[House Hearing, 113 Congress] [From the U.S. Government Publishing Office] WHAT IS CENTRAL ABOUT CENTRAL BANKING?: A STUDY OF INTERNATIONAL MODELS ======================================================================= 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 __________ NOVEMBER 13, 2013 __________ Printed for the use of the Committee on Financial Services Serial No. 113-50 [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] U.S. GOVERNMENT PRINTING OFFICE 86-685 PDF WASHINGTON : 2014 ----------------------------------------------------------------------- For sale by the Superintendent of Documents, U.S. Government Printing Office Internet: bookstore.gpo.gov Phone: toll free (866) 512-1800; DC area (202) 512-1800 Fax: (202) 512-2104 Mail: Stop IDCC, Washington, DC 20402-0001 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 ---------- Page Hearing held on: November 13, 2013............................................ 1 Appendix: November 13, 2013............................................ 35 WITNESSES Wednesday, November 13, 2013 Lachman, Desmond, Resident Fellow, American Enterprise Institute. 5 Makin, John H., Resident Scholar, American Enterprise Institute.. 8 Orphanides, Athanasios, Professor, Practice of Global Economics and Management, Sloan School of Management, Massachusetts Institute of Technology........................................ 7 Posen, Adam S., President, Peterson Institute for International Economics...................................................... 10 APPENDIX Prepared statements: Lachman, Desmond............................................. 36 Makin, John H................................................ 49 Orphanides, Athanasios....................................... 62 Posen, Adam S................................................ 68 Additional Material Submitted for the Record Huizenga, Hon. Bill: Wall Street Journal article entitled, ``ECB's Praet: All Options on Table,'' dated November 13, 2013................ 79 Written statement of Lawrence Lindsey........................ 82 Wall Street Journal article entitled, ``Andrew Huszar: Confessions of a Quantitative Easer,'' dated November 11, 2103....................................................... 98 WHAT IS CENTRAL ABOUT CENTRAL BANKING?: A STUDY OF INTERNATIONAL MODELS ---------- Wednesday, November 13, 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 2:27 p.m., in room 2128, Rayburn House Office Building, Hon. Bill Huizenga [vice chairman of the subcommittee] presiding. Members present: Representatives Huizenga, Pearce, Posey, Fincher, Stutzman, Mulvaney, Pittenger, Cotton; Clay, Perlmutter, Carney, and Kildee. Ex officio present: Representative Hensarling. Mr. Huizenga [presiding]. The subcommittee will come to order. And without objection, the Chair is authorized to declare a recess of the subcommittee at any time. It appears that we will be having votes somewhere around 4:15 or 4:30, is the indication that we have. So with that, we are going to get moving, because we have a lot of very interesting stuff ahead of us as a committee today. And the Chair is going to recognize himself for 5 minutes for the purpose of an opening statement. So we have to ask ourselves, what is central about central banking? What works? What doesn't? What thinking went into forming the European Central Bank 80 years after the formation of our own Federal Reserve and how has it lived up to expectations so far? Did it perform better or worse among its peer institutions in the wake of the financial crisis? It is these questions and others that our committee is interested in exploring as we consider potential reforms of our own Federal Reserve System, which is posting its 100th anniversary this year. This afternoon, we welcome our witnesses: Dr. Desmond Lachman from the American Enterprise Institute; Dr. Athanasios Orphanides from the Massachusetts Institute of Technology; Dr. John Makin from the American Enterprise Institute as well; and Dr. Adam Posen from the Peterson Institute for International Economics. Gentlemen, thank you very much for being here today. We appreciate your time. Today's hearing will examine the central banks of the other advanced economies around the world, focusing on their governance and policy tools, as well as their successes and failures in implementing monetary policy. The Federal Reserve prides itself on being an independent central bank here in the United States. However, independence is hard to measure and even more difficult to demonstrate. The appointment process of policymakers, reporting requirements, and policy review processes all play a role in defining the relationship that central banks have with their own national governments. Even still, the most independent central banks are ones where there is very little coordination or interference by fiscal policy decisions. In 2009, the Bank of International Settlements (BIS) surveyed 41 central banks and reported on both the broad commonalities in the structures and roles of these institutions as well as the differences among them. The BIS reported that all the central banks it surveyed have full or partial responsibility for monetary policy. Over half are given policy objectives, usually specified in domestic law or international treaty, but some policy objectives come by published statements that do not have the force of law. Many have either a ``single mandate'' of pricing stability or a primary goal of price stability with secondary macroeconomic objectives. The United States and Canada are the only two countries identified as having a price stability mandate equally weighted with other macroeconomic objectives. I think this dual mandate is what we will be discussing quite a bit. Nearly all central banks have full responsibility for formulating and implementing monetary policy. Specifically, we will explore today international models of central banking. Some central bank models, like our own U.S. Federal Reserve System, have a ``dual mandate'' of enacting monetary policy with a goal of maximizing employment while simultaneously minimizing inflation. Other countries' central banks work under a more focused or prioritized mandate or set of mandates. And that is what I am hoping to personally hear today from all of you. Some, like myself, also believe that the employment component at a minimum has diverted the Fed's attention from the more important issue of inflation, which in my opinion should be the sole focus. In the worst case, an equal price stability and employment mandate has the potential of a moral hazard, with the Fed playing off its regulatory role against its monetary role. I look forward to hearing from our witnesses today as we compare and contrast with other international banking models. What we will learn today should not only inform our own understanding of the increasingly global and complex macroeconomy, but should also contribute to our efforts to enact reforms on our own Federal Reserve System as it hits its 100th anniversary milestone. And with that, the Chair is going to yield back the rest of his time. The Chair now recognizes the distinguished ranking member of the subcommittee, Mr. Clay of Missouri, for 5 minutes. Mr. Clay. Thank you, Mr. Chairman, and thank you for holding this hearing regarding central banks of other advanced economies and focusing on their governance. In the United States, the Full Employment and Balanced Growth Act of 1978, better known as the Humphrey-Hawkins Act, set four benchmarks for the economy: full employment; growth in production; price stability; and balance of trade and budget. Also, Humphrey-Hawkins charges the Federal Reserve with a dual mandate: maintaining stable prices; and full employment. The Bank of International Settlements report found that many nations have either a single mandate of price stability or a primary goal of price stability with a secondary macroeconomic objective like full employment. The United States and Canada are the countries identified as having a price stability mandate equally weighted with other macroeconomic objectives. Many central banks have sole inflation targets, sole exchange rate targets, and others have price stability targets. Also, asset portfolios of central banks vary considerably. Some hold foreign assets, government debt, and claims on financial institutions. And during the financial crisis, the Federal Reserve purchased commercial paper, made loans, and provided dollar funding through liquidity swaps with foreign central banks. Due to this action, the Federal Reserve Bank balance sheet has expanded. When you look at the European Central Banks (ECBs), their main objective for the euro system is price stability and safeguarding the value of the euro. During the financial crisis and the euro crisis, the ECB used several policy tools, including long-term liquidity, refinancing liquidity swaps with the Federal Reserve, and purchase of the euro denominating covered bonds and other government bonds on the secondary market. The ECB's balance sheet has expanded. The Bank of Japan set monetary policy to achieve price stability. During the financial crisis, the Bank of Japan purchased private debt security, offered long-term refinancing operation, and provided dollar funding through liquidity swaps with the Federal Reserve. The Bank of Japan's balance sheet has expanded. And one more example. The Swiss National Bank's primary goal is to ensure price stability. During the financial crisis, its balance sheet has expanded. Mr. Chairman, I will conclude there with my opening statement. And I look forward to the witnesses' comments. I don't know if the gentleman from Colorado wants me to yield--I yield the rest of my time to the gentleman from Colorado. Mr. Perlmutter. I thank the gentleman. Just a couple of points. Listening to the Chair's opening, I personally think that you can't operate in a vacuum, that you have to compare your price stability inflation versus how many people are working and what the economy is doing. And we have enjoyed a very low inflation rate now for a number of years, even with pretty expansionary monetary policy. But we have had very checkered fiscal policy in the process. And so, I do appreciate the gentlemen for testifying today. I look forward to your testimony. But I, for one, support sort of the Humphrey-Hawkins approach, which is you don't look at just any one thing. And I know certain central banks, that is their sole focus. I appreciate the fact that the Federal Reserve in our country gets to look at more than just one thing and has the responsibility to address more than just one thing. With that, I yield back. Mr. Huizenga. The gentleman yields back. With that, the Chair would like to recognize Mr. Stutzman from Indiana for 3 minutes for an opening statement. Mr. Stutzman. Thank you, Mr. Chairman. And I want to thank each of you for being here, and also thank the chairman and the ranking member for holding this hearing to evaluate various central bank structures throughout the world, many of which look very different than our own U.S. Federal Reserve System. I want to thank each of you for being here and for bringing your expertise in order to examine the ways we might analyze these different central banking systems. Conducting an honest evaluation here will allow us to better understand how well our own systems function. I remain particularly interested in those governments without a dual mandate, which is most of the world. As you may know, Mr. Chairman, I have authored a bill, the FFOCUS Act, which eliminates the Fed's dual mandate in order to focus on price stability. I have said before that the American people can ill afford the inflation, debt, and insecurity that this misguided approach threatens. Now is the time to repeal the dual mandate and break this destructive cycle and return to a predictable, rules-based system. Numerous economists and scholars have come before our committee supporting this position and reiterating that the dual mandate undermines any attempt to fashion predictable monetary policy. I agree with those who say the dual mandate underpins the Fed's rationale for greater discretion when forming monetary policy, creating a troubling lack of accountability and oversight. Today, I look forward to examining other global models and how they seek to strike the right balance of independence and oversight. Lastly, I remain troubled at the Fed's bloated balance sheet and I remain unconvinced that there is a viable exit strategy from the Fed's policy of quantitative easing. So in this light, I am in interested