[House Hearing, 113 Congress]
[From the U.S. Government Publishing Office]
THE FED TURNS 100: LESSONS LEARNED
OVER A CENTURY OF CENTRAL BANKING
=======================================================================
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
__________
SEPTEMBER 11, 2013
__________
Printed for the use of the Committee on Financial Services
Serial No. 113-42
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86-677 WASHINGTON : 2014
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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
KEITH J. ROTHFUS, Pennsylvania
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
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Page
Hearing held on:
September 11, 2013........................................... 1
Appendix:
September 11, 2013........................................... 41
WITNESSES
Wednesday, September 11, 2013
Bivens, Josh, Research and Policy Director, Economic Policy
Institute...................................................... 12
Gagnon, Joseph E., Senior Fellow, Peterson Institute for
International Economics........................................ 11
Goodfriend, Marvin, Friends of Allan Meltzer Professor of
Economics, Tepper School of Business, Carnegie Mellon
University..................................................... 5
Meltzer, Allan H., Gailliot and Scaife University Professor of
Political Economy, Tepper School of Business, Carnegie Mellon
University..................................................... 3
Pollock, Alex J., Resident Fellow, American Enterprise Institute. 7
White, Lawrence H., Professor of Economics, George Mason
University..................................................... 9
APPENDIX
Prepared statements:
Bivens, Josh................................................. 42
Gagnon, Joseph E............................................. 57
Goodfriend, Marvin........................................... 69
Meltzer, Allan H............................................. 79
Pollock, Alex J.............................................. 97
White, Lawrence H............................................ 104
THE FED TURNS 100: LESSONS LEARNED
OVER A CENTURY OF CENTRAL BANKING
----------
Wednesday, September 11, 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 1:46 p.m., in
room 2128, Rayburn House Office Building, Hon. John Campbell
[chairman of the subcommittee] presiding.
Members present: Representatives Campbell, Huizenga,
Pearce, Posey, Stutzman, Mulvaney, Pittenger; Clay, Peters,
Foster, Sewell, and Kildee.
Ex officio present: Representative Hensarling.
Chairman Campbell. Good afternoon, everyone. The
Subcommittee on Monetary Policy and Trade will come to order.
Without objection, the Chair is authorized to declare a recess
of the subcommittee at any time.
With the concurrence of the ranking member and of the
witnesses, we are beginning this hearing a little bit early in
order to accommodate the vote schedule that we will have this
afternoon. My understanding is that the votes will be called at
2:10, so we will continue the hearing until probably about
2:15, at which time we will recess while we go down for votes.
There are 3 votes, which should take approximately 30 minutes.
Then we will come back, and we will continue the hearing until
whenever questions are finished, the witnesses need to leave,
or the next vote is called, which I think is supposed to be
around 4:15-ish, and we will adjourn the hearing at that point.
So as the Chair, I now recognize myself for 5 minutes for
the purpose of an opening statement. But before I go into the
opening statement, I would like to note that today is the
anniversary of the attacks on America on 9/11. And although I
am sure you all have seen and I have seen and we have seen the
memorials and the moments of silence in New York and here in
Washington and elsewhere around the country, I don't ever think
we can do it too much. So I would first ask that we all observe
a moment of silence in remembrance of those who perished on 9/
11.
Thank you.
Now, I will continue my opening statement--which will be
brief, because we are mainly here to hear all of you--which is
just to explain what we are doing here. This year is the 100th
anniversary of the Federal Reserve. And we felt that after 100
years of an institution, it is a good time to stand back and
look at it and say, okay, why was it formed? What has it done?
What has it changed? How did it start out? What did it do in
the middle? Where is it now?
And to take a look at the past 100 years of the Fed with
the idea of trying to understand better--I don't think anyone
in this room was here in 1913 when it was founded, so given
that none of us personally saw it, I think it is good to take a
look at what happened and what has happened in the last 100
years and where we are today so that we can begin to think
about, what does the next 100 years of the Fed look like? What
should it look like? What have we done right? What have we done
wrong? What successes have we had? What mistakes have we made?
And what can we learn from those successes? What can we learn
from those mistakes? What can we learn from what we did right
and learn from what we did wrong?
I am looking forward to the testimony of all of the
witnesses this morning as we begin a series of hearings on the
Federal Reserve and on where it has been and then perhaps where
it might be going.
So with that, I would like to recognize the ranking member,
the gentleman from Missouri, for his opening statement.
Mr. Clay. Thank you so much, Mr. Chairman, for holding this
hearing on the Federal Reserve Bank then and now.
As you mentioned, in 1913 Congress enacted the Federal
Reserve Act to provide for the establishment of the Federal
Reserve Bank. In 1978, Congress enacted the Full Employment and
Balanced Growth Act, better known as the Humphrey-Hawkins Act.
This law charges the Federal Reserve Bank with a dual mandate,
both maintaining stable prices and full employment.
Currently, the U.S. unemployment rate is 7.3 percent, the
lowest level of unemployment in 5 years. Still, millions of
Americans would like to work, but cannot get work. The Consumer
Price Index, which shows the price consumers pay for goods and
services, has increased over the past 12 months by 2 percent.
The cost of all items, less food and energy, has risen 1.7
percent over the last year. This compares to 1.6 percent for
the 12 months ending in June. The energy index has risen 4.7
percent over the last 12 months. It is the largest increase
since the 12 months ending February 2012, and the food index
has risen 1.4 percent. All of these factors play a very
important role in the U.S. economy.
And, again, Mr. Chairman, I want to thank you. And I look
forward to questions that I may submit to the witnesses. I
yield back.
Chairman Campbell. Thank you. I thank the ranking member
for his comments and for yielding back.
In the absence of any other opening statements, we will
proceed directly to the witnesses. And we just got word that
there will not be a second series of votes, so we are going to
have this one series at apparently 2:10, and then after that,
there will not be another series, so we will just go from 2:10
until whenever the hearing finishes after that.
So, a warm welcome to all of you. And we will start with
Dr. Allan Meltzer, professor of political economy at Carnegie
Mellon, and also visiting scholar at the American Enterprise
Institute. He chaired the International Financial Institution
Advisory Commission, known as the Meltzer Commission, and is a
founding member of the Shadow Open Market Committee. He served
on the President's Economic Policy Advisory Board and on the
Council of Economic Advisers.
Dr. Meltzer, you are recognized for 5 minutes.
STATEMENT OF ALLAN H. MELTZER, GAILLIOT AND SCAIFE UNIVERSITY
PROFESSOR OF POLITICAL ECONOMY, TEPPER SCHOOL OF BUSINESS,
CARNEGIE MELLON UNIVERSITY
Mr. Meltzer. Thank you, Mr. Chairman. I welcome the
opportunity to have this discussion. I think that you asked the
right question: What can the Federal Reserve do better in the
next century than what it has done in the past century? And the
ranking member's questions about how far we have strayed from
full employment and how slow we are getting back there, those
are critical questions for our citizens.
The Federal Reserve has some very good things about it. One
of them is that in its 100 years, it is one of the few
institutions of government that has never had a major scandal.
That is quite an achievement, and it is one that we should, of
course, welcome.
It also has a number of blemishes. I am going to talk more
about the blemishes, because those are the things that need
correction.
The 1913 Federal Reserve Act created an institution with
very limited powers. President Wilson's compromise resolved the
main political obstacle to passing the Act. The reserve banks
became semiautonomous, controlled by their managements and
directors. Boards of directors had the power to reject
portfolio decisions. The Board in Washington had undefined
supervisory responsibility.
The United States was on the gold standard, limiting
Federal Reserve actions to the requirements of that rule. In
addition, the new system authorized reserve banks to discount
commercial paper, banker's acceptances, and the like. The
discounting operation was always at the initiative of the
borrower. Also, the Act prohibited any direct purchases of
Treasury debt.
All of these restrictions ended long ago. The gold standard
limped to an end in the 1930s. Discounting became an
unimportant part of the Federal Reserve's activities, and a
limited volume of direct loans to the Treasury replaced the
prohibition. Far more important, reliance on open-market
operations circumvented the prohibition on direct purchases of
Treasuries.
Currently, and for many years, the Federal Reserve has
bought or sold unlimited amounts of Treasury securities in the
marketplace at the time of the offering or at any subsequent
time. The transformation occurred in many steps, many of them
in response to major crises, especially the Great Depression,
the Great Inflation, and the current prolonged recession and
slow recovery, black marks on the Federal Reserve's record.
Within months of Benjamin Strong's departure, Board Members
gained influence. Later, the Banking Acts of 1933 and
especially 1935 shifted power toward the Board by giving the
Board a majority on the new Federal Open Market Committee and
eliminating the power of reserve bank directors to decide on
their bank's participation in open-market purchases or sales.
During the Great Inflation, Congress amended the Federal
Reserve Act by adding the so-called dual mandate. After the
recent housing and financial crisis of 2007-2009, Congress
approved the Dodd-Frank Act, containing hundreds of regulations
on banks, as many as 400, according to some counts.
Among the many new regulations is the use of Federal
Reserve earnings to allocate credit toward consumers. The Fed
had previously resisted credit allocation, but it will
henceforth finance it out of its earnings without any right to
decide on the allocation. This right is reserved to the
Director of the consumer agency now embedded into the Federal
Reserve Act. The Director does not report to the Chairman, nor
to the Congress, nor to anyone else. And although the earnings
that the Director uses would otherwise return to the Treasury
as receipts, Congress does not vote on the allocation.
Political decisionmaking is now unavoidable.
This change is a startling reduction in the mandated
independence of the Federal Reserve. Federal Reserve
independence has often been compromised, but never before by
act of Congress.
Once Congress understood the importance of monetary
expansion for employment, it took extraordinary effort and a
strong Chairman to remain independent. Paul Volcker was an
independent Chairman. Alan Greenspan also remained relatively
independent. Others were willing to compromise. The current
Federal Reserve has engaged in such nonmonetary functions as
fiscal policy, debt management, and credit allocation.
To sum up the evolution, I conclude that the Federal
Reserve evolved under pressure of events and political
responses to crises from independent agencies with constrained
powers to become the world's major central bank with a nearly
unrestricted ability to expand. It retains a vestige of
independence, but it pays the price of much-reduced
independence for its greatly expanded authority. Within the
system, power has shifted from the reserve banks to the Board
of Governors, and the reserve bank directors have a greatly
diminished role.
One of the great failures of recent years has been the
failure of Congress to find an effective way of providing
congressional oversight. This is a serious lack of
responsibility. We have an agency which is increasing--has
doubled and then redoubled the size of its balance sheet
without any vote by the Congress to spend that amount of money,
trillions of dollars. That is a mistake, a mistake by the
Federal Reserve, but an even greater mistake by the Congress,
because under Article I, Section 8--
Chairman Campbell. Thank you, Dr. Meltzer. Time has
expired. So if you have a sentence to sum up or--I think we get
the point.
Mr. Meltzer. Yes, I think the most important thing that the
Congress could do to enhance its oversight and improve the
performance of the Federal Reserve is to adopt a monetary rule,
one which embodies the dual mandate necessary, but adopt a
monetary rule--
Chairman Campbell. All right.
Mr. Meltzer. --a rule which would tell you whether they
have done what they said they were going to do and whether you
could correctly monitor them.
[The prepared statement of Dr. Meltzer can be found on page
79 of the appendix.]
Chairman Campbell. Thank you. Thank you, Dr. Meltzer.
Next, Dr. Marvin Goodfriend, who is also a professor at
Carnegie Mellon, but a professor of economics, and he
previously served as the Senior Vice President and Policy
Advisor to the Federal Reserve Bank of Richmond, and also
worked as a Senior Staff Economist for the White House Council
of Economic Advisers. Dr. Goodfriend, you are recognized for 5
minutes.
STATEMENT OF MARVIN GOODFRIEND, FRIENDS OF ALLAN MELTZER
PROFESSOR OF ECONOMICS, TEPPER SCHOOL OF BUSINESS, CARNEGIE
MELLON UNIVERSITY
Mr. Goodfriend. Thank you, Mr. Chairman.
I will speak today on lessons learned from a century of
Federal Reserve last resort lending. My overarching message is
that the constraints on the Federal Reserve's lending powers
were loosened gradually over time, resulting in the
distortionary and destabilizing implied promise of even more
expansive lending in the future.
The story starts in the Depression, when Congress was
reluctant to expand the credit policy powers of the independent
Fed beyond depositories and instead established the
Reconstruction Finance Corporation to allocate credit widely to
nonbank entities. So much has changed.
But the Fed exhibited a tendency on its own to expand
lending beyond short-term liquidity assistance to banks. For
instance, in 1974 Fed lending supported the insolvent Franklin
National Bank, and in 1984-1985, the Fed supported the
undeclared insolvency of Continental Illinois Bank. Then, the
Monetary Control Act expanded access to the Fed's discount
window to all depositories in 1980, whether or not they were
members of the Federal Reserve System.
