[Senate Hearing 112-9]
[From the U.S. Government Publishing Office]



                                                          S. Hrg. 112-9

 
   NOMINATIONS OF: KATHARINE G. ABRAHAM, CARL SHAPIRO, AND PETER A. 
                                DIAMOND

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

                                HEARING

                               before the

                              COMMITTEE ON
                   BANKING,HOUSING,AND URBAN AFFAIRS
                          UNITED STATES SENATE

                      ONE HUNDRED TWELFTH CONGRESS

                             FIRST SESSION

                                   ON

                          THE NOMINATIONS OF:

    KATHARINE G. ABRAHAM, OF IOWA, TO BE A MEMBER OF THE COUNCIL OF 
                           ECONOMIC ADVISERS

                               __________

CARL SHAPIRO, OF CALIFORNIA, TO BE A MEMBER OF THE COUNCIL OF ECONOMIC 
                                ADVISERS

                               __________

  PETER A. DIAMOND, OF MASSACHUSETTS, TO BE A MEMBER OF THE BOARD OF 
                   GOVERNORS, FEDERAL RESERVE SYSTEM

                               __________

                             MARCH 8, 2011

                               __________

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


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            COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

                  TIM JOHNSON, South Dakota, Chairman

JACK REED, Rhode Island              RICHARD C. SHELBY, Alabama
CHARLES E. SCHUMER, New York         MIKE CRAPO, Idaho
ROBERT MENENDEZ, New Jersey          BOB CORKER, Tennessee
DANIEL K. AKAKA, Hawaii              JIM DeMINT, South Carolina
SHERROD BROWN, Ohio                  DAVID VITTER, Louisiana
JON TESTER, Montana                  MIKE JOHANNS, Nebraska
HERB KOHL, Wisconsin                 PATRICK J. TOOMEY, Pennsylvania
MARK R. WARNER, Virginia             MARK KIRK, Illinois
JEFF MERKLEY, Oregon                 JERRY MORAN, Kansas
MICHAEL F. BENNET, Colorado          ROGER F. WICKER, Mississippi
KAY HAGAN, North Carolina

                     Dwight Fettig, Staff Director

              William D. Duhnke, Republican Staff Director

                Brian Filipowich, Legislative Assistant

                   Lisa Frumin, Legislative Assistant

             Andrew J. Olmem, Jr., Republican Chief Counsel

              Michael Piwowar, Republican Chief Economist

                       Dawn Ratliff, Chief Clerk

                     Levon Bagramian, Hearing Clerk

                      Shelvin Simmons, IT Director

                          Jim Crowell, Editor

                                  (ii)
?

                            C O N T E N T S

                              ----------                              

                         TUESDAY, MARCH 8, 2011

                                                                   Page

Opening statement of Senator Johnson.............................     1

Opening statements, comments, or prepared statements of:
    Senator Shelby...............................................     2
    Senator Reed.................................................     5

                                NOMINEES

Katharine G. Abraham, of Iowa, to be a Member of the Council of 
  Economic
  Advisers.......................................................     7
    Prepared statement...........................................    20
    Biographical sketch of nominee...............................    21
    Responses to written questions of:
        Senator Reed.............................................    72
Carl Shapiro, of California, to be a Member of the Council of 
  Economic Advisers..............................................     8
    Prepared statement...........................................    33
    Biographical sketch of nominee...............................    34
    Responses to written questions of:
        Chairman Johnson.........................................    72
        Senator Shelby...........................................    73
Peter A. Diamond, of Massachusetts, to be a Member of the Board 
  of Governors, Federal Reserve System...........................     9
    Prepared statement...........................................    49
    Biographical sketch of nominee...............................    50
    Responses to written questions of:
        Chairman Johnson.........................................    77
        Senator Vitter...........................................    79

                                 (iii)


                          THE NOMINATIONS OF:

                     KATHARINE G. ABRAHAM, OF IOWA,

          TO BE A MEMBER OF THE COUNCIL OF ECONOMIC ADVISERS;

                      CARL SHAPIRO, OF CALIFORNIA,

          TO BE A MEMBER OF THE COUNCIL OF ECONOMIC ADVISERS;

                  PETER A. DIAMOND, OF MASSACHUSETTS,

    TO BE A MEMBER OF THE BOARD OF GOVERNORS, FEDERAL RESERVE SYSTEM

                              ----------                              


                         TUESDAY, MARCH 8, 2011

                                       U.S. Senate,
          Committee on Banking, Housing, and Urban Affairs,
                                                    Washington, DC.
    The Committee met at 10:05 a.m., in room SD-538, Dirksen 
Senate Office Building, Hon. Tim Johnson, Chairman of the 
Committee, presiding.

           OPENING STATEMENT OF CHAIRMAN TIM JOHNSON

    Chairman Johnson. Good morning. I call this meeting to 
order.
    Today, we consider three nominations. Dr. Peter Diamond has 
been nominated to become a member of the Board of Governors of 
the Federal Reserve System, and Drs. Katharine Abraham and Carl 
Shapiro have been nominated to be members of the Council of 
Economic Advisers.
    At present, our economy is recovering from one of the worst 
downturns in history. We have seen some signs of progress, but 
for more than 13 million Americans who are out of jobs and 
looking for a job, the recovery cannot come to soon. 
Unemployment remains at about 9 percent, and even with hundreds 
of thousands of new jobs added every month, it will take years 
to get back to precrisis levels.
    At the same time, we face daunting long-term budgetary 
imbalances, strong foreign competition, rising oil prices, and 
the ever present need to maintain low inflation. It is for 
these reasons that we need all hands on deck for our Nation's 
economy policymaking. I am glad that the President has sent us 
three extremely qualified individuals to fill current vacancies 
in posts important to our Nation's economic recovery.
    Dr. Peter Diamond is a distinguished economist who has 
worked on unemployment, economic growth, and the economics of 
Social Security and pensions. He has served as President of the 
American Economic Association and President of the Econometric 
Society. Since his original nomination in 2010, he was awarded, 
along with two other economists, the Nobel Prize in Economics. 
The models for which Dr. Diamond won the Nobel Prize helped us 
understand the ways in which unemployment, job vacancies, and 
wages are impacted by regulation and economic policy. His 
search theory has also been used to study questions related to 
monetary theory, public economics, financial economics, 
regional economics, and family economics.
    Sir James Mirrlees, a 1996 Nobel Prize winner in economics, 
said of Dr. Diamond, ``No economist is smarter. His reasoning 
is amazingly accurate. The theories and models he uses are 
defined with the greatest precision. More than most economic 
theorists, he has always chosen his research topics and 
questions for their real importance.''
    Dr. Diamond was reported favorably with bipartisan support 
by this Committee twice in the last session of Congress by 
votes of sixteen to seven.
    Dr. Katharine Abraham is a professor in the Joint Program 
in Survey Methodology and Faculty Associate in the Population 
Research Center at the University of Maryland. Dr. Abraham 
served as a Commissioner for the Bureau of Labor Statistics at 
the U.S. Department of Labor from 1993 to 2001. She joined the 
University of Maryland in 1987, where she served as a Professor 
of Economics and she also taught at MIT's Sloan School of 
Management from 1980 to 1985. Dr. Abraham received her Ph.D. in 
economics from Harvard in 1982 and her B.A. in economics from 
Iowa State University in 1976.
    Dr. Carl Shapiro is the Deputy Assistant Attorney General 
for Economics at the Antitrust Division of the U.S. Department 
of Justice, where he supervises more than 50 Ph.D. economists 
in the Antitrust Division's Economic Analysis Group. Dr. 
Shapiro is on leave from the University of California at 
Berkeley, where he is the Transamerica Professor of Business 
Strategy at the Haas School of Business and a Professor of 
Economics. He earned his Ph.D. in economics from MIT in 1981.
    I thank all of the nominees for your willingness to serve 
at the Federal level, especially at a time when our country is 
trying to overcome significant economic challenges.
    Senator Shelby, would you like to give a statement?

             STATEMENT OF SENATOR RICHARD C. SHELBY

    Senator Shelby. I do. Thank you, Mr. Chairman, for calling 
these hearings. They are very important.
    Today, we are considering the nominations of three 
economists, two to be members of the Council of Economic 
Advisers and one to be a member of the Board of Governors.
    Dr. Katharine Abraham and Dr. Carl Shapiro have been 
nominated to be members of the Council of Economic Advisers, 
CEA. The CEA is an agency within the Executive Office of the 
President that is charged with providing the President economic 
advice. Although I do not share many of the policy preferences 
of these nominees, I am inclined to give greater deference to 
the President in his choice for his own personal economic 
advisers.
    I do not believe, however, that the same deference should 
be given to nominations for our financial regulators. In light 
of the inexcusable failures leading up to the recent crisis, I 
believe that the Senate needs to take a much more active role 
in ensuring that our financial regulators have the proper 
leadership. The poor job our regulators did in supervising our 
financial institutions was a key contributor to the recent 
financial crisis. If we learned anything, it is that it matters 
who serves in these very important positions.
    That is especially true at the Federal Reserve. The Fed's 
collective authorities make it one of the most powerful 
organizations in the world. It supervises our largest financial 
institutions and has extensive regulatory authority over our 
entire financial system. The Federal Reserve's inherent 
independence and the 14-year terms of Governors make it the 
least accountable agency in our Government. As a result, Fed 
Governors exercise immense power with very little oversight.
    It is proper, therefore, that the Senate should take its 
constitutional advice and consent duties for Fed nominees very, 
very seriously. In my opinion, the nomination of a Fed Governor 
is the economic equivalent of a Supreme Court nomination and 
should be treated accordingly.
    Applying this standard to the nomination of Dr. Peter 
Diamond to the Board of Governors, I believe that Dr. Diamond 
should not be confirmed. Dr. Diamond is, of course, a very 
accomplished academic and economist. Nevertheless, a reasonable 
comparison of the qualities a Fed Governor should possess and 
Dr. Diamond's background clearly demonstrates that he is not 
the right person, I believe, for this particular job.
    The Fed's responsibilities cut across three broad areas: 
Conducting monetary policy, supervising our financial system, 
and responding to financial crises. Any qualified nominee 
should have, at a minimum, some level of experience in at least 
one of these areas. Let us examine Dr. Diamond's experience in 
each of these areas.
    Does Dr. Diamond have any experience in conducting monetary 
policy? The answer is no. In the written testimony that Dr. 
Diamond provided for his nomination hearing last July, he 
listed several areas of focus in his teaching and research. 
Monetary economics is not on the list. Instead, his academic 
work has been one on pensions and labor market theory.
    Does Dr. Diamond have any experience in bank management or 
supervision? Of course, the answer is no. None of his 
professional positions or activities involves working as a bank 
regulator or even working in a bank.
    Does Dr. Diamond have any experience in crisis management? 
The answer is no. While his resume contains an extensive list 
of academic and policy activities, none of them suggest that he 
has any experience in effectively managing a crisis, let alone 
a worldwide financial crisis.
    In addition to a nominee's expertise and experience, their 
policy preferences also matter. A Fed Governor's economic 
philosophy impacts not only how the Fed exercises its vast 
regulatory authority, but also the tenor of its policy debates, 
because Fed Governors have a very powerful bully pulpit.
    What are Dr. Diamond's policy preferences? Let me continue. 
He supports QE2. He supported President Obama's $800 billion 
stimulus package and has argued for additional fiscal stimulus. 
He wrote a paper with President Obama's former Budget Director, 
Peter Orszag, arguing for higher taxes to fund Social Security. 
He supported bailing out big banks during the financial crisis. 
He supports the use of behavioral economics to help bureaucrats 
more effectively control the choices that Americans make. He 
has even advocated the creation of a GSE modeled after Fannie 
and Freddie to subsidize health care.
    In short, Dr. Diamond is an old fashioned, big Government 
Keynesian. Many of us believe that this is not the economic 
philosophy the Fed should be embracing at this point in our 
economic history. Our economy is already suffering from 
excessive Government debt and misguided regulation. Our 
financial regulators should be trying to take steps to 
strengthen our markets rather than replace them with new layers 
of Government.
    For those who say that policy preference should not be 
considered, I would only point out that the renomination of Dr. 
Randy Kroszner to the Fed was blocked by the majority of the 
Democratic Party because he was viewed as being too free 
market. Unlike Dr. Diamond, Dr. Kroszner is an expert in 
monetary policy and banking regulation. Yet, the majority party 
never even gave him a hearing. Why? Because they agreed that 
the policy preference of Fed nominees do matter.
    Although Dr. Diamond is a skilled and accomplished 
theoretical economist, it is clear to many of us that he does 
not possess the appropriate background, experience, or policy 
preferences to serve on the Board of Governors.
    Dr. Diamond may be a talented economic theorist and he may 
be very well suited for a number of positions in the 
Administration, but I do not believe he is the best person for 
this position at this time at the Federal Reserve.
    Therefore, before I conclude, let me address the issue of 
Dr. Diamond's Nobel Prize. Unquestionably, the Nobel is a major 
honor. Yet being a Nobel recipient does not mean one is 
qualified for every conceivable position. Any private sector 
human resource manager would likely say that Dr. Diamond would 
not be a good selection for a CEO of a large bank. The skills 
needed to win the Nobel Prize are simply not the same as those 
required to manage a large financial institution. The same is 
true here. The skills needed to win the Nobel are not 
necessarily the same as those needed to be a good Fed Governor. 
I seriously doubt that many of Dr. Diamond's supporters would 
have favored the appointment of Milton Friedman or Myron 
Scholes to the Fed simply because they won the Nobel Prize.
    Finally, I am compelled to again point out that Dr. Diamond 
is legally not eligible to serve. According to Section 10 of 
the Federal Reserve Act, no two members of the Board of 
Governors can come from the same Fed district. Once again, Dr. 
Diamond's nomination papers indicate he is, quote, ``of 
Massachusetts.'' Current Board member Daniel Tarullo's 
nomination papers also indicated he was, quote, ``of 
Massachusetts.'' Dr. Diamond and Dr. Tarullo cannot serve at 
the same time and comply with Section 10 of the Federal Reserve 
Act. We can debate the wisdom and historical application of 
this requirement at a later date, but for now, it is the law, 
even if prior Congresses have chosen to look the other way.
    There are plenty of good nominees that could be selected 
from historically overlooked districts, like the Cleveland and 
Minneapolis Districts. In fact, there has not been a Fed 
Governor from the Cleveland District in 65 years. I would think 
that some of my friends from Ohio might find that a bit 
concerning.
    Mr. Chairman, I encouraged the President to withdraw this 
nomination and look beyond the Boston-to-DC corridor for a new 
nominee. Thank you.
    Chairman Johnson. Senator Reed.