in how other central banks handle the makeup of their balance sheets and what lessons we can take away from them. Again, thank you for holding this hearing, and I look forward to the testimony of our witnesses. And I yield back, Mr. Chairman. Mr. Huizenga. The gentleman yields back. And with that, I would like to extend a warm welcome to our panel of distinguished witnesses today. We are going to be starting from our left to right here with Dr. Desmond Lachman. He is a resident fellow at the American Enterprise Institute. He has previously taught at Georgetown and Johns Hopkins Universities. He served as a deputy director of policy development review at the International Monetary Fund and has worked as a managing director and chief emerging market economic strategist at Solomon Smith Barney. We also have Dr. Athanasios Orphanides, a professor of the practice for global economics and management at MIT Sloan School of Management. He served a 5-year term on the European Central Bank Governing Council as a governor of the Central Bank of Cyprus. He also served as a senior adviser to the Federal Reserve Board of Governors and taught courses at Georgetown and Johns Hopkins Universities as well. Dr. John Makin is a resident scholar at the American Enterprise Institute. Previously, he worked as the chief economist at Caxton Associates. He has served in capacities at the Bank of Japan, the U.S. Treasury Department, the International Monetary Fund, and the Federal Reserve Banks of both San Francisco and Chicago. He has also taught courses at the University of Wisconsin, Milwaukee, the University of Virginia, and the University of British Columbia. Finally, last but not least, Dr. Adam Posen is president of the Peterson Institute for International Economics. Previously, he has served as a member of the Bank of England's Monetary Policy Committee and also worked as an economist at the U.S. Treasury Department. Gentleman, you will be recognized for 5 minutes each to give your oral presentation of your testimony. And, without objection, your written statements will also be made a part of the record. On your table right in front of you, you see lights. It will start out green. When it turns yellow, you have 1 minute to sum up. And when it turns red, you will be hearing my gavel shortly after that. So we would like you to wrap that up and pay attention to that timing. And once each of you has finished presenting, each member of the committee will have up to 5 minutes within which to ask any or all of you questions. And with that, Dr. Lachman, you are recognized now for 5 minutes. And welcome. STATEMENT OF DESMOND LACHMAN, RESIDENT FELLOW, AMERICAN ENTERPRISE INSTITUTE Mr. Lachman. Thank you, Mr. Chairman, Ranking Member Clay, and members of the subcommittee for affording me the honor of testifying before you today. I am going to talk about the four major central banks of the world: the United States; Japan; Europe; and the Bank of England. Over the past 5 years, all of those banks have pursued unorthodox monetary policies on an unprecedented scale. This has led to massive expansion in these central banks' balance sheets and it has taken monetary policy into entirely uncharted waters. Since September 2008, with the Lehman crisis, the motivation for the pursuit of unorthodox monetary policies in all of the major industrialized economies has broadly been similar. All of these countries' central banks needed to intervene aggressively in financial markets to repair the damage wrought by the Lehman crisis. In addition, with policy interest rates having reached their zero lower bound, and with unusually weak economic recoveries and very low inflation, these central banks have all felt obliged to resort to policies aimed at reducing long-term interest rates, increasing asset prices, and encouraging risk-taking. While unorthodox monetary policies have led to a dramatic expansion in all four major central banks' balance sheets to a range of between 20 and 30 percent of the respective countries' GDPs, there has been a marked difference in the manner in which these central banks have implemented their policies. Underlying these differences have been basic differences in the structure of these countries' financial systems, as well as in the specific problems that these individual central banks have been trying to address. Assessing the relative success of unorthodox monetary policy pursued by the major industrialized countries is rendered difficult and subject to debate for two basic reasons. The first is that we cannot know what the counterfactual would have been had these policies not been pursued. The second is that it is still far too early to know what the longer run consequences of these policies will be since we do not yet know what will happen once these policies are unwound. Having said that, there would seem to be little room for debate about the success of these policies in restoring the proper functioning of the global financial system in the immediate aftermath of the Lehman crisis. There also seems to be little room for doubt that the world's major central banks have succeeded in lowering long-term interest rates and in boosting asset prices. In addition, it would seem that the ECB's Outright Monetary Transaction program, announced in August 2012, was highly successful in substantially reducing sovereign borrowing costs in Europe's troubled economic periphery, while the Bank of Japan's more aggressive round of quantitative easing, announced in 2012, has succeeded in substantially weakening the Japanese yen, thereby increasing Japanese inflationary expectations. Now, critics of qualitative easing observe that despite the large decline in long-term borrowing rates and the strong increasing local asset prices, the economic recovery in industrialized countries is the weakest of the post-war period. While true, this criticism would not seem to be a serious indictment of recent quantitative easing policies. It overlooks the fact that absent forceful central bank action, it is highly probable that the industrialized countries would have again leapt into serious recession. A more serious line of criticism of the unorthodox monetary policies being pursued by the world's major central banks is that too little regard is being paid to the unintended longer run consequences flowing from these policies. These consequences could materially compromise the longer run global economic outlook. Among these unintended consequences are, first, the risk that these policies might be giving rise to excessive risk- taking and to bubbles in asset and credit markets. In this context, one has to wonder whether historically low yields on junk bonds in industrialized countries now understate the risk of owning those bonds and whether yields on sovereign bonds in European periphery have not become disassociated from those countries' economic fundamentals. The second unintended consequence is that there have been large spillovers to other economies through capital flows and exchange rate movements that have given rise to the charge of currency war. This is of particular concern to the dynamic emerging markets' economies, whose growth prospects have been compromised. The third drawback of these policies is the moral hazard to which they give rise by reducing the urgency of governments to undertake necessary but painful economic reforms. This would seem to be particularly apparent in both Europe and Japan. Since the Lehman crisis, the U.S. economy has performed relatively well in relation to those of the eurozone, Japan, and the United Kingdom. Nevertheless, it would seem at least two lessons for the Federal Reserve can be drawn from the experience of the central banks in those countries. First, Europe's particularly poor economic performance in the aftermath of the Lehman crisis would suggest that a single inflation objective mandate and a high degree of central bank independence do not guarantee meaningful economic recovery. Second-- Mr. Huizenga. I'm sorry, Dr. Lachman, but your time has expired. So I will let you wrap up with one quick sentence, and then we are going to have to move on. We can explore that further in questions. Mr. Lachman. All right. The final point I would make is that aside from the experience of other central banks, I think that the United States' own experience would also caution it against the danger of running up very large assets and credit market bubbles, and that in the conduct of this policy, one really has to be mindful not simply of the short run effects of policy, but also of the longer run costs that we might yet find that we are going to pay. Mr. Huizenga. Thank you. With that, the gentleman's time has expired. [The prepared statement of Dr. Lachman can be found on page 36 of the appendix.] Mr. Huizenga. Dr. Orphanides, you are recognized for 5 minutes. STATEMENT OF ATHANASIOS ORPHANIDES, PROFESSOR, PRACTICE OF GLOBAL ECONOMICS AND MANAGEMENT, SLOAN SCHOOL OF MANAGEMENT, MASSACHUSETTS INSTITUTE OF TECHNOLOGY Mr. Orphanides. Thank you, Mr. Chairman. I appreciate the opportunity to testify at this hearing. As requested, my testimony will focus on differences and similarities between the Fed and the ECB. I think the 100-year anniversary of the Fed is an apt occasion for reflecting on the structure of the institution. Historical experience suggests that a well- functioning monetary system is a prerequisite for the greatness of any nation, and this is what has been achieved since the creation of the Federal Reserve 100 years ago. Since its founding, the Fed has evolved into a very powerful central bank and serves a leading role in global central banking. As a public institution, the Federal Reserve is unparalleled in the professional integrity, technical expertise, dedication to public service, and collegiality that has characterized its staff and leadership. Over its first 100 years, the Fed has contributed, I believe, to the welfare of the Nation, but has not always managed to avoid major errors. The Great Depression of the 1930s and the great inflation of the 1970s are the most noticeable examples. I am certain that historians will reflect on the most recent crisis over the next many years. In my view, the Fed's actions in late 2008 and 2009 were decisive for averting what could have become an economic collapse of Great Depression dimensions. However, the easy money policies that have been pursued do create additional challenges. And right now we do see that the central bank's balance sheet and associated continued easing are unprecedented. What I would like to draw attention to is three elements between the Fed and euro system. One is in the decentralized nature of the institutions. This is a common characteristic that is quite important in that the inclusiveness and incorporation of regional perspectives ensures that monetary policy better reflects the needs of a broad economy, which we have in both cases. The second element is the independence of both institutions. Both the Federal Reserve and the ECB are very independent central banks, but the ECB is more independent than the Federal Reserve in that its operations are governed by treaty and not by law, and as a result it cannot be changed very easily by modifying a piece of legislation. There is another difference that has to do with the appointment process of Board Members. Both in the United States and in Europe, once appointed, the Board Members are independent; however, the reappointment process and turnover in the United States arguably makes that aspect of independence less in the United States relative to Europe. I believe that the independence of the Federal Reserve could be strengthened, and that would be an improvement, if its Board Members were appointed similarly to the ECB Executive Board Members for just one nonrenewable 8-year term. The third element I would like to draw attention to is the difference in the mandates of the two institutions where, as has been pointed out already in the introductory remarks, the Federal Reserve is governed by a dual mandate that emphasizes, in addition to price stability, full employment. Whereas, in the case of the ECB, price stability is the primary focus of the institution. There I believe that the ECB's mandate better reflects the accumulated knowledge we have had in central banking experience over the 20th Century. It is generally accepted that better results, both in terms of economic stability and in terms of price stability, can be delivered by a central bank that can focus its attention better and be held accountable