Anna Schwartz has documented a widespread tendency in the
1980s for Fed lending to delay the closure of insolvent banks
at taxpayer expense. In 1991, the Federal Deposit Insurance
Corporation Improvement Act (FDICIA) famously acted to limit
Fed lending to undercapitalized banks, although the law would
be compromised by capitalization measured largely on a book
rather than market valuation. Overlooked in FDICIA, however,
was something more important: It amended Section 13(3) of the
Federal Reserve Act to enable the Fed to lend widely to
nonbanks for the first time in the Fed's history, as Alan
Greenspan has written, granting virtually unlimited authority
to the Federal Reserve Board to lend in unusual and exigent
circumstances.
Expanded Fed lending authorization unaccompanied by
supervision and regulation would encourage the huge expansion
of money market finance that fueled the credit boom. And in the
2007-2008 turmoil, the Fed was put in a no-win situation. Given
its wide powers to lend, the Fed could disappoint expectations
of accommodation and risk financial collapse or take on
expansive, underpriced credit risk, as Paul Volcker put it,
with the implied promise of similar actions in times of future
turmoil. The Fed chose the latter course of action, even
allowing two major investment banks to quickly become bank
holding companies so they could access the Fed discount window.
In the 19th Century, the Bank of England followed Walter
Bagehot's classic last resort lending advice, ``to lend freely
at a high rate on good collateral,'' so as not to take on
underpriced credit risk. The bank followed Bagehot's advice
because the Bank of England was a private profit-maximizing
institution whose shareholders earned the profit and bore the
risk of loss.
The Fed, however, is inclined to take on underpriced credit
risk when worried that not doing so threatens a systemic
crisis. Why? Because the Fed's own funds are not at stake. The
fiscal authorities receive any Fed income after operating
expenses, and taxpayers bear any Fed losses.
Moreover, even when the Fed protects itself by taking good
collateral, the Fed harms taxpayers if the entity to which the
Fed lends fails with a Fed loan outstanding. Why? The Fed takes
collateral at the expense of taxpayers exposed to losses from
backstopping the Deposit Insurance Fund or from other financial
guarantees that the government may have put in place. The
bottom line is that fully independent Fed lending facilitates
lending laxity and moral hazard.
Fed credit policy works by interposing government
creditworthiness, the power to borrow credibly against future
taxes between private borrowers and lenders to facilitate
distressed borrowers. Fed credit policy involves lending to
private institutions with freshly created bank reserves or the
proceeds from the sale of Treasuries from the Fed's own
portfolio.
To prevent inflation in the future, the Fed must reverse
the reserve creation eventually by selling Treasuries from its
portfolio or else the Fed will have to pay a market interest on
reserves that is used to finance those credit policies. Either
way, Fed credit policy involves the lending of public funds to
particular borrowers, financed by interest-bearing liabilities
issued against future taxes.
In short, Fed credit policy is really debt-financed fiscal
policy. The Fed returns the interest on its credit assets to
the Treasury, but all such assets carry credit risk and involve
the Fed in potentially controversial disputes regarding credit
allocation. So credit policy is necessarily a political fiscal
policy matter that ought to be handled by the fiscal
authorities, not by the independent Fed.
That said, in my view occasional Fed lending to solvent
supervised depositories on short term against good collateral
is protected against ex post losses and ex ante distortions,
and so I believe the Fed should be given a degree of
operational independence with respect to such circumscribed
lending to depositories that it regulates.
But Congress should insist that the Fed adhere to a
Treasuries-only asset acquisition policy, except for such
occasional lending. Moreover, I believe that any expansive Fed
lending initiatives should be authorized by a committee of
Congress before the fact, be done only as a bridge loan, and be
accompanied by an explicit taxpayer takeout, which, of course,
would deter the Fed from doing such things, except in
exceptional circumstances. Thank you.
[The prepared statement of Dr. Goodfriend can be found on
page 69 of the appendix.]
Chairman Campbell. Thank you, Dr. Goodfriend. Welcome back.
Next, Mr. Alex Pollock, resident fellow at the American
Enterprise Institute. He also serves as lead director of the
CME Group, and was formerly the President and CEO of the
Federal Home Loan Bank of Chicago. Mr. Pollock, you are
recognized for 5 minutes.
STATEMENT OF ALEX J. POLLOCK, RESIDENT FELLOW, AMERICAN
ENTERPRISE INSTITUTE
Mr. Pollock. Thank you, Chairman Campbell, Ranking Member
Clay, members of the subcommittee, and Chairman Hensarling.
I think the most striking lesson of the 100-year history of
the Federal Reserve is how it has been able from the beginning
to inspire entirely unjustified optimism about what it can know
and what it can accomplish. In contrast to the warm hopes of
1913 and since, the Fed has not made financial disorders
disappear, while it has often enough contributed to creating
them.
A high point of optimism about what discretionary
manipulation of interest rates could achieve came in the 1960s,
when economists actually came to believe in what they called
``fine-tuning.'' The fine-tuning notion, ``turned out to be too
optimistic, too hubristic, as we collectively learned,'' Fed
Chairman Bernanke recently wrote. ``So,'' he continued, ``a
little humility never hurts.''
Indeed, the performance of the Federal Reserve at economic
and financial forecasting in the last decade, including missing
the extent of the housing bubble, missing the huge impact of
its collapse, and failing to foresee the ensuing sharp
recession certainly strengthens the case for humility on the
Fed's part. The Fed is as poor at knowing the future as
everybody else.
So as Arthur Burns, Fed Chairman in the 1970s and architect
of the utterly disastrous Great Inflation of that decade said,
``The opportunities for making mistakes are legion.''
Nonetheless, the 21st Century Federal Reserve and its
economists again became optimistic and perhaps hubristic about
the central bank's abilities when Chairman Greenspan had been
dubbed ``the maestro.'' In the early 2000s, central bankers
thought they were observing a durable ``Great Moderation,'' but
the ``Great Moderation'' turned into the ``Great Bubble'' and
the ``Great Collapse.''
Then, the Dodd-Frank Act gave the Fed much expanded
regulatory authority over firms deemed systemically important
financial institutions, or SIFIs, in order to control systemic
risk. But the lessons of history make it readily apparent that
the greatest SIFI of them all is the Federal Reserve itself. It
is unsurpassed in its ability to create systemic risk for
everybody else. Who will guard these guardians, as the classic
question goes?
In 1927, the Fed's Benjamin Strong famously decided to give
the stock market ``a little coup de whiskey.'' In our times,
the Fed has decided to give the bond and mortgage markets a
barrel of whiskey. This massive manipulation of government debt
and mortgages has almost certainly induced a lot of new
systemic interest rate risk into the economy, as well as a
remarkable concentration of interest rate risk into the balance
sheet of the Federal Reserve itself.
Central banking is not rocket science. In fact,
discretionary central banking is a lot harder than rocket
science, because it is not and cannot be a science at all. It
cannot make reliable predictions, and it must cope with
ineluctable uncertainty and an unknowable future.
I believe we can draw four lessons from this instructive
history. One, we should have no illusions, in sharp contrast to
the 100 years of illusions we have entertained, about the
probability of sustained success of discretionary central
banking, no matter how intellectually brilliant and personally
impressive its practitioners may be.
Two, we should try to implement Henry Thornton's classic
advice from 1802, ``to limit the total amount of paper money
issued, to let it vibrate only within certain limits, to allow
a slow and cautious extension of it, as the general trade
enlarges itself,'' in other words, to have the Fed focus on the
medium- to long-term noninflationary or very low inflationary
expansion of base money. The Fed is much more likely to succeed
at this than in trying to manage the economy.
Three, given that the Fed is the single greatest source of
systemic risk, we should reconsider who should guard these
guardians. Are there appropriate checks and balances, rather
than a philosopher king-like independence? This includes the
question of rules, the role of Congress, and as Allan Meltzer
mentioned, the internal balance between the regional Federal
Reserve banks and the Federal Reserve Board.
Fourth and last, a serious 100-year review, as this
subcommittee is undertaking, of the 6 mandates of the Federal
Reserve make sense. It has been 78 years since the Fed was
restructured by the Banking Act of 1935, 36 years since the
Federal Reserve Reform Act of 1977, and 35 years since the
Humphrey-Hawkins Act, which the ranking member mentioned, was
enacted. A careful, rigorous, thoughtful review of the many
difficult questions involved in governing the pure fiat
currency, paper dollar, floating exchange rate world we have is
certainly appropriate.
Thank you.
[The prepared statement of Mr. Pollock can be found on page
97 of the appendix.]
Chairman Campbell. Thank you, Mr. Pollock.
Dr. Larry H. White is a senior scholar at the Mercatus
Center and a professor of economics at George Mason University,
and also serves as a member of the Financial Markets Working
Group. He previously taught at the University of Missouri in
St. Louis, and at the University of Belfast, and worked as a
visiting scholar at the Federal Reserve Bank of Atlanta.
I want to mention, before I forget, that without objection,
all of your written statements will be made a part of the
record. Also, I did fail to mention--as Dr. Meltzer mentioned
that the Federal Reserve has had no scandals in its 100-year
history, I want to point out that this body, the U.S. House of
Representatives, has not had a scandal in the last week of
which I am aware.
[laughter]
And so I don't know if that is equivalency, but I just
thought I would mention that.
With that, Dr. White, you are recognized for 5 minutes.
STATEMENT OF LAWRENCE H. WHITE, PROFESSOR OF ECONOMICS, GEORGE
MASON UNIVERSITY
Mr. White. Thank you, Chairman Campbell, Ranking Member
Clay, and members of the subcommittee. Thank you for inviting
me to testify.
In my written testimony, I argue that the actions of the
Federal Reserve during the financial crisis of 2007 to 2010
abandoned the rule of law. That is, the Fed abandoned the
principle that those in authority should execute the law as
written, predictably and in accordance with established
precedent. The Fed instead took arbitrary, ad hoc measures
without clear statutory authority or precedent.
The rule of law would have been a better guide to resolving
the crisis and I think a better guide to helping us avoid
future financial crises. So in enunciating this principle, I
follow the historian and philosopher David Hume in affirming
that the long-term benefits of consistently adhering to the
rule of law outweigh the short-term convenience of ad hoc
measures.
Now, what measures am I talking about? You are all aware of
the Fed's having created special purpose vehicles, the Maiden
Lane, LLC, I, II and III to protect the bondholders of Bear
Stearns by taking $30 billion of bad assets off of its books,
thereby sweetening an acquisition deal for JPMorgan Chase to
take over the remainder of the firm. It declined to do the same
for Lehman Brothers, but it created two other vehicles to buy
and hold bad assets from the failed insurance company AIG.
There wasn't any precedent for this. There wasn't any
apparent legal authority in the Federal Reserve Act for such a
special purpose funding operation. That is well-known.
Equally worthy of note, but not often noticed, is that the
Fed in 2008 assumed the role of selectively channeling credit
in directions that it favored. It began to lend funds to and
purchase bad assets from an array of financial institutions it
deemed worthy, going beyond the traditional scope of its
lending to commercial banks. The Fed began lending to firms
that do not participate in the payment system for the first
time--well, not the first time, but the first time in recent
memory, namely investment banks, primary dealers, broker-
dealers, and even mutual funds.
These funds it lent, as other speakers have mentioned,
weren't allocated to it by Congress. They were created by the
Fed itself out of thin air, as they say, and in the amounts
that the Fed itself decided. The total of the Fed's credits
outstanding at the end of 2008 stood at over $1.5 trillion,
more than double the size of the Treasury's bailout authority.
Now, the Fed has an established role as a lender of last
resort. What does that role involve? That role involves
injecting cash into the system to keep the broader money stock
from shrinking. It does not call for the Fed to inject capital
into failing firms by overpaying for assets or by lending at
below market rates, actions that, as Marvin Goodfriend said,
put taxpayers at risk.
The Fed's statutory authority to lend is actually limited,
even in exigent circumstances, and was never meant to encompass
the sort of capital injections that the Fed took in 2008
through its Maiden Lane vehicles.
Now, the Dodd-Frank Act properly places limits on this kind
of lending, but in other ways, the Dodd-Frank Act enshrines the
Fed's discretion to lend. It enshrines the too-big-to-fail
doctrine, the application of which inherently involves
arbitrary judgments. I think it thereby erodes the rule of law,
increases the probability that taxpayers will be funding
bailouts in the future, and it weakens the market discipline
between risk and reward.
In justification of these actions, the Fed during the
crisis repeatedly invoked the lender of last resort rule, but I
think in so doing, they were stretching the term beyond its
proper meaning. The Fed, of course, conducts monetary policy.