                 STATEMENT OF SENATOR JACK REED

    Senator Reed. Well, Mr. Chairman, thank you very much. We 
have three extremely qualified nominees that are before us 
today. I think both Dr. Abraham and Dr. Shapiro have 
demonstrated a remarkable record, and we can get into some of 
the details of the issues and policies.
    Dr. Diamond, I think, is also superbly qualified, and I 
think that despite the Ranking Member's comments, I think there 
is, I would say, a misperception of the role of the Board of 
Governors of the Federal Reserve. No one Governor is a 
supervisor, as, for example, the OCC Director or the 
Chairperson of the Securities and Exchange Commission, with the 
exception of perhaps Chairman Bernanke.
    But what the Federal Reserve can do collectively is to 
engage in vigorous debate, and that debate, I think, is 
enhanced by having individuals of Dr. Peter Diamond's ability 
and perspective. One of the critiques, I think, looking back 
over the last several years, is a certain group-think at the 
Federal Reserve about many different policies. I think Dr. 
Diamond's nomination, and I hope confirmation, to the Federal 
Reserve will provide an interesting perspective from a very 
gifted individual that might challenge some of the orthodoxies 
within the Fed, that might force the individual members of the 
Fed from different sort of economic perspectives to ask 
fundamental questions and re-ask the questions, and in that 
sense, I think he will be a very, very valuable contributor to 
the Federal Reserve Board.
    The issue of the legal status is something that I think we 
can address and will address. I am hopeful that that is an 
issue that has already been successfully decided by the 
Administration.
    But I find it just interesting to note that if there is a 
general criticism of the role of the Federal Reserve and then 
the suggestion is, find people just like the people we have had 
on the Federal Reserve for the last 10 years, it seems to me to 
be inconsistent and I would hope that we would support and 
confirm Dr. Diamond.
    Chairman Johnson. Senator Toomey.
    Senator Toomey. Thank you, Mr. Chairman. If I could pass 
for now, I would like to follow up in a few minutes. Thank you.
    Chairman Johnson. Senator Hagan.
    Senator Hagan. Thank you, Mr. Chairman. I think we have 
three excellent and very well qualified individuals before us 
today and I am certainly looking forward to the questions and 
their testimony. Thank you.
    Chairman Johnson. Before we begin opening statements, I ask 
all nominees to stand and raise your right hand for the 
swearing in.
    Do you swear or affirm that the testimony that you are 
about to give is the truth, the whole truth, and nothing but 
the truth, so help you God?
    Ms. Abraham. I do.
    Mr. Shapiro. I do.
    Mr. Diamond. I do.
    Chairman Johnson. Do you agree to appear and testify before 
any duly constituted Committee of the Senate?
    Ms. Abraham. I do.
    Mr. Shapiro. I do.
    Mr. Diamond. I do.
    Chairman Johnson. Please be assured that your written 
statement will be part of the record, so if you could confine 
your remarks to 5- to 8-minutes, that would be greatly 
appreciated. Please note, also, that Members of the Committee 
may submit written questions to you for the record and you need 
to respond to these questions promptly in order that the 
Committee may proceed with your nomination.
    I invite all witnesses to introduce their family and 
friends in attendance before beginning your statement. Ms. 
Abraham.
    Ms. Abraham. Thank you. I do have some people I would like 
to introduce. I will start with my wonderful husband of 25 
years, Graham Horkley. My mother, Roberta Abraham, who has been 
throughout my life a source of encouragement and support. My 
brother, David, his wife, Carol, and their two children, 
William and Allison. My sister, Sarah. My childhood friends 
from Iowa, Patricia Behneke [phonetic] and Ann Peterson 
[phonetic], and Patty's daughter, Laura.
    I, believe it or not, have more relatives who would have 
liked to be here today and could not. My father, William 
Abraham, could not travel to be here. My brother, John, my 
sister, Molly, and my two college-age sons, who I hope are hard 
at work on their classwork. Thank you.
    Chairman Johnson. Thank you, Ms. Abraham.
    Mr. Shapiro.
    Mr. Shapiro. Thank you. I am really pleased that my parents 
are here, Sherman and Ellen Shapiro, sitting in the front row. 
And behind them, my children, my daughter, Eva, and my son, 
Benjamin, were able to come, as well, from California. My 
partner and best friend, Marti Hearst, is sitting next to Eva 
here, as well. And I have support from my recent colleagues at 
the Justice Department, Christine Varney, who is the Assistant 
Attorney General for Antitrust, Gene Kimmelman, Sharis Pozen, 
Janet Fikow [phonetic], and Joe Matelis are all from the 
Antitrust Division. I really appreciate it. And some older 
friends, Steve Salat [phonetic], Joe Farrow [phonetic], and 
Dewey Graham [phonetic] are here, as well.
    Chairman Johnson. Ms. Abraham and Mr. Shapiro, would you be 
seated. And last, but not least, Dr. Diamond.
    Mr. Diamond. Thank you, Mr. Chairman. I am traveling very 
light, compared to the others.
    [Laughter.]
    Chairman Johnson. After two tries.
    Mr. Diamond. My wife, Kate, is here. My son, Matt, and my 
cousin, Burcu Duygan-Bump. Thank you.
    Chairman Johnson. Thank you.
    Ms. Abraham, proceed with your statement.

 STATEMENT OF KATHARINE G. ABRAHAM, OF IOWA, NOMINATED TO BE A 
           MEMBER OF THE COUNCIL OF ECONOMIC ADVISERS

    Ms. Abraham. Thank you, Chairman Johnson, Ranking Member 
Shelby, distinguished Members of the Committee. I am pleased 
and honored to appear before you today as a nominee to be a 
member of the President's Council of Economic Advisers.
    Mr. Johnson has already given some of my background. I am 
currently a professor at the University of Maryland. From 1993 
to 2001, I served as Commissioner of Labor Statistics in the 
Department of Labor, where I was responsible for many of the 
key economic indicators produced by the Federal Government. 
Prior to that, I held faculty positions at the University of 
Maryland in the Department of Economics and the Sloan School of 
Management at MIT.
    I fell in love with economics as a freshman in college and 
I have not stopped being in love with economics. What drew me 
to economics is the power that I believe economic analysis has 
to inform the policy process and contribute to better outcomes 
for society.
    Something I have also come to appreciate is that economic 
analysis can only be as good as the data on which it rests. 
That is something that I came particularly to appreciate during 
my 8 years as Commissioner of Labor Statistics, and I have 
maintained a continuing interest in the quality of our economic 
data and the ways in which they might be improved.
    My research and writing have examined a variety of labor 
market policy issues and relevant economic data on employment, 
unemployment, inflation, wages, and national output. It is my 
hope that, if confirmed, my expertise can be useful for 
interpreting the new data about our economy that will become 
available over the coming months and years and for assessing 
their implications for important policy decisions.
    As has already been alluded to, these continue to be 
extraordinary times for our economy. Following the worst 
macroeconomic shock experienced in a generation, the economy is 
beginning to recover, but for too many Americans, things are 
still far from being back to normal. Looking to the future, we 
know, I think, that investments in physical, human, and 
knowledge capital will be essential to ensuring our Nation's 
long-term prosperity.
    Should I be confirmed, I look forward to working with other 
members of the Administration and with this Committee to 
provide economic insights and analysis that will help with the 
formulation of policies conducive to broadly shared growth.
    Thank you very much. I will, of course, be happy to answer 
any questions that you or Members of the Committee might wish 
to pose.
    Chairman Johnson. Thank you, Ms. Abraham.
    Mr. Shapiro.

  STATEMENT OF CARL SHAPIRO, OF CALIFORNIA, NOMINATED TO BE A 
           MEMBER OF THE COUNCIL OF ECONOMIC ADVISERS

    Mr. Shapiro. Thank you, Chairman Johnson, Ranking Member 
Shelby, and other Members of the Committee. I am pleased and 
honored to appear before you today as a nominee to serve as a 
member of the President's Council of Economic Advisers.
    I already introduced you to my family, but I would like to 
pause for a moment to especially note my father, Sherman, 
sitting right here behind me. He grew up terribly poor in the 
Great Depression. Through hard work and tremendous dedication 
to improving himself, he was able to earn a Ph.D. in economics 
at the University of Chicago. He had tremendous influence on 
me, always has. He taught me the virtues of giving all 
Americans the opportunity to make the most of themselves while 
always, always, stressing the importance of personal 
responsibility.
    I was born in Austin, Texas, grew up in South Bend, 
Indiana, and Wilmette, Illinois, and went to school at MIT, and 
you have described some of my other schooling and 
qualifications. I was a professor at Princeton for 10 years 
during the 1980s. I have been a professor at Berkeley for about 
20 years.
    But during the mid-1990s, I came to Washington to serve as 
the Chief Economist in the Antitrust Division. My interests 
have always gone toward public policy and applying the 
economics for public policy. And then I returned 2 years ago, 
again as Chief Economist in the Antitrust Division, working 
with Christine Varney, who is here, as well, the Assistant 
Attorney General for Antitrust. In that role, my job has been 
to supervise the economists and give the very best economic 
analysis and advice to the Assistant Attorney General in 
support of antitrust enforcement.
    My research, consulting, and public service have 
consistently emphasized the importance of promoting competition 
and innovation as drivers of economic growth. I have a special 
interest and expertise in the economics of high-tech 
industries, intellectual property, some of the other drivers of 
innovation. My book with Hal Varian, ``Information Rules: A 
Strategic Guide to the Network Economy'', which applies 
economic principles to the information economy, has been widely 
read by managers and adopted for classroom use. So I have a 
business side, if you will, consulting and teaching MBAs, as 
reflected in that book, as well as my public policy side of my 
background.
    If I am confirmed as a member of the CEA, I hope to 
contribute my expertise to the development of policies that 
promote economic growth by creating a business environment that 
encourages private sector innovation and investment.
    The CEA has a great tradition, going back 65 years, of 
providing high-quality, unbiased economic policy advice to the 
President based on the best thinking and scientific evidence 
the economics profession has to offer. If I am confirmed, I 
look forward to continuing that tradition.
    Thank you. I would be happy to answer any questions you 
have for me.
    Chairman Johnson. Thank you, Mr. Shapiro.
    Mr. Peter Diamond.

