target is, how specific 
are we going to be, how transparent is the Fed going to be, how 
clear is the announcement going to be? Are we going to leave it 
at the sort of vague 1 to 2 percent or are we going to tighten 
it?
    I think if we tighten it, we have to go in the direction of 
making sure that we are clear about exactly what the Federal 
Reserve is going to do. I am going to talk about that a little 
bit more.
    To Congresswoman Maloney, I have to say that I agree 
broadly with what the Fed has been doing. The unemployment rate 
is relatively low and they are concentrating on inflation. If 
the unemployment rate was higher, as I said before, they would 
be doing things a little bit differently.
    Now is a good opportunity. They have had the benefit of 
going through a period where they were able to lower the 
measured inflation rate without having unemployment rise, and I 
think that certainly has influenced them in their decisions.
    So I agree broadly with the aims that they have been 
generating and the direction in which they have been going. I 
think the problems remain, and many of the problems that you 
have talked about do remain, but they are not primarily 
monetary problems. Monetary policy is a powerful instrument but 
it is not all that powerful: it cannot do much about the saving 
rate; it cannot do much about the distribution of income; and 
it cannot do much about the budget deficit. Those are problems 
which, for better or worse, Congress has to work on, and the 
Administration has to work on, but not the Fed.
    Let me turn to my written remarks. They are brief. In the 
past 25 years, central banking has been transformed in all 
developed countries. Several announce inflation targets and 
make serious and generally successful efforts to achieve the 
targets.
    The European Central Bank uses judgment about current or 
recent data supplemented by concern about money growth, the so-
called second pillar of the strategy. The Federal Reserve 
continues its discretionary policy, but as I have said, a 
discretionary policy aiming at a loose inflation target.
    All of these techniques have been much more successful than 
previous policies or methods of operation. Although they differ 
in their approach, current operations have two common features. 
First, central banks are more independent of politics and 
government than in the past. This is obvious in Britain and New 
Zealand where the meaning of central bank independence and its 
limits are set out explicitly in an agreement between the 
government and the central bank. Second, central banks now give 
much more weight to avoiding inflation than in the past.
    In the 1960's and the 1970's, the mantra preached by 
central banks all over the world and certainly here told the 
public that inflation would start to rise before the economy 
reached full employment. Price and wage guidelines were a 
necessary policy tool to achieve full employment with price 
stability and low inflation. That is the essence of the 
argument of James Tobin in the landmark 1962 Report of the 
Council of Economic Advisors.
    Instead of getting low unemployment and low inflation, 
major countries, Britain and the United States especially, had 
higher inflation and rising unemployment. Even the politicians 
noticed the failure because the public noticed the failure. 
More importantly the voters noticed that countries like Germany 
and Switzerland put more effort into controlling inflation and 
did not suffer higher average unemployment at the time.
    Governments and central banks discarded the old mantra. 
Guideposts and wage controls went into the dust bin where they 
belonged. In their place was a new mantra preaching a very 
different point of view. The new claim was that sustained low 
inflation or price stability is a necessary condition for 
sustained full employment. Free markets work better than 
controls. The approximately 25 recent years of low inflation 
have strengthened this belief. With floating exchange rates and 
low inflation, Britain and the United States have had long 
expansions and relatively mild recessions. The United States is 
now in a third long expansion. The three longest peacetime, if 
I may use that word, peacetime expansions in the United States 
are the three most recent expansions. That is a very good 
record.
    If we do not worry so much about what has happened in the 
last few months, but we go back and look what has happened over 
the 20 years since we have changed to a less inflationary 
policy, we can see quite a remarkable increase in living 
standards in the United States.
    Maintaining low inflation has worked extremely well in 
Britain and the United States but less well in European 
countries that joined the European Central Bank. Within the 
European Central Bank, the experience of countries like Ireland 
with pro-growth policies differs markedly from countries like 
Germany and Italy that tax and regulate excessively. The voters 
have noticed that and there seems to be some change happening.
    Virtually everyone recognizes that for Germany, France, and 
Italy, the required solutions to current problems are real, not 
monetary, and more generally political, not economic.
    Central banks in Britain and the United States should not 
rest on the achievements of past reforms, as important as they 
are. Both now claim to value transparency and clear 
communication, a break from the past secrecy that central 
bankers once prized. It took many decades for central bankers 
to recognize that just as financial markets depend on them, 
they depend on financial markets. In principle, interdependence 
has become accepted.
    Central banks have not explained an ever present part of 
the uncertainty that accompanies all economic changes. The 
duration of any change is often in doubt. A change may be 
temporary or persistent. Changes may alter the level or the 
growth rate. It usually takes time to decide the type of change 
that has occurred and how long it will persist.
    Inflation occurs when the central bank lets money grow 
persistently above the growth rate of real output on a 
sustained basis. The price level rises and continues to rise as 
long as the central bank remains on this course.
    Contrast this inflation with the rise in the price level 
that continues for a few months or a year, something like the 
shock that we have had recently. Money growth is not expansive. 
The rise in the price level can be the result of an oil shock, 
an increase in excise taxes, devaluation of the currency, and 
many other one-time changes. As the change spreads through the 
economy, the price level rises. The rise is typically spread 
over time so the rate of price increase will at first look very 
similar to a monetary inflation just discussed. But it is 
important to keep them apart.
    The Fed is in the money business. It can do something about 
the monetary inflation without any harm to the economy. It 
cannot do much about most of those other price rises without 
harming the economy. If it tries to roll back the domestic 
prices to offset the oil price we will have more unemployment.
    The difference is that the one-time increase does not 
persist. Oil prices do not rise from $35 to $70 a barrel this 
year into $140 a barrel next year and $280 the following year. 
Central banks must learn to distinguish these one-time 
increases from the sustained inflation that they and only they 
can cause.
    A great part of the dispute, I believe, in the economics 
profession about what to do about inflation has to do with the 
fact that some of us define inflation the way I do, sustained 
increases in the price level continuing over time, and others 
define it as any increase in the price level. Those are two 
different things and it is useful whatever names are applied to 
them, it is useful to keep them separate.
    Some make the distinction, or appear to, when they describe 
their role as preventing a surge in oil prices from increasing 
the expected rate of inflation. Many market watchers do not 
make the distinction and some official statements are 
misleading. Central banks should clarify their role and their 
view.
    Separating one-time changes and persistent changes is a 
major problem. Decades ago, in 1948, the late distinguished 
economist, Jacob Viner, wrote to the President of the New York 
Federal Reserve to caution him about over-responding to 
temporary transitory changes.
    Viner wrote, ``You certainly have the advantage over me of 
being closer to the market.'' But it may not be an unmixed 
advantage. The ticker may loom too large in your perspective 
and what from the point of view of the national economy are 
molehills may appear to you as mighty mountains. Mistaking one-
time price changes for inflation can be costly. An oil price 
increase is a tax on consumers and producers whether it comes 
as a restriction of supply as in the 1970's or mainly an 
increase in demand as currently, it is not a monetary event. 
Reducing money growth to roll back the effect of the oil price 
increase is costly. The first effect is to reduce output over 
its growth rate. Further, letting the price level rise but 
holding the maintained rate of inflation unchanged is a low-
cost way of reducing real income. A reduction that must be made 
to pay the oil producers for the real increase in the cost of 
their product.
    Central bankers and markets must be much more, must become 
more familiar to the duration of changes, whether the change is 
permanent or temporary. They cannot do that if they adjustment 
policy fully to new information at each meeting.
    I am writing the history of the Federal Reserve. I have 
read more Federal Reserve minutes than any living person would 
ever want to do and I can tell you that most of the discussion, 
most of the discussion at the meetings has to do with very 
near-term events. Trying to interpret whether the inventory 
increase is going to persist, whether the unemployment increase 
reported this month is going to persist, whether the big surge 
in prices this month is going to persist. The answer is they do 
not know. They cannot know. So they should direct their policy 
at a longer-term target. They must hold to medium term 
strategies. One reason the economy's performance has been 
better in recent years is that to a large extent they have done 
that. Central banks should announce and follow a policy rule 
that seeks stability over the medium term. Thank you.