for what it can do, and that is price stability. So in this sense, I would share concerns that have been expressed, for instance, recently by Chairman Volcker, who pointed out that if the Federal Reserve is trying to pursue multiple objectives, it runs the risk of losing sight of its basic responsibility for price stability that would end up delivering worse results in all of its objectives together. I believe that these risks could be mitigated by Congress with a clarification that explicitly recognizes the primacy of price stability as an operational goal for the FOMC. And I believe that subject to that objective, the Fed would be in a better position to attain additional objectives such as full employment for the Nation. Thank you. [The prepared statement of Dr. Orphanides can be found on page 62 of the appendix.] Mr. Huizenga. Thank you, Dr. Orphanides. With that, we have Dr. John Makin for 5 minutes. STATEMENT OF JOHN H. MAKIN, RESIDENT SCHOLAR, AMERICAN ENTERPRISE INSTITUTE Mr. Makin. Thank you, Mr. Chairman. I want to briefly review the experience of the Fed and the experience of other central banks since the financial crisis. Given that time is somewhat limited, I have tried to lay out some of the approaches that central banks have taken to the crisis. I would remind the committee that the Fed was originally formed after a series of financial crises, the last of which was the crisis of 1907, which underscored the need for some kind of an institution to provide adequate liquidity in order to avoid the negative effects of financial crises, such as those that followed from the numerous crises that occurred in the 30 to 40 years before the Fed was formed. The Lehman crisis was unique. I bring to it the perspective both of an academic and a think tanker, but also someone who was in the middle of the crisis, working at a hedge fund at the time. And I can assure you that the role of the central bank as an institution designed to avoid a total financial meltdown was one of the primary activities that emerged. The typical goals of the Fed, that is price stability and full employment, were subsumed beneath or among the more primary objective of the Fed to try to staunch the severe bleeding that had emerged in the financial sector. In order to follow up and try to restore the growth of employment and to maintain stable prices, the Fed extemporized, using the zero interest rate policy, the quantitative easing, forward guidance. All of these measures were pioneered by the Fed in response to the crisis that was facing them. Other central banks to some degree followed the example of the Fed. You may remember that initially the European Central Bank felt that they had avoided the financial crisis and its fallout. And that outlook was changed in 2009 when it was revealed that the Greek Government was concealing the amount of fiscal deficits that it was undertaking. So basically, central banks have tended to stylize their responses to the crisis, again, as measures designed to try to avoid financial meltdowns. The Bank of Japan this year, as most of you know, initiated measures that were quite similar to what the Fed had undertaken, that is they set a goal for 2 percent inflation and they undertook aggressive additions to their balance sheet in order to try to effect that goal. The outcomes have varied, and I have tried to actually summarize them in my testimony in terms of evaluating what central bank has performed best. In the first figure, I look at the path of gross domestic product from 2008 to the present, and the winner is the United States. Although growth has been slow to somewhat lagging--it is on page 7 of the testimony--the United States has seen a total increase, cumulative increase in output of about 8 percent since 2008. The biggest loser is Spain in this picture because Spain is part of a monetary union in which it does not belong; that is the ECB sets monetary policy for Germany, the rest of Europe has to struggle, and the result is a rapid drop in output. Inflation has not been a big problem so far. In fact, disinflation is emerging as a big problem in Europe and the United States. Figure 2 looks at price levels. The cumulative increase in the price level in the United States, in spite of heavy quantitative easing since 2008, is something on the order of, again, 8 percent. In Switzerland and Japan, prices have actually fallen. And one of their big problems has been to intervene heavily to avoid currency appreciation intensifying their deflation problem. The second wing of the mandate, that is employment, is looked at in terms of figure 3. Central banks have not been terribly successful at engendering growth of employment. And here again, in terms of what the committee is considering, I, too, share the idea that it is probably best to have the central bank target a stable price level. And by that, I mean that inflation should not be above 2 percent, but it should not be below 1 percent. And in an environment where you can get deflation, it is important to put a floor on that range. But in general, the behavior of employment suggests that the central banks have not been terribly successful in pursuing that goal. I see my time is up, so I will stop. [The prepared statement of Dr. Makin can be found on page 49 of the appendix.] Mr. Huizenga. Thank you, Dr. Makin. Dr. Posen, you are also recognized for 5 minutes. STATEMENT OF ADAM S. POSEN, PRESIDENT, PETERSON INSTITUTE FOR INTERNATIONAL ECONOMICS Mr. Posen. Thank you, Mr. Chairman. Since my colleagues, Athanasios, Desmond, and especially John, have taken you through the basics comparisons, I am going to make slightly more pointed remarks. I am going to talk about the operational structure of central banks and what the Fed is doing right and wrong in two major areas, The first issue is of governance and how its goals are set, which goes to the mandate issues and Humphrey-Hawkins issues that people have raised, and the second is about the tools that are available for policy implementation. I would argue that the differences between central banks are going to actually become more important in the next couple of years. In the midst of a crisis, whatever a country's mandate, whatever a central bank's mandate, everybody is going in the same direction, pretty much. And if they don't go in the same direction, they realize very quickly that they have to catch up, and you throw everything you have at the problem. And if you look back, particularly at John, but also at the other testimony, you will see that the central banks did largely the same thing. All this talk about the difference in mandate and uncertainty caused by the Fed's dual mandate is absolute nonsense. There is no evidence econometrically that it makes a difference either to the perceived uncertainty in financial markets or to the levels of inflation you see. So what does matter? Let's talk a bit about goals. The central banks, as Stanley Fischer has pointed out, should not have goal independence, but should have instrument independence. In other words, all of you here as the elected officials should be setting what the central bank's goals are, debating them, resetting them as necessary, but then leaving the central bank alone to get on with the job and not worry too much about how they get on with it, only checking for competence and results after the fact. Perhaps this sounds evident, but this distinction matters greatly. Athanasios mentioned that the ECB has an extreme form of independence and insulation from political oversight. Back in 1993, I predicted that this would be the case and would lead to excessively rule-based behavior. And that is exactly what we saw with the ECB running the European economy partway into the ground. We know that in the Bank of England, and then more recently in the Bank of Japan, we have seen resetting of the policy goals by elected officials in an explicit, transparent manner, taking advantage of the crisis and saying, what have we learned? And this has suffered no shock to inflation, nor stability; it is the way it should work. So does the Fed have it right? I think largely we can say yes. But I think there are three points I would make. First, an atmosphere of extreme distrust from Congress towards the Fed is harmful and unnecessary. We have the whole notion of auditing the Fed, which is looking as though the Fed isn't totally transparent about its balance sheet, which it is. We have the idea of minutes having to be very explicit and tell you everything that was said exactly, which has the effect of making people ashamed to really debate in the FOMC because they are worried about being caught up. We have the fact that capital in the central bank is not guaranteed and therefore the Fed restricts itself from engaging in policies it should, such as potentially selling off assets, because they don't want to have to come to you and explain an on-paper loss. You could indemnify the Fed against losses incurred in the operation of its duties, as Her Majesty's Treasury does for the Bank of England. Most importantly and harmfully, Congress has put increasing restrictions on what the Fed can purchase. This is a terrible step backwards in policy. Every central bank in the world except the Fed can purchase a broader range of assets than the Fed currently does. Every central bank in the world for centuries has purchased private assets and a wide range of assets. It was only this brief interlude from the late 1970s to the early 2000s when central banks made the mistake of thinking they could affect the whole economy by playing at the short end of the yield curve in the government bond market. That has been demonstrated to be completely wrong by the experience of the last few years. Look at the fact that in Europe right now, you have a total crushing of small business credit in southern Europe because the ECB chooses only to purchase certain things at the international level. Let's talk for 1 minute left on tools. Building on this point about where the central bank--Congress has fruitlessly and destructively restricted the Fed's purchases. We have the fact that we get this demonization of purchases and large balance sheets and so-called unconventional monetary policy. Now, the fact is, unless you buy the right things, your policies will be ineffective. The Bank of Japan proved this with its quantitative easing in the mid-2000s when it only bought short duration debt and had no effect on the economy. Once they shifted to buying private and longer term debt, they have managed to reverse deflation. It is wrong in the United States to think that there has been any mistake here. If the United States hadn't been lucky in the fact that Congress has allowed the Fed to buy guaranteed mortgage-backed securities, we would not have had an effective policy response. Had we not had that effective policy response, we would not have the housing-led recovery, such as it is that we have today. And that was sheer luck that Congress happened to have approved of MBS purchases. To repeat, no other major central bank is constrained the way Congress has constrained the Fed in its purchases. This is taking the Fed in exactly the wrong direction. Thank you, Mr. Chairman. [The prepared statement of Dr. Posen can be found on page 68 of the appendix.] Mr. Huizenga. I appreciate that input. And I need to make sure that I get my notes here for a moment. Because of the shutdown that had occurred, we had a well-known expert on the subject who we invited to the original scheduled October hearing, but he is unable to attend today. And without objection, I would like to put Dr. Larry Lindsey's prepared testimony into the record. So without objection, we will do so. And with that, the Chair is going to recognize himself for 5 minutes. Mr. Posen, you are on a bit of a roll against Congress here, and I would add that you are not unique in that in many ways lately. Mr. Posen. My complaints are more narrow, sir. Mr. Huizenga. Yes, yes. I understand your complaints are more narrow. Come to a town hall meeting sometime, and you will have your world broadened. But I just wanted to make sure that you had a chance to express that fully about the limits on the purchases and those kinds of things. And then I would like the rest of the panel to maybe touch on that and whether they would agree with that. Mr. Posen. Very kind of you, Mr. Chairman. And again, obviously, I am working in shorthand; there is no one entity of Congress, and there are obviously people like you and this committee who want to thoughtfully try to do the best possible