[House Hearing, 113 Congress]
[From the U.S. Government Publishing Office]



 
                   NEAR-ZERO RATE, NEAR-ZERO EFFECT?

                     IS ``UNCONVENTIONAL'' MONETARY

                         POLICY REALLY WORKING?

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


                                HEARING

                               BEFORE THE

                            SUBCOMMITTEE ON

                       MONETARY POLICY AND TRADE

                                 OF THE

                    COMMITTEE ON FINANCIAL SERVICES

                     U.S. HOUSE OF REPRESENTATIVES

                    ONE HUNDRED THIRTEENTH CONGRESS

                             FIRST SESSION

                               __________

                             MARCH 5, 2013

                               __________

       Printed for the use of the Committee on Financial Services

                            Serial No. 113-4




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                 HOUSE COMMITTEE ON FINANCIAL SERVICES

                    JEB HENSARLING, Texas, Chairman

GARY G. MILLER, California, Vice     MAXINE WATERS, California, Ranking 
    Chairman                             Member
SPENCER BACHUS, Alabama, Chairman    CAROLYN B. MALONEY, New York
    Emeritus                         NYDIA M. VELAZQUEZ, New York
PETER T. KING, New York              MELVIN L. WATT, North Carolina
EDWARD R. ROYCE, California          BRAD SHERMAN, California
FRANK D. LUCAS, Oklahoma             GREGORY W. MEEKS, New York
SHELLEY MOORE CAPITO, West Virginia  MICHAEL E. CAPUANO, Massachusetts
SCOTT GARRETT, New Jersey            RUBEN HINOJOSA, Texas
RANDY NEUGEBAUER, Texas              WM. LACY CLAY, Missouri
PATRICK T. McHENRY, North Carolina   CAROLYN McCARTHY, New York
JOHN CAMPBELL, California            STEPHEN F. LYNCH, Massachusetts
MICHELE BACHMANN, Minnesota          DAVID SCOTT, Georgia
KEVIN McCARTHY, California           AL GREEN, Texas
STEVAN PEARCE, New Mexico            EMANUEL CLEAVER, Missouri
BILL POSEY, Florida                  GWEN MOORE, Wisconsin
MICHAEL G. FITZPATRICK,              KEITH ELLISON, Minnesota
    Pennsylvania                     ED PERLMUTTER, Colorado
LYNN A. WESTMORELAND, Georgia        JAMES A. HIMES, Connecticut
BLAINE LUETKEMEYER, Missouri         GARY C. PETERS, Michigan
BILL HUIZENGA, Michigan              JOHN C. CARNEY, Jr., Delaware
SEAN P. DUFFY, Wisconsin             TERRI A. SEWELL, Alabama
ROBERT HURT, Virginia                BILL FOSTER, Illinois
MICHAEL G. GRIMM, New York           DANIEL T. KILDEE, Michigan
STEVE STIVERS, Ohio                  PATRICK MURPHY, Florida
STEPHEN LEE FINCHER, Tennessee       JOHN K. DELANEY, Maryland
MARLIN A. STUTZMAN, Indiana          KYRSTEN SINEMA, Arizona
MICK MULVANEY, South Carolina        JOYCE BEATTY, Ohio
RANDY HULTGREN, Illinois             DENNY HECK, Washington
DENNIS A. ROSS, Florida
ROBERT PITTENGER, North Carolina
ANN WAGNER, Missouri
ANDY BARR, Kentucky
TOM COTTON, Arkansas

                     Shannon McGahn, Staff Director
                    James H. Clinger, Chief Counsel
               Subcommittee on Monetary Policy and Trade

                  JOHN CAMPBELL, California, Chairman

BILL HUIZENGA, Michigan, Vice        WM. LACY CLAY, Missouri, Ranking 
    Chairman                             Member
FRANK D. LUCAS, Oklahoma             GWEN MOORE, Wisconsin
STEVAN PEARCE, New Mexico            GARY C. PETERS, Michigan
BILL POSEY, Florida                  ED PERLMUTTER, Colorado
MICHAEL G. GRIMM, New York           BILL FOSTER, Illinois
STEPHEN LEE FINCHER, Tennessee       JOHN C. CARNEY, Jr., Delaware
MARLIN A. STUTZMAN, Indiana          TERRI A. SEWELL, Alabama
MICK MULVANEY, South Carolina        DANIEL T. KILDEE, Michigan
ROBERT PITTENGER, North Carolina     PATRICK MURPHY, Florida
TOM COTTON, Arkansas


                            C O N T E N T S

                              ----------                              
                                                                   Page
Hearing held on:
    March 5, 2013................................................     1
Appendix:
    March 5, 2013................................................    43

                               WITNESSES
                         Tuesday, March 5, 2013

Gagnon, Joseph E., Senior Fellow, Peterson Institute for 
  International Economics........................................    12
Malpass, David R., President, Encima Global......................     7
Meltzer, Allan H., Professor of Political Economy, Tepper School 
  of Business, Carnegie Mellon University........................     8
Taylor, John B., Mary and Robert Raymond Professor of Economics, 
  Stanford University, and George P. Schultz Senior Fellow in 
  Economics, Hoover Institution, Stanford University.............    10

                                APPENDIX

Prepared statements:
    Gagnon, Joseph E.............................................    44
    Malpass, David R.............................................    48
    Meltzer, Allan H.............................................    62
    Taylor, John B...............................................    68

                   NEAR-ZERO RATE, NEAR-ZERO EFFECT?


                     IS ``UNCONVENTIONAL'' MONETARY


                         POLICY REALLY WORKING?

                              ----------                              


                         Tuesday, March 5, 2013

             U.S. House of Representatives,
                           Subcommittee on Monetary
                                  Policy and Trade,
                           Committee on Financial Services,
                                                   Washington, D.C.
    The subcommittee met, pursuant to notice, at 10:02 a.m., in 
room 2128, Rayburn House Office Building, Hon. John Campbell 
[chairman of the subcommittee] presiding.
    Members present: Representatives Campbell, Huizenga, 
Pearce, Posey, Grimm, Stutzman, Mulvaney, Pittenger, Cotton; 
Clay, Moore, Peters, Foster, Carney, Sewell, Kildee, and 
Murphy.
    Also present: Representative Green.
    Chairman Campbell. The committee will come to order. 
Without objection, the Chair is authorized to declare a recess 
of the committee at any time.
    The Chair now recognizes himself for 4 minutes for an 
opening statement.
    I would like to first of all welcome our distinguished 
panel of witnesses.
    Last week, Federal Reserve Chairman Bernanke testified in 
this room during the semiannual Humphrey-Hawkins testimony that 
he gives before Congress. He was asked many questions about 
quantitative easing, so-called ``QE Forever,'' and the 
persistently low interest rates that the Fed is holding, and as 
to whether the benefits of this policy still outweighed the 
risks and negatives of this policy. Chairman Bernanke quite 
vigorously, I would say, defended the policy and defended that 
its benefits are still outweighing the risks in spite of some 
dissension in the Federal Open Market Committee itself, and 
certainly some disagreement here amongst members of this 
committee.
    The purpose of this hearing today is to find out from you 
all, from some of the country's most distinguished economists, 
what your view is and whether you believe that the benefits of 
this policy equal the risks, exceed the risks, or outweigh the 
risks, and what, and if at any point in the future, when those 
different metrics might perhaps change to warrant the ending of 
QE Forever or a change in the interest rate environment in 
which we find ourselves. And so we will look forward to hearing 
all of your comments and thoughts on this issue which is 
pressing before us now.
    And with that, I will recognize the ranking member of the 
subcommittee, Mr. Clay from Missouri, for 5 minutes for his 
opening statement.
    Mr. Clay. Thank you, Mr. Chairman, and thank you for 
conducting this hearing entitled, ``Near-Zero Rate, Near-Zero 
Effect? Is `Unconventional' Monetary Policy Really Working?''
    And also, I want to thank the witnesses for appearing.
    Mr. Chairman, I will begin with a short summary of why the 
economy is in its current state and what has led to the Federal 
Reserve System's use of quantitative easing policy.
    The U.S. economy has taken a beating over the past 10 
years. U.S. engagement in two unpaid wars, one in Iraq and a 
second in Afghanistan, has produced record amounts of 
government debt. Also during the past 10 years, bad actors in 
the housing and financial industries have contributed to the 
problems in the U.S. economy.
    According to the Financial Crisis Inquiry report, a 
combination of excessive borrowing, risky investments, and a 
lack of transparency put the financial system on a collision 
course of self-destruction. The Full Employment and Balanced 
Growth Act of 1978, better known as the Humphrey-Hawkins Act, 
charges the Federal Reserve with a dual Band-Aid, both 
maintaining stable prices and full employment.
    But during the height of the financial crisis, the Federal 
Reserve took major measures to pump more liquidity into the 
financial system. In September of 2007, the Federal Open Market 
Committee (FOMC) lowered the Federal fund rate from 5.25 
percent to between 0 to .25 percent. Currently, the interest 
rate on overnight loans between banks has been close to zero 
since December of 2008.
    To stimulate the economy, the Federal Reserve used two 
policies. The first is forward guidance regarding the Federal 
Open Market Committee's anticipated path for Federal fund's 
rate. According to Chairman Bernanke, ``Since longer-term 
interest rates reflect market expectations for shorter-term 
rates over time, our guidance influenced longer-term rates and 
thus supports a stronger recovery.''
    The second type of policy tool employed by the FOMC is 
large-scale purchase of longer-term security, which, like 
forward guidance, is intended to support economic growth by 
putting downward pressure on longer-term interests rates. Also, 
the Federal Open Market Committee has indicated that it will 
continue purchases until it observes a substantial improvement 
in the outlook for the labor market in context of price 
stability.
    According to the Federal Reserve, these monetary policies 
are supportive to the recovery while keeping inflation close to 
the Federal Open Market Committee's 2 percent objective. One 
example of this policy working is in the housing market.
    Low long-term interest rates have helped spark recovery. 
With rising employment, family wealth, and the growth in the 
housing market, consumer sentiment and spending have been 
positive. Currently, the unemployment rate is 7.9 percent, down 
from a year ago of 8.3 percent and from 2 years ago of 9.2 
percent.
    In regards to inflation, the Federal Reserve remains 
confident that it has the tools necessary to tighten monetary 
policy when the time comes to do so. Currently, inflation is 
subdued and the expectations appear well-based.
    Again, thank you, Mr. Chairman. I look forward to the 
witnesses' comments.
    Chairman Campbell. The gentleman yields back his time. 
Thank you, Mr. Clay.
    The vice chairman of the subcommittee, Mr. Huizenga, the 
gentleman from Michigan, is recognized for 3 minutes.
    Mr. Huizenga. Thank you, Chairman Campbell and Ranking 
Member Clay, and thank you for bringing this distinguished 
panel to discuss, ``Near-Zero Rate, Near-Zero Effect.'' 
Obviously, we know it is an important issue which has 
tremendous impact on our economy, and I am eager to hear your 
insight.
    For too long, I believe, the government in many forms has 
looked upon itself as sort of the sole source to solve the 
social and economic ills that our country faces, and 
unfortunately, the Federal Reserve is no different. The Federal 
Reserve has continued to implement government-based solutions, 
whether it was prolonged reduction of near-zero interest rates, 
sort of, I would argue--excuse me--this artificial lowering of 
interest rates with quantitative easing, quantitative, QE2, 
QE3, QE Infinity, Operation Twist, and all these other things 
that has, frankly, only just led to prolonged high levels of 
unemployment, continued lack of consumer confidence, and 
frankly, erratic to no growth in the economy.
    So what does the Federal Reserve decide to do in December 
of 2012? To continue purchasing mortgage-backed securities at a 
rate of $40 billion a month and $45 billion in long-term 
Treasury securities per month, so these measures must be 
working, right? I think that jury is very much out and the 
answer seems to be ``no.''
    With our GDP stagnant and unemployment even higher than 
when President Obama took office in 2009, you don't see many 
economists predicting the economy taking off at anywhere near 
its historic rates and pace in the past.
    So the answer is simple: The policies implemented and 
prolonged by the Federal Reserve have failed to deliver as 
advertised, and we need to correct that.
    Now, when do these failed policies come to an end? The 
Federal Open Market Committee, FOMC, says they plan on keeping 
these zero rates, or near-zero rates, until at least sometime 
in 2015 with a target 6.5 percent unemployment rate. The 
ranking member brought up the Humphrey-Hawkins--this dual 
mandate; I am looking forward to having that conversation.
    But I think the question is, at what cost? We need to 
explore that. And if not at what cost then, frankly, what 
benefit are we deriving from this?
    And frankly, as a proponent of the free market and having a 
smarter, more efficient, more effective size of government and 
government put in place, let me point out that just one of the 
many problems with the Administration's policy, such as 
targeting of near-zero rates by the FOMC, it is an abomination, 
in my mind, that under this Administration, the new normal for 
unemployment has been around 8 percent.
    We have seen it higher, and we have seen it just under 
that. But we know, frankly, that it is not a success at getting 
people back to work; it is a Bureau of Labor and Statistics 
that the way they keep their counting of this--and 
unfortunately, we have seen people--unfortunately, people do 
not becoming employed, but because they are getting discouraged 
and leaving the workforce.
    So thank you. I appreciate that and I look forward to 
learning how we are going to continue to have the private 
investment grow our economy.
    Chairman Campbell. Thank you.
    The gentleman's time has expired.
    I now recognize the gentleman from Illinois, Mr. Foster, 
for 3 minutes for an opening statement.
    Mr. Foster. Thank you, Mr. Chairman.
    And I have a couple of slides, if I could have the first 
one. There are two slides here that I think will be useful in 
framing the discussion of the recovery.
    The first one is a comparison of the drop in household net 
worth during the Great Depression and during the downturn that 
we just went through. When people ask me to reduce to a single 
number where are we and where our economy is, I go to household 
net worth, which is simply the value of everything owned by 
families in America.
    And so the top curve that you can see on there is the 
fractional drop in household net worth during the first 
Republican big financial collapse in 1929, where over the 
course of the next 5 years household net worth dropped by 
approximately 12 percent. And then when we transition to FDR's 
policies, over the course of the next nearly-a-decade, we have 
slowly recovered that.
    If you contrast that to what we just went through in the 
last 15 months of the Bush Administration, where household net 
worth dropped by about a trillion dollars a month for the last 
15 months, households in America lost a quarter of their net 
worth. So what we underwent was a financial drop that was twice 
as rapid and twice as deep as the onset of the Great 
Depression. It is remarkable, in that context, that we are not 
in a great depression today.
    Fortunately, after roughly the beginning of 2009 we had a 
series of changes in policies. There was the big intervention 
by the Federal Reserve, probably 2 quarters before the V-shaped 
turnaround that you see not only in household net worth but in 
business profitability, the stock market, essentially every 
financial indicator you can look at.
    This also happened, perhaps not as an accident, the quarter 
after we passed the stimulus--the so-called ``failed 
stimulus.'' And so when you look at these, it is hard to 
actually look at this and conclude that there was not a 
positive benefit.
    Interestingly, if you look at this in terms of just return 
on investment--the costs of the stimulus, and so on--it is less 
than--it is on the order of a trillion dollars. Household net 
worth has rebounded by more than 10 times that, and so you find 
a pretty high return on investment from that point of view.
    If I could have the second slide, there are a lot of 
discussions about what would have happened if we had done 
nothing. Many of these get to be partisan. I have chosen here 
to put a bipartisan calculation of what would have happened if 
we had done nothing. This is by John McCain's financial advisor 
and also a Democratic economist who collaborated, and if you 
look at what would have happened with no intervention, they 
estimate that our economy would simply not have recovered, in 
terms of household net worth, and that they apportion roughly 
equal share of the credit for the recovery to the actions of 
the Federal Reserve and the stimulus.
    So, I would like to bring up a lot of these points in the 
ongoing questioning. And thanks so much.
    Chairman Campbell. Thank you.
    The gentleman's time has expired.
    Mr. Grimm from New York is recognized for 1 minute for an 
opening statement.
    Mr. Grimm. Thank you, Mr. Chairman. I appreciate you 
calling this hearing, and I want to thank the witnesses for 
coming and testifying today.
    I am very glad to see that we are devoting our very first 
hearing of this subcommittee to a very important, if not 
central, topic to the long-term health of U.S. capital markets, 
and indeed, the economy as a whole--namely, examining the long-
term risks of the Fed's extraordinarily accommodative monetary 
policy over the last 5 years. And I personally am very 
concerned about the risks that the Fed's rapid balance sheet 
possesses to the stability of the Fed as well as its inability 
to possibly unwind its unprecedented asset purchases in a way 
that will not do significant damage to U.S. markets or, even 
worse, cause world markets to question the very soundness of 
the U.S. dollar.
    So with that, I look forward to hearing what our witnesses 
have to say on these very important topics and I yield back the 
balance of my time. Thank you.
    Chairman Campbell. The gentleman yields back.
    And for the final opening statement, the gentleman from 
Indiana, Mr. Stutzman, is recognized for 2 minutes.
    Mr. Stutzman. Thank you, Mr. Chairman, for holding this 
very important hearing. I want to, of course, welcome the 
panel, as well, and I look forward to their comments.
    Of course, as we are examining the effects of the Fed's 
unconventional approach to keeping interest rates so long is of 
great concern for me, and as for as long as they are. I am 
extremely concerned about how this market manipulation 
invariably distorts private investment decisions in the short 
and in the long term.
    Furthermore, I look forward to discussing with our 
witnesses whether the Fed's market intervention is meeting its 
stated goal of creating economic growth and how it may, in 
fact, be doing just the opposite.
    As a subcommittee, I believe we need to press the Fed to 
provide greater clarity on what the economic environment may 
need to look like in order for them to roll back some of these 
policies. Only then can we provide precise oversight.
    Of most recent concern to me has been the Fed's decision to 
buy $85 billion a month until the unemployment rate falls below 
the largely arbitrary rate of 6.5 percent. To avoid some of the 
unconventional approaches discussed today, I remain committed 
to focusing the Fed exclusively on price stability by 
eliminating its dual mandate.
    To do just that, I have introduced H.R. 492, the FFOCUS Act 
of 2013. I look forward to the witnesses' testimony and their 
expertise today.
    Thank you, Mr. Chairman. I will yield back.
    Chairman Campbell. The gentleman yields back.
    And so, we welcome our panel of distinguished witnesses.
    Mr. David Malpass is president of Encima Global, LLC. 
Encima Global is an economic research and consulting firm 
serving institutional investors. He previously served as the 
chief economist at Bear Stearns, as Deputy Assistant Secretary 
of the Treasury, and as Deputy Assistant Secretary of State.
    Welcome, Mr. Malpass.
    Dr. Allan Meltzer is the Allan H. Meltzer professor of 
political economy at Carnegie Mellon University. He is also a 
visiting scholar at the American Enterprise Institute.
    Dr. Meltzer chaired the International Financial Institution 
Advisory Commission, also known as the Meltzer Commission--you 
get your name on a lot of things--and was a founding member of 
the Shadow Open Market Committee. Dr. Meltzer served on the 
President's economic advisory policy board and on the Council 
of Economic Advisors.
    Welcome, Dr. Meltzer.
    Dr. John Taylor is the Mary and Robert Raymond professor of 
economics at Stanford University. He is also the director of 
the Stanford Introductory Economics Center and the former 
director--now a senior fellow--at the Stanford Institute for 
Economic Policy Research. Previously, Dr. Taylor served as 
Undersecretary of the Treasury for International Affairs and as 
a member of the President's Council of Economic Advisors.
    I welcome my fellow Californian, Dr. Taylor.
    And last but not least, Dr. Joseph Gagnon is senior fellow 
at the Peterson Institute for International Economics. 
Previously, he served as the Associate Director of Monetary 
Affairs at the Federal Reserve Board of Governors and as an 
economist at the U.S. Treasury Department.
    Welcome, Dr. Gagnon.
    Each of you will be recognized for 5 minutes to give an 
oral presentation of your testimony. Without objection, each of 
your written statements will be made a part of the record after 
your oral remarks.
    I suspect you all know the drill, but I will state it 
anyway. On your table, there is a light. It will start out 
green. When it turns yellow, you have a minute to sum up. When 
it turns red, please suspend.
    Once each of you has finished presenting, each member of 
the committee will have 5 minutes to ask any or all of you 
questions.
    With that, Mr. Malpass, you are now recognized for 5 
minutes.