 STATEMENT OF PETER A. DIAMOND, OF MASSACHUSETTS, NOMINATED TO 
 BE A MEMBER OF THE BOARD OF GOVERNORS, FEDERAL RESERVE SYSTEM

    Mr. Diamond. Chairman Johnson, Senator Shelby, 
distinguished Members of the Committee, I am honored to have 
been nominated by President Obama to be a member of the Board 
of Governors of the Federal Reserve System and grateful to this 
Committee for having me here today.
    If confirmed, I will work to the best of my abilities to 
fulfill the responsibilities of this office. Those 
responsibilities have always been significant. The experience 
of the recent financial crisis and the ensuing financial reform 
legislation have underlined the multiple responsibilities of 
the Fed in working to foster maximum employment and price 
stability. The Fed has much work ahead in order to implement 
and fulfill the tasks laid out by the financial reform 
legislation. I would be honored and pleased to be part of the 
process of responding to this challenge.
    I studied both mathematics and economics as an 
undergraduate at Yale University. I received my Ph.D. in 
economics from the Massachusetts Institute of Technology in 
June 1963. Since then, I have been a faculty member, first at 
the University of California at Berkeley, and since 1966 at 
MIT.
    Throughout this period, I have taught and done research in 
economics. My primary focus in both graduate teaching and 
research has been economic theory, particularly macroeconomics, 
search theory, and public finance. Within public finance, my 
primary focus has been on taxes, pensions, and social 
insurance, particularly Social Security. I have done both 
theoretical analyses and policy analyses. At the undergraduate 
level, I have taught microeconomics, macroeconomics, public 
finance, money and banking, and law and economics. Being a 
member of two economics departments with great collegial 
interactions, I have gained wide knowledge in a variety of 
economics topics, as well as detailed knowledge in my areas of 
expertise.
    A central theme in my research career has been how the 
economy deals with risks, both risks at the individual level 
and risks that affect the entire economy. I have thought 
extensively and written about the risks in the economy and how 
markets and Government can combine to make the economy function 
better.
    In particular, the research that led to my being a 
corecipient of the Nobel Prize in Economic Sciences has 
addressed how the costs and delays in learning about market 
opportunities affect the workings of the economy. As noted by 
the Prize Committee, the basic research on this topic has been 
used as a starting place for applied research in a wide variety 
of areas, not only the housing and labor markets, where sizable 
delays are clearly visible, but also in monetary theory and 
finance economics. Indeed, the varying speeds with which 
surprises occur to financial firms and their abilities to 
respond is a central element in the development of financial 
crises, making search theory an important part of understanding 
how to avoid and limit future shocks to the financial system.
    In sum, I believe my background would prove very helpful at 
the Federal Reserve, particularly as a part of the process of 
addressing our heightened awareness of the dangers of systemic 
risks.
    If confirmed, I would welcome the opportunity to help 
address the important issues that have been raised by the 
financial crisis as well as the longstanding issues and 
concerns in monetary policy and bank regulation that the 
Federal Reserve faces.
    Thank you again for holding today's hearings. I would be 
pleased to answer your questions.
    Chairman Johnson. Thank you, Mr. Diamond.
    Would the Clerk put on the clock 5 minutes.
    Mr. Diamond, an article in the Boston Globe stated that 
colleagues have said that your work changed the way economists 
think about national debt, taxes, risk, unemployment, and 
Social Security. What insight on these issues, particularly 
unemployment, can you bring to the Federal Reserve Board of 
Governors as it sets its economic and regulatory policy?
    Mr. Diamond. Thank you, Mr. Chairman, for the question. The 
way we teach about markets at the start of economics is demand 
and supply and a price clears the market. But if you look at 
the labor market, at any point in time, there are unemployed 
workers and there are vacancies. So that picture of the stocks 
of unemployment and vacancies is an inadequate basis for 
thinking about the dynamic process of how the economy goes into 
a recession and how it comes out and the role of policy, both 
unemployment insurance to help the workers affected and macro 
policy generally.
    The picture that comes when you look at the flows shows 
over the last 20 years, in an average month, six million 
workers gain employment and a slightly smaller number lose 
employment. The impact on unemployment is the difference 
between two large numbers. So focusing on the flows, focusing 
on the way that firms find it profitable to seek and hire new 
workers and to decide which workers they want to hire and 
focusing on how workers decide where to look for jobs, what 
kinds of jobs to look at, these are the central elements in 
thinking about the dynamic process.
    The monetary policy followed by the Fed influences this 
process, and conversely, studying this process is essential for 
understanding the state of the economy, the risks of inflation, 
and how to impact the unemployment that is going on. This 
attention to the risks of the economy as a whole, is very 
important for going ahead from this terrible crisis we have had 
and are still definitely not out of.
    Chairman Johnson. Mr. Shapiro and Ms. Abraham, a question 
for you both. I believe key investments in innovation, 
education, and infrastructure will strengthen our 
competitiveness globally. While Congress debates budget and 
prioritizes spending, how important is it that we use a scalpel 
to make targeted budget cuts to ensure that we protect those 
needed investments? Ms. Abraham?
    Ms. Abraham. I think that it is very important. I think 
that we can all agree that we need to be looking hard at 
spending. We need to be looking at ways to bring down the 
deficit. But at the same time, we would be harming our future 
if we were not making--continuing to make needed investments in 
the areas that you have identified. Education, innovation, and 
infrastructure are critical to our future.
    Chairman Johnson. Mr. Shapiro, do you have any thoughts?
    Mr. Shapiro. Yes, along similar lines. I think particularly 
investments in basic research and promoting basic research is 
something we cannot really count on the private sector to do, 
and so there is an important role for the Government there, 
after which we then turn it over to the private sector to 
commercialize and build the jobs based on that innovation. We 
have decades of successful experience in that, and so that is 
an example of an area where a meat axe would be unwise. A 
scalpel is the way to go.
    Chairman Johnson. Mr. Diamond, since the downturn in the 
economy, the Fed has managed to keep inflation in check, but 
too many Americans remain out of work. Can more be done to 
create jobs? What is your view of the Federal Reserve's actions 
so far in promoting the recovery?
    Mr. Diamond. The traditional tool used by the Federal 
Reserve is the short-term interest rate. By lowering short-term 
interest rates, they encourage consumers to spend, particularly 
on consumer durables. Second, that encourages businesses to 
invest because it will be cheaper to do it. And third, there is 
the general sense of the economy moving forward because 
critical to business is the projection of the ability to sell 
things out in the future.
    Currently, and for an extended period, we have had a short-
term interest rate that cannot be lowered any more. So the Fed 
has had to address how to lower long-term interest rates that 
matter for these same phenomena and how to do that in a way 
that will encourage both consumption and investment. The action 
that the Fed has taken in the asset markets, purchasing assets 
to help bring down interest rates to encourage more consumption 
and more investment, seems to me to have been an appropriate 
way to go, although obviously not being part of the FOMC, I was 
not part of the explicit discussions and the working out of 
details.
    Chairman Johnson. Senator Shelby.
    Senator Shelby. Thank you, Mr. Chairman.
    Dr. Abraham, the headline number from last week's jobs 
report was that total unemployment for February was 8.9 
percent. An alternative measure of unemployment contained in 
the report, which includes people who have stopped looking for 
work or who cannot find full-time jobs, stood at 15.9 percent. 
Dr. Abraham, as the former Commissioner of Labor Statistics in 
the Department of Labor, what do you think is the best 
indicator of labor under-utilization? In other words, is the 
unemployment rate closer to 9 percent or is it closer to 16 
percent?
    Ms. Abraham. Hmm. I appreciate your interest, Mr. Shelby, 
in these economic data. That is a hard question to answer. 
They----
    Senator Shelby. But we need to try to put our hands around 
it, do we not?
    Ms. Abraham. I think--I guess that what I----
    Senator Shelby. Because we are looking for the truth, are 
we not?
    Ms. Abraham. Oh, absolutely. I guess that what I would say 
is that from my perspective, the most important use of these 
data is to tell us about how we are doing today compared to how 
we were doing in the past, to look at whether things are 
getting better or things are getting worse. And a comment about 
those numbers is that they do tend to go up and down together. 
Whether you look at the narrower unemployment rate or the 
broader unemployment rate, they both are telling us that things 
are not good now.
    Senator Shelby. You do not dispute those numbers----
    Ms. Abraham. Oh, no. No, no, no, no----
    Senator Shelby. Either the 8.9 or the 15.9?
    Ms. Abraham. No.
    Senator Shelby. OK.
    Ms. Abraham. They are measuring different things and----
    Senator Shelby. They are metrics that you are familiar 
with.
    Ms. Abraham. And the conclusion, the main conclusion I take 
from them is that we are not in a good place right now.
    Senator Shelby. And what does that mean----
    Ms. Abraham. That----
    Senator Shelby. ----to us up here and to the American 
people?
    Ms. Abraham. I think it means that we need to be thinking 
hard about how to create more jobs.
    Senator Shelby. To build support for the Obama 
administration's stimulus bill, the CEA--you were not there, I 
understand that--created an estimate of the number of, quote, 
``jobs saved'' by the bill--jobs saved. A number of well-
respected economists have criticized the so-called ``jobs 
saved'' estimate as being nonmeasurable. For example, Dr. Allan 
Meltzer said, and I will quote, ``The Council of Economic 
Advisers shamefully invented a number called jobs saved that 
has never been seen before, has no agreed meaning, and no 
academic standing.'' What is your professional opinion about 
the accuracy and validity of the CEA's ``jobs saved'' estimate?
    Ms. Abraham. Well, I think that the estimate was an attempt 
to answer a really important question, which is how much 
difference did the Recovery Act make to the employment that we 
saw compared to what we would have had without it. Answering 
that kind of question is hard and there are a lot of 
uncertainties around the number, so I would not want to pin my 
hat on a specific number. But I do think that the estimate is 
pretty comparable to what other analysts, private sector 
analysts looking at the effects of the stimulus have come up 
with, and I am convinced that the Recovery Act had a 
significant and positive effect on employment, though I agree 
it is hard to quantify.
    Senator Shelby. Do you believe that it is appropriate for 
the Council of Economic Advisers to create highly speculative 
statistics that perhaps are designed solely to support an 
Administration's political agenda, be it this one or a 
Republican, whatever? In other words, is that not----
    Ms. Abraham. You are asking an important question about the 
role of the CEA----
    Senator Shelby. Sure.
    Ms. Abraham. ----and I think that the, from my perspective, 
the role of the CEA is to provide the best information possible 
to inform policy formation and the evaluation of policy. With 
something like this, it is very hard to come up with a precise 
number, but I think it is quite appropriate to try to produce 
the best number possible as an input into discussion of the 
policies that were adopted.
    Senator Shelby. Would you agree, though, that basic 
economic policy should not be based on speculation, should be 
based on hard numbers?
    Ms. Abraham. The economic policy should be based on the 
best numbers possible.
    Senator Shelby. That is right, harder numbers.
    Ms. Abraham. And in some cases, coming up with something 
that is a precise estimate is going to be impossible, and in 
that case, I think you do the best job you can.
    Senator Shelby. Dr. Shapiro, I have a question for you, if 
I could. In your role as the Deputy Assistant Attorney General, 
you recently submitted a Department of Justice letter on a 
proposed CFTC rule regarding ownership limitations and 
governance requirements for swap clearinghouses. Your letter 
has received harsh criticism from academic economists and 
market participants. For example, one economist said that the 
Department of Justice letter treats safety and soundness 
concerns, quote, ``dismissively, cavalierly, and 
superficially.'' Those are harsh words.
    Explain how your proposed ownership limitations and 
governance requirements will affect the incentive of owners to 
run well-managed and well-capitalized clearinghouses.
    Mr. Shapiro. I would be happy to. The Antitrust Division 
takes a competition perspective and we were here attempting to 
explain, to give advice to the CFTC and the SEC regarding how 
some of the provisions of the Dodd-Frank Act could, indeed, 
promote competition in some of these areas, particularly for 
the exchanges.
    Senator Shelby. Mm-hmm.
    Mr. Shapiro. So in terms of the question about the 
difference between--about safety and soundness, we were much 
more cautious about clearinghouses versus exchanges in terms of 
the natural monopoly elements, and I think that is reflected in 
the statute. There were certainly some criticisms of what we 
put in, but there were also quite a lot of support. It is quite 
a controversial area.
    Senator Shelby. Do you disagree that what one economist 
said, it treats safety and soundness concerns, again, 
dismissively, cavalierly, and superficially?
    Mr. Shapiro. I strongly disagree with that, and I guess 
that was what I was attempting to convey in my previous answer, 
which is the safety and soundness concerns, I think, are 
critical in the setting up of a centralized clearinghouse, 
which was something that was a problem that was missing in 
these derivatives areas that contributed to the financial 
crisis. And the Treasury and the CFTC and the SEC are all 
working together following the Dodd-Frank to improve safety and 
soundness by having the clearinghouses set up and have a lot of 
the trading go through the clearinghouses.
    We were, therefore, though, saying much more--took a 
lighter hand in terms of promoting competition in 
clearinghouses because the safety and soundness issues are very 
important. They are less of an----
    Senator Shelby. Very, very, important.
    Mr. Shapiro. Extremely important, and the risks are not as 
great for the exchanges as they are for the clearinghouse 
itself.
    Senator Shelby. Thank you, Mr. Chairman.
    Chairman Johnson. Senator Reed.
    Senator Reed. Thank you very much, Mr. Chairman.
    Dr. Diamond, you have done over the course of your career 
research in a number of different very critical areas--
taxation, public debt, Social Security, market dynamics, et 
cetera. And again, I think, personally, that this will be a 
tremendous asset on the Board of Governors because of the 
various perspectives you can bring.
    Can you give just a brief response to the two areas which I 
think are of increasing importance. One is how do we increase 
employment opportunities, and second, how do we anticipate 
concentration of risk, you know, the bubble phenomenon that we 
saw manifested over the last several years?
    Mr. Diamond. OK. Thank you, Senator. On creating more jobs, 
I think we have the familiar money and fiscal policy elements. 
We got a stimulus package on the tax cut and spending side 
passed by the Congress in December, and I think that is a 
package that will help with this process. Beyond that, trying 
to lower the longer-term interest rates to encourage both 
consumption and investment is the way to go. The recovery has 
been slow. The unemployment rate has come down very slowly and 
I think it is quite important to go forward as quickly as we 
can.
    We know that part of the slow-down process is happening 
through the credit markets, that there are a number of small 
banks that are not in very strong shape, and as such, are 
somewhat limited in their abilities to lend. The role of small 
