[Senate Hearing 110-182]
[From the U.S. Government Publishing Office]
S. Hrg. 110-182
FEDERAL RESERVE'S FIRST MONETARY POLICY REPORT FOR 2007
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HEARING
before the
COMMITTEE ON
BANKING,HOUSING,AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED TENTH CONGRESS
FIRST SESSION
ON
OVERSIGHT ON THE MONETARY POLICY REPORT TO CONGRESS PURSU-
ANT TO THE FULL EMPLOYMENT AND BALANCED GROWTH ACT OF 1978
__________
FEBRUARY 14, 2007
__________
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COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
CHRISTOPHER J. DODD, Connecticut, Chairman
TIM JOHNSON, South Dakota RICHARD C. SHELBY, Alabama
JACK REED, Rhode Island ROBERT F. BENNETT, Utah
CHARLES E. SCHUMER, New York WAYNE ALLARD, Colorado
EVAN BAYH, Indiana MICHAEL B. ENZI, Wyoming
THOMAS R. CARPER, Delaware CHUCK HAGEL, Nebraska
ROBERT MENENDEZ, New Jersey JIM BUNNING, Kentucky
DANIEL K. AKAKA, Hawaii MIKE CRAPO, Idaho
SHERROD BROWN, Ohio JOHN E. SUNUNU, New Hampshire
ROBERT P. CASEY, Pennsylvania ELIZABETH DOLE, North Carolina
JON TESTER, Montana MEL MARTINEZ, Florida
Shawn Maher, Staff Director
William D. Duhnke, Republican Staff Director and Counsel
Aaron Klein, Chief Economist
Peggy R. Kuhn, Republican Senior Financial Economist
Joseph R. Kolinski, Chief Clerk and Computer Systems Administrator
Jim Crowell, Editor
(ii)
C O N T E N T S
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WEDNESDAY, FEBRUARY 14, 2007
Page
Opening statement of Chairman Dodd............................... 1
Opening statements, comments, or prepared statements of:
Senator Shelby............................................... 4
Senator Casey................................................ 5
Senator Bunning.............................................. 5
Senator Bayh................................................. 6
Senator Martinez............................................. 6
Senator Menendez............................................. 6
Senator Hagel................................................ 7
Senator Tester............................................... 8
Senator Bennett.............................................. 8
Senator Brown................................................ 9
Senator Allard............................................... 10
Senator Reed................................................. 10
Senator Sununu............................................... 11
WITNESS
Ben S. Bernanke, Chairman, Board of Governors of the Federal
Reserve System, Washington, DC................................. 12
Prepared statement........................................... 60
Response to written questions of:
Senator Shelby........................................... 64
Senator Sununu........................................... 66
Additional Material Supplied for the Record
Monetary Policy Report to the Congress dated February 14, 2007... 68
Letter to Senator Christopher J. Dodd from Ben S. Bernanke,
Chairman, Board of Governors of the Federal Reserve System
dated February 26, 2007........................................ 98
Letter to Senator John E. Sununu from Ben S. Bernanke, Chairman,
Board of Governors of the Federal Reserve System dated February
26, 2007....................................................... 101
(iii)
FEDERAL RESERVE'S FIRST MONETARY POLICY REPORT TO CONGRESS FOR 2007
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WEDNESDAY, FEBRUARY 14, 2007
U.S. Senate,
Committee on Banking, Housing, and Urban Affairs,
Washington, DC.
The Committee met at 10:07 a.m., in room SD-106, Dirksen
Senate Office Building, Senator Christopher J. Dodd (Chairman
of the Committee) presiding.
OPENING STATEMENT OF CHAIRMAN CHRISTOPER J. DODD
Chairman Dodd. The hearing will come to order.
Let me thank all of our colleagues and others who have made
it in this morning to participate in this hearing on our first
true winter morning this year. Mr. Chairman, we thank you for
being with us as well, and we appreciate your testimony before
the Committee.
What I will do is open up with a brief opening statement. I
will turn to my colleague, Senator Shelby, and then any of our
other colleagues who would like to make some brief opening
remarks. Your full statements, I will guarantee you, will be
included in the record, as will yours and any supporting
documentation, Mr. Chairman, you would like to be a part of
this record this morning. We will try and move along so we can
get to the question and answer period with you as quickly as
possible.
This morning, the Committee is pleased to welcome Federal
Reserve Chairman Bernanke to deliver the Fed's Semi-Annual
Monetary Policy Report. I want to congratulate you, Mr.
Chairman, for completing your first year as Chairman. Following
in the footsteps of a very successful Chairman can be
difficult, and it is something that I can certainly relate to,
sitting in this chair and sitting next to my friend from
Alabama. But I believe that you have done a very good job in
gaining the respect and confidence of the markets and your
colleagues on the Federal Reserve Board.
The Fed's monetary policy--most notably, its decision to
stop rising interest rates in June--has played a very important
role in some recent positive economic developments. During
2006, the economy grew at a sustainable rate and unemployment
was kept to under 5 percent. While this is not quite as strong
as it was in the late 1990's--when growth was higher and
unemployment fell below 4 percent, with much higher labor force
participation--this economic news is welcome. Long-term
interest rates have remained at modest levels, despite a large
Federal budget deficit, a historic current account deficit, and
the cumulative effect of the Fed's 2-year cycle raising the
interest rates that ended in June.
While these developments are, as I said, positive, there
are other facts that, in my view, raise some very important
questions about our Nation's long-term ability to provide
economic security, opportunity, and prosperity to the people of
this country.
As I travel around these days and talk to many people from
all walks of life, I am confronted by people who are concerned
about the future, whether or not we will have the kind of
stability and long-term growth necessary for our success. What
I am hearing from people is that they are concerned about many
of the same things.
Health care costs are rising at a rate that is
unsustainable for businesses and employees. Over the past 6
years, health care costs have increased by 30 percent. More
than 46 million Americans have no health insurance at all
today, as we all know. That is an increase of 6 million people
over the past 6 years. The price of gasoline, home heating oil,
and other forms of energy has skyrocketed over the past years.
This past summer, gasoline cost over $3 per gallon in many
parts of the country. And while it is much lower today, it is
still twice as high as it was 5 years ago. Families are
concerned as well that they cannot afford to send their kids to
college. My colleague from New York, Senator Schumer, has spent
a lot of time on this issue. College tuition has risen by more
than twice the rate of inflation over the past 20 years. Room,
board, and tuition at many private universities now cost well
over $50,000 a year.
As these costs rise, working Americans are experiencing
more and more uncertainty about their future. People are
wondering whether their home is losing value as they see houses
in their neighborhood sell for less today than they did a year
ago. And millions of Americans are in exotic and subprime
mortgages while the potential for sharp increases in monthly
payments is right around the corner. Several credible reports
say that we are facing a tidal wave of defaults and
foreclosures, which could strip these families of their major,
if not their only, source of wealth and long-term economic
security.
Despite some recent gains in household incomes, the real
median family income, what a family right in the middle of the
middle class earns in a year, is lower today than it was 6
years ago. People are working longer and harder, and many are
not bringing home enough money to keep pace with what they
need. And for those who lose their jobs, the prospect of
falling out of the middle class is far greater today. Americans
are more than twice as likely to experience a precipitous drop
in income as Americans of a generation ago, according to a
recent research study by Jacob Hacker at Yale University.
As we worry about some Americans falling out of the middle
class, we must also be concerned about those working hard to
climb into the middle class. Over 10 million Americans today do
not have access to mainstream financial institutions, such as a
bank, a credit union, or a thrift. For these entrepreneurs and
workers, affordable credit and capital services are scarce, if
not impossible to find. And as a result, millions of our fellow
citizens lack the financial tools that they need to build more
secure and prosperous futures for themselves and their
families.
Finally, Mr. Chairman, our Nation finds itself with trade
policies that are unsustainable, as well, in my view. We have
learned this week that last year, we ran a record trade deficit
of $763 billion. Our Nation's current account deficit will
approach 7 percent of our GDP. We are relying on over $2.4
billion a day from foreign investors, who are increasingly
foreign governments, to finance our economic growth because of
the lack of savings here at home.
The Administration has an official trade policy that is, in
key respects, out of touch with reality. For instance, it is
widely believed that China manipulates its currency. We had a
very good hearing, as you may know, with Hank Paulson before
this Committee a week or so ago on the exchange rate issue.
Yet, the Administration refuses to officially recognize that
fact. When Chairman Bernanke was in China, as part of the
Strategic Economic Dialogue, he gave a speech that pointed out,
``effective subsidy that an undervalued currency provides for
Chinese firms that focused on exporting.''
While this subsidy is not the sole cause of either our
record international trade deficit or our loss of over 3
million manufacturing jobs, including about 1 million of those
jobs in critical national defense-related industries, the
distortion of Chinese currency manipulation is having a very
significant negative impact on American manufacturing jobs.
As policymakers, I think we need to ask ourselves a very
fundamental question: Are we satisfied with America's place in
the world at the beginning of this new century? I do not think
that any one of us can look at all the facts and reach any
conclusion other than that we can do a lot better than I think
we are. And for the sake of the people we serve and generations
coming after them, I think all of us would agree we have to do
better.
There are steps we can and should take, in my view, to
build a stronger foundation for a more secure and prosperous
future. Today's hearing provides the Committee with an
opportunity to discuss some of these steps. We can start by
keeping interest rates at modest levels, and, again, I
congratulate the Fed on doing that since last June. Certainly,
monetary policy is obviously an important component of our
economic future. The Fed's dual mandate is to promote full
employment and price stability. This is a vital and difficult
mission, and we look forward to hearing from the Chairman about
the steps the Fed has taken since its last report to fulfill
that statutory mandate.
In addition, we need our Federal financial regulatory
agencies to be vigilant in assuring not only the safety and
soundness of our financial institutions, but also that those
institutions are serving, not thwarting, the aspirations of
Americans to build a more secure and prosperous life for
themselves and those families.
I look forward to discussing the aspects of the Fed's
mission as well as with you today, Mr. Chairman, and I will
turn to my colleague from Alabama for any opening comments he
may have and then to my colleagues here as well for any brief
statements they want to make as we start this hearing.
Senator Shelby.
STATEMENT OF SENATOR RICHARD C. SHELBY
Senator Shelby. Thank you, Chairman Dodd.
Chairman Bernanke, we are pleased to have you before the
Committee again to deliver the Federal Reserve's Semi-Annual
Monetary Policy Report. This hearing provides an important
mechanism for assuring accountability over the Fed's policies
and operations.
Chairman Bernanke, you have recently completed one year at
the helm of the Federal Reserve System. When President Bush
nominated you for this position, I noted at the hearing that
you would have big shoes to fill, following in the footsteps of
the distinguished Chairman Greenspan. I also noted my belief
that the President made a superb choice in asking you to take
on this responsibility. The Federal Reserve's conduct of
monetary policy thus far under your leadership has given me
further reason to applaud your service.
Chairman Bernanke, as 2006 began, there was much debate as
to whether the Federal Reserve would prove successful in
engineering a ``soft landing,'' after many successive increases
in the Fed funds target rate. Certainly the economic data in
recent weeks tells us that the debate maybe all but over.
Analysts and other Fed watchers are now giving you high praise
for the manner in which you have handled your responsibilities,
and I join them.
Real gross domestic product, GDP, increased at an annual
rate of 3.5 in the fourth quarter of 2006. For all of 2006, GDP
grew 3.4 percent compared with the 3.2-percent increase in
2005. Both numbers topped the 20-year average of 3.1 percent.
Along with this strong growth, we have seen positive news
on the job front. The Labor Department reported that the
economy created, Mr. Chairman, more than 2.2 million jobs last
year, 400,000 more than previously estimated. We continue to
enjoy a low unemployment rate, both historically and relative
to other industrialized nations.
At its most recent meeting on January 31, Federal Open
Market Committee kept the Federal funds target rate at 5.25
percent, the fifth consecutive meeting with no change. Fed
watchers noted that the latest FOMC statement seemed more
upbeat on growth prospects and keeping inflation in check. My
colleagues and I, Mr. Chairman, will no doubt spend time this
morning trying to figure out how long the FOMC intends to leave
short-term rates unchanged.
I am certain that today's hearing will also include some
discussions of the potential risks in the economy, such as the
housing market slowdown, among others.
Mr. Chairman, while it is our responsibility to continue to
examine the horizon for such risks, we must also note the
strong performance of this economy. I hope that we will also
take time today to discuss the very strengths and how to
maintain and build upon them.
Chairman Bernanke, again, we welcome you back to the
Committee, and we like the job you are doing.
Chairman Dodd. He is not here, but Senator Schumer was next
on our list, but, Senator Casey, this early bird rule applies
here.
Senator Casey.
STATEMENT OF SENATOR ROBERT P. CASEY
Senator Casey. Mr. Chairman, thank you very much for
gathering us here. Chairman Bernanke, thank you for your time
here today and for your service.
I do not have a long statement, but I just wanted to
highlight a couple of things I know that you have touched on
before and that I am sure we will speak to today, some of the
long-term fiscal challenges that you outlined here in your
previous testimony, I guess a week or so ago, with regard to
Medicare, Social Security, and other demands that are being
placed on the Federal budget into the future. I appreciate the
fact that you are thinking about and focusing on that and
building that into the planning that you do.
I think also the people that I represent in Pennsylvania
are concerned about those costs. They are concerned about the
deficit, which I guess last year was $248 billion. This year,
the projection is for something less than that. But they are
also concerned about the impact, as Chairman Dodd outlined, of
the costs in their own lives, in their real lives, and you know
the cost of health care and college tuition and housing and so
many other areas. I hope that one of the things we have a
chance to discuss today is the impact that those costs have,
the impact not just on that family, the horrific impact it can
sometimes have on their budgets, but also the impact that that
has on overall long-term economic growth and stability.
So, I look forward to discussing that today with you, and
we appreciate the time you are spending with us, and we
appreciate the report.
Chairman Dodd. Senator Bunning.
STATEMENT OF SENATOR JIM BUNNING
Senator Bunning. Thank you, Mr. Chairman.
Chairman Bernanke, thank you for being here today. To
repeat what I told you at the Budget Committee hearing a few
weeks ago, the Federal Open Market Committee did the right
thing by stopping the increases in the Fed fund rates after the
June 2006 Fed meeting. By holding rates constant, you have done
the right thing ever since. After the latest increase, the
stock markets took off and the cost of credit leveled off. If
the Fed had chosen to continue hiking rates, mortgages and
other forms of credit would have become less and less
affordable to the average American.
Over the last 2 years, the costs of credit, such as
mortgages, student loans, and credit cards, have all increased.
I am not sure how much more tightening consumers could have
handled before serious harm was done to the economy. Higher
interest rates accelerated the housing decline. We will not
know the full extent of the damage for months, if not longer.
If the Fed had not stopped when it did, we would have been in
even more danger.
You have been at the helm of the Fed for a year now. My
initial fears were that you would be a carbon copy of your
predecessor, yet you have done some things I have never seen
your predecessor do: Embrace open and full debate. There is an
old saying that there is a reason we have two ears and one
mouth: It is often more important to listen than to talk.
During your brief tenure at the Fed, you have made a
serious effort to improve on how the Fed listens, but you know
I am not going to let you off that easy, even though today is
Valentine's Day. The people of my State and I have real
concerns about the dangers that lie ahead for our economy. As
this Committee discussed with Secretary Paulson last month, our
constituents are nervous when they see more and more
manufacturing jobs going to the Chinese. They are concerned
about the future of the housing market. They are particularly
concerned about the effects that the potential repeal of the
Bush tax cuts will have on our economic recovery. You inherited
an economy that was approaching a tipping point, and so far you
have managed not to push it over. I urge you to act with
caution and deliberation in the coming year.
Finally, soon there will be two vacancies on the Board of
Governors. I hope the President moves quickly to fill these
positions with people who have real experience in financial
services and commercial banking, not just ivory tower
academics. I look forward to your remarks.
Thank you, Mr. Chairman.
Chairman Dodd. Thank you, Senator Bunning.
Senator Bayh.
COMMENTS OF SENATOR EVAN BAYH
Senator Bayh. Thank you, Mr. Chairman.
Chairman Bernanke, I suspect that most of the people here
today have gathered to listen to you, not me, and I will,
therefore, reserve my comments for the question period.
Chairman Dodd. Very good.
Senator Martinez.
STATEMENT OF SENATOR MEL MARTINEZ
Senator Martinez. I will almost resist the temptation.
Chairman Dodd. That was a standard Senator Bayh set there.
Senator Martinez. But I will be very brief, Mr. Chairman.
Thank you very much.
Chairman Bernanke, welcome, and I again join in the high
praise that you have been receiving for your first year on the
job. I will simply look forward to hearing your comments as it
relates to the housing market, a great concern to me, housing
affordability; also, the issue that we dealt with last week in
this Committee, which is subprime lending and the rate of
defaults in that area; and just in general the effect of the
hurricanes in the Gulf Coast, which continue to be an impact on
the economies of the Gulf States.
So, I look forward to your comments, and thank you for
being with us today.
Chairman Dodd. Thank you very much.
Senator Menendez.
STATEMENT OF SENATOR ROBERT MENENDEZ
Senator Menendez. Thank you, Mr. Chairman.
Chairman Bernanke, welcome. It is great to welcome a fellow
New Jerseyan back again to the Committee.
Today, some people say the economy is solid due to some of
the leading economic indicators appearing generally healthy,
with unemployment below 5 percent, with moderate economic
growth, with inflation stabilized, and I certainly want to
commend you for the stewardship you have shown at the Fed in
working on this economy. But at the same I also worry about who
is benefitting from this economy and who is being left behind.
Indeed, there are serious limitations, I think, in judging
a situation solely through looking at the big-picture numbers,
as this view often hides the details of a situation, and
specifically I am talking about the burden being placed on our
middle class. So while some in this country might believe that
our economy is chugging along quite well because our gross
domestic product continues to grow, there seems to be an
increasing gap between the average citizen and those at the top
of our economic ladder. And the disparity that continues to
grow, in my mind, is widening at an alarming rate.
When I am back in New Jersey, I hear more and more from New
Jerseyans that our current economic policies are not working
for them. The middle class continues to shrink, poverty is
increasing, the gap between the rich and the poor is growing
wider. We have a record-breaking national debt and a record-
breaking trade deficit. The personal savings rate is now below
zero, which has not happened since the Great Depression.
Millions of Americans are seeing their wages stagnant and their
pension and health care benefits slashed, while the wealthiest
people in the country are doing better than ever.
So ultimately my concern is that our economy is not working
for the broadest scope of Americans that we would hope. The
middle class is shrinking instead of growing, and we seem far
more concerned about boosting the incomes of the wealthiest
Americans while denying our responsibility to those struggling
to make ends meet. I do not think we can sustain that position
over the long-term. We are borrowing to pay for tax cuts and
the war effort. It is an unfair burden we are placing on our
children and grandchildren.
So, I look forward to your testimony today and hearing your
thoughts on some of these things I have mentioned, some of the
other things I hope you will address, like the cooling off of
the housing market, what that may mean; energy prices; the
consequences of deficit and debt, from large budget deficits to
record personal debt. And I understand that in your capacity as
Chairman of the Federal Reserve, you are responsible for
keeping inflation low and stable while maintaining economic
growth, not economic equality. But I do hope either in your
opening statement or subsequently in the questions that we will
have an opportunity to ask to hear your views about how we get
this economy working in a direction that it really helps
middle-class families in this country.
Thank you, Mr. Chairman.
Chairman Dodd. Thank you very much.
Senator Hagel.
STATEMENT OF SENATOR CHUCK HAGEL
Senator Hagel. Mr. Chairman, thank you.
Mr. Chairman, welcome. We are glad you are here. I want to
personally thank you for you taking time to address the Greater
Omaha Chamber of Commerce at their annual meeting 2 weeks ago.
It was a rather significant event, as it always is, and your
speech matched the expectations that many had, and I appreciate
you very much taking a day of your time to come to my State and
deliver that speech and spend some time with our leaders in
Nebraska. And I look forward to your testimony.
Thank you.
Chairman Dodd. Thank you very much.
Senator Tester.
COMMENTS OF SENATOR JON TESTER
Senator Tester. Thank you, Chairman Dodd.
Chairman Bernanke, I want to also welcome you here. This is
one of those odd occasions where I do not have another
committee. Thank God for snow. So, I look forward to your
comments, and I will have questions when you are done.
Thank you.
Chairman Dodd. Thank you very much.
Senator Bennett.
STATEMENT OF SENATOR ROBERT F. BENNETT
Senator Bennett. Thank you, Mr. Chairman. I had planned to
follow Senator Bayh's standard, but I have heard so many things
being said here that I think at least one voice should rise in
defense, if you will, of where certain things have been going.
Mr. Chairman, you know my personal affection for you, but
it will not be a surprise that I disagree with your opening
statement.
Chairman Dodd. I am shocked to hear that.
[Laughter.]