    STATEMENT OF DAVID R. MALPASS, PRESIDENT, ENCIMA GLOBAL

    Mr. Malpass. Thank you very much.
    Chairman Campbell, Congressman Clay, Congressman Grimm from 
New York, and members of the subcommittee, thank you for the 
invitation to testify on the effectiveness of current monetary 
policy. It is a great pleasure to join Allan Meltzer, John 
Taylor, and Joe Gagnon on this panel.
    I think Federal Reserve policies have been weakening and 
distorting the economy rather than providing stimulus. The 
policies are hurting savers, distorting markets, and 
redistributing capital rather than increasing it.
    The policies subsidize government, big corporations, big 
banks, foreign investment, and gold, none of which is a robust 
private sector job creator, and it comes at the expense of 
small and new businesses and other job-creating parts of the 
economy. The result is a departure from market-based capital 
allocation that is contractionary in the same way that price 
controls, income redistribution, and industrial policy are 
contractionary.
    What I would like to do, Mr. Chairman, is walk through some 
of the graphs in my written testimony and mention them to you. 
I am on page one. What the Fed has done is keep interest rates 
very low and then substantially lengthen the duration of its 
assets by selling all of its Treasury bills.
    So you see the graph at the bottom of one. The Fed is out 
of Treasury bills, and that used to be the mainstay of U.S. 
monetary policy.
    The result of this extreme monetary policy experiment has 
been an actual decline in the GDP growth rates. Real growth has 
slowed from 2.4 percent in 2010 to 2 percent in 2011 and only 
1.6 percent in 2012. So basically, the economy has been going 
backward at the time when the Fed is trying to stimulate it.
    The Fed itself has had to lower its original growth 
projections. That is at the top of three. Each year, they have 
started with a projection and then had to reduce it because the 
results haven't turned out.
    I think there is a problem in the transmission mechanism of 
quantitative easing to the economy. It isn't working under 
current circumstances of heavily regulated growth in private 
sector credit.
    Private sector credit over the 3-year period of this Fed 
monetary policy, 2010 through 2012, is up only 1.6 percent, 
government debt is up 32 percent, and the Fed's liabilities are 
up 30 percent. So there is not a transmission from what the Fed 
is doing to what the private sector is feeling.
    The Fed is setting an artificially low interest rate. What 
it hopes is that this will encourage consumer spending, but at 
the same time, it is undercutting the normal impetus of the 
economy to borrow during a recovery to lock in low rates before 
they go up.
    The low-rate policy penalizes savers, it distorts capital 
allocation, and undermines critical interbank markets. The 
graph on page four shows you the paralysis going on in 
interbank markets, a point Professor Ron McKinnon has made.
    The Fed is also pushing down yields for longer-term credit. 
That benefits a select group of favored borrowers, like the 
government, at the expense of non-favored borrowers, such as 
new businesses, small businesses, and businesses that the 
government considers risky.
    On page 5 of my testimony, I go through a number of other 
problems. The Fed is contracting the economy. In addition, the 
Fed has greatly expanded its role in the economy.
    The Fed is asserting a legal authority to make unlimited 
large-scale asset purchases on its sole discretion when there 
is no systemic crisis. That has huge implications for the 
future, when each slowdown will cause the markets to believe 
the Fed might buy assets.
    By using short-term credit, the Fed has created a maturity 
mismatch. The result of the Fed policy is a more powerful Fed 
and a risk to taxpayers when interest rates go up. The Fed now 
owes over $2 trillion in floating rate liabilities to 
commercial banks, which itself is a danger.
    So in conclusion, Mr. Chairman--and I am going to flip to 
the end of my statement here--rather than quantitative easing 
providing stimulus, it is compounding the capital misallocation 
problem by trying to push more credit into corporate bonds. The 
Fed is operating as a speculator, borrowing short and lending 
long, while ignoring the conflict of interest this creates when 
it sets interest rates.
    The best exit, in my view, would be for the government to 
adopt growth-oriented tax, spending, and regulatory policies in 
parallel with a new growth-oriented Fed resolve to downsize its 
role in capital allocation and commit to providing a strong and 
stable dollar. The combination would encourage private sector 
investment and hiring in the U.S. economy and would meet the 
Fed's mandate of maximizing employment while assuring price 
stability.
    Thank you, Mr. Chairman.
    [The prepared statement of Mr. Malpass can be found on page 
48 of the appendix.]
    Chairman Campbell. Thank you, Mr. Malpass.
    Dr. Meltzer, you are recognized for 5 minutes.

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

    Mr. Meltzer. Mr. Chairman and members of the committee, our 
Constitution assigns responsibility for monetary policy to the 
Congress, that is, to you people. The Federal Reserve acts as 
your agent.
    The Federal Reserve has expanded bank reserves more than 
350 percent in the last few years. This is an enormous and 
unprecedented increase, and it continues.
    In my opinion, no entity or agent in our government should 
have so much unrestrained authority. Current practice violates 
all our beliefs about checks and balances. It sets a terrible 
precedent that should be avoided and it achieves very limited 
benefits to our economy.
    Many bankers applaud the current expansive policy. They 
profit from it because they can borrow from the Fed or in the 
money market at a quarter percent or less and lend to the 
Treasury at 1 percent or more. They are able to improve their 
stock prices by paying dividends and increase their incomes by 
paying bonuses.
    Does the Congress approve this transfer from taxpayers to 
the owners and managers of financial firms? I doubt seriously 
that you would vote for such a policy.
    Chairman Bernanke describes the expansive policy as on 
balance of benefit to the economy. I disagree for several 
reasons.
    First, we agree that the low interest rate policy 
encourages risk-taking, but among those taking their investment 
risk are retirees who cannot live on the income they receive 
currently from their usual source of investment, often bank 
certificates of deposit. Many are said to seek higher income by 
investing in emerging market bonds or domestic junk bonds.
    We know from our history how this practice ends. It ends in 
losses and tears when interest rates rise, bond prices fall, 
and risky assets default. Or note what has happened to the 
prices of farmland, in part a result of the ethanol program 
that raised agricultural prices. We have seen this pattern of 
rising farmland prices many, many times. It ends in tears and 
heavy losses to those who invest in it.
    These are examples of a general pattern of increased risk. 
Increasingly, investors do not want to hold money or low 
interest rate bonds. They shift into holding equities, raising 
equity prices, and taking the risk of holding high-yield bonds 
or claims on farmland, or other risky assets.
    Federal Reserve policy is repeating the same mistake that 
brought us the great inflation of the 1970s. Then and now, the 
Federal Reserve expanded its balance sheet by financing the 
government's budget deficit. This time, the deficits are larger 
and the Fed's purchases are much, much larger.
    And then, as now, the Fed tried to push unemployment rates 
down. Doing so, they ignored the lessons that Paul Volcker 
repeated here and elsewhere many, many times: expected 
inflation is the way to get low inflation.
    We know from that experience and repeated experiences all 
over the world how highly expansive policy ends. It ends with 
inflation, followed by a big recession required to end the 
inflation by reducing money and credit growth and raising 
interest rates.
    Ask yourselves, please, what you expect to happen to all 
the low interest rate bonds that the banks and others hold. 
Will they have enough equity reserves to absorb the losses that 
they will surely take or will there be another debt crisis?
    The first Federal Reserve balance sheet expansion in 2008 
prevented a breakdown of the payments system. That was the 
right thing to do at the time.
    The next large balance sheet expansion, called QE2, added 
$600 billion to bank reserves and the Federal Reserve balance 
sheet. $500 billion went into bank excess reserves. That pays 
some interest to the bankers but does absolutely nothing for 
employment and economic activity.
    Much of the remaining $100 billion went into reserves of 
foreign central banks. They bought the dollars to limit the 
depreciation of the dollar against their currency. Other 
central banks are now expanding reserve growth rapidly. This 
prevents their currencies from appreciating.
    We are now in the third round of QE expansion.
    Let me close with this comment: The Federal Reserve will be 
100 years old this year. Its history includes 2 multi-year 
periods during which inflation was low--the only two such 
periods in its history.
    Real income and employment fluctuations were modest and 
recessions were mild. The two periods are 1923 to 1928 and 1985 
to 2002. In both periods, the Federal Reserve generally 
followed a monetary rule. In 1923-1928, the rule was the gold-
exchange standard; in 1985-2002 or 2003, the rule was Mr. 
Taylor's rule.
    No rule will be perfect all the time, but the lesson you 
should draw is that following a rule gave much better results 
for the public and the country than policies based on forecasts 
and judgment. That is a lesson you should discuss and implement 
as you consider how to get off the path to crisis and improve 
on your responsibility for regulating the Federal Reserve and 
its monetary policy.
    Thank you.
    [The prepared statement of Dr. Meltzer can be found on page 
62 of the appendix.]
    Chairman Campbell. Thank you, Dr. Meltzer.
    Dr. Taylor, you are now recognized for 5 minutes.