job. And that is why I am grateful that we are having this hearing. Mr. Huizenga. Duly noted, the buttering up. I appreciate it, though. So I thank you. Mr. Posen. Transparency. The issue is pretty straightforward in my eyes. Central banks literally did most of their operations on private loans and private securities throughout the 19th Century and throughout much of the 20th Century. They did so in an environment with many different things going on, but rarely resulting in inflation, rarely resulting in hyperinflation, rarely resulting in instability. And they did this because it had two advantages. First, it directly went after issues in the markets where there were blockages in the markets. And second, this helped to make markets and create more liquid conditions more broadly that you could intervene. Now, there are costs to doing this because it does of course benefit specific holders of given assets at a given time, which you don't want to do. And there are costs because if it is a narrow market you happen to buy into, it is not that easy to get in and out and the Fed can have too large, or whatever central bank, can have too large an effect on the asset prices. So it is not costless, but it is a tool. Mr. Huizenga. Would anybody else on the panel care to comment on that quickly? Dr. Lachman? Mr. Lachman. I would just make the point that the size of the asset purchases by central banks is without any precedent. It is on a scale that is humongous. So I think not to have congressional oversight on the particular assets that are being made when you are getting distributional effects, I am not sure that I would go along fully with Mr. Posen's point. Mr. Huizenga. Okay. And I would like to just quickly, I am going to take a moment. I would like to submit this into the record, without objection. This is from yesterday's Wall Street Journal, ``Confessions of a Quantitative Easer.'' This was Andrew Huszar, who is a senior fellow at Rutgers Business School, and a former Morgan Stanley managing director. In 2009 and 2010, he managed the Federal Reserve's $1.25 trillion agency mortgage-backed securities purchase program. And I don't know if anybody else has read this. If so, I would love to get a comment on it. But basically, a little headline: ``We went on a bond-buying spree that was supposed to help Main Street. Instead, it was a feast for Wall Street.'' Dr. Makin? Mr. Makin. The ``feast for Wall Street'' rhetoric is popular, but I think it obscures a problem that the Fed faces. And that is, on the one hand, they want to make sure that they keep the recovery going. And so, they are buying assets. I agree that they should be able to buy a wider range of assets. But given the constraints they are facing, they have to buy the assets in order to keep the recovery going. On the other hand, they are supposed to avoid affecting asset prices, which of course is impossible. And the dilemma they face was highlighted last May when Fed Chairman Bernanke suggested that perhaps they should taper or they should reduce the rate at which they are purchasing securities. The result was a 1.5 percentage point increase in mortgage borrowing rates. So I think perhaps the author of the Journal piece, it is easy to criticize, but, on the other hand, if you withdraw what the Fed is doing, you risk some serious problems in the financial markets. And so in summary, what the central bank, especially the Fed is trying to do is to find a way out of providing a large amount of support for financial markets without disrupting the behavior of the economy and causing a sharp rise in interest rates. It is very difficult to do. Mr. Huizenga. Dr. Orphanides, for the last 30 seconds. Mr. Orphanides. Thank you, Mr. Chairman. I would also agree that it is an unfair criticism both for the Federal Reserve and for other major central banks to claim that they have been trying to help the banking system and not Main Street. In order to best help Main Street, central bank policies often have to focus on the financial sector. This is what we have seen both in this country and in other countries. With regard to the purchases of securities, I would agree with Dr. Posen that it would be useful for the Federal Reserve to have the authority to make purchases of other instruments. This is exceptionally important in times of crisis when even very small interventions by the central bank could unclog markets. In the case of Europe, this proved very important. For example, in 2008, 2009, the ECB made small purchases in the covered bond markets just for a short while, and that helped stabilize the market and restore stability. So you don't need many purchases, you need it as a crisis management tool. That said-- Mr. Huizenga. I'm sorry. Unfortunately, my time has expired. So we are going to have to allow one of my colleagues to explore that. The last thing I would like to do, without objection, is also put into the record an article entitled, ``ECB's Praet: All Options on Table, Central Bank Could Adopt Negative Deposit Rate, Asset Purchases If Needed.'' So without objection, it is so ordered. With that, I would like to recognize Mr. Clay for 5 minutes. Mr. Clay. Thank you, Mr. Chairman. Today, it is widely acknowledged that over the past few decades the United States experienced a sharp rise in income inequality, levels of inequality not seen since the late 1920s. Moreover, a recent study out of Berkeley has shown that most of the benefits of growth experienced during the recent recovery have accrued to the wealthiest in society. And when you talk about Fed policies having important distributional impacts on society, do you believe these policies in any way contribute to the problem of growing inequality? Can you give us some examples of Fed decisions that have impacted different segments of society differently and how? I want to start with Dr. Posen. Mr. Posen. Thank you, Mr. Clay. The ongoing rise in income inequality, and particularly wealth inequality in the United States, is largely driven by the U.S. Tax Code, which you are well familiar with, obviously. It is secondarily driven by a global trend that low-skilled Americans and low-skilled workers are getting less and less ability to bargain for wages, while people at the high end of the scale in terms of perceived skill or opportunity get to bargain at superstar status. Those are the two main drivers, and those continued through the crisis. The crisis made things worse in the United States and elsewhere because of course the most vulnerable become unemployed and you see fiscal cutbacks on the provisions that go out to them. Particularly in the United States we saw at the State and local government level, that it was a big cutback and cutback opportunities through the community college and other such systems. Again, this committee is well familiar with that. Where does the Fed come into this? The Fed basically is contributing to inequality. But similar to what Athanasios, Dr. Orphanides just said, it is contributing to inequality in a minor way to prevent a very concentrated blow to inequality in a major way. Let me spell that out. The way the Fed policy is working is it is benefiting stockholders and relatively middle-income householders, people with mortgages, disproportionately. And then you hope that by benefiting those, that will lead to growth in the rest of the economy. And that isn't going for equality. Had the Fed not taken the course it did, you would have seen a much higher increase in small business failures and in unemployment. And so the overall inequality picture might not have been that different, but the concentration of very bad outcomes would have been very high. Mr. Clay. I see. Dr. Makin? Mr. Makin. I agree that the tax system is a much more effective way to address problems of inequality than the Fed. The Fed's goals are already perhaps more than instruments they have to achieve them with, that is to maintain inflation at a low and stable level and to try to minimize unemployment. To that extent, they are trying to deal with all sectors of the economy. But for the Fed to be charged in any specific way, I don't know what instrument the Fed would use to affect income distribution. So I would turn to the Tax Code to effect that outcome, and suggest that perhaps a flatter schedule of tax rates would be a good idea. Mr. Clay. Thank you. Dr. Orphanides, would you have any comment on the income inequality? Mr. Orphanides. Thank you. I would like to emphasize that central banks do not have the tools to achieve all that society might wish that government institutions might be able to contribute to. The best way central banks can contribute to even an element such as the reduction of inequality is by ensuring stability in the economy, the preconditions for economic growth that can then allow households and corporations and businesses to prosper and allow the Congress with fiscal policy to select distributional policies it would have with high income. We cannot expect central banks to deal with this problem. I believe that in the last few years, we have been overburdening central banks already. We expect them to keep interest rates low and help fiscal policy as well. We expect them to contribute much more than they can to full employment. We expect them to fix all the problems of the financial system. We cannot have all of these expectations simultaneously. Mr. Clay. Dr. Lachman? Mr. Lachman. Yes, I would basically agree-- Mr. Huizenga. The Chair is going to take a prerogative here. My time went a little long, so without objection, I will grant just this answer. Mr. Clay. Thank you. Mr. Lachman. I will keep it really brief. I would certainly agree that you don't want to overburden the central bank with too many things to do, that price stability is a big enough task that will do a lot of good. So I would think that other policies, fiscal policies, stuff of that sort, is a more appropriate way to deal with the distribution issue. Mr. Clay. Thank you, Mr. Chairman. Mr. Huizenga. No problem. Thank you. With that, the Chair is going to recognize Mr. Pearce of New Mexico for 5 minutes. Mr. Pearce. Thank you, Mr. Chairman. Mr. Makin, you had made a comment there in response to the gentleman from St. Louis' question about income inequality. Would you state that again? I am just not sure that I heard the whole thing. Mr. Makin. Very briefly, as the other panel members have suggested, the central bank is really not equipped to address issues of income distribution. And the tax system is a better way to do that. Mr. Pearce. And would you have any ideas, understanding it is not the Federal Reserve or central bank's job, but what would you recommend on the tax policy if you were going to make a recommendation? Mr. Makin. I would prefer a kind of textbook approach, which was followed in the 1986 tax reform, which was to have the lowest possible rate on the broadest possible base. So that would partly involve financing lower marginal tax rates by closing loopholes, among other things. Mr. Pearce. Mr. Posen, the Federal Reserve has driven interest rates to almost zero--or to actually zero. Is that a good policy long term for the United States? Mr. Posen. Congressman, it was a good policy and it remains a good policy given the economic context in which we find ourselves, and it is a policy that has very little in the way of long-term implications. Despite the comments made by Dr. Lachman earlier, there is no statistically significant evidence across countries that low interest rates lead to bubbles. It is just not there in the data. It requires a combination of regulatory changes and animal spirits to get bubbles. Low interest rates don't cause them. And if it is not about bubbles, it is not clear what it does. There are second order, meaning existing but not huge distributional effects. My mother, who is a retiree, who has mostly invested all her savings in government bonds has less income now because the Fed did that. Other retirees who happen to have 401(k)s have more income because the stock market went up. The Fed can't fine tune that without getting into deep trouble. And I think on net, it is not a big deal one way or the other. The interest rate only-- Mr. Pearce. If I could take back my time right there, I would invite you to come to my town halls. Mr. Posen. Okay. Mr. Pearce. I have seniors, we have a little bit older population in New Mexico, they come there for the hot, dry weather. They say, we lived our life correctly, we paid for our houses, we have cash equivalents. We used to get 4 percent income--this