Senator Bennett. And, by coincidence, I suppose the best
rebuttal is in a piece that appeared in this morning's paper by
Brian Wesbury, who is the Chief Economist at First Trust
Advisors, LP, in Illinois, ``A Portrait of the Economy.'' I
would ask unanimous consent that the entire piece appear in the
record.*
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* Held in Committee files.
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Chairman Dodd. Without objection.
He starts out, ``It is the best of times. It is the
scariest of times. Last year, U.S. exports, industrial
production, real hourly compensation, corporate profits,
Federal tax revenues, retail sales, GDP, productivity, the
number of people with jobs, the number of students in college,
airline passenger traffic, and the Dow Jones Industrial Average
all hit record levels. For the third consecutive year, global
growth was strong, continuing to lift and hold millions of
people out of poverty. From 30,000 feet--heck, from 1,000 feet,
it sure looks like the best of times. In relative terms, the
first 5 years of the current recovery have been much better
than the first 5 years of the 1990's recovery. But this has not
softened the pessimism of many pundits and politicians who are
either unimpressed or expect the whole thing to come crashing
down any minute, unless the Government firmly grabs the rein of
the global economy and steers it clear of disaster.''
And then he goes on to outline the history of how badly
things have gone every time the Government has tried to step in
and steer it clear, starting with the 1930's and then the
1970's. He makes this comment about the 1970's, which I
responded to, and it says, ``Forgotten in the rush to pass
judgment on capitalism is the fact that the last two times the
Government seriously tried to control the economies in the
1930's and 1970's and made a terrible mess of it''--well, I
will leave the rest of it for people to read, but the one thing
I would say to you, Mr. Chairman, if he is right--and I think
he is--in the year of your stewardship, the last year, exports,
industrial production, real hourly compensation, profits, tax
revenues, retail sales, all are at record levels, you must have
been doing a pretty good job. And if you were running for
office, you would take full credit for absolutely all of it.
Thank you, Mr. Chairman.
Chairman Dodd. Thank you, Senator Bennett.
Senator Brown.
STATEMENT OF SENATOR SHERROD BROWN
Senator Brown. Thank you, Mr. Chairman.
Chairman Bernanke, I appreciate your joining us today to
share your thoughts on the direction of monetary policy in the
months ahead. I also appreciate the comments you have made in
Nebraska and other places before other groups and the steps you
have taken toward greater transparency.
I am sure that you can appreciate for most of the families
in my State of Ohio and elsewhere, many of the issues we
discuss today are far removed from their day-to-day lives. As
Senator Menendez said, the uncertainties that middle-class
families face are not the uncertainties that the columnist that
Senator Bennett mentioned and others and economists worry about
as often perhaps as they should.
I know and appreciate your acknowledging the widening gap
of income in our society. I commend you for adding your voice
to that discussion. I agree with you that we should look at
ways to improve education and training of our citizens, but I
do not think that is nearly enough. Globalization has had a
tremendous impact on workers in this country, on communities,
on teachers, on firefighters, on cities' ability to deliver
services to their constituents. There is no question that good-
paying manufacturing jobs have gone offshore. Fourteen years
ago, the trade deficit in this country was $38 billion. Today,
announced just this week, it exceeds $760 billion. George Bush
the First said that a $1 billion trade deficit translates into
13,000 lost jobs. You do the math.
Of course, we must trade with the world. The question is
not if we will trade with other countries; rather, it is how we
will trade with them and who will benefit. If the beneficiaries
are limited to those with investment capital and the losers too
often are workers and their communities across the country, we
simply will not have a very sustainable trade policy. We devote
substantial time and effort to protecting intellectual property
in our trade negotiations and enforcement. We need to do this,
but we exert almost no effort in protecting the rights of our
workers and their counterparts overseas. That simply has to
change.
Many in the media and some in Government label those of us
who advocate for labor and environmental standards as
``protectionist.'' Yet when our trade agreements protect the
drug industry or Hollywood films, we call that simply ``free
trade.'' If we can protect an Ohio inventor, if we can protect
pharmaceuticals, if we can protect copyrights, as we should, we
can do a much better job protecting workers and the
environment.
I thank you for your time.
Chairman Dodd. Thank you very much, Senator.
Senator Allard.
STATEMENT OF SENATOR WAYNE ALLARD
Senator Allard. Thank you, Mr. Chairman. I would like to
thank you and Senator Shelby for holding this important
hearing. I always look forward to hearing from Chairman
Bernanke. I think that you have started off very well in your
tenure as Chairman of the Federal Reserve, and I want to
congratulate you on that initial effort. I think you have
gained the confidence of the markets, and I think you have
gained the confidence of many Members of the Congress, although
there are a few skeptics still among us.
I would like to emphasize that the economy is doing well.
If we look at economic growth, this last year it is 3.4
percent; the previous year it was 3.2 percent. The average over
20 years is 3.1 percent. So we are above the average in
economic growth. I think a lot of that is attributable to the
economic growth package that we put in place in 2003 and the
tax cuts that we had in 2001. We have heard a lot of comments
here in this Committee about how it is going to impact the
family. In my view, the hardest-working American is the small
businessman, and those economic growth packages were targeted
to the small businessman. That is where economic growth occurs.
There are Members in Congress that are pushing hard to do away
with those temporary tax reductions that we put in place to
stimulate the economy.
My question to you is: I hope you will address this. If we
let those temporary tax cuts go away, what kind of impact is it
going to have on the average family? I think it is going to
have a dramatic impact, particularly on the hard-working men
and women of this country who are in business for themselves.
And I hope that you can address that in your comments.
Thank you very much.
Chairman Dodd. Thank you, Senator Allard.
Senator Reed.
STATEMENT OF SENATOR JACK REED
Senator Reed. Thank you, Mr. Chairman, and thank you,
Chairman Bernanke, for joining us today. Your task in setting
the right course of monetary policy is complicated by fiscal
policy and international imbalances. We no longer have the
fiscal discipline that we had in the 1990's which allowed for a
monetary policy that was more encouraging of robust investment
and long-term growth.
The present large and persistent budget deficits have led
to an ever-widening trade deficit that forces us to borrow vast
amounts from abroad and puts us at risk of a major financial
collapse if foreign lenders suddenly stop accepting our IOU's.
Continued budget and trade deficits will be a drag on the
growth of our standard of living and leave us ill prepared to
deal with the effects of the retirement of the baby-boom
generation. Strong investment, financed by our own national
saving, not foreign borrowing, is the foundation of a strong
and sustained economic growth and rising standards of living.
One final issue that I would like to raise is the growing
inequality of income earnings and wealth in the U.S. economy.
Between 2003 and 2005, GDP grew at a rate of 3.5 percent per
year. However, after adjusting for inflation, the typical
weekly earnings of full-time wage and salary workers at the
median of the earnings distribution went up only 0.6 percent
between the end of 2000 and the end of 2006. Obviously, these
median workers are not sharing in that robust GDP.
Data from the Federal Reserve Board Survey of Consumer
Finances show that household wealth is very unevenly
distributed. The wealthiest 1 percent of families held more of
the country's wealth than the bottom 90 percent of families
combined. Even more disturbing is the large number of families,
particularly African-American and Hispanic communities, that
have little or no net wealth.
Chairman Bernanke, I was heartened to read you comments in
Omaha last week emphasizing the importance of education and
training in reducing this economic inequality. And I know you
share the concern that widening inequality is not good for our
democracy and the fabric of the country. So, I hope you will
agree there is an inconsistency at best in the Administration's
pursuit of tax breaks for those who are already well off,
including the permanent elimination of the estate tax, while
continuing to propose cuts to elementary and secondary
education, student aid and loan assistance for higher
education, and job training for displaced workers. The
challenges facing our economy are compounded by the disarray
that characterizes our fiscal policy. We have been running
unsustainable fiscal deficits, and in order to make the
necessary investments in training and education, we must
reverse this course. And I would be remiss if I did not note
that the lead story today in most of the wire services is that
Chrysler is cutting 13,000 jobs. I suspect that will probably
raise the stock of Chrysler, make the investors happy, and
investment bankers who are structuring the transformation of
the company; it is necessary perhaps to do. But for 13,000
Americans who used to have good jobs with good health benefits,
they are in a quandary, and our obligation is to them as well
as it is to the shareholders of that company.
So, I think we have to do a lot more, and I think you do
sense that, and I think together, hopefully, we can make some
progress.
Chairman Dodd. Thank you, Senator Reed.
Senator Sununu.
STATEMENT OF SENATOR JOHN E. SUNUNU
Senator Sununu. Thank you very much, Mr. Chairman.
Senator Bennett, I thought, was somewhat eloquent in
talking about the very positive trends we have seen in the
economy: Record job creation and above average recovery period,
record homeownership, rising income levels. It is fair to say,
though, for any Member who has spent a little time back home,
there is a sense of insecurity that can be felt even in what
are relatively strong economic times. And I think that is an
issue or a set of issues dealing with their insecurity or
uncertainty that we should deal with as policymakers and
perhaps that at some level can even be addressed by the Fed.
But I think it is important to understand that the role of the
Fed is not to redistribute wealth, not to raise taxes, not to
establish protectionist trade measures. And I think that is a
good thing. I suspect maybe Chairman Bernanke thinks that is a
good thing, because he has a tall enough order as it is.
The areas where the Fed can have a very positive impact
within their mission are to deal with the uncertainties of
inflation, the uncertainties of establishing a sustainable and
steady record of economic growth, the security that comes from
the establishment of safe and sound financial markets. And
those are all responsibilities of the Fed, I think
responsibilities that Chairman Bernanke takes very seriously.
You have spoken very well to those issues in the past, and I
look forward to hearing your comments on those and other issues
this morning.
Thank you Mr. Chairman.
Chairman Dodd. Thank you very much, Senator Sununu.
Mr. Chairman, we welcome you again to the Committee. We are
anxious to hear your comments, and your full statement and
supporting documents will, of course, be a part of the record.
STATEMENT OF BEN S. BERNANKE, CHAIRMAN,
BOARD OF GOVERNORS, FEDERAL RESERVE SYSTEM
Chairman Bernanke. Thank you. Chairman Dodd, Senator
Shelby, and other Members of the Committee, I am pleased to
present the Federal Reserve's Monetary Policy Report to the
Congress. Real activity in the United States expanded at a
solid pace in 2006, although the pattern of growth was uneven.
After a first-quarter rebound from weakness associated with the
effects of the hurricanes that ravaged the Gulf Coast the
previous summer, output growth moderated somewhat on average
over the remainder of 2006. Real gross domestic product is
currently estimated to have increased at an annual rate of
about 2.75 percent in the second half of the year.
As we anticipated in our July report, the U.S. economy
appears to be making a transition from the rapid rate of
expansion experienced over the preceding several years to a
more sustainable average pace of growth. The principal source
of the ongoing moderation has been a substantial cooling of the
housing market, which has led to a marked slowdown in the pace
of residential construction. However, the weakness in housing
market activity and the slower appreciation of house prices do
not seem to have spilled over to any significant extent to
other sectors of the economy.
Consumer spending has continued to expand at a solid rate,
and the demand for labor has remained strong. On average, about
165,000 jobs per month have been added to nonfarm payrolls over
the past 6 months, and the unemployment rate, at 4.6 percent in
January, remains low.
Inflation pressures appear to have abated somewhat
following a run-up during the first half of 2006. Overall
inflation has fallen in large part as a result of declines in
the price of crude oil. Readings on core inflation--that is,
inflation excluding the prices of food and energy--have
improved modestly in recent months. Nevertheless, the core
inflation rate remains somewhat elevated.
In the five policy meetings since the July report, the
Federal Open Market Committee, or FOMC, has maintained the
Federal funds rate at 5.25 percent. So far the incoming data
have supported the view that the current stance of policy is
likely to foster sustainable economic growth and the gradual
ebbing of core inflation. However, in the statement
accompanying last month's policy decision, the FOMC again
indicated that its predominant policy concern is the risk that
inflation will fail to ease as expected and that it is prepared
to take action to address inflation risks if developments
warrant.
Let me now discuss the economic outlook in a little more
detail, beginning with developments in the real economy and
then turning to inflation. I will conclude with some brief
comments on monetary policy.
Consumer spending continues to be the mainstay of the
current economic expansion. Personal consumption expenditures,
which account of more than two-thirds of aggregate demand,
increased at an annual rate of about 3.5 percent in real terms
during the second half of last year, broadly matching the brisk
pace of the previous 3 years. Consumer outlays were supported
by strong gains in personal income, reflecting both the ongoing
increases in payrolled employment and a pick-up in the growth
of real wages. Real hourly compensation, as measured by
compensation per hour in the nonfarm business sector deflated
by the personal consumption expenditures price index, rose at
an annual rate of around 3 percent in the latter half of 2006.
The resilience of consumer spending is all the more
striking given the backdrop of the substantial correction in
the housing market that became increasingly evident during the
spring and summer of last year. By the middle of 2006, monthly
sales of new and existing homes were about 15 percent lower
than a year earlier, and the previously rapid rate of house
price appreciation had slowed markedly.
The fall in housing demand in turn prompted a sharp slowing
in the pace of construction of new homes. Even so, the backlog
of unsold homes rose from about 4\1/2\ months' supply in 2005
to nearly 7 months' supply by the third quarter of last year.
Single-family housing starts have dropped more than 30 percent
since the beginning of last year, and employment growth in the
construction sector has slowed substantially.
Some tentative signs of stabilization have recently
appeared in the housing market. New and existing home sales
have flattened out in recent months. Mortgage applications have
picked up, and some surveys find that homebuyers' sentiment has
improved. However, even if housing demand falls no further,
weakness in residential investment is likely to continue to
weigh on economic growth over the next few quarters as
homebuilders seek to reduce their inventories of unsold homes
to more comfortable levels.
Despite the ongoing adjustments in the housing sector,
overall economic prospects for households remain good.
Household finances appear generally solid, and delinquency
rates on most types of consumer loans and residential mortgages
remain low. The exception is subprime mortgages with variable
interest rates, for which delinquency rates have increased
appreciably.
The labor market is expected to stay healthy, and real
incomes should continue to rise, although the pace of
employment gains may be slower than that to which we have
become accustomed in recent years. In part, slower average job
growth may simply reflect the moderation of economic activity.
Also, the impending retirement of the leading edge of the baby-
boom generation and an apparent leveling out from women's
participation in the workforce, which had risen for several
decades, will likely restrain the growth of the labor force in
coming years. With fewer job seekers entering the labor force,
the rate of job creation associated with the maintenance of
stable conditions in the labor market will decline.
All told, consumer expenditures appear likely to expand
solidly in coming quarters, albeit a little less rapidly than
the growth in personal incomes, if, as we expect, households
respond to the slow pace of home equity appreciation by saving
more out of current income.
The business sector remains in excellent financial
condition with strong growth and profits, liquid balance
sheets, and corporate leverage near historical lows. Last year,
those factors helped to support continued advances in business
capital expenditures. Notably, investment in high-tech
equipment rose 9 percent in 2006, and spending on
nonresidential structures, such as office buildings, factories,
and retail space, increased rapidly through much of the year,
after several years of weakness.
Growth in business spending slowed toward the end of last
year, reflecting mainly a deceleration of spending on business
structures, a drop in outlays in the transportation sector
where spending is notably volatile, and some weakness in
purchases of equipment related to construction and motor
vehicle manufacturing.
Over the coming year, capital spending is poised to expand
at a moderate pace, supported by steady gains in business
output and favorable financial conditions. Inventory levels in
some sectors, most notably at motor vehicle dealers and in some
construction-related manufacturing industries, rose over the
course of last year, leaving some firms to cut production to
better align inventories with sales. Remaining imbalances may
continue to impose modest restraint on industrial production
during the early part of this year.
Outside the United States, economic activity in our major
trading partners has continued to grow briskly. The strength of
demand abroad helped stir a robust expansion in U.S. real
exports, which grew about 9 percent last year. The pattern of
real U.S. imports was somewhat uneven, partly because of
fluctuations in oil imports over the course of the year. On
balance, import growth slowed in 2006 to 3 percent.
Economic growth abroad should further support steady growth
in U.S. exports this year. Despite the improvements in trade
performance, the U.S. current account deficit remains large,
averaging about 6.5 percent of nominal GDP during the first
three quarters of 2006.
Overall, the U.S. economy seems likely to expand at a
moderate pace this year and next, with growth strengthening
somewhat as the drag from housing diminishes. Such an outlook
is reflected in the projections that the members of the Board
of Governors and presidents of the Federal Reserve Banks made
around the time of the FOMC meeting late last month. The
central tendency of those forecasts, which are based on the
information available at that time and on the assumption of
appropriate monetary policy, is for real GDP to increase about
2.5 to 3 percent in 2007 and about 2.75 to 3 percent in 2008.
The projection for GDP growth in 2007 is slightly lower than
our projection last July. The difference partly reflects an
expectation of somewhat greater weakness in residential
construction during the first part of this year than we
anticipated last summer. The civilian unemployment rate is
expected to finish both 2007 and 2008 around 4.5 to 4.75
percent.
The risks to this outlook are significant. To the downside,
the ultimate extent of the housing market correction is
difficult to forecast and may prove greater than we anticipate.
Similarly, spillover effects from developments in the housing
market onto consumer spending and employment in housing-related
industries may be more pronounced than expected. To the upside,
output may expand more quickly than expected if consumer
spending continues to increase at the brisk pace seen in the
second half of 2006.
I turn now to the inflation situation. As I noted earlier,
there are some indications that inflation pressures are
beginning to diminish. The monthly data are noisy, however, and
it will consequently be some time before we can be confident
that underlying inflation is moderating as anticipated.
Recent declines in overall inflation have primarily
reflected lower prices for crude oil, which have fed through to
the prices of gasoline, heating oil, and other energy products
used by consumers. After moving higher in the first half of
2006, core consumer price inflation has also edged lower
recently, reflecting a relatively broad-based deceleration in
the prices of core goods. That deceleration is probably also
due to some extent to lower energy prices, which have reduced
costs of production and thereby lessened one source of pressure
on the prices of final goods and services. The ebbing of core
inflation has likely been promoted as well by the stability of
inflation expectations.
A waning of the temporary factors that boosted inflation in
recent years will probably help to foster a continued edging
down of core inflation. In particular, futures quotes imply
that oil prices are expected to remain well below last year's
peak. If actual prices follow the path currently indicated by
futures prices, inflation pressures would be reduced further as
the benefits of the decline in oil prices from last year's high
levels are passed through to a broader range of core goods and
services.
Non-fuel import prices may also put less pressure on core
inflation, particularly if price increases for some other
commodities, such as metals, slow from last year's rapid rates.
But as we have been reminded only too well in recent years, the
prices of oil and other commodities are notoriously difficult
to predict, and they remain a key source of uncertainty to the
inflation outlook.
The contribution from rents and shelter costs should also
fall back following a step-up last year. The faster pace of
rent increases last year may have been attributable in part to
reduced affordability of owner-occupied housing, which led to a
greater demand for rental housing. Rents should rise somewhat
less quickly this year and next, reflecting recovering demand
for owner-occupied housing as well as increases in the supply
of rental units, but the extent and pace of that adjustment are
not yet clear.
Upward pressure on inflation could materialize if final
demand were to exceed the underlying productive capacity of the
economy for a sustained period. The rate of resource
utilization is high, as can be seen in rates of capacity
utilization above their long-term average, and most evidently
in the tightness of the labor market. Indeed, anecdotal reports
suggest that businesses are having difficulty recruiting well-
qualified workers in certain occupations. Measures of labor
compensation, though still growing at a moderate pace, have
shown some signs of acceleration over the past year, likely in
part the result of tight labor market conditions.
The implications for inflation of faster growth in nominal
labor compensation depend on several factors. Increases in
compensation might be offset by higher labor productivity or
absorbed by a narrowing of firms' profit margins rather than
passed on to consumers in the form of higher prices. In these
circumstances, gains in nominal compensation would translate
into gains in real compensation as well.
Underlying productivity trends appear favorable, and the
mark-up of prices over unit labor cost is high by historical
standards, so such an outcome is certainly possible. Moreover,
as activity expands over the next year or so at the moderate
pace anticipated by the FOMC, pressures in both labor and
product markets should ease modestly. That said, the
possibility remains that tightness in product markets could
allow firms to pass higher labor costs through their prices,
adding to inflation and effectively nullifying the purchasing
power of at least some portion of the increase in labor
compensation. Thus, the high level of resource utilization
remains an important upside risk to continued progress on
inflation.
Another significant factor influencing medium-term trends
in inflation is the public's expectations of inflation. These
expectations have an important bearing on whether transitory
influences on prices, such as those created by changes in
energy costs, become embedded in wage and price decisions and
so leave a lasting imprint on the rate of inflation. It is
encouraging that inflation expectations appear to have remain
contained.
The projections of the members of the Board of Governors
and the presidents of the Federal Reserve Banks are for
inflation to continue to ebb over this year and next. In
particular, the central tendency of those forecasts is for core
inflation, as measured by the price index for personal
consumption expenditures, excluding food and energy, to be 2 to
2.25 percent this year and to edge lower to 1.75 to 2 percent
next year. But as I noted earlier, the FOMC has continued to
view the risk that inflation will not moderate as expected as
the predominant policy concern.
