[Joint House and Senate Hearing, 113 Congress]
[From the U.S. Government Publishing Office]
S. Hrg. 113-30
THE FED AT 100: CAN MONETARY POLICY CLOSE
THE GROWTH GAP AND PROMOTE A SOUND DOLLAR?
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HEARING
before the
JOINT ECONOMIC COMMITTEE
CONGRESS OF THE UNITED STATES
ONE HUNDRED THIRTEENTH CONGRESS
FIRST SESSION
__________
APRIL 18, 2013
__________
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JOINT ECONOMIC COMMITTEE
[Created pursuant to Sec. 5(a) of Public Law 304, 79th Congress]
HOUSE OF REPRESENTATIVES SENATE
Kevin Brady, Texas, Chairman Amy Klobuchar, Minnesota, Vice
John Campbell, California Chair
Sean P. Duffy, Wisconsin Robert P. Casey, Jr., Pennsylvania
Justin Amash, Michigan Mark R. Warner, Virginia
Erik Paulsen, Minnesota Bernard Sanders, Vermont
Richard L. Hanna, New York Christopher Murphy, Connecticut
Carolyn B. Maloney, New York Martin Heinrich, New Mexico
Loretta Sanchez, California Dan Coats, Indiana
Elijah E. Cummings, Maryland Mike Lee, Utah
John Delaney, Maryland Roger F. Wicker, Mississippi
Pat Toomey, Pennsylvania
Robert P. O'Quinn, Executive Director
Niles Godes, Democratic Staff Director
C O N T E N T S
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Opening Statements of Members
Hon. Kevin Brady, Chairman, a U.S. Representative from Texas..... 1
Hon. Amy Klobuchar, Vice Chair, a U.S. Senator from Minnesota.... 4
Witnesses
Hon. John B. Taylor, Ph.D., Mary and Robert Raymond Professor of
Economics at Stanford University and the George P. Shultz
Senior Fellow in Economics at the Hoover Institution, Stanford,
CA............................................................. 6
Dr. Adam S. Posen, President, Paterson Institute for
International Economics, Washington, DC........................ 7
Submissions for the Record
Prepared statement of Chairman Brady............................. 26
Chart titled ``When It Comes to Growth 1% is a Big Deal''........ 28
Chart titled ``To $3 Trillion and Beyond''....................... 29
Chart titled ``An Average Recovery = 4.2 Million More Private
Jobs''......................................................... 30
Chart titled ``Recovery's Growth Gap: Large and Growing''........ 31
Chart titled ``Total Growth in Real Per Capita Disposable Income
Following Post-1960 Recessions''............................... 32
Prepared statement of Hon. John B. Taylor........................ 33
Prepared statement of Dr. Adam S. Posen.......................... 37
THE FED AT 100: CAN MONETARY POLICY
CLOSE THE GROWTH GAP AND PROMOTE A SOUND DOLLAR?
----------
THURSDAY, APRIL 18, 2013
Congress of the United States,
Joint Economic Committee,
Washington, DC.
The committee met, pursuant to call, at 9:31 a.m. in Room
216 of the Hart Senate Office Building, the Honorable Kevin
Brady, Chairman, presiding.
Representatives present: Brady, Duffy, Paulsen, Hanna,
Maloney, and Delaney.
Senators present: Klobuchar, Coats, Lee, and Wicker.
Staff present: Corey Astill, Doug Branch, Conor Carroll,
Gail Cohen, Connie Foster, Al Felzenberg, Niles Godes, Paige
Hallen, Colleen Healy, Robert O'Quinn, Jeff Schlagenhauf,
Andrew Silvia, John Trantin.
OPENING STATEMENT OF HON. KEVIN BRADY, CHAIRMAN, A U.S.
REPRESENTATIVE FROM TEXAS
Chairman Brady. Well good morning, everyone, and welcome to
the Joint Economic Committee hearing ``The Fed at 100: Can
Monetary Policy Close the Growth Gap and Promote a Sound
Dollar?''