STATEMENT OF JOHN B. TAYLOR, MARY AND ROBERT RAYMOND PROFESSOR 
OF ECONOMICS, STANFORD UNIVERSITY, AND GEORGE P. SCHULTZ SENIOR 
  FELLOW IN ECONOMICS, HOOVER INSTITUTION, STANFORD UNIVERSITY

    Mr. Taylor. Thank you, Mr. Chairman, Ranking Member Clay, 
and other members of the subcommittee for inviting me to 
testify. And also, thank you very much for having this hearing 
on a very important topic.
    You asked us to review monetary policy before, during, and 
after the financial crisis, and some of you in your opening 
remarks have already done that. I think to do that you need to 
go back almost a decade to the period of 2003, 2004, and 2005 
when the Federal Reserve held interest rates very low by any 
historical standard, especially the previous 2 decades of the 
1980s and 1990s. This caused the housing boom to be much worse 
than it otherwise was. It caused the search for yield; it 
caused risk-taking; and ultimately, the bust, which brought on 
the financial crisis in part.
    When the financial crisis first showed up, the Fed 
misdiagnosed that. They provided liquidity facilities at a time 
where there were problems--credit problems--in the banking 
sector. This is how I think helped bring on the crisis part of 
the--the panic part of the crisis.
    When the panic hit, the Fed did help stabilize things with 
their actions--in particular, the commercial paper market and 
the money market funds. That particular phase, October, 
November of 2008, was constructive.
    However, when the emergency ended, the Fed continued with 
the emergency operations--quantitative easing and the other 
actions that have already been mentioned in this hearing.
    My view is if you look at this whole period, it is 
characterized by unprecedented actions by the Fed. It has been 
unpredictable movements of their instruments of policy, and I 
think it has caused harm.
    If you think of the Fed's old criteria for performance, it 
looks very bad. Unemployment much higher than it needs to be 
during this period, and inflation stability no better than in 
the past. So by its own methods of comparing and evaluating 
itself, the Fed's performance has been very bad.
    You can get some sense of this by thinking of what the Fed 
has forecast for this recovery. There are some charts in my 
testimony, similar to Mr. Malpass', which show that the 
recovery has been very disappointing for the Fed.
    They thought growth in 2012 was going to be 4 percent on 
average. The most pessimistic forecasts were going to be 3.5 
percent for 2012. It turned out to be about 1.5 percent.
    Why the disappointing performance? Of course you can point 
to external factors, and you hear testimony along those lines 
from the Fed.
    In my view, you can't really explain this by external 
factors. It really is related to the policy itself.
    And what is so bad about the policy? Think about this. I 
have a chart in my testimony, if you can look, perhaps, on page 
5, to show how unprecedented what we are doing is. This is not 
just normal monetary policy.
    The Fed has expanded its balance sheet in ways we have 
never even seen before, and it is expected to continue that 
with its current Quantitative Easing Infinity, if you like. I 
think this caused enormous risks. It is a two-sided risk: one, 
inflation may pick up if the Fed can't undo this ease fast 
enough; and two, it is a downside. If they bring the funds back 
too quickly, that is a downturn. It is contractionary.
    So there is this risk overhanging the financial system and 
the economy. I think that is a drag on growth. Firms are 
sitting on a lot of cash. Actually, some consumers are now 
sitting on a lot of cash. They don't want to go out and buy 
things with that uncertainty.
    I think it is already a drag. This is not our future risk. 
This is a current risk.
    When you talk about risks and benefits, or costs and 
benefits, the costs are now greater than the benefits and it is 
a great concern to me. It is one of the reasons unemployment 
remains high.
    You also have the low interest rates, which reduce income 
for savers. And you have this adverse effect in the credit 
markets that has already been discussed by Mr. Malpass.
    It is nice to be able to borrow at low interest rates. It 
is not so great to lend at low interest rates. It is not 
surprising that credit flows, especially to less-credit-worthy 
borrowers. It is low at this point in time. So I think it is 
basically that is a negative, and I--many other reasons why it 
is negative.
    So on balance, to answer the questions raised in this 
hearing, I don't think the unconventional monetary policy is 
working. I am very concerned it is having perverse effects.
    My hope is the economy will pick up this year, like 
everyone hopes, and that will give the Fed the opportunity to 
begin to back off some of these extraordinary measures. And if 
so, I think the economy will improve, in which case the Fed can 
maybe have another reason to back off. I hope that is the case.
    Thank you, Mr. Chairman.
    [The prepared statement of Dr. Taylor can be found on page 
68 of the appendix.]
    Chairman Campbell. Thank you, Dr. Taylor.
    And now, Dr. Gagnon, you are recognized for 5 minutes.