Lender of last resort should be thought of as an adjunct to
monetary policy; that is, it is injecting enough cash into the
system to keep the money supply from shrinking.
It does not involve preferential credit allocation, which
is what the Fed has gotten into. Subsidizing, papering over
inadequate net worth, delaying the resolution of insolvent
institutions, that has nothing to do with keeping the money
supply from shrinking.
So the lender of last resort rule doesn't require, and the
traditional guidelines of Walter Bagehot that have been
mentioned actually forbid, providing insolvent firms with
capital injections or loans at below market interest rates. In
fact, the lender part of the lender of last resort is actually
an anachronism. As Professor Goodfriend mentioned, the Fed can
inject cash without making loans to particular banks by
purchasing securities, and it doesn't need to purchase
securities from those banks. It can purchase Treasuries in the
open market.
The Fed claimed legal authority for its actions--
Chairman Campbell. If you could wrap up, because your time
has expired.
Mr. White. --under 13(3) of the Federal Reserve Act, but I
think even as amended, Section 13(3) did not convey unlimited
or carte blanche authority.
So, in conclusion, I think we should be concerned to
prevent arbitrary credit allocation by the Federal Reserve,
however well-meaning the Members of the Board undoubtedly are.
Thank you.
[The prepared statement of Dr. White can be found on page
104 of the appendix.]
Chairman Campbell. Thank you, Dr. White.
There are three votes on the Floor right now, so we will
recess the hearing for the moment. According to the people on
the Floor, these votes should be over about at 2:50, and so we
will return in about 30 minutes or so, and we will reconvene at
that point, and continue with Dr. Gagnon and Dr. Bivens. So,
the hearing is in recess.
[recess]
Chairman Campbell. All right. The committee will return to
order. And we will continue with the testimony on the part of
our witnesses. We will now turn to Dr. Joseph Gagnon, a senior
fellow at the Peterson Institute for International Economics.
He previously 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.
Dr. Gagnon, you are recognized for 5 minutes.
STATEMENT OF JOSEPH E. GAGNON, SENIOR FELLOW, PETERSON
INSTITUTE FOR INTERNATIONAL ECONOMICS
Mr. Gagnon. Thank you, Chairman Campbell, Ranking Member
Clay, and members of the subcommittee. I welcome this
opportunity to testify.
In my view, the Federal Reserve has performed at least as
well over its first 100 years as could have been expected,
given the powers it was granted and the evolving understanding
of how the economy operates. The key to improving performance
in the future is to give the Fed the tools it needs to do its
job, to allow the Fed free reign in using those tools, to
demand that the Fed explain its actions fully, and to hold the
Fed accountable for any failure to achieve its objectives.
My biggest worry is that the Fed faces more restrictions on
its powers than any of the world's other major central banks,
raising the risk that it may be unable to achieve its
objectives at some time in the future. Under U.S. law, the Fed
has been asked to foster a sound and stable financial system
which will help to achieve its broader goals of full employment
with low inflation.
Historically, however, the Fed has had three major
failures. First, the Fed did not have the tools to prevent a
leveraged equity bubble in the 1920s, and it did not use its
tools adequately to prevent the bursting of this bubble from
causing the Great Depression. Second, through a protracted
period of passivity in the late 1960s and 1970s, the Fed
allowed inflation to ratchet upward to damaging levels. Third,
through insufficiently aggressive use of its supervisory and
regulatory authorities, the Fed allowed a leveraged housing
bubble to develop in the 2000s, but it did a better job of
responding to the ensuing crisis than it did in the 1930s.
I group the lessons learned from Fed history into four
categories: monetary objectives; monetary rules; policy tools;
and emergency lending. On monetary objectives, I support the
dual mandate. Experience shows that successful central banks do
not focus solely on inflation, even if that is their only
mandate. Stabilizing employment is a socially valuable
objective in itself and it helps to stabilize inflation. Making
the employment mandate explicit is an acknowledgement of
reality that has benefits for credibility, transparency, and
accountability.
It might be helpful, but not essential, for political
leaders to specify a numerical goal for inflation. We are all
aware of the dangers of inflation that is too high. And the
evidence is mounting of the harm from inflation that is too
low. The target should not be set below 2 percent, and some
believe that a slightly higher target would be beneficial,
perhaps as high as 4 percent. I don't have a strong view on
that, but I note that an average inflation rate of 4 percent in
the late 1980s was widely viewed as a huge success.
On rules versus discretion, it is not possible to design a
policy rule that can allow for all contingencies. The best
strategy is for the Fed to use various rules in assessing the
stance of policy. Whenever it deviates noticeably from popular
rules, the Fed should explain clearly why it is doing so.
The difficulty of using policy rules is highlighted by the
experience of the past 5 years, when some proposed rules called
for large negative interest rates that are not technically
feasible. The Fed's response was to engage in quantitative
easing, or QE, an unconventional policy that was not
contemplated by the existing policy rules.
My own call for more QE back in 2009 was based on the fact
that the Fed did not forecast a return to full employment and
target inflation within 3 years. Looking forward over the next
3 years, there still seems to be some room for easier Fed
policy, but the case is less strong than it was back in 2009.
On policy tools, I note that of the world's major central
banks, the Fed faces the greatest restrictions on its powers.
It can buy only government- and agency-backed debt. Other
central banks can buy corporate debt, equities, and even real
estate. As long as there is sufficient transparency and
accountability, there is no reason to restrict the Fed's
ability to achieve its mandate. I note that the Bank of Japan
is buying broad baskets of Japanese equity and real estate as
part of its fight against deflation.
Another important tool is the ability to impose loan-to-
value limits and/or debt-to-income limits on consumer and
business loans. Strict lending limits kept the equity bubble of
the 1990s from causing excessive damage when it burst in 2000.
We need to make it easier for the Fed to impose similar limits
on leverage in real estate. We also need higher capital
standards for banks.
Finally, on lender of last resort, during the recent crisis
the Fed made emergency loans to specific institutions, which
attracted considerable criticism. Yet, the Fed was scrupulous
in requiring sufficient collateral on its loans, as evidenced
by the fact that all of its loans were fully repaid at a profit
to the taxpayer.
The new limit on the Fed's ability to make emergency loans
raises the risk of disorderly failures in the future. And it is
not clear how much of this risk is offset by the advanced
resolution plans that are now required of large-scale financial
institutions.
Thank you. This concludes my opening remarks.
[The prepared statement of Dr. Gagnon can be found on page
57 of the appendix.]
Chairman Campbell. Thank you, Dr. Gagnon.
And last but not least, Dr. Josh Bivens is research and
policy director at the Economic Policy Institute and conducts
research on macroeconomics, globalization, social insurance,
and public investment. Dr. Bivens, you are recognized for 5
minutes.
STATEMENT OF JOSH BIVENS, RESEARCH AND POLICY DIRECTOR,
ECONOMIC POLICY INSTITUTE
Mr. Bivens. Thank you. I would like to thank the members of
the subcommittee for the invitation to testify today. I have
submitted written testimony for the record.
The year of the 100th anniversary of the Federal Reserve
would always be an appropriate time to assess its role in the
American economy, and the current swirl of questions
surrounding its conduct in the wake of the Great Recession
makes it especially so.
I am going to make essentially five quick arguments today.
First, the economy remains far from fully recovered from the
Great Recession, and the obvious barrier to this full recovery
is clearly deficient aggregate demand for goods and services.
Second, this demand shortfall has been aggravated in recent
years by too contractionary fiscal policy.
Third, given this demand shortfall and given this
contractionary fiscal policy, the Fed's current efforts to
boost economic activity and employment through unconventional
monetary policy are entirely appropriate and talk of reducing
the extent of this economic boost, or tapering as it is sort of
called in the popular press, is clearly premature.
Fourth, the lessons of the burst housing bubble and the
consequent Great Recession for the Fed should be that: one, it
is crucial to keep asset market bubbles from inflating in the
first place; and two, we cannot rely solely on conventional
monetary policy to return the economy to full employment after
they burst.
This unique episode again illustrates that monetary policy
has to balance too many competing demands and will encounter
too many contingencies over any window of time to make very
simple, tailored rules the optimal policy.
And fifth, as the Fed in the future becomes a hopefully
more vigilant financial regulator, it should follow the
complete version of what are often referred to--and people on
the panel have referred to it--the Bagehot rules, should lend
freely during a crisis, but at a penalty rate against
collateral that is valuable during noncrisis times, and only to
fundamentally solvent institutions.
And to be clear, I find little to fault with how the Fed
managed the crisis of 2008-2009. I think it was balancing many
things. We were not well-prepared for such a financial crisis.
And it chose the path that would support economic activity and
employment, even at the expense of perhaps giving some
financial aid to specific financial institutions that engaged
in too many excesses. That said, we should be better prepared
for next time. Hopefully, the Dodd-Frank legislation has,
indeed, made us better prepared for next time.
To expand just a little bit, as of June 2013, a full 4
years after the official end of the Great Recession, the gap
between actual economic output and what could be produced if
all productive factors were fully utilized is nearly $900
billion in annualized terms. This is $900 billion of pure
economic waste that persists because we have not engineered a
full recovery from the Great Recession.
This output gap is mostly driven by deficient aggregate
demand. And, again, that has been aggravated in recent years by
contractionary fiscal policy. Given this, it is premature to
argue the Fed should begin tapering its own support for the
economy.
There has been a lot of uncertainty about the estimates of
how much the Federal Reserve quantitative easing programs have
boosted the economy over the past couple of years. It is
important to realize that none of the estimates say it has
damaged economic activity or employment growth over that time.
There may be considerable uncertainty about just how much it
has boosted this activity, but it is important to realize that
it has boosted it and the economy has needed a boost.
Trying to engineer a recovery using just monetary policy
when fiscal policy is going in the wrong direction is far from
optimal, but flying an airplane on one engine is a lot better
than zero.
Lastly, the source of the Great Recession is as clear as
day: There was an $8 trillion bubble in home prices that formed
and then burst. The Federal Reserve and all other macroeconomic
policymakers were far too reluctant in the run-up to that
bubble to deflate it before it formed to such damaging levels,
and they were too confident in their ability to use
conventional monetary policy, short-term interest rate cuts to
neutralize its effects when it burst.
These lessons should be heeded. In going forward, the Fed
needs to be willing to intervene to keep destructive financial
sector excesses from providing tinder for another crisis, and
it has a greatly expanded menu of tools to do this, with
legislation that has passed since the crisis, and not least of
which is simply public comment. We all have seen recently, for
good or bad, that just public comment on the part of Fed
officials can move financial markets. It should be cognizant of
this power. And it should use it to deflate destructive asset
market bubbles before they reach crisis levels. They should be
willing to use these new tools in the future.
Thank you. I would be happy to answer any questions the
subcommittee may have.
[The prepared statement of Dr. Bivens can be found on page
42 of the appendix.]
Chairman Campbell. Thank you so much, Dr. Bivens.
I will now recognize myself for 5 minutes for questioning.
And I have in this 5 minutes just one question, which I will
ask all of you to answer, and then in the second round, I will
have a second question for all of you, because I am sure we
will be able to do a second round here.
My first question--and I will go in reverse order. We will
start with you, Dr. Bivens, and go down this way. Is the
Federal Reserve today more or less independent than it was at
its founding or somewhere near its creation? And is it more or
less independent in your judgment than it ought to be? Dr.
Bivens?
Mr. Bivens. On the first question, more or less independent
than at its founding, I am afraid I am going to have to defer
to experts. My sense is, it is an independent institution. That
independence means being willing to break the economy when it--
or to break economic growth when it is going too fast and
threatening inflation, but it also means having the freedom to
reflate the economy when in the Fed's judgment that is what is
needed. I think it retains that independence today, and so I
think the idea that it has become too tied to the winds of
other economic policymakers is not a criticism I endorse.
Chairman Campbell. So in your opinion, its independence is
proper at the current time?
Mr. Bivens. That is correct.
Chairman Campbell. Adequate.
Mr. Bivens. Thank you.
Chairman Campbell. Dr. Gagnon?
Mr. Gagnon. Yes, I would agree that its independence is
proper. Having worked there, I was always quite struck--and I
worked in other parts of the government as well--by how
independent the Fed really is. Throughout almost all the
process of decision-making, it is only thinking about what is
right and any thought about political influence is very small,
as far as I could tell.
Chairman Campbell. From a historical perspective?
Mr. Gagnon. From a historical perspective, I think at the
founding of the Fed until the 1930s, independent, well, it was
certainly independent from Washington. It may have been too
independent and too closely tied to regions of the country and
the banking industry, and I think that was changed,
appropriately so, in the 1930s to give it more control from
Washington.
And yet the balance was struck right, because you have
these long fixed terms, even though they were appointed by
Washington. They then had the freedom to go out and, without
short-term pressure, do what they think is in the national
interest.
Chairman Campbell. Dr. White?