    [The prepared statement of Dr. Meltzer can be found on page 
60 of the appendix.]
    The Chairman. Thank you, Mr. Meltzer.
    Professor Galbraith, the point about inflation--we have 
that paper that you mentioned on that, and I--many people in 
America have felt, in addition to the overall growth pattern, 
some of the negative impacts of globalization, it does seem to 
be--you're telling us that there are some benefits for them 
they haven't been able to reap either, namely that--well, we 
are told reduction in prices, advantages for consumers, that 
that's one of the results of globalization and trade. You're 
kind of generalizing that and saying that there is a basis for 
taking that into account in policy.
    So let's--what is the policy implication of your view that 
inflation has been substantially--the possibility of inflation 
is substantially diminished by economic trends for the context 
specifically of monetary policy. What should that mean to the 
Fed?
    Mr. Galbraith. Well, globalization came very abruptly and 
roughly to the United States in the early 1980's. A great many 
industries were downsized and offshored, and a great many 
workers lost their jobs. The system of wage setting that we had 
up to that time greatly diminished in importance, largely 
disappeared.
    We also got afterwards a rising tide of imported goods, 
low-cost imported goods from oversees. Those two things had a 
sustained, permanent effect on the previously inflationary 
structure of the economy. That's the basic point.
    What that meant was when we got to the 1990's, we, in fact, 
were able to pursue a full employment monetary policy, and 
inflation didn't return. What we got instead when we got to 
full employment was sustained increases in productivity. 
Productivity turned out to be dependent on, endogenous to, the 
state of the economy. It improved when labor became scarce.
    So the implication I would draw from this for the present 
is that we can have a full employment policy in this country. 
It does not by itself pose a risk of higher inflation, and that 
is the key point which I don't think--the evidence does not 
suggest that the Federal Reserve has taken that point on board. 
The evidence suggests that they are still very wary of low 
rates of unemployment and that they tend to regard those low 
rates of unemployment as intrinsically risky. But I would 
suggest that they aren't.
    Inflation could return, but if it does return, it will 
return as a result of the deterioration of our international 
position rather than as a result of an eruption of wage 
pressures in the domestic economy. And it seems to me that's a 
different set of problems and one that can't be easily 
addressed simply by manipulations of the interest rate.
    So the Federal Reserve ought to be supportive of a full 
employment policy.
    The Chairman. When you say the danger of inflation is 
deteriorating internationally, is this a dumping of American 
debt that people hold?
    Mr. Galbraith. Precisely. We do supply the reserve currency 
to the world. We greatly benefit from the willingness of 
foreign central banks and institutions to hold American dollar 
assets. If they decided that they would prefer euro in large 
quantities we would have a very serious problem and that would 
include inflationary consequences.
    That's an issue which we may have to deal with in the 
future, but it's not a question that can be dealt with by 
short-term monetary policy decisions.
    The Chairman. Professor Meltzer, you're eager to say 
something.
    Mr. Meltzer. Yes. I don't think that's factually correct.
    The Chairman. Which part?
    Mr. Meltzer. The part of what he just said about the reason 
inflation has come down. Productivity growth did not begin, did 
not rise until 1990. Inflation was cut, more than cut in half 
in the 1980's. It was 1982 when Paul Volcker and the Fed gave 
up the attempt--gave up the anti-inflation, the strict anti-
inflation--under pressure both from the Congress and from 
events abroad, gave it up. But growth rate of productivity does 
not increase for at least another decade, so it's hard to put 
it.
    Second, how much can the growth rate of productivity, which 
is where globalization is going to mainly affect the economy, 
how much can it affect the inflation rate? I mean the growth 
rate of productivity is 1 percent, 1\1/2\ percent during part 
of this period higher. The inflation rate is substantially 
lower by much more than 1\1/2\ percent.
    So it has to do with something else. That something else is 
the much better monetary policy that we've had.
    Mr. Galbraith. Just to clarify, I think we don't have a 
disagreement of facts. What I was saying was that the rise in 
productivity which occurred in the late 1990's--in the 
timeframe that Allan is referring to--was what happened instead 
of a rise of inflation that many predicted when unemployment 
fell very low.
    It turned out that we got a great deal of productivity 
growth at precisely that period.
    The Chairman. Let me ask--Professor Friedman, I think by 
the way, is very clear on it. Alan Greenspan is seen by many as 
a great conservative. In fact, during the 1990's, he was 
arguing that we could sustain a lower unemployment rate without 
a risk of inflation. He was in fact acting on that premise, 
contrary to what--a lot of conventional liberals.
    I mean the New York Times--I remember one great event--
reporting a story in the New York Times financial page which 
said that if unemployment had remained below the level that 
would cause inflation for 11 quarters without causing inflation 
and therefore we should just wait for the inflation rather than 
thinking that maybe that equation they had was not accurate. I 
think that was a very important time.
    Let me just close my time with Professor Friedman. You've 
been, to my mind, very persuasively critical of the notion of 
inflation targeting. How should the Fed balance the dual 
mandate? Is there a big conflict, and if there is, how do they 
balance it?
    Mr. Friedman. Mr. Chairman, on the balancing of the two 
parts of the dual mandate, I think the word is, precisely, 
balanced. What is wrong with inflation targeting is not that 
the Federal Reserve would suddenly have some objective for 
inflation that they do not already have.
    Allan Meltzer is exactly right in this regard. Everybody in 
the market has a reasonably good understanding today, and many 
people in the general public too, that what the Federal Reserve 
would like to see is somewhere between 1 and 2 percent for some 
appropriately defined inflation rate.
    The issue is that if the Federal Reserve were to announce 
publicly a specified numerical inflation rate without 
simultaneously having some kind of a numerical description of 
what unemployment rate or rate of economic growth it were 
pursuing then we would be back in a situation like, for 
example, when the Federal Reserve was pursuing monetary 
targets.
    Many of us remember well what it was like on Thursday 
afternoons when the Federal Reserve had a monetary target. If 
you happened to have been standing on the trading floor of any 
brokerage firm or any bank at approximately 3:15 in the 
afternoon, every trade would stop. The room would fall into a 
hush as everyone would wait to see what number the Federal 
Reserve announced at 3:30 for the previous week's money supply, 
as if there were any information of any serious economic 
content in one week's money supply movement.
    Now why is this the case? The reason is clearly that once a 
central bank or for that matter any other economic policymaker 
states a clear numerical objective, then the public wants to 
hold the policymaker accountable for that objective.
    If the Federal Reserve felt in a position to be evenhanded, 
and have a numerical target for inflation and a numerical 
target for the growth rate or the unemployment rate, then the 
problems of undoing the dual mandate that I was describing 
would go away. But the Federal Reserve has been very 
articulate, I think, about why they do not want or are not able 
to announce a clear numerical target for growth or for 
unemployment. And in that context, I think it would be a 
mistake for all of the reasons that I described to have one for 
inflation.
    Now what should they do? At a hearing like this, I suppose 
it's always somewhat awkward to say that current practice is 
pretty good, but I think if one reads carefully the statements 
that the Federal Reserve Chairman makes when appearing before 
this committee and its Senate counterpart, I think one sees the 
thought process of trying to steer one's way between the 
tensions that inevitably arise in the short and medium run 
between wanting to have unemployment as low as possible, and 
growth as rapid as possible, and yet not wanting to ignite 
either inflation or inflationary expectations.
    Now no doubt these reports can be made better, and I agree 
with what both Allan Meltzer and Jamie Galbraith said about the 
role of this committee and its Senate counterpart in causing 
these reports to be written and questioning the Federal Reserve 
Chairman when he appears, but I think the process of talking 
through and thinking through and questioning through what the 
conflicts and tensions are is exactly right.
    Let me finally offer if I may--
    The Chairman. Quickly.