    STATEMENT OF JOSEPH E. GAGNON, SENIOR FELLOW, PETERSON 
             INSTITUTE FOR INTERNATIONAL ECONOMICS

    Mr. Gagnon. Chairman Campbell, Ranking Member Clay, and 
members of the subcommittee, I would like to thank you for 
inviting me to explain why I believe America needs more 
expansionary monetary policy.
    There are four major forces holding back our economic 
recovery: one, consumers are saving more to make up for losses 
in the value of their houses; two, banks are applying tighter-
than-normal standards in lending; three, foreign governments 
continue to resist appreciation of their currencies, thus 
perpetuating a large U.S. trade deficit; and four, State and 
local governments initially, and now the Federal Government, 
have been cutting spending and raising taxes.
    All of these forces reflect either greater saving or 
reduced borrowing, both of which hold down spending in the U.S. 
economy. Expansionary monetary policy is helping to offset 
these forces.
    Low interest rates encourage consumption and investment, 
but total spending in the U.S. economy remains too low and most 
private sector forecasters expect employment to remain 
depressed and inflation to remain low for the next few years. 
This suggests strongly that the current stance of monetary 
policy is still too tight.
    With the short-term interest rate essentially at zero, more 
expansionary monetary policy must work through unconventional 
channels. One element of unconventional monetary policy is to 
use newly printed money to purchase long-term assets.
    Another element is to communicate to market participants 
that the future path of the short-term interest rate will be 
lower than they otherwise might expect. In these ways, the 
monetary authority can lower long-term rates of interest, which 
are not at the zero bound.
    My research shows that the Fed's purchases of long-term 
bonds have lowered long-term interest rates not only on the 
bonds being purchased, but also on a broad range of long-term 
assets. Other researchers have confirmed this result.
    I estimate that the 10-year Treasury yield and the 30-year 
mortgage rate are at least 1 percentage point lower than they 
would have been in the absence of the Fed's unconventional 
policies.
    Most market participants believe that these policies have 
boosted stock prices and helped to keep the dollar from 
appreciating. There is no doubt that all of these financial 
developments encourage spending, including on consumption, 
investment, and exports, and thus support economic growth. I 
note in particular that refinancing long-term debts at lower 
interest rates goes a long way toward repairing household and 
corporate balance sheets that are holding back spending.
    Chairman Bernanke has identified four costs or risks that 
are of greater concern with unconventional monetary policy than 
with conventional policy. In my view, none of these costs is 
close to being significant now or at any time in the 
foreseeable future.
    The first cost of unconventional monetary policy is that 
the Fed could become the dominant buyer of long-term Treasury 
and agency securities, potentially reducing the liquidity and 
efficiency of the market for these assets. So far, this concern 
is purely hypothetical. But if it should ever materialize, 
there are strategies the Fed could adopt to prevent harm to 
financial markets and the economy.
    The second cost is that the public might believe that it 
will be difficult for the Fed to tighten policy at the right 
time to prevent excessive inflation in the future. Such a fear 
might increase uncertainty and instability in financial 
markets.
    The Fed has developed several tools to adjust policy that 
provide ample scope for future tightening. However, the real 
concern may be more with the Fed's willingness than with its 
ability.
    Experience shows that inflation fears are highly sensitive 
to strong policy actions, or the lack thereof, in response to 
observed inflation. It is within the Fed's power to prevent 
this cost from occurring by adjusting its policy stance 
appropriately and visibly in response to unexpected deviations 
of inflation from its target.
    The third cost is that low long-term yields may encourage 
risky behavior that threatens financial stability. Low long-
term yields are not in and of themselves risky when they 
reflect expectations of the path of the short-term interest 
rate that are guided by the Fed and are supported by its 
holdings of long-term securities. Moreover, by boosting the 
economic recovery, increasing corporate profits, and decreasing 
the rate of bankruptcies, unconventional monetary policy 
reduces risks to the financial sector.
    As Chairman Bernanke said last month, the current low level 
of interest rates reflects weakness in the economy. The sooner 
we can return to full employment, the sooner we will return to 
normal levels of interest rates. Premature tightening will only 
delay this return.
    Indeed, in my view, if the Fed had been more aggressive in 
easing earlier, we might already have returned to normal rates 
of interest.
    The fourth and final cost I will mention is the possibility 
that the Fed could incur financial losses on its enlarged 
balance sheet. This so-called ``cost'' is a complete red 
herring.
    Since 2009, the Fed has passed the Treasury record profits 
on unconventional monetary policy and it is likely to continue 
to do so for a least a few more years. Any losses in the more 
distant future must be considered in tandem with the previous 
windfall profits. In addition, Treasury has benefited from 
higher tax revenues and from issuing debt at lower interest 
rates.
    On balance, there is no doubt that unconventional monetary 
policy lowers the long-term burden of our national debt.
    Thank you. This concludes my prepared remarks.
    [The prepared statement of Dr. Gagnon can be found on page 
44 of the appendix.]
    Chairman Campbell. Thank you, Dr. Gagnon.
    I will now recognize myself for 5 minutes to ask questions.
    My first question is for the three of you who are not fond 
of the current monetary policy: Last week, amongst the things 
that Chairman Bernanke said was, ``monetary policy must remain 
accommodative if it is to support the recovery and reduce 
disinflationary risks.'' Clearly, the specter of a Japan-type 
scenario is hovering over the Fed currently, and wanting to 
avoid deflation. For the three of you, do any of you see that 
as a legitimate reason to keep monetary policy accommodative, 
as it is?
    Mr. Malpass. No.
    Mr. Taylor. No.
    Chairman Campbell. Dr. Meltzer?
    Mr. Meltzer. No.
    Chairman Campbell. No. One word. Would anyone like to 
elaborate on why the answer is no?
    Mr. Meltzer. Yes. I think the evidence goes in the opposite 
direction. Since summer of this year--this last year--expected 
inflation, measured by the gap between nominal and real yields, 
which is not precise but at least indicative, has increased by 
about 50 basis points--that is a half a percentage point. It 
seems to be headed up, not down, indicating that the market is 
beginning to believe that inflation is a problem. And that is 
exacerbated by the uncertainty about when the Fed will get off 
its current policy.
    There is a good deal of resistance to the policy within the 
Federal Reserve. Many of them have spoken out about it. One has 
dissented from it. So there is a growing internal opposition to 
the policy for many of the reasons that we have all elaborated 
here.
    Chairman Campbell. Mr. Malpass?
    Mr. Malpass. I am concerned that as the Fed is setting 
artificial interest rates, it causes the rest of the 
government, and in particular, the fiscal policy and regulatory 
policy, not to take the burden. The Fed is taking too much of 
the burden.
    If there is a disinflationary risk, then a response to that 
would be to create productive growth. Tax reform, for example, 
would be a very important policy to stop a Japan-type loss 
decade.
    Chairman Campbell. Okay.
    Dr. Taylor?
    Mr. Taylor. I just don't see risk of deflation at all right 
now. I would add, though, that it is frequently mentioned by 
monetary policymakers as a reason, if you like, for excessively 
accommodative policies. And in particular, in the 2003, 2004, 
and 2005 period I mentioned, where I think rates were too low, 
given what has happened, and one of the reasons frequently 
mentioned at that time was concerns about deflation.
    It is a very common thing that is said. I think it should 
be looked at with some skepticism. Of course, it can occur; it 
is not like it doesn't ever occur. But it seems to me it is not 
an issue right now.
    Chairman Campbell. Let me also ask the three of you--Mr. 
Malpass, you mentioned at the end of your remarks that instead 
of this monetary policy we should be doing tax reform, various 
fiscal matters in order to restore--continue or--or accelerate 
economic growth. But that is fiscal policy, that is not 
monetary policy.
    So now, taking fiscal policy aside and assuming for the 
moment that it is what it is, or it will be what it will be, 
and so you have only monetary policy--you are at the Fed now 
and so you only have that trigger to pull, what should we do? 
What would the correct monetary policy be, absent the one that 
we have now?
    Mr. Malpass. My thought is to stop digging the hole deeper. 
The Fed is taking on more and more burden and giving people 
longer-and longer-term promises of zero rates. I think those 
should be walked back, and that would allow the economy to 
begin functioning more naturally and the capital allocation 
process to resume.
    Chairman Campbell. Dr. Meltzer?
    Mr. Meltzer. I think you need a rule. I think you need a 
rule for two reasons--two major reasons. Many reasons, but two 
major reasons. One is, you need to exercise greater discipline 
over the Fed. No one, as I said in my testimony, should have 
the authority to increase its balance sheet as much as it does 
without any congressional oversight. So you need a rule that 
you can enforce on the committee on the Fed.
    The second is, you need to give--
    Chairman Campbell. Something like the Taylor Rule, perhaps?
    Mr. Meltzer. You need to give--the Taylor Rule would be 
fine. No rule would be perfect. But a rule will discipline the 
Fed and it will give information to the public about the long-
range consequences of monetary policy. Too much of what they do 
is aimed at the very near term.
    Chairman Campbell. Dr. Taylor, 10 seconds?
    Mr. Taylor. I think we learned so much about what worked in 
monetary policy in the 1980s and 1990s until recently, so go 
back to that general style of policy as soon as possible.
    Chairman Campbell. Thank you.
    My time has expired, so I will recognize the ranking 
member, the gentleman from Missouri, Mr. Clay, for 5 minutes.
    Mr. Clay. Thank you, Mr. Chairman.
    Let me start with Dr. Gagnon. Tell me, critics of 
quantitative easing have argued that it is incompatible with 
the Fed's price stability mandate. However, in discussing 
quantitative easing the Fed has consistently noted that the 
program is designed to promote a stronger pace of economic 
growth and to ensure that inflation over time is at levels 
consistent with the Fed's mandate.
    To what extent has quantitative easing been effective in 
keeping inflation in the desired range of 2 to 2.5 percent, and 
is there any evidence whatsoever that the dual mandate creates 
a perverse inflation merit base?
    Mr. Gagnon. Thank you. I think the dual mandate is in some 
sense unavoidable. If you look around the world, whether 
central banks have a dual mandate or not, they almost uniformly 
act as if they do.
    So in the interest of transparency, I think we should keep 
a dual mandate. We can't pretend that monetary policy doesn't 
affect both inflation and the real economy, employment and 
activity, so why not be open about it?
    I think the Fed's--we did see a decline in inflation in the 
early years after the recession, and the Fed's easy policy, I 
believe, has been helpful in preventing that from going lower. 
One thing we have learned, though, out of this is that it is 
very hard to make prices fall.
    Deflation doesn't come easy. We see that in Japan. And so I 
don't fear deflation right now. But we would have come closer 
to it if we had not had this easy policy.
    Mr. Clay. According to Dr. Taylor, the Fed's current 
monetary policies perversely decrease aggregate demand and 
increase unemployment while they repress the classic signaling 
and incentive effects of the price system. Do you agree that 
current monetary policies increase unemployment?
    Mr. Gagnon. No, I do not. I think a good analogy for where 
the economy is right now, we often hear the story that monetary 
policy is like driving a car, only with no windshield and only 
a rearview mirror. You can just see a little bit of where you 
have just been, so you don't know what is going on.
    I think we have hit a hill that may be steeper than any of 
us have seen in our lifetimes and we didn't know it. When you 
hit a hill when you are driving, you step on the accelerator, 
and you hope that you will go faster. But if you are starting 
up a steep hill, you might go slower.
    Then the question becomes, what is wrong? Some people think 
that perhaps the car is broken down, perhaps the brake pedal 
and the accelerator have mixed up. Maybe if we press on the 
brake, we will go faster.
    I don't think so. I think if we press harder on the 
accelerator, we will go faster; we are just facing a very steep 
hill.
    Mr. Clay. Anyone can take a stab at this one. What is the 
tipping point? What tips us that inflation is about to kick in?
    And I will start with you, Dr. Gagnon. What are good 
indicators?
    Mr. Gagnon. I think you would see--if you see broad and--
measures of prices, sort of--not just a few extreme ones, like 
commodities, but broad measures, and especially in the labor 
market, if you start seeing large pay increases that were well 
ahead of productivity, that would be an early indicator that 
maybe this is becoming a problem. I don't see any evidence of 
that.
    Mr. Meltzer. May I answer that?
    Mr. Clay. Each one of you can. I am trying to get to 
everybody. Go ahead.
    Mr. Meltzer. Asset prices start to rise, money starts--
people start to get out of money and bonds and shift into asset 
prices. Farmland prices start to rise. All the things that we 
see happening now are happening. The Fed missed that completely 
in the run up to the 2007-2008 fiasco because they don't pay 
much attention to asset prices, but they should.
    Mr. Clay. But does that include housing prices, too? They 
are starting to rise. Is that a signal of a recovering housing 
market or inflation coming?
    Mr. Meltzer. Part of that is people buying houses on 
speculation. That is a sign that they expect prices of houses 
to rise. When prices of houses rise, don't you think rents are 
going to rise?
    Mr. Clay. That is not what the housing market is indicating 
to us now, is that this is the spring--spring is coming and 
people are starting to buy houses.
    Chairman Campbell. The gentleman's time has expired, so 
maybe someone else can follow up with that.
    The gentleman from Michigan, the vice chairman of the 
subcommittee, Mr. Huizenga, is recognized for 5 minutes.
    Mr. Huizenga. Thank you, Mr. Chairman.
    I appreciate you all being here today, and I'm sorry I had 
to step out for a quick radio call-in.
    But, Mr. Malpass, you hit on something that I exactly used 
those words, artificially low rates, and it seems to me--and I 
don't want to put words in your mouth; I want a few of you to 
address this--but you are saying that these artificially low 
interest rates have not spurned economic activity as was hoped, 
correct?
    Mr. Malpass. That is right.
    Mr. Huizenga. Okay. So what you are saying is if I am going 
to go buy a house, maybe the make it and break it isn't whether 
it is a 3.75 percent interest rate on my 30-year mortgage 
versus a 4 percent 30-year mortgage, or maybe, like my family's 
circumstance, we own a construction company in Michigan. You 
may have noticed that it has been a bit soft in the last few 
years.
    I have a 12-year-old loader that I need to replace. It 
doesn't matter what the interest rate is because banks and, 
frankly, their regulators, are coming in saying, ``We don't 
want construction equipment on your books.'' So who is going to 
give me that loan, because I haven't had a whole lot of time 
here to ramp up my savings to try to get enough cash together 
to go purchase that?
    So I just wanted you to maybe talk a little bit about these 
artificially low interest rates.
    And then the other thing, this really struck me as--the 
best exit, as you were talking about, is not just spending, but 
tax as well as regulatory policies. And it seems to me that 
those tax and regulatory policies--and I tried bringing this up 
with Chairman Bernanke last week at our hearing as well--has a 
huge amount of impact. Isn't that true?
    Mr. Malpass. Yes. Thank you, sir.
    The Fed had the rates at zero for more than 4 years, and 
yet the recovery has been very subpar. The reason for that is 
because it is an artificially low rate.
    Economics is very, very clear. When you set the price of 
something too low, you end up with shortages, and that is what 
you were describing in Michigan.
    The big corporations and the government can get lots and 
lots of loans, but smaller businesses can't. That is a natural 
part of a price-fixing mechanism, which is what the Fed has 
been doing.
    What you are describing is logical, that some parts of the 
economy are feeling this asset price inflation that Dr. Meltzer 
has described, and then other parts are not feeling the growth 
at all. That is because the capital is getting channeled and 
redistributed.
    Mr. Huizenga. I can tell you, the housing prices in 
Michigan have bottomed. Raw land has bottomed. There is only 
one way to go but up, and people are literally sitting there 
saying, ``I don't know if I could buy a home for cheaper than 
what I could build a home right now.'' And, lots that used to 
go for $75,000 or $100,000 are going for $25,000, maybe 
$30,000.
    Dr. Meltzer, I do want to--on page 3 you talked a little 