statement was made this past week--on our investments, and now we are getting one quarter of 1 percent. So for every $16 they used to live on, now they have $1. And they are spending into their capital. And to hear you describe that as not significant, I would like you to use that terminology in front of the hostile people that I get to face at our town halls. Because I will guarantee you, my friend, it is a significant impact on the lives of seniors who have lived correctly, and because of the policies of this government and this Administration, they cannot even live in retirement. And to have that described as nonsignificant statistically just drives people insane when they hear folks in Washington say crap like that. Statistically not important. Do you have a response? Mr. Posen. Yes, indeed. Mr. Pearce. Yes? Mr. Posen. I have two responses. First, when I was serving at the Bank of England I did those town halls myself, without the protection of some local Congressman or MP. I talked to over 8,000 individual U.K. citizens while I was there. And I held myself accountable to people. And I explained to them that just as you think about the 4 percent you used to have wasn't controlled by you and wasn't set by the government, it was a market effect. In reality, if this economy is not growing, there is no interest rate out there. And it is not for the Federal Reserve to subsidize people just because they happened to have done what you call living correctly. Secondly-- Mr. Pearce. I have 24 seconds, sir. And the Federal Reserve is subsidizing Wall Street, because zero interest rates are a boon to the big bankers. They get money for free, and they are able to then charge more. Mr. Chairman, I yield back my time. Thank you. Mr. Huizenga. The gentleman yields back his 5 seconds. All right. With that, the Chair recognizes-- Mr. Perlmutter. The gentleman from Colorado. Ed Perlmutter, the gentleman from Colorado. Mr. Huizenga. Yes, my former neighbor who moved away from me. Mr. Perlmutter. How soon you forget. Mr. Huizenga. Yes. With that, the gentleman has 5 minutes. Mr. Perlmutter. Mr. Posen, I have a bunch of questions. Do you want to finish your second point to Congressman Pearce? Mr. Posen. That is very generous. I will be brief. The definition of living correctly is in the eye of the beholder. Most human beings in the United States live correctly. And whether it is the children of the unemployed; they don't deserve to bear the burden of the crisis any more than the people you are meeting with in your town halls. I wouldn't make a moral judgment. Mr. Perlmutter. And I thank the gentleman for that. I thought you might want to say they ought to take a look at the value of their homes, which had dropped like a rock. And because there has been some effort to stabilize and grow the economy again, really only on the backs of monetary policy, that they can look at their house and see some value returned to their house that fell like a rock in 2008 and 2009 and 2010. That is where I thought you might go. Mr. Posen. That is better. Mr. Perlmutter. I appreciated a couple of words that were used. Dr. Lachman, you used one, and, Dr. Makin, you used one. One was ``humongous.'' I understand the word humongous. And the other was extemporize. And, through this recession, crash, fall on Wall Street, whatever you want to call it, we saw some constrictions in the stock market and in the financial market that we hadn't seen at least--maybe ever, but certainly not since the Depression or before then. It was a different kind of a constriction. And I appreciated the comments of all the panelists that some very difficult steps, some new steps were taken by the Federal Reserve, as well as a number of the other central banks, because they are looking at the whole economy crashing. And then it is like, price stability, we saw prices drop in 2008 and 2009, certainly in the real estate market, and in other markets, oil and gas. It went from $4 during the summer of 2008 in Colorado down to about $2 or less. So I guess I would ask just as a general comment, and I know all of you were focused on this, have we as legislators, where we really have not had much of a fiscal policy over the last 2 years except for a very contractionary fiscal policy, and we put restraints on our Federal Reserve, have we done the right thing? And I will start with you, Dr. Posen, but I definitely want to get to the other gentlemen to get their response. Mr. Posen. I should defer to the other people's time. Just quickly, we have basically done the right thing. It doesn't fix everything. It doesn't fix everyone. But putting the restrictions on means when the next crisis hits outside the housing market, we are not going to be able to respond to it, and you are just going to have very indirect means of responding to it. Mr. Perlmutter. Dr. Makin? Mr. Makin. Yes, let me pick up on the word ``extemporize.'' A financial crisis presents policymakers with unprecedented problems. We have seen a combination of measures undertaken by the Fed, as well as fiscal stimulus packages undertaken by the Congress. Putting it all together, the outcome is okay, the best, actually, among the industrial countries. Mr. Perlmutter. And looking at your graphs, I think your graphs verify that or support that. Mr. Makin. Right. We have had about 2 percent growth without a lot of inflation. The employment picture hasn't improved a lot, but that is partly because of some major changes that have occurred in the labor market. But so we have extemporized in a difficult situation and done better than most industrial countries. We certainly do need to do better. And we will eventually need to abandon these extreme policies, as the Congress has already done on the fiscal side. It just takes a very cautious and gradual approach. But for example, if we were to want to abandon the quantitative easing and the zero interest rate policy, interest rates would shoot up, the stock market would collapse, owners of bonds would get a higher return on their savings, but they might be faced with substantial wealth losses in terms of the value of some of their other assets. So we are in a difficult period now, but so far we have extemporized and done reasonably well. Mr. Perlmutter. Dr. Orphanides? Mr. Orphanides. Thank you. Central banks are incredibly powerful institutions, especially during crises when using the balance sheet of a central bank can paper over a lot of problems that you wouldn't have thought about that could be done during the crisis. I am worried that with the additional restrictions that have been placed on the Federal Reserve in light of the actions that they took in 2008, the Federal Reserve may be overly constrained. And because of the need to coordinate with the Treasury, and in some instances with Congress, the additional delay might actually create problems if we had a crisis such as the one we had in 2008. That is the concern. Mr. Perlmutter. Thank you, Doctor. And I'am sorry, Dr. Lachman, that I didn't get to you. Maybe one of my colleagues can let you respond. Thanks. Thanks, Mr. Chairman. Mr. Huizenga. And my apologies to my friend from Colorado for totally being the deer in the headlights and blanking. So, 2 years of being directly next to each other and I am blank. With that, we are going to go to Mr. Mulvaney for 5 minutes. Mr. Mulvaney. Thank you, Mr. Chairman. Gentlemen, I will read you a statement from last year's meeting of the Joint Economic Committee. It says, ``With respect to employment, monetary policy as a general rule cannot influence the long run level of employment or unemployment.'' That is a true statement, isn't it? That is economic orthodoxy, correct? Does anyone disagree with that? Mr. Makin. I will jump in. I essentially agree with that, that what monetary policy can do is to move employment increases forward, but they tend to get lost. Mr. Mulvaney. I think the general consensus is they can affect short run, but not long run. Dr. Posen, you had a look on your face like maybe you disagreed with that statement. Mr. Posen. I disagree slightly, sir. If you go to the most recent paper issued by the Federal Reserve by Mr. Wilcox and co-authors-- Mr. Mulvaney. I am familiar with it. Mr. Posen. --it talks about the idea of hysteresis, that if you have a negative shock it could become self-fulfilling; that people who are out of work for a long time don't get to get back into work at the same rate, say, of a young person. We saw monetary policy have a positive lasting effect on employment in the mid-1990s. We had welfare reform in the United States that increased the incentives for people to go to work. Monetary policy was allowed to run hotter for longer than it normally would have under the leadership of Chairman Greenspan. The unemployment rate dropped much lower than what people thought the limit was because of that. So under certain conditions, I think it can matter. Mr. Mulvaney. All right. There is another quotation I will read very briefly: ``In the longer run, increasing the potential growth of the economy, that is not really the Fed's job. That is the private sector's job and Congress' job in terms of things like the Tax Code, investment, infrastructure, and training.'' That is Chairman Bernanke. Both of those quotations are from him. So my question to you is this: Why are we one of the only two countries that has the dual mandate? Is it because it is economic orthodoxy that you cannot impact--the Chairman of the Federal Reserve says that we cannot impact long-term employment with monetary policy. Yet, it is our mandate. And that is what I don't understand. Why are we one of two countries that has the mandate when we know that monetary policy can't influence it in the long run? Dr. Lachman? Mr. Lachman. I think one really has to be cautious. One really doesn't want to have a single mandate that you pursue with great vigor to the exclusion of what you are doing to the economy. That really gives the incentive for being too vigorous in the pursuit of the inflation. And I would just take a look at the European experience, where the single mandate right now is leading them down a path towards deflation-- Mr. Mulvaney. No, I don't know about that, because I went on to ask Dr. Bernanke on a similar line and what he told me was very clear. It is actually consistent with what Dr. Posen said earlier today, which is that the activities of the Fed over the course of the last several years since the crisis would have been essentially the same, because you could have undertaken the same policies for the last 4 or 5 years in the name of fighting deflation. We happen to be saying we are doing it in pursuit of full employment, or close to full employment, but really without the dual mandate, the Federal Reserve would have undertaken the same couple of steps. So I understand that. I am just worried about the situation where those two things diverge. And that is what the paper is about, are we going to tolerate higher inflation in the future in order to pursue this lower rate of employment? And I guess my question is, why would we do that if we know that we cannot impact long- term employment. But I am going to move on to my question, because Dr. Posen said some very interesting things in his testimony, his written testimony about limiting the tools. If I can very quickly recognize, we have a minute to cover two very important things. Limiting the tools. Should we limit some of the tools? If Detroit comes to Congress and asks for us to lend them money and we tell them no, shouldn't we restrict the Federal Reserve from participating in that? Wouldn't that be crossing the line into fiscal policy? Mr. Posen. Yes. But I am not sure you need to restrict it in advance. I think you can afford to wait and then call up the chairperson and say you made a bad judgment there, I wish you hadn't done that. Mr. Mulvaney. Fair enough. I guess the cows are a little bit out of the barn after that, though, aren't they? Mr. Posen. No. Because just as happened in Japan, sir, you can make a major change. Obviously, it is like with the military, like with the FDA, at some point you let them do their job, and if they don't do their job right then you hold them accountable. You have to allow for that. Mr. Mulvaney. Secondly, and I am sorry to cut you off, you recognize the fact we are limited on time, you mentioned indemnifying the Fed against the losses. Your paper says that of course they have made so much money over their lifetime that they would never eat into that surplus. I think it was actually a Bloomberg report