    Mr. Friedman.--just one comment on the exchange that you 
and Jamie and Allan were just having.
    A key way to understand how international influences have 
affected our economy in the last 20 years is to ask whether, 20 
years ago, any of us would have believed that the United 
States, in the context of a falling dollar and huge increase in 
oil prices, would be able to have 2 percent inflation and an 
unemployment rate in which the digit in front of the decimal 
point is a four?
    That was exactly the achievement that Alan Greenspan 
delivered when he was the Chairman of the Federal Reserve. In 
September of 1994, the unemployment rate first dropped below 6 
percent. A widespread view announced in the Wall Street 
Journal, the New York Times, and elsewhere, and widely shared 
among economists, was that this would be inflationary, and 
therefore, the Federal Reserve had better tighten monetary 
policy.
    But Alan Greenspan was explicit that he saw a combination 
of increasing productivity and, importantly, international 
pressures that would prevent firms from having pricing power 
and therefore avoid the need to tighten policy, and therefore, 
he didn't.
    Three years later, in September of 1997, the unemployment 
rate for the first time in a very long time--
    The Chairman. We have to move quickly.
    Mr. Friedman. --dropped below 5 percent, and once again 
everybody expected this to be inflationary and Greenspan again 
didn't tighten. I think this was a tremendous achievement, but 
it was based on recognizing both the role of productivity and 
the importance of international competition.
    The Chairman. I would say that there was reference to the 
role of this committee and greater transparency, and I have to, 
I think, give deference to Henry Gonzalez whose picture is up 
there. During my time in this committee, he was a consistent 
advocate of greater openness. He was told by people at the Fed 
that what he was pushing for would be destructive.
    When I got here, they didn't announce what they did. The 
FOMC didn't announce for 6 weeks what it had done. They denied 
that there were minutes. Meltzer would have had to find another 
topic because they used to deny they even had the minutes until 
we found them.
    And Henry Gonzalez was a very effective advocate for that. 
The other thing I would notice, and it just has occurred to me, 
is we talked about this at--particularly what Professor 
Friedman said. There was this substantial absence of expected 
inflation and it doesn't seem to me that an anchoring of 
inflation expectations was a major factor in that in the 
1990's.
    Mr. Paul.
    Dr. Paul. Thank you, Mr. Chairman. Adding to the case for 
transparency, I would like to see the day that the Fed returns 
to at least reporting M3 unless they've decided money supply 
has no value, but I want to deal a little bit with inflationary 
expectations and the future of the dollar on international 
exchange markets.
    We talk about inflationary expectations, and I think we 
have to recognize that expectations are very subjectively 
motivated, and I think it's very important. But in reality, it 
has to be in relationship to the money supply. But inflationary 
expectations are really the reverse side of the value of the 
dollar, and we can't ignore that.
    Today the dollar is having a bit of a problem on the 
international exchange market, and I'm just wondering what the 
future will bring. My question, as I conclude this short 
statement, is what will the future of the dollar be in the 
short run in the next 1 or 2 years?
    Already we have some evidence that there has been an attack 
on the dollar. As far as the euro goes, it has lost more than 9 
percent in the past year. It has lost more than 10 percent 
against the pound. And lo and behold the Indian rupee, if you 
had been in Indian rupees, you would have made 13 percent, so 
that doesn't say a whole lot for a sound currency.
    As a matter of fact, if you had just gone north and 
invested in Canadian dollars, in 6 months, you could have made 
11 percent. So it seems to me that if you want sound money and 
stable prices you have to deal with that, you can't ignore it 
and resort to saying, well, the CPI is going up at 2 percent. 
The CPI, if you use the old CPI calculation, which I see no 
problem with, it's going up over 10 percent.
    And besides, poor people and the middle class have a higher 
inflation rate than other people. If you have to pay for 
medical care and food and fuel, you might have an inflation 
rate of 15 percent, for all we know. So it ultimately is the 
value of the dollar.
    Dr. Galbraith mentioned that the dollar, you know, is--
inflation and the dollar can be weakened in times of war. And 
certainly the 1970's rushed it in after we had the guns-and-
butter attitude of the 1960's, and it is true, it isn't the war 
that causes the inflation, it's the spending, and it's the 
monetizing of the debt that causes inflation. And we can well 
expect to see a lot more inflation coming because of this 
tremendously excessive spending today as well as no attempt to 
cut back on entitlements.
    But the dollar, up until recently, may well have been much 
stronger than it really deserved. There was a false trust. It's 
a reserve currency, and there's a fair amount of trust. And I 
think I sense from Dr. Galbraith that there is a concern; maybe 
attitudes will change.
    And the characteristics of so many currencies over history 
is that the confidence in currencies can gradually decrease and 
then they can collapse because there's a subjective element to 
it. And this is my great concern, what will the future bring 
for the dollar because if the dollar goes down, you have 
inflation.
    Already we have Kuwait asking for euros, and we have the 
Iranians not taking dollars. This to me seems to be a very, 
very serious problem if the dollar is to be rejected. Of 
course, the Chinese aren't going to attack the dollar, but they 
themselves indicated that they might buy a few more currencies 
other than just dollars.
    And we had a serious attack on the dollar in 1979 and 1980. 
It was rescued with 21 percent interest rates. So my question 
is, are we moving into a new era? Will the IMF be able to bail 
us out? How serious is this? Or should we forget about it and 
just say, well, CPI is not going up, and unemployment is high, 
and nobody seems to be suffering? Or should we really be 
concerned about some of these indicators now that show that our 
dollar is under attack?
    I'd like to see if I can get comments from you about what 
you expect in the next 1 to 2 years, with regard to the dollar.
    Mr. Friedman. Well, Congressman, I'm happy to address the 
dollar, although I have to say that if what you're really 
interested in is the outlook for currencies over something like 
a 1-year horizon, the last group of people in the world whom 
you should ask is professional economists. Certainly that would 
include all three of us sitting before you today.
    But if you're interested also in the longer run 
perspective, say a half-a-decade or a decade, I think the fears 
that you express are quite well-founded, but in a slightly 
different way than you express them. The way I would put it is 
that today the United States is paying for what we buy from 
abroad, over and above what we receive from what we sell to 
people abroad, an amount equal to approximately 6\1/2\ percent 
of our national income.
    If any country other than the United States were to do 
this, this would be unanimously recognized as irresponsible. 
Now as Jamie Galbraith mentioned, we have the privilege at the 
moment of issuing the world's reserve currency, and therefore 
people don't normally use the word irresponsible to refer to us 
in this way. But it is irresponsible, nonetheless. And the 
further question is whether it is sustainable. The answer there 
is clearly no, and so what will happen as a result?
    One thing that could happen is that we would find a variety 
of ways of increasing our country's competitiveness, increasing 
what we save, and reducing what the government borrows. And 
putting all of those together, we would be able to reduce the 
size of our international imbalance in such a way that we would 
avoid a major decline in the dollar.
    Failing those steps then, I think it's clear that the 
dollar will have to move toward a lower exchange value compared 
to the currencies of the other countries with whom we trade. 
And then the crucial question from the perspective of your 
inquiry is whether that would happen abruptly and in a 
disorderly way--you point entirely correctly to the events of 
1979 and 1980--or whether it would happen over a longer period 
and in a much more orderly way.
    The United States currency has declined enormously over the 
past 40 years compared to, for example, the Japanese yen and 
the Swiss franc. But nobody looks at this as a disaster. This 
is just the ordinary working of differential competitiveness 
and differential inflation rates, and there's no reason to 
think that would be harmful to the economy now.
    The key issue is whether we move in a timely fashion on a 
whole variety of fronts--saving, government borrowing, 
competitiveness, and education--in a way that makes our 
workforce more productive. All of these ways that would allow 
us to narrow our trade deficit by at least, let us say, half, 
or whether we continue to borrow from abroad in a way that 
really is irresponsible, in which case then we certainly will 
risk the kind of eventuality that you're concerned with.