Mr. White. There are at least two meanings of independence.
One is that the Fed gets to choose its own goals, and the other
is that the Fed gets to choose its own operations, but given a
set of goals. When the Fed was founded, it was understood that
the gold standard would constrain the monetary system, so the
Fed's independence to set its own goals was very limited.
That, of course, has changed. There is no longer that kind
of constraint on the Fed. We have gone from a gold standard to
a PhD standard. That is how monetary policy is made these days.
I think the Fed is probably too independent. I think it
should be accountable. And to the extent that is at variance
with independence, understood as they get to choose their own
goals, then I am in favor of less independence for the Fed.
Chairman Campbell. That is a fascinating concept which
deserves more delving into, but, Mr. Pollock?
Mr. Pollock. Thank you, Mr. Chairman. The Fed in the
beginning was a complicated balancing of a lot of interests--
the political board that Woodrow Wilson insisted on, the
bankers in the regional banks, and the Secretary of the
Treasury who was, under the original Act, ex officio a Member
of the Board.
Throughout the history of the Fed, there have been cycles
of being more or less independent. During the Second World War,
the Fed was completely unindependent. It was entirely the slave
of the Treasury, and the purpose was to finance the war. That
happens in wars.
William McChesney Martin, the longest-serving Chairman, the
one who has the best record on average inflation in the postwar
era, used to talk about ``independence within the government,''
by which I guess he meant independent, but not quite. And by
the end of his term, he was giving way to the politicians to
let inflation rise to finance the combined Johnson social
initiatives and war.
So if anything, I think when you look at the Fed, it is a
good example of the constant debate between philosopher kings,
as in Plato, and checks and balances, as in the theory of
republics.
Chairman Campbell. Okay, I need to--
Mr. Pollock. We need to address that balance.
Chairman Campbell. Dr. Goodfriend?
Mr. Goodfriend. I would concur that the gold standard
constrained the Fed early on. And the gold standard is no
longer with us. So in that sense, the Fed was less independent,
and I think appropriately so.
The 14-year terms for Board of Governors officials meant a
lot more in the early days, when the pay meant that people
could stay for 14 years. One of the striking things about
Federal Reserve Board Members these days is that they stay
something like 3 or 4 years. I really don't know the exact
number. And that means there are more chances for appointments
by politicians. In that sense, I think the Federal Reserve
Board has become a lot less independent than it was in the
early days.
I would also add a couple of things. The discussion of the
Chairman's succession also indicates that the personality of
the Chairman has a lot more discretion these days than it used
to. In the old days--maybe Allan Meltzer can tell me
otherwise--I doubt the whole country would be focused on who
became the Fed Chairman. These days, it is indicative to me of
the idea that there is a lot of discretionary that has been
piled in.
In that sense, the Fed is more independent, but
inappropriately so. As I would say, based on my testimony, the
Fed's power should be restricted so that it isn't doing--
Chairman Campbell. Okay.
Mr. Goodfriend. --fiscal policy of Congress--
Chairman Campbell. Okay. I am going to run a little over,
but don't worry, I will give an equal amount of time to you,
Mr. Clay, so we keep it even here. But just so Dr. Meltzer
can--and we can get all six on this.
Mr. Meltzer. In the best academic tradition, I am going to
give you two answers. Politically, the Fed is less independent
than it was in 1913-1914. As an example, President Wilson would
not invite Board Members to White House parties because he
didn't want to influence them. There was really a very close,
very distant separation of the board from the political system.
But in another sense, the Fed is completely unrestrained.
It has quadrupled the size of its balance sheet. And the
failure there is, I believe, as I said in my testimony, a
failure by Congress to monitor, control, and limit what the
Fed--it is your responsibility under Article I, Section 8, to
decide what the monetary policy of the United States is. The
Fed is your agent, and you don't have a very effective means of
regulating your agent.
Chairman Campbell. Okay--
Mr. Meltzer. And let me just say one last thing. In a year
in which the Fed finances 75 percent of the U.S. Government's
borrowing, how can we think of the Fed as independent of the
political process?
Chairman Campbell. Thank you, Dr. Meltzer.
I now recognize Mr. Kildee. Because we started the hearing
early, he wasn't able to get here for his opening statement, so
he is going to be recognized for 8 minutes, which gives him the
opportunity to give an opening statement and then proceed to
ask you all questions and divide that 8 minutes in whatever way
he would like.
The gentleman from Michigan is recognized for 8 minutes.
Mr. Kildee. Thank you, Mr. Chairman, and thank you to Mr.
Clay for allowing me to step in and for allowing me to sit
here. It is probably not something I am going to experience for
quite some time, but I enjoy the chance.
Chairman Campbell. These seats aren't any different, you
may have noticed.
Mr. Kildee. They are not? All right.
Chairman Campbell. They are not that special.
Mr. Kildee. Well, that one is.
So I will make some opening comments, and I will refer back
to the first two instances when I served here, when the
Chairman of the Federal Reserve came to address us, and ask you
to comment, particularly a couple of you to comment on some
questions that I have around the strength of America's
municipal governments and their effect on what is a significant
part of the Fed's dual mandate, the effect on the economy,
particularly on employment.
It is interesting that this hearing, of course, marks 100
years. And when you think back to the period when the Federal
Reserve was initiated, I think about America's great cities. I
am from Flint, Michigan. Some of you might be familiar with
that place, the birthplace of General Motors.
But when I think back to 100 years ago, GM was 5 years old.
Many older industrial cities in the United States were really
just beginning to get their legs under them and were about to
experience an unprecedented period of growth and expansion. We
became a highly productive society, and somewhere along the
way, most point to around the 1930s, 1940s, we began to see the
tremendous productive capacity of our society also begin to
deliver pretty significant wages to the workforce, creating a
growing and really significant middle class in the United
States.
In my own hometown, interestingly enough, about the time
that the dual mandate was recognized and initiated by Congress,
it was about the peak employment for the auto industry. And you
could point to that period roughly for a lot of the larger
industrial communities, older industrial communities in our
country.
The reason I lay that preface is that when Mr. Bernanke was
here--and I would ask some of you to comment on this--I pressed
the question of whether or not the sustainability of these old
industrial cities has any implications for the mandate of the
Fed and whether or not the Fed itself, either through advice or
through policy, could address what is, I think, a growing
problem of inequality.
And I reference--and, Dr. Meltzer, you mentioned two
answers to one question. It is a common theme. What I have
seen, what we witnessed in this country for many American
cities is that during the periods--particularly recently--of
great economic expansion, significant economic expansion, for
example, in the 1990s, many older American cities were left
behind.
And so we had this situation where much of the country was
doing extremely well, with unemployment at relatively low
levels, with wages at reasonable levels, with productivity
growing, but some significant parts of America, some of which I
represent, were not doing well at all and, in fact, didn't
participate in any of that growth in economic expansion.
So from an economist's point of view, one might say that
some parts of the country were doing very well, a few parts
were not doing very well at all, but on average, the country
was doing just fine. And so what I want to ask you, first--and
if I could start with Mr. Gagnon and Mr. Bivens, but also ask
others to comment on whether or not you think the Federal
Reserve has any interest or role in helping municipal
governments.
There had been a point in time not too long ago when I know
there was some consideration for playing a role in stabilizing
municipal governments by offering or considering the
development of a credit facility to finance municipal
securities, for example. And if you could just--not just so
much on that, but comment on whether or not you think somewhere
in the charge to the Federal Reserve is an interest in
municipal governments.
And I will just preface one more thing. When I asked Mr.
Bernanke, he said, well, the Fed historically has not become
involved, nor the Federal Government involved in the issue of
municipal insolvency. And I just pointed out that there are
many things about which we could say the Federal Reserve had
not been involved or the Federal Government had not been
involved until a need arose to do so.
If I could start with Mr. Bivens, Mr. Gagnon, and then if
others would like to comment, I would appreciate it.
Mr. Bivens. As to whether there is active interest at the
Fed in this, I don't know. Whether or not they are--what I
guess the Fed would say on this is a couple of things.
I think they would say, one, if you look at distressed
municipalities around the United States, the number-one thing
that can help them is a better national economy and a lower
unemployment rate across-the-board, and they would say they are
working hard on that, and I tend to largely agree with that. I
think the Fed right now is, indeed, trying to boost the overall
economy, and is, indeed, trying to boost employment growth, and
presumably that should have some good spillover effects even to
specific municipalities.
I would say--and I think they are right on this, as well--
that they would say that the problem with a lot of
municipalities, say, the ones that are entering financial
crises is that there is a real fundamental mismatch between
revenues and outlays in those cities. It is not necessarily a
malfunctioning financial market. If it was a malfunctioning
financial market, the Fed might really have a role in making
sure it is well-greased. If you are talking about a fundamental
mismatch between revenues and outlays, I think the argument
would be, those are much better addressed by fiscal transfers,
and I know politically the prospects for that are pretty low
these days, but it is the most direct and genuinely helpful way
that could be done.
And then last thing I would also say that I think you have
to look at other aspects of economic policy, in terms of
hitting really distressed municipalities. And I would talk
about international trade policy. Detroit specifically has been
hammered by the decline in manufacturing employment, which to
me, in the 2000s, was overwhelmingly a problem of an overvalued
dollar, and I think that gets beyond the Fed's mandate into
exchange rate policy.
Mr. Kildee. Mr. Gagnon?
Mr. Gagnon. Yes, I think--having worked inside the Fed, I
think the reluctance you probably heard from Chairman Bernanke
reflects a desire to think of Fed policy as only things that
affect the entire country as equally as can be, and that if one
gets into municipal lending, then one eventually, inevitably,
gets into decisions about who is more creditworthy and how do
you make that equal, and that gets to be politically difficult
for the Fed.
I think you could say, well, what about the emergency loans
to Wall Street firms? Didn't that help New York? And I think
the only thing in response I could say is the Fed felt that a
breakdown of the financial system would have hurt everybody and
they got collateral for those loans. And I don't know what kind
of assurance the Fed could get in municipal loans that would be
comparable to--the Fed was made whole in those loans in the
crisis from the collateral, which I don't know how that would
work.
Mr. White. Yes, I would agree with Dr. Bivens. It is a
fiscal policy issue. It is not appropriately charged to the
Fed. They are--some people think the Fed can just create
loanable funds, but if the Fed is directing credit one place,
it is necessarily reducing the supply available elsewhere, and
that is not the sort of call the Fed should be making.
Chairman Campbell. The gentleman's time has expired. We
will now move from one part of Michigan to another part of
Michigan, as we will go to the vice chairman, Mr. Huizenga. You
are recognized for 5 minutes.
Mr. Huizenga. Thank you, Mr. Chairman.
And, yes, it is true, I get the pretty sunset side of the
State, not that the east side isn't a great spot. My mother is
from Flint, as well, but--it is a great place to be from, the
gentleman just said, so, but--no, we are--the pure Michigan ads
are true. Come on up. We would love to see everybody up there.
So I want to--before I turn into a total infomercial, I
would like to actually return to our policy question here. And,
Dr. Gagnon, I would like to--I have a quick question for you.
On page seven, there is sort of your discussion about the Fed
and the rule and quite a bit of discussion about the Taylor
rule and the Svensson rule.
And after one of the recent FOMC meetings, President
Bullard from the St. Louis Fed, whom I believe has been in
front of our committee, the full Financial Services Committee,
argued that the FOMC has not stuck to its intermediate target
guidance. As Professor Svensson noted, forecast targeting is
meaningless without some sort of mechanism for commitment to an
optimal rule.
Obviously, Chairman Bernanke feels a little differently. He
has argued that his guidance is ``similar'' to the Svensson
approach. But isn't it really true that Chairman Bernanke isn't
following a real meaningful forecast or targeting rule, like
the one advocated by even Professor Svensson?
Mr. Gagnon. Yes, I would say the thing about the Svensson
rule is that you should set your policy so that you should hit
your target. And at a minimum, you should hit your target in
your own forecast, but that is obviously a low bar. The Fed
isn't even hitting that. The Fed is--
Mr. Huizenga. Yes, which I think you point out on page
eight. So basically, they are not operating under a rule, as
you--
Mr. Gagnon. Under that rule or--yes, that is right. And
other forecasters would agree.
Mr. Huizenga. Okay. Mr. Bivens, you were nodding your head,
as well. Would you care to chime in on that? And I would love
to hear from everybody else.
Mr. Bivens. Yes, from my perspective, I think they are
missing any conceivable unemployment target, in terms of
unemployment is too high for any reasonable target, and they
are missing inflation on the low side. Inflation is too low for
their target.
And so that to me says, when you are missing on both sides
like that, it definitely says you should not be talking about
tapering off support to the economy, because that is just going
to make them miss worse on both sides.
Mr. Huizenga. I am not trying to argue whether we need more
easy money or less easy money. I am trying to get at, are they
actually operating under a rule? Because it seems to me, not
really.