Monetary policy affects spending and inflation with long
and variable lags. Consequently, policy decisions must be based
on an assessment of medium-term economic prospects. At the same
time, because economic forecasting is an uncertain enterprise,
policymakers must be prepared to respond flexibly to
developments in the economy when those developments lead to a
reassessment of the outlook. The dependence of monetary policy
actions on a broad range of incoming information complicates
the public's attempts to understand and anticipate policy
decisions.
Clear communication by the central bank about the economic
outlook, the risks to that outlook, and its monetary policy
strategy can help the public to understand the rationale that
is behind policy decisions and to anticipate better the central
bank's reaction to new information. This understanding should
in turn enhance the effectiveness of policy and lead to
improved economic outcomes. By reducing uncertainty, central
bank transparency may also help anchor the public's longer-term
expectations of inflation.
Much experience has shown that while anchored inflation
expectations tend to help stabilize inflation and promote
maximum sustainable economic growth, good communication by the
central bank is also vital for ensuring appropriate
accountability for its policy actions, the full effects of
which can be observed only after a lengthy period. A
transparent policy process improves accountability by
clarifying how a central bank expects to attain its policy
objectives and by ensuring that policy is conducted in a manner
that can be seen to be consistent with achieving those
objectives.
Over the past decade or so, the Federal Reserve has
significantly improved its methods of communication, but
further progress is possible. As you know, the FOMC last year,
established a subcommittee to help the full committee evaluate
the next steps in this continuing process. Our discussions are
directed at examining all aspects of our communications and
have been deliberate and thorough. These discussions are
continuing, and no decisions have been reached.
My colleagues and I remain firmly committed to an open and
transparent monetary policy process that enhances our ability
to achieve our dual objectives of stable prices and maximum
sustainable employment. I will keep Committee Members apprised
of the developments as our deliberations move forward. I look
forward to continuing to work closely with the Members of the
Committee and your colleagues in the Senate and the House on
the important issues pertaining to monetary policy and the
other responsibilities with which the Congress has charged the
Federal Reserve.
Thank you. I would be happy to take questions.
Chairman Dodd. Thank you very much, Mr. Chairman, for a
very comprehensive statement. What I am going to do is we will
have 7 minutes per Member. I will not hold to that so tightly.
I would just ask Members to be conscious of the time, and you
have the clocks in front of you here so we can make sure
everybody has adequate time to ask questions and give you an
adequate time to respond to them as well.
Let me pick up, if I can, a number of my colleagues
referred to your speech in Omaha. Senator Hagel talked about
your reception there and the comments you made about income
inequality, and I want to pick up on those comments, if I can
as well.
I think all of us recognize here, I would say to my friend
from Utah, we are all very conscious the tremendous wealth that
has been created in certain sectors of our economy, that there
are good things that are happening. None of us is suggesting
all is bad.
There is a sense, as Senator Sununu has said, and others,
of uncertainty that people are feeling across the country about
the long-term economic growth and stability of the Nation. And
I think those of us who are expressing those views to you here,
Mr. Chairman, probably reflect your comments as well as I read
them. Your quote in Omaha, ``By many measures, inequality in
economic outcomes has increased over time.''
Your predecessor, Chairman Greenspan, was very concerned
about the growth in income inequality as well. He testified,
``I think the income distribution issue is very critical
because we cannot have a significant inequality of income and
expect to have support for the type of institutions that have
been made this country great.''
Do you share Chairman Greenspan's concern, Mr. Chairman,
that continued economic growth of inequality is a significant
threat to our Nation's fundamental promise of economic
opportunity? Do you suggest by your comments here that we
should have a balanced view? I just left a markup a few minutes
ago before coming here, marking up a new Head Start bill that
will hopefully deal with greater accountability, but serving
about 900,000 to 1 million young people in this country in the
past 41 or 42 years that has tried to give those children an
opportunity to become active and successful members of our
economy in the future.
I am concerned as we look at this that the decisions we
make here will lack that kind of balance, and your comments
seem to suggest a similar train of thought. And I wonder if you
might just take a few more minutes this morning to expound on
those comments in Omaha, and just a general observation. I am
not asking if you endorse a specific spending program here and
there, but just your general observation about this inequality
issue and your concern that you obviously expressed in Omaha.
Chairman Bernanke. Thank you, Mr. Chairman. The very
important drivers of economic growth and prosperity in this
country include free and open trade and technological progress.
It is very important to allow those forces to continue to
operate in our economy. However, we do have to recognize, as I
discussed in Omaha, that the effects of these forces can be
differential across the population. They may create greater
income possibilities for some than others. They may create
painful dislocations, for example, if the composition of
industries changes or job skill requirements change.
I agree with Chairman Greenspan's general point that in
order to support and retain support for policies of free trade,
open borders, technological change, flexible labor markets, we
need to make sure that the gains and benefits from these
powerful, growth-producing forces are broadly shared and that
people understand that these things are good for the American
economy and good for people generally in the economy.
How to do that is very difficult. It is easy enough to say
let us promote economic opportunity. I certainly support that
idea. Doing it is not necessarily easy. I discussed in my
speech some general issues and approaches, including education,
not only K-12 education but also training throughout the life
span, from early childhood through adult retraining. We need to
help people who are dislocated by these powerful dynamic forces
to find new jobs, to find new opportunities. I think that is
very important.
I would just say, though, that I am glad you did not ask me
to endorse specific policies, because making that work in
practice is difficult. We have to find ways to achieve these
objectives. For example, retraining workers in ways that are
effective, and are effective in terms of the spending that we
put into it.
So it is a great challenge for us going forward to look
among all the possible approaches and decide which types of
programs, which types of initiatives will be most effective at
achieving this objective.
That being said, again, I do agree that we need to spread
the benefits widely and make people understand that open trade
and technological change are beneficial for not only the
economy in the aggregate, but also for the great majority of
people in the economy.
Chairman Dodd. Well, I do not know if you had the chance to
read a report called ``The Gathering Storm.'' It was prepared
by a number of senior retired corporate executives along with
some of our leading academicians in the country about a year
and a half ago who took a month off and examined where we were
in K-12 in science and math--again, without getting into the
specifics of individual programs, but they were very cautious.
In fact, they warned us, all of us, those of us who sit on this
side of the dais, as well as others across the country, that if
we did not make some investments in the quality of education,
particularly in math and science, we could find abrupt changes
occurring in our country very quickly in this century.
I do not know if you have had an opportunity to look at
that report or not, whether or not you agree with their
conclusions about your concerns over whether or not this
inequality could be exacerbated by the failure of us to have a
level of education, investments in education from that earliest
early childhood area through the higher educational
opportunity.
Chairman Bernanke. Mr. Chairman, I did read that report. It
had a lot of interesting things to say. I think if you look at
it carefully, it suggests that the issues are different in
different parts of the educational system. For example, our
universities remain very strong. Our research universities lead
the world. So in terms of research, development, innovation,
and so on, the United States retains substantial leadership in
the world. But in other parts of the educational system,
perhaps in elementary school, for example, we are probably not
doing what we should in terms of ensuring that all children
have opportunities to learn math and science and the
applications of those areas.
Again, my wife is a teacher, and I have been in education
for a long time. I was on the school board for many years, so I
am very sensitive to these issues. But I also appreciate from
those particular positions that we have been worrying about
educational quality for a long time, and it is a difficult
thing to achieve. I encourage continued thought and continued
efforts to improve these vital components of our economy
without having any delusions about how difficult that really is
to accomplish effectively.
Chairman Dodd. I thank you for that.
I am going to turn to my colleague from Alabama, but I will
probably send this as a written question, unless one of my
colleagues raises it with you here.
Back in December, Senator Sarbanes, Senator Allard, Senator
Reed, Senator Bunning, Senator Schumer, and myself sent you and
other regulators a letter regarding these exotic mortgages. We
had a hearing here the other day, and I have talked about this.
I am a strong advocate of subprime lending. It has made a huge
difference in accessibility to homeownership. I am also
simultaneously very concerned about the predatory lending
practices that go on. That concern about providing those
subprime borrowers with the same kind of protections we do to
the prime borrowers is a matter of concern to many of us here
on this Committee.
The letter we got back, frankly, Mr. Chairman, was a little
inadequate. The notion, ``We are thinking about it,'' was nice
to know, but I think many of us would like to know they are
taking some additional steps. And, again, I will make this a
written question to you, but I am very concerned about this
issue, and some of the data we are receiving were as many as 2
million of our fellow citizens may be foreclosed out of their
homes because of predatory practices.
Again, I will not ask you here. I want to turn to Senator
Shelby, but I want to raise that issue with you and ask you to
be thinking about it because it is an important concern for
many of us.
Senator Shelby.
Senator Shelby. Thank you, Chairman Dodd.
Chairman Bernanke, the Federal Open Market Committee has
held the Federal funds rate target at 5.25 percent since June
2006. In the FOMC statement following your most recent meeting
in January, the FOMC noted, ``the high level of resource
utilization has the potential to sustain inflation pressures.
The Committee judges that some inflation risks remain.''
Mr. Chairman, what data related to resource utilization
will you be paying the closest attention to between now and the
next FOMC meeting in March?
Chairman Bernanke. Senator, a flip answer is,
``Everything.'' I should be clear: Our concern is not about the
labor market per se. Our concern is about the overall balance
of spending and productive capacity.
Senator Shelby. The whole picture.
Chairman Bernanke. The whole picture. The Federal Reserve
contributes to setting overall financial conditions, which in
turn stimulates spending by consumers and businesses on the
product of our companies.
If spending is growing more quickly than the underlying
productive capacity for a sustained period, we risk creating
inflation which will then make it more difficult to sustain a
healthy expansion over a longer period of time.
So we are looking for evidence that consumption spending
and other components of spending growth are exceeding the
underlying capacity. In doing so, we look at a wide variety of
indicators, including the strength of various spending
components, measures of resource utilization, which include not
only capacity utilization and unemployment, but also many
indicators in labor markets and capital markets.
We also look very much at prices because they are the
canary in the coal mine. If prices begin to rise, that is
indicative that there is too much demand given the amount of
supply.
We do not have any fixed speed limit in mind when we think
about the economy going forward. We do not have any fixed
number for the unemployment rate. But rather, we are looking at
the overall balance of supply and demand, looking at the
evolution of inflation, and trying to ensure that there is a
reasonable balance between demand and supply so that our
economy can continue to grow at a sustainable, moderate pace
going forward.
Senator Shelby. Is your economic goal here basically price
stability?
Chairman Bernanke. Price stability consistent with strong
employment as well.
Senator Shelby. Productivity. The President's economic
report noted that between 2000 and 2005, productivity growth in
the United States accelerated to about 3 percent, Mr. Chairman,
the fastest growth of any G-7 country, which includes Canada,
France, Germany, Italy, Japan, and the United Kingdom. Most
other major industrialized countries suffered a slowdown in
productivity growth.
What factors do you believe explain the difference in
productivity growth given that the other G-7 countries also
have access to the same technological improvements and broad
capital markets the United States has? And could you expand on
these differences in productivity, what productivity implies
for our standard of living and our long-term growth?
Chairman Bernanke. Senator, you are quite correct that
productivity began to grow more quickly in the United States
about a decade ago, and that has been a very important factor
in the strength of our economy.
In 1995, we saw a step-up in productivity growth from 1.5
to 2.5 percent, which seems to have been driven primarily by
improved and more efficient methods of producing high-tech
equipment--faster computers, stronger, better communications
equipment, and the like.
Over the succeeding few years--and, in fact, we saw
productivity growth step up further around 2000--those
technological innovations had been diffused through the economy
and helping industries across the economy manage their
production and distribute their output more efficiently, and
reduce costs and increase productivity. So in some sense, the
underlying factor is the technological change, the investment
in information and communications technologies, and the
diffusion of those technologies throughout the economy.
Now, you ask, quite properly, why we have seen better
results here in the United States than in some other countries,
and I have given some speeches on that subject. I do believe
that it is the interaction of the new technologies and our
flexible dynamic economic system. That includes flexible labor
markets that can adjust to changes in the market associated
with technological change. That includes deep and liquid
capital markets that can allocate capital toward new ventures,
toward new technologies. And I believe that flexibility has
been essential in helping us take technological advances and
create from them economic benefits. This relates to my answer
to Chairman Dodd that we need to maintain that flexibility in
our economy and that providing broad opportunity and education
is one way to support that going forward.
Senator Shelby. Mr. Chairman, I want to get to another part
of your responsibilities, and that is, bank regulation.
Regulation Z, Senator Dodd has already referred to this. The
Banking Committee held a hearing on the credit card industry
that was widely followed. Witnesses at the hearing highlighted
a number of troubling industry practices, many of which are
subject to Federal Reserve oversight. I understand that the
Federal Reserve Board is currently reviewing its Regulation Z,
which implements the Truth in Lending Act.
What is the status of the Board's Regulation Z review? And
does the Board intend to use this review to address any of the
questionable industry practices raised in the Committee's
hearing?
Chairman Bernanke. Senator, we have been putting a great
deal of effort into our review of Regulation Z, with a
particular focus on short-term revolving credit, like credit
cards. One of the real challenges in improving disclosures for
credit cards and other types of lending is to make the
disclosures both compliant with legal requirements, but also
sufficiently clear and understandable that people can
understand what it is that they are getting into.
In order to improve the understandability and the clarity
of disclosures, the Federal Reserve has conducted extensive
consumer testing. We have not just done it in the ivory tower,
as somebody mentioned. We have gone out into the public and
conducted focus groups. We have done psychological testing to
try to figure out how to structure disclosures in a way that
people will notice them, pay attention to them, and understand
them. So that has been a big part of our effort.
We are very close to the end of that effort. We expect to
have a proposed rule out within a few months, by the middle of
this year, and I believe and hope that it will address many of
the appropriate concerns that people have had about disclosures
and practices in the credit card industry and other short-term
debt.
Senator Shelby. Chairman Dodd, I know my time is up, but
could I just ask the Chairman a question for the record? I
think it would take some time.
We have been concerned for some time about the
implementation of the Basel II Capital Accord and the impact
that Basel II may have on safety and soundness of the U.S.
banking system. I am worried that Basel II may lead to a sharp
reduction in the amount of capital banks are required to hold,
which would put U.S. taxpayers ultimately at risk of having to
pay for expensive bank failures, if there are some. I believe
that it is critical that Basel II be implemented with the
utmost care and diligence.
Mr. Chairman, would you for the record update the Committee
on the status of Basel II Capital Accords, the current time
frame for implementing Basel II, and also comment on whether
there is another time for banking regulators, including
yourself, to finalize the rules in implementing Basel II so
that banks adopting Basel II can start the test run for Basel
II presently scheduled to begin next year? If you care to, you
can do it for the record.
Chairman Bernanke. Should I answer, Mr. Chairman?
Chairman Dodd. We will make that for the record, and let me
add to that quickly before turning to Senator Schumer. Some of
my bankers have raised the issue, too, about foreign
acquisition of domestic banks and whether or not they are
really meeting the capital requirements today. We have some
real concerns raised by my bankers in Connecticut about this
issue. They follow it very closely. And I would add that to the
question that Senator Shelby has raised with you, whether or
not that is something we should be looking more closely at. Are
they actually meeting those criteria before those acquisitions
occur?
Senator Schumer.
Senator Schumer. Thank you, Mr. Chairman, and it is your
first year. You have completed a year. You are getting good
grades everywhere, and I would concur. I think you are doing a
fine job and have vindicated the support that you received
almost unanimously from this Committee.
My first question deals with the issues of income
inequality in the speech you gave yesterday where you pointed
out that this has just been an ideas, almost instantaneous,
economy and wealth agglomerates to the top. You talked about
Manny Ramirez. I would like to talk about Henry Ford, his great
idea. He deserved to become rich from it, but he needed a
million people to carry it out, and each of them made $10,000 a
year to make the cars, distribute the cars.
Bill Gates, maybe the Henry Ford of our generation, had
another. He mass produced in a certain sense computer
platforms, but he needed 10,000 people to carry it out, and
they each made a couple million dollars.
Given that this is happening--and it is not the
Government's doing. This is just the nature of our economy, as
you pointed out in the speech. Doesn't it make sense, if this
goes too far, to have a more progressive tax code, even though
Government did not cause it, to keep a middle-class base, to
keep too much wealth from agglomerating at the top? I am not
asking you any specific policy, but just a general view that
wouldn't progressivity, further progressivity in the tax code
help be an antidote to the natural flow of money to the very
top, to the few who create those new ideas and deserve to make
money from that and not get in the way of doing that?
Chairman Bernanke. Senator, your comparison of Henry Ford
and Bill Gates was very telling, actually. Henry Ford developed
the assembly line, and it allowed relatively low-skilled
workers to be very productive in that context and generated
high wages for those workers.
Bill Gates created a new model of operating systems in the
high-tech industry. The kinds of workers he needed were much
more skilled workers.
Senator Schumer. Exactly, and many fewer of them as well.
Chairman Bernanke. And fewer of them, certainly. So, I
think that one very important lesson from that comparison is
that those who are going to benefit the most from globalization
and technology are those who have the skills, who have the
capabilities to benefit and to be productive in that context.
So, I would say whatever we do with tax policy and transfer
policy, I hope that we will try to address the issues of skills
and individual productivity.
Senator Schumer. I agree with you completely. But that is
going to take a while.
Chairman Bernanke. Senator, on the issue of progressivity,
you will be unsatisfied. As the head of the nonpartisan central
bank, I think it is very important for me not to take sides on
issues where values are very important.
Senator Schumer. Talking about more money or more help for
education is as much a policy decision as talking about the
progressivity of the code. I am not asking you about a specific
policy, and I think you should address it.
Chairman Bernanke. Senator, I am sorry, I decline, because
there really is a value judgment involved in trading off--I
talked about this in my inequality speech. I said, on the one
hand, you have the importance of promoting incentives. Senator
Bennett mentioned entrepreneurs, people who take risks. We have
to give them incentives to take risks. On the other hand, as
you point out, correctly the tax code has an important role to
play in generating more equality. But I am not an elected
official, so I cannot comment.
Senator Schumer. Okay. I think you are ducking it, in all
due respect, because you do talk about other policy issues, but
let me move on.
Trade deficit. Are you happy with the size of the trade
deficit, at the rate of its growth? And do you think stronger
policies, particularly against those who we have huge balance
of trade deficits with to open their markets, not particularly
to close ours, would be helpful in reducing the trade deficit?
Obviously, my focus is on China, but I would ask a more general
question.
So, the first question, are you happy with the size of the
deficit and its rate of growth?
Chairman Bernanke. No, I am not happy with it.
Senator Schumer. Do you think policies that would not
require, but importune other countries whose markets are not as
open as ours to open theirs would be a salutary change and that
we should emphasize that as a, if you will, pro-free trade way
to deal with the trade deficit?
Chairman Bernanke. Senator, I am entirely in favor of
trying to open markets. We have the World Trade Organization,
and China is a signatory. We should aggressively pursue
attempts to open markets to foreign investment and----
Senator Schumer. Do you think the Chinese have done enough
on their currency?
Chairman Bernanke. They have moved in the right direction,
but, no, I do not think they have done enough.
With respect to trade, though, I would like to add that
trade policies alone are not going to resolve the trade
deficit. There is also the issue of saving and investment,
which we do need to address as well.
Senator Schumer. I think I agree with you on that.
Senators Graham, Baucus, Grassley, and myself are going to
try to do a WTO-friendly way or compliant way of getting the
Chinese to do more on currency, and I hope you will look at
that carefully and be supportive.
A final question is on competitiveness of our financial
institutions and industries. Coming from New York, I am
obviously concerned, but so should my colleagues from many
other States be. The Carolinas, South Dakota, New Jersey, so
many other States have a stake here. And the problem we seem to
be facing is this: That other regulatory and legal schemes--you
know, regimens in other countries are looser than ours. And now
that capital can flow quite freely, companies who are
international and their loyalty to their stockholders means
they are not going to be loyal to the United States or it will
precede their loyalty to the United States may seek the lowest
common denominator or a lower common denominator. And the
pretty exquisite balance between regulation and
entrepreneurialness that we have had over the last quarter of
the last century seems to be in some trouble, that people are
fleeing to go to less regulated places for their short-term
gain, even if it creates problems in the system as a whole.
Could you comment on that problem? Do you think it is a
real one? Do you think it is only caused by simply knowledge
spreading and the Internet or is caused by some of these
regulatory differences? And do you think we should look at that
in a policy way to do something about it?
Chairman Bernanke. Senator, to some extent, it is caused by
the diffusion of knowledge and the growth of other markets, and
to the extent that we are having a more competitive, deeper,
broader capital market around the world, that is probably good
for world growth. It is probably good for even our companies
because they have more options for raising funds.