banks is very important, particularly for small business. So as 
those banks get stronger, as the supervision encourages them to 
do sound lending, that should be a help. And we also know that 
with small businesses, often, startup capital, new businesses, 
comes by drawing on home equity wealth, both individual and 
friends and family who are pitching in to help. So I think as 
the housing market gets sorted out, I think that should help, 
as well.
    I think there is no single tool, no magic bullet. I think 
we have to work on all of these pieces.
    I am sorry, the second question?
    Senator Reed. The second question is that one of the 
expectations now is that the Federal Reserve will be much more 
sensitive to growing accumulations of risk, bubbles, areas of 
economic activity that could present another rapid sort of 
breakdown as we witnessed.
    Mr. Diamond. I think it is useful here to separate out two 
pieces. One is the issue of bubbles, which you have mentioned. 
And then the second is the way the creation of a bubble itself 
will often lead to misallocation of capital. But it is the 
bursting of the bubble that will often ripple through the 
financial system and cause great harm, as happened this time.
    So these are two separate issues. I think the attention to 
bubbles is inherently difficult. Nobody flies a flag and says, 
``hey, we have got a bubble.'' There are people who think we 
have got a bubble and people who think fundamentals have 
changed. I think it is always probabilistic. One forms in a 
judgment of how likely something is a bubble or not. I think 
monetary policy is a very blunt tool that affects a lot of the 
economy, so I think we need to focus in terms of bubbles on the 
kinds of tools that will address them directly, particularly in 
terms of what the Fed does, making sure the lenders are 
applying good standards to the loans to make it less likely 
that the loans are only being taken out because there is a hope 
of making money out of a bubble.
    In terms of what happens afterwards, I think that is where 
the issue of how the economy generally responds to risks, 
shares risks, spreads risks, when derivatives help in sharing 
risks and spreading them more widely and more efficiently, and 
when, as we have seen some examples of, derivatives add to 
risks. And I think we need to be alert to both the extent to 
which different financial institutions are holding very similar 
portfolios, and so subject to much more widespread systemic 
impact from a bubble bursting, and the connections across 
financial institutions, the functioning of capital markets and 
finance markets.
    So I think it is getting a better understanding of the risk 
spreading, the successful part, and the risk concentration, the 
unsuccessful part, which is very important going forward on 
dealing with these risks. We know there is a long history of 
centuries of bubbles. Everyone learned a lot from this one. 
That does not mean we will never see one again.
    Senator Reed. Thank you. My time has expired, but I will 
try to get back, Mr. Chairman, because I have to go to Armed 
Services, but I just want to commend Dr. Abraham on her work on 
work share, which is an important program, and I would like to 
follow up, if I could, in questions, either written or oral. 
Thank you, Mr. Chairman.
    Chairman Johnson. Senator Toomey.
    Senator Toomey. Thank you, Mr. Chairman.
    Some questions for Dr. Diamond. I will start by suggesting 
that I sometimes wonder how much we learned from the recent 
bubbles, and given the current policy, I worry about whether we 
are not in the process of creating new ones.
    My first question is, is it your view that QE2 constitutes 
monetizing a portion of our budget deficit?
    Mr. Diamond. No, it does not, because the holding of these 
assets is viewed as a temporary phenomenon by the Fed. The 
announcement by the FOMC viewed this as a temporary stimulus, 
just as doing things at the short end is addressing stimulus or 
the need to pull back on stimulus, if we were worried about 
inflation. And the portfolio goes up and down, and I think it 
should be thought of in that context, that this is not 
monetizing the debt. This is a temporary position that will get 
unwound when the circumstances are appropriate.
    Senator Toomey. Yes, we hope that that is going to happen 
and it is going to happen well, but I am not so convinced, and 
I think when the Fed, indirectly through bank intermediaries, 
nevertheless directly is effectively purchasing the debt that 
we are issuing on a massive scale, something on the order of 
two-thirds of the deficit that we are running this year, it 
certainly looks a lot like monetizing it to me.
    The other thing that concerns me is the range of sort of 
conventional measures and approaches to monetary policy that 
suggest that what we have now is a very unusually 
accommodative, and I would fear maybe dangerous accommodative, 
policy. The Taylor Rule would call for a Fed funds rate of 
about 1 percent right now. We have commodity prices that are 
almost uniformly at very high levels. I mean, really, precious 
metals, other metals, agricultural commodities, across the 
board, commodities are all at very high levels, many at record 
high levels. We have money supply by some measures as growing 
very rapidly. We have negative real interest rates.
    You know, you look at all of these indices and they suggest 
generally that our policy is too accommodative, but yet we are 
pursuing this huge infusion of cash. Do you not worry that 
maybe some--that maybe we are going down the wrong path here, 
that with all of these indications that we could very well have 
problems in the future, maybe not so distant future, that this 
is a dangerous policy to pursue?
    Mr. Diamond. First of all, the issue you raised is 
critically important. You asked, do I worry, and the answer is 
yes. I think it is terribly important for these policies to be 
reviewed and reviewed repeatedly, and I have thought of them as 
an outsider and I am sure the FOMC is weighing up these issues 
as well.
    The critical question to my mind is, where are we now 
relative to unemployment and inflation? Inflation is 
exceedingly low, below the normal 2 percent that people talk 
about, and----
    Senator Toomey. But----
    Mr. Diamond. ----unemployment is very high, and the issue 
is, are there signs that inflation might be picking up quickly. 
I view the rise in commodity prices as driven by microfactors, 
not general stimulation of the economy. We obviously have oil 
disruptions in the Middle East----
    Senator Toomey. But before the oil--well, we have not 
actually had supply disruptions. We have had major political 
turmoil that gives rise to worries about potential supply 
disruption----
    Mr. Diamond. Right.
    Senator Toomey. ----but we have not had supply disruptions. 
It seems unlikely to me that micro incidents would occur across 
the entire range of commodities, everything from corn and wheat 
and cotton to gold and silver and aluminum. You know, this 
strikes me as something broader than specific narrow micro 
effects.
    Mr. Diamond. Well, let me continue with my list of the 
things that have happened that really matter for some of these 
prices. We have had some serious droughts that are affecting a 
range of agricultural products.
    We have a number of large economies, of which China is the 
obvious leader, that are growing very rapidly and boosting 
demand across the board for all the inputs into the production 
and construction that they do. So that China is growing rapidly 
is something that will affect prices around the world. It is 
not part of a large stimulus, and at some point, the Chinese 
have to address the risk of their economy overheating, but I do 
not know that that will trigger our economy overheating. I do 
not see that kind of connection.
    Senator Toomey. Do I have time for one more quick question, 
Mr. Chairman?
    Chairman Johnson. One quick question.
    Senator Toomey. Thank you very much, and the question is 
about the exit strategy. One of the things that concerns me is 
that the strategy itself is designed, in part, to raise 
inflation expectations. About that, I am afraid it will be very 
successful.
    If it is successful in that respect, the obvious response 
from the market to rising inflation expectation is higher 
interest rates, higher bond yields. In the face, therefore, of 
higher bond yields, I fear that the Fed could find itself in 
the situation where it also has to exit by selling bonds, and I 
worry that the process of exit could lead to much higher 
interest rates from the combination of these phenomena. Is that 
something that you are concerned about, how they can exit?
    Mr. Diamond. The exit strategy is obviously terribly 
important, and I think it is important to keep in mind that the 
Fed has multiple tools. The interest paid on excess reserves 
can play a critical role in adjusting the way the exit strategy 
is executed so that we do not get a rapid burst of lending and 
inflation. I think the combination of tools available will 
permit a smooth exit. But the great recession we have had is a 
new experience and I think we are looking at trying to respond 
to a very major problem and trying to respond to a very high 
unemployment rate, which is very harmful, and trying to deal 
with it in a way that does not lay down problems for the 
future. And I think it is necessarily something that takes 
close monitoring and following while laying out a plan and 
monitoring it and changing it, as needed.
    Senator Toomey. Thank you very much, Mr. Chairman, for your 
indulgence on the time, and thank you.
    Chairman Johnson. Senator Hagan.
    Senator Hagan. Thank you, Mr. Chairman.
    Dr. Abraham, we have been talking about unemployment 
numbers and I wanted to raise a particularly concerning labor 
market issue that I have been watching closely, and that is the 
unemployment numbers for our returning veterans in Afghanistan 
and Iraq. They are unacceptably high. Last Friday, the Bureau 
of Labor Statistics released the February unemployment numbers 
that showed unemployment for these returning service members to 
be about 12.5 percent, and that is almost 4 percentage points 
higher than the national average.
    I am always looking for additional ways to help our 
returning soldiers, and my question is, do you have any 
insights on why this number might be so high versus the rest of 
the employment figures?
    Ms. Abraham. Thank you for that question. I also have been 
looking at these numbers. It has not been very long that we 
have actually had regular unemployment figures for veterans and 
so it is welcome that we have them now. I have--I cannot really 
say why they are so much higher than for the population as a 
whole. The veterans have demographic characteristics that are 
associated with somewhat higher unemployment. They are young 
men. Young men tend to have higher unemployment rates. But it 
is more than that and I think this bears looking into.
    Senator Hagan. Thank you. I look forward to working with 
you on that issue. And how long have we been keeping numbers on 
returning veterans?
    Ms. Abraham. It has been a few years now.
    Senator Hagan. OK. Dr. Shapiro, America's small businesses 
are an essential component of economic growth and these 
businesses create a disproportionate share of the net new jobs, 
the small businesses. In North Carolina, these small businesses 
account for nearly 50 percent of our private sector jobs. But 
right now, these companies are having a very difficult time 
accessing credit and the capital markets. I hear this 
everywhere I go throughout my State. And the economic report of 
the President showed that small businesses receive 90 percent 
of their financing from banks, community banks, in particular, 
and the report cites information asymmetries and other market 
frictions as an impediment to small business financing.
    Last year, we passed the Small Business Jobs Act that would 
help accelerate a return to lending to small businesses, but as 
I hear over and over again, that small companies are really 
having a hard time accessing these funds. What steps do you 
suggest that Congress takes or the Administration takes to 
restore the flow of credit to small business? What can we do on 
a proactive basis?
    Mr. Shapiro. Well, I think your State is not alone in the 
small business having a difficult time, both with credit, and 
the report concerns about poor sales is the fundamental issue, 
that the demand is not there and that, of course, it makes it 
harder to get a loan. And we have small business association 
programs that help in this regard and the Administration, with 
Congress, has pushed those forward.
    There is a lending fund to help community banks, OK. So I 
think this is part of--because community banks are so important 
for small business and they understand the local situation 
better, this is some of these informational concerns that a 
bigger bank might not know. The support for the community banks 
is very important and there is a lending fund that has been set 
up for that that seems to be well crafted for that purpose.
    There have also been tax cuts that are helping, as well, 
for small businesses and large businesses that Congress enacted 
and the President signed last December, particularly to be able 
to write off more of their investments in 2011.
    Senator Hagan. Well, I know the application for the small 
business funds that we passed last September is still open for, 
I think, until the end of March for small and independent 
community banks to file for that, so I am really looking 
forward to the change once those funds start getting out into 
the market, because my small businesses are really hurting. And 
I do think it is an economic driver, especially from the 
standpoint of employment opportunities.
    Mr. Shapiro. Well, I think it is something we need to keep 
a close eye on and watch, and if I am confirmed, I look forward 
to doing that with this Committee.
    Senator Hagan. OK. Thank you.
    Dr. Diamond, also, thank you for appearing today. I know 
you have been speaking to this Committee before, but it is my 
first chance to have an opportunity to be here and to hear from 
you, so I have just got a couple of questions.
    There seems to be a divide among economists about whether 
the quantitative easing should continue, and some, like the 
President of the Federal Reserve Bank of Richmond, Jeffrey 
Lacker, argue that the U.S. growth outlook is tilted against 
further quantitative easing and that inflation has bottomed and 
will only head upward from this point. And then others, like 
Christina Romer, former Chair of the President's Economic 
Advisers, has advocated for more aggressive quantitative 
easing, both in size and scope.
    With unemployment around 9 percent, 9.8 percent in North 
Carolina, and core inflation around 1 percent, it would seem 
inflation expectations are under control for now, but with 
commodity prices, as we have been discussing, climbing 
steadily. Do you have concerns that the general inflation could 
emerge quickly despite continued high unemployment, and what 
actions would you recommend the Fed to take should such a 
circumstance emerge?
    Mr. Diamond. Well, I think you have described the current 
situation correctly. The inflation rate is very low. Beyond 
that, the studies of inflation expectations show that inflation 
expectations are very low. And the primary pusher of inflation 
historically has been the state of aggregate demand. When the 
state of aggregate demand gets too big relative to what the 
economy can produce. Potential output and the labor market in 
terms of the availability of workers to fill jobs, that is when 
we get inflation that starts to move seriously. We are 
obviously in no danger of that process giving us rapid 
inflation.
    On the prices that have boosted, the question at hand is, 
is this part of an inflationary process or have we had a jump 
in some prices? Obviously, a drought will leave you a jump in 
prices, but it does not tell you that the prices are going to 
keep going up.
    The Chinese economy expanding so rapidly is going to push 
up prices of the inputs they need for their production. The 
question of how rapidly they will continue growing, and again, 
will their growth speed up? Will that give us rising inflation? 
I think there is no reason to think it will grow faster. If 
anything, I think they are beginning to worry about the 
possibility of overheating.
    So I do not see the link between these individual price 
problems and a rapid appearance of inflation, given the general 
state of the labor market and aggregate demand in the U.S.
    Senator Hagan. Thank you, Mr. Chairman.
    Chairman Johnson. Thank you, Drs. Diamond, Abraham, and 
Shapiro, for your testimony and for your willingness to serve 
our Nation.
    We are going to submit questions for the record to you by 
12 noon this Friday, March 11. Please submit your answers to us 
as soon as possible so that we can move your nomination in a 
timely manner.
    This hearing is adjourned.
    [Whereupon, at 11:11 a.m., the hearing was adjourned.]
    [Prepared statements, biographical sketches of nominees, 
and responses to written questions supplied for the record 
follow:]