Mr. Bivens. I think that is fair to say, yes.
Mr. Huizenga. Okay, all right. Would anybody else care to
chime in on that quickly?
Mr. Meltzer. I agree with you, that is, they are not
operating under a rule--
Mr. Huizenga. Dr. Meltzer, if you wouldn't mind just
pulling that microphone a little bit closer to you?
Mr. Meltzer. There were only two periods in Federal Reserve
history where they came close to operating under a rule. They
happened to be the two best periods in Fed history: 1923 to
1928; and 1985 to 2003. In the first case, they operated under
some form of the gold standard; in the second, under the Taylor
rule, more or less, not slavishly, but more or less. And those
were the two, the only two periods in the Fed history that have
low inflation, relatively stable growth, small recessions, and
quick recoveries.
Mr. Huizenga. And so I am assuming, based on that answer,
you would advocate that it would be a good idea for the Fed to
get a rule? We can talk--
Mr. Meltzer. I believe--
Mr. Huizenga. --Svensson rule, Taylor rule, PhD rule, some
sort of rule, though, that is predictable and able to hit.
Mr. Meltzer. Any rule that the Congress can agree on and
monitor. That is important.
Mr. Huizenga. A key element, it seems.
Mr. Meltzer. A key element is not only to bind them to
doing sensible, consistent things that everyone can understand,
but also to get you, the Congress, to say, look, you told us
that we would have this inflation and that unemployment and you
haven't done it. That is a statement you can make which is very
consistent with your authority and responsibility for
monitoring the way the monetary system works.
Mr. Huizenga. I am not sure most people would accept
``sensible'' and ``Congress'' all in the same sentence, but I
appreciate those sentiments. Anybody else, quickly here in the
last 30 seconds? Mr. Pollock?
Mr. Pollock. Congressman, I might just add that the 1977
rule, which is usually called the dual mandate, which has been
referred to, is, in fact, a triple mandate. If you simply read
the letter of the law, it was stable prices, which we don't
have, maximum unemployment, and moderate long-term interest
rates, that third mandate from Congress. I think it is
impossible for the Fed to do all three, but Congress did tell
them to do all three.
Mr. Huizenga. Okay.
And, Mr. Goodfriend, very quickly?
Mr. Goodfriend. Very briefly, if you go back to May 22nd,
when Chairman Bernanke hinted, I think somewhere on Capitol
Hill, at a Joint Economic Committee meeting, that they would
consider a taper, you saw a tremendous surprise in markets, as
if it came out of nowhere. The 10-year yield jumped 1
percentage point within a month. That is evidence that the Fed
is not following a rule, because--by virtue of the fact that it
was a discretionary rhetorical action that Bernanke took that
just was not understood by anybody.
Mr. Huizenga. So, basically, we need to smooth out the
edges and a rule can do that?
Mr. Goodfriend. A rule would tend to mitigate surprises and
basically give you outcomes for which people could plan.
Mr. Huizenga. All right. Thank you, Mr. Chairman.
Chairman Campbell. Thank you.
And now we will get back to regular order, and we will
recognize the ranking member, but he gets an extra 2 minutes,
because I took an extra 2 minutes, so we will give him 7
minutes. The gentleman from Missouri, Mr. Clay, is now
recognized for 7 minutes.
Mr. Clay. Thank you, Mr. Chairman, especially for your
generosity.
This is a panel-wide question. Currently, the U.S.
unemployment rate is 7.3 percent, the lowest level in 5 years.
Currently, the unemployment rate for African-American citizens
stands at 13 percent in August. This is an increase of
unemployment rate from 12.6 percent in July. The difference in
the U.S. unemployment rate and the African-American
unemployment rate is 5.7 percent.
Studies have shown communities with high unemployment rates
have a higher crime rate compared to communities with low
unemployment rates. Do you believe high unemployment rates are
at least a national issue? And what course of action do you
believe the Federal Reserve Bank should take to lower the
higher than average unemployment rate in African-American
communities and in other high unemployment rate communities
throughout the United States?
I will start with Dr. Bivens.
Mr. Bivens. I absolutely think that the excessively high
unemployment rate in the U.S. economy right now is our biggest
economic challenge. I think from the point of view of the
Federal Reserve, the main thing they can do to bring it down,
both overall and for groups that have disproportionately high
unemployment rates, is to continue what they are doing in terms
of asset purchases to boost economic activity and jobs.
That is what they are trying to do with their monthly
purchases. They are trying to keep long-term rates low. They
are trying to ensure that demand does not fall so low that we
see that unemployment rate tick up even further. I would like
to see them continue it. I would actually even like to see them
be a bit more aggressive on that front. I think they are
greatly hampered by the fact that fiscal policy has gone in
absolutely the wrong direction and is dragging on growth.
So, in my view, of all the economic policymaking
institutions right now that seem most concerned with keeping
that unemployment rate low, the Federal Reserve seems to be the
one that is most concerned with that.
Mr. Clay. And you don't think the banks should raise the
interest rates?
Mr. Bivens. No.
Mr. Clay. Thank you.
Dr. Gagnon?
Mr. Gagnon. Yes, I would agree with Dr. Bivens. I think, to
the extent that the Fed can bring down the total unemployment
rate, I suspect the African-American rate will come down
proportionately more. And I think that is the right--that, to
me, is also job number one for economic policy in this country.
And I agree that the Fed does seem to be focused on it more
than almost anyone else, but I don't think they are doing
enough.
I think they are too concerned about the potential costs of
quantitative easing tools, which to me are quite low. Those
costs are quite low and the benefits are quite high, so I don't
quite--I don't think they are getting the balance right, but at
least they are worried about it.
Mr. Clay. Dr. White?
Mr. White. Yes, we have had a very slow recovery, and so
unemployment has not dropped the way it normally does in a
recovery. We are many months behind where we would normally be,
in terms of unemployment coming down.
And it is not clear that looser monetary policy would help
speed the process. I think a large part of the problem is that
investment is sitting on the sidelines. There needs to be
greater regime certainty, greater tax certainty, greater
monetary policy certainty, so that the investment climate
becomes more favorable, and that will be helpful to economic
growth and, thereby, bring down unemployment.
Mr. Clay. So you contend that some of the reason is market-
driven?
Mr. White. Yes.
Mr. Clay. Okay. Mr. Pollock?
Mr. Pollock. Thank you, Congressman. I think the best thing
any central bank can do for employment is a medium- to long-
term stability in monetary behavior and stability in prices. I
think managing short-term economic consequences, such as the
ones you have mentioned, is beyond the competence of a central
bank.
Mr. Clay. And so what effect would raising the interest
rates have on it? Do you think it would have any effect?
Mr. Pollock. We have extraordinarily low interest rates, of
course, negative real interest rates, extremely low long rates.
That is due to the current manipulation of the markets by the
Fed. At some point, those rates have to return to normal. That
would be healthy, again, in a medium- to long-term basis.
What gets the Fed or any central bank in trouble, in my
opinion, is trying to react all the time to short-term
conditions, which it can't know enough about or influence
enough to do successfully.
Mr. Clay. Thank you for that response.
And Dr. Goodfriend?
Mr. Goodfriend. What I would add to these comments is that
the Federal Reserve doesn't really control the interest rates
that matter, which are the long-term interest rates. I get back
to the comment I said before. What is happening is, markets are
looking forward 10 years to figure out what is likely to
happen. So it is kind of, I think, a little bit of an illusion
to think that the Fed is having a big effect on long rates.
It was able to appear that the Fed had an effect on long
rates when the recession started. Now that we are moving toward
the exit, when we look out 2 or 3 years, the market is already
projecting what is likely to happen. So I think this is largely
superfluous, unless you want to argue that the Fed should
continue to keep short rates so low as to create some sort of
inflation problem in which long rates would go up even more.
In other words, the Fed does not, I believe, have a lot of
leeway to have much effect either way, except being excessively
inflationary. What it is doing now is basically treading water.
Mr. Clay. And, Dr. Goodfriend, why has the economy had such
a difficult time in growing jobs?
Mr. Goodfriend. Job growth is based in part on two things:
people need to spend; and then people need to invest. And it is
clear that the spending--people's willingness to spend in the
future, among those people who have the money to spend, is they
are not willing to really gear it up. Why? Because the people
who have the money to spend are worried about higher future
taxes, and they are basically keeping their powder dry.
So one thing we need to do on the spending side is put--I
believe simplify the tax code so that people who have the money
are not going to be penalized for having more money in the
future. And then they might begin to spend some of it. And on
the other side, they might be willing to invest to increase
jobs, and you get both job growth and spending going in tandem,
and then you have a good recovery.
What is impeding that is that there is an open-ended
question about how high taxes might stay or even go higher in
the future.
Mr. Clay. Thank you. And my time is up.
Chairman Campbell. Thank you, Mr. Clay.
We will move now to the gentleman from South Carolina, Mr.
Mulvaney. You are recognized for 5 minutes.
Mr. Mulvaney. Thank you, Mr. Chairman.
And thank you, gentlemen. I am going to go down a line of
questions that I didn't anticipate doing before the gentleman
from Michigan, Mr. Kildee, asked his questions, because I think
he was asking the questions around the fringes of an issue that
I want to explore.
His questions pertain to the advisability, perhaps, of the
Federal Reserve getting involved in helping some of America's
financially struggling cities. It is something I know that is
certainly near and dear to his heart, and perhaps rightly so,
but let me ask it a different way. Does the Federal Reserve
have the authority to do that? Do they have the authority to
bail out cities, to bail out States? Dr. Gagnon is saying yes.
Why is that?
Mr. Gagnon. I am not recommending it. I am just saying the
powers--
Mr. Mulvaney. I am not interested in recommendations. I am
interested in whether or not the Fed actually has the legal
authority to do that and, if so, what would it look like?
Mr. Gagnon. The Fed has the legal authority to buy
municipal debt up to 6 months' maturity.
Mr. Mulvaney. And that would be directly or that would be
on the secondary market?
Mr. Gagnon. Oh, in secondary markets, but that would
presumably help conditions in the primary market.
Mr. Mulvaney. All right. Now, when I asked that question of
Dr. Bernanke at a previous hearing, he said that he didn't have
the authority to bail out cities, and then he mentioned the
exact same thing, that he could only buy 6-month debt. So help
me reconcile those two statements, gentlemen. Don't everybody
jump up at once.
Dr. Meltzer?
Mr. Meltzer. Yes, it has to be debt which is not in
default, which is highly rated. It is just the opposite. He can
buy short-term debt from cities as part of his open-market
operations, but he can't finance cities which are on the verge
of bankruptcy.
Mr. Mulvaney. Because it wouldn't meet the credit
requirements?
Mr. Meltzer. Because he would be taking a market risk that
was not intended to be taken by the Federal Reserve. He has
to--as some of the witnesses here have said, he was very
careful about seeing that what he did when he was lending was
always collateralized safely, protecting the taxpayers from
losses. If he starts buying up bad debt or debt which is about
to go bad, he is not doing that.
Mr. Mulvaney. And I am not a conspiracy theorist--or at
least I am trying hard not to be after 3 years here--but if I
imagine a circumstance in which the Federal Government has
issued a guarantee of that municipal debt, that would get
around your restrictions, wouldn't it, Dr. Meltzer?
Mr. Meltzer. Yes, but that would not be a Federal Reserve
action. That would be something which you in the Congress have
to do.
Mr. Mulvaney. True, but then he would be able to buy that
debt and issue that credit.
Mr. Meltzer. Yes. But, of course, once you gave it a
guarantee, he wouldn't need to do that.
Mr. Mulvaney. Okay. Dr. Bivens, you looked like you were
agreeing or--you had some thoughts on that?
Mr. Bivens. I actually disagree with that last statement.
If there was a guarantee, he could buy it, but he wouldn't have
to.
Mr. Mulvaney. Okay. Are there any other methods other than
buying municipal debt that the Federal Reserve has the
authority to bail out--for lack of a better term; and I don't
mean that term to be used in a narrow sense, but a broad
sense--a city or a State? Is municipal debt the only tool
available to it? Dr. White?
Mr. White. It is certainly not part of the Federal
Reserve's mandate in terms of monetary policy. It doesn't fall
under their bank--
Mr. Mulvaney. You just heard Mr. Kildee make the argument
that will be made at some point in the future--perhaps not with
Detroit, but with the State of Illinois or the State of
California, which is that if California tanks, it will drive up
unemployment nationwide and, therefore, it will call on the
Federal Reserve or some will call on the Federal Reserve to get
involved under that part of its dual mandate.
Mr. White. The Fed can certainly offset any effects that
California has on the banking system and on the money supply
without bailing out California.
Mr. Mulvaney. Okay. Dr. Goodfriend?