This year marks the centennial of the Federal Reserve, so
it is appropriate for the Joint Economic Committee to examine
the Fed's role in the current economic climate as well as its
focus for the next 100 years.
Today's hearing on monetary policy is the third in a series
that touches on our most vexing economic challenge: the growth
gap.
We are all rooting for America to bounce back, but
regrettably the U.S. economy is missing 4.2 million private
sector jobs and $1.3 trillion in real output due to the gap
that exists between this weak recovery and the average recovery
of the last 70 years.
For every American, the growth gap means that he or she has
$2,935 less in real disposable income at this point in the
recovery.
This gap persists despite extraordinary actions by the
Federal Reserve to stimulate growth and employment as part of
its dual mandate.
Even more troubling, the Congressional Budget Office
projects that the future growth rate for America's potential
real GDP will be a full percentage point below its post-war
average--which may not sound like much, but the consequences
are alarming.
With one percent lower growth, our economy will be $31
trillion smaller in 2052, and the Treasury will collect $97
trillion less in tax receipts over the next four decades--
making it significantly harder to balance the budget and reduce
America's risky level of debt.
The question before this Committee is whether the
extraordinary actions taken by the Federal Reserve are capable
of closing this growth gap, and if a focus instead on price
stability and establishing a sound dollar will provide a
stronger foundation for economic growth over the long term.
Since 2008, beyond the appropriate role of lender of last
resort to financial institutions and markets, the Federal
Reserve has selectively bailed out investment banks, maintained
interest rates at an extraordinarily low level for almost five
years, engaged in three rounds of quantitative easing by buying
massive amounts of Treasuries and mortgage-backed securities,
and indicated that the Fed will continue this accommodative
monetary posture until the unemployment rate falls to 6.5
percent.
But can the Federal Reserve boost real economic growth over
time through discretionary monetary policy? Or should the
Federal Reserve adopt a rules-based monetary policy to achieve
price stability and let Congress and the President determine
the combination of budget, tax, regulatory, and trade policies
that will boost real economic growth to close the growth gap?
In 1977, Congress established a dual mandate for monetary
policy that gave equal weight to achieving long-term price
stability and the maximum sustainable level of output and
employment.
During the 1970s, as you may remember, the Federal
Reserve's monetary policy was discretionary and
interventionist. The results were accelerating inflation, short
expansions, frequent recessions, and rising unemployment.
In the early 1980s, Chairman Paul Volcker broke the back of
inflation. Over the next two decades, monetary policy became
increasingly rules-based. The results were outstanding: low
inflation and two long and strong expansions, interrupted only
by a brief, shallow recession.
Since the Great Moderation, as it's called, monetary policy
has again become discretionary and interventionist. Not
surprisingly, the results are disappointing.
From 2002 to 2006, Chairman Alan Greenspan kept interest
rates too low for too long which helped to inflate an
unsustainable housing bubble.
Chairmen Volcker and Greenspan correctly believed monetary
policy could contribute to achieving full employment--if and
only if--the Federal Reserve focused solely on price stability.
Beginning in 2008, however, the Federal Reserve explicitly
deviated from this view, invoking the employment half of its
dual mandate to justify its extraordinary actions.
In January 2012, the Federal Open Market Committee
correctly observed in its ``Longer-Run Goals and Policy
Strategy'' this statement:
The maximum level of employment is largely determined by
nonmonetary factors that affect the structure and dynamics of
the labor market.
Despite the clear admission of the limits of monetary
policy to spur employment, in December of the same year the
FOMC announced that it would (1) expand its current round of
quantitative easing, and (2) retain its extremely low target
range for federal funds for ``at least as long as the
unemployment rate remains above 6\1/2\ percent.''