There is, though, I think, an issue of regulation, as has
been pointed out in the two reports that you are quite familiar
with. There is a subtle distinction to make. If you take
Sarbanes-Oxley as an example, to the extent that Sarbanes-Oxley
appropriately balances disclosures and governance against the
cost of achieving those disclosures and governance, I think it
is worthwhile to keep. Even if there is some short-run tendency
for firms to run away from that, because the investor wants
that protection, ultimately the investor will reward firms that
list on exchanges that have appropriate, adequate protections
such as a well-designed Sarbanes-Oxley.
That being said, there are always concerns about Sarbanes-
Oxley, about Basel II, about the regulatory structure, about
securities litigation, about CIFIUS, where legitimate questions
can be raised whether the costs of those regulatory schemes
exceed the actual benefits to investors and to others of
implementing them. As a general matter, not just in the context
of competitiveness of our exchanges, we should always be
looking to restore that balance and make sure that the costs we
are imposing from a regulatory side are justified in terms of
the social benefits.
So, for example, it is a good step that the Public Company
Accounting Oversight Board and the SEC have taken some steps in
revising the audit standard to reduce the burden of SOX 404
while maintaining, I believe, many of the benefits in terms of
disclosure and controls that that law was intended to achieve.
Senator Schumer. Thank you, Mr. Chairman.
Chairman Dodd. Thank you very much, Senator Schumer.
Senator Bunning.
Senator Bunning. Thank you, Mr. Chairman.
Two of your predecessors, Paul Volcker and Alan Greenspan,
always expressed great concern. I happen to have served on the
House Banking Committee when Mr. Volcker was the head of the
Federal Reserve and then Chairman Greenspan, both House Banking
and now Senate Banking. And yesterday in the Washington Post,
there was an article about the inversion of the yield curve for
8 straight months and how local banks and banking in general--
and since that is the Fed's charge, to make sure that our banks
are sound and secure--were having difficulty with the inverted
yield curve.
I have questioned you about this before, and you have
always said it is not very important in this day and time. I am
going to ask you again: How long can we stand to have--we have
had it 8 straight months now--an inverted yield curve, where
short-term rates are higher than our 30-year bond rate?
Chairman Bernanke. Senator, the usual context of this
question is: Does an inverted yield curve presage a recession
or a slowdown in the economy?
Senator Bunning. Well, it also hurts our banks very badly.
Chairman Bernanke. I will address that, sir. Just very
quickly, though, on the forecasting power of the yield curve:
There has been a good bit of evidence that declines in the term
premium and perhaps a great deal of saving chasing a relatively
limited number of investment opportunities around the world
have led to a somewhat permanent flattening--or even
inversion--of the yield curve, and that pattern does not
necessarily predict slowing in the economy or a recession.
Indeed, if you look at other measures of financial markets such
as corporate bond spreads, you do not see anything that
suggests anticipations of future stress.
The question you raise is a different one, of course, which
is the effect on the banking system. Specifically, banks that
do their traditional business of taking deposits and making
loans are going to be put under pressure because the short-term
deposit rates tend to be higher than the loan rates they can
get. I recognize that is a problem for some banks. Other banks
have been able to deal with it by hedging interest rate risk,
by getting fees, and finding other ways of doing their
business.
So, overall, I do not see the banking sector as being under
tremendous pressure in terms of its profits and asset quality
at the moment. But I recognize--particularly for smaller banks,
which have fewer options in terms of raising funds and earning
fees and income--that the inverted yield curve does produce
some pressure.
From the Federal Reserve's point of view, we are entirely
cognizant of that and hear about it from bankers. We have to
set monetary policy, of course, to achieve overall price
stability and maximum sustainable employment growth. So we
sometimes find that in the context of various industries policy
creates some pressure in individual industries. But we only
have this one tool, and we try to use it to achieve overall
macroeconomic stability, while fully recognizing that it does
create some problems for some sectors.
Senator Bunning. You are telling us today that an inverted
yield curve down the road will not affect the economy. Did I
misunderstand that, or is that accurate?
Chairman Bernanke. I think the yield curve could be
inverted for a considerable period without significant
implications for the economy as a whole, yes--possibly for some
banks, but not for the economy as a whole.
Senator Bunning. How does this economic cycle that we are
in, and recovery and expansion, compare to previous recoveries
and expansions? In other words, when we hit the wall in 1992
and then also in 2002, how does this recovery that we are
involved in now compare to those recoveries?
Chairman Bernanke. I would say that qualitatively it is
fairly similar to the recovery that followed the 1991
recession, with many of the same features. There was weakness
for some time after the recession ended, including a period of
so-called ``jobless growth.''
Senator Bunning. But we did not have a housing market
that----
Chairman Bernanke. Well, the housing market was actually
quite weak during the recession itself. The decline in
residential starts during 1991 was not quite as large, but in
the same neighborhood, as what we have seen recently. During
the recovery period, we did not have that particular pattern,
but in many ways, it was a fairly similar expansion.
Senator Bunning. Could you estimate how close we are to a
full employment in the United States?
Chairman Bernanke. It is very hard to say specifically, and
I do not pretend to know an exact number or an exact estimate.
But the economy has certainly been growing faster than
potential for a number of years, and that can be seen in the
tightening of labor markets and capacity utilization. So,
clearly, we are much closer today, I think it is safe to say,
to full employment, to the sustainable level of growth than we
were a few years ago.
Senator Bunning. And in your opening statement, you made
the remarks to the effect that you have not seen any new
evidence of inflation since your last Fed meeting in January or
February?
Chairman Bernanke. We have not had much information on
inflation since just 2 weeks ago, but the recent readings on
inflation have been encouraging.
Senator Bunning. Encouraging?
Chairman Bernanke. Yes.
Senator Bunning. Okay.
Chairman Bernanke. But as I indicated in my remarks, they
are somewhat noisy, the data, and we do not want to draw a
complete conclusion----
Senator Bunning. Well, that is why we have Fed meetings,
you know, every month or two.
Chairman Bernanke. That is correct, Senator.
Senator Bunning. Thank you very much, Mr. Chairman.
Chairman Dodd. Thank you very much, Senator Bunning.
Senator Casey.
Senator Casey. Thank you, Mr. Chairman, and the other
Chairman in the room, thank you for your time and for your
service. I have two general questions, one on debt and one on
children.
With regard to debt, I was looking at the report that the
Federal Reserve Board is submitting in connection with your
appearance here today and your testimony. And, in particular, I
wanted to direct your attention and the attention of others to
the report.
I note here that in the section which deals with the
Federal Government and expenditures and outlays by the Federal
Government, it says, ``Net interest payments increased 23
percent in fiscal year 2006 as interest rates rose and Federal
debt continued to grow.''
Then it goes on from there and talks about the outlays for
Medicare Part D, Medicare itself up 10.5 percent. It talks
about disaster relief, Medicaid spending, and then it gets to
the next part of the paragraph. ``Outlays for defense in fiscal
year 2006 slowed to their lowest rate of increase since fiscal
year 2001, although the rise was still about 6 percent.'' That
is the first predicate of my question.
It goes on to talk about debt, the Federal debt subject to
the statutory limit has increased, now we are at the $8.6
trillion level.
I guess with that as a predicate, let me tell you what I
think about this. I think that that is unsustainable, and as
much as we have talked, as important as it is to talk about the
good sound bite, reducing our dependence on foreign oil, I
think we need a lot more effort in this Congress and in this
town on reducing our dependence on foreign debt. I think it is
making us less safe in the fight against terrorism. I think it
is making us less safe in terms of our ability to spend money
on defense, not to mention our inability to spend money on good
investments in the economy, as you talked about, education,
training, and the rest.
So, I guess my basic question is: In light of that data,
and any other data you want to factor into this question, are
these numbers sustainable, an $8.6 trillion debt and a 23-
percent increase in net interest payments? Is that sustainable
over time?
Chairman Bernanke. I recently testified before the Senate
Budget Committee, and I pointed out--and it is not exactly a
secret--that the long-term prospects for the U.S. fiscal
situation are quite serious. In particular, we are going to
start seeing--as the population ages--expanded costs of
entitlements, Social Security and Medicare; those grow very
quickly. And we will generate, if no action is taken, an
increasing spiral of higher interest payments and debt.
I quoted in that testimony several interesting, useful
simulations by the Congressional Budget Office. The
intermediate simulation suggests that by the year 2030 the
deficit will be 9 percent of GDP, and the debt-to-GDP ratio,
which is currently about 37 percent, will be closer to 100
percent of GDP--a number which we have not seen since World War
II.
So, obviously, there are a lot of issues that Congress will
debate about short-term spending and tax proposals. But if you
think about fiscal sustainability in a longer time frame,
dealing with the fiscal implications of the aging population
and rising health care costs are going to be dominant, and
essentially there will not be any way to address fiscal
sustainability without addressing that issue in some way.
Senator Casey. I wanted to pick up, in the remaining time I
have, on the issue of how we invest in children, pick up on
what Chairman Dodd spoke of earlier.
There is a great organization out there that has as its
moniker, as its message, ``Fight crime, invest in kids.'' It is
a great sound bite. Sometimes we need sound bites to make the
point. I would also assert--and I would ask for your sense of
this and your reflections on this--that you could use the same
construct for the impact on how we invest in children and how
we grow our economy. Instead of saying, ``Fight crime, invest
in kids,'' you could say, ``Grow the gross national product''
or ``Grow GDP'' or ``Grow the economy, invest in kids.''
Now, I ask you that because we are going to be making some
critically important decisions in the next couple of months and
certainly in this 110th Congress. Chairman Dodd talked about
the issue of the Head Start program. There have been votes cast
in the U.S. Senate in the last couple of years where the choice
was clearly and unambiguously a choice between investing in
Head Start or investing in education or investing in any other
support for children and their economic future, not to mention
our future, and tax cuts. Sometimes the votes have been that
stark, and there are people here who voted for the tax cuts
over Head Start and over some other priorities.
So, I would ask you about your opinion--and this is a
policy question, but I think you can answer this--your opinion
on the level of investment in children, whether it is with
regard to education or Head Start, early learning, all of these
initiatives to give kids a healthy and smart start in life, how
you see that in the context of economic growth and GDP growth,
and whether or not you think the investment currently is
adequate.
Chairman Bernanke. I think that investing in children is
extremely important and has significant economic and social
benefits. I hope that Congress will continue to look very
carefully at that.
What I do not know is precisely how best to do that, and I
think you are going to have to bring real experts here to talk
about different approaches--what works and what does not. But I
urge you to continue to do that.
In terms of priorities, to go back to Senator Schumer's
question, clearly, there are always priorities. But you can
weigh these things against tax cuts, you can weigh them against
other kinds of spending. Clearly, you have to have an overall
picture of what is important.
Again, I cannot speak to the overall combination of taxes
and spending other than to say that they should be in balance.
But I will go so far as to say that I think that there is a
significant return to investing in young kids.
In my remarks in Omaha, I even cited some Federal Reserve
research from the Federal Reserve Bank of Minneapolis, which
showed the very substantial economic returns associated with
early childhood education, and I do think that that is
certainly worth investigating.
Senator Casey. Thank you.
Chairman Dodd. Thank you, Senator Casey. Very good
questions. I appreciate your focusing attention on that.
I want to just mention, before turning to Senator Martinez,
your response, Mr. Chairman, to Senator Schumer's questions
about Sarbanes-Oxley and competitiveness. I appreciated your
answer very much to that question. There are some things
clearly that could be done to try and show some balance and
making sure we are not overburdening smaller public companies,
but your thrust was that this is working pretty well. And,
frankly, anecdotally, I suspect most of us here ask the
question of every business we talk to: How is this working? And
I must tell you, overall the response I get is a good one.
I had one company the other day say to me that, ``Even if
Congress decided tomorrow to repeal Sarbanes-Oxley, we would
decide to stay with all the things that have been required of
us. We have found that it has been very worthwhile for our
company.'' So, I appreciate your comments about that.
Senator Martinez.
Senator Martinez. Mr. Chairman, thank you very much.
I hate to differ with the Chairman, but I must say that the
experience that I hear on the competitiveness and Sarbanes-
Oxley issue is far different from that. I hear a great deal of
concern about the incredible cost and the burden of
competitiveness that it has created. And, in fact, I will begin
with this area because I intended to get into it, but our
colleague from New York, Senator Schumer, and Mayor Bloomberg
recently released a report that I found quite interesting
detailing an analysis of market conditions in the United States
and abroad and about the concern that there is about whether
New York will continue to be the financial capital of the world
or whether, in fact, there seems to be others competing for
that title, which might include London. And there were some
rather dramatic statistics of declines and increases in New
York vis-a-vis London.
One of the things that was mentioned in the report was the
U.S. regulatory framework being too complicated and the
implementation of Sarbanes-Oxley having produced heavier costs
than were expected at the beginning or when you initiated that
effort. Also it was mentioned immigration policies which create
problems for those abroad who might wish to come here to do
business, to invest in America, and the difficulties that
current immigration problems raise for that, and some of them
coming to be educated, others coming just as business people
and investors.
In any event, I wondered if you had an opportunity to see
that report and whether its finding cause the same concerns to
you that they raised to me.
Chairman Bernanke. Senator, as I indicated, I do think that
we should be trying to reduce regulatory burden, and in
particular ensuring that the costs of the burden are
commensurate with the benefits.
With respect to Sarbanes-Oxley, my intent was to say that I
do believe that there are benefits from that legislation,
including improved controls, improved disclosures, improved
governance of corporations. So there are certainly some
benefits.
It is important to decide whether we can reduce the costs
and retain the benefits, and in that respect, I think that the
proposed change in one audit standard being put forth by the
SEC and the PCAOB is a step in the right direction because it
attempts to focus on the most materially important issues, and
it also makes allowance for the size and complexity of a firm
in setting up the audit standard.
So to try to summarize, Sarbanes-Oxley accomplishes some
important objectives, but I do believe those objectives can be
accomplished at lower cost, and I think the new audit standard
moves in that direction. And in all other regulatory areas,
including those the Federal Reserve is involved, we should
continually be looking to find ways to accomplish the social or
economic objectives of the regulation at a lower cost.
Senator Martinez. Well, I agree that there are many good
features to Sarbanes-Oxley. What I was speaking of is some of
the excesses, particularly in the auditing arena and some of
the areas that have caused such an overburden of costs. So, I
appreciate your comment on that.
Shifting to the issue of home sales, I used to sit in that
very chair when I was Housing Secretary before this Committee,
and at times, I would be asked a question about a housing
bubble and in the overheated housing market whether, in fact,
we were headed for a collapse and a bubble that would burst. In
fact, we have seen as significant decrease in housing starts.
We have seen the market cool down significantly, but we have
not seen a bursting bubble. I always said at the time that the
fears of a bubble were misplaced and that the housing market is
more regional than it is national, and there were many
different features between that and a localized market.
But do you feel that the fear of a bubble has receded given
the fact that the market cooled off, that it has done so in a
fairly modest way without any cataclysmic consequences?
Chairman Bernanke. Senator, as I indicated in my opening
testimony, we think we see some tentative signs of
stabilization in demand in the housing market, that
nevertheless takes some time yet to work its way out because of
the inventories of unsold homes that still exist on the market.
I would emphasize that the signs of stabilization are
tentative, and we do not want to jump to conclusions. It will
be helpful to see what happens when the spring selling season
begins and strong demand is at that time.
But it is interesting that so far the economy has done a
good job of withstanding the slowdown in construction, which,
although substantial relative to the last couple of years, is
still similar to the late 1990's, for example. It is not that
we have had a complete collapse in construction by any means.
So the decline in construction, while it has slowed the
economy, has obviously not thrown us into a much slower growth
situation. And we have not seen substantial spillovers from the
housing slowdown to consumer spending or to other parts of the
economy.
So it is early to say that this problem is over. I think we
are going to have to continue to watch it very carefully, and
as I indicated, I think it is a downside risk to the economy
going forward. But so far, the economy has reasonably adapted
to this adjustment in the housing market.
Senator Martinez. You mentioned in your remarks also that
household finance appears solid and that delinquency rates on
most consumer loans, including residential mortgages, were low,
but you did note the subprime mortgages with variable interest
rates where delinquency rates have increases appreciably. And
it is an issue that is of great concern to several of us on
this Committee, the issue of predatory lending, the abuse of
some of our most vulnerable consumers.
Any comments on that or any issues that you see there which
could impact the overall economy?
Chairman Bernanke. I think, first of all, that this
distress in the subprime area is a significant concern. I am
obviously following it very carefully, both in terms of the
impact it has on the borrowers and lenders as well.
I do not think that it has at this point implications for
the aggregate economy in terms of the ongoing expansion, but as
I said, it is an important issue for those sectors.
I could certainly list a wide variety of things that we do
to try to address predatory lending, which I do think is an
important issue, and I think the subprime market, which is
distinct from predatory lending, it is a legitimate market.
Senator Martinez. Right. That is a good distinction to
make.
Chairman Bernanke. It also has some issues.
Just to note one action we have taken recently, along with
the other Federal banking agencies, we have issued guidance on
nontraditional mortgages, mortgages that involve interest-only
or option ARM's that may not be amortizing mortgages. We have
emphasized to the lenders that they should be, first, very
careful in their underwriting--that is, they should ensure that
the borrower is equipped to deal with payment shock if interest
rates go up, that they have sufficient income to meet higher
payments; and, second, that disclosures are adequate so that
the borrowers are fully informed about the nature of the
contract that they are getting involved in.
There are some loans that have been made that are not
turning out well, and to the detriment of both the lenders and
the borrowers. We will certainly be watching that carefully and
trying to provide guidance and oversight to minimize that risk
going forward.
Senator Martinez. Thank you, Mr. Chairman.
Chairman Dodd. Thank you very much, Senator Martinez.
Senator Bayh.
Senator Bayh. Mr. Chairman, I would like to ask you some
questions about our national security interests and the role of
the Fed in our financial system in protecting those interests.
As you probably have read, there are the tentative outlines
of an agreement with North Korea to begin to get them to change
their behavior with regard to their nuclear program. And one of
the reasons that we were able to at least achieve a tentative
understanding was because of pressure that we brought to bear
on a bank in Macau that the North Koreans used to interact with
the global banking system.
Iran, as you know, is pursuing nuclear ambitions as well.
Several Iranian banks do business in Western Europe. We are
currently attempting to do something similar with regard to a
couple of Iranian banks.
My question to you is: What can the Fed do, what can the
United States banking system do, to cut off Iranian access to
the global banking system to exert some pressure on them to
behave in a more responsible way with regard to their nuclear
ambitions?
Chairman Bernanke. Senator, the primary responsibility for
initiating such measures and enforcing them is with the
Treasury, the Financial Crimes Enforcement Network, for
example, and OFAC. They have take the leadership in trying to
ensure that American banks and, through negotiation, banks from
other countries do not deal with the banks you are referring to
in Iran and North Korea.
So we are not the leaders in that effort. However, we as
bank regulators and overseers have an important responsibility
to try to ensure that it is carried out as the rules dictate,
and as a very extensive part of our oversight responsibility,
we evaluate banks' compliance with the Bank Secrecy Act and
other such rules.
Senator Bayh. I hope you will make this a priority and
bring some sense of urgency to it. Iran is a tremendous
problem. You know, the military option is obviously something
that no one wants to have to resort to, and so we are looking
for other levers that we can utilize to try and get them to do
the right thing here. And this seems to have been effective in
the North Korean context.
My investigations in this area tell me that it has, you
know, increased the cost of doing business to the Iranians. It
has made things more inconvenient for them, and perhaps if we
continue to pursue this, we might encourage a change in
behavior on their part as well. So, I would encourage you to be
vigorous in this effort because it does affect our national
security interests in a very important area.
Staying on the subject of Iran for a moment--and you are
busy with many other things; you may not have noticed. But they
have indicated publicly that their response, if we did get to
the point of having to take some action against them because of
their nuclear program, would be to try and cut off the flow of
oil from the Persian Gulf by closing the Straits of Hormuz, so
that not only they would suffer but also the Saudis and others,
trying to maximize the pain on the global economy.
I hope that there is some contingency planning being
undertaken, so my question to you is: If such an event were to
occur, what would the impact be on the global economy, on the
U.S. economy, obviously the price of oil? You mentioned the
role that the cost of energy plays in our inflation
expectations and that thing. So what would the effect of such
an act be on the economy? And, second, are you aware of any
steps that we can take to mitigate those consequences? The
President in his State of the Union address has suggested
doubling the Strategic Petroleum Reserve, for example. Are
there other things that we could do to prepare for such an
eventuality so that we would mitigate the consequences?
Chairman Bernanke. Senator, you are pointing to an
important problem. I am not really equipped to say what the
impact of these actions would be on aggregate supply of oil and
on the oil price. I assume it would be dramatic, but I do not
know exactly how big the effect would be.
It would certainly have an impact on the world economy.
There is no question about that. And I doubt that there is
anything we can do in advance that would completely offset that
impact.