               PREPARED STATEMENT OF KATHARINE G. ABRAHAM
           To Be a Member of the Council of Economic Advisers
                             March 8, 2011

    Chairman Johnson, Ranking Member Shelby, and distinguished Members 
of the Committee, I am pleased and honored to appear before you today 
as a nominee to be a Member of the President's Council of Economic 
Advisers.
    Before I begin, I would like to introduce several people who are 
with me here today. First is Graham Horkley, my wonderful husband of 
more than 25 years. Second is my mother Roberta Abraham, who throughout 
my life has been a source of encouragement and support. I am also very 
pleased to introduce my brother, David Abraham, his wife, Carol Popolow 
Abraham, my nephew and niece, William and Allison Abraham, and my 
sister, Sarah Abraham. My college-age sons, Ian and Ben Horkley, my 
father, William Abraham, my brother, Jon Abraham, and my sister, Molly 
Abraham, would very much have liked to be here today, but unfortunately 
were not able to attend.
    I have been Professor of Survey Methodology and Faculty Associate 
of the Maryland Population Research Center at the University of 
Maryland since 2002. From 1993 to 2001, I served as Commissioner of 
Labor Statistics in the Department of Labor, where I was responsible 
for many of the key economic indicators produced by the Federal 
Government. Prior to that, I held faculty positions in the Department 
of Economics, University of Maryland, and the Sloan School of 
Management, Massachusetts Institute of Technology.
    I first became enamored of economics as an undergraduate student. 
What drew me to economics is the power that economic analysis has to 
inform the policy process and contribute to better outcomes for our 
society. Economic analysis can be only as good as the data on which it 
rests. This is something that I came particularly to appreciate during 
my 8 years as Commissioner of Labor Statistics and I have maintained a 
continuing interest in the quality of economic statistics and the ways 
in which they might be improved.
    My research and writing have examined a variety of labor market 
policy issues and relevant economic data on unemployment, employment, 
inflation, wages, and national output. It is my hope that, if 
confirmed, my expertise can be useful for interpreting the new data 
about our economy that will become available over the coming months and 
years and for assessing their implications for important policy 
decisions.
    These continue to be extraordinary times for our economy. Following 
the worst macroeconomic shock experienced in a generation, the economy 
is beginning to recover, but for too many Americans things are still 
far from being back to normal. Looking to the future, we know that 
investments in physical, human, and knowledge capital will be essential 
to ensuring our Nation's long term prosperity. Should I be confirmed, I 
look forward to working with the other members of the Administration 
and with this Committee to provide economic insights and analysis that 
will help with the formulation of policies conducive to broadly shared 
growth.
    Thank you. I will be happy to answer any questions you or other 
Members of the Committee may have.

























                   PREPARED STATEMENT OF CARL SHAPIRO
           To Be a Member of the Council of Economic Advisers
                             March 8, 2011

    Chairman Johnson, Ranking Member Shelby, and Members of the 
Committee, I am honored to appear before you as a nominee to serve as a 
Member of the Council of Economic Advisers.
    Before I begin, I would like to introduce you to my family. My 
parents, Sherman and Ellen Shapiro, were able to come from California 
to be here today. My daughter, Eva, and my son, Benjamin, are also 
present. My partner and best friend, Marti Hearst, is also here today.
    I am especially pleased that my father Sherman can be here today. 
He grew up terribly poor during the Great Depression. Through hard work 
and a tremendous dedication to improving himself, he was able to earn a 
Ph.D. in economics at the University of Chicago. He taught me the 
virtues of giving all Americans the opportunity to make the most of 
themselves, while always stressing the importance of personal 
responsibility.
    I was born in Austin, Texas, and grew up in South Bend, Indiana, 
and Wilmette, Illinois. I went to school at M.I.T., earning my Ph.D. in 
1981. I was on the faculty of Princeton University during the 1980s, 
and have been a Professor at the Haas School of Business and the 
Department of Economics at the University of California at Berkeley 
since 1990. I was honored with an endowed chair in 1994; since then I 
have been the Transamerica Professor of Business Strategy. I served as 
the Director of the Institute of Business and Economic Research at U.C. 
Berkeley from 1998 to 2008. During 1995-1996 and again during 2009-
2011, I served as chief economist in the Antitrust Division of the 
Department of Justice, supervising some 50 Ph.D. economists to provide 
sound economic analysis in support of antitrust enforcement.
    My research, consulting, and public service have consistently 
emphasized the importance of promoting competition and innovation as 
drivers of economic growth. I have special interest, and expertise, in 
the economics of innovation and high-tech industries. My book with Hal 
Varian, ``Information Rules: A Strategic Guide to the Network 
Economy'', which applies economic principles to the information 
economy, has been widely read by managers and adopted for classroom 
use. If confirmed as a Member of the CEA, I hope to contribute my 
expertise to the development of policies that promote economic growth 
by creating a business environment that encourages private sector 
innovation and investment.
    The CEA has a great tradition, going back 65 years, of providing 
high-quality, unbiased economic policy advice to the President based on 
the best thinking and scientific evidence the economics profession has 
to offer. If confirmed, I look forward to continuing that tradition.
    Thank you. I would be happy to answer any questions you might have.