    Mr. Galbraith. I would take--well, agreeing with many 
things that Professor Friedman just said, I would take a 
somewhat more sanguine view of the stability of the system, at 
least in the short term.
    We issue the world's reserve currency. Other countries hold 
it because we provide a very liquid and very safe financial 
asset, more liquid even now than the euro is. And they have 
their reasons. The Chinese have their reasons in particular for 
accumulating the reserves that they accumulate. They are 
engaged in managing a massive project of urbanization, massive 
growth of exports, and the accumulation of dollars is an 
artifact of that.
    So they're not inclined to destabilize the system, and 
there are only a few players who are large enough that their 
actions would be decisive. I think it's possible that this 
system could go on for a while. As long as the world economy is 
growing, the corresponding demand for reserves will be there, 
and the corresponding current account deficit will be there for 
the United States.
    The problem, as I see it, is that the system, like all 
monetary systems, is inherently precarious. It is subject to a 
shock, a crisis, a panic, a collapse down the road. The form of 
that, I think, is very difficult to predict. It could be 
incident to a political crisis of some kind.
    We should be thinking strategically about how to deal with 
that should it occur. And that's the issue, it seems to me, 
that we ought to be focusing on.
    Mr. Meltzer. I think you've raised an appropriate long run 
question. As Professor Friedman said, not just economists, no 
one knows what's going to happen with the dollar over any short 
period.
    The great economist Keynes is alleged to have said that if 
you owe your banker $100 and can't pay, then you have a 
problem, but if you owe your banker $1 million and can't pay, 
then he has a problem. So with the Chinese, they have $1.2, 
$1.3 trillion dollars. There's not much that they can do to get 
out of that position without hurting themselves along with us 
and many other people, and they show every evidence of 
collecting more no matter what they say as they follow the 
Golden Rule of Paul Samuelson, never give the forecast and the 
date in the same sentence. So they say, we are going to revalue 
our currency, but they never quite say when.
    But the long-term problem is a serious problem. That is, if 
you said over the long term what will happen with the dollar 
you have to believe that over the long term the dollar is going 
to decline in value. Why is that? Basically because we invest 
more than we save; we save too little.
    Look at the political campaigns that are now well underway. 
What are we hearing? We hear a lot about the need for more more 
money spent on health care. That may be a very desirable thing 
to do and say, but very little is said about how we're going to 
pay for the additional health care or even for the present 
heath care programs.
    The unfunded liability in health care is something in the 
order of $60 trillion. Nobody has a good idea. Nobody even 
wants to discuss how we're going to get $60 trillion to pay for 
that. So if you add that to the Social Security program, which 
is small compared to the health care program, and the health 
care programs are getting bigger, it's hard not to believe that 
we're going to continue to spend at a faster rate than we save. 
That cannot be resolved with a strong dollar.
    So finally I'd like to say we always have to make a choice 
between whether we want domestic price stability or foreign 
exchange stability. We can't do both with the same instruments. 
We've chosen to have domestic price stability, so the Federal 
Reserve's policy, the government's policy, and the Congress's 
policy is to live in hope, as Jamie Galbraith said, that the 
dollar will decline gradually.
    They have no policy to make sure that's going to happen. 
They just hope that's what's going to happen.
    The Chairman. The gentlewoman from California.
    Ms. Waters. Thank you very much, Mr. Chairman and members.
    I'd like to thank our guests for being here today. And I 
would like to go back to some of the discussion that was 
afforded us by Dr. James Galbraith about income equality and 
monetary policy.
    Mr. Bernanke was here, I don't know, several months ago, 
and I complimented him on several speeches that he had made on 
income equality. However, I was basically jeered by one of my 
colleagues who said something to the effect of, well how could 
you possibly be that passionate about a speech by Mr. Bernanke 
on income equality. But I was, because I had not heard that 
issue coming from a Chairman since I'd been here.
    I had been here since Mr. Greenspan was here, and I 
interacted with him a lot; but, I don't believe that he saw the 
relationship between the conduct of monetary policy and income 
equality. I think Chairman Bernanke does. And I would like 
you--even though you did so, I think, in your presentation, and 
there may have been some additional discussion--to explain why 
there is such a debate about the role of monetary policy and 
the problem of income equality? What can you tell us about the 
divergent perspectives on this issue?
    Are you suggesting, or have you said to us, that there 
certainly is a relationship, some correlation between the 
conduct of monetary policy and income equality? If there is 
such a correlation, what might the Fed do to address inequality 
and income over the long term which appears to have grown in 
the past several years?
    Mr. Galbraith. A great deal of this discussion--and 
Professor Meltzer alluded to it in his remarks--is couched in 
terms of the functioning of the labor market, the capacity of 
workers to meet the demands of employers to have the 
appropriate sets of skills.
    We found in looking very carefully at the way in which the 
inequality in structures of pay actually received by workers 
behaves over time--and we've measured it very precisely going 
back as far as 1947, that a large part of the movement of 
inequality is very closely related to the overall performance 
of the economy.
    That is to say, when times are bad, it is low wage 
workers--who work variable hours, who work at hourly rates, who 
have overtime or don't have overtime--who suffer the most. And 
they suffer more than higher paid workers, workers in more 
stable industries, workers with regular salaries.
    When times are good on the other hand, as they were in the 
late 1990's, it's the low paid workers--whether they're skilled 
or unskilled--the workers at the bottom of the scale who gained 
the most rapidly.
    Ms. Waters. May I interrupt you for just a moment because I 
want you to include in your discussion some of my concerns 
about the exportation of jobs to third world countries for 
cheap labor?
    When I first got elected to office, the Goodyear plant 
closed down in my district, and those were well-paid workers 
who had been there for years. They sent their children to 
college, they bought homes. What I have not seen in that 
community is the kind of jobs and incomes tied to Goodyear 
since that time.
    Mr. Galbraith. Certainly that has happened, and certainly a 
great many high quality blue collar jobs have been lost over 
the past couple of decades. But what happened in the late 
1990's, in particular, was that we had, as Ben Friedman 
referred to, a sustained period of very low unemployment. It 
was correspondingly a good period for relatively low wage 
workers. They gained ground.
    They worked a lot of hours. They had overtime. They had 
continuous employment. And that then enabled poverty rates, 
particularly for minority populations, to fall to levels they 
had not seen before.
    So it's possible for a well-functioning economy in other 
words that pursues and reaches the objective of full employment 
to greatly reduce the inequality which is experienced in the 
labor market. That is to say, inequality between the wages paid 
to low wage workers and those paid to higher paid salaried and 
managerial employees.
    There are other aspects to inequality. Inequality that 
emerges from stock market incomes is an entirely different 
phenomenon. I don't want to address that. But just focusing on 
what happens in the labor market because that is where one 
hears all the talk about the need for education and skill 
development, it turns out that one can have a very material 
effect in the short run by pursuing a high employment strategy.
    These two things are in fact not distinct. They are 
connected, and that's something that makes it relevant to 
monetary policy.
    Ms. Waters. Thank you very much. I yield back.
    The Chairman. The gentleman from Delaware.
    Mr. Castle. Thank you very much, Mr. Chairman. Dr. 
Galbraith, I'm struck by your comment, which has been repeated 
in the questions too, in your written testimony, and in your 
oral testimony, about inflation being permanently defeated in 
the early 1980's.
    I guess it's in the eyes of the beholder to a degree 
because certain things come to mind, particularly higher 
education, in which a lot of you are involved, which has had 
tremendous inflationary aspects to it, medical insurance and 
the health assurance that's attended to it, as you can imagine, 
the cost of housing, which has had tremendous inflation as 
well.
    And I would agree with you that in the case of many goods, 
the quality has improved and the cost has stayed roughly the 
same. But in those instances, the quality arguably is roughly 
the same as it was, and the cost has gone up tremendously.