Mr. Goodfriend. I want to make a point by analogy to the
mortgage-backed security purchases by the Fed.
Mr. Mulvaney. Okay.
Mr. Goodfriend. These mortgage-backed securities have a
guarantee of sorts, and the Fed is buying them. You might think
that the Fed doesn't need to buy them, so you can imagine, why
doesn't the Fed swap out the mortgage-backed securities to
somewhere else in the government and take on Treasuries on its
balance sheet? The Fed won't do that, and the government won't
agree to that, because mortgage-backed securities, while they
have a guarantee, they don't have as much of a guarantee, what
we like to call full faith and credit, that U.S. Treasuries
have. And therefore, there is a spread on these.
So there would still be pressure, perhaps--I don't know
whether--we just don't know--for the Fed to finance these--
whatever you want to call them, the municipals, even if the
municipals got a credit enhancement from the government, just
because they might trade at a higher rate than Treasuries.
And so, there might be pressure on the Fed to finance these
things, rather than have the private sector finance at a higher
rate or to have the U.S. Treasury borrow on behalf of
municipals to fund them.
In other words, the guarantee to municipals is not going to
be as good as the full faith and credit of Treasuries. And
therefore, there will be pressure for the Fed to buy these at a
lower rate or--
Mr. Mulvaney. Thank you, gentlemen. It is an interesting
topic that I think bears additional consideration, but I am out
of time. Thank you, Mr. Chairman.
Chairman Campbell. Yes, I think all of the questions and
answers have been interesting, and I am sure that will continue
with the gentleman from Illinois, Mr. Foster, who is now
recognized for 5 minutes.
Mr. Foster. At the risk of drifting a little bit further
off-topic, I think almost everyone present in the room or who
has been present in the room comes from States that are huge
losers in the redistribution of wealth that is happening due to
the Federal Government. I know that about $20 billion a year
flows out of Illinois, I think about $5 billion a year out of
Michigan, and I think some number north of $10 billion a year
flows out simply because of the imbalance between Federal taxes
and money spent by the Federal Government, which is more than
enough to bail out Detroit and others. And so, I think that is
something which has to creep into our thinking, if not the
Fed's directly.
And actually, in the opposite direction, it strikes me in a
lot of the political debate that we are having over things like
monetary policy that we don't--we have this single compartment
model in our minds of the economy that is insufficiently
globalized. When you talk about trying to pressurize the whole
system with money to support asset values in the United States,
what Mr. Bernanke will pressurize the U.S. economy and then see
it pop out as an asset bubble in foreign countries.
And that this really changes the calculus. It means that
any of these simple rule-based things don't have a chance of
working unless the rule is so complex that it includes all the
major economies in some manner. I spent a little while to see
if these sort of macro--international macro models even exist
and they are woefully simplified, by necessity. But I think
this is a major problem in, really, the thinking of both
parties, because it generates unsolvable problems.
And I was wondering generally if you have any comments,
anyone, on the Fed's role or the central bank's role in
fighting asset bubbles, which--if I step back from the
financial crisis, by several years now, if I had my choice of
getting rid of the banking crisis or the housing bubble, it is
not even close. I would prefer to get rid of the housing
bubble. The damage that has done to the net worth of the middle
class is incomparably larger than the banking crisis, which, by
and large, we fixed within a couple of years.
And so I was wondering if you have any words of wisdom on
how the Fed should balance its duties of keeping the banking
system solvent and keeping the--and stabilizing, particularly
housing bubbles, which I think are the big dog and the pain
that we are still living through.
Mr. Meltzer. Think of how the problem arises of a bubble.
Take the housing market. Returns to investment in housing are
20 percent, 30 percent at the instant. You raise the interest
rate by 1 percentage point, 2 percentage points, 3 percentage
points, that is enough to kill the rest of the economy,
perhaps. It is not going to have a big effect on the 30
percent. That is the basic problem. That was the problem in
1929. It was the problem in 1968. And--
Mr. Foster. Right. And so in other countries, then, they
have independently controlled, for example, the downpayment on
housing from the interest rates. And one of the fundamental
problems with--you had mentioned like triple mandates. And it
is a fundamental theorem of control theory--I am a physicist,
so forgive me--is that you cannot control three variables with
one actuator, all right?
And so that if--is the problem that the Fed actually has to
consciously manipulate both the leverage allowable in the
housing market and other asset markets with the interest rates?
And--
Mr. Meltzer. The housing bubble occurred at least in
largest part because of the desire, the understandable desire
on the part of the Congress and the Administration to spread
housing ownership down the income distribution. So it gave the
opportunity for Fannie Mae and Freddie Mac to make loans, no-
downpayment loans, in which the owner didn't own anything
except an option to perhaps benefit if the housing prices
continued to rise at 20 percent or 30 percent a year, which is
not a likely event.
Now, people like Angelo Mozilo saw an opportunity to
package these loans and sell them to Fannie Mae and Freddie
Mac, and he walked away--
Mr. Foster. No, I understand that narrative. Let's say, if
I could--yes, Alex, do you have a--
Mr. Pollock. Yes, I agree, the international dimensions are
central and make the problems much harder. Yes, with multiple
mandates--in my testimony, I suggest the Fed has six--and you
can't possibly do them all. Yes, the housing bubble was much
worse than other financial bubbles. Yes, we should attack it
through controlling leverage, which in housing is also equally
controlling down payments or loan-to-value ratios. And
likewise, in other markets, it is how much margin you allow
that sector to run on. That is a key control variable which I
think should be used.
Mr. Foster. Any other comments on--
Chairman Campbell. One more quick comment, and then we
will--
Mr. Gagnon. Yes, just ask yourself why the equity bubble
crash in 2000 had much--it was billions of dollars--smaller
effects than the housing bubble crashing in 2008. And I think
the difference is leverage. You want to reduce leverage.
Chairman Campbell. Okay. I'm sorry, Mr. Goodfriend. I will
just--and perhaps if Mr. Pittenger would like to hear that
answer--the gentleman from North Carolina is recognized for 5
minutes.
Mr. Pittenger. You are welcome to respond for 30 seconds,
if you can.
Mr. Goodfriend. Just 30 seconds. I think leverage matters
mainly because of access to money market short-term financing
of illiquid housing mortgage products. That was an important
component to remember about this. It is always advantageous to
finance in the money market where interest rates are low,
because people expect to get liquidity out of it. The problem
was, there was too much liquid money market finance of this
stuff via leverage that caused the system to be fragile. That
is my own addition.
Mr. Pittenger. Thank you, Mr. Chairman. I will proceed.
Chairman Campbell. Yes. Yes, please, go ahead.
Mr. Pittenger. Dr. Meltzer, you have argued that the Fed is
at its best when it follows clear monetary policy rules. Do you
believe that this applies even in emergency situations?
Mr. Meltzer. No. In an emergency situation--no rule is
going to work under--in a world of uncertainty, under all
conditions. It is just not in our ability to write such a rule.
So, no, there have to be--the way in which I would run that
rule is to say they should come to you and say, we have to
deviate, and this is why we are deviating, and then it is the
public interest served by your saying okay.
Mr. Pittenger. So there is some accountability. Mr.
Pollock, in your view, has the Federal Reserve adequately
planned and modeled for interest rate risk?
Mr. Pollock. In my view, the Federal Reserve has, in
current times, through its huge bond market manipulation,
created a massive amount of interest rate risk, and we will see
how it all works out. Nobody knows enough to know how it will,
but it will certainly be coming home to roost as we go forward.
Mr. Pittenger. Sure. As a follow up, I would like to ask--
earlier this year, you described the Fed as meeting its own
criteria for classifying an institution as too-big-to-fail.
What monetary policy decisions in your view have led to the Fed
becoming too-big-to-fail?
Mr. Pollock. That was an article I was having a lot of fun
with, Congressman, but I think it is true, that if you apply
their criteria, they are exactly a too-big-to-fail bank
themselves. And, of course, what has caused that is the massive
bond investments which they have undertaken. The Fed at the
moment owns about $2 trillion of long Treasury bonds--not
Treasury bills, but Treasury bonds of long duration, and $1.3
trillion of long-term mortgages. This is a risk position which,
if any of their bank charges had it, they would be all over
them, firing the management and making them unwind it.
Mr. Pittenger. Sure, thank you.
Professor Meltzer, you have described a number of mistakes
that seem to be repeated by the Fed over the course of its
history, from the inability to consider the effect of policy
over the intermediate or long term to its lack of independence
from its fiscal policy decisions by the Treasury. Why do you
think these mistakes are continually repeated? And what can we
do to help ensure that they are not repeated over the next 100
years of the Fed?
Mr. Meltzer. Thank you. I think that is the critical
question, that is, the successful policies were periods where
policies--Mr. Volcker is a wonderful example. When he took on
the inflation problem, he knew he wasn't going to solve that in
a month or 6 months. He knew it was going to take a while. It
took a couple of years, right?
But he had a consistent policy of trying to lower the
inflation rate. He deviated at times because events required
him to, but he always went back to doing that. That is what the
Fed does not do.
Take the current example. It has over $2 trillion of excess
reserves. It is not going to get rid of those in a a week or a
month. It is going to get rid of them over several years, if
then. So it needs to have a long-term strategy. Does it have a
long-term strategy? No. It says it depends upon the next
unemployment rate and whether it is this or that. What earthly
reason could there be for thinking that the next unemployment
rate is going to have very much to do with whether they
successfully manage to bring down $2 trillion? They need a
long-term strategy. They don't have it.
Mr. Pittenger. Yes, sir, Mr. Pollock?
Mr. Pollock. Thank you, Congressman. May I just comment
that the well-deserved plaudits Mr. Volcker gets for bringing
down inflation was bringing down an inflation created by the
Federal Reserve itself.
Mr. Pittenger. Yes, sir, Mr. Gagnon?
Mr. Gagnon. Just one point. I don't think the Fed needs to
bring down the reserves. It will pay interest on them, and that
will make people happy to hold them. I think that is its plan.
Mr. Meltzer. Maybe.
Mr. Pittenger. Thank you very much. I yield back my time.
Chairman Campbell. Thank you. Gee, and I thought it was--
was it Carter or Ford who had those little buttons, ``Whip
Inflation Now?'' It was Ford. That is what I thought, yes. So I
thought that is what did it. Yes, WIN, whip inflation now, oh,
boy. Okay.
The gentleman from New Mexico, Mr. Pearce, is recognized
for 5 minutes.
Mr. Pearce. Thank you, Mr. Chairman. I appreciate the
presentation that you each made.
I was looking at an article from Forbes earlier this year
and talking about looking at the stock market, it is just
booming. The housing market is bouncing back. CPI, it is not
even moving the needle. Gold, we have crushed it. Everything is
great. Move forward, Mr. Gagnon--that would be you--move
forward, print more money, more QE.
But then they go on and say, but Spain, hopelessly
bankrupt, can borrow money at 5 percent, 60 percent of the home
purchases in the major markets are being made by cash, by hedge
funds, and inside groups. The Dow and S&P are hitting highest--
record highs, while 47 million people are on food stamps.
Official unemployment rate is going down, while the number of
people not working is going up, CPI less than 2 percent.
This is what I find in my district. We are 47th in per
capita income. Mr. Gagnon, do you have a rebuttal to this idea
that it is just an insider's game, that is the conclusion here,
that what we have done is we have made this economy so complex
that only the insiders are going to do okay, and everybody else
is going to suffer and suffer pretty badly? You are one who is
saying, print more money. Would you like to address the
positions in this article?
Mr. Gagnon. I haven't read the article. I am worried about
inequality of income. It seems to me, though, that what the
Federal Reserve is doing benefits probably the lower end of the
income distribution more than anything, because buying the MBS
has helped keep mortgage rates low, which rich people usually
don't need to borrow as much as poor people do to get a
mortgage--
Mr. Pearce. If I could address that piece--
Mr. Gagnon. --to get a house--
Mr. Pearce. --that it is somehow helping the people on the
low end of the spectrum, let me tell you what I hear at my town
halls. I hear people say, ``We lived our life correctly. We put
money into savings accounts. We have 401(k)s. We paid for our
house. Now, the house is worth half what we paid for it. We get
zero, 0.25 percent, interest on our money.''
Seniors are more likely to use cash and cash equivalents
than any other segment of society. What the printing of money
is doing is driving everyone to these speculative, higher rates
of return that threaten our seniors more than ever. And so, I
don't find that the seniors are sitting here applauding the
strategies.
You also make the comment in your paper that--in your
statement that Bear Stearns--or that Lehman didn't have enough
resources to bail them out. When I look at a list, I see that
Bear Stearns had 34 to 1 asset to equity ratio, Morgan Stanley
33 to 1, Merrill Lynch 32 to 1, Lehman 31 to 1. It was the best
of those four. Why do you say that they didn't have enough
assets and the others did? Bear Stearns did.