    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
                 PREPARED STATEMENT OF PETER A. DIAMOND
    To Be a Member of the Board of Governors, Federal Reserve System
                             March 8, 2011

    Chairman Johnson, Senator Shelby, and Members of the Committee, I 
am honored to have been nominated by President Obama to be a member of 
the Board of Governors of the Federal Reserve System and grateful to 
this Committee for having me here today.
    If confirmed, I will work to the best of my abilities to fulfill 
the responsibilities of this office. Those responsibilities have always 
been significant. The experience of the recent financial crisis and the 
ensuing financial reform legislation have underlined the multiple 
responsibilities of the Fed in working to foster maximum employment and 
price stability. The Fed has much work ahead in order to implement and 
fulfill the tasks laid out by the financial reform legislation. I would 
be honored and pleased to be part of the process of responding to this 
challenge.
    I studied both mathematics and economics as an undergraduate at 
Yale University. I received my Ph.D. in economics from the 
Massachusetts Institute of Technology (MIT) in June 1963. Since then I 
have been a faculty member, first at the University of California at 
Berkeley, and, since 1966, at MIT. Throughout this period I have taught 
and done research in economics. My primary focus in both graduate 
teaching and research has been economic theory, particularly 
macroeconomics, search theory, and public finance. Within public 
finance, my primary focus has been on taxes, pensions, and social 
insurance, particularly Social Security. I have done both theoretical 
analyses and policy analyses. At the undergraduate level I have taught 
microeconomics, macroeconomics, public finance, money and banking, and 
law and economics. Being a member of two economics departments with 
great collegial interactions, I have gained wide knowledge in a variety 
of economics topics, as well as detailed knowledge in my areas of 
expertise.
    A central theme in my research career has been how the economy 
deals with risks, both risks at the individual level and risks that 
affect the entire economy. I have thought extensively and written about 
the risks in the economy, and how markets and Government can combine to 
make the economy function better. In particular, the research that led 
to my being a corecipient of the Nobel Prize in Economic Sciences \1\ 
has addressed how the costs and delays in learning about market 
opportunities affect the workings of the economy. As noted by the prize 
committee, the basic research on this topic has been used as a starting 
place for applied research in a wide variety of areas--not only the 
housing and labor markets where sizable delays are clearly visible, but 
also in monetary theory and analysis of the capital market. Indeed, the 
varying speeds between the occurrence of surprises to financial firms 
and their abilities to respond is a central element in the development 
of financial crises, making search theory an important part of 
understanding how to avoid and limit future shocks to the financial 
system.
---------------------------------------------------------------------------
     \1\ The full name is the Sveriges Riksbank Prize in Economic 
Sciences in Memory of Alfred Nobel.
---------------------------------------------------------------------------
    In sum, I believe my background would prove very helpful at the 
Federal Reserve, particularly as a part of the process of addressing 
our heightened awareness of the dangers of systemic risks. If 
confirmed, I would welcome the opportunity to help address the 
important issues that have been raised by the financial crisis, as well 
as the longstanding issues and concerns in monetary policy and bank 
regulation that the Federal Reserve faces.
    Thank you again for holding today's hearing; I would be pleased to 
answer your questions.













































         RESPONSES TO WRITTEN QUESTIONS OF SENATOR REED
                   FROM KATHARINE G. ABRAHAM

Q.1. What has your research shown on whether work sharing can 
be helpful to stem layoffs and be part of a strategy to help 
employers and employees in advance of the next recession? What 
thoughts do you have on how to best encourage work sharing?

A.1. My research has examined how employers adjust hours and 
employment in response to cyclical changes in demand. In other 
countries, more of the adjustment to changes in demand commonly 
takes the form of reductions in hours (work sharing) rather 
than reductions in employment (layoffs) than is the case in the 
United States. Work sharing as opposed to layoffs can have 
significant benefits for employers and workers. Companies can 
avoid the loss of valued employees who are laid off during a 
temporary downturn and the burden of the economic downturn is 
spread more equitably.
    One factor that has contributed to the greater use of work 
sharing in these other countries is that workers whose hours 
have been reduced are eligible for prorated unemployment 
insurance benefits, referred to as short-time compensation. 
Similar prorated benefits are already available in 17 U.S. 
States. Changes to the U.S. unemployment insurance system to 
encourage work sharing, thereby reducing the need for layoffs, 
would be a step in the right direction in terms of mitigating 
job loss in future recessions.

Q.2. Can you provide your view of how the Recovery Act 
contributed to economic and employment growth and/or mitigated 
the effects of the economic downturn?

A.2. In my view, the Recovery Act contributed significantly to 
mitigating the effects of the economic downturn that began at 
the end of 2007 and worsened during 2008. It is of course 
inherently difficult to know exactly what would have happened 
had the Recovery Act not been passed. One way to estimate the 
effects of the Recovery Act is to predict the path that 
employment would have followed absent passage and then to 
compare what actually happened to that prediction. Another 
approach is to apply fiscal employment multipliers reported in 
the economics literature to the different types of spending 
under the Recovery Act to estimate the total employment effect. 
Previous CEA analyses using these two very different approaches 
yield estimates that are broadly consistent, showing employment 
as of the end of 2010 to have been roughly 3 million jobs 
higher than would have been the case without the Recovery Act. 
While it is important to recognize the uncertainty inherent in 
any such exercise, this seems to me to be a reasonable estimate 
of the Recovery Act's effects. Private analysts and the 
nonpartisan Congressional Budget Office have reached similar 
conclusions about the positive effects of the Recovery Act.
                                ------                                


       RESPONSES TO WRITTEN QUESTIONS OF CHAIRMAN JOHNSON
                       FROM CARL SHAPIRO

Q.1. Given your academic and professional background, where do 
we find potential changes to current business regulation in 
order to spur economic growth? What opportunities are there to 
help bolster small businesses?

A.1. Regulations should be carefully tailored to impose the 
least burden on society consistent with achieving their stated 
goals, such as safety, health, or environmental protection. As 
an economist who has studied Government regulation of business 
for 30 years, I am a proponent of using economic incentives to 
encourage the desired behavior. If confirmed as a member of the 
Council of Economic Advisers, I look forward to pursuing these 
goals as articulated in the Executive Order issued by President 
Obama on January 18, 2011, ``Improving Regulation and 
Regulatory Review.''
    Small businesses will benefit from the recently released 
Presidential Memorandum supporting the Regulatory Flexibility 
Act, which requires Federal agencies to consider regulatory 
flexibility to reduce the burden on small business. Small 
business also will be bolstered by the Administration's 
proposal to make permanent the 100 percent tax exemption on 
capital gains on qualified small business investments, and by 
the Administration's proposal to provide $2 billion of capital 
to small businesses.

Q.2. President Obama referenced the need for innovation along 
with education and investment as important factors to improve 
the economy. How could we incentivize innovation to achieve 
this?

A.2. Innovation--broadly defined as the process by which 
individuals and organizations generate new ideas and put them 
into practice--is absolutely critical to our economic growth 
and international competitiveness. One way to incentivize 
private-sector innovation is to improve the operation of our 
patent system. Administrative and legislative reforms for the 
Patent and Trademark Office can reduce the time it takes for an 
inventor to receive a patent and improve the quality of issued 
patents. A second way to incentivize innovation is to invest in 
basic research while facilitating the transfer of research 
findings from our universities and research labs into the 
private sector. A third way to incentivize innovation is to 
provide tax incentives for private firms that engage in 
research and development. Expanding and making permanent the 
Research and Experimentation (R&E) tax credit would serve this 
goal.
                                ------                                


        RESPONSES TO WRITTEN QUESTIONS OF SENATOR SHELBY
                       FROM CARL SHAPIRO

Q.1. In your role as Deputy Assistant Attorney General at the 
Department of Justice (DOJ), you recently submitted a letter 
(DOJ letter) on a proposed Commodity Futures Trading Commission 
(CFTC) rule regarding ownership limitations and governance 
requirements for designated clearing organizations (DCOs), 
designated contract markets (DCMs) and swap execution 
facilities (SEFs).
    Explain the nature of your personal involvement with the 
analyses and recommendations contained in the letter.

A.1. As Deputy Assistant Attorney General for Economics in the 
Antitrust Division, I was involved in preparing these comments. 
I supervised the staff economists who worked with staff 
attorneys to draft these comments. I gave input to the staff 
during the process, reviewed drafts, and recommended to 
Assistant Attorney General Christine Varney that these comments 
be filed at the CFTC.

Q.2. To the best of your knowledge, were there any relevant 
communications, written or oral, between the CFTC and DOJ's 
Antitrust Division prior to submission of the DOJ letter? If 
so, please explain.

A.2. To the best of my knowledge, DOJ staff met with CFTC staff 
to discuss the CFTC's proposed rules.

Q.3. Do you believe that impartial access is necessary to 
protect consumers and to promote competition?

A.3. Section 733 of the Dodd-Frank Act seeks to provide market 
participants with impartial access to SEFs. I believe impartial 
access to an SEF promotes competition among market participants 
on that SEF, which in turn helps protect consumers.

Q.4. If you do, explain why laws and/or regulations that 
require impartial access are not a sufficient solution. Explain 
why the DOJ letter advocates a solution that is inconsistent 
with American Airlines/British Airways alliance analogy 
referenced in your letter.

A.4. In my experience, it is desirable wherever possible to 
rely on market competition rather than Government regulations 
to protect consumers. Rules mandating access to a dominant 
platform can be difficult or costly to enforce, in part due to 
disputes regarding what constitutes ``impartial access.'' Here, 
competition among SEFs may well provide additional protections 
to market participants, above and beyond those resulting from 
access regulations imposed on a dominant SEF.
    In my opinion, the DOJ letter to the CFTC and the DOJ 
comments to the Department of Transportation (DOT) regarding 
the Star Alliance are consistent. The DOJ letter to the CFTC 
favors certain restrictions on the ownership and governance of 
SEFs. The DOJ letter argues that those restrictions will 
promote competition among SEFs without undermining the ability 
of SEFs to operate efficiently. The DOJ comments to DOT favor 
``carve-outs'' on certain nonstop routes. The DOJ comments 
argue that these carve-outs will preserve competition on those 
routes without undermining the ability of the alliance to 
operate efficiently on other routes. In both cases, DOJ seeks 
to promote competition without undermining the efficiencies 
that can be achieved through a joint venture among rivals.

Q.5. If you do not, explain why your personal belief differs 
from the beliefs expressed in the DOJ Letter that you signed.

A.5. Not applicable.

Q.6. The DOJ letter states ``[t]he Department believes that 
allowing three to five large participants in the derivatives 
sector to control a trading a platform would greatly increase 
the risk that those entities will use their control to block or 
limit rival dealers' or buy-side firms access to the 
platform.'' Do you agree with the belief that voting and 
ownership limitations are necessary?

A.6. I support efforts by the CFTC to put in place rules to 
mitigate potential conflicts of interest in the operation of 
trading platforms. In my opinion, voting and ownership 
limitations are important for this purpose.

Q.7. If you do: How do you reconcile this statement with Core 
Principle 2 in Section 733 of the Dodd-Frank Act, which states 
that a swap execution facility shall establish, among other 
things, ``participation rules that will deter abuses . . . to 
provide market participants with impartial access to the 
market''? Explain why this explicit language does not directly 
address your concern that dealers would ``block or limit rival 
dealers' or buy-side firms access to the platform.''

A.7. Structural solutions that rely on market competition are 
often more effective and less onerous than ongoing oversight 
and regulation. In the current context, disputes may well arise 
regarding whether a given SEF provides ``impartial access'' to 
market participants who are actual or potential competitors to 
the entities controlling the SEF. The DOJ comment seeks to 
promote competition among SEFs. Effective competition among 
SEFs will tend to reduce the frequency and magnitude of 
disputes over ``impartial access,'' since a market participant 
whose access to one SEF has been limited can trade on another 
SEF.

Q.8. How do you reconcile this statement with Dodd-Frank 
antitrust core principles for derivatives clearing 
organizations, swap execution facilities, and designated 
contract markets, which states that each entity ``shall not 
adopt any rule or take any action that results in any 
unreasonable restraint of trade or impose any material 
anticompetitive burden on trading''? Explain why this explicit 
language does not directly address your concern that dealers 
would ``block or limit rival dealers' or buy-side firms access 
to the platform''.

A.8. Structural solutions that rely on market competition are 
often more effective and less onerous than ongoing oversight 
and regulation. In the current context, disputes may well arise 
regarding whether a given SEF has adopted any rule or taken any 
action ``that results in any unreasonable restraint of trade'' 
or imposes ``any material anticompetitive burden on trading.'' 
The DOJ comment seeks to promote competition among SEFs. 
Effective competition among SEFs will tend to reduce the 
frequency and magnitude of these disputes, since any given SEF 
will have less market power that could be abused.