To achieve a policy objective, Nobel Laureate Economist
Robert Mundell stated: Policymakers have to use the right
lever. Monetary policy affects prices over the medium and long
term. In contrast, budget, tax, and regulatory policies are
what affect real output, real investment, and employment.
Monetary policy cannot solve the problems that poor fiscal
policy has helped to create.
By targeting the unemployment rate, the Federal Reserve is
attempting to use monetary policy to achieve what the Fed
acknowledged 11 months earlier that it cannot achieve--full
employment--while risking what economists acknowledge that the
Fed can achieve through appropriate monetary policy: long-term
price stability.
To close the growth gap, my belief is that we must refocus
the Federal Reserve on a rules-based monetary policy which is a
necessary, but not sufficient, condition for robust real
economic growth and job creation.
This is not a false choice between jobs or stable prices;
it is the proven acknowledgement that stable prices and a sound
dollar create the best foundation for job growth over the long
term.
Congress, which has delegated its constitutional authority
to coin money and maintain its value to the Federal Reserve,
should provide it with a clear direction to return to an
achievable mandate for price stability.
The Federal Reserve should also ensure a soft landing for
the housing market by initiating a slow and orderly unwinding
of its $1.1 trillion position in federal agency residential
mortgage-backed securities.
Gradually reducing the excess reserves that could be the
fuel for future inflation will reduce market uncertainty,
strengthen the foundation for non-inflationary economic growth,
and reduce the likelihood of undue political interference in
Federal Reserve policy.
So looking to the future, today's hearing provides this
Committee with the opportunity to hear from two of the most
distinguished monetary economists in the world on their
recommendations for the role of the Federal Reserve during its
second 100 years.
Dr. John Taylor is the creator of ``the Taylor Rule'' which
central banks have used to implement a rules-based monetary
policy.
Dr. Adam Posen served on the Monetary policy Committee of
the Bank of England, and is a widely acknowledged expert on
Japan.
We are fortunate to have them with us today. We look
forward to their testimony.
And with that, I would like to recognize the Vice Chairman
of the Joint Economic Committee, Senator Klobuchar.
[The prepared statement of Chairman Brady appears in the
Submissions for the Record on page 26.]
OPENING STATEMENT OF HON. AMY KLOBUCHAR, VICE CHAIR, A U.S.
SENATOR FROM MINNESOTA
Vice Chair Klobuchar. Thank you very much, Chairman Brady.
Thank you for holding today's hearing on our Nation's monetary
policy and the mission of the Federal Reserve.
We are fortunate, as you have noted, to be joined by two
witnesses with deep knowledge of these issues, and I want to
thank both of you for being here today.
Since the financial crisis began in 2007, the Fed has used
many tools to bolster the economy. It has kept short-term
interest rates near zero since late 2008, and taken action to
keep longer term interest rates and mortgage interests rates
low. However, as I have said before, I always believe that we
can do better, and we have been working in the Senate on a
number of issues with accountability and greater transparency.
And I appreciate the fact that Chairman Bernanke will be coming
before this Committee in May.
While the economy is not yet out of the woods, and too many
Americans still struggle to find work or make ends meet, we all
know that there have been promising signs and that we are a lot
better off than we were at the beginning of this downturn.
More than 1.2 million private-sector jobs have been added
in the past 6 months.
Unemployment reached a 4-year low last month of 7.6
percent. I would note that in my own State it is 2 points
better than that at 5.6 percent.
Housing, so critical to the construction sector, has begun
to rebound, with new-home sales exceeding 400,000 for two
consecutive months for only the second time since the crisis
hit in September 2008.
But even with all the progress, we all know families that
are working several jobs that don't have their employment
situation back to what it once was; that there are some long-
term unemployment issues; and that there are other problems
that need to be solved.
The Fed, which is buying about $85 billion in Treasury
Bills and mortgage-backed securities each month to further
reduce long-term interest rates, continues to play an important
role in the recovery.
A survey released today by a Minnesota business group shows
Minnesota manufacturers remain very concerned about the
economy.