In the short-run, one of the tools we have you already
mentioned--the Strategic Petroleum Reserve--which does provide
some protection for a certain number of months, anyway, against
those kinds of disruptions. I think that would be helpful.
In the longer-term, as many people have noted, reducing our
dependence on oil would be beneficial. If we could find ways to
diversify our energy portfolio and, therefore, rely less on
this particular source, that would be helpful from a national
security perspective.
Senator Bayh. Well, I know your people are probably
stretched to their limits, dealing with a variety of things,
but I do think that some part of the Government--whether it is
your shop or Treasury or working in concert with some of the
national security agencies--we need to at least begin to some
thinking about this. God willing, we have a number of years
before we get to such an event, and God willing, it will never
happen. But I am always a big believer in you start with the
worst case, protect yourself from that, and you kind of work
back from there.
When Secretary Paulson was before us a couple weeks ago, he
reiterated the comments that had become routine by his
predecessors, and that is the Treasury's belief that a strong
dollar is in the interest of the United States of America. Do
you agree with that point of view?
Chairman Bernanke. Senator, I do agree with it, and I would
add that I defer to the Secretary of the Treasury in all
matters related to currency policy.
I would only add that the Federal Reserve, to the extent
that we can keep our economy strong and attractive to foreign
investment, will help keep a strong dollar.
Senator Bayh. Well, I agree with that, and this relates in
some regard to what Senator Casey was asking about. You may
recall that previously there had been--oh, there was a rumor in
Seoul at one point that they were going to diversify in dollar-
denominated assets, and that caused a run on their currency. A
similar rumor went through Japan not long thereafter.
What would be the impact on the value of the dollar in our
economy if the Chinese were to, for example, announce that they
were going to either diversify out of dollar-denominated assets
or were to, in fact, begin a precipitous sale of such assets?
Chairman Bernanke. Well, Senator, first, I think it is
important to understand that that is not a very likely
scenario, and China own interests would not be well-served by
such actions. They would take portfolio losses themselves and--
--
Senator Bayh. Forgive me for interrupting. That is
something similar to what the Treasury Secretary said, and the
reason for my question, Chairman, is this: You are right, it
might not be in their pecuniary best interests, but nation
states do have interests other than their financial concerns.
Let's just say hypothetically, you know, bringing pressure to
bear on Taiwan and Taiwan's allies might be worth the loss of
some money to the Chinese at some point in time.
So my concern is simply this: Global interdependence is one
thing, but the dependency is another. And it puts us in the
position of being somewhat vulnerable to another country's view
of their own best interests. And I have real concerns about
whether that is in our best interest.
Chairman Bernanke. I will answer your question, but I just
wanted to reiterate that I think the costs to them of doing
this would be greater than the costs to us.
That being said, I think a substantial move on their part
would be disruptive in the market in the short-term. In the
longer-term the dollar, the Treasury yield and so on, would
largely recover. Part of the reason is that Chinese holdings of
United States fixed-income securities--which, of course,
include not only Treasury but also GSE's and corporate debt and
other instruments as well--amount to something less than 5
percent of the outstanding dollar fixed-income securities in
the global market--which is a very significant amount, but is
not by itself enough to be a monopoly of some sort in this
market.
So if they were to do that--which, again, I do not
anticipate--it would have short-term disruptive effects. I
think that most of those effects would be short term as the
market, which is very deep and liquid, began to adjust to that
shock.
Senator Bayh. Thank you, Chairman. My time has expired.
Again, the reason for my question is simply, as a great power,
I am reluctant to see us, even for a short duration, to be in a
position of vulnerability to the actions of another government.
Thank you.
Chairman Dodd. Senator Bayh, thank you. Those are excellent
questions, and I appreciate your raising them.
Senator Allard.
Senator Allard. Thank you, Mr. Chairman.
We are currently working on our budget, and it is a 5-year
budget, I assume, you have looked at 5-year projections as far
as how our economy is going to be doing. If I remember
correctly, you pretty much feel that we are going to have a
pretty good economy for the next 5 years, certainly within the
average. Is that correct?
Chairman Bernanke. We have not released any forecasts of
the economy beyond a couple of years. The projections I gave
today suggest reasonable growth and inflation over the next 2
years. The underlying fundamentals of the economy in terms of
productivity and so on look good to me, and so my expectation
is that the economy will continue to be strong after that
period. But we have not released any specific forecasts.
Senator Allard. Now, in 2009, our Social Security surplus
begins to decline, and that is the projection that we are
looking at now, where we have had the surpluses but now they
begin to reduce. How does that get factored in? That is within
the next 2 years. We will be working on the 2009 budget in a
year from now. How does that factor into your economic growth
projections? Or is it too early to begin to have much validity
to that?
Chairman Bernanke. It is a bit early to be thinking about
that. From a macroeconomic point of view, if we focus on the
cashflows of the deficits, current in, current out, it looks
like the deficit will not be rising significantly and may even
be declining for the next few years for various reasons. So, I
do not anticipate that fiscal policy will be a major force
shaping the near-term growth pattern of the economy.
The concerns that I emphasized in my Senate Budget
testimony were really the longer-term issues of solvency and
fiscal responsibility in the context of the aging of the
population and the large increase in entitlement spending.
Senator Allard. The deficit is going down. In my view, it
is more attributable to revenues. It is not that we have done
anything particular to hold down on spending. If we do
something--and I do not know how you factor in the expiration
of these temporary taxes that have been put in place. It looks
to me like they have had a positive impact on the economy and
the revenues that are coming in. When those expire, what kind
of adjustments do you think we will have to make in our budget
projections from that point on?
Chairman Bernanke. Well, again, I am not going to take a
position on whether they should be allowed to expire. I think
if they do expire, it would probably increase revenues
somewhat. It would have other effects on the economy in terms
of incentives and growth potential as well.
From the Federal Reserve's point of view, we are simply
going to look at the fiscal situation as it evolves and make
our adjustments to try to maintain full employment as the
economy goes forward. I think the considerations the Congress
should have with respect to near-term tax policy should be less
to do with maintaining short-term full employment--we will be
able to address that--but, rather, think about the long-term
trade-offs between the benefits of lower taxes and the costs of
lower taxes, essentially.
Senator Allard. I am going to move over to the small
business question. When you look at the economy, it seems as
though--most of the figures I look at on the small business
sector, they contribute about 50 percent, 52, 53 percent of the
growth in the economy. Is that about what you look at?
Chairman Bernanke. It is similar--small and large
businesses are similar in magnitude, and so in that respect,
you are correct, yes.
Senator Allard. You are saying that the small business
sector would grow--you think it is 50-50, then, between
economic growth from large business and economic growth from
small business?
Chairman Bernanke. I do not recall the exact data, but I
believe I have heard that number for job creation as opposed to
growth. But it would be similar, yes.
Senator Allard. Okay. Thank you for that. That was just a
point of information. I wanted to see how you were looking at
that.
Chairman Bernanke. We can provide you with more detailed
information.
Senator Allard. I would appreciate that, if you could.
The other question is Sarbanes-Oxley. Apparently, there is
a rise in private equity firms, and they are increasingly
acquiring some public companies and apparently taking them
private. Does that phenomenon concern you?
Chairman Bernanke. Not necessarily. It can be a good method
of enforcing discipline on corporations and management. By
taking the firms private, they essentially create a situation
where the private equity investors have a short period of time
in which to create a more productive, more effective, and more
profitable firm. They then usually try to bring the firm back
into the public markets, so it is not in some sense an attempt
to permanently escape Sarbanes-Oxley, because they do
eventually want to come back into the public markets.
So, generally, it is a policy development in that it
creates more competition for corporate control and should
increase discipline among management. There may be some
circumstances where the leverages are excessive or that there
are other problems associated with it.
Senator Allard. When I was taking economics in college, I
think full employment was considered 5 percent. Is there a
figure like that that most people generally agree is a full
employment figure? Or are there other variables you have to
bring in, you cannot use a static number like that?
Chairman Bernanke. The Congressional Budget Office uses, I
think, 5.2 percent.
Senator Allard. Yes.
Chairman Bernanke. But the Federal Reserve does not have a
fixed number that we use. Again, as I indicated earlier, we try
to look at a wide variety of indicators, both of the labor
market and of the general economy in terms of prices, for
example. In the past, we have found that the amount of
employment the economy can sustain on a long-term basis changes
over time. It changes within demographics, with the structure
of the labor market, and with the structure of industry. It is
not, I think, good policy to have a fixed number in mind. It is
important to be flexible, look at all the information that is
coming in, and try to make an ongoing judgment about how the
capacity of the economy is adjusting.
Senator Allard. And do you think the unemployment is at a
desirable place in the economy right now?
Chairman Bernanke. Well, as I indicated earlier to Senator
Bunning, we are certainly much closer to the capacity of the
economy now than we were a few years ago, as we have seen
unemployment come down and capacity utilization go up. Whether
we are at that level or not, again, I cannot say. We will be
looking at a wide variety of indicators and trying to make a
judgment about where the economy should go.
Senator Allard. In addition to that, wages have gone up,
haven't they?
Chairman Bernanke. Nominal wages have gone up, and we have
seen some increase in real wages as well, and that is a good
development.
Senator Allard. Thank you, Mr. Chairman.
Chairman Dodd. Thank you, Senator.
Senator Menendez.
Senator Menendez. Thank you, Mr. Chairman.
Chairman Bernanke, I want to start where I started off in
my opening comments to you. I am very concerned about the
economic squeeze that has been put on the middle class,
particularly since the turn of the 21st century. Since the
beginning of 2001, middle-class families have experienced
increased levels of debt, anemic growth in real wages, all the
while essential costs for food, housing, and medical services
have increased at levels drastically higher than inflation.
As a result, the financial security of middle-class
households has suffered, and more and more American families
are unable to afford life emergencies such as an unexpected
health problem or unemployment.
Employment opportunities are at their lowest level since
the Great Depression. Since the recession ended in November
2001, job growth has averaged a mere eight-tenths of a percent
per month, less than a third of the 2.7 percent average growth
we experienced in previous recovery periods since World War II.
For the first time since the 1950's, job opportunities have
actually decreased from a 16-percent growth rate in the 1990's
to a 14-percent decrease since March 2001.
I look at that and I add to that factor that families seems
to me to be living on thin ice. I hear these stories of
families in New Jersey that they are only one unexpected
illness or lay-off away from sinking into perpetual debt. I
think one measure of this economic insecurity is the percentage
of middle-class families who have at least 3 months of their
salary in savings. The percentage of middle-class families who
had 3 or more months salary in savings rose 72 percent from
16.7 percent in 1992 to 28.8 percent in 2001. So middle-class
families are becoming more secure year by year. But,
unfortunately, in the span of less than 4 years, that
percentage dropped by over 36 percent, down to 18.3 percent in
2004.
Finally, I noted with interest in your written statement,
you said, ``Consumer spending continues to be the mainstay of
the current economic expansion.'' That is true, but when you
add that reality to anemic growth in wages and sharp increases
in the cost of necessities, household debt in America has risen
to record levels over the past 5 years. By the third quarter of
2006, outstanding household debt was 130 percent relative to
disposable income. That means that the average family is in
debt of over $130 for every $100 it has to spend. And,
additionally, the average household savings rate has actually
been negative for the past seven quarters, averaging about a
negative 1 percent rate for 2006.
So, I look at all of this, and I say to myself, you know, I
have my friends and colleagues who are heralding this great
economy. I do not get the sense that people back at home and in
other parts of the country feel that good about it. You see it
in every poll of the barometer of their feelings. They feel
really squeezed and really put upon.
And so my question to you is: Aren't these indicators a
real cause for concern as it relates to the struggle that the
middle-class families in this country are facing? And how do we
create an economy that is more inclusive and which the macro
benefits end up being achieved by those who are the great
center of those who keep this country afloat?
Chairman Bernanke. Senator, in my remarks in Omaha, I did
the usual economist's ``on the one hand, on the other hand''
approach. On the one hand, average living standards in the
United States have risen very substantially since World War
II--very substantially--and that is true for the majority of
the population. Even in the last 10, 15 years, we have seen on
average, or even at the median, middle parts of the income
distribution, pretty good overall growth, not year-to-year but
over a period of time. So there has been a general improvement
in living standards, which has affected a very large part of
the population.
That being said, on the other hand, there are various
issues, as I talked about in my remarks, that inequality has
increased. We have seen more concerns about job security
related to trade and technology. Health care remains a concern.
People are concerned if they lose their job they will not be
able to afford new health care or move their health care
between their existing employer and a potential new employer.
You mentioned wealth. Wealth is very unequally distributed
in the United States. A big challenge is to help people in the
lower part of the wealth distribution begin to save and
accumulate assets so they can have some reserve against the
kinds of problems you referred to, like a health emergency or
unemployment or some other problem that may arise.
So my broad answer is that I do think the economy has
strengthened over time and the benefits have been felt by a
large part of the population. But there are persistent issues
that relate to people's sense of security or insecurity, and
there is no single answer because each of these issues--wealth
creation, health care, inequality--are all large issues, and
they each require individual attention.
Senator Menendez. I appreciate that. It seems to me that
the policies both in the taxing side as well as in the
incentive side and in the programmatic side that would go to
narrow these divisions--you have mentioned education; I
certainly agree with you on that. But we have seen educational
outcomes rise, and yet we have still seen inequality rise.
We have challenges, as it relates to how families achieve
health care. We have challenges maybe in policies that
incentivize savings and find ways to help that segment of
society save. It seems to me that this consumer-driven
expansion of the economy at some point at the cost of debt has
a consequence to it. And so it is a real concern.
One last question. In the written version of your remarks
to the Chinese Academy of Social Sciences in December, you
referred to China's currency policies as ``an effective
subsidy'' for the country's exporting industries. I am just
wondering why you omitted that reference in your presentation
on December 15?
Chairman Bernanke. I omitted it because I thought at the
time that it would be more clear to my audience there in
Beijing if I explained it a little bit differently. But I stand
by my written comment. I think it is accurate.
Senator Menendez. Thank you, Mr. Chairman.
Chairman Dodd. Thank you very much, Senator.
Senator Sununu.
Senator Sununu. Thank you, Mr. Chairman.
I want to first begin by going back to a subject that was
brought up, and I think inappropriately so, in a discussion
about whether you, Chairman Bernanke, should be willing to talk
about ``policy'' before this Committee. As most everyone has
noted, you talked about education in your opening statement.
And the suggestion was made, by, I think, more than one
Senator, that while education is policy and if you talked about
education, therefore, you should be willing to talk about
policy prescriptions on the tax side, and in particular talk
about raising tax rates. And I think a lot of this discussion
about income inequality, quite frankly, is a prelude to a
policy recommendation from some on the other side of the aisle
to raise tax rates on entrepreneurs and individuals in certain
income brackets.
Well, I think that that sequence of conclusions is just
flat wrong because it is entirely appropriate for the Fed
Chairman to talk about education as an input, like productivity
or technology. Education and technology affect productivity,
productivity affects growth rates, and perhaps inflation. That
is entirely appropriate.
But it is, of course, not appropriate for Chairman Bernanke
to talk about or recommend specific policy prescriptions in the
area of education at the State, the Federal, or the local
level, spending on a particular program, school vouchers or
issues that people on various sides of the aisle might support.
So, I think we need to make this distinction. I think it is
unfair to the Chairman to suggest that because he talks about
the value of education, generally speaking, to the workforce in
terms of its flexibility that he should be willing to weigh in
on education legislation or tax legislation that Members might
be writing.
I guess that is the opinion piece, and now I will go on to
my questions.
You noted that growth in the second half of 2006 was 2.75
percent. Was that higher or lower than you originally expected,
or expected, say, a year prior, a year out? And why was it
higher or lower than your expectations?
Chairman Bernanke. It was close to our expectation. Our
assessment was that the economy was making a transition to a
more moderate and sustainable pace, which would be something in
that general vicinity.
It does look that the fourth quarter GDP growth number is
going to be revised down somewhat, and so the actual number
will be a bit lower. But probably the implications will be
slightly stronger first quarter, so it does not really change
the overall picture, which is that we see the economy growing
at a healthy pace, but it is one that is sustainable and not
overheated.
Senator Sununu. Thank you, and I want to apologize for not
presenting the option that you might have been correct in your
projection. I suppose that should have been one of the choices.
You noted in your testimony that real incomes should
continue to rise. At what rate do you project real incomes to
rise over the next four to six quarters?
Chairman Bernanke. Well, it depends on what your definition
of ``income'' is. We have seen real wages growing the last half
of 2006 by about 3 percent in real terms. I hope to see
continued strong growth in real wages. I am not quite sure
whether it will be quite that strong, but I think as long as
energy prices do not rise quickly again, we should continue to
see good growth in real wages.
Broader measures of income should grow broadly at the same
pace as GDP, and our forecasts are for something between 2.5
and 3 percent.
Senator Sununu. And when you talk about broader measures of
income----
Chairman Bernanke. Including capital income and so on.
Senator Sununu. You talked about the fact that there was a
7-month supply in unsold homes in the third quarter of 2006.
Where do you expect that inventory to go in the next 6 to 12
months? Has it peaked or do you expect the inventories to
increase further?
Chairman Bernanke. The predicate is that we have seen what
we call ``tentative signs of stabilization in demand for
housing.'' If, in fact, the demand for housing is stabilizing--
and, again, we will not know that for sure, I think, until we
see sales figures in the spring--then we should see from here a
gradual decline in the months for sale inventory. The normal,
at least for the last 8 to 10 years, is 4\1/2\ months of homes
for sale, and my anticipation would be that we would get back
toward that general level by the end of next year, assuming
that demand stabilizes.
Senator Sununu. By the end of 2008, not the end of 2007.
Chairman Bernanke. Yes, 2008.
Senator Sununu. The last question. I guess the question is:
Please explain this to me. It is one of the charts, and the
monetary policy booklet is, I think, very well written and very
informative, no surprise there because, as you know, you have
very good staff. But there is the graph of the savings rate
from 1983 to 2006.
From 1983 to 2006, we had two recessions, three bull
markets, two market crashes. We had rising and falling
deficits. We did have a relatively steady trend in improving
employment numbers and a lowering of the rate of unemployment
and a fairly strong record of dealing with and containing
inflation. And yet the personal savings rate, you know, that
chart is a steady downward trend through all of these things.
And I am curious to know what the factors are that go into that
steady decline in savings rate. We know it means that people
are consuming more than they are earning or a greater
proportion of what they are earning. But what is contributing
to that trend? And is this something that the Fed is worried
about?
Chairman Bernanke. Well, you raise a question that a lot of
people have weighed in on. It is a complicated question. I
think several factors have been pointed to. One is
demographics. Different cohorts or different generations have
different propensities to save. The baby boomers have not been
particularly impressive in that respect, and as they have
become the biggest recipients of income their savings rates
have shown through.
Senator Sununu. I apologize for interrupting, but has there
been an evaluation of the propensities of different cohorts
currently?
Chairman Bernanke. Yes.
Senator Sununu. And how much of this declining savings rate
can be attributed to that one cohort?
Chairman Bernanke. Well, there have been a number of
papers, and we would be happy to send you a few surveys or
summaries of some of the research that has been done. A number
of papers have looked at this demographic issue and viewed it
as being important, although not necessarily the whole story.
The other important part of the story is that personal
savings rates are out of current income, and they do not
include capital gains of any kind. So the general strength of
the stock market and then more recently of the housing market
has meant that people could increase their wealth without
saving, and that has been, I think, an important factor in
leading to a lower savings rate more recently.
The other technical point to make is that private saving
actually consists of the sum of the household or personal
savings together with the savings done by corporations. Savings
by corporations has become a larger share of the private saving
than overall, and in a sense, the corporations ultimately
belong to the households, whether you are a small business
owner who is keeping profits in your business or an investor
who is enjoying capital gains in stocks. Some of that saving is
not appearing in households because it is taking place in
corporations. It is a measurement issue.
But I think it is an issue because the national savings
rate has come down, and it contributes to issues like the
current account deficit we have talked about. Our anticipation,
as I mentioned in the testimony, is that the household saving
rate should rise a bit in the next couple of years partly
because housing prices are not rising as fast and people will
turn back to saving from their current income. But we do not
anticipate anything like the 12 percent in 1985 anytime soon.
It is going to be a slow process.
Senator Sununu. Thank you very much. Thank you, Mr.
Chairman, and I would note, since I am not a member of the
baby-boom generation and you are, I look at every possible
opportunity to blame something bad on your generation.
Thank you.
Chairman Dodd. Well, you have not proven you are part of
the Greatest Generation either yet.
[Laughter.]
Senator Sununu. And I would never make such a claim.
Chairman Dodd. I was just going to note, I have been on
this Committee some 25 years, and I recall with great fondness
your predecessor appearing here on numerous occasions, and I
cannot recall specifically the Members who may have raised, but
the number of times Chairman Greenspan was asked to support
specific tax cut policies was rather frequent on the Committee.
So this is not a first-time occurrence that a policy question
was raised to a Chairman of the Federal Reserve.
Senator Sununu. But my point is that he would never answer
the question, and that was the right thing to do.