bit about being in the third round of quantitative easing, and 
I thought you put it beautifully here. Why does the chairman 
claim greater benefits than costs? Mainly, he makes the 
mistakes of looking only at interest rates, never mentioning 
what happens to growth of credit and money.
    I am not a Ph.D. economist like you all, all right? But I 
did take a few economics classes, and I recall one of my first 
economics classes discussed the law of diminishing returns. It 
seems to me that is exactly what we are talking about right 
here and what we are going after. ``Well, if maybe we just 
lower it a little bit more then we will get this greater cost, 
or maybe if we spend or stimulate the economy by spending twice 
as much we will get double the amount of activity.''
    Could you address that a little bit?
    Mr. Meltzer. Yes. The only time--I have written the Fed's 
history, so I read most of their minutes from the 1920s to the 
1980s. There is hardly ever a time when they say the following: 
``If we do this today, where will we be a year, or 2 years from 
now?'' That is a question because we know that monetary policy 
doesn't work quickly.
    The one time that they actually discussed the policy that 
would relate to your question was at the end of the Volcker 
disinflation. They had very high real interest rates. Real 
interest rates during that whole expansion were 5 to 7 percent 
after allowing for inflation, and money growth was very high.
    And they discussed the question, which one of these things 
will dominate? Will we have a slow recovery because of the high 
real interest rate or a fast recovery because of the fast money 
growth and the fast growth of credit?
    The answer is pretty obvious now, in hindsight. In 1983, 
the economy grew at gangbuster rates despite the high real 
interest rates.
    That is, the interest rate matters, but so does the money 
and credit growth. And we are not getting the money and credit 
growth because most of the reserves that the Fed are creating 
are going to finance the government's deficit and sitting in 
excess reserves.
    Chairman Campbell. The gentleman's time has expired.
    And you should know, Mr. Huizenga, that Dr. Meltzer and I 
both have economics degrees from UCLA. Now, his happens to be a 
master's and a Ph.D., and mine is a bachelor's, but I think 
that is an insignificant distinction.
    Mr. Huizenga. I didn't want to point out anything beyond 
that, Mr. Chairman--
    Chairman Campbell. Oh, yes. Okay. I just thought that was 
an interesting point--
    Mr. Huizenga. I will note that he is on that side of the 
table, though.
    Chairman Campbell. So no, we are basically the same. Yes, 
okay.
    And now, I recognize the gentlelady from Wisconsin, Ms. 
Moore, for 5 minutes.
    Ms. Moore. Thank you so much, Mr. Chairman.
    And I want to thank the witnesses for appearing.
    It is hard to dispute the expertise of this panel with 
respect to the Fed policy sort of forcing the investor to chase 
the highest yield, and that might have a negative impact on 
bonds and so forth. But in an effort just to defend the Chair a 
little bit, he is trying to create some kind of economic 
activity by lowering the interest rates, maybe trying to 
increase some risk-taking so that there is some economic 
activity.
    I will start with Dr. Gagnon. With those stipulations, 
Chairman Bernanke also said that he thought a more direct way 
of helping our economy is to deal with people who don't have a 
lot of bonds--maybe those mothers who need Women, Infant, and 
Children programs, or those seniors who need low-income heating 
assistance, or senior meals, that if we were to stop the 
sequesters and this cut--cutting--being concerned about the 
debt on a short-term basis instead of a more long-term 
strategy, that might be more stimulative to the economy than 
just continuing to do the quantitative easing.
    But to the extent that we keep cutting and cutting and 
cutting, the Fed is doing the only thing that it can do.
    Mr. Gagnon, would you respond to that?
    Mr. Gagnon. Yes, certainly. And I think Chairman Bernanke 
himself even would support what you just said. I think this is 
not a good time for further cuts right now. We had a big--we 
had a tax increase this year. That is, in my view, more than 
enough for 1 year.
    We don't need any further spending cuts this year. I would 
stretch them out in the out years. It is certainly holding back 
growth in the economy.
    Ms. Moore. Okay.
    Dr. Taylor, I wanted to ask you about your economic models 
that produced the connection between interest rates and the 
housing boom, and I was wondering if you had any models that 
demonstrate that the Fed's QE could just briefly in 20 seconds 
just sort of outline the models that you have that the Fed 
policy is hurting the economy.
    Mr. Taylor. The study of quantitative easing that I did was 
right after it began in 2009. It focused on the mortgage-backed 
securities purchases. I looked at the--tried to control for 
other things that affect risk and found that did not reduce the 
mortgage interest rates.
    That was my main, own research, so it is quite 
contradictory to what Mr. Gagnon has stated. That model is 
well-documented and published.
    The other model used to show that the rates were too low in 
2003, 2004, and 2005 was a different model that was simulated, 
and I think that has been proven to be pretty accurate.
    Ms. Moore. Okay. Thank you, Dr. Taylor.
    I guess the question I would like to ask the other two 
gentleman in my remaining time is, with respect to, again, the 
sequestration and our worry that we are going to have interest 
rates which are too low, don't you think it would be very 
harmful to the economy to just immediately raise interest 
rates? Aren't we concerned about inflation with respect to the 
Fed suddenly pulling back from these low interest rates?
    Dr. Meltzer?
    Mr. Meltzer. Yes. I don't think that we want to go through 
a draconian policy of suddenly raising the interest rate a lot. 
We want to get on a path toward a long-term, stable policy. We 
have to send people a message--
    Ms. Moore. Do you think that stopping dramatic cuts and 
taking huge sums of money out of the economy immediately is 
part of that?
    Mr. Meltzer. The money isn't going into the economy. Most 
of it is going into bank--
    Ms. Moore. I am talking about with respect to consumer 
spending, like the sequester.
    Mr. Meltzer. There isn't much financing of consumer 
spending coming out of the QEs.
    Ms. Moore. I understand that.
    Mr. Meltzer. I don't question--let me just say, I do not 
question Chairman Bernanke's intentions. I question his 
results. His results are not nearly consistent with his stated 
intentions.
    We are not getting growth of money and credit at a very 
rapid rate that would stimulate consumption or investment. And 
we are not getting a great deal of investment. We need 
investment for growth. We need a long-term policy. We are not 
getting that.
    Chairman Campbell. The gentlelady's time has expired.
    But I must say, Ms. Moore, when--at one point there where 
you said you wanted to defend the Chair, for a brief instant I 
thought you were defending me rather than--
    Ms. Moore. Oh, I always defend you.
    Chairman Campbell. Oh, okay. All right, rather than 
Chairman Bernanke. But then you went on about Chairman 
Bernanke, so I am a little hurt. But I will get over it. I will 
get over it.
    Now, I would like to recognize for 5 minutes the gentleman 
from South Carolina, Mr. Mulvaney.
    Mr. Mulvaney. Thank you, Mr. Chairman.
    Dr. Gagnon, I would like to start with you. You mentioned 
in your written testimony a couple of the costs of 
unconventional policy. I guess I could ask questions about each 
one, but I will go through them very quickly because I want to 
talk about the last one more specifically.
    The first one, you say that the risk is that the Federal 
Reserve would become the dominant buyer and holder of long-term 
Treasuries. I think the Treasury bought about 77 percent of all 
the debt last year. I wonder what more it would take for them 
to become the dominant buyer. But again, that is not my 
question.
    The second risk you discuss is that the public might 
believe it will be difficult for the Federal Reserve to tighten 
policy, thus leading to worry of inflation. I would suggest to 
you that some members of the Federal Reserve Board, sir, are 
doing exactly the opposite, which is that I think late last 
year the head of the Minneapolis Fed said that he would be 
willing to go above the 2 percent range to 2.5 percent. San 
Francisco Fed said they would go to 2.5 percent. And the head 
of the Chicago Fed said he would like to go to 3 percent on 
inflation. So I would suggest to you that those risks are real 
and that certain members of the Federal Reserve are doing the 
exact opposite of what you would suggest.
    Third, you talk about encouraging risky behavior. The long-
term yields being at a low rate for a long period of time would 
encourage risky behavior. And I was stunned here a little bit 
ago to see you go into the effects of systemically important 
institutions and how risk managers could handle this.
    But I think Dr. Meltzer made the excellent point that I am 
not really concerned about the important financial institutions 
as much as I am about the individuals. And it is the retirees 
and the folks living on fixed incomes who are really the ones 
we are encouraging to engage in risky behavior. And as Dr. 
Meltzer correctly pointed out, I think that ends in no good.
    But again, with 5 minutes, I only get one question to ask.
    So I want to talk about the last one which you talk about, 
which you describe as a red herring, which is the losses that 
the financial, that the Federal Reserve could incur on its 
enlarged balance sheet. And you go on to say that the Federal 
Reserve is--the term, I guess, is remittance--giving a lot of 
money back to the Treasury.
    Elsewhere in your testimony, you said you thought that the 
current interventions policies probably depress interest rates 
by about 1 percent. I ran the math on that in the back of my 
head and on the tablet in front of me, and that tells me that 
if the Federal Reserve gets out of this business tomorrow, 
interest rates on a 10-year would go up by 1 percent. If I 
translate that into a capital loss on the balance sheet of the 
Federal Reserve, which is roughly $3 trillion--I know it is not 
all in 10 years but it makes the math easier--roughly you are 
talking about a 10 percent loss, $300 billion worth of capital 
loss in an instant, which, I would suggest to you, exceeds the 
total remittances that the Federal Reserve has given to the 
Treasury since 2009.
    They gave $90 billion, roughly, last year, according to 
Chairman Bernanke's testimony last week. They have given about 
$290 billion since 2009. That doesn't include the losses that 
they would incur on paying additional interest on the reserves 
they hold from the financial institutions.
    So I want you to tell me why this is a red herring. A 1 
percent increase in interest rates would lead to several 
hundreds of billions of dollars of capital losses and operating 
losses, perhaps, at the Federal Reserve. So tell me why that is 
a red herring.
    Mr. Gagnon. Sure. The Federal Reserve has already given 
extra profits, above normal profits, that are almost equal to 
the costs of $300 billion that you mentioned, and in the next 
couple of years, it will have done so. So you will be 
subtracting $300 billion from excess profits that exceeded $300 
billion--
    Mr. Mulvaney. But that is only 1 percent. Let's think about 
what happens if we go back at the historical average of 5.5 
percent. That is 450 basis points, or 400 basis points over 
where we are now.
    Mr. Gagnon. It is possible there could be larger losses 
than $300 billion, that is correct. But again, profits will be 
quite a bit higher than that going in.
    Also, what you are not including is the gains to the 
Treasury. The Treasury will have issued long-term Treasury 
bonds yielding much less, and those gains are locked in 
forever, or for the life of the bond, 10 to 30 years. That is 
money the Treasury would have had to pay in interest it will 
not, and that is hundreds of billions, too.
    And on top of that, by getting the economy growing faster, 
and more spending, and a bit more inflation than otherwise, tax 
revenues will be higher. And that is paying down the debt, too.
    So it all adds up. If you add all the pieces together, 
there is no way it does not lower the burden of our debt.
    Mr. Mulvaney. So several hundred billion dollars, 
potentially a trillion dollars of capital losses, an additional 
billions of dollars in operating losses is something we 
shouldn't be concerned with because it will be, what, made up 
someplace else?
    Mr. Gagnon. Exactly.
    Mr. Mulvaney. Thank you, Dr. Gagnon.
    Chairman Campbell. The gentleman yields back.
    Mr. Foster of Illinois is recognized for 5 minutes.
    Mr. Foster. Thank you, Mr. Chairman.
    In Dr. Taylor's testimony, he emphasized the role of 
monetary policy in the early 2000s as a real driver of the 
housing bubble, presumably. But there are really three legs of 
policy. There is monetary, fiscal, and regulatory policy.
    And I was wondering how you would apportion the credit or 
blame for the financial collapse or the bubble that led to the 
financial collapse between those three legs of policy. What 
fraction of it was due to each?
    Mr. Taylor. I think the regulatory policy is maybe 
equivalent and equal to the monetary policy measures. It is 
very hard to quantify, to be sure.
    But there you had, I think, a situation where certain 
entities who should have been not taking the risks they took, 
took the risks, and they were overlooked by regulators. Fannie 
Mae and Freddie Mac are an example, but in addition, a lot of 
the large commercial banks were certainly, in retrospect, 
taking risks that the Federal Reserve should have been watching 
for--the New York Fed, in this particular case, mainly.
    So I think that is very high. It raises questions about the 
way that regulators enforced regulations, and that should be 
examined. It is not that you need more regulations; just means 
the ones on the book need to be taken seriously.
    So I would put that up there along with the monetary 
policy. It is actually part of monetary policy.
    Mr. Foster. So for example, the Fed's apparent refusal to 
enforce mortgage origination standards nationwide, which was, I 
think, given to them in 1994, sometime in there, and then 
despite repeated urging, then-Chairman Greenspan decided not to 
enforce that. You view that as a significant driver of the 
housing bubble?
    Mr. Taylor. I would focus more on the risks that the banks 
were taking and holding as securities.
    Mr. Foster. And then the other--the third leg of the triad 
is fiscal policy, where, of course, during the Republican years 
it went from basically a surplus to a trillion dollar 
structural deficit by the time President Bush left office. How 
would you mix that in, in terms of--
    Mr. Taylor. By 2007, the Federal deficit was a little over 
1 percent of GDP, and Federal spending had increased to 19.7 
percent of GDP. And remember, in the year 2000, Federal 
spending was only--
    Mr. Foster. But by 2008, when the bubble popped, there was 
a huge structural deficit because of all the costs that the 
government incurs when household net worth drops by $17 
trillion.
    Mr. Taylor. I would say that in the year 2007, before--
    Mr. Foster. During the peak of the bubble. Right.
    Mr. Taylor. --near the end of that year, during that year 
you could argue we were close to full employment and the 
deficit was a little over 1 percent of GDP, so that would be 
one measure, maybe somewhat larger than one measure of the 
structural deficit. But I think it is hard for me to see why 
that is the cause of the crisis, because--obviously, we would 
like to have a smaller deficit, but you can see that 1 percent 
is--hard to see why that would drive things.
    Mr. Foster. I would like to talk quickly about the rules-
based--Dr. Meltzer has emphasized the need for rules-based 
things, and particularly when you look at the housing bubble, 
which I view as the main driver--that along with the buildup of 
leverage in the financial system. There have been, at the 
American Enterprise Institute, as Dr. Meltzer may be aware, a 
panel of discussions and there will be a workshop this summer 
on countercyclical loan-to-value requirements for real estate, 
which other countries very successfully use to fight bubbles. 
Israel, for example, and other countries have squelched housing 
bubbles by turning up the downpayment requirement at times when 
they see bubbles developing.
    There are rules-based approaches to this, the simplest 
being, for example, just a requirement that federally-backed 
mortgages cannot exceed the value the property had 3 years ago, 
being one simple example of one. And I was wondering if you 
could comment, maybe starting with Dr. Meltzer, on the 
feasibility and desirability of having countercyclical elements 
in the real estate market, and particularly ones that might 
protect for the federally-backed section of the real estate 
market, ones that might protect the taxpayer from the sort of 
damage they have seen in the collapse of the bubble.
    Mr. Meltzer. Most countries have housing policies--housing 
without having as many subsidies as we have, and one of the 
problems--you mentioned regulatory policy. Regulatory policy 
was really a big factor in this crisis.
    You had a system in which people like Angelo Mozilo, a 
well-known name, could make tens of millions of dollars by just 
shoveling bad mortgages onto Fannie Mae and the regulators did 
nothing about that except to encourage it. That is a terrible 
problem with regulation. Regulation gets captured, it gets 
circumvented, it breeds crony capitalism.
    I am convinced that the only regulations which are really 
effective are regulations which change the incentives of the 
people you regulate. You want them to want what you want. You 
don't want to give them rules which tell them, ``Be good,'' 
because they will circumvent them and ignore them.