The impact of the Federal Reserve's past and current
efforts would have been diluted if the Fed were restricted to
only purchasing short-term U.S. Government securities, as some
have proposed.
In 1977, 64 years after the Federal Reserve System was
created, Congress clarified that the Fed's mission was to
promote maximum employment and stable prices. The question
raised in today's hearing is whether now is the time to change
the Fed's goals to focus only on price stability. I think now
is not the time for the Fed to take its eye off promoting
employment.
I note that presently inflation is in check--about 1.3
percent over the past 12 months according to the Fed's core
measure, and there is no sign of inflation for the foreseeable
future.
Additionally, the Federal Reserve has signaled that it has
an exit plan to change course once the economy is stronger than
it is today.
While there have been improvements in the employment
situation, it is clear that the economy is still healing from
the downturn. Yet requiring the Fed to focus solely on price
stability would be directing it to essentially ignore
employment.
I believe the Fed does not need a change of mission at this
time in our Nation's recovery.
I am looking forward to questioning both of you on this, as
well as Chairman Bernanke. I believe, though, that Congress
must do more to bring our debt down in a balanced way. I think
it is worth looking at the Senate's budget proposal. We did
pass a budget a few weeks ago, as well as the one that has been
proposed by the President and the House, and I am hopeful we
can come together in a bipartisan way to bring the debt down
without causing what Chairman Bernanke has called ``the sharp
contraction in the economy'' by setting us back.
I believe we can bring the debt down with a mix of revenue
and spending cuts, and at the same time invest in those core
things that are so important: education, our economy, making
sure we move forward with exports, doing all the things we need
to do to train workers for the jobs that are available today.
With that, I have about a minute left and I would love to
turn it over to Mr. Delaney to see if he would like to add a
few words to my opening.
Representative Delaney. Yes. Thank you, Vice Chair
Klobuchar.
I do think in today's discussion, which is important, we
should also think about it in the context of what is happening
in the real and political world. Because I agree with the
Chairman that Congress is a much more precise instrument in
terms of stimulating growth in our economy through
comprehensive immigration reform, adopting a national energy
policy, investing in our infrastructure, improving educational
outcomes, changing trade policy, and to do many of these things
we have to address our fiscal challenges, obviously.
But Congress's inability to use this precise instrument has
to be considered when we think about changing the Fed's dual
mandate. Because when we analyze the Fed's dual mandate, it is
important not to do it in a vacuum but to do it in the context
of the real world and the political world that we live in.
Because Congress has been unable to do the things we need to do
to stimulate economic growth in this country. And I think it is
important that we evaluate the dual mandate of the Fed in that
context, not in a vacuum.
Thank you.
Vice Chair Klobuchar. Thank you.
Chairman Brady. Thank you both.
We are honored to have these two witnesses with us today.
This is the appropriate time to be asking some constructive,
thoughtful questions about the Fed's role both in today's
economic climate, and in its second century.
With that--and both Dr. Taylor and Dr. Posen are leading
experts and widely respected in this field. So with that, Dr.
Taylor, you are recognized for five minutes.
STATEMENT OF HON. JOHN B. TAYLOR, Ph.D., MARY AND ROBERT
RAYMOND PROFESSOR OF ECONOMICS AT STANFORD UNIVERSITY AND THE
GEORGE P. SHULTZ SENIOR FELLOW IN ECONOMICS AT THE HOOVER
INSTITUTION, STANFORD, CA
Dr. Taylor. Thank you, Mr. Chairman and Vice Chair, for
inviting me to be here. I appreciate it.
In the invitation letter, it asked me to comment on the
departure from a more rules-based policy by the Federal
Reserve. I think there has been such a departure. I think it is
quite large, especially if you compare it with the type of
policy of the 1980s and the 1990s until recently.
In my view, this departure has led to problems. It has led
to a poorer economy than otherwise, and after all we have had a
Great Recession and a very, very weak recovery.