    One key element in all of these is that there has been 
government involvement, as we know, with health care obviously, 
Medicare, Medicaid and other programs, lending on higher 
education and the same thing with housing, mostly through this 
committee. What does this suggest about the wisdom of expanding 
government's role in the economy, or is that unrelated to the 
three areas which happen to have had real inflationary growth?
    Mr. Galbraith. Well, I think, Congressman, that you're 
entirely right, that these are areas in which economic activity 
and to some degree pricing power has been sustained in part 
because these are areas where you have a public-private system 
in which the backstopping influence of the government is there. 
And as a result we have had, in part--that's part of the reason 
why we've had a rising share of GDP devoted to health care, a 
very high share by comparative standards devoted to higher 
education and a very high proportion of the population who owns 
their own homes compared to other advanced countries.
    I tend to regard these things as strengths of the American 
economy, actually, areas in which we perform quite well in 
terms of delivering high quality services to at least part of 
the population. Obviously health care has at least major 
problems with the part of the population that isn't insured, 
with the costs of certain services and with the costs of the 
insurance system that many who are privately insured have to 
bear. But it is a dynamic and technologically advanced sector 
that delivers a lot of services to the population.
    So one has to balance these things. And I think that the 
question--if your question is, could one have done better by 
leaving these sectors entirely to the private market, my answer 
would be, I don't think so. I think that one would have run the 
risk of not having the services and not being able to sustain 
the quality that we've seen. And so I would see the problem of 
controlling costs as something that has to be addressed in each 
of these sectors. It essentially can't be evaded. It's part of 
the public policy issue that the system that we have presents.
    Mr. Castle. Dr. Meltzer.
    Mr. Meltzer. Can I just add a little bit? If you look at 
the research, and there's tons of it, on education and what 
makes a big difference, the answer that pops out at you 
everywhere is family structure. If you're a middle class 
family, you're helping the kids do their homework. That's not 
true of the whole population, and that's the biggest single 
problem that we have to solve, and it's not an easy one to 
solve.
    We can substitute in the public sector for that by having 
things like early childhood education. There seems to be some 
evidence that early childhood education, if it's maintained, 
not if you start it in the first grade, if you start it well 
before the first grade, that in fact it has some effect that 
doesn't wear out.
    A lot of these programs, they have an initial effect, they 
raise the standards for the children, but then by the time they 
get to the fifth grade or the eighth grade, it's gone. There 
seems to be some evidence now that if we start it early and 
maintain it that maybe we get somewhere. In effect we replace 
the family with doing the discipline and the training.
    Mr. Castle. Let me ask you this question, or maybe to 
anybody who would like to answer, and that is the relationship 
of education to employment and to wages. I mean this is 
something that's a given. We've all talked about it. We've all 
seen the statistics that if you graduate from college you earn 
this much more, and college that much more, or whatever.
    From an economics point of view, is all of that rhetoric 
that generally we talk about, and others talk about, a given or 
is there any inaccuracy to it in terms of employment for this 
country? Should we be looking to education to advance 
employment as far as the future is concerned?
    Mr. Friedman. I'll speak to that, Congressman.
    Mr. Meltzer. Let me just say it not only is true what you 
said, that you get a big jump because of college education, but 
you get a bigger jump now than you did earlier.
    Mr. Friedman. Yes, Congressman what you say is absolutely 
true. And importantly, the origin of much of the wage 
inequality that we've been talking about this morning has been 
the widening of these wage differentials. The amount by which a 
college educated person in the United States earns more than a 
high school educated person has doubled over the past 
generation, and so the incentive both for an individual to go 
to college and also for the public policy process to provide 
opportunities for people to go to college is much greater than 
it was before.
    The same thing is true also for the kind of early education 
policy that Allan Meltzer was just describing. Many years ago, 
Project Head Start, for example, got a very bad rap because all 
we had to go on in evaluating it was questions like, does it 
increase students' test scores. If you think about how you 
would evaluate a program after 2 or 3 years, of course, that's 
all you can measure.
    But now we've been at Head Start for 30 years and we can 
address questions like, does it affect who graduates from high 
school 12 years later, does it affect who goes on to college, 
and does it affect who has a stable job by age 23? We can even 
address pathology questions like, does it affect who gets in 
trouble with the law while in high school, or does it affect 
which of the girls get pregnant while in high school?
    In every case, the answer to that question is ``yes.'' Yes, 
the incentive both for individuals to get educated is much 
greater today, but we shouldn't just stop there. There is also 
an important incentive and signal for what the education 
process, which is mostly a public institution in the United 
States as you point out ought to be doing.
    Ms. Waters. [presiding] Thank you very much.
     The gentlelady from New York, Mrs. Maloney.
    Mrs. Maloney. Thank you. Dr. Galbraith, in your testimony 
you raise the charge that there is a presidential election 
cycle for monetary policy. Monetary policy is more restrictive 
when a Democratic Administration is in office but more 
permissive when a Republican Administration is in office. Does 
that mean that you expect monetary policy to be less 
restrictive heading into 2008?
    Mr. Galbraith. It is a statistical finding and it relates 
to the year before a presidential election, compared to other 
periods, after controlling for the position of inflation and 
unemployment. And it's a remarkably stable finding. So it does 
suggest that there has been, going back to 1969, a pattern in 
which this variance in monetary policy has occurred in the year 
before presidential election.
    I would make no prediction about what Chairman Bernanke and 
his colleagues may do in the next year as we approach the 
presidential election. I would hope that this pattern would not 
persist--that if I ran the study 2 years from now, I would find 
that this cycle was an exception.
    I think it's worthwhile, though, for this committee to be 
aware that this pattern does exist in the data. The committee 
should be wary of interest movements in future presidential 
election cycles that are otherwise difficult to explain. You 
should be prepared to ask questions so that a more stable 
policy can, in fact, emerge going forward.
    Mrs. Maloney. Professors Meltzer and Friedman, would you 
care to comment on the theory that there is a presidential 
election cycle to monetary policy?
    Mr. Meltzer. Yes, as I said earlier, I have been writing 
the history of the Federal Reserve, and I would be glad to 
share with you 1,100 pages of manuscript covering just the 
period from 1951 to 1986. It is certainly true that in 1968, 
President Johnson decided that he had to raise the tax rate and 
tighten policy in December of 1968, after the election; he 
didn't do anything before the election.
    The Chairman. We should note that he wasn't a candidate, so 
that made it a little easier for him.
    Mr. Meltzer. No, but his vice president was a candidate. It 
may have had some effect, it may not.
    In 1971, 1972, what happened? Well, President Nixon put on 
price controls, all right, following out what was then the 
belief that you couldn't stop the inflation by other means 
without having serious loss of unemployment.
    In 1975, 1976, Republican Administration, President Ford 
was in office. President Ford was an anti-inflationist and the 
Federal Reserve tightened in 1975 in preparation for the 1976 
election. And many people believe that's one of the reasons 
that President Ford lost the election.
    The next case is Jimmy Carter. This is one I'm very 
familiar with. I had a meeting with Bert Lance right after the 
Carter Administration came in. I told him that they were doing 
an expansive policy at that time. They were going to pay for it 
later very likely by having high inflation when they wanted to 
run for reelection and not to do that.
    And he said to me, ``Well, Walter Heller was just in here 
and he said the opposite of what you just said. What would you 
say to Walter Heller?''
    And I said, my answer to Walter Heller would be that if you 
follow my proposal, you can always expand before the election, 
but if you follow his, you are going to have to contract. And 
of course, we did get a big inflation, partly because of the 
oil shock, partly because of poor Federal Reserve policy.
    So I won't go through all the others--1984 we now have the 
Volcker disinflation, right? It was more expansive in 1983 and 
1984 because the disinflation was over.
    So we can go through those. I just don't think--the Fed is 
in Washington. It is, of course, aware of politics. How can you 
not be? How can you live in Washington and not be aware of 
politics, but it mostly does a reasonable job of trying not to 
play politics because it knows that if it plays that game, it 
is going to lose. You're not going to let them play that game 
and you're certainly not going to let them play the game that 
Jamie Galbraith is talking about.