Chairman Dodd. And I suspect my colleague from New
Hampshire may have been one of the people to ask those
questions.
I would just note as well on the savings rate issue here, I
am told--and maybe you can correct me on this if I am wrong,
Mr. Chairman--that the last time we had a negative savings rate
of this magnitude, it was the Great Depression. Is that correct
historically?
Chairman Bernanke. I think that is correct.
Chairman Dodd. Someone mentioned to me the other day as
well that, of course, the consumer debt issues are staggering,
and at least the revolving debt, a good part of which is
probably credit card debt, on the average is around $9,300 per
individual. Does that number ring true with you?
Chairman Bernanke. I do not know the number for revolving
debt specifically. The incidence of debt issues varies quite a
bit across the population. For a good bit of the population,
particularly those of higher incomes, there has been asset
accumulation which offsets the debt.
Chairman Dodd. Right.
Chairman Bernanke. So, in particular, over the economy as a
whole, the average loan-to-value ratio for homes is about 50
percent. That is, the mortgage companies own half the housing
stock and the public owns half the housing stock. But there are
certainly segments of the population who are facing very high
debt loads, either through their mortgage borrowing or through
credit card revolving debt, and for them it is obviously a
hardship.
Chairman Dodd. Thanks very much.
Senator Tester.
Senator Tester. Yes, Mr. Chairman, I do have questions, and
I do hope to ask them, but my comrade Senator Brown has a
commitment, and I will defer to him for now.
Chairman Dodd. Thank you.
Senator Brown. I thank my friend from Montana. Thank you,
Senator Tester.
Chairman Bernanke, in your remarks last week in Omaha, you
noted that our policy responses to economic inequality must be
informed by our ethics and our values and are ultimately
political questions. You said a moment ago that inflation was
the canary in the mine. I have for 5 or 6 years worn a
depiction of a canary in a cage on my lapel to signify the
Government's role in everything from mine safety to the
environment to minimum wage to Medicare.
You also expressed--and I think that the ethics and values
in our domestic economy, I think those ethics and values are
reflected in what we do in our domestic economy, like the
canary in the cage. It is minimum wage and it is Medicare and
it is Social Security, and it is helping the middle class
thrive, as it has done in the last 100 years. And there has
been clearly a consensus in this country, differences on the
edges perhaps, but a consensus that those ethics and values
drive what we do in our domestic economy.
It seems to me those values and ethics do not stop at the
water's edge, that as a Nation we should continue to propagate
and promote those same ethics and values as we have done in our
country in our domestic policies and our domestic economic
issues. We should look at those internationally.
I know you expressed concern that inhibiting trade flows
would do more harm than good, but I would argue that if our
country is, in fact, going to live its values and going to live
the ethics that we discuss and that we sometimes pat ourselves
on the back about, we would look internationally in some of
those cases.
I would just start by asking if--we have as a Nation our
values say that we should not buy products manufactured by
slave labor in China. Do you agree with that?
Chairman Bernanke. Absolutely.
Senator Brown. Okay. And would you say then that we should
not import products made by child labor.
Chairman Bernanke. Yes. I agree that we should not.
Senator Brown. Okay. Then I guess that would be--the next
step would be we should not import products produced in
sweatshops, if we, in fact, can agree on a workable definition
of ``sweatshops.''
Chairman Bernanke. Well, that is a very difficult
qualification you just added at the end. Just to get where you
are going, I think it is probably not a good idea to try to
enforce Western-level standards of worker benefits in emerging
market countries. Since those workers have such low
productivity, if we were to insist on the same standards we
have in the United States in terms of benefits and the like,
the workers would either have very low wages or no job at all.
I think the way to get to the kinds of living standards we have
in America is to allow people to participate in the market and
to produce.
We in the United States, of course, have come a long way,
starting from situations where workers did not have very good
protections to a situation now where we have much better
protections.
Senator Brown. But, Mr. Chairman, if I could, we also did
not have a foreign government implanting on us an economic
structure with foreign investment and that international
economic structure.
Let me take this in a little bit different direction. I
agree we should not impose--we should not have imposed under
NAFTA or CAFTA minimum wage--the minimum wage that we have in
the United States, of course, we should not have imposed it in
Guatemala. But these are not Western--when you talk about
International Labor Organization standards, that is an arm of
the United Nations, I believe, and that is not Western economic
standards.
Does that mean then you would support, if you were looking
more internationally, would you support International Labor
Organization standards in these trade agreements that we
negotiate?
Chairman Bernanke. I believe those standards come in many
different levels, and there are literally hundreds of them.
Senator Brown. There are five central International Labor
Organization provisions and standards, there are questions
within those, but the right to organize and bargain
collectively, the prohibition on forced labor, the prohibition
on child labor, those kinds of general standards that we have
not--we did in the Jordan Trade Agreement, but we have not in
the last 6 or 7 years. Is that a policy question reflecting our
ethics and values that we should pursue?
Chairman Bernanke. I think it is. I think it would be
reasonable to look to basic human rights, such as slave labor
and forced labor. I think those are not something we want to
countenance. When it becomes a question of whether we should
require minimum wage, for example, it is a much difficult
issue, and----
Senator Brown. That is not one of the ILO standards.
Chairman Bernanke. Okay.
Senator Brown. Okay. Fair enough.
Let me shift for a moment to industrial loan companies
briefly. As you know, the FDIC has extended for 1 year a
moratorium on commercial firms like Wal-Mart owning a bank
through and ILC charter. This Committee and this Congress have
just a short time--a year--to address the important issues
involved before the moratorium expires. Do you have any
concerns on the uneven regulatory structure between banks and
what perhaps would be an unlimited number of commercial firms
owning ILC's?
Chairman Bernanke. The Federal Reserve is concerned about
an unlimited expansion of the industrial loan company
exception. We have two particular concerns, which we have
talked about on a number of occasions. First is the mixing of
banking and commerce. The Congress in Gramm-Leach-Bliley and
other contexts has expressed its desire to keep banking and
commerce separated. I agree with that, and I think that is an
issue for the Wal-Mart acquisition, for example.
The other concern is about consolidated supervision. If
there is an acquisition of an ILC by either a commercial or
noncommercial firm, I think it is important that the oversight
of that combined entity be done at the higher level to ensure
that there is sufficient financial strength in the holding
company to ensure the safety of the deposit insurance funds for
the ILC itself.
So those two principles are important to keep in mind as we
debate this question.
Senator Brown. Thank you.
And, Chairman Dodd, Senator Johnson as you know has been
very involved in the ILC issue.
Chairman Dodd. Right.
Senator Brown. And we clearly in this Committee need to
pursue that.
Thank you, Senator Tester, very much.
Chairman Dodd. Thank you very much, and I am sorry Senator
Bennett was not here to engage. I know he has some strong
interest in this subject matter. I was going to give you the
opportunity--and I thank Senator Brown for raising the
question--there has been some issue about whether or not this
is--tough issues have been raised, and I want to give you a
chance to respond to this. Some have suggested that the reason
the Fed has taken the position it has is because it is an area
of jurisdiction that they like to have.
I think I know the answer to this question, but what is
your response to that particular concern?
Chairman Bernanke. If the ILC exemption is limited and not
allowed to expand indefinitely, we are perfectly comfortable
with the FDIC doing the consolidated supervision, and we think
they do a very good job.
Chairman Dodd. Thank you, Mr. Chairman, very much.
Senator Crapo.
Senator Crapo. Thank you very much, Mr. Chairman. And
Chairman Bernanke, we appreciate you being here with us.
I want to return to the global competitiveness issue for a
minute. I know that others have spoken to you about this
already. First and foremost, I want to commend Senator Schumer
for working with Mayor Bloomberg for the McKenzie report. There
is also, as you know, the new interim report of the Committee
on Capital Markets Regulation, and both of those reports I
think add significantly to this debate and to the issue. I am
working on a resolution, and talking with Senator Schumer about
it as well, and hope to be working with him on a resolution to
help highlight this and to express the sense of the Senate
about what steps we need to take in terms of better dealing
with our global competitiveness.
Now what I want to focus my questioning on with you is
derivatives and hedge funds. I will start by noting that in the
McKenzie report this following quote occurs.
London already enjoys clear leadership in the fast-growing
and innovative over-the-counter derivatives market. This is
significant because of the trading flow that surrounds
derivative markets and because of the innovation these markets
drive, both of which are key competitive factors for financial
centers. Dealers and investors increasingly see derivatives and
cash markets as interchangeable, and are therefore combining
trading operations for both products. Indeed, the derivatives
markets can be more liquid than the underlying cash markets.
Therefore, as London takes the global lead in derivatives,
America's competitiveness in both cash and derivatives flow
trading is at risk, as is its position as a center for
financial innovation.
Would you agree with that portion of the McKenzie report?
Chairman Bernanke. I agree that derivatives are an
incredibly important part of our expanding financial market,
part of financial innovation, and I would like to see the
United States remain competitive in those areas.
Senator Crapo. So you think it would be appropriate for us
to focus in this Congress on things that we can do or not do to
assure that we remain competitive or that we become more
competitive in those arenas?
Chairman Bernanke. Again, I think the best way to be
competitive is to make sure that the regulatory structure has a
minimal costs as needed to justify the benefits that are seen
to be obtained from those regulations.
Senator Crapo. One of the common themes that we are seeing
in terms of the movement of business away from the United
States to London and other capital markets is just that, the
regulatory burdens and the regulatory regime that we impose
here in the United States. I do not think anybody would say
that we should simply take down our regulatory position,
because we do have one of the strongest markets in the world.
But the question is, are we over-regulating.
I want to go specifically to an issue that you and I have
talked about many times before, and that is the regulation of
energy derivatives. As you know, we have faced proposals in
Congress and the Senate now for the last 4 or 5 years to
increase the regulatory climate around the handling of energy
derivatives. There has yet been another bill introduced just
yesterday or day I think, to do the same thing, so we are back
into the same issue.
You have expressed a position on this in the past. I have
in front of me the last letter that was put out by the
President's Working Group, of which you are a member. The last
paragraph of that letter says, ``several times in recent years
the PWG has been asked for its views on various legislative
proposals to expand regulation of energy derivatives. Most
recently, in testimony before the Senate Banking Committee on
September 8, 2005 representatives of the PWG agencies
reaffirmed the position of the PWG that additional regulation
of energy derivatives is not warranted.''
Is that still the position of the PWG, and is it still your
position that we do not need to further increase the regulatory
regime surrounding energy derivatives?
Chairman Bernanke. The PWG has not discussed it recently
but I have no reason to think the position has changed. I
believe it is a reasonable position, that we should be very
careful about adding additional regulatory costs in this
market. There are two reasons to regulate. Potentially one is
investor protection. But in this market, of course, we have
very large institutions, very sophisticated institutions who
are, I think, able to take care of themselves.
The other would be a concern about price manipulation.
There the CFTC does have, of course, ex post powers to
investigate potential frauds or manipulation. But it seems
unlikely that manipulation in most cases would come from the
OTC markets since the exchanges provide a good venue for
determining prices.
So, I have not changed the position I expressed before.
Senator Crapo. Thank you. I appreciate you sharing that
with us. I suspect that we will be asking the entire PWG to
reevaluate this issue since we now have legislation yet again
introduced on the issue. So, I would just give you that advance
warning that we will be coming to you for some guidance as we
once more enter into this debate.
Just one last question; moving a little bit to hedge funds.
Can you explain what is involved in fostering market discipline
in the hedge fund context? It is my understanding that you
believe that that is a superior approach to direct regulation.
Chairman Bernanke. That is correct, Senator.
The proposal of the President's Working Group, once again,
in their report following the LTCM crisis focused on the so-
called ``indirect'' or market-based regulation of hedge funds.
That has essentially two components. The first is through the
counterparties, that is, the investment banks or the banks, who
lend money to the hedge funds or serve as their prime brokers.
The supervision process requires that these large
counterparties manage their counterparty risk effectively, that
is, that they have good information about the risks being taken
by the hedge funds, their financial positions, and so on. And
it is both in the interest of those counterparties, obviously,
since they do not want to lose money, that they pay close
attention to what their counterparties are doing, and the
supervisors give additional encouragement, incentive, for the
counterparties to manage those risks effectively.
The other type of counterparty is the investor itself,
particularly large institutions like endowments or insurance
companies and the like, which also provide a good bit of market
discipline on the hedge funds by gathering information as they
make their investment decisions.
So we believe that is a very important, and so far,
successful method of overseeing hedge funds. I would be very
reluctant to get involved in heavy-handed direct regulation of
hedge funds. They are a very diverse group of institutions.
They have a wide variety of strategies, and one of their key
characteristics is that they are very nimble. They change very
quickly. And that is good for the economy because they help to
create more liquidity in markets, they help to spread risks
around more broadly. A regulatory regime that inhibited that
flexibility and nimbleness would eliminate a lot of the
economic benefits of the hedge funds and the other types of
private pools of capital that use sophisticated instruments to
share risk.
That being said, it is always useful for regulators and
supervisors to keep abreast of what is happening in the hedge
fund market, to speak to hedge fund managers, to understand
recent developments.
The G-7 meeting which I attended over the weekend, in the
spirit of information gathering, proposed that the Financial
Stability Forum, which is an international group consisting of
central bankers and supervisors, update a report they did in
2000 about the status of this market. I think that is
consistent with us simply trying to keep up our information
base that we know enough so that we are keeping up with
developments in that industry.
Senator Crapo. Thank you very much, Mr. Chairman. I want to
just say, personally, I appreciate your candor and the candor
that we get from the President's Working Group as we face these
kinds of issues. The expertise that you and the other members
of the working group can bring to the issue to help us evaluate
them is invaluable, so thank you for providing that.
Chairman Dodd. Those are great questions, Senator. I
appreciate you raising them as well. Very well done.
Senator Tester.
Senator Tester. Thank you, Mr. Chairman.
I also want to thank Chairman Bernanke for being here today
and being forthright in your answers. It is very nice.
The reason I want to stick around and ask these questions,
quite frankly, is because I value your opinion. It is not for
political reasons. It is not for anything other than I want to
know your perspective. Because quite frankly, from my
perspective of being a farmer in North Central Montana, there
is a lot of things that are just flat backward in this country
right now.
So the first question I wanted to ask is what is the number
one factor that concerns you as a potential impediment for our
economic growth here in this country?
Chairman Bernanke. Well, over the medium-term, it is the
demographic transition that we are going through. We are
getting older, our society is aging. We are going to have a
much larger share of the population in retirement age, or even
in the oldest of the old, 80 and 90 years old. And we have not
really made good preparation for that, either in terms of
broader savings in the society, or in terms of fiscal policy,
which I have discussed in previous context.
Senator Tester. Does the $8.6 trillion debt fall into that
issue then? Or is that somewhere else?
Chairman Bernanke. Well, it is closely related because if
we do not take some measures to address how we are going to
deal with the fiscal implications of an aging society, the debt
and deficits are going to grow, interest payments on those debt
and deficits are going to grow, and we will be in an
unsustainable fiscal situation.
So the fiscal picture is closely linked to the underlying
demographic changes that are going on.
Senator Tester. I have had a tough time struggling with,
because quite frankly tax load is something I am very concerned
about, too, as I think everybody on this Committee is. But the
debt load concerns me, too, very much.
Could you rank them as what could be the most severe
impediment? Is it the debt load or is it tax policy that is
flawed?
Chairman Bernanke. I do not think I can rank those. The
main concern would be that Congress has to decide how big the
Government is going to be and what share of national resources
are going to flow through the Government, either for Government
spending or through entitlement programs.
The tax collections need to be commensurate with that, and
that is the main decision. I am not qualified or in a position
to tell you how big that share should be.
Senator Tester. Foreign investment. I hear occasionally on
TV, I hear from some of my constituents in Montana, that those
people that are able to save some dough are being encouraged to
put a certain percentage--I think 20, 25 percent is what I am
hearing--into foreign markets. Is that a concern?
Chairman Bernanke. No, not necessarily. Foreign markets
have strengthened considerably in terms of their quality.
Clearly, the world is experiencing a lot of growth and so there
are a lot of opportunities out there. By investing broadly, an
investor diversifies his or her portfolio and reduces the
overall risk that they face.
Senator Tester. How about from an economic growth
standpoint here in this country? I think from an investor
standpoint, I hear you. But what about an economic growth
standpoint here? Is it a negative factor, positive factor, or
no impact?
Chairman Bernanke. I think it is probably slightly positive
in the sense that it gives American investors greater
diversification. And implicit in your question is where do we
get the funds for domestic investment? Well, they flow in from
abroad.
And so by swapping essentially between foreign and domestic
investors, you get better diversification for everybody.
Senator Tester. Sounds good.
Last question, and this deals with employment versus
inflation. It has been talked about here a lot today, but when
we get near full employment, does that necessarily drive
inflation up?
Chairman Bernanke. There is no specific level of employment
or unemployment that is a trigger, in some sense, for
inflation. The main concern is to make sure that the overall
spending in the economy, which is driven in turn by financial
conditions, does not exceed the underlying productive capacity
for a sustained period. That seems to generate inflation.
But as I have mentioned a couple of times, it is not easy
to determine exactly where that balance should be struck. And
simply looking at the unemployment rate, for example, is not
going to tell you. You need to look at a wide variety of
indicators, including price indicators, to get a sense of when
the economy is overheating and when it is more or less in
balance.
Senator Tester. That is great. And that is actually what I
was hoping to hear.
So we should be continuing to strive to make employment
complete, full to the best of our ability?
Chairman Bernanke. Certainly. The Federal Reserve has a
mandate for maximum sustainable employment, and we want to
achieve that. We do not want to achieve employment which is
high for a short moment but then crashes.
Senator Tester. No.
Chairman Bernanke. We want something that is sustainable.
Senator Tester. Exactly.
Once again I just want to go back, thank you, Mr. Chairman.
I think this has been a great hearing. And I want to thank you,
Chairman, for your honest forthright answers.
Thank you very much.
Chairman Dodd. Thank you, Senator Tester. Very good.
Senator Reed.
Senator Reed. Thank you very much, Mr. Chairman.
Again, thank you, Chairman Bernanke, for your testimony.
I was very impressed, as so many of my colleagues were,
with your speech in Omaha. I thought it was thoughtful,
comprehensive, and balanced, which is typical of your
leadership at the Fed.
At least one phrase or section struck me as interesting and
that is you talked not only about technological change and
international trade as causing this divergence between equality
of incomes. But you also talked about institutional
arrangements. The principal one you alluded to was labor
unions.
You say in your speech whatever the precise mechanism
through which lower rates of unionization affected the wage
structure, the available research suggests that it can explain
between 10 percent and 20 percent of the rise in wage
inequality among men during the 1970's and 1980's. I would
suspect if it is 10 percent and 20 percent in the 1970's and
1980's, it is at least that now, perhaps more, since unions
have declined since that period of time.
And it begs the question is one of the responses to wage
inequality a more robust representation in the labor unions in
the United States.
Chairman Bernanke. It is difficult to know the answer
because, as I indicated in my remarks, there have also been
structural changes--like changes in the share of manufacturing
employment in the economy as a whole--which have affected the
rate of unionization. It is a little hard to tell whether it is
the decline of unionization itself or the structural reasons
for that that are the causes of the inequality.
I do think that if workers want to be represented by a
union, of course, they should be allowed to do that.
Senator Reed. One of the issues here is that this is not
just the hidden hand of the marketplace and technological
change. There is Government policies. Policies which, until
recently, one might say favored more, encouraged more
participation in unions. Policies pursued by this
Administration seem to go against it. The National Labor
Relations Board, court decisions, Congressional activities.
So this is an area, too, I think, that should be on the
table, I presume, in terms of at least consideration by the
Congress, if we are really concerned about narrowing this gap
in terms of the economic equality. Is that a fair statement?
Chairman Bernanke. Well, again, there is the problem of
deciding how much of the effect comes from the structural
changes that underlie the changes in unionization patterns and
how much comes from changes in unionization propensity itself.
So, I do not really know how much effect that would have.
Senator Reed. Well, I think you have opened up a very
serious line of inquiry, and I applaud you for doing that.
Because once again, I think this is an issue that is there.
And maybe anecdotally, I grew up in a State where everyone
seemed to be in a union and they seemed to make pretty good
wages and had health benefits. And now that is declining
dramatically. And that, I think, contributes to this anxiety we
have all referred to.
Today, of course, I alluded in my opening statement, 13,000
workers from Chrysler presumably--I would guess with some sense
of probability that they are union workers--are losing their
jobs and probably will not find union employment again. So, I
think this is something we should consider.
Again, I think mentioning it in your speech opens up a line
of inquiry that is important.
There is another issue, too, that you talked about and we
all talk about the average income being stagnant for many
working Americans. There is something else that I am hearing,
is that the volatility of incomes for individual Americans
fluctuates so wildly and causes huge problems. You could be a
vice president for sales in a jewelry manufacturing company in
Rhode Island making a handsome salary of $100,000. The next
year you are making $35,000 because you are working at a lumber
yard.