recently that projects could lose as much as $537 billion, which would absorb all of the money that they have made. Tell me again how this indemnification would work. I am not familiar with that. Mr. Posen. Thank you. I will just be very quick. What has happened in the U.K. and a few other places is they say the balance sheet, any profits belong to the government, the elected government, as it should. And we reckon those at a set term, whether it is once a year, once every 2 years, once every 6 months. There is a fixed, transparent term that doesn't get played with. If in the operation of your duties, not just benefiting Detroit because you happen to have a Governor of the Fed from Detroit, but in the operation of your general duties you take a loss on the balance sheet, there will be some buffer of the Fed's capital. You don't want to have that go to zero. It doesn't really matter if it does in economic terms, but it is seen as a problem. And so the Treasury or the Congress would say if that capital drops below a certain number, we will replenish it. Mr. Mulvaney. Thank you, sir. Mr. Huizenga. The gentleman's time has expired. With that, we go to Mr. Carney of Delaware for 5 minutes. Mr. Carney. Thank you, Mr. Chairman. And thank you to each of the witnesses for being here today. This is a very interesting conversation. But I think at the end of the day the question is what is the role of Congress, what is the role of elected officials? Dr. Posen, you said that elected officials should set the goals and then check for results. And we have been talking, Mr. Mulvaney has been talking about the dual mandate of price stability and employment. Is there a general agreement among the panelists that ought to be the goals for the Fed? Mr. Makin. Price stability and employment? Mr. Carney. Yes. Mr. Makin. I would disagree. I think I indicated earlier that price stability is something the Fed can achieve. There is not much evidence to indicate that they can achieve either a long-term reduction in the rate of unemployment or a long-term increase in the rate of employment growth. Mr. Carney. How do you answer Dr. Lachman's answer to the last question, where he said if you get overboard like the European central banks have recently, you very negatively affect employment and the economy? Dr. Makin? Mr. Makin. I am not quite sure that I understand Dr. Lachman's point. In other words, what the central bank is responding to in that type of a situation, it seems to me, based on what was happening in 2008, is the situation in the asset markets where you have a threat to the functioning of the financial system. So they are stepping in to try to sustain the financial system. Mr. Carney. Okay. Fair enough. How about the other two gentlemen and then Dr. Posen? Mr. Orphanides. If I may provide my response as well to Dr. Lachman's remark earlier on, I think that with regard to the euro area, we should not confuse what is happening, that is quite dramatic and unfortunate, as a failure of monetary policy. Unfortunately, it had nothing do with monetary policy. Monetary policy cannot fix it. We have a governance problem where the States are essentially fighting with each other and do not coordinate in a proper manner, because really they do not have a Federal Government and they do not have the equivalent of the U.S. Congress that can hold things together. Mr. Carney. Okay. Fair enough. Mr. Orphanides. I would not really attribute to mistakes of monetary policy what we see in Europe. With that said, I would agree with Dr. Makin that in my view as well, price stability should be the primary objective of the central bank, because this is what they can be held accountable for. And then beyond that, I think what is critical for Congress is to watch the appointment process so that the independent officials who are appointed to make the tough decisions are the best possible. Mr. Carney. Okay. Fair enough. Dr. Lachman, how about you, where do you fall on this? Mr. Lachman. I would just say that Europe has just emerged from its longest post-war recession, that inflation in Europe has gone down to levels that are now threatening deflation, and the central bank has been very slow in either reducing interest rates or taking measures to improve the monetary transmission mechanism in Europe. So to me it looks like the European Central Bank, with its single-minded mandate of getting prices very low, is risking the economy in terms of deflation. Mr. Carney. So if you have a dual mandate, you are keeping your eye on two different things. And what does that require that central bankers do that mitigate against the severe kind of effect? Mr. Lachman. I guess if they have a balanced approach towards meeting their target. Mr. Carney. Thank you. Dr. Posen, would you like to weigh in? Mr. Posen. Yes, really quickly. In an ideal world, it would be a dual mandate of price stability and avoiding excess volatility in the real economy, meaning huge swings in employment and growth, but not a level target for unemployment. I would still rather have Humphrey-Hawkins and the dual mandate as it is than a single mandate. I differ with Athanasios Orphanides on this. I think central banks that have the single mandate, I am echoing Dr. Lachman here, tend to become inflation nutters and not live up to their needed role. We also need to think about financial stability, whether it is said explicitly or not. Central banks have to worry about that. Mr. Makin. Could I add a quick-- Mr. Carney. Sure. Mr. Makin. The problem in Europe is not so much the lack of a dual mandate as it is that the European Central Bank is the central bank for over 20 very different countries. Mr. Carney. So they effectively would have a difficult time affecting employment across those boundaries anyway. Mr. Makin. Their policy is fine for Germany; it is terrible for Spain. Mr. Carney. Thank you. Thank you all very much. I wish I had more time to carry on this conversation. Mr. Huizenga. The gentleman yields back. The Chair now recognizes Mr. Stutzman of Indiana for 5 minutes. Mr. Stutzman. Thank you, Mr. Chairman. I have really enjoyed this conversation. And I appreciate each of your perspectives. Dr. Posen, you just made a comment, and I want to see if you could expound on it a little bit. You said price stability and then excessive volatility. Could you expound on that a little bit? Because I agree with you. I think certainty and stability is what is going to help middle income, help folks of lower income get to the next bracket, find the next rung on the ladder. Because right now that is what they don't have. They don't have certainty. Could you expound on that a little bit? Mr. Posen. I will try, Congressman. And I know from your past proposals that you are concerned about uncertainty generated by monetary policy, and I respect that concern. Essentially what the issue is, as Dr. Orphanides on this panel and others have written about, is in the 1970s we made a huge mistake, as you are well aware, because we assumed there was this stable tradeoff between inflation and unemployment and that if we just were willing to accept higher inflation we would get lower unemployment. And that was doubly mistaken. First, we underestimated how costly the higher inflation would be. And second, we didn't get permanent employment gains; we just got temporary ones. And so since that time there is a lot of academic work and a lot of policy work that has tried to get central bankers to not talk about employment at all. For various reasons that we have discussed, that seems to be something of a mistake. It takes it too far. But there is a truth there that if you target a specific rate of unemployment or you pretend that you can really control the unemployment rate through monetary policy, you probably are going to induce either inflation or uncertainty. So what I found in practice, and this is something we did at the Bank of England, and which other central banks have done in the past, is to say we may not know precisely what the rate of unemployment is, and we may not be able to push it to where people beg us to push it, but we can see when there is a big swing in the economy, a very rapid change, be it a runup because there is some uncontrolled boom, say, through a housing bubble, or a rundown like we had in 2008 because of a financial crisis, and the real economy, meaning real people, real businesses, real savers are being put through the wringer, we should try and offset that. And doing that in a short-term way should not conflict with price stability. Mr. Stutzman. Thank you. I appreciate that a lot. I would like to go to Dr. Orphanides. I would like to ask about some of the experiences that have developed under the European Central Bank, which is the most recent central bank that stood up a developed economy or economies. Given your experience on the ECB Governing Council, what did the architects look to when determining how to structure the ECB? And then also, did they look to existing central banks as a model? Mr. Orphanides. Indeed, they did. And I have to say that I believe that the Federal Reserve did have an influence on the design, institutional design of the European Central Bank in two ways, both directly--the Fed is the closest they could look at in terms of a Federal institution that would bring together Federal Reserves, Federal Reserve banks, and the central banker in the middle, and coordinate this view--and also indirectly-- so many of the elements that the ECB drew on were from the Bundesbank that was set up in the 1950s. But the Bundesbank, when it was set up in the 1950s, actually had a structure that also drew on the Federal Reserve. So the ECB did try, and the founders of the ECB did try to bring the best they could find internationally in their experience. Indeed, this is why they selected to have the lexicographic mandate that places price stability first, because this is what had been recognized as the state of the art when this was done in the late 1980s and early 1990s. And I believe that is still the state of the art. If I contrast that with the Fed, I think that the reason that the Fed has a dual mandate right now is simply because its own mandate was written in the 1970s, before we developed a consensus that suggests that focusing on price stability and helping central bankers not target real variables is best practice. Mr. Stutzman. If I could quickly, Dr. Makin, if you could comment on Japan's QQE. Will it produce any different results from just the QE program in Japan? Mr. Makin. I believe it will. The Bank of Japan has frequently attempted to get out of their deflationary trap. And until this year, the bank was very conservative when they announced more aggressive asset purchases. They said, we will be very cautious, we are worried about hyperinflation, it probably won't work. This year, the Bank of Japan, under new leadership, undertook to set an inflation target of 2 percent, which is very important to do when you are trying to end deflation, which is a very different game, and they have suggested that they will follow through until they achieve the goal. The ironic result I think that the Bank of Japan came to realize is that a necessary condition to end deflation is to promise inflation, a sufficient condition as to make it happen, and then have the presence of mind to throttle back when the inflation actually picks up. Mr. Stutzman. Thank you. I yield back, Mr. Chairman. Mr. Huizenga. The gentleman's time has well expired. I do appreciate everyone's charity as we are getting into some of these very important issues. And without objection, I think if the panel is willing to stay, we can maybe do another slightly quicker, if possible, lightning round of questions. I know I have some. And with that, I would like to recognize myself--and I don't anticipate using the 5 minutes--but I will recognize myself for 5 minutes. Mr. Makin, I think I got your quote down, and I believe it was extemporaneous, I don't think it was in your written testimony, but eventually we need to abandon these extreme policies--this is the Fed, as you are talking about--just as Congress has done fiscally. There are a number of us who might be concerned that we haven't exactly abandoned our extreme policies on stimulus spending. In fact, we are having this debate right now dealing with unemployment going to be expiring at the end of the year, the extended 2 years instead of the much shorter time of almost a year. We have had that with additional funding that went into nutrition programs, WIC, and others. And the political