In my view, the departure began around 2003, 2004, and 2005
where the Fed held interest rates much too low compared to the
conditions in the economy at the time, and also compared to the
policy that was followed in most of the 1980s and 1990s.
This was one of the reasons we had the excesses, the search
for yield, the risk taking, the boom in housing, and ultimately
the bust which led to the financial crisis itself.
In my view, those kinds of actions and interventions
continued right up until the panic itself, and certainly did
not prevent the panic. In my view, they were basically harmful.
During the panic period, I think it is very important to
point this out, the actions of the Fed in providing liquidity
were positive. They bolstered confidence. They got markets
moving again.
However, when the panic subsided in late 2008, early 2009,
rather than let those facilities draw down, the Fed continued
its interventions. We began to see the Quantitative Easing, the
massive purchases of Treasury Securities, the massive purchases
of mortgage-backed securities, the Operation Twist, and the
continued extension of the zero interest rate policy not only
to the present but into the future.
It seems to me that if you look at this--and I have for
this whole period--it should make you worry. Back in 2009, I
warned that these kinds of policies would cause risks and would
be harmful to the economy. And, to be sure, the results have
been disappointing--outcomes have been much lower than what the
Fed said would happen in this period.
It is hard to make the case that these policies are
working.
It is for this reason that I think it would be appropriate
for the Fed to begin to consider exiting from these policies.
Of course it should be done in a gradual, credible way so as
not to upset markets. And indeed, I believe that if it is done
in such a way it will remove risks to the economy that are
currently holding back the expansion.
I think there is an opportunity to make this exit if in
fact we have a bit of a growth spurt this year. What it could
lead to is an extension of a growth spurt, and we have seen
several of them in this disappointing recovery. But an exit
would make that growth spurt more sustained so we would get the
real recovery that we have been hoping for, which will bring
unemployment down.
In the invitation letter, I was also asked to comment on
what kind of rules-based policy the Federal Reserve should
follow.
It seems to me we have tremendous experience and things to
learn from history in this regard. In particular, in the 1980s
and 1990s, until recently, the Federal Reserve adhered more
closely than really at any other time in its 100-year history
to a more rules-based policy. It was not perfect, but it was
very close.
The results were dramatic. Unemployment came down.
Inflation came down. Economists look back on that period and
see how stable it was. They have a name for it: The Great
Moderation. Because it was so stable. It worked.
So in many respects, we need to get back to some kind of a
rules-based policy for the instruments like that. The world is
different. Policy does not have to be exactly the same. But
rules for the instrument are essential.
It is very important to have a target for inflation, but
that is not enough if it is accompanied by a do-whatever-it-
takes philosophy, because that will lead to these interventions
which quite frankly have been disappointing, as we all know.
One way to integrate a rules-based philosophy into monetary
policy would be to go back to the requirements that the Fed
report its strategy for its instruments. Those requirements
were removed from the Federal Reserve Act in the year 2000.
Those should be put back in. The Fed would be required to
report its strategy for its instruments of policy, whatever it
chooses to do so, and describe how they will follow them. And
if they deviate for an emergency or for whatever reason, they
would have to come back and explain this to the Congress.
I don't think the Congress should tell the Federal Reserve
what kind of strategy to follow for its instruments. But it
should ask the Fed to report explicitly on what that strategy
is. And if the Fed deviates from that strategy, to say why as
soon as possible.
It seems to me that way the Congress would be exercising
its Constitutional authority without interfering with the day-
to-day operations of the Federal Reserve.
Thank you for the opportunity to testify.
[The prepared statement of Hon. John B. Taylor appears in
the Submissions for the Record on page 33.]
Chairman Brady. Thank you, Dr. Taylor.
Dr. Posen, thanks for joining us here today. You are
recognized.