Q.9. Did you sign the letter supporting voting and ownership 
limitations because you believe that the CFTC will be unable to 
enforce this language?

A.9. I believe that structural solutions designed to mitigate 
potential conflicts of interest and to promote competition 
among SEFs will reduce the frequency and magnitude of disputes 
over compliance with the cited language, thereby reducing the 
cost and increasing the effectiveness of CFTC enforcement of 
this language.

Q.10. If you do not, explain why your personal belief differs 
from the beliefs expressed in the DOJ Letter that you signed.

A.10. Not applicable.

Q.11. Provide a real-world case that the DOJ has successfully 
argued where an exchange blocked market participants from 
trading on its execution platform.

A.11. I am not aware of any such example. Access to execution 
platforms is normally addressed by regulators rather than 
through enforcement of the Sherman Act.

Q.12. It is my understanding that it has been a long-standing 
DOJ Antitrust Division's policy to rely on ``conduct 
remedies,'' that are conceptually analogous to Core Principle 2 
in Section 733 of Dodd-Frank, as the preferred approach to 
deter anticompetitive conduct. ``Structural remedies,'' 
including divestitures and ownership restrictions, are to be 
pursued only where conduct remedies have proven to be 
inadequate. Do you have any empirical evidence that conduct 
remedies are not adequate for DCMs, SEFs, and/or DCOs?
    If you do, provide that evidence.
    If you do not, explain how you reconcile the structural 
remedies approach taken in the DOJ letter with the DOJ's long-
standing policy of relying on conduct remedies.

A.12. The DOJ does not have a long-standing policy of relying 
only on conduct remedies. DOJ approaches remedies on a case-by-
case basis. In many situations, including horizontal mergers, 
the DOJ has historically preferred structural remedies to 
conduct remedies. The Antitrust Division Policy Guide to Merger 
Remedies, October 2004, available at http://www.justice.gov/
atr/public/guidelines/205108.pdf states (p. 7): ``Structural 
remedies are preferred to conduct remedies in merger cases 
because they are relatively clean and certain, and generally 
avoid costly Government entanglement in the market.'' This 
policy guide goes on to state (p. 8): ``A conduct remedy, on 
the other hand, typically is more difficult to craft, more 
cumbersome and costly to administer, and easier than a 
structural remedy to circumvent.''

Q.13. Question 2 asks (emphasis added): ``To the best of your 
knowledge, were there any relevant communications, written or 
oral, between the CFTC and DOJ's Antitrust Division prior to 
submission of the DOJ letter? If so, please explain.''
    Mr. Shapiro responded in the affirmative, but he did not 
provide any explanation. At a minimum, his explanation should 
include:

    A list all DOJ and CFTC individuals involved in 
        those communications.

    A description of the nature of those 
        communications.

    Answers to the following questions:

      Who initiated those communications?

      Did anyone from the CFTC or from the 
        Administration request or direct anyone in the DOJ to 
        send the letter? If so, please explain.

      Did anyone from the CFTC or from the 
        Administration review and/or edit the letter before it 
        was submitted? If so, please explain.

A.13. To the best of my knowledge, DOJ staff met with CFTC 
staff to discuss the CFTC's proposed rules. However, I did not 
personally participate in any of these meetings, and I do not 
recall participating in any conference calls, e-mails, or other 
communications that may have taken place between DOJ and the 
CFTC.
    My recollection from staff updates I reviewed at the time 
is that the initial recommendation to respond to the proposed 
CFTC rules came from career staff members in the Antitrust 
Division. Following that recommendation, I recall that DOJ 
initially contacted the CFTC to discuss these issues. To the 
best of my knowledge, DOJ attorneys Gene Kimmelman and Ihan Kim 
were involved in these communications. As the Deputy Assistant 
Attorney General for Economics, I was typically not involved in 
these sorts of communications. I do not know the names of any 
individual CFTC staff members who attended subsequent meetings 
with DOJ staff. While I am unaware of precisely which DOJ staff 
attended any particular meeting, I do know that DOJ economists 
Jeff Wilder, Charles Taragin, and Fan Zhang were studying these 
issues and I believe they each attended at least one meeting 
with the CFTC based upon the weekly reports I received from 
staff economists.
    To the best of my knowledge, no members of the 
Administration outside of DOJ, or anyone from the CFTC, 
requested or directed anyone in DOJ to send the letter.
    To the best of my knowledge, no members of the 
Administration outside of DOJ, or anyone from the CFTC, 
reviewed or edited the letter prior to its submission. As I 
noted in my prior responses to the Committee, I was involved in 
preparing these comments, and I supervised the DOJ staff 
economists who worked with DOJ staff attorneys to draft these 
comments. I gave input to the DOJ staff during the process, 
reviewed drafts, and recommended to Assistant Attorney General 
Christine Varney that these comments be filed at the CFTC.
                                ------                                


       RESPONSES TO WRITTEN QUESTIONS OF CHAIRMAN JOHNSON
                     FROM PETER A. DIAMOND

Q.1. Dr. Diamond, you have worked on unemployment and economic 
growth. The models for which you won the Nobel Prize help us 
understand the ways in which unemployment, job vacancies, and 
wages are affected by regulation and economic policy.
    Can you please explain how your expertise in employment and 
the job market is relevant to the mandate of the Federal 
Reserve Board of Governors?
    What expertise and knowledge can you bring to the Board of 
Governors to facilitate the crafting and implementation of job 
growth policies as required by the Federal Reserve Act?
    In addition to your knowledge of employment and the job 
market, what other expertise and skills can you bring to the 
Board of Governors of the Federal Reserve to achieve its vital 
objectives?

A.1. In turn, I will discuss how my extensive background as an 
economist and my expertise should be very valuable to the Fed 
in three key areas of its responsibility: monetary policy, bank 
supervision and regulation, and crisis prevention and 
amelioration. My background can be a helpful complement to the 
range of expertise of the current Board members.
    It is important that monetary policy decisions reflect 
careful analysis of the labor market, along with information on 
inflation and inflation expectations and other aspects of 
economic performance. The current crisis has resulted in 
considerable discussion of the link between labor market 
performance--jobs lost, jobs sought, jobs offered--and 
desirable monetary policy. The crisis has caused unemployment 
to rise to a very high and painful level. With inflation very 
low at the same time, an accommodative monetary policy was 
implemented. After an extended period of economic decline, the 
economy began a slow recovery. For a period the unemployment 
rate showed little decline while the job vacancy rate grew, 
presenting a critical question for monetary policy of how best 
to interpret these developments. Some analysts saw them as 
calling into question the appropriateness of continuing with an 
accommodative monetary policy.
    The framework that has served as the ``industry standard'' 
for interpreting outcomes in the labor market, referred to as 
the DMP model, was the basis for the Nobel Prize that I shared 
with Dale Mortensen and Christopher Pissarides. In addition to 
my role in creating the DMP model, I wrote a series of papers 
together with Olivier Blanchard (currently IMF chief economist) 
analyzing the empirical relationship between unemployment and 
vacancies over a typical business cycle as well as setting out 
a theoretical framework for such analysis. \1\
---------------------------------------------------------------------------
     \1\ ``The Beveridge Curve'', BPEA 1:1989, 1-76, ``The Aggregate 
Matching Function'', in P. Diamond (ed.) Growth, Productivity, 
Unemployment: Essays To Celebrate Bob Solow's Birthday (Cambridge: MIT 
Press), 1990, ``The Cyclical Behavior of the Gross Flows of U.S. 
Workers'', BPEA 2:1990, 85-155.
---------------------------------------------------------------------------
    Relevant to the Fed mandate is my analysis of the current 
situation in the labor market in the Nobel Prize Lecture that I 
delivered in Stockholm on December 10, 2010, and in a much 
longer analysis that will appear in the American Economic 
Review in June 2011. This analysis went behind the aggregate 
numbers to examine hiring at the level of firms and industries. 
\2\ This analysis led me to conclude that there was 
insufficient evidence that firms were experiencing increased 
difficulty in hiring qualified workers. Thus, I read the 
evidence as suggesting that the aggregate behavior of the labor 
market does not, in fact, signal a break in the efficiency of 
matching jobs and workers. That is, the pattern of hiring would 
likely return to normal after the economy had grown 
sufficiently to approach its potential output, apart from the 
lingering effects of long-term unemployment. As this discussion 
indicates, careful analysis of the labor market, an analysis in 
which I have considerable expertise and experience, is 
essential for setting monetary policy well.
---------------------------------------------------------------------------
     \2\ Specifically, I examined the ratios of unemployment to 
vacancies across industries and the patterns of hiring relative to 
vacancies across industries, across firms of different sizes, and 
across firms with different growth rates. Also relevant is the decline 
in quits by employed workers, which imply a decline in replacement 
hiring.
---------------------------------------------------------------------------
    The global financial crisis has added macroprudential 
considerations to the list of issues that must be addressed in 
the course of conducting supervision and regulation of banks. 
That is, it is not sufficient to ask whether the current 
position of a bank is sound, but also how the bank might be 
affected by adverse economic developments and whether the bank 
is at risk of contributing to widespread financial 
difficulties. In part, macroprudential issues are being 
addressed through the design of financial institution stress 
tests. Stress test design is in an early stage and will no 
doubt evolve with experience with stress testing itself, and 
with further research on the nature of systemic risks, 
particularly risks to the financial sector developing through 
direct and indirect connections between financial institutions. 
Analysis of these connections between firms will draw on models 
of the capital market, a subject that I have researched. 
Moreover, much of the concern about liquidity comes from the 
differences in speed between actions that impact financial 
institutions, such as a reduced availability of short-term 
financing, and the abilities of the financial institutions to 
respond. Analysis of dynamics in markets with direct lender-
borrower relations is naturally built on search theory. While 
greatly different in detail, there is a parallel between the 
need for time to match workers and jobs and the need for time 
to match lenders and borrowers. Indeed, in its scientific 
background statement for my prize, the Nobel Prize committee 
included financial economics among the wide range of uses that 
have been made of search theory. Thus my expertise in both 
general equilibrium and search theories should be of great 
practical use in the development of bank supervision and 
regulation. \3\
---------------------------------------------------------------------------
     \3\ I discussed a paper on stress testing banks at the recent 
Monetary Policy Forum: Comments on ``Stressed Out: Macroprudential 
Principles for Stress Testing'', by David Greenlaw, Anil K Kashyap, 
Kermit Schoenholtz, and Hyun Song Shin, U.S. Monetary Policy Forum 
Report No. 5, Initiative on Global Markets, University of Chicago Booth 
School of Business, 2011.
---------------------------------------------------------------------------
    The global financial crisis has greatly increased awareness 
of the importance of preserving financial stability. This has 
resulted in changes in the regulation of financial institutions 
world wide and in efforts by researchers to enhance our 
understanding of how crises happen, how to lower their 
likelihood, and how to reduce their negative impacts on the 
economy. Both regulation and research need to be ongoing 
processes. The research process and the analysis of regulatory 
rules take time and require feedback. Moreover, ongoing 
financial innovation means that the financial markets are 
themselves changing. It would be a mistake to limit regulatory 
and supervisory changes to the causes of the particular crisis 
we have experienced--crises can come in a variety of forms and 
the evolution of the economy will change the ways that crises 
can occur. My ability to understand how and when basic research 
is informative for policy design should be very useful at the 
Fed in crisis prevention and limitation. \4\
---------------------------------------------------------------------------
     \4\ Also I can draw on my extensive experience studying and 
advising about social security systems in many countries. As with the 
financial system, social security systems must address individual risks 
and aggregate risks, they must function well in ordinary times and must 
weather financial crises.
---------------------------------------------------------------------------
    In sum my extensive background as an economist, and high 
level of expertise, should be very valuable to the Fed in three 
key areas of its responsibility: monetary policy, bank 
supervision and regulation, and crisis prevention and 
amelioration.
                                ------                                


        RESPONSES TO WRITTEN QUESTIONS OF SENATOR VITTER
                     FROM PETER A. DIAMOND

Q.1. The Wall Street Journal reported this week that PIMCO, the 
world's largest bond investor, has divested all holdings in 
U.S. treasuries. Fund managers pointed to potential bond price 
declines as the U.S. Government approaches the statutory debt 
limit and the approaching end to the Federal Reserve's second 
round of quantitative easing (QE2). This was followed by the 
following two comments:

    ``U.S. Government bonds are not a safe haven,'' Jim 
        Rogers, the global investor who predicted the 2007-2009 
        housing-market crash, said in a telephone interview 
        from Singapore. ``I cannot conceive of lending money to 
        the U.S. Government for 30 years.''