Mr. Gagnon. Actually, I am about to release a paper that
looks at the balance sheets of all those institutions you
named. And what is really striking is that even though it had a
little bit less leverage, as you say, the value of the assets
were vastly inflated for Lehman. Lehman was just overstating
the value of its assets to a degree that was much higher than
the other institutions. And so--
Mr. Pearce. Okay.
Mr. Gagnon. --in hindsight, it has lost a lot more.
Mr. Pearce. So you think there is a relationship between
debt and asset value? What do you think about the United
States' off-balance-sheet accounting?
Mr. Gagnon. The United States--
Mr. Pearce. In other words, we have about $202 trillion
that we don't consider as debt. That is Medicare, Medicaid, and
Social Security. So you declare that Lehman had off-balance-
sheet assets that were stated incorrectly. Do you have a
position on the U.S. Government's off-balance-sheet nonassets,
loans that are stated incorrectly?
Mr. Gagnon. One thing I would say is that a lot of these
obligations are not legal liabilities like bonds. They can be
changed legally over time, and we can find ways to save money
on health care, for example, and so that can affect them in a
way that you can't do to a bondholder.
Mr. Pearce. Yes, so you are saying that they are not
really--that we really don't owe that money. I would challenge
you to come out to one of my town halls and sit and listen to
seniors who, by God, will tell you that you are going to pay
their Social Security. They are going to be there with
pitchforks. I will tell you, this--the anger in the American
people is neck-deep.
The anger at the insider game that is going on here and the
way that this economy is being manipulated, it is not
understood by the unsophisticated. They just know they have
been had. And the printing of money is one of the biggest ways
they have been had, and this Federal Reserve is the key to
that. I yield back.
Chairman Campbell. Thank you. We are going to go one more
round. I know Dr. Meltzer has to leave at 4:00, so--but we will
make one more quick round. There are 4 Members here, so we need
20 minutes, and then we will be all set.
So I will yield myself another 5 minutes, and this time I
will start with Dr. Meltzer, because you have to leave soon, I
know. And my question this time is, in the 100 years of the
Fed, what is the best action they have taken, the best thing
they have done? And what is the worst action they have taken,
the worst thing that has been done?
Mr. Meltzer. As a policy, the best action they have taken
was ending the inflation and more or less following the Taylor
rule, because that gave us the longest period of any period in
Fed history with low inflation, stable growth, and small
recessions, just what we wanted.
And since--if I looked at the current period, I would say,
after providing $2 trillion or more of QE reserves, I would
look around and say, why are we getting so little effect? And
the answer is, maybe we have the wrong strategy. Maybe, as Mr.
Gagnon sort of suggested at one point, it is not a monetary
problem. Those are not his words; those are my words. It is not
a monetary problem.
But as he said, it is a tax problem. You tell people who
are investors, if you invest more, I am going to want to tax
you more. There is nothing in economics which says that is the
correct strategy. In fact, there is everything in economics
which says that is a silly strategy. You may want to tax more
at some point, but you certainly don't want to get out of a
recession by taxing people more.
And regulating them? Regulating them to death. When you go
around and talk to businessmen, they talk about the costs of
regulation, so they don't invest in labor. And we have--we all
know that--of the employment benefits that we see going up,
most of them are part-time jobs. Part-time jobs. Why? Well, we
know why. It is because of the silly parts--
Chairman Campbell. Okay.
Mr. Meltzer. --of the Obamacare law.
Chairman Campbell. Okay. Thanks, Dr. Meltzer.
Dr. Goodfriend?
Mr. Goodfriend. For the best, I would say Paul Volcker's
moment. When the Fed restrained inflation, that was very tough
to do. It was a huge success.
For the worst, I want to set aside the Great Depression,
because that is obviously the worst mistake, but there is
another mistake that I want to emphasize. In the early stages
of the Great Inflation, there was a mistake that the Fed made
analytically that it thought the Phillips curve, the tradeoff
between inflation and unemployment, was stable. So the Fed
thought it could create a reduction in unemployment by creating
higher inflation.
That collapsed, because the so-called correlation--Phillips
curve correlation proved to collapse as soon as the Fed tried
to exploit it. That is a very famous analytical mistake which
everybody teaches--
Chairman Campbell. I remember. I was at UCLA in economics
then. I remember that stuff.
Mr. Goodfriend. Yes, but there is another mistake, which is
really the same mistake. Now, I was at the Federal Open Market
Committee as a back-bencher until 2005. And I remember, in the
run-up to the housing--the credit turmoil, people at the Fed
would say, there has never been a nationwide house price
collapse. In other words, it looked like, if you diversified
your mortgages across the United States, you were safe.
But that correlation--or the lack of that correlation
collapsed when the markets tried to exploit it. House prices
became highly correlated in the end, and they all collapsed
together. But that is an analytical mistake which is equivalent
to the Phillips curve mistake, in the sense that you look back
at history and you see, in this case, a lack of correlation
that is a safe bet that we won't have a housing crisis.
It was exactly the same analytical mistake in a slightly
different context made by our policymakers, only this time it
was in the credit markets and it caused a boom and bust in
housing.
Chairman Campbell. Okay. Mr. Pollock?
Mr. Pollock. Mr. Chairman, I would say the best thing the
Fed has done is actually create a working elastic currency,
which was the principal assignment they got in the Federal
Reserve Act of 1913, and that has been done and fully achieved.
The worst thing they did, I think, was the Great Inflation
of the 1970s, which set up the amazing and horrible financial
catastrophes of the 1980s.
If I may nominate a second worst thing, it was making the
market believe in the Greenspan put in the 1990s and the early
2000s.
Chairman Campbell. Dr. White?
Mr. White. Rather than look for--I agree with what has been
said about high points and low points, of course. But if we
look at the 100 years of the Fed and sort of come back to the
theme of this hearing, if you compare the Federal Reserve track
record on inflation and on inflation unpredictability, price
level unpredictability, and on stability in the real economy,
it hasn't done better than the far-from-perfect system that
preceded it.
Inflation has been much higher. The predictability of the
price level has been much lower under the Fed, which is why you
don't have 50-year railroad bonds anymore--besides not having
railroads. You don't have 50-year corporate bonds anymore. And
in terms of business cycles, the Fed has not succeeded in
ironing out business cycles, with some rare exceptional periods
that have been mentioned. So--
Chairman Campbell. Okay, if I can catch--I am going to be
strict with time because we have to give up this room.
Mr. Foster, if you want to continue on that line of
questioning, you may, or whatever you like. You are recognized
for 5 minutes.
Mr. Foster. Yes, sure. Does anybody want to finish up on my
last question? Then I will go on to--just, first, to make a
comment actually on what has been happening in our economy.
When people ask me to report in a simple way, I go to household
net worth. And in the last 18 months prior to March of 2009,
households and families in America lost $16 trillion. Then, we
passed the stimulus and a number of very aggressive
interventions into our economy. And since then, households in
America have regained more than $18 trillion. So we have more
than made up. And so the--this government intervention in an
emergency is one of the crucial--it would be nice if we didn't
have emergencies, but there are times when it is necessary.
And one of the things I would like to--back to the
unemployment thing is, there used to be this thing that was
called the Okun rule, which you are probably all familiar with,
that says when the economy gets better, that unemployment goes
down, a correlation between the rate of GDP growth, I think,
and the drop in unemployment.
And so what we have seen during this time, the $18 trillion
rebound of household net worth, we have also seen a V-shaped
rebound in business profitability, in GDP, and just everything
you can name, but the unemployment has been much slower. This
is called by some, that Okun's rule broke.
And I was wondering if you have any comments on this. Is
this really just a structure change, the triumph of capital
over labor, the fact that machine thought is now up to the
point where you can actually replace a lot of human brains with
automation? Or is it--is there something else going on here?
Mr. Bivens. My view is that Okun's rule is actually holding
up pretty well over this recovery. What we really have is a
very slow growth recovery. We don't have a particularly slow
employment growth contingent on GDP growth.
If you look at productivity, which should be the wedge
between how fast GDP is growing and how fast employment is
growing, it has actually been slower in this recovery than
previous ones. We still are just far too below potential. We
still have far too deficient demand in the economy. And so to
the degree to which employment growth is disappointing, it is
because GDP growth is disappointing.
We did a lot of good things in the wake of the first
housing bubble burst, but I think we withdrew lots of them too
soon. The Fed is one thing that was not withdrawn too soon, but
all the talk of the taper makes me worried that the one engine
that is still pushing the economy forward may soon be
sputtering, as well.
Mr. Gagnon. There is a secular decline in sort of how much
of GDP goes to workers versus capital, which I don't fully
understand myself, but it is--
Mr. Foster. It was first observed by Senator Paul Douglas,
whom my mother worked for in the 1950s, the famous economist
from the University of Chicago. Anyway, just a side point. But
do you have any deep thoughts on this or--and it is outside the
realm of anything the Fed can do? This is just a secular shift
and--
Mr. Gagnon. I don't see--I worry about this, but I don't
make it my special area of study, because I don't see what the
Fed can do. I think it is a huge issue, and I think a Member
over there raised it, too. And I wish I knew what the Fed could
do about it. It seems more of a micro, regulatory, education,
structural issue, not a macro, monetary issue.
Mr. Pollock. Congressman, Goodhart's paradox in economics
and monetary policy is that whenever you find a statistical
relationship that looks reliable and you then try to make it
into a tool to manage the economy, it breaks down.
Mr. Goodfriend. On the point about the rising so-called
labor share of national--on falling labor share of national
income, that has to be related to the globalization of labor
markets in a way that is hurting--it actually has a bifurcating
effect on countries around the world. Those people positioned
to benefit from globalization and what they do are getting
benefits, but most people are having their real income
constrained by competition from other parts of the world.
And this is happening in countries all around the world. It
is a global phenomenon. There is very little an independent
central bank can do in a country about it.
But on a note of optimism, I would say, it is going to take
years for this to end, but it is already beginning to end in
China. In other words, China's benefits over the last 20 years
have been because they have been able to sell goods by
exploiting their own labor. They are coming to the end of the
line with that policy, as workers from the interior moving to
the cities are becoming more scarce, and so wages have had to
be paid up. And so wages--
Mr. Foster. Yes, but there is also the flattening of
corporate structures. Middle management can be smaller with
good software. A lot of it is internal. It is not all foreign
wage pressure.
Mr. Goodfriend. That is true, but my feeling is that--
Mr. Foster. That is the domino effect?
Mr. Goodfriend. --this is being driven by global trade,
which is going to come to an end, if we can be optimistic about
that.
Chairman Campbell. Okay, the gentleman's time has expired.
I now recognize the gentleman from Michigan, Mr. Huizenga,
for 5 minutes.
Mr. Huizenga. Thank you, Mr. Chairman. I appreciate that.
And I wish that Dr. Meltzer was still here. He was giving us
that classic economist two-sided answer about whether the Fed
was more constrained or less constrained or less independent.
And it seemed to me, as he was going through that, it
struck me, as he was talking about the expansiveness that the
Fed has taken on, that it hasn't just been on their own
volition, that there has been some direction, and certainly
they have been allowed and have not had much push-back, maybe,
on this committee, led by our Chairman Hensarling and a few
others, but I want to talk a little more specifically about QE
and quantitative easing and reading Dr. Gagnon's piece that he
had submitted to us in arguing that it should have been more
aggressive and earlier.
I want to delve into that a little bit more and maybe get
somebody else's--Dr. Goodfriend or Dr. White, somebody else,
because it seems to me that what we have done is we have
artificially lowered interest rates. It seems to me that--I
know that the chairman takes a bit of umbrage at that
description, but I don't know how you describe it any other
way.
The reverse of that is, my kid set up a lemonade stand at
the end of the driveway, and they are curious why Mom is the
only one who bought the $2 glass of lemonade. It is because
everybody else is waiting for the 50 cent cup of lemonade.
And we have done the exact opposite. We have gone in and
said, hey, who wants to buy? Not many hands have gone up,
except for Treasury. Or the Fed. And so suddenly we are finding
ourselves in this era that we are trying to call it as a free-
market decision, but it really isn't. Isn't that the case? Dr.
Goodfriend or Dr. White?
Mr. Goodfriend. I will start briefly. I think you are
referring to the mortgage-backed securities that the Fed is
financing. Essentially, the Fed is financing 75 percent to 80
percent of new mortgages in the United States. And in doing so,
it impairs the free market's ability to do that, because by
virtue of the fact what the Fed is trying to do, it's cutting
the spread, the mortgage-backed spread relative to Treasuries
so low that it is not profitable for private markets to go in
and resume funding of mortgages. It is a problem.
And my view is, the Fed should set a strategy by which it
intends to exit that market so that people can--so that
businesses can plan to resume their financing of mortgages in
America, and the Fed has not done that. This is an example of
what Allan Meltzer was saying and what I said earlier.