    So there may be statistical evidence that comes true. I 
just don't believe if you look at them one by one, that you see 
a pattern there which says that they're systematically trying 
to do things. And I can tell you that very rarely at a Federal 
Reserve meeting does anyone ever mention political facts. The 
only person I can remember doing it regularly was Preston 
Martin, and he didn't stay very long.
    Mrs. Maloney. My time has expired. Dr. Friedman.
    Mr. Friedman. There have been a few episodes that clearly 
meet this test. The most obvious one involved Arthur Burns in 
1972, and it has been widely reported in the press because of 
various leaks by people who were present.
    But the key thing to remember is that it's not necessarily 
the case that the majority of the people who are serving as 
members of the open market committee are appointed by, or even 
sympathetic to, any particular person who is running for 
President at the moment. The Federal Reserve Bank Presidents 
tend to stay in office for a very long time. Members of the 
Federal Reserve Board don't necessarily stay for their full 14-
year terms, but typically it has been the case that a person 
who is running for President, even if it's an incumbent running 
for reelection, can look at only a small number of members of 
the open market committee as people to whom he would have some 
connection. I would, therefore, find it surprising as well if 
this were a very strong regularity.
    The Chairman. The gentleman from Missouri.
    Mr. Cleaver. Thank you, Mr. Chairman. It is an honor to 
have the opportunity to have some dialogue with the three of 
the best brains in our country and I'm going to ask two 
questions in one just to reduce the time, since you probably 
are interested in having lunch.
    I'm very much concerned over the fact that we have probably 
less than another $800 billion to spend before we reach the 
debt ceiling. And with us borrowing a considerable amount each 
month for the war in Iraq, we're borrowing probably close to 
$14 billion, certainly more than $10 billion each month, so I 
think it is like $600,000 a minute.
    Pretty soon we're going--this is the question. Do you 
believe that in a short period of time, certainly within the 
next 2 years, the support of the war is going to require a vote 
of Congress to raise the debt ceiling beyond $9 trillion. And 
if so, how does that speak to the world, considering that China 
and Japan are buying a lot of our debt?
    The second part of it, which has some impact on it, I 
believe, and that is--since the Great Depression, we have not 
had a minus savings rate in this country. I think in the 
Depression it was like -0.5 percent. The second part of the 
question is do you think--we hear the words that the economy is 
going fine, everything is good, everybody should be happy, and 
if that is so what is happening with the savings rate 
considering that the Asians are close to 20 percent? And 
because we have no savings rate in this country, the domestic 
borrowing by the government is almost nonexistent; is this 
dangerous for our capacity to defend this Nation as well?
    Dr. Friedman. Congressman, I'll address primarily your 
first question but also the second because the two are clearly 
related. The answer to your first question is very simply, 
``yes.'' If we continue with the current levels of government 
spending and government taxing, then within some quite finite 
period, Congress will be called upon once again to raise the 
debt ceiling.
    Now some people think that this ritual of having to raise 
the debt ceiling is pointless. I disagree. I think that it 
serves a useful function of focusing people's attention on the 
extent to which the government is borrowing as a result of 
spending more than it takes in.
    At the moment, a large part of that excess spending is 
going for Iraq, but the same would be true if it were spending 
for something else. The real issue is the balance of the 
spending and the taxing.
    But, the government's debt today, while large in absolute 
dollars, is actually smaller than it was some time ago. At the 
end of World War II, the government owed more than a dollar of 
debt for every dollar of our national income. Over a period of 
years, by running only small deficits, the government got the 
debt ratio down to only 26 cents on the dollar of GDP. It then 
went up dramatically between 1980 and 1993. Then it came down 
again during the Clinton Administration, and now under the Bush 
Administration, it's going back up again, but not as 
dramatically as it had been rising earlier.
    In a world in which the Baby Boom generation is going to 
retire very soon, we have this liability that Allan Meltzer 
associated with keeping the Medicare system going. Nobody knows 
how we're going to manage to do that. We also have borrowing 
from abroad that's equal to 6\1/2\ percent of our national 
income. We should be running a surplus now, not running a 
deficit. The useful purpose of the debt ceiling ritual, I 
think, is to focus people's attention on exactly that problem.
    Mr. Cleaver. Dr. Friedman. Before you move on to Dr. 
Galbraith, when you were saying that the debt today is probably 
smaller than it was in World War II, I'm not sure what the loan 
guarantees were then, but the loan guarantees that we have 
today are not even included in this $8.3, $8.4 trillion debt 
that we have.
    Mr. Friedman. That's exactly right, Congressman. My reason 
for focusing on the actual secured indebtedness, the part that 
you were describing, was that's what is involved in the debt 
ceiling. When Congress votes to raise the debt ceiling, it 
isn't about all of the unfunded liabilities, nor the credit 
guarantees. What that's about is the debt securities that the 
U.S. Treasury issues. To the extent that we also have $60 
trillion of unfunded Medicare liabilities, they are completely 
separate from the amount included in the debt ceiling that you 
will inevitably be asked to raise within the next short period 
of time.
    Mr. Galbraith. Here Ben Friedman and I do have something of 
a difference of view.
    I would be very wary of measures that tried to move 
directly back toward a budget surplus in the present 
environment because those measures would tend to slow economic 
activity, and they would tend to put people out of work. It 
would either be by raising taxes or by cutting expenditures on 
public programs. They would tend to cause direct harm.
    And the benefit is at least somewhat uncertain, perhaps 
even very uncertain. So given the choice between a strong 
economy and public deficits which, while large in dollar terms 
are not historically very large in relation to GDP, and as Ben 
said, a debt burden which is not historically out of line--it's 
lower than it was in the 1940's and through much of the 
1950's--I would be careful about making radical changes in 
fiscal policy just because the deficit is high, and the debt is 
going up.
    I would say, since you mentioned the war, and since talking 
earlier about the degree to which our position depends upon the 
confidence that the world has in our economic dynamism of 
viability and prosperity, that the war is very troubling in 
this respect. It raises questions about the extent to which the 
United States really can anchor the global security system on 
its own.
    And to the extent that those uncertainties and anxieties 
exist in the world, you're going to see other governments and 
foreign players, financial players, diversifying, hedging their 
bets. I would like to see us consider the global security 
situation as part and parcel of our global financial stability.
    These issues tend to be considered entirely apart, but they 
are not entirely unrelated. And we could find that if we make 
serious errors in one area, that it comes back to be very 
costly in the other.
    The Chairman. Oh, I'm sorry. Go ahead, Professor Meltzer, 
did you want to--
    Mr. Meltzer. I just want to add briefly, I agree with most 
of what Ben Friedman said. I would only disagree that when you 
raise the debt ceiling, nothing happens. I mean people have 
forecast pretty well that you're going to have to do that, you 
forecast that you're going to have to do it. It's not going to 
be a secret when it comes, so it will be a hassle in the 
Congress. Because Congress doesn't like to increase the debt 
ceiling, the public misinterprets it, but the fact is that it 
won't have any economic effect.
    The Chairman. Let me restate that, as there is an important 
principle here. The Minority is always strictly opposed to 
raising the debt ceiling, whomever is in the Minority. The 
gentleman from Minnesota.
    Mr. Ellison. Mr. Chairman, thank you very much for holding 
this hearing. It is a shame sometimes but there are so many 
things going on because I really wanted to hear the bulk of the 
testimony. I apologize for not being here.
    And, Mr. Chairman, I wonder if I could ask some questions 
about debt, personal debt that Americans are facing. I know 
that is not exactly on the subject, but I would be very 
grateful for your view on the subject.
    You know, Americans on average have a negative savings 
rate. Could you talk about what that means for the overall 
functioning of our economy, what it means in terms of what the 
implications are for individuals, and for our consumer sector? 
Could you talk about that a little bit?
    Mr. Friedman. I am guessing that is probably closer to my 
interests than either Jamie Galbraith's or Allan Meltzer's.