That seems to be more common these days. And again, it gets
lost in the aggregate, but for individuals we have to do
something. Do you have any first thoughts about this
phenomenon?
Chairman Bernanke. Well, it is an issue that has been
raised by Mr. Hacker and others, and I have a footnote in my
speech about some of the impact it might have on measures of
inequality. It is a little bit mysterious exactly what the
source of this is. It could be more or less benign things, like
job changes and so on. It could be less benign things like
periods of unemployment or health problems.
There does not seem to be an increase in this pattern. The
1990's, if anything, seemed a little bit less volatile in that
respect. There is no data that I know of for the most recent
years. So it is a little bit of a black box, a little bit not
clear what policy implications of that volatility should be.
Senator Reed. By the way, anyone who has footnotes to his
speeches should be commended, so you are commended on that.
Is this an area of inquiry, though, that you intend to
pursue at the Federal Reserve, in terms of this volatility as
well as the aggregate income levels?
Chairman Bernanke. We looked at that in preparing the
speech and we did discuss it. And we were not, again, able to
come to a strong conclusion about what the policy implications
might be, and so we did not highlight it in the remarks.
Senator Reed. I know that you are--and I think you do this
very well--wary of making endorsements of particularly
policies. But in your speech you did allude to some policies
that should be considered.
So in the spirit of what we should be considering, you talk
about portability of health and pension benefits as one area.
There are other areas, for example wage insurance proposals
that have been made. Again, rather than taking a position, is
that something that we should be considering?
Chairman Bernanke. The general principle I was trying to
address was the insecurity the people feel about job loss and
job change. And I think it would be beneficial if we could
reduce that insecurity.
One way to do that would be to increase portability of
benefits across jobs. There are many ways to do that, so I am
not taking a specific means. Wage insurance is an interesting
idea that has been advocated by a number of economists. Again,
I am not sure I can take a specific position on it.
One of the things I said, and I should reiterate, is that
it is easy enough for me to say we should address these issues.
The actual implementation is quite difficult. These are very
complex problems. I just urge Congress to look at them and try
to get as much good input and advice as they can in thinking
about how to best address these issues.
Senator Reed. A final issue, which is the Earned Income Tax
Credit, which seems to me to be a very efficient way to deal
with this issue that has been the constant source of our
discussions this morning, inequality of wages, inequality of
opportunity. Is that something that we should be looking at
seriously, to expand it?
Chairman Bernanke. Well, I was asked in the past about the
minimum wage and, at that time, I said the Earned Income Tax
Credit had some advantages compared to the minimum wage and
that it was better targeted to the poor, to lower income
people. And I still believe that to be the case.
Of course, it does not come without cost. But I think it
does have some advantages.
Senator Reed. Thank you very much, Mr. Chairman.
Thank you.
Chairman Dodd. Thank you.
Senator Carper.
Senator Carper. Chairman Bernanke, I would like to say that
we saved the best to the last. That is probably not true, but I
might be the last. And for you, that is probably blessed
relief.
Thanks for coming today. Thanks for sharing your thoughts
with all of us, and responding to our questions.
Senator Reed mentioned an announcement earlier today by
DaimlerChrysler, that they are taking steps to cut their work
force, it sounds like, by as much as 13,000 across the country.
Sometimes we listen to those announcements and they do not
strike very close to home. In our case, in Delaware, they do.
We have a DaimlerChrysler assembly plant we have had for over
50 years in Newark, Delaware, close to the university. And so
this one is one that is troubling to us.
Having said that, I want to ask you a question. I
telegraphed my pitch. And then I want to say a couple of other
things.
I am going to come back and talk to and raise an issue that
the leaders of the big three--GM, Ford, and Chrysler--raised
with President Bush 2 months ago when they came to Washington.
Among the concerns that they raised was concerns about whether
or not the Japanese are manipulating their currency in order to
make their products more competitive in this country. So that
is where I am going with this.
But with respect to our own State, we build all of the
Dodge Durangos and Chrysler Aspens in our plant. We have a
reputation for doing a good job, and have had for a long time.
About 14 years ago, literally the month I was elected Governor
of Delaware in November 1992, our friends at General Motors
announced that they were going to close their assembly plant in
Wilmington, Delaware, along with a bunch of other plants,
assembly plants and parts plants, across the country.
They ended up closing, I think, just about all of them
except this one in Wilmington, Delaware. It is one of two auto
assembly plants that is still operating on the East Coast. I
think the Ford Taurus plant down in Norfolk is going to close
fairly soon. Then there will just be two plants, and one is the
GM plant in our State. The other is the DaimlerChrysler plant.
Our friends at DaimlerChrysler have announced today that
they were going to go back to one shift at our plant in Newark.
They are going to prepare to idle the plant at the end of 2009
if they do not have a new product for the plant then, then the
plant might close, which is worrisome to us all.
But we have seen this movie before and we did not just wait
for the inevitable to happen. We fought very hard to make sure
that it did not happen. The workers at GM, the labor and the
management people, did a great job. I hope the State did, as
well. And we averted what could have been a bad situation, not
there is a very successful operation there.
There are a number of things, I think, that can be done.
This question relates to how do we revitalize manufacturing in
our country, particularly auto manufacturing, which I hope we
can do and think we ought to. But there are a number of things,
in my own view, that can be done and should be done. I will
just start with Chrysler, and then I am leading up to monetary
policy.
The people at Chrysler, they have to make vehicles that
people want to buy. They have to make vehicles that are energy
efficient, environmentally friendly, have good quality. The
people at Chrysler, they have to go to what Toyota has done
very well, flexible manufacturing where the people at Toyota
make maybe three or four vehicles at a plant. And if the demand
for product A is stronger than B, they make more A. If product
C gets hot, they make more C. They usually have a fourth
vehicle that is a pilot vehicle that they are getting ready to
develop and to sell when it is time to launch it on the market.
So there is a lot of things that DaimlerChrysler can do. Those
are some.
There are things that we can do at the local level, in
Delaware or any other State that is affected by announcements
by this. You could take a page from what happened at our GM
plant. It is being more committed to quality, more committed to
productivity, more committed to good labor management
relations, more committed to innovation, and willing to work
and think outside the box. We did that 14 years ago and we need
to do that again here, at our Newark plant.
The State can work even harder to provide a nurturing
environment for manufacturing jobs. There is a lot that we have
done and there is more than can still be done.
And at the Federal level, and I am finally coming to my
question to you, but at the Federal level we do a fair amount
with R&D. The President has proposed, in his budget,
significant investments in research and development with
respect to new battery technology, these lithium ion batteries
that can be used to plug in hybrid vehicles, flex fuel/plug-in
hybrid vehicles, which I think is a very promising technology.
We have an opportunity to use the Government's purchasing
power on the civilian side and on the defense side, to help
commercialize technologies that have a great deal of promise,
whether they are variable fuel, flex fuel, plug-in hybrids, or
next generation hybrids or low emission diesel.
We have tax credits in our law. We have a tax credit for
people who buy highly energy efficient hybrids and it caps out
at 60,000. After 60,000 units have been sold by a manufacturer,
I think that tax credit begins to go away. But until it does,
there is a tax credit that can incentivize people to buy high
energy efficient hybrids.
We have a mirror tax credit that not many people know about
but they are going to be learning about, that works on the
diesel side, highly energy efficient low-emission diesel, which
DaimlerChrysler is beginning to bring onto the roads here, also
qualifies for a similar tax credit.
We can do better work on the health care costs, harnessing
information technology, and all kinds of things to work on the
health care side. Those are things for the people at
DaimlerChrysler to do, State and local, at the plants
themselves that are put here in harm's way. And there are
opportunities for us at the Federal level.
Now to you. The people who run these three companies--GM,
Ford, and Chrysler--suggested to the President that the
Japanese were manipulating the currency. Secretary Paulson was
there, he pushed back and said no, in fact, we talked about
this here in the last month. And he said no, I do not think
they are. Maybe they were at one time, but we do not think they
are today.
There was a time not long ago when the Japanese economy was
in such a fund, they were going through deflation. And we
wanted them to take strong actions to change that.
But fast-forwarding to the present, what is going on? Are
these concerns or allegations, are they baseless? Is there some
basis to them? Is this something that we should be mindful of,
concerned about, do something about?
Chairman Bernanke. The Treasury and the Federal Reserve
have expressed the view that exchange rates should be
determined in free and open markets. As best as we can tell,
the yen's value is being determined in a free, open, and
competitive market. There is no evidence of any intervention
going on. The last time the Japanese purchased dollars was in
March 2004.
The behavior of the yen appears to be consistent with the
monetary policies they are conducting which, in turn, are
closely related to the state of their domestic economy. So we
do not see any manipulation or intervention in the value of the
yen.
Senator Carper. How would we know if they were doing it?
Chairman Bernanke. We can see it, for example, in the case
of China where there is a very closely managed exchange rate.
It moves very slowly and there are large capital inflows. In
order to maintain the yuan within the range that they are
trying to achieve, they have to acquire huge amounts of
reserves and they have to sterilize the effects of those
reserves on the domestic money supply. And so there is a very
clear type of behavior that we can see.
Now it is true that there are many factors that affect the
value of a currency. But to my knowledge there are no overt
interventions or any such factors affecting the yen at this
time.
Senator Carper. My last, if I could, just in closing. If
you are giving advice to domestic auto manufacturers on what to
do to regain market share to return to profitability, what are
some of the steps that you would suggest that they and we take?
Chairman Bernanke. You made a number of good points. One of
them, I think, is R&D. It is not really true that U.S.
manufacturing is disappearing. That is not the case. The output
of U.S. manufacturing has grown more quickly than almost any
other industrial country in the last 10 years and it has been
supported by enormous increases in productivity, which is one
of the reasons why we need fewer and fewer workers. But the
output continues to rise.
The other feature of U.S. manufacturing is that it has
shifted very much from lower tech type production to the most
high tech type production. We see that in airplane exports and
sophisticated capital equipment, medical equipment, silicon
chips and so on, things that we currently export.
And indeed, one more point, one effect of that has been
that the demand for labor and manufacturing has shifted very
dramatically from low-skilled workers to the highest skilled
workers.
One of the things that has really supported those
successful areas of manufacturing has been our leadership in
R&D and technology. The Government can support that in various
ways. Among them, helping to support basic research, which may
not be in the interest of any specific company to undertake on
its own, but with Government assistance or Government
coordination the industry as a whole can undertake and find, in
the case of automobiles, new fuel efficient technologies, for
example, or other changes that make the cars more attractive.
Senator Carper. Mr. Chairman, you have been good with your
time.
Thank you, Chairman Bernanke. Thank you, Mr. Chairman.
Chairman Dodd. Thank you.
Senator Carper. That is probably good advice, not just for
auto manufacturers, but for people running for President.
Chairman Dodd. Or any office, for that matter.
Senator Carper. There you go. Thank you.
Chairman Dodd. The basic research point is an excellent
one. I do not have the numbers on the top of my head here, but
the decline of the U.S. Government's commitment to basic
research has dropped precipitously. I think over the last
number of years, it is not something that has occurred in the
last couple of years. I am pleased to hear you say that. That
is something we do not pay enough attention to, and how much we
have benefitted over the years for applied research to live off
the basic research commitments we have made in the past, so it
is worthwhile.
If I can, Mr. Chairman, just a couple of points I wanted to
raise with you, and I thank my colleague from Delaware for his
comments. Just a couple of cleanup things.
I mentioned earlier, the issue we had in the hearings on
the predatory lending issue. We did not bring up GSE's today.
My colleague from Delaware has a strong interest, as I do. And
we are going to move fairly quickly here on a Senate bill. It
is an important issue.
Although I think things are in pretty good control. It is
not as if there is some immediate threat out there. There are a
number of things we need to be doing and we intend to move in
that direction.
One of the things I wanted to raise with you, because with
Fannie Mae and Freddie Mac, is the purchasing of some of these
ARM's that are pretty abusive. Understand in these things, the
broker and the bank is out of it pretty quickly, 10 to 12
weeks. These things are bundled and then go off and are
securitized.
And the fact that Fannie and Freddie are purchasing these
at a pretty high standard, AA or AAA, whatever the standard is
they are applying to them, concerns me in a sense. One good way
to begin to try and reverse some of these practices, in
addition to what regulators may be able to do, is to have some
different requirements here in terms of the securitization of
these products.
I wonder if you have any comment on that at all you care to
share.
Chairman Bernanke. I am not quite sure about how one
distinguishes so-called ``legitimate ARM products'' from those
which may be less legitimate. If you could do so, then that
would be a direction to go.
I think more broadly that it would be a good thing for the
GSE portfolios to be more consistent with their housing
mission. According to OFHEO, the GSE portfolios are only 30
percent related to affordable housing. The rest is all
different other kinds of things. So to match their mission with
their portfolios would be, I think, very desirable.
The specific suggestion you make might be feasible, but it
would require some way of determining which types of loans are
to be acceptable or not.
Chairman Dodd. I just wanted to raise that point with you.
Let me come back, if I can, to the points that Senator
Carper was raising about trade and foreign governments. It was
reported yesterday, you have heard this again from some other
colleagues this morning, that our trade deficit has now reached
a record $763 billion last year. That is the fifth straight
year that we have had a record trade deficit.
The Wall Street Journal reported, ``Following yesterday's
report, economists on Wall Street said the Government, later
this month, would likely lower its final growth estimate
sharply for the fourth quarter.''
In order to finance our trade budget and current account
deficits, we are required to have an influx of something in the
neighborhood of a little less than $2.5 billion of foreign
capital on a daily basis, as I am told. Now some have argued
that this is all right and it is no great threat because it is
coming from the private investors offshore.
But in your report the Fed states, ``On net private
foreigners purchased few U.S. treasuries.''
The obvious question is then it is governments who appear
to be buying them. I put that in the form of a question. I
should not make the statement. Is it your conclusion that the
decline in private investors here, it is governments then that
are purchasing this?
Chairman Bernanke. Are you referring to private foreign
investors or private domestic?
Chairman Dodd. Yes, private foreign investors.
Chairman Bernanke. Private foreign investors are still
holding significant U.S. assets, but it is true that
acquisition of treasuries and other fixed income instruments
for the purposes of foreign reserves are an important component
of the in-flow.
Chairman Dodd. The end of the line was, in fact, that
foreign direct investment flows in the United States remains
robust. So again, it is that public commitment that we are
relying on at this particular junction. So it is not so much
the private foreign investor, it is the governmental investor
that we are----
Chairman Bernanke. We can send you some numbers. It depends
on the instrument. Foreign private investors are more likely to
buy equities, for example, than central banks.
Chairman Dodd. Going back to the issues raised earlier
about China, and again the question is a good question Senator
Carper was raising. He talks about the yen and I think you
had--and I agree with your answer on the yen, based on what I
have known. It is troubling, to some degree. We have the cost
like a health care cost, I think at a GM automobile, is $1,500.
I think someone has made that conclusion. At Toyota, it is
$150.
So in addition to what other factors may exist out there,
we have some built-in costs that I think have contributed to
the lack of competitiveness, in some cases, in our American-
produced automobiles.
But there is an issue of China's manipulation of their
currency. What would recommend, if anything at all? I accept
the fact that they are getting better. And I heard you say that
is the case. But we get this all the time. When Senator Carper
and I go back to our constituencies, one of the first questions
that come up, if we get into any discussion of economics at
all, is this issue. I am just wondering if we are not doing
enough or there is something else we could be doing to take
what you have said here and call it what it is. I agree with
you, it is manipulation of their currency. There is no question
about it.
Then what do we do about that? How do we respond to this?
Chairman Bernanke. Senator, I did not use the word
manipulation.
Chairman Dodd. I thought I heard you say that?
Chairman Bernanke. No, sir. If I did, it was a mistake.
Chairman Dodd. I tried.
Chairman Bernanke. I think a point to make, and this is, to
some extent, recognized in Secretary Paulson's Strategic
Economic dialogue, is that while the exchange rate is a very
important issue and one that we are continuing to press China
on, we have many, many other issues of mutual concern in
economics.
Just to talk specifically about the trade balance, another
dimension besides the exchange rate is whether China can become
more reliant on its own domestic demand, its own consumption
spending as a source of growth, rather than relying on exports
to the United States.
I think it is somewhat encouraging that the Chinese have
officially recognized the problem of a growing trade surplus
and both the economic and political risks that that poses. They
have proposed a plan for trying to increase domestic
consumption which, over time, should reduce the reliance of
China on exports. It should reduce their trade surplus. So
there are some other measures that they are taking, albeit ones
that will take some time to work.
But again, rather than putting everything on that
particular issue of the exchange rate, we should also note that
we have common interests with the Chinese on matters of the
environment, for example, on matters of energy, trade and
investment, and immigration and visas.
So, I would hope that while we continue to press China to
make progress on this very important issue of the exchange
rate, it is not exclusive of all the other very important
issues that we have in common and that we could collectively
benefit from if we were to work with the Chinese to come to
better arrangements than we have.
Chairman Dodd. I appreciate that. Again, I know you
appreciate the concerns we hear about and using your language
in China, the subsidy notion here. And clearly, when you have
lost your job because the company you work for can no longer
compete because your competitor is able to adjust that currency
to such an extent that it causes your job to disappear, that
level of frustration is beyond just an intellectual exercise.
If you are walking home that night to face your family because
there is no longer the job there, and what it means.
I want to return last, if I can, to one point. Again, your
candor has been terrific and your comments. The quote that Jack
Reed raised in your Omaha speech, where too often this
discussion about unionization falls on an ideological fault
line. And I appreciate immensely here that you talked about it
based on just data here, rather than drawing conclusions about
whether you like or dislike unions.
But the important role they played, in terms historically
of closing income gaps. This is not the first time we are
talking about income gaps. In fact, income gaps were far more
pronounced during the early part of the 20th century.
And what I read from your quote here is that, and I will
ask the question here in a sense. You talk about these numbers
back in the 1970's and 1980's, and I presume even earlier, some
of those income gaps that closed up, you attribute to the fact
that there was the ability of people to organize and to
negotiate for better wages and working conditions for
themselves.
I wonder if you might just expound on that a little bit,
without getting involved in the ideological discussion. I am
not asking you to do that. But it is a very important point, I
think, as those of us try to assist in this effort of closing
that gap, to realize how important that particular element can
play in making it possible for people to move up that economic
ladder.
Chairman Bernanke. I was reporting some research, which I
think is good research.
Chairman Dodd. I know you were.
Chairman Bernanke. Again, I think that workers who wish to
be represented by unions have every right to do, and we should
not block that in any way. We should give them the
opportunities to do that.
The implications of unionization for income equality or
inequality, as I indicated before, are a bit difficult to tease
out because there have been changes in union rates. But there
have also been changes in the structure in the economy, the
most notable one being the decline of manufacturing jobs and
manufacturing employment, and the increase in international
competition. There certainly was a time when GM, for example,
had a certain amount of monopoly power and was able to charge
probably a higher price than it otherwise could. And now, of
course, GM is in very intense competition with other companies
around the world.
So it is an open question, a very interesting question, to
what extent that association between wage changes and
unionization is causal--that the changes in unionization have
changed the wage pattern--or to what extent they are both the
product of a third force such as the change in manufacturing
employment or the change in the extent of international
competition.
The kinds of studies we have seen so far really cannot
distinguish between those two hypotheses.
Chairman Dodd. I appreciate your comments. This will be
part of an ongoing conversation. But the comments here, based
on just hard data I thought were very valuable to contribute to
the debate and discussion as to what we need to be doing to
move forward in closing that gap that you have spoken about so
eloquently.
Thank you immensely. I thank my colleagues, they have had
to leave here. But there were great questions that came up this
morning and your answers were very candid and very
straightforward and forthright, and we appreciate it immensely.
So we look forward to having an ongoing conversation with
you and we thank you for your appearance here this morning.
This hearing will stand adjourned.
[Whereupon, at 1:18 p.m., the hearing was adjourned.]
[Prepared statements, response to written questions, and
additional material supplied for the record follow:]
PREPARED STATEMENT OF BEN S. BERNANKE
Chairman, Board of Governors of the Federal Reserve System
February 14, 2007
Chairman Dodd, Senator Shelby, and other Members of the Committee,
I am pleased to present the Federal Reserve's Monetary Policy Report to
the Congress.
Real activity in the United States expanded at a solid pace in
2006, although the pattern of growth was uneven. After a first-quarter
rebound from weakness associated with the effects of the hurricanes
that ravaged the Gulf Coast the previous summer, output growth
moderated somewhat on average over the remainder of 2006. Real gross
domestic product (GDP) is currently estimated to have increased at an
annual rate of about 2\3/4\ percent in the second half of the year.