    Chairman Campbell. The gentleman's time has expired.
    And without objection--we have three more questioners here 
in this round--we will have a second round of questioning, but 
I will now move to the gentleman from North Carolina, Mr. 
Pittenger, and he is recognized for 5 minutes.
    Mr. Pittenger. Thank you, Mr. Chairman.
    Thank you, gentlemen, for your assistance to this committee 
and your service to our country.
    I would like to Dr Meltzer, the central planning model that 
this Administration has pursued, albeit through the Fed's 
expansionary monetary policy, has clearly not achieved their 
desired objectives, trying to find 6 percent unemployment and 4 
percent economic growth. But more importantly, of concern to me 
is the unprecedented legal authority that has been advanced by 
the Fed.
    In light of that, we recognize that the Fed is an 
independent central bank. However, are there any reforms you 
think that Congress should consider as it pursues its 
relationship with the Fed and trying to improve the 
accountability of the Fed?
    Mr. Meltzer. Yes. Absolutely.
    I believe the Congress has an obligation, in order to 
fulfill its requirement under the Constitution, to adopt a rule 
which restricts what the Federal Reserve can do without your 
permission. I think the Taylor Rule is an acceptable rule. A 
price stability rule would be a fine rule.
    No rule will be perfect under all circumstances, so the 
rule has to say something about what you do when you don't 
think it is appropriate.
    Years ago, I made a proposal to the Reserve Bank of New 
Zealand. I said, adopt a target. If you hit the target, fine. 
If you don't hit the target, you send two messages. One says, 
``Here is our resignation; we failed. And here is our 
explanation of why we failed.'' And the authorities have a 
right to choose among those explanations because there are 
legitimate reasons why you may miss.
    Now, 20 countries have adopted something which improves on 
that rule by adding price stability. The United States has not.
    It is time that we adopt a rule for monetary policy to 
assure yourself that you can say to the Federal Reserve when 
they appear here, ``Look, you told us that in this year, 2 
years from when you made--no, 3 years from when you made the 
forecast, that we would have this outflow, and this inflation, 
and you haven't done it. Explain to us why you haven't done 
it.'' That puts the Congress back into the game where it 
belongs.
    Mr. Pittenger. Thank you.
    Mr. Malpass, Chairman Bernanke testified before us last 
week that there are not any asset bubbles forming as a result 
of his exceptionally accommodating monetary policy. Does this 
coincide with what you and your clients are seeing in asset 
markets today?
    Mr. Malpass. Thank you, sir. Today, the stock market hit a 
new all-time high, so there is a levitation going on in equity 
prices. We have also seen high-yield markets levitate. The 
yields fall, the price goes up, and the Fed has been explicit 
in its policy in stating that it is trying to cause asset 
prices to go up.
    My concern is that tends to be a narrow set of financial 
assets and not connected to job growth and small business 
growth that would be more desirable in the economy as a whole. 
Dr. Meltzer mentioned farmland, and the Federal Reserve Board 
itself has talked about asset price bubbles in farmland and 
also in the high-yield market. A recent statement by a Fed 
official talked about it being a tip of the iceberg in terms of 
what banks are now holding on their balance sheet in terms of 
appreciated assets.
    May I come back to your previous point very briefly?
    Mr. Pittenger. Sure.
    Mr. Malpass. Sir, there is also the question of whether you 
want to leave the Fed with unrestricted asset-buying authority, 
which is the implication of the current policy of the Fed. 
Apart from our current crisis, 20 years from now I am worried 
that the markets and the economy will look to the Fed to keep 
buying things and they will expand their desire for the Fed to 
buy municipal bonds, or other assets. I am worried about that 
open-ended authority.
    Mr. Pittenger. Slippery slope. Never ends. Thank you very 
much.
    Chairman Campbell. The gentleman's time has expired.
    The gentleman from Delaware, Mr. Carney, is now recognized 
for 5 minutes.
    Mr. Carney. Thank you very much, Mr. Chairman.
    And I thank the panelists for being here.
    Dr. Taylor, it is good to see you again. We met out in 
California in your office.
    Very interesting, if not a little esoteric, conversation 
today for me. I am a first-time member of this subcommittee, 
certainly no expert. I don't have the kind of economics 
training that you all do, so I appreciate your expertise.
    I have just a few questions, if I may. One is about the 
dual mandate of Humphrey-Hawkins--price stability and full 
employment. Do each of you think that is an appropriate mandate 
for the Fed, and if not, I think you have had--we have had some 
discussion about maybe how it would be different.
    But why don't we start with Mr. Malpass?
    Mr. Malpass. If I may defer to Dr. Meltzer or Dr. Taylor--
    Mr. Carney. Sure. Please do.
    Mr. Meltzer. I find it acceptable because it is politically 
desirable, and it is important that what we do is acceptable to 
the public. I would prefer a price stability target, because 
that is what the Fed is really capable of doing. It is capable 
of enforcing price stability, and that is a very desirable 
thing.
    As Paul Volcker testified many, many times before this 
committee and elsewhere, the way to get low unemployment is to 
get low expected inflation.
    Mr. Carney. Is it your view that has become maybe the 
primary focus of the Fed, in terms of price--
    Mr. Meltzer. One of the things I object to in the way the 
Fed operates is it concentrates on one of the goals in the dual 
mandate until the other one gets out of line and then it 
concentrates on that. That puts additional variability into the 
economy.
    Professor Taylor has measured variability several times. 
Chairman Bernanke, before he was a policymaker, when he was an 
academic, measured variability. We could reduce the variability 
in the economy, and that would be good, if we didn't shift from 
looking at--worrying about unemployment until inflation rises, 
and then worrying about inflation and raise the unemployment, 
and worrying about unemployment and so--
    Mr. Carney. Dr. Taylor, do you have--my time is ticking--
    Mr. Meltzer. That is a bad bicycle to ride.
    Mr. Taylor. Just briefly, I am concerned about the way the 
dual mandate is being used. For most of Paul Volcker's term, he 
focused on price stability as the way to get unemployment down, 
and it did come down with that.
    Recently, the dual mandate is already put forward as a 
reason to intervene, a reason for the quantitative easing. We 
heard much more about it recently.
    I think the reality is when the Fed focuses too much on 
that goal, it gets worse. If you think of the 1970s, they 
focused on unemployment, and unemployment became high. In my 
view, one of the reasons unemployment is high now is because 
they focused on that too much in 2003, 2004, and 2005.
    Mr. Carney. Dr. Meltzer, and I think Mr. Malpass, both said 
that you thought that the focus on monetary policy alone has 
taken the focus off fiscal policy. What would be more 
appropriate? Do you think the fiscal policy we have now is the 
right one, and what would be more appropriate, if not?
    Mr. Malpass. The issue is whether monetary policy is going 
to carry the burden of stimulus.
    Mr. Carney. You said it shouldn't, and so what--
    Mr. Malpass. The Fed has taken on too much of that burden.
    Mr. Carney. So what should we be doing on the fiscal side 
for stimulus?
    Mr. Malpass. There should be corporate tax reform. There 
should be a streamlining and simplification of the individual 
tax system, which is very cumbersome, and costly to the 
economy.
    And on the regulatory policy side, we have an array of very 
costly Federal regulations that are burdensome.
    Mr. Carney. Sorry for interrupting, but my time is 
expiring.
    Dr. Meltzer or Dr. Taylor, on fiscal policy?
    Mr. Meltzer. Fiscal policy--I agree with exactly what he 
said. And I think I want to emphasize what he said at the end. 
Regulatory policy, particularly at the present time, makes 
businessmen think that the Administration is hostile. I don't 
know whether the Administration is hostile or not, but they 
think it is hostile. That deters investment and creates 
uncertainty.
    Mr. Carney. What about the idea of automatic spending cuts 
that are taking effect right now as part of that fiscal policy 
equation?
    Dr. Taylor?
    Mr. Taylor. The Congress has laid out a strategy to reduce 
spending gradually over time. I think moving back off of that 
would be a mistake. It would reduce the credibility of the 
government, so stick to the path that has been agreed to, try 
to deal with the sequester itself by giving flexibility to--
    Mr. Carney. The problem was that it wasn't quite an agreed-
to strategy. It was the fallback plan, if you will.
    But thank you very much, each of you, for coming today and 
for your advice.
    Chairman Campbell. The gentleman's time has expired.
    And now the gentleman from New York, Mr. Grimm, is 
recognized for 5 minutes.
    Mr. Grimm. Thank you, Mr. Chairman.
    I will start off with Mr. Malpass.
    Mr. Malpass, you mentioned before and in your testimony 
that the policies favor a select group, which would be the 
government, but not new businesses, small businesses, et 
cetera. Can you expand on that a little bit? Just because the 
average person out there would say, doesn't a small and new 
business benefit from having very low interest rates? So can 
you just explain that a little bit?
    Mr. Malpass. Thank you, Mr. Grimm.
    The National Bureau for Economic Research has a study out 
this morning talking about how banks are actually responding to 
the current interest rate policy. It explains a little bit of 
what Mr. Huizenga was saying he felt in Michigan, that small 
businesses are having trouble getting credit, whereas larger 
businesses and, of course, the government are having an easy 
time getting credit.
    My explanation in the testimony is that this is normal 
economic behavior when you fix the price of something. For 
example, if the government said that gasoline prices should be 
lower and then put a ceiling of $1.50 on a gallon of gasoline, 
what would happen? People who were privileged would get the 
gasoline. Businesses that were wasteful of gasoline would use 
too much. And that is basically going on.
    The Fed has set the price of credit artificially low. It is 
causing people who don't need the credit--for example, the 
government or big corporations--to snarf up the credit and take 
too much.
    Mr. Grimm. I am sorry, because I have limited time. So 
basically what you are saying is, it sounds great in theory 
that new businesses and small businesses will also have low, 
low interest rates, but the truth is, they don't get access to 
the credit--to take--to get the benefits of those low interest 
rates.
    Mr. Malpass. That is exactly right.
    Mr. Grimm. Great. Thank you.
    Mr. Meltzer, can you also expand for just 1 minute on why 
bankers applaud the current policy? And my question is, is it 
similar almost to an arbitrage, where it is a riskless 
transaction? I am going to borrow lower, then I know I can give 
it back to the government at higher, so there is really no 
risk. And if that is the case, if that is accurate, then does 
this limit--it goes back to what we just said--the appetite or 
the desire for a bank to lend to who they are supposed to be 
lending to, which is these businesses that desperately need it?
    Mr. Meltzer. Yes. To amplify that, in addition to the 
interest rate, there is the risk. The bank looks at the risk 
and it says, ``These new startups are a heck of a lot riskier 
than lending to the government. So I can make a good profit by 
borrowing from the Fed at a quarter of a percent or less and 
lending on government bonds at 1 percent or 2 percent, and why 
not do that and make a huge profit,'' which is what they are 
doing.
    That isn't in the public interest and that isn't getting us 
toward the goal that we all agree on, which is good growth, a 
stable economy, and low inflation.
    Mr. Grimm. Dr. Gagnon, you had mentioned before, and I know 
it was touched upon when my colleague went into this, but I am 
still not satisfied, so I would like to just talk about it for 
the last minute. My understanding is that the Fed is buying up 
longer-term instruments to push--put pressure on mortgage rates 
and the longer-term instruments that have interest rates as--to 
go down, as well. But they don't have any T-bills at all in 
their balance sheet.
    If they don't have short-term instruments and interest 
rates do start to rise, the Fed has said that to avoid capital 
losses, they will hold them to maturity. But if they hold them 
to maturity then they don't have anything to sell to actually 
affect the interest rates or the potential for a run on the 
bond market. So isn't that dangerous?
    Mr. Gagnon. No, because they have unlimited ability to repo 
them out to the market at short term--
    Mr. Grimm. I am sorry, say--say that one more time--
    Mr. Gagnon. They can lend them to the market at short 
terms, so it is as if they sold short term--borrowed short term 
from the market. They can borrow short term from the market 
using them as securities--long-term bonds as securities, so 
they can regulate short-term interest rates that way.
    And the key thing will be that they need to set interest 
rates where they need to be for the economy, and they have the 
tools to do that. They can print money; they can repo out 
securities; and they can choose whether or not they want to 
sell those bonds in their portfolio. I would urge them never to 
sell them.
    Chairman Campbell. The gentleman's time has expired.
    The gentleman from Florida, Mr. Murphy, is recognized for 5 
minutes.
    Mr. Murphy. Thank you, Mr. Chairman.
    And thank you all for being here today. We appreciate your 
time.
    Similar to many Members of Congress, I came here to talk 
about real solutions and what we can do to address the 
problems. I have been working very closely with the gentleman 
from North Carolina, who is stepping out, on focusing on a 
grand bargain, and I think that is perhaps one of the single 
biggest things we can do in our country to get our country on 
the correct fiscal path and then get out of the way.
    In this hearing we have talked about unconventional 
monetary policy. What would it mean for unconventional monetary 
policy if Congress were to really do its job and get this grand 
bargain--in perhaps a perfect world, say we were to get this 
grand bargain immediately--what would that mean for monetary 
policy? And this is for all of you, starting with Dr. Gagnon.
    Mr. Gagnon. I think the Federal Reserve traditionally is 
like the second mover in this process. The Federal Reserve 
looks at what Congress and the President do with regard to 
taxes and spending and then it responds as best it can, and 
that is always the way I think it needs to be, because the 
Federal Reserve has the ability to move quicker.
    I think ideally you would like to delay spending cuts and 
tax increases until the unemployment rate had fallen further or 
inflation were a risk, neither of which is an issue now, and 
that would make the Fed's job easier, yes.
    Mr. Murphy. Dr. Taylor?
    Mr. Taylor. I think a consolidation plan for fiscal policy 
would improve monetary policymaking because it would reduce a 
lot of the uncertainty the Fed is trying to deal with. I think 
it is quite remarkable to me, a lot of the concerns I have 
about monetary policy--the unconventional, the 
unpredictability--also characterize fiscal policy. They go 
together and it hasn't always been that way. We used to have 
regular order for budgeting. We don't have that anymore so it 
is unpredictable.
    So I think the more that fiscal and monetary policy can get 
more predictable, get more sensible, like you are trying to do, 
the better off the country will be.
    Mr. Murphy. Thank you.
    Dr. Meltzer?
    Mr. Meltzer. Yes. To your efforts, I say amen and good 
luck, because I can't think of any policy operation that would 
be more important at the present time than to put us on a 
predictable path to a balanced budget achieved over a sequence 
of years.
    And what would it do for monetary policy? It would make--
hopefully encourage them, make them do the corresponding thing: 
put us on a path toward price stability over the longer term. 
And the last thing that would need to be done would be to 
improve the regulatory policy.
    But you are on a great track, and I wish you every good 
wish I can.
    Mr. Murphy. Thank you.
    Mr. Malpass?
    Mr. Malpass. I will give a caution on the fiscal policy and 
also on the monetary policy, if I may. As I have seen the grand 
bargains done in the past, the concern is the taxes go up in 
the early years and the spending reductions are put off into 
the out years. Try to make sure that there are spending 
restraints at the beginning of the process.
    I testified last week to the Senate Budget Committee and 
talked about the positive impact that has on the private 
sector. If the U.S. private sector saw the Federal Government 
in a continuous process of spending restraint rather than the 
one-off sequester that we are doing, a permanent process that 
held back the rapid growth that we keep seeing in government 
spending, it would cause a true boom. There would be job 
growth.
    With regard to the Fed, I am worried that it will have 
trouble conducting monetary policy. It is true that they can 
repo bonds, but the Fed is right now the dominant player in the 
bond market, so it makes it very difficult and distortive to 
markets if the Fed were to begin a repo operation in an effort 
to conduct monetary policy under the current conditions. I 
think it would be disruptive for markets.
    Mr. Murphy. The question I propose is under a sort of 
perfect scenario. Under the reality of this Congress and the 