    I think we have to be very careful to distinguish different 
parts of the population, Congressman. There are some families 
who have very large debts but also have very large amounts of 
assets behind those debts. Some of those assets are stable in 
value but others aren't. People who keep taking out larger and 
larger mortgages because their houses keep rising in value, for 
example, are exposed in a particular way, namely, what happens 
if the value of their house drops significantly?
    Then a much larger part of the population is borrowing not 
against assets, but in an unsecured way on credit cards, 
borrowing to buy washing machines, refrigerators, or to take 
vacations. These are typically smaller amounts of debt and they 
are exposed less to that kind of asset risk than to the risk 
that a person is going to lose his or her job. Hence, there is 
a part of the population that is exposed to asset value risk, 
and there is another part of the population that is exposed to 
employment risk.
    For many years, at least the last 10 years that I can 
recall, economists have been concerned that the rising consumer 
debt burden would cause consumer spending to drop back to be 
more in step with the increase in personal incomes, and this 
has not really happened yet.
    Clearly borrowing more than one earns cannot go on forever 
unless one is the government. But the question then is, when 
does something stop that we know is unsustainable? Economists 
have been predicting for a long time that rising debt levels 
would cause consumers to pull back. This might cause the 
economy to slow, perhaps even go into recession. But it just 
has not happened yet. Perhaps this means that the American 
consumer is becoming used to higher debt levels. Perhaps it 
means that our lending institutions are more capable of finding 
efficient ways to lend to consumers, although the collapse of 
the subprime mortgage market certainly suggests that these 
institutions do not work as well as the lenders would like to 
believe.
    Mr. Ellison. Excuse me, Doctor. I was going to say that 
example you just mentioned on the prime, you know, we do have a 
lot of people whose housing prices were increasing, they were 
refinancing their houses, and then the housing market flattened 
out. And now some of them are what they call upside down, and 
then they are in foreclosure, and they lose their houses, which 
has implications throughout the economy.
    Is that an example of sort of this, the end of the consumer 
debt gravy train? Sort of the chickens coming home to roost 
situation?
    Mr. Friedman. It may be, Congressman. But even apart from 
the subprime market, it could be simply that the cessation of 
increase in house prices would mean that all sorts of middle 
class families who were not in the subprime market at all will 
have to stop borrowing more simply because their house--against 
which they have been borrowing--is no longer going up in value.
    Mr. Ellison. Right.
    Mr. Friedman. So there are many, many reasons to believe 
that at some stage, the ability of the American consumer to 
keep increasing spending more rapidly than family incomes are 
going up is going to come to a halt. But it has not happened 
yet and, therefore, expecting it to happen this year or next 
year or the year after is simply a speculation.
    Mr. Ellison. Okay. Let me ask you this, Doctor. What about 
the fact that people are living on credit cards nowadays? I 
mean, if we have a 1 percent negative savings rate, does that 
mean that, you know, you have an average number of working 
families who run out of money by Wednesday, but don't get paid 
until Friday? Is that a way to understand the negative savings 
rate situation in which we find ourselves?
    Mr. Friedman. I think it is both that and the borrowing 
against houses, Congressman. Both pieces are quantitatively 
very important.
    Mr. Ellison. What do you think about individual development 
accounts to help poor people save money?
    Mr. Friedman. I think it is a terrific idea. Indeed, there 
are all sorts of such devices. If we had been having this 
conversation 20 years ago, I think every one of us at this 
table would have bemoaned the country's low savings rate and 
then gone on to say that we know very little about how to use 
public policy to encourage saving. It turns out that all of 
these tax-favored saving plans were very disappointing in their 
effect.
    But today all sorts of new research has suggested new ideas 
like the ones that you suggest. One of my own colleagues at 
Harvard, for example, has come up with a terrific idea that the 
Congress, I think, has been moving forward with, to change the 
default option on 401(k) plans. It turns out that merely such a 
small thing as changing the default option--which is not 
forcing anybody to do anything, it is just what happens if you 
do not check any of the boxes on the form--even that device 
turns out to have a significant impact on what people save. So 
I think the state of play in terms of what public policy can 
contribute to the low saving problem is very different than it 
was 2 decades ago, and I am pleased to see Congress moving 
forward in some of these respects and I think there are plenty 
of others, too.
    Mr. Meltzer. May I just say--
    The Chairman. We are running out of time, I am afraid. If 
you are real quick--
    Mr. Meltzer. Very quick.
    That is a very poor number, the saving rate, the personal 
saving rate, for the reasons that he just outlined. I mean 
mortgages, capital gains, things like that are just not in 
there. So a better number of what the society is doing is to 
look at the overall saving rate which includes businesses and 
so on. We do not save enough but that number is misleading.
    The Chairman. Is the second number better or worse? Better?
    Mr. Meltzer. Better.
    The Chairman. The gentleman from Colorado.
    Mr. Perlmutter. Thanks, Mr. Chairman. Just a couple of 
questions on the auto industry. We have this CAFE standards 
bill coming up and I have been getting besieged by both sides 
as to the need to really increase mileage beyond 35 miles per 
gallon in the next 10 or 15 years. And the other side is 
saying, ``Gee, let the SUVs and the pick-ups kind of go their 
own direction and we can do this with cars, otherwise the 
entire industry is going to be gone.''
    I guess my question to you, gentlemen, is where do you see 
the auto industry going?
    The Chairman. In fairness to the witnesses, they can answer 
if they want to, but we did have a hearing on this specific set 
of subjects, and they were not asked to come with any 
particular reference to either the auto industry or energy 
efficiency or any others. If they wish to answer it, okay, but 
in fairness, we do like to have some kind of notice of what 
people are going to be asking.
    Mr. Perlmutter. So now that I have been slightly chastised, 
I still am going to ask my question. If you cannot answer it, 
it is okay. It is what is on my mind and, if not, then I do not 
have any questions, Mr. Chairman.
    Mr. Meltzer. Let me give you an answer which is not a 
direct answer to your question, which is highly relevant. We 
are unwilling to do things to raise the price of gasoline and 
cut down on the amount of oil. So we are giving money, sending 
money to our adversaries. To the Iranians, to the Saudi 
Arabians, even to minor adversaries like the Venezuelans. We 
are going to pay in defense because of our unwillingness to pay 
for the energy.
    If we would cut down on our importation of energy and the 
price were lower, they would have less money. That is a really 
important in my opinion national security issue which affects 
our economy.
    I do not know much about the automobile industry, but I do 
think that is an area where we are going to spend for defense 
because we are unwilling to tell the consumers they have to pay 
more for oil and we have to do things to get rid of oil 
imports.
    Mr. Galbraith. I have to say I agree with Allan on that. I 
would add that if we do now what is necessary to move to the 
front of the technological curves in these areas then we may 
have a competitive industry which we may lose if we do not. It 
is inevitable that we are going to have to transform the way we 
do transportation in this country in order to meet, among other 
things, the challenge of climate change, the challenge of 
energy security. We should be taking on that assignment with 
real intensity at this point or it will quite soon too late.
    Mr. Friedman. I agree with what both Allan Meltzer and 
Jamie Galbraith said, but I would add one more point that I 
think is pertinent to your question, Congressman.
    The history of American business in the post-World War II 
period is full of examples of things that public policy has 
asked business to do and that business has resisted on the 
ground that it would be destructive of the industry. But many 
have turned out not only not to be destructive of the industry, 
but to be stimulative in ways that nobody imagined.
    The most obvious example is putting stack scrubbers in 
utility plants. I am old enough to remember that debate after 
the Clean Air Act was passed and the question was whether it 
was conceivable that the American public utility industry could 
afford to put stack scrubbers in the utility plants or whether 
this was going to lead to the collapse of industry or the price 
of electricity becoming too expensive for middle class families 
to pay.