As we anticipated in our July report, the U.S. economy appears to
be making a transition from the rapid rate of expansion experienced
over the preceding several years to a more sustainable average pace of
growth. The principal source of the ongoing moderation has been a
substantial cooling in the housing market, which has led to a marked
slowdown in the pace of residential construction. However, the weakness
in housing market activity and the slower appreciation of house prices
do not seem to have spilled over to any significant extent to other
sectors of the economy. Consumer spending has continued to expand at a
solid rate, and the demand for labor has remained strong. On average,
about 165,000 jobs per month have been added to nonfarm payrolls over
the past 6 months, and the unemployment rate, at 4.6 percent in
January, remains low.
Inflation pressures appear to have abated somewhat following a run-
up during the first half of 2006. Overall inflation has fallen, in
large part as a result of declines in the price of crude oil. Readings
on core inflation--that is, inflation excluding the prices of food and
energy--have improved modestly in recent months. Nevertheless, the core
inflation rate remains somewhat elevated.
In the five policy meetings since the July report, the Federal Open
Market Committee (FOMC) has maintained the Federal funds rate at 5\1/4\
percent. So far, the incoming data have supported the view that the
current stance of policy is likely to foster sustainable economic
growth and a gradual ebbing of core inflation. However, in the
statement accompanying last month's policy decision, the FOMC again
indicated that its predominant policy concern is the risk that
inflation will fail to ease as expected and that it is prepared to take
action to address inflation risks if developments warrant.
Let me now discuss the economic outlook in a little more detail,
beginning with developments in the real economy and then turning to
inflation. I will conclude with some brief comments on monetary policy.
Consumer spending continues to be the mainstay of the current
economic expansion. Personal consumption expenditures, which account
for more than two-thirds of aggregate demand, increased at an annual
rate of around 3\1/2\ percent in real terms during the second half of
last year, broadly matching the brisk pace of the previous 3 years.
Consumer outlays were supported by strong gains in personal income,
reflecting both the ongoing increases in payroll employment and a
pickup in the growth of real wages. Real hourly compensation--as
measured by compensation per hour in the nonfarm business sector
deflated by the personal consumption expenditures price index--rose at
an annual rate of around 3 percent in the latter half of 2006.
The resilience of consumer spending is all the more striking given
the backdrop of the substantial correction in the housing market that
became increasingly evident during the spring and summer of last year.
By the middle of 2006, monthly sales of new and existing homes were
about 15 percent lower than a year earlier, and the previously rapid
rate of house-price appreciation had slowed markedly. The fall in
housing demand in turn prompted a sharp slowing in the pace of
construction of new homes. Even so, the backlog of unsold homes rose
from about 4\1/2\ months' supply in 2005 to nearly 7 months' supply by
the third quarter of last year. Single-family housing starts have
dropped more than 30 percent since the beginning of last year, and
employment growth in the construction sector has slowed substantially.
Some tentative signs of stabilization have recently appeared in the
housing market: New and existing home sales have flattened out in
recent months, mortgage applications have picked up, and some surveys
find that homebuyers' sentiment has improved. However, even if housing
demand falls no further, weakness in residential investment is likely
to continue to weigh on economic growth over the next few quarters as
homebuilders seek to reduce their inventories of unsold homes to
morecomfortable levels.
Despite the ongoing adjustments in the housing sector, overall
economic prospects for households remain good. Household finances
appear generally solid, and delinquency rates on most types of consumer
loans and residential mortgages remain low. The exception is subprime
mortgages with variable interest rates, for which delinquency rates
have increased appreciably. The labor market is expected to stay
healthy, and real incomes should continue to rise, although the pace of
employment gains may be slower than that to which we have become
accustomed in recent years. In part, slower average job growth may
simply reflect the moderation of economic activity. Also, the impending
retirement of the leading edge of the baby-boom generation, and an
apparent leveling out of women's participation rate in the workforce,
which had risen for several decades, will likely restrain the growth of
the labor force in coming years. With fewer jobseekers entering the
labor force, the rate of job creation associated with the maintenance
of stable conditions in the labor market will decline. All told,
consumer expenditures appear likely to expand solidly in coming
quarters, albeit a little less rapidly than the growth in personal
incomes if, as we expect, households respond to the slow pace of home-
equity appreciation by saving more out of current income.
The business sector remains in excellent financial condition, with
strong growth in profits, liquid balance sheets, and corporate leverage
near historical lows. Last year, those factors helped to support
continued advances in business capital expenditures. Notably,
investment in high-tech equipment rose 9 percent in 2006, and spending
on nonresidential structures (such as office buildings, factories, and
retail space) increased rapidly through much of the year after several
years of weakness. Growth in business spending slowed toward the end of
last year, reflecting mainly a deceleration of spending on business
structures; a drop in outlays in the transportation sector, where
spending is notably volatile; and some weakness in purchases of
equipment related to construction and motor vehicle manufacturing. Over
the coming year, capital spending is poised to expand at a moderate
pace, supported by steady gains in business output and favorable
financial conditions. Inventory levels in some sectors--most notably at
motor vehicle dealers and in some construction-related manufacturing
industries--rose over the course of last year, leading some firms to
cut production to better align inventories with sales. Remaining
imbalances may continue to impose modest restraint on industrial
production during the early part of this year.
Outside the United States, economic activity in our major trading
partners has continued to grow briskly. The strength of demand abroad
helped spur a robust expansion in U.S. real exports, which grew about 9
percent last year. The pattern of real U.S imports was somewhat uneven,
partly because of fluctuations in oil imports over the course of the
year. On balance, import growth slowed in 2006, to 3 percent. Economic
growth abroad should support further steady growth in U.S. exports this
year. Despite the improvements in trade performance, the U.S. current
account deficit remains large, averaging about 6\1/2\ percent of
nominal GDP during the first three quarters of 2006 (the latest
available data).
Overall, the U.S. economy seems likely to expand at a moderate pace
this year and next, with growth strengthening somewhat as the drag from
housing diminishes. Such an outlook is reflected in the projections
that the Members of the Board of Governors and Presidents of the
Federal Reserve Banks made around the time of the FOMC meeting late
last month. The central tendency of those forecasts--which are based on
the information available at that time and on the assumption of
appropriate monetary policy--is for real GDP to increase about 2\1/2\
to 3 percent in 2007 and about 2\3/4\ to 3 percent in 2008. The
projection for GDP growth in 2007 is slightly lower than our projection
last July. This difference partly reflects an expectation of somewhat
greater weakness in residential construction during the first part of
this year than we anticipated last summer. The civilian unemployment
rate is expected to finish both 2007 and 2008 around 4\1/2\ to 4\3/4\
percent.
The risks to this outlook are significant. To the downside, the
ultimate extent of the housing market correction is difficult to
forecast and may prove greater than we anticipate. Similarly, spillover
effects from developments in the housing market onto consumer spending
and employment in housing-related industries may be more pronounced
than expected. To the upside, output may expand more quickly than
expected if consumer spending continues to increase at the brisk pace
seen in the second half of 2006.
I turn now to the inflation situation. As I noted earlier, there
are some indications that inflation pressures are beginning to
diminish. The monthly data are noisy, however, and it will consequently
be some time before we can be confident that underlying inflation is
moderating as anticipated. Recent declines in overall inflation have
primarily reflected lower prices for crude oil, which have fed through
to the prices of gasoline, heating oil, and other energy products used
by consumers. After moving higher in the first half of 2006, core
consumer price inflation has also edged lower recently, reflecting a
relatively broad-based deceleration in the prices of core goods. That
deceleration is probably also due to some extent to lower energy
prices, which have reduced costs of production and thereby lessened one
source of pressure on the prices of final goods and services. The
ebbing of core inflation has likely been promoted as well by the
stability of inflation expectations.
A waning of the temporary factors that boosted inflation in recent
years will probably help foster a continued edging down of core
inflation. In particular, futures quotes imply that oil prices are
expected to remain well below last year's peak. If actual prices follow
the path currently indicated by futures prices, inflation pressures
would be reduced further as the benefits of the decline in oil prices
from last year's high levels are passed through to a broader range of
core goods and services. Nonfuel import prices may also put less
pressure on core inflation, particularly if price increases for some
other commodities, such as metals, slow from last year's rapid rates.
But as we have been reminded only too well in recent years, the prices
of oil and other commodities are notoriously difficult to predict, and
they remain a key source of uncertainty to the inflation outlook. The
contribution from rents and shelter costs should also fall back,
following a step-up last year. The faster pace of rent increases last
year may have been attributable in part to the reduced affordability of
owner-occupied housing, which led to a greater demand for rental
housing. Rents should rise somewhat less quickly this year and next,
reflecting recovering demand for owner-occupied housing as well as
increases in the supply of rental units, but the extent and pace of
that adjustment is not yet clear.
Upward pressure on inflation could materialize if final demand were
to exceed the underlying productive capacity of the economy for a
sustained period. The rate of resource utilization is high, as can be
seen in rates of capacity utilization above their long-term average
and, most evidently, in the tightness of the labor market. Indeed,
anecdotal reports suggest that businesses are having difficulty
recruiting well-qualified workers in certain occupations. Measures of
labor compensation, though still growing at a moderate pace, have shown
some signs of acceleration over the past year, likely in part the
result of tight labor market conditions.
The implications for inflation of faster growth in nominal labor
compensation depend on several factors. Increases in compensation might
be offset by higher labor productivity or absorbed by a narrowing of
firms' profit margins rather than passed on to consumers in the form of
higher prices; in these circumstances, gains in nominal compensation
would translate into gains in real compensation as well. Underlying
productivity trends appear favorable, and the markup of prices over
unit labor costs is high by historical standards, so such an outcome is
certainly possible. Moreover, if activity expands over the next year or
so at the moderate pace anticipated by the FOMC, pressures in both
labor and product markets should ease modestly. That said, the
possibility remains that tightness in product markets could allow firms
to pass higher labor costs through to prices, adding to inflation and
effectively nullifying the purchasing power of at least some portion of
the increase in labor compensation. Thus, the high level of resource
utilization remains an important upside risk to continued progress on
inflation.
Another significant factor influencing medium-term trends in
inflation is the public's expectations of inflation. These expectations
have an important bearing on whether transitory influences on prices,
such as those created by changes in energy costs, become embedded in
wage and price decisions and so leave a lasting imprint on the rate of
inflation. It is encouraging that inflation expectations appear to have
remained contained.
The projections of the Members of the Board of Governors and the
Presidents of the Federal Reserve Banks are for inflation to continue
to ebb over this year and next. In particular, the central tendency of
those forecasts is for core inflation--as measured by the price index
for personal consumption expenditures excluding food and energy--to be
2 to 2\1/4\ percent this year and to edge lower, to 1\3/4\ to 2
percent, next year. But as I noted earlier, the FOMC has continued to
view the risk that inflation will not moderate as expected as the
predominant policy concern.
Monetary policy affects spending and inflation with long and
variable lags. Consequently, policy decisions must be based on an
assessment of medium-term economic prospects. At the same time, because
economic forecasting is an uncertain enterprise, policymakers must be
prepared to respond flexibly to developments in the economy when those
developments lead to a reassessment of the outlook. The dependence of
monetary policy actions on a broad range of incoming information
complicates the public's attempts to understand and anticipate policy
decisions.
Clear communication by the central bank about the economic outlook,
the risks to that outlook, and its monetary policy strategy can help
the public to understand the rationale behind policy decisions and to
anticipate better the central bank's reaction to new information. This
understanding should, in turn, enhance the effectiveness of policy and
lead to improved economic outcomes. By reducing uncertainty, central
bank transparency may also help anchor the public's longer-term
expectations of inflation. Much experience has shown that well-anchored
inflation expectations tend to help stabilize inflation and promote
maximum sustainable economic growth. Good communication by the central
bank is also vital for ensuring appropriate accountability for its
policy actions, the full effects of which can be observed only after a
lengthy period. A transparent policy process improves accountability by
clarifying how a central bank expects to attain its policy objectives
and by ensuring that policy is conducted in a manner that can be seen
to be consistent with achieving those objectives.
Over the past decade or so, the Federal Reserve has significantly
improved its methods of communication, but further progress is
possible. As you know, the FOMC last year established a subcommittee to
help the full Committee evaluate the next steps in this continuing
process. Our discussions are directed at examining all aspects of our
communications and have been deliberate and thorough. These discussions
are continuing, and no decisions have been reached. My colleagues and I
remain firmly committed to an open and transparent monetary policy
process that enhances our ability to achieve our dual objectives of
stable prices and maximum sustainable employment. I will keep Members
of this Committee apprised of developments as our deliberations move
forward. I look forward to continuing to work closely with the Members
of this Committee and your colleagues in the Senate and House on the
important issues pertaining to monetary policy and the other
responsibilities with which the Congress has charged the Federal
Reserve.
Thank you. I would be happy to take questions.
RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY
FROM BEN S. BERNANKE
Q.1. I have been concerned for some time about the
implementation of the Basel II Capital Accord and the impact
Basel II may have on the safety and soundness of the U.S.
banking system. In particular, I am worried that Basel II may
lead to a sharp reduction in the amount of capital banks are
required to hold, which would put U.S. taxpayers at risk of
having to pay for expensive bank failures. Accordingly, I
believe that it is critical that Basel II be implemented with
the utmost care and diligence. Would you please update the
Committee on the status of the Basel II Capital Accords and the
current timeframe for implementing Basel II? I would like you
to comment on whether there is enough time for banking
regulators to finalize the rules implementing Basel II, so that
banks adopting Basel II can start the test run for Basel II
presently scheduled to begin next year. What, if any, is the
likelihood that the timeframe currently envisioned may need to
be adjusted?
A.1. First, let me reiterate that the primary goal of the
agencies in implementing Basel II in the United States is to
enhance the safety and soundness of the U.S. banking system.
Accordingly, we will not permit capital levels to decline under
the Basel II framework so as to potentially jeopardize safety
and soundness. We remain committed to ensuring that regulatory
capital levels at all U.S. banking organizations remain robust.
It is important to keep in mind that under Pillar II, banking
supervisors will be reviewing total capital plans relative to
risk at each Basel II bank, not just the minimum capital
requirements calculated under Pillar I. We also continue to
believe, subject to the receipt of comments on the outstanding
Basel II notice of proposed rulemaking (NPR), that it is
critical to move forward with Basel II implementation so that
our largest and internationally active banking organizations
have the most risk reflective regulatory capital framework and
can remain competitive with other banking organizations that
apply similar risk sensitive frameworks.
The Basel II NPR issued in September 2006 remains open for
comment through March 26, 2007. As outlined in the NPR, the
first opportunity for a bank to be able to begin a parallel run
(that is, apply the Basel II framework and report results to
the appropriate supervisor, but continue to use Basel I ratios
for regulatory purposes) would be January 2008. The first
opportunity for a bank to begin applying the Basel II framework
subject to the proposed transition floors would be January
2009. We remain committed to this schedule; however, it will be
challenging to meet the previously announced June 2007 date for
a final rule. We are very interested in public comments
submitted on the proposal. We will need to take sufficient time
to fully consider comments and to make corresponding
modifications to the proposed framework as the agencies deem to
be appropriate. Because the comment period is still open, it is
difficult to estimate how comprehensive the comments will be.
While we already are aware of a number of issues raised by the
industry, in complex rulemakings such as this one there are
always unanticipated issues as well. The extent and complexity
of the comments overall will have an impact on the ultimate
timing for issuing a final rule. We continue to believe that it
is important to meet the previously stated first live start
date of January 2009 and at this time do not anticipate that
that start date will need to be adjusted.
Q.2. Your testimony noted that the U.S. current account deficit
remains large, averaging about 6\1/2\ percent of nominal GDP.
You also note that economic growth abroad should support
further steady growth in U.S. exports this year. Do you
anticipate much improvement in the current account deficit over
the next year as a result of export improvement? Do you see any
other economic factors changing over the next year that might
lead to an improved trade deficit?
A.2. In the past year, U.S. exports have grown strongly,
reflecting a number of factors, including solid foreign
economic growth, increases in investment spending abroad that
have boosted sales of capital goods produced in the United
States, and the booming market for agricultural goods and other
commodities. These developments have played out against the
backdrop of continued innovation and productivity growth in the
U.S. economy that, along with the decline in the foreign
exchange value of the dollar since earlier in this decade, have
buoyed the attractiveness of American-made products. As a
result of strong export growth, in combination with sharp
declines in the price of imported oil, the trade deficit has
narrowed from 6 percent of U.S. GDP in the third quarter of
last year to about 5\1/4\ percent of GDP in the fourth, and the
current account deficit has improved by a broadly similar
extent. These movements, coming as they did toward the end of
2006, may well cause the trade and current account deficits for
2007 as a whole, measured as a share of GDP, to be smaller than
those for 2006.
Focusing on their evolution from the current quarter
onwards, however, it is uncertain whether our Nation's external
deficits will narrow further over the next few years. On the
export side, the extraordinary growth in overseas sales of some
U.S. products during 2006 may be difficult to sustain; for
example, exports of aircraft grew more than 20 percent last
year. On the import side, the price of imported oil has bounced
back from recent lows, and futures markets suggest that further
increases may be in the offing. Another important determinant
of U.S. trade flows, the foreign exchange value of the dollar,
is volatile and extremely difficult to predict. Finally, even
if the trade balance were to continue to improve, it is not
clear that the current account balance--which is equal to the
trade balance plus the balance on international income flows
and transfers--would follow suit. The need to finance continued
trade deficits, even if these deficits are smaller than in the
past, puts upward pressure on the Nation's external debt and
thus investment income payments to foreigners, thereby tending
to expand the current account deficit.
Q.3. This Committee continues to have a great degree of
interest in the Chinese economy, particularly currency
practices. China's foreign exchange reserves now stand at over
$1 trillion, creating excess liquidity in their banking system.
Some financial experts have stated that the United States
should not view China's large stock of foreign currency
reserves as a problem. What is your view of this level of
reserves? Do you believe China's ratio of reserves to money
supply is reasonable? To what extent do you believe that
China's reserves are the result of speculation? Could this, in
fact, result in an even lower value for the RMB should that
currency become more flexible in the future?
A.3. For some time now, the monetary authorities in China have
been resisting upward pressure on the value of the renminbi in
foreign exchange markets by purchasing dollars and perhaps
other foreign currencies. Even though these accumulated
purchases have reached a value of more than $1 trillion, it is
not certain that the accumulation has created excess liquidity
in China's banking system. Reserves and liquidity do not move
in lockstep in China, because Chinese authorities have policy
tools available to drain liquidity, including issuance of
official securities (so-called ``sterilization bonds'') and
increasing banks' reserve requirements. At present, it does not
appear that China has had any substantial difficulty using
either of these tools to drain liquidity, although that may
change in the future. Because the linkage between reserves and
money need not be tight, it would be hard to determine a
reasonable range for the ratio of reserves to the money stock
appropriate for China's economy.
I do not believe China's substantial accumulation of
reserves in itself represents a problem for the United States
or for United States monetary policy. Official demand in China
and other countries for United States assets reflects the
dollar's role as preeminent reserve currency, which results in
great part from the strength of our economy and the safety and
liquidity of the United States financial system. Because
foreign holdings of U.S. Treasury securities represent only a
small part of total U.S. credit market debt outstanding, U.S.
credit markets should be able to absorb without great
difficulty any shift in foreign allocations. And even if such a
shift were to put undesired upward pressure on U.S. interest
rates, the Federal Reserve has the capacity to operate in
domestic money markets to maintain interest rates at a level
consistent with our domestic economic goals.
It is not easy to identify the portion of the upward
pressure on the renminbi, and hence on the accumulation of
reserves, that might be the result of speculation. It is also
difficult to predict where the renminbi would settle were the
currency to float freely. However, speculation in the renminbi
would not occur if investors did not expect the Chinese
currency to appreciate at some point. It seems reasonable to
conclude that, at the present exchange rate with the dollar,
the renminbi is undervalued.
RESPONSE TO A WRITTEN QUESTION OF SENATOR SUNUNU
FROM BEN S. BERNANKE
Q.1. Does the arbitrary deposit cap, which bars any U.S. bank
from an acquisition that would give it more than 10 percent of
the Nation's total bank deposits, make American banks
vulnerable to foreign acquisition?
A.1. Federal law currently prohibits a bank holding company or
bank from acquiring an additional bank if, after the
acquisition, the resulting banking organization would control
more than 10 percent of all deposits held by insured banks and
savings associations in the United States. At the present time,
it appears unlikely that this restriction makes U.S. banks
materially more vulnerable to acquisition by a foreign entity
than they would be if this deposit cap were not in place. Of
course, as the banking and financial systems evolve, the impact
of the current deposit cap also may change, and thus the
Congress may wish to review the benefits and costs of the
current restriction at regular intervals.
The deposit cap could potentially increase the likelihood
of foreign acquisitions of U.S. banks if it prevented U.S.
banks from reaching the size needed to achieve important
economies of scale or scope. However, research overwhelmingly
indicates that economies of scale in banking are achieved at
sizes far below those of our largest banks. In addition, the
landmark Gramm-Leach-Bliley Act significantly expanded the
ability of U.S. banking organizations to achieve any important
economies of scope that may exist within the broad financial
services industry. Indeed, U.S. banks are among the most
profitable, most efficient, and best capitalized in the world.