The Fed needs to give guidance to markets about its
strategy so markets can then plan for their re-entry into this
mortgage market. Not giving guidance is just making it
impossible for markets--private people to resume and plan for
re-entry into the mortgage market in America. It should have
started already, and I hope it starts as soon as possible. The
Fed needs to provide a plan for its own exit from the mortgage
market.
Mr. Huizenga. Mr. Pollock, do you care to try to--we will
see how far down I will go.
Mr. Pollock. Congressman, I will comment on the very low
interest rate strategy, if I may. As was pointed out before,
short-term rates are extremely low. In fact, in real terms they
are negative. For a long time, rates on 10-year Treasuries were
negative in real terms, in inflation-adjusted terms. This has
crushed savers, as the Congressman pointed out. I think one way
to think about this--
Mr. Huizenga. Can I add a little something in there?
Mr. Pollock. Yes.
Mr. Huizenga. Has that benefit, I think, as Dr. Gagnon was
arguing, about the lower-income homeowner purchaser, does that
outweigh what my friend from New Mexico is hearing in his town
hall meetings and what I am hearing from my own elderly parents
and from other constituents?
Mr. Pollock. In my opinion, no, because the other set of
regulatory overreactions has cut out a lot of those borrowers.
But it is a trade-off. Of course, the point has been to favor
borrowers at the expense of savers. That is a political
decision made by the Fed.
Once you have a bubble, if I can just finish this thought,
there is no easy, pleasant outcome. There are only bad outcomes
and painful outcomes. The losses have occurred, the losses have
to be taken by someone. The Fed's strategy has put a large
amount of those losses on savers, just as a matter of fact.
Mr. Huizenga. Dr. White?
Mr. White. Yes, I share your concern about artificially low
interest rates. One of the big contributors to the housing
bubble was the Fed holding interest rates too low for too long,
from 2002 to 2005, and we don't want to repeat that episode. So
as the recovery proceeds, the Fed should be ready to let
interest rates rise.
Chairman Campbell. Okay. The gentleman's time has expired,
so thank you.
Next, we will move to the gentleman from South Carolina,
Mr. Mulvaney.
Mr. Mulvaney. Thank you, Mr. Chairman.
Chairman Campbell. You are recognized for 5 minutes.
Mr. Mulvaney. Thank you, Mr. Chairman. Of course, the
purpose of the hearing today on the 100th anniversary of the
Fed is to sort of look back over the last 100 years and maybe
look forward to the next 100 years. And it strikes me that one
of the things that may be very, very different, at least for
the next several years, was referred to by Mr. Pollock in one
of his earlier answers about interest rate risk and what--the
interest rate risk the Fed has currently exposed itself to over
the--as a result of the immense growth in its balance sheet.
I want to talk a little bit about the combined earnings of
the Fed and about how the Fed funds itself. My understanding is
that the Fed earns money in a couple of different ways. They
provide a couple of services, but they also earn interest on
their balance sheet. I would consider those in my old line of
work to be sources of cash or earnings. They also have
expenses. They have to pay for themselves, and they also have
to pay interest on the reserves that various financial
institutions hold at the Federal Reserve.
It strikes me--and I could be wrong about this--that
ordinarily, that that was a positive number over the course of
the last 100 years. Again, I wish Dr. Meltzer was here, because
he knows more about it off the top of his head than I think
everybody else put together, but my understanding is that
generally speaking, that number has been positive, and the Fed
has made enough money off of its combined earnings to fund
itself.
I think it is very easy to anticipate a circumstance in the
near future where that number will turn negative, that as you
start unwinding, if you start tapering, not only will there be
a tremendous balance sheet loss, in terms of the value of the
assets on the balance sheet--but, of course, that is not
earnings--but also in the amount of money that the Federal
Reserve has to pay out on the reserves on which it pays
interest that the financial institutions are holding with it.
So I ask you the question, gentlemen, that if we go into
this--in this hypothetical situation, I suppose, where the
Federal Reserve is not--does not enough combined earnings to
fund itself, where will its money come from?
We will start with Dr. Goodfriend and then go Mr. Pollock,
and to anybody else who wants to respond.
Mr. Goodfriend. Okay, you are absolutely right. There is a
situation in our future where it is doubtful the Fed will be
able to withdraw reserves and shrink its balance sheet back
before it has to pay interest on reserves to get overall
interest rates in the economy higher to act against inflation.
And so what will happen is--the possibility of what we call
a negative cash flow problem may very well occur, and the Fed
should prepare for it, talk about it to you all, because it is
going to be a fiscal policy drain. It becomes a matter of the
Congress about how the Fed plans for this. So the Congress
needs to ask the Fed, how do you plan for this?
Mr. Mulvaney. I asked that question, and he said he was
going to create--is it a deferred asset? I forget the name of
the term. He would create that, and I didn't really understand
what that meant, because it is a term I think that in
accounting only makes sense at the Fed.
Mr. Goodfriend. If I may, let me describe something which
is interesting. The Fed a few years ago put out a warning for
commercial banks, ``Please take care of the interest rate risk
on your balance sheet.'' The Fed is worried about whether the
commercial bank system will prepare for the day when long-term
rates rise, and the commercial banks will have to pay higher
rates on their deposits.
And the Fed said, ``You should hold more surplus capital,
build up now against those losses which you will certainly have
to deal with as the economy normalizes.'' But the Federal
Reserve has never built up its surplus capital. It has never
taken its own advice that it gives to the commercial banks to
prepare for the day in which it is going to need that kind of
residual financial tinder.
Mr. Mulvaney. And when it does need that financial tinder,
where is it going to come from?
Mr. Goodfriend. That is the point. Banks build up--the Fed
should withhold--
Mr. Mulvaney. But they haven't done that.
Dr. Gagnon, it looked like he had the answer--an answer
or--help me understand.
Mr. Gagnon. Yes, because I was at the Fed when we were
planning for this. And you are right that the Fed can book an
asset which will make it look as if it is solvent, and that is
what you were talking about, but what really matters is the
cash flows. And you are right. The Fed, I believe, will have
negative cash flows at some point in the future, and it will
pay that just by creating more reserves to pay the interest on
the existing reserves, and it can do that without limit if it
wants.
This situation won't last forever. It is unfortunate, but,
Marvin, I--it is my understanding is that the Fed isn't allowed
to keep capital. It has to hand over its profits to Treasury
every year, according to a formula. It would have liked to have
kept reserves, because it has been earning a lot of money
lately, and it would like--
Mr. Mulvaney. And those are the remittances--
Mr. Goodfriend. That is not actually true.
Mr. Gagnon. What?
Mr. Goodfriend. There is a gentleman's agreement between
Congress and the Fed that was established in the period before,
or right after World War II, and it is a gentleman's agreement,
to my understanding. It is an understanding. The Fed, if it
wanted to, could retain surplus capital against interest rate
risk.
Mr. Mulvaney. Mr. Pollock is actually saying no. And this
is what I love about this discussion.
Mr. Pollock. I think it is true that it could, but if it
did, it would increase the budget deficit. The Fed makes a lot
of money. The Federal Reserve banks are almost always, measured
by return on equity, the most profitable banks in the country,
and the money goes to the Treasury, by and large, after a small
dividend and small expenses.
If it comes to the point that payment on reserve balances
exceeds the yields on the assets or assets are sold at a loss,
generating negative cash, then those payments to the Treasury
will disappear. That will make the deficit go up.
But you raised an accounting point. There is a debit there
when that happens. Normal people would think the debit would go
to net worth, but, in fact, under the Federal Reserve
accounting, it goes to a ``deferred payment to the Treasury''--
Mr. Mulvaney. Okay, I have to--
Mr. Pollock. --intangible asset.
Mr. Mulvaney. I have to give back. I hear--because we have
to give up the room. So--
Chairman Campbell. Thank you.
Mr. Mulvaney. --thank you, gentlemen. Thank you, Mr.
Chairman.
Chairman Campbell. Thank you. So the gentleman from New
Mexico, Mr. Pearce, is recognized for the final 5 minutes.
Mr. Pearce. Okay, thank you, Mr. Chairman.
Mr. Pollock, you had addressed the idea of an elastic
currency, and so I will ask--first of all, to make an
observation, I had my dad carry me to where I was born, and it
was a dirt floor chicken place. They ran the chickens out. And
so I was--Dad got a raise, and he started working for $2.62 an
hour, raised 6 kids on $2.60 an hour.
So I was--I have been contemplating that. How could Dad do
that? How could he raise so many on $2.62? So the staff--I had
them digging around on it--so we want to consider 100-year
periods, because the Federal Reserve has been in operation 100
years. So the first 100 years of our country's operation, we
were on a gold standard. And what you could buy for $1 in
George Washington's day, 100 years later, cost you 50 cents.
There were economies of scale, transportation, competition came
in. So you basically had a double--your wage doubled because
the money was worth more.
But then if we look at the last 100 years, what $1 would
buy 100 years ago takes $24 today, so my dad was actually
making about 12 times, half--it was about 50 years ago, so half
that time. So he was working for the equivalent of about 242 at
$2.62--or $24 an hour at $2.62. So, again, I see what the
Federal Reserve is doing is waging a war on the poor with this
elasticity.
And I would appreciate your evaluation, your observation of
that critical nature I have of the Federal Reserve. If it is
incorrect, I would appreciate you telling me.
Mr. Pollock. Thank you, Congressman. I haven't checked your
math, but something like that is certainly right. Elastic
currency I think is a good thing, because it is very useful in
crises, which is why it was created.
If you look at the long-term inflation rates, they are
basically flat, and then, starting in the 1930s, they go up for
the next 80 years. We always forget about the power of compound
interest. As you are pointing out, a 2 percent inflation, 2
percent compound interest, extended over many years, creates a
tremendous change. I point out in my testimony, 2 percent
inflation, the Fed's stated target, will quintuple prices in a
normal lifetime. So my answer is yes.
Mr. Pearce. Okay. Mr. Bivens, you seem to think that the
idea of lenders of last resort, bailouts, whatever you want to
call it, is an adequate task. Now, the firms that we bailed out
made hundreds of billions of dollars in very risky assets, so
you feel like that a taxpayer, say in New Mexico, who makes an
average of $31,000--I have one county where it is closer to
$14,000--the taxpayer who is making $14,000 a year should bail
out somebody who is getting $1 million bonuses on Wall Street
from making crazy, crazy risks where they were leveraged 33 to
1, 40 to 1. Do you think that is an appropriate assignment of
risk for taxpayers in New Mexico to have to bail that out?
Mr. Bivens. No, not at all. I would--
Mr. Pearce. And so you think, then, that the lender of last
resort, if they take the risk, if they take risks that do not
pan out--for instance, maybe it is going to pan out okay on
Fannie and Freddie, but I remember Mr. Paulson coming
downstairs at the Capitol saying, if you will guarantee the
whole thing on Fannie Mae and Freddie Mac, you won't have to
pay a thing. He was about $200 billion wrong on that
assessment. But so you think that is an appropriate use of
taxpayer dollars?
Mr. Bivens. If you could more specific on what--
Mr. Pearce. Fannie and Freddie. To bail Fannie and Freddie
out at $200 billion.
Mr. Bivens. Yes, I--
Mr. Pearce. Okay, that is fine. When does the stuff hit the
fan here? We have been printing money. Mr. Gagnon, maybe--it
doesn't work in Argentina. When is it going to stop working
here?
Mr. Gagnon. You want a middle-of-the-road, you want a
moderate target. Countries who have chosen inflation targets
that are too low, like New Zealand and Japan, have changed
their mind and decided to raise them. I think 2 percent seems
like a moderate level.
Mr. Pearce. Let me go ahead and reclaim my time. I have 14
seconds. The reason that it works, I think, is because we can
export inflation. We are the world's reserve currency. In the
last year, the BRIC nations have said they are no longer going
to trade in our currency. I feel like that we are going to get
all that inflation back inside our country at one fell swoop. I
think that there is a major problem looking at us in the face
when those BRIC nations actually begin to trade in something
other than dollars.
Again, maybe the scheme won't work out, but right now it
looks like it is on thin ice. I yield back my time, Mr.
Chairman.
Chairman Campbell. Thank you, Mr. Pearce.
And I thank all of you on the panel, very much. I don't
know about you, but I think this is pretty fascinating. I
thought there was some very interesting discussion, and it is
all helpful, and I appreciate all six of you and Dr. Meltzer in
absentia that--for your contributions to the beginning of this,
as I hope you can see, very wide-ranging and open discussion
about how did we get here, what does it look like now, and what
should it look like going forward.
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.
With that, and without objection, this hearing is now
adjourned.
[Whereupon, at 4:27 p.m., the hearing was adjourned.]
A P P E N D I X
September 11, 2013
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