current dysfunction we have, what do you recommend, Mr. 
Malpass, that Fed Chairman Bernanke do in these times?
    Mr. Malpass. I mentioned earlier to stop digging the hole 
deeper. Because the policy is not working, the Fed's response 
has been to double the policy. And that has made it work even 
less well, so the growth rate has come down.
    I would encourage the Fed to stop making promises about 
future interest rates and future bond purchases, to walk back.
    Mr. Murphy. Thank you.
    Thank you all.
    Chairman Campbell. The gentleman's time has expired.
    Without objection, Mr. Green of Texas will be recognized 
for 5 minutes.
    Mr. Green. Thank you very much, Mr. Chairman. Thank you 
especially for allowing me to be an interloper, given that I am 
not officially a part of this committee.
    I would like to thank the witnesses for appearing and to 
address Mr. Gagnon.
    Sir, you have indicated from your testimony that you 
believe that more expansionary monetary policies are necessary. 
We do know that the Fed announced on December 12th that it 
would keep buying $40 billion in mortgage-backed securities per 
month and that it would begin buying $45 billion in long-term 
Treasury securities.
    I assume that you concur with what the Fed is doing. Is 
that a fair statement?
    Mr. Gagnon. Yes.
    Mr. Green. All right. Given that you concur, will you 
elaborate on the type of monetary policies you think would 
benefit us, in terms of them being expansionary?
    Mr. Gagnon. Sure. Over 3 years ago now, I warned that the 
Fed was on a path to being too tight and urged it to do a lot 
more in terms of buying long-term assets to hold long-term 
rates to get spending up. Over the years the Fed has belatedly, 
begrudgingly moved to pretty much do what I had asked 3 years 
ago.
    At this point, I think what they could usefully do is to 
give some more assurance to the housing market that mortgage 
rates will stay low for a fixed period of time, perhaps 12 
months. That would give banks comfort that if they want to make 
a mortgage to a borrower they can sell the MBS to the Fed at a 
fixed price, say 2 percent, for 12 months.
    It would encourage banks to staff up their mortgage 
departments, to make more mortgage loans, and it would give 
house buyers that if they go into the market this year, they 
would have several months to shop for a house, and the credit 
would be there, and they wouldn't have to worry about rising 
rates. And it would really, I think, have a nice dynamic for 
the housing market. I think that is an important thing the Fed 
could do, which would be better than what they are doing.
    Mr. Green. You also mentioned other types of refis. Would 
you elaborate on some of the other refis that might stimulate 
the economy?
    Mr. Gagnon. What would really be helpful, and this is sort 
of beyond the Fed's ability, would be to really get the housing 
agencies to stop discouraging refinancing of old conforming 
mortgages. A lot of people still have 6 percent mortgages.
    Mr. Green. Just for edification purposes, when you say 
``housing agencies,'' would you be more specific? Are you 
talking about Fannie and Freddie?
    Mr. Gagnon. Yes.
    Mr. Green. And that would be under FHFA?
    Mr. Gagnon. That is correct.
    Mr. Green. And that would be Mr. DeMarco?
    Mr. Gagnon. That is correct.
    Mr. Green. Continue, please.
    Mr. Gagnon. I do not understand why FHFA has been allowed 
to not push the agencies harder. A refinance--fairly automatic 
refinance of--automatic approval of refinances of existing 
mortgages, mortgages that are already guaranteed by Fannie and 
Freddie but are paying high interest rates.
    Mr. Green. For edification, are you saying an automated 
system that would allow FHFA to ascertain which of these 
products can be refinanced and streamline a process so that we 
can sort of clear out many of the homes where persons are 
underwater and would probably walk away from, some of them--I 
don't know how many, but a good many might--but if they can 
refi they will get a reduced payment and they will stay in that 
home. Is that some of what you are saying?
    Mr. Gagnon. That is exactly what I am saying, and I think 
it would reduce the risk to the government, because if people 
can get a lower payment they are less likely to walk away from 
their mortgage. And since the government is already 
guaranteeing that mortgage, it is better to reduce the payment 
to make it less likely to fail.
    Mr. Green. This is not something that the Fed can do; this 
is obviously within FHFA's purview.
    Mr. Gagnon. That is correct.
    Mr. Green. Now, quickly, one more thing: Are you familiar 
with the term, ``expansionary fiscal contraction?''
    Mr. Gagnon. Yes.
    Mr. Green. Would you quickly explain, in your opinion, 
whether this term applies to the current economic 
circumstances?
    Mr. Gagnon. Absolutely not.
    Mr. Green. And if you would quickly, I only have 30 
seconds, but maybe you will be allowed to go over to give your 
explanation.
    Mr. Gagnon. One of the things we are learning is that the 
effect of fiscal policy on the economy depends a lot on the 
state of the economy and it depends a lot on how the Federal 
Reserve will react to fiscal policy. And so when the economy is 
booming, fiscal policy has a very big effect, because the Fed 
tends to offset it. If you cut taxes in a boom, it doesn't 
stimulate the economy any more; it just tends to raise interest 
rates.
    But if you cut taxes or raise spending in a low state of 
the economy, the Fed will not react, and it will pass through 
to spending much more strongly. So a lot of studies are coming 
out and saying that fiscal policy has a big effect on the 
economy in a recession, but it has very little effect in a 
boom.
    Mr. Green. Thank you, Mr. Chairman.
    Chairman Campbell. Thank you.
    Without objection, we will go to a second round of 
questioning now and I will first recognize the gentleman from 
South Carolina, Mr. Mulvaney, for 5 minutes.
    Mr. Mulvaney. Thank you, Mr. Chairman. I appreciate the 
second round of questions.
    Dr. Taylor, I would like to talk to you a little bit, 
because you have introduced something in your written testimony 
and talked a little bit about it briefly today that was news to 
me--a new topic. We have talked a little bit here today about 
the risks of the unconventional policy, and generally speaking, 
a lot of the debate has been focused on how maybe it is not 
working as well as it should or it is not working at all.
    But you have introduced a new concept, which is that it is 
actually making things worse. And in your written testimony on 
page 7, you talk about the relationship, you say, ``The 
perverse effect comes when the ceiling is below the--what would 
be the equilibrium between borrowers and lenders who normally 
participate in that market. While borrowers might like a near-
zero rate, there is little incentive for lenders to extend 
credit at that rate.'' And then you go on to talk about the 
fact that with lenders not supplying enough credit that the 
decline in credit availability reduces aggregate demand, which 
tends to increase unemployment, ``a classic unintended 
consequence of the policy.''
    That is the first I have heard of this. Would you mind 
exploring that a little bit with us, giving us more detail?
    Mr. Taylor. Sure. It is very similar to what my colleagues 
over here have indicated, somewhat different words, and maybe 
mine is more academic-sounding, but it is very similar.
    The idea here is if you think about monetary policy, it is 
not simply just the interest rate; it is the credit system. It 
is getting the funds from, if you like, the--intermediating 
from the lenders to the borrowers. And that credit system is 
not taken account of when you are thinking about the low 
interest rates. Of course you are going to stimulate some 
spending--investing with low interest rates, but if the credit 
doesn't come because of the very low interest rate because 
people don't want to lend at those rates, the margins are too 
small, then you will get--
    Mr. Mulvaney. And that impact is immediate, isn't it?
    Mr. Taylor. That is credit intermediation, yes.
    Mr. Mulvaney. But, for example, we are talking about 
certain risks. There is risk of inflation--that is down the 
road. There is risk of credit bubbles, or asset bubbles--that 
would be down the road.
    This depressing impact, the downward pressure on GDP that 
you are talking about, is happening right now.
    Mr. Taylor. In my view, it is. I think it is something that 
isn't emphasized enough. You are thinking about risks in the 
future but it is a present issue. I think that is why the Fed 
has been disappointed in its policies, is the policies have 
been implemented and they haven't worked--that is my 
assessment--and so they have actually had more. They have done 
more of it, and I hope that vicious circle stops.
    Mr. Mulvaney. Mr. Malpass, do you want to add something to 
that?
    Mr. Malpass. It is, sir, an immediate response because the 
market looks forward. In my work on this in 2009, I called it a 
rationing process, meaning if the Fed sets an artificial price 
for something then the market begins to ration through 
shortage, which is a very common economic phenomenon, and it is 
exactly what we have seen happen in 2010 in the credit markets 
of the United States.
    I think as the Fed set this up they didn't think about the 
deleveraging going on in the banking system. They were thinking 
that if you put in a very low interest rate, it must cause more 
credit. Yet, the regulators were causing less credit or the 
same amount. So you have a rationing or a redistribution of 
credit rather than growth.
    Mr. Mulvaney. Thank you, gentlemen.
    Mr. Malpass, I want to stay with you on another topic, 
because my colleague from New York, Mr. Grimm, asked a question 
of Dr. Gagnon regarding exit strategy, and in response to one 
of his questions Dr. Gagnon suggested that maybe the Fed could 
hold these Treasuries to maturity but enter into the repo 
market. You didn't look very satisfied with that answer.
    At the risk of asking a question I don't know the answer 
to, what were your thoughts on that, sir?
    Mr. Malpass. I am not sure I know the answer because we 
haven't done this before. The Fed has become an absolutely 
dominant player in the government bond market. In the past when 
the Fed did repo operations, they were a very small player in a 
large market. Now, they are a very large player relative to the 
market.
    There are unpredictable consequences from the idea of the 
Fed lending a bond into a smaller market.
    Mr. Mulvaney. Is it possible that the efficacy of that 
particular tool has been reduced because of the size of the 
balance sheet?
    Mr. Malpass. More than possible. It is likely that it has 
been reduced and probably wouldn't be very workable when the 
Fed gets to that point.
    The point Mr. Grimm had made was that the Fed doesn't have 
any short-term Treasury bills. Dr. Meltzer is a world expert on 
Fed history. In the past, the Fed never used any other 
instrument than short-term Treasury bills and repos in a robust 
government bond market. We are in unexplored territory.
    Mr. Mulvaney. Thank you, gentlemen.
    Thank you, Mr. Chairman.
    Chairman Campbell. Thank you.
    The gentleman from Illinois, Mr. Foster, is recognized for 
5 minutes.
    Mr. Foster. Thank you, Mr. Chairman.
    I would like to return for a moment to the issue of asset 
price--bubbles that--and I was interested in your view of the 
state of the art of macroeconomic modeling of the housing 
market, and in particular, whether various things can actually 
be understood in terms of how the housing market in other 
countries who have consciously suppressed housing bubbles and 
whether those things are accurately modeled. Can we get some 
understanding of possible policy or rules we can put in place, 
such as the one I mentioned, and how they might have worked and 
might work in the future to suppress housing bubbles in an 
automatic way. Because I personally, from a political point of 
view, am very skeptical that unless we have an automatic 
punchbowl retractor, it is going to be very difficult to hold 
back.
    Anyone may answer.
    Mr. Malpass. I will make a brief comment. The point that 
you are making is very strong, that we need to have a 
countercyclical policy. My one observation is we are actually 
going the other way. With each year the Federal Government is 
lowering the standards, making the equity requirement less and 
less for FHA.
    I think you are right in what you are suggesting and I am 
afraid we are going the other way.
    Mr. Taylor. I also think your concern about bubbles or 
excesses is well-taken. I think the experience, though, with 
monetary policy is that frequently the bubbles are coming at a 
time when policy is, if you like, overly easy. In other words, 
it is almost like the central bank is helping to cause the 
bubble rather than prevent it. And that is what I think we saw 
in 2003 and 2004.
    It is also, if you look at Europe, countries which 
experience these real bubbles, say Greece and Ireland and 
Spain, the same kind of thing. One interest rate for Europe 
didn't really handle their situation. Often, it is the monetary 
policy that is the cause, so I would address that first.
    And with respect to automatic changes in capital 
requirements, we haven't seen those work very well yet. But if 
it does, if we have something like that I agree 100 percent. It 
should be--
    Mr. Foster. They were done sort of by fiat. For example, in 
Israel, they very aggressively turned up the downpayment 
requirements for houses, and you can imagine rules that kick in 
that force--at least for the federally-backed part of the 
mortgage market, you can imagine rules that would automatically 
pull the government out of the housing market when it starts to 
heat up.
    I think that one of the things we are wrestling with is the 
phase lag between--the reason the system oscillates is that you 
are trying to regulate on lagging indicators, like 
unemployment, which is one of the most--
    Mr. Taylor. Absolutely. I couldn't agree more. You need to 
work these through with models, and lags, and uncertainty, and 
there hasn't been enough of that done, unfortunately, to say 
this is what we should do, but I encourage it.
    Mr. Foster. All right.
    And on a related thing, there are various rules that you 
can imagine, and one of them is this so-called ``targeting of 
nominal GDP,'' and it is an example of--it is one of the exit 
rules. If I remember properly, Dr. Taylor actually testified in 
2010 on possible exit rules for--which is actually, the 
transparency as we exit I think will be important in getting 
business confidence back and the predictability of the system.
    And one of those possibilities is simply to target nominal 
GDP and say it is simply the sum of inflation and GDP growth. 
Or you can obviously sort of feedback and try to regulate any 
linear combination of all the variables you can imagine, or 
some nonlinear function of them.
    I was just wondering what you thought of that as a general 
approach.
    Mr. Taylor. I think a predictable exit strategy is 
essential to lay out what the strategy would be when the time 
comes. And everyone wants to have stable nominal GDP growth. 
The question is, what should the Fed do to get that? What 
should the changes in the instruments be, the changes in the 
interest rate? And that is left open when people talk about a 
nominal GDP target so it needs to be supplemented with some 
other kind of rule, if you like, for what the Fed should do to 
get to that target.
    Mr. Foster. So the gain of the feedback loop, as it were.
    Mr. Taylor. Yes.
    Mr. Foster. Okay. I guess that is it.
    I yield back the balance of my time.
    Chairman Campbell. Okay, thank you.
    The gentleman from Indiana, Mr. Stutzman, is recognized for 
5 minutes.
    Mr. Stutzman. Thank you, Mr. Chairman, and I apologize if 
my question maybe repeats some of the questions that were asked 
earlier. I had to jump out due to another meeting, but I want 
to talk a little bit about the dual mandate, but also how the 
Fed's policies are affecting seniors, affecting Main Street, 
and what they are seeing and what they are feeling right now.
    I have several friends that I spoke to before this hearing 
and just asked them what they are seeing and where people are 
putting money, and they said other than just the old principles 
of a balanced portfolio, there is nothing really out there that 
is attracting dollars because of Fed policy, low interest 
rates.
    People are not putting money into CDs because there is not 
much return. Maybe they are getting pushed towards the stock 
market but people still are very wary of the stock market. My 
wife's grandmother, who lives on Social Security but has her 
savings, pulled everything out and is just sitting on it.
    What kind of message is that sending from the Fed to Main 
Street? People are very skeptical and especially--and Dr. 
Taylor, I guess I will ask you this question, that the Federal 
Reserve predicted that GDP would be at 4 percent growth in 
2012, but it actually just turned out to be 2 percent. Is it 
possible that the Fed's policies, whether it is dual mandate, 
it is working against American especially seniors right now, 
and especially the amount of retirees who are going into 
retirement, they are not seeing any growth in their pensions or 
their savings.
    Mr. Taylor. Absolutely. That is the distributional effect 
that we are concerned about with monetary policy. It is helping 
some and hurting others.
    I think the question about the overall effect being 
negative is based partly on that but also on the uncertainty 
that the policy is causing, which is a drag on investment. 
Remember, firms are sitting on a lot of cash, and they are 
holding back, and one reason is the uncertainty about monetary 
policy. Other policies too, but that is a big part of it.
    And so again, you might think that low interest rates are 
good, and it is easy to talk about it and you can try to 
convince people, but there is this other side of the coin with 
the policy, which is actually, I think, a drag, and makes--one 
of the reasons why growth has been slower than the Fed 