lesson that I have been learning out of this is that it is very difficult to extract out of that. And I think what you might have been hearing from Mr. Pearce and some of my other colleagues is it seems like we are taking care of Daddy Warbucks on Wall Street, and with quantitative easing we are, I think as Dr. Posen was pointing out, oftentimes that might be the vehicle you need to make sure you have a strong financial center to let that all trickle down, but there are a lot of us I think who are questioning, can we ever really get out of that cycle? And I am curious how the Fed is going to extract itself out of a QA position when you see markets and Wall Street and maybe markets around the world say, oh, no, no, we can't move off of $85 billion a month because that might mean we are going to have some movement here in a direction we don't like in the short term. So if you care to answer that, and then Dr. Lachman, I would like you to, really quickly. Mr. Makin. Mr. Chairman, you have certainly hit the nail on the head in terms of the dilemma. When I was thinking of fiscal policy, I was thinking that in spite of many complaints the Congress has managed to reduce the budget deficit by about a third over the past year through a combination of the sequestration cuts and the tax increases. And I was thinking of that progress. The Fed's problem is perhaps just as difficult. And as I mentioned earlier, it is highlighted by what happens in the marketplace when, as Chairman Bernanke did in May, they hint they might buy less, and interest rates go up and security prices go down, and everybody gets very nervous. So the short answer is I don't know exactly how to do this. But neither does-- Mr. Huizenga. I think part of the problem, exactly right, is that neither does the Fed. Now, we are caught in this hamster wheel. Mr. Makin. Nobody does. So I think in terms of being very practical, slowly and cautiously, and having reversibility as you go along, which is what I think the Fed is trying to engineer here. There is no book that tells you how to exit the Fed's current strategy. Mr. Huizenga. Dr. Lachman? Mr. Lachman. Yes, I would agree that we are in uncharted waters. But I think a crucial point is that the longer that we delay the decision, the bigger the chance that we get asset price bubbles, credit bubbles. We are at some point going to have to exit. By delaying it, we just are going to make the exit all the more difficult. We have been to this dance a number of times before. So my fear is that if you keep printing $85 billion a month, and you have the Japanese printing $70 billion a month, what you are going to do is you are just going to create a very large asset and credit bubble that when you unwind it is going to be all the more difficult. So I think that you really have to be mindful that the benefits you get from the short run you might be getting at the price of large costs in the longer run. Mr. Huizenga. I think I will do this in writing, because, Dr. Posen, we only have a minute left. But I would love to get a reaction from you at some point of how you envision that we are going to pull this liquidity out. As Dr. Lachman is pointing out, Japan is at $70 billion a month, and we are at $85 billion a month. We don't know what the ECB is going to do. But apparently they are prepared to do something as well. And how do we extract ourselves. I do want to ask a very specific question, and maybe we can get some answers in writing as well on that. What are those reforms that you would like to see us do as we are approaching this 100th anniversary? I think it was Dr. Posen, I am not sure, but there was some discussion about an 8-year--is this what the European Central Bank--maybe it was Dr. Orphanides-- European Central Bank you get an appointment for an 8-year period, and then you are cycled out, correct, you are done? That to me sounds like something that might be a positive. I am curious if anybody has a reaction? Mr. Orphanides. There are two suggestions I would make. One is on the appointment process, that it would simplify and reduce the political battles we have right now with multiple rounds of potential appointments if you have a one-term, nonrenewable, longer term for all Board Members. Eight years is what is being done at the ECB. I think that would work better in the United States as well. The most important change, however, I think is to clarify the mandate. I am concerned that the lack of clarity of the mandate will be creating difficulties going forward precisely because we have the uncharted territory and the humongous, I think was the technical term used earlier, size of the balance sheet of the Federal Reserve. Mr. Huizenga. All right. Thank you. Mr. Carney is recognized for 5 minutes. Mr. Carney. Thank you. I am not sure I will need the whole 5 minutes. But I do want to go back to-- Mr. Huizenga. That is what I thought, too. Mr. Carney. --our discussion again. Not long after our discussion, Dr. Posen, you made an argument against the dual mandate I think when referring to the experience of the 1970s. Was that what that was? Mr. Posen. It was an argument, sir, against setting a specific level of unemployment target. So, I am in favor of the dual mandate that there has to be concern for the real economy for growth and employment as well as price stability. Mr. Carney. Because it creates a sense of balance in the thinking of the Members? Mr. Posen. Exactly. And it gives you room to respond to very large short-term fluctuations in the economy. And I would still, as I said to you, I would still rather have a dual mandate with an unemployment level than a single mandate. Mr. Carney. Great. Dr. Lachman, in your testimony you talk about the Lehman crisis and what you considered the effective response of the central banks and the Fed and how it avoided a global meltdown and a lot worse conditions than we saw. And you reference certain programs, including TARP. Have we eliminated tools that the Fed needs to address a crisis in the future? Mr. Lachman. I don't know whether you have eliminated them, but I think that the Dodd-Frank Act might put certain limits on what they can do or that their room for maneuver isn't quite as what it would be prior to the Lehman crisis. Mr. Carney. Notwithstanding some of the rhetoric in this committee, we can't bail out banks in the way that was done in 2008. There is an orderly liquidation process, as you may know, that banks are required to go through once it is determined that they are dying, I guess. Is that a good thing or a bad thing from the perspective of the broader economy? Forget about the politics of it. Mr. Lachman. My concern is that if we really do build up very large credit and asset bubbles, we have a chance that we are back into the kind of situation that we were at the Lehman crisis, in which case you would want a Federal Reserve that had wide capabilities of dealing with the mess when it occurred. Mr. Carney. Lastly, what should our role be as a subcommittee of Congress? Or what should Congress' role be? Just, in a sentence or two each, each of you. Dr. Posen? Mr. Posen. As I tried to say in my written testimony, which I apologize for delivering so late, I think Congress' role should be very aggressive control of two things. First, what the stated goals of the Federal Reserve are, and changing those every couple of years as needed. Not, obviously, every day. That would be counterproductive. But as needed. And second, as I tried to say to the gentleman--sorry, I don't remember what State you are from, I apologize. Mr. Carney. New Mexico. Mr. Posen. Thank you. The gentleman from New Mexico, the Congressman from New Mexico, that you need to have much more retrospective accountability of holding Fed officials, did you do your job well or not? What specifically did you do? And are you accountable for that? But doing it in a holistic, retrospective way, not a starting off and saying there are things we want the Fed to do and not do. It has to be context and results based. Mr. Carney. Dr. Makin? Mr. Makin. Yes, I would like to see a directive for the Fed to pursue price stability, but not to ignore other goals. In other words, to emphasize that the Fed consistently pursues price stability and minimizes uncertainty, and thereby helps to improve the picture for employment and asset prices. In other words, I don't think the Fed should be seen as saying, hey, we don't care what happens. But they should be seen as saying, we want to continue to maintain low and stable inflation. There is a lot of empirical evidence to suggest that the economy performs better under those circumstances and that labor markets perform better as well. Mr. Carney. Dr. Orphanides? Mr. Orphanides. I am a supporter of the primacy of price stability as an objective. And something we did not discuss sufficiently today, I believe, is that financial stability should be elevated as one of the explicit secondary mandates of the Federal Reserve rather than growth and employment. Those come naturally once you have price stability and financial stability. Mr. Carney. Dr. Lachman, a last word? Mr. Lachman. Yes. I agree with the way Dr. Posen posed the idea that the dual mandate should be working without a specific unemployment target. I am not sure that Congress should limit itself to retroactive review of the purchases that the Fed is doing given the scale of the purchases and given that it does have a distribution effect. I would think that Congress should have some input into those decisions. Mr. Carney. Thank you. Mr. Huizenga. The gentleman's time has expired. With that, we will go to the gentleman from New Mexico, Mr. Pearce, for 5 minutes. Mr. Pearce. Thank you, Mr. Chairman. So we began this process--and Dr. Lachman, I am probably going to come to you--of quantitative easing, printing money, whatever you are going to call it, and now it looks like we have initiated maybe that kind of an effect worldwide, that if it is good for us, everybody can do it. What are the downside effects of everybody beginning to create money out of thin air? Mr. Lachman. I think the reason that everybody has to do it is it does have impact on their currencies. That cheapens certain currencies, puts countries at a disadvantage. They will find themselves in the same position, so they go ahead with doing it. My view is that if all of us do this to a very large degree, and we have global financial markets, the risk is that what you get is you get global bubbles, and that when you begin withdrawing from that policy you are going to be paying a heavy price. I am not saying that quantitative easing wasn't the right thing to do at the time that it was initiated. But I am saying that now that the balance sheets are so large and it looks like there is froth in the markets, I think that there has to be pause as to whether you just continue this indefinitely or do you start the process of unwinding. Mr. Pearce. But then when we started unwinding we had one Member of the Federal Reserve saying at one point the same day we need to start tapering, and another Member of the Federal Reserve shrieked that we can't start tapering. And so you get this mixed signal, and the markets are a little bit volatile. What is going to happen, Dr. Orphanides, if we get dropped as the world's reserve currency? What will the effect of the quantitative easing be on the currency inside the United States? Mr. Orphanides. I would put this in reverse. Of course, it would be catastrophic for the United States if the dollar loses the status of reserve currency. Mr. Pearce. And so, it would be catastrophic. Mr. Orphanides. This is one of the risks of continuously expanding the balance sheet of the Federal Reserve without having-- Mr. Pearce. If I can reclaim my time, it would be catastrophic. You can look at Argentina. They don't have a currency. They can't export inflation like we do. We get to export to 200 other countries, and so we diminish the effects inside. And so Argentina a couple of years ago had a 1,500 percent inflation rate, and so your statement that it would be catastrophic. So it really got my attention this year, maybe it was late last year, that the BRIC nations said they were going to start trading in other currency--Brazil, Russia, India, and China--and then two of them actually did that. So we are getting these warning signs from the rest of the world that you are creating some very unstable things with very catastrophic effects. We have started a printing war. And nobody knows the way out. Any hope? So what stops it all? Anyone? Dr. Makin, I will