    Not only did neither of those outcomes take place, but 
after a very short interval, it dawned on people that there was 
going to be a business in which somebody had to make the stack 
scrubbers, somebody had to install the stack scrubbers, and 
somebody had to maintain the stack scrubbers. This was all 
about profits and jobs that nobody had ever imagined.
    I am very optimistic about the capacity of American 
industry to meet the requirements that are placed on it. Today 
the story is that it would be impossibly expensive and either 
the automakers would go out of business or consumers would 
never buy the cars if they had to meet some higher CAFE 
standards. My guess is that the technology will not only be 
doable for the industry, but turn out to be a further source of 
jobs and profits for whoever is smart enough to be able to make 
it and install it and maintain it.
    Mr. Perlmutter. Thank you very much. Thanks, Mr. Chairman.
    The Chairman. I am going to ask one final question. We have 
a vote.
    On the role of the bank, there was a quote, I think from 
Professor Galbraith, from the current and previous Chairman of 
the Federal Reserve about how monetary policy is irrelevant to 
the issue of inequality and they accept that it is a factor.
    It does seem to me that--I disagree with that and the 
monetary policy in fact has had an effect on inequality. Let me 
put it this way. First, Professor Meltzer, you did note 
correctly that there is a worldwide phenomenon now of the 
erosion of real wages, but it is not uniform. It does appear 
that there are institutional mechanisms that can have an 
impact, particularly on strong labor market mechanisms.
    And they do not have to be bad ones. The Scandinavians do 
better than the Chinese or us and so--and that is all in the 
sense--here is the problem we now have. It was still the view 
on the part of, I think, the establishment, all three of you in 
various ways dissent to that and that is why we were glad to 
have you here, that it is important for the central bank 
occasionally to crack down on overall growth to keep inflation 
from getting out of hand. And that despite the previous 
experience with the NAIRU and it seemed to me that during the 
1990's the NAIRU was a lagging indicator of unemployment. As 
unemployment went down, the NAIRU to economists. It was always 
about a half-a-point more than the reality. But it clearly got 
discredited.
    There are still people who see that trade-off, that 
Phillips Curve. The problem with that is that it does affect 
inequality. The one recent period when we have had a halt in 
the excessive trend--the trend towards excessive inequality was 
the late 1990's when a very tight labor market and it seems to 
me we had a very good situation there. We had a very tight 
labor market which helped wages go up but not to the point 
where they caused inflationary pressures. To his credit, 
Bernanke has acknowledged as long as wages significantly are 
lagging productivity increases the fact that they are going up 
should not be--is not inflationary.
    So here is the situation that we run into. The erosion of 
labor market institutional factors in the United States has 
been a problem. And we now have the point where there is still 
this tendency on the part of some, it would seem to be the 
Federal Reserve and Governor Mishkin talks about this and says, 
``Well, we have reduced the pain that will come in the 
employment area if we raise interest rates and slow down the 
economy, but it is still going to be there.''
    What is the response to those who say that it is still 
going to be necessary from time to time to combat inflation by 
reducing overall growth, by raising interest rates in the most 
blunt way to raise unemployment, and that to some extent, it is 
still important for the Fed to be willing to see unemployment 
rise as a way of checking inflation.
    Let me ask each of you, because that still clearly is, I 
think, a received opinion. Let me start with Professor 
Galbraith.
    Mr. Galbraith. Well, I would say as the gentleman from 
Missouri might say, ``Show me.'' Wait until the evidence is in 
and as the gentleman from Massachusetts might say, ``Don't 
shoot until you see the whites of their eyes.''
    The Chairman. But, of course, they will tell us that once 
that happens, then inflation will be out of control and it will 
be too late.
    Mr. Galbraith. Well, what they still need to have is 
evidence for their point of view. And that evidence has been 
singularly lacking. If the evidence is clear, it is presented 
that their case, that there is a run-away wage inflation such 
as we have not seen in this country in a generation, then one 
would have to consider the evidence.
    But as Allan Meltzer said earlier, you would not want to 
mistake a one-time increase in the oil price for a sustained 
rise in the inflation rate, and you will not know the 
difference until substantial time has elapsed.
    And as Ben Friedman just said, if you impose standards on 
the auto companies, they will adapt and innovate. The same 
insight underlay the Scandinavian model that you just referred 
to in the labor market. What the Scandinavians did was to say, 
we are going to have a relatively egalitarian structure of 
wages with strong union representation. Firms will have to 
adjust and become more productive. And that underlay the rise 
of Scandinavian productivity from the middle of Europe to the 
top at the present time. So it is a strategy for a stronger and 
more competitive America.
    The Chairman. I cannot be more inclined to--you cited the 
Massachusetts response from Bunker Hill, but I did go up into 
the New York area, and I think my response would be more likely 
to be ``Forget about it.''
    Professor Meltzer?
    Mr. Meltzer. Unfortunately, if we get a big inflation, 
there is no way we are going to end it without more 
unemployment. I mean that is just a fact.
    The Chairman. Right. But is it--I guess I phrased it 
unartfully. Do we have to anticipate the problem by being very 
tough on the interest rate if the unemployment rate starts 
trickling down?
    Mr. Meltzer. Look at the record of the last three 
expansions. Now, we did not end up with a high inflation. We 
did not end up with big unemployment. We pursued a moderate 
policy through that period and in 2001, 2002, we had a slight 
rise in unemployment, but, boy, I have never seen a recession 
in which consumer spending went up and up dramatically. Home 
buying. Home building. Businesses were the ones that took the 
heat in the 2001 and 2002 recession. They pursued, I would say, 
a really strong counter-cyclical policy.
    Talk about the dual mandate in operation. The dual mandate 
was certainly uppermost in Greenspan's mind in 2001 and 2002.
    The Chairman. Oh, yes, that is very important. You say that 
clearly in 2001 and 2002, they took very seriously both aspects 
of the mandate and the results were benign.
    Mr. Meltzer. They were good.
    The Chairman. Good.
    Mr. Meltzer. Good. Hard on corporate profits, hard on 
investment, you know, but we took the burden off the consumers. 
We had a housing boom and an automobile boom. We sold 17 
million cars in a recession year.
    The Chairman. Professor Friedman, let's finish up.
    Mr. Friedman. Two points, Mr. Chairman. First, the fact 
that inequality tends to be abated during a strong economy is 
yet another reason why the Federal Reserve should take 
seriously the real part of its dual mandate, but the underlying 
point is that they should be doing that anyway.
    It is not as if they need the connection to inequality to 
think that low unemployment, all else being equal, is better, 
and more rapid growth, all else being equal, is better. It is 
very useful to have the connection to inequality, to the extent 
that it is there, and I look forward to reading Jamie 
Galbraith's paper. But it should not be the case that the 
Federal Reserve needs that argument to think that a low 
unemployment is better than a high unemployment rate. They 
should be doing that anyway.
    Second, is it going to be necessary from time to time to 
arrest the growth of the economy in order to keep inflation in 
check? Well, yes, of course it is. But the real issue is the 
extent to which the Federal Reserve is willing to press forward 
on both sides of the dual mandate. In the same way that when 
inflation is beginning to get out of hand then what they are 
supposed to do, by Congress' instruction, is to take steps to 
arrest it, similarly when inflation is not getting out of hand, 
what they are supposed to do also by Congress' instruction is 
to press forward to achieve maximum employment. That is what 
the Act says: maximum employment. It is terrific if maximum 
employment means impeding the widening increase in wage 
inequalities, but they should be doing that anyway.
    The Chairman. Thank you. I appreciate that. We are going to 
have to break. We are going to go vote. I thank the panel for 
showing up.
    I will just say, Professor Meltzer, we will be awaiting the 
book. And if the book becomes a movie, some of us will be 
thinking about who should play us in the history of the Federal 
Reserve.
    This has been very useful to us and we really appreciate 
the thoughtfulness of today.
    The hearing is adjourned.
    [Whereupon, at 12:20 p.m., the hearing was adjourned.]


                            A P P E N D I X



                             July 17, 2007


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