forecast.
    Mr. Stutzman. Mr. Malpass, I don't know if you would want 
to comment on that as well? And also, are we pushing more 
dollars into the stock market because there is just not the 
return on bonds, long-term or short, that could be creating a 
bubble here? We are just about to top the old record today. I 
haven't seen the numbers if we have, but I fear--
    Chairman Campbell. Dow is up 144.
    Mr. Stutzman. I am sorry, what?
    Chairman Campbell. Dow is up 144, so they have blown 
through the record.
    Mr. Stutzman. Did they? Okay.
    Mr. Malpass. One of the complaints is that the Fed is in so 
much control of this. The Fed was somewhat explicit over the 
last couple of years that it wanted to see more money go into 
stocks. I think that is too broad a role for the Fed.
    There have been questions about the dual mandate today. It 
seems to me that there is a way to seek maximum employment in 
the context of price stability and those go together well 
enough. The Fed could go in a better direction. The Fed has 
gone way beyond the rules and the thoughts of what the 
boundaries should be. That creates risk for financial markets 
going forward and for the economy.
    Mr. Stutzman. Anyone else want to speak to that or touch on 
that?
    Let me ask just another question. Going back a little bit 
to where people are putting dollars, I don't know if Dr. 
Gagnon--what are we seeing internationally? Are we seeing the 
same trends internationally? Are we seeing anything that is 
different here that we could maybe learn from somewhere else or 
learn not to do?
    Mr. Gagnon. Actually, that is a good question, because I 
think we do see different policies. The only other country that 
has really done what the Federal Reserve has done is the United 
Kingdom, and I think if you compare them to their neighbors in 
Europe, despite being much more the center of the--they had a 
much more important financial sector that was much more hurt by 
this crisis, and they have equally tough fiscal contraction 
right now--tax increases and spending cuts--and yet they are 
doing better than the rest of Europe, in part because they have 
chosen to do quantitative easing and Europe has not.
    Mr. Stutzman. Thank you. I yield back.
    Chairman Campbell. The gentleman from Delaware, Mr. Carney, 
is recognized for 5 minutes.
    Mr. Carney. Thank you, Mr. Chairman. I have come back. I 
had a couple other questions I just wanted to ask, now that we 
have the distinguished panel before us, and it piggybacks a 
little bit on what my friend from Indiana was just talking 
about in terms of short-and long-term interest rates. At a 
conference in San Francisco recently, the Chairman of the Fed, 
in response to questions, said raising interest rates 
prematurely would carry a high risk of short-circuiting the 
recovery, possibly leading, ironically enough, to an even 
longer period of lower long-term interest rates.
    The idea that if we short-circuit the recovery now then 
that is going to have that negative impact on the long-term. 
But Dr. Meltzer or Dr. Taylor, do you have any response or 
thoughts on that question?
    Mr. Taylor. I think there is just a disagreement, different 
views about the impact of the policy. He feels that if he 
starts moving off of the quantitative easing or even just 
delays it, that is contractionary. I don't agree with that.
    I think it is actually going to be a bonus or a benefit if 
we go back--it has to be gradual, as Dr. Meltzer indicated--to 
a policy that has worked in the past in similar circumstances.
    Mr. Carney. What would your rule dictate? Your rule has 
been referred to several times.
    Mr. Taylor. My rule would not have the quantitative easing. 
That is the most important thing right now. The interest rate 
would remain low but we wouldn't have the quantitative easing.
    Mr. Carney. So the second question really relates to a 
statement that Dr. Meltzer made earlier that we are, in some 
ways, abdicating our constitutional responsibility for monetary 
policy here in the Congress, which suggested to me that somehow 
we ought to be, I don't know, involved. It is hard for me to 
believe that we could get it right. In fact, it sounds like the 
worst possible thing, to involve the Congress in the activities 
of the Fed. I just can't imagine.
    Dr. Meltzer, I don't--you probably didn't mean that, but 
what did you mean by that, because I can't think of a worse 
idea, frankly.
    Mr. Meltzer. Yes, I can't imagine the Congress doing that 
either, not running the policy. Prescribing a rule and 
enforcing the rule, that is what you want to do.
    Mr. Carney. So isn't the rule--
    Mr. Meltzer. So when the Chairman comes in here or the 
Members of the Board come in here to testify, you want them to 
say, ``Look, in 2 years we are going to have low inflation and 
high employment, and these are the numbers that we are aiming 
for.''
    And then 2 years later when they come in you can say, 
``Well, you didn't get there, so what we want you to do is 
explain to us why you didn't get there, and if we don't think 
the explanation is good, we think you should resign and we will 
get people who can do the job better.'' That is what I think is 
the Congress' responsibility. It is an oversight 
responsibility.
    Mr. Carney. Yes, so we--
    Mr. Meltzer. What you have now, it is just very difficult 
for you to do it because the Chairmen--not just Chairman 
Bernanke but Chairman Burns, Chairman Volcker, Chairman 
Greenspan--can run circles around you talking about things that 
are very difficult to sort out and for you to clearly know.
    Mr. Carney. That is a fact.
    Mr. Meltzer. Yes.
    Mr. Carney. Just like this panel can as well, I might add, 
but--
    Mr. Meltzer. I don't think we are trying to do that. I 
think we are trying--my own view and I am sure the view of my 
colleagues here, including Mr. Gagnon, are trying to help you.
    Mr. Carney. I appreciate that. And we do, I think, have a 
framework anyway. It is called Humphrey-Hawkins. We had a 
conversation about that a few minutes ago, and you conceded 
that the full employment piece, although it wouldn't be your 
preference, it is a political thing, and of course, that is 
what drives us. We are driven by the people that we represent 
every--
    Mr. Meltzer. Yes, and you need to add to Humphrey-Hawkins 
something which incentivizes the Fed to pay attention to it, 
and that is--
    Mr. Carney. In terms of a rule.
    Mr. Meltzer. That is the rule and the addition to the rule, 
which says if you don't hit the target that you said you were 
going to hit, if you don't achieve what we have told you to 
achieve or what you have told us you were going to achieve, 
then you have to tell us why and offer a resignation, and 
political authorities have to be willing to make that choice. 
That gives incentives.
    Regulation that is goodwill regulation doesn't work. 
Regulation works when they incentivize the people who are 
regulated. That is what you need to do both in banking and with 
the Fed. You have to give them an incentive to follow the rules 
which you and they agree upon.
    Mr. Carney. I see my time has expired.
    Let me thank each of you again for coming and for your 
expertise and your advice.
    Chairman Campbell. The gentleman from Delaware yields back.
    And now, the vice chairman of the subcommittee, the 
gentleman from Michigan, Mr. Huizenga.
    Mr. Huizenga. Again, thanks, Mr. Chairman, for doing this.
    And I want to thank the panel for coming in. I can tell you 
that every time I have a conversation with you all, I feel like 
I am making significant leaps toward having a Ph.D., or maybe a 
master's, in banking and financing and economic theory, so 
thank you very much.
    I have a couple of very short, kind of quick questions. In 
your opinion, who is benefitting the most right now from our 
current policy? And I would love to have you just kind of go 
down the row. Who is benefitting from it and is this the path 
that we need to be on?
    Mr. Malpass. My thought is that the government is the 
biggest beneficiary because it is the biggest debtor. The 
interest rates are being kept artificially low; that helps the 
debtor. The cost is borne by the savers, and in the United 
States the biggest saver is the household sector. So it is a 
direct transfer from the private sector saver to the 
government.
    Mr. Meltzer. I agree with what he said, the government, but 
I would add, would you vote for a policy which said, we are 
going to bail out the banks and increase their returns?
    But that is what the Fed is doing. It is allowing them to 
borrow from the market or from the Fed at a quarter a percent 
or less and lend to the Treasury for 1 percent or more, and 
they make big profits.
    What is the social benefit of that? None, as far as I am 
concerned. It has a social cost, and that social cost is high 
because it is keeping interest rates too low, and we have 
talked about that a lot.
    So you wouldn't vote for that policy and yet you have that 
policy.
    Mr. Taylor. I just think it is focused on the overall macro 
effects, which I think are negative, in terms of trying to 
figure out who are the winners and who are the losers here. It 
is very difficult. But I would say my main concern is that the 
overall effect is negative.
    Mr. Gagnon. I would say the beneficiaries, as Mr. Malpass 
said, are the U.S. Government, the Federal Government 
particularly, as I said before, but also, younger people and 
people with mortgages are benefitting. I think the people who 
are losing are, it is true, older savers are losing something, 
and the other big loser is foreign governments who are 
investing in our country and getting a low rate of return and I 
think that is fine.
    Mr. Huizenga. But it is fair to say it is not the mom 
sitting around the kitchen table trying to figure out how she 
is going to feed her kids and how she is going to put gas in 
the minivan, and all those things, right?
    Mr. Gagnon. Well, if she has a mortgage and she refinanced 
it, she is much better off now.
    Mr. Huizenga. If she qualifies, if she can get through the 
Dodd-Frank Act.
    Mr. Gagnon. Yes, that is an issue--can I make one very 
brief--
    Mr. Huizenga. Please.
    Mr. Gagnon. --point about--one thing I don't understand is 
this talk about credit rationing. It seems to me that is 
confusing the level of rates with the spread of rates. Banks 
charge a spread over what they can borrow at. The Fed sets that 
at zero and no one tells the banks how much--limits how much 
they can charge on--to borrowers, so there is no rationing 
going on.
    And if you give banks a lower cost to funds, they can lend 
it at a lower rate. So I don't see any way this could hurt--
    Mr. Huizenga. That beautifully ties into my next question, 
actually, which is, I would like you all to touch on what some 
of the effects are of the regulation that has been on there. 
And this might be a little outside of what we are specifically 
talking about today but it seems to me it is not just our 
spending and it is not just monetary policy; it is the 
regulatory environment and the tax policy that dramatically 
impacts that, and I hear that all the time.
    And I used this with Dr. Bernanke. It is not one grain of 
sand that is going to gum up the works on that machine, and you 
can't--who can argue with, okay, one little grain of sand, a 
regulation that is going to be added, but when suddenly it is a 
whole handful and suddenly you are using a rubber mallet to 
pound it into the gears, now you have a problem, and it seems 
to me that we have done that. So that might go to some of my 
concern about what you are bringing up, but would anybody care 
to comment?
    Mr. Malpass. When I say the government is the beneficiary, 
I mean in the sense of Washington, D.C., government employment, 
and the real estate boom. This is the center of the beneficiary 
of these policies, whereas outside of Washington is having a 
harder time.
    And with regard to the regulatory side, Sarbanes-Oxley and 
Dodd-Frank are putting very real costs onto businesses. The 
regulators in the banking sector are causing challenges in the 
allocation of capital. Some banks are able to make more loans, 
but many banks are constrained or scared by the regulators into 
not making loans that are considered risky loans.
    Mr. Huizenga. I know my time has expired, but I appreciate 
that.
    And if anybody has any other comments they would like to 
share in writing, I think probably, or unless the chairman so 
chooses to do something different, I would love to hear your 
views, so--
    Chairman Campbell. I thank the gentleman.
    And the gentleman's time has expired. I saved myself the 
final 5 minutes to bat cleanup, and so I will yield myself 5 
minutes at this time.
    I think this hearing has been very interesting, very 
productive, and very helpful. And one of the things that has 
come to me from this hearing that I didn't necessarily have 
coming in was, the risks of the current monetary policy out--
the sort of tail risks are obvious. The Fed acknowledges them, 
et cetera.
    What I heard today was a lot of not risks but, in fact, 
negatives--current negatives. Things that are from the current 
monetary policy that are depressing current employment and 
current GDP growth, which--and I would like to just touch on a 
few of these.
    One we talked about was the loans being priced below where 
they should be, and even if milk is free, it doesn't help you 
if you can't get it. Now, Dr. Gagnon just suggested that it is 
about the spread and not about the price of the loans. How do 
those of you who believe that is a constricting factor respond 
to Dr. Gagnon on that?
    Mr. Meltzer. If a bank can lend to the government and make 
quite nice profits, why would it want to take risk that--to a 
new, unsecured--
    Chairman Campbell. So are you saying, then, that the spread 
between a no-risk loan and a risk-loan has compressed?
    Mr. Meltzer. And that is what they are doing.
    Chairman Campbell. Right. Okay.
    Dr. Gagnon?
    Mr. Gagnon. I would say that the issue is whether that is 
because of monetary policy, or because of regulatory policy, or 
because banks have felt they have been burned through their 
misbehavior in the past and are overcompensating now, and--
    Chairman Campbell. Okay, but it is probably a fact, though, 
right, that spread is down and that is going to limit the 
availability of loans?
    Mr. Gagnon. I don't see it from the point of view of 
monetary policy. I do see it from the point of view of 
regulatory policy and bank--
    Chairman Campbell. However, it may be the--
    Mr. Meltzer. Of course, it is due to monetary policy. It is 
the monetary policy which is keeping the interest rates down 
there and telling banks--Dr. Taylor wrote a piece in The Wall 
Street Journal and talked about it here. Sure, the borrowers 
want to borrow, but try to get a mortgage if you are an 
unsecured, not-well-known borrower coming into the mortgage 
market. You just won't find a bank or mortgage company that is 
going to want to lend to you when that is the case.
    If you are a commercial real estate operator speculating on 
the future of asset prices, commercial market prices in New 
York or the Silicon Valley, you can get all kinds of credit.
    Chairman Campbell. Okay.
    We talked about cash on balance sheets not deployed, and it 
is not just on corporate balance sheets. Again, I see that 
anecdotally all the time--people just sitting on cash because 
interest rates are too low, returns are too low now but they 
think they are going to go up in the future so they just sit.
    And so everybody just sits until the Fed takes action. 
Rather than trying to read a market, they are trying to read 
what the Fed is going to do, which is very distorting, in my 
view.
    We talked about banks borrowing at a quarter percent and 
selling to the Treasury at a percent. Older people or savers--
and, Dr. Gagnon, you acknowledged this as well--are losing in 
this environment. And when I asked Chairman Bernanke last week 
about how the benefits of this were going to big banks and 
governments, he pushed back hard, saying, ``Oh, no, no, there 
is all this employment and stuff that is being created.''
    We haven't looked at all the things. What are the cutbacks 
of savers? What are they doing differently? What are seniors 
who are largely or partially dependent on fixed incomes doing 
to cut themselves back on that?
    And then, Dr. Gagnon, you said a minute ago that you felt--
you acknowledged that but you felt younger people were getting 
some benefit, and I saw a great deal of angst from the other 
end of the table when you said that.
    So either Mr. Malpass or Dr. Meltzer, I believe both of you 
lit up on that?
    Mr. Malpass. The unemployment rate for young people is very 
high, and that is, I think, in part the result of a 
contractionary and distortive monetary policy.
    Mr. Meltzer. What Chairman Bernanke never says or discusses 
is, why is this the slowest recovery in the whole post-war 
period? There hasn't been another one like this since 1937 to 
1938. It is very slow, harming lots of people, especially new 
entrants to the labor force.
    That is a question which the Fed doesn't approach. It is 
helping bankers make large profits lending and borrowing with 
the government. That is not a policy which gets us substantial 
growth and employment.
    Chairman Campbell. Thank you.
    My time, and all time having expired, I very much 
appreciate all four of you coming. And I very much appreciate 
the nature and tenor of the discussion, and as I said, I think 
it was very helpful.
    The Chair notes that some Members may have additional 
questions for this panel, which they may wish to submit in 
writing. Without objection, the hearing record will remain open 
for 5 legislative days for Members to submit written questions 
to these witnesses and to place their responses in the record. 
Also, without objection, Members will have 5 legislative days 
to submit extraneous materials to the Chair for inclusion in 
the record.
    The hearing is now adjourned.
    [Whereupon, at 12:17 p.m., the hearing was adjourned.]


                            A P P E N D I X



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