just come to you next. Dr. Posen, I give you the last shot to wrap it up. Mr. Makin. There would be much more cause for urgent concern if we were seeing all this money printing and observing a big pickup in inflation. In fact, we are seeing the reverse, that inflation is actually slowing down. It is below 1 percent in Europe. It is about 1.2 percent in the United States. And so, you have a deflationary situation that was kind of akin to what was happening in the early 1930s, and central banks tend to want to export deflation by printing money, causing their currencies to depreciate, which means other currencies appreciate. So we have to avoid a kind of overt currency war of that type and at the same time try to get past a situation where everybody is using easy money to get a bigger piece of world trade. In other words, avoid a trade war, which is one of the things that made the Depression worse. Mr. Pearce. Thank you. Dr. Posen, I assume that was your saying. You didn't really have a comment to make on this. I guess the final thing is, what does this look like to the American family? My dad raised 6 of us on $2.62 an hour, the entry level in the oil field. Today, what his dollar would buy it takes $12 to buy. I think that is one of the reasons we are having such great stress in the American economy, that the value of what people make is being diminished radically by policies that the government is setting. I yield back, Mr. Chairman. Mr. Huizenga. The gentleman yields back. Seeing none on my over side of the dais here, we will go to Mr. Mulvaney for 5 minutes. Mr. Mulvaney. Thank you. Mr. Huizenga. And I should also announce we have just gotten notice that we will have votes at about 4:15. So if it is all right with you gentlemen, we will be wrapping up shortly after this round. Mr. Mulvaney. Thank you, Mr. Chairman. And thank you for the opportunity to do a second round of questions. Dr. Posen, this gives us an opportunity to spend a little more time on the last topic we had to sort of rush through at the end. I think I misspoke on a couple of numbers. And I want to give you the opportunity to speak at some length as well. We are talking about losses on the Federal Reserve's balance sheet. I asked you previously about the concept of indemnification. I want to point out in your testimony the thing that caught my attention and re-ask my question. It is on page 10, the last paragraph: ``Worries about losses on risky assets are nothing but a distraction. Whether the Fed temporarily loses money on a small portion of its portfolio or temporarily distorts a hypothetical pure market outcome for a particular asset class in service of that greater good should not be a constraint on doing the right thing.'' You go on to close by saying, ``And of course, the cumulative gains that the Fed has transferred to the U.S. Treasury over the decades outweigh by two orders of magnitude any potential losses on the Fed's balance sheet.'' I guess we could have had a long conversation of a day about whether or not losses that the Fed faces now, the potential losses, and the number was actually $547 billion that Bloomberg estimated the Federal Reserve could lose in a higher interest rate environment, whether or not that is a temporary loss on a small part of its portfolio or whether or not we are simply seeing a temporary distortion in the pure market for, say, mortgages, or whether or not there is a larger, more significant distortion. I want to come to the issue about the cumulative gains and losses. The point that I was making is that I think of the cumulative gains last year, the combined earnings of the Fed, out of the combined earnings they were able to return back to the Treasury about $89 billion, $90 billion. And this is, as you mentioned, the case with other central banks, the policy, which is they take much of their combined earnings, they give it back to the Treasury. But now we are facing, and I had several Members of the Federal Reserve actually admit that they were facing the likelihood of large losses over a longer period of time. In a higher interest rate environment and a $4 trillion balance sheet, these losses could be substantial. Again, as Bloomberg estimated, on the order of half a trillion dollars. So I would ask you again to walk me through this process of indemnification. And I am seriously asking a question to which I don't know the answer, which is a dangerous thing to do in Congress, but I have not heard that before. And I would like you to walk me through it. Maybe we can talk about it a little bit. Mr. Posen. Thank you, sir. I will try to be responsive. Just one note on the numbers. I don't remember the particular Bloomberg report you are discussing. You can create, and I don't mean that in a bad way, you can on some reasonable assumptions create loss numbers that big. I would suggest that those loss numbers are pretty much the upper bounds. Mr. Mulvaney. I will tell you, and I don't mean to cut you off, but I will tell you that we actually had witnesses in another hearing say that 100 basis points would lead to roughly $100 billion in losses. Mr. Posen. That sounds about right. But again, you have to spread that over several years probably. But, yes. I think that is fair. So onto the point of the indemnification. The idea is not that the Congress and therefore the American people are writing a check to the Fed to fill up its balance sheet in total. Mr. Mulvaney. That is what it sounded like, so I am glad you went there first. Mr. Posen. I tried to say, and I apologize for being unclear or too cryptic, there is a core level of the balance sheet, just like with a private business, that is essentially the Fed's capital. It needs a certain amount of equity in order to conduct its operations. That amount is a tiny fraction of the $2 trillion balance sheet we now have. The Fed was able to do its operations back before 2008 with a balance sheet that was a very small portion of what it now is. Mr. Mulvaney. Balance sheet is $4 trillion, right? Mr. Posen. Sorry, $4 trillion. Mr. Mulvaney. $2 trillion, $4 trillion, pretty soon it is real money. Right. I get it. Mr. Posen. The point being that all you would be indemnifying the Fed for is that it wouldn't have to at some point under duress come to Congress or come to the executive and say, we have no money left in the kitty. Mr. Mulvaney. Can't they just conjure it up? Mr. Posen. They can, but that would be inflationary. And then also there would be room for people to say, oh, the Fed is a rogue entity. It is just making up its own policy. It is unconstrained. I think it is legitimate for Congress to have the control of saying we own, in some sense, the Fed. We own the equity. But the amount you need to identify, again, I want to stress this, is a very small amount. I don't know what the exact number is, but it would probably-- Mr. Mulvaney. If the Fed were to lose $100 billion, Dr. Posen, who loses that money? I understand who gains. They make $100 billion, their combined earnings are $100 billion, they remit that to the Fed, the deficit goes down, the taxpayers are better off. When they lose that same $100 billion, who loses? Mr. Posen. Unless and until they run out of money for their operations, on paper they lose that asset. Right? So the balance sheet of the Fed shrinks. And that is it. The balance sheet of the Fed shrinks. Mr. Mulvaney. Thank you. Again, I appreciate the opportunity for the longer discussion. Thank you, Mr. Chairman. Mr. Huizenga. I appreciate that. And with that, we will recognize Mr. Stutzman for the last 5 minutes. Mr. Stutzman. Thank you, Mr. Chairman. Dr. Makin, I would like to come back to you about the Japanese policy and quantitative and qualitative easing. How is it that the Japanese Government can be so involved in the Bank of Japan's policy decisions? Mr. Makin. The Bank of Japan is not that independent. And so the Prime Minister--it is a parliamentary government--was very clear when he was elected that he was going to appoint people at the Bank of Japan who would be very aggressive about pursuing an inflation target, and did appoint Mr. Kuroda, who promptly followed that line. So the Bank of Japan is obviously not independent, because we wouldn't see in the United States, for example, a similar directive. Mr. Stutzman. Okay. Dr. Lachman, how does the Bank of England or the Swiss National Bank remain accountable to their national government if they are an independent entity? There has to be some sort of expectations and accountability between the two at some point, doesn't there? Mr. Lachman. Absolutely. And Dr. Posen can probably talk better to it with the Bank of England. But the government is very much involved in setting what the goals are for the Bank of England in terms of an inflation target. And the Bank of England has to report at regular intervals on how it is doing with respect to the inflation target. So you are granting them what one would call instrument independence, but you are setting for them what the goals are. Mr. Stutzman. And, Dr. Posen, if you would want to comment on this as well, because it just seems to be fascinating, especially even with the European Central Bank, the challenges that they would have within the European Union could be even greater. But, Dr. Posen, if you could maybe talk a little bit about the Bank of England and how their government relates to the different committees that they have structured? Mr. Posen. Thank you. My colleague, Dr. Lachman, has it essentially right. There is an explicit inflation target set for the Bank of England. That target is set by the elected government. They can review it at any time, although for practical reasons of not wanting to seem too inflationary or too disruptive to markets, they generally review it every few years. Mr. Stutzman. And you mentioned that earlier. Is that something that appears to work for them? Mr. Posen. A colleague of mine, Kenneth Kuttner from Williams College, and I just did a paper in which we showed that there is really no difference in inflation performance between central banks like the Bank of England, but not just the Bank of England, where the target gets reset by Parliament or the executive, versus central banks like the ECB, where you have very little control. It is just a question of legal structure. And if I may, I had the privilege to co-author with current Fed Chairman Bernanke a book on inflation targeting that came out back in 1999. And one of the main arguments we made for it was not to solely focus on inflation, because that would provide more accountability for the Fed. Mr. Stutzman. So you think that creates not only accountability for the Fed, but you think that by resetting they can refocus on what the environment is for the day. How often would they potentially or have they historically reset, maybe at the Bank of England or some other-- Mr. Posen. Let me give you just three quick examples. At the Bank of England, they have reset it approximately 4 times in 16 years. One was a purely definitional thing. There was a particular inflation series. They switched the inflation series. Actually, it is only 3 times. And the most recent one was explicitly telling the bank not to worry about fluctuations in output as long as you don't really imperil inflation. So, that was a change in focus. The Swiss National Bank, which is very independent, had a reset. There is a speech the current Swiss Bank Governor gave at our institute that is available on our Web site, they were facing, as I think Dr. Makin mentioned, huge capital inflows out of Europe that were driving up their currency and causing them deflation. And they explicitly changed their goal to doing with the exchange rate to try to keep a lid on that imported deflation. And that required parliamentary approval. Mr. Stutzman. Thank you. I find it very fascinating. I yield back, Mr. Chairman. Mr. Huizenga. The gentleman yields back. And I, too, actually sat down with the Swiss Ambassador right about that time. And it was interesting. It was a flight of capital. Mr. Posen. Yes. Mr. Huizenga. Flight of capital to something that was solid, the Swiss franc, and that was the reaction that they were having to deal with. All right. I would like to thank each one of our witnesses again for your testimony today. This was I think very helpful, very illuminating. 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. This hearing is now adjourned. [Whereupon, at 4:13 p.m., the hearing was adjourned.] A P P E N D I X November 13, 2013 [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]