    ``Pacific Investment Management Co. said yesterday 
        that Bill Gross, who runs the $237 billion Pimco Total 
        Return Fund, eliminated Government-related debt from 
        his flagship fund last month as the U.S. projected 
        record budget deficits.''

    What do these comments say to you about QE2?

A.1. These comments seem to have been spurred mostly by three 
concerns: normal recovery from the recession, inflation risk, 
and the long-run fiscal challenge.
    At present, the interest rates on longer-term Treasury debt 
are very low, and QE2 has contributed to these low rates. Once 
the recovery is far along and growth has picked up interest 
rates will rise, and QE2 will be unwound. Of course, the timing 
and magnitude of a rise in interest rates is uncertain. To help 
minimize uncertainties regarding the future course of long-term 
interest rates, the Federal Reserve has indicated that the 
eventual unwinding of its asset purchases will be done 
gradually, and will be carefully communicated in advance.
    Regarding the prospects for inflation in the near and 
intermediate term, the Federal Reserve remains committed to its 
statutory objectives of maximum employment and stable prices. 
At present, underlying inflation remains low and inflation 
expectations have been stable. The Federal Open Market 
Committee (FOMC) has noted that it will regularly review the 
asset purchase program in light of changes in the economic 
outlook and that it will use its policy tools to support the 
economic recovery and help ensure that inflation, over time, 
remains at levels consistent with its mandate.
    Regarding the fiscal outlook in the United States and the 
potential for inflation that could impair the value of 
investments in long-term Treasury securities, the Congress and 
the Administration will need to make tough decisions in coming 
years to address the Nation's fiscal challenges.

Q.2. Bill Gross also wrote that, ``Yields on Treasuries may be 
too low to sustain demand for U.S. Government debt as the 
Federal Reserve approaches the end of quantitative easing.'' Do 
these comments give you pause about your previous support for 
QE2? If so, why? If not, why not?

A.2. The quotation suggests a concern that the demand for 
Treasuries may fall sharply as the QE2 program nears an end. 
However, Federal Reserve asset purchases appear to affect 
interest rates primarily by reducing the total stock of long-
term securities available to the public rather than through the 
anticipated flow of new purchases. Thus, the effect of the 
purchases should not diminish as the program is wound down. 
Experience with the conclusions of Federal Reserve asset 
purchase programs conducted over 2009 and early 2010 generally 
supported this view; aggregate demand for securities did not 
fall and long-term interest rates did not increase sharply as 
those programs came to a close. Consistent with this historical 
experience, the term structure of interest rates suggests that 
most market participants do not expect a sharp increase in 
longer-term interest rates over coming months, even though 
investors do appear to anticipate that the asset-purchase 
program will be completed early this summer.

Q.3. What is the dollar value of U.S. Treasuries currently held 
by the Federal Reserve?

A.3. The Federal Reserve publishes information on its balance 
sheet weekly in the Board's H.4.1 statistical release (http://
www.federalreserve.gov/releases/h41/). As of March 9, the 
Federal Reserve's holdings of U.S. Treasury securities stood at 
$1.27 trillion or about 14 percent of total marketable Treasury 
debt outstanding. By way of comparison, the Federal Reserve's 
holdings of U.S. Treasury securities in June of 2007, prior to 
the onset of the crisis, stood at about $0.79 trillion or about 
18 percent of total marketable Treasury debt outstanding at the 
time.

Q.4. How does this compare to the amount of U.S. Treasury 
securities held by China or Japan?

A.4. According to the Treasury International Capital (TIC) data 
collected by the U.S. Department of the Treasury, mainland 
China and Japan held $1.16 trillion and $0.88 trillion of U.S. 
Treasury securities, respectively, as of December 2010.

Q.5. Given that QE2 is not yet halfway finished, what do you 
think will happen to the demand for Treasuries over the next 
few months?

A.5. U.S. Treasury securities are widely regarded as a safe and 
highly liquid financial instrument in global fixed income 
markets. The global demand for U.S. Treasury securities is 
likely to remain solid over coming months.

Q.6. Are you concerned that since QE2 other central banks and 
purchasers of Treasury securities have scaled back their 
purchases?

A.6. The Federal Reserve's purchases have been largely 
concentrated in previously issued Treasury securities. As a 
result, global investors have continued to be the primary 
source of demand for new Treasury securities. Demand at recent 
U.S. Treasury auctions has been solid, and market participants 
generally do not appear to be anticipating any significant 
waning in the global demand for Treasury securities over coming 
months.

Q.7. What, in your mind, are the potential long term risks with 
the QE2 strategy?

A.7. The Federal Reserve's asset purchase program is intended 
to put downward pressure on long-term interest rates. Lower 
long-term interest rates reduce the costs of borrowing for 
households and businesses and boost asset prices, thereby 
providing impetus to spending. The potential risks associated 
with this program are similar to the risks associated with 
monetary policy stimulus provided with conventional monetary 
policy tools. An accommodative policy stance that is maintained 
for too long could result in excessive growth in aggregate 
demand that would put upward pressure on prices, and could, if 
unchecked, result in an increase in long-term inflation 
expectations that could prove costly to reverse. The Federal 
Reserve will need to continue to monitor economic developments 
very carefully and can change policy if that is warranted, just 
as it can change interest rate policy using conventional 
monetary policy tools.

Q.8. How can we be confident that those who used to purchase 
Treasury securities, but have withdrawn due to the dramatic 
increase in Federal Reserve purchases, will return once QE2 is 
ended?

A.8. The Federal Reserve purchased $300 billion of Treasury 
securities in 2009, and markets adjusted readily to the 
conclusion of that program. In addition, the Federal Reserve 
purchased $1.25 trillion of agency MBS over 2009 and the first 
quarter of 2010, and markets again adjusted smoothly to the 
conclusion of that program. The level of activity in Treasury 
markets currently remains very high and the Federal Reserve's 
asset purchases represent only a modest proportion of total 
trading volume in U.S. Treasury securities. I see no reason to 
question the view that market participants generally expect a 
smooth conclusion to the Federal Reserve's current asset 
purchase program. Moreover, forward 10-year yields at horizons 
beginning beyond June do not suggest that investors see any 
special strains associated with the conclusion of the asset 
purchase program, and uncertainty about long-term Treasury 
yields embedded in options prices has actually moved lower over 
recent weeks.

Q.9. What are the implications of the Federal Reserve being the 
chief purchaser of our Nation's debt?

A.9. Since the stated intention of the FOMC is to continue the 
high level of purchases on a temporary basis and to unwind the 
holdings after that, I see no long-run implications of this 
program and a short-run implication of helping the economic 
recovery. Of course, care must be taken to monitor the economy 
to make sure the policy remains appropriate while it is in 
effect.

Q.10. In an Op-Ed entitled, ``Health Care for Everyone'', you 
suggested bundling families together into groups which private 
insurance companies would provide coverage too in the way that 
Fannie Mae and Freddie Mac bundle individual mortgages 
together. You have supported the bailouts of the megabanks 
during 2008 and the President's ``stimulus'' effort. Can you 
cite some instances where you don't believe that direct 
intervention of the Federal Government is the best policy 
answer?

A.10. Like most American economists, I begin with the 
presumption that the basic system of free enterprise is the 
most efficient way to organize economic activity. One of the 
great strengths of the American economy is the widely shared 
understanding that markets work and work well. Absent 
compelling evidence of market failure, intervention by the 
Federal Government would not benefit our economic functioning. 
Indeed, our own governmental experience--and much of the 
academic literature published during the past century--can be 
seen as working to identify and refine a list of conditions in 
which Government intervention might be capable of improving a 
purely market-based outcome. By now, the basic outlines of 
those conditions are well understood. Unless a given situation 
meets a well-understood test of market failure, most economists 
would counsel against Government intervention, and I share that 
consensus view. For example, policies of Government price 
regulation in competitive settings do not enhance market 
efficiency.

Q.11. On National Public Radio last October you said that 
investing in public works is worth the risk of increasing the 
deficit. Despite the fact that we are facing our third trillion 
dollar deficit in American history and in December Moody's 
warned that it may downgrade the U.S. credit rating do you 
still feel that investing in public works is worth the risk?

A.11. Projections of U.S. debt show an unsustainable path, and 
I strongly favor putting in place reforms that would move the 
U.S. to a sustainable fiscal path. Investing in public works, 
done right, can be an economically smart decision because the 
benefits of a well-designed investment can far outweigh the 
costs, thereby contributing to long-term economic growth. In 
light of the fiscal pressures that the country faces, it is 
important that each commitment of taxpayer resources be 
undertaken with careful thought to both costs and benefits. 
Moreover, while unemployment remains very high, it is 
particularly advantageous to put in place reforms that address 
the long-term trajectory of the debt while avoiding a 
combination of actions that risk slowing or reversing the 
current economic recovery.

Q.12. Mr. Diamond, as you may be aware, since the Federal 
Reserve lowered the Federal Funds rate to ``0 to \1/4\ 
percent'' the FOMC statement has included the following 
statement, the Fed ``continues to anticipate economic 
conditions . . . are likely to warrant exceptionally low levels 
of the Federal funds rate for an extended period of time.'' Do 
you support the continued inclusion of that sentence in future 
FOMC statements?

A.12. I have not been part of the FOMC and have not received 
the detailed evaluations of the performance of the economy that 
members of the FOMC receive. If confirmed I will have an open 
mind to evaluate policies in light of the information and 
discussion that surrounds and occurs at FOMC meetings. While 
labor market conditions have improved somewhat of late, the 
unemployment rate remains very high and underlying inflation 
has declined over the last 2 years and is currently at a low 
level. Thus, I consider it worthwhile to encourage investments 
in both consumer durables and production assets. Sustaining low 
levels of the Federal funds rate for an extended period is one 
way to encourage such investments. As the economy recovers, the 
statement language will eventually need to change to be 
consistent with the Committee's developing assessment of the 
economic outlook and the appropriate stance of monetary policy.

Q.13. Would you vote against the inclusion of that sentence at 
the next meeting of the FOMC?

A.13. Without the benefit of participating in previous FOMC 
discussions of this issue, and without the information and 
discussion that will occur in the next FOMC meeting, I cannot 
say how I would vote if I did attend the next meeting. The 
evolution of the sentence noted, along with many other elements 
of the stance of policy, must be carefully evaluated in light 
of changes in the economic outlook.

Q.14. Many economists believe that dropping the ``extended 
period'' language from the FOMC would provide a crucial signal 
to the markets that the time of excessive, cheap liquidity will 
be coming to an end soon. What would it take for you to support 
removing that sentence from the FOMC statement?

A.14. The extended period language and other aspects of the 
current stance of policy reflect the current view of the FOMC 
on the needs of the economy. As such they will need to be 
adjusted as there are changes in the FOMC's assessment of the 
outlook for its dual mandate of maximum employment and price 
stability. Since the Committee, appropriately evaluates a very 
wide range of economic data in making its assessment, and I 
have not been party to the range of assessments considered at 
FOMC meetings, it is not possible to state precisely what 
changes in which variables would make a specific adjustment to 
the statement seem appropriate.
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