STATEMENT OF DR. ADAM J. POSEN, PRESIDENT, PETERSON INSTITUTE
FOR INTERNATIONAL ECONOMICS, WASHINGTON, DC
Dr. Posen. Thank you, Mr. Chairman. Thank you, Vice Chair
Klobuchar. Thank you, all. I will try to be very brief and as
timely as my colleague, John Taylor, in hitting the mark.
I think it is entirely right and appropriate for committees
of this Congress to be examining the performance, not only the
performance but the goals of the Federal Reserve. And I think
it is perfectly reasonable after five years from the crisis to
be doing that.
I broadly support the idea of Chairman Brady that a
commission about the Fed is--if done correctly, can be a
productive thing. But let me give you three comments on how I
think it needs to be done in order to be productive, and about
what kind of goals need to be set.
Independent central banks are useful. They keep inflation
down. They keep the politicians out of monetary policy. As
Stanley Fischer pointed out 20 years ago, there is a
distinction to be made between the instrument independence, the
ability of a central bank to set its policy instruments at any
given meeting or series of meetings, versus goal-independence,
the ability of a central bank to say what it cares about.
I have always believed, along with he and a large number of
other economists, that it is right for elected officials to set
the goals, and it is wrong for elected officials to interfere
with the instruments.
I think it is entirely viable to make that distinction,
even though there are obviously specific cases where those
things can get muddied, but that is no more of a challenge than
when Congress oversees any other agency, or the military, or
any other independent group.
Therefore, I think it is reasonable to speak about
Congress, looking in a multi-year framework, at what should be
the targets of the Fed? What should be the goals? As long as
you don't do it too often--whether it's 100 years or 5 years,
this Congress has not done it too often, so I welcome that.
I do think it is important, though, to realize that the
goals have to be practical. So just to give three recent
examples, in Japan they just turned over the new central bank
head and they reaffirmed a stronger commitment to raising out
of deflation. That was done in full respect of the central
bank's independence. They waited until the governor's term was
up before replacing him. They did not change the rules of how
the Bank of Japan met. They simply asserted you haven't done a
good job of meeting it, and here is how we are going to hold
you to account.
In the UK where I served, they recently announced a review
of the inflation-targeting regime that had been in place for 15
years. They did it with a finite length of time, a fixed
transparent set of reports, and then they immediately said:
Well, we want to fix this, and this, but we actually are pretty
happy with the regime.
I am not going to say whether that was right or wrong, but
the point was you have to have a commission or an examination
that is open to making no changes if you come to the
conclusion. You don't want to simply have threats of changes be
a way to bully the central bank into doing what politicians
want.
Third, we have the contrast with Hungary which right now,
for a number of fronts, not just monetary, is going in an anti-
democratic direction and they have, rather than examining the
goals of their central bank, overthrown their central bank
essentially, packed it with political people, fired a number of
staff. Obviously no one on this Committee or this Congress
would do that, but that is an example of how you can interfere
too much.
So what in practice are the kinds of goals you might want
to set? I say ``practical'' because if you just do broad goals
like price stability, or full employment, it just gets into
politization, too much vagueness, too much room for
interpretation and discretion on the part of the central bank,
and then too much debate about what accounts--what is
accountability.
That is why I and Chairman Bernanke and others worked
together advocating for things like inflation targeting for the
U.S. some years ago. The point of inflation targeting is not a
sole focus on inflation. We are very explicit about that. Nor
am I saying that inflation targeting is necessarily the right
way.
What we did say that I think is important is you need to
have a transparent set of goals, a set of goals that is
measurable, a set of goals that is subject to review, a clear
hierarchy but allowing for there to be more than one goal
depending on what the conditions are, a time framework of say
two to three years on which progress is evaluated. These kinds
of practical transparency steps I think are applicable to
whatever goal the Congress sets the Fed.
Finally, on the question that has been raised about real
activity or not, I will have to respond to this more I hope if
you give me the opportunity in questions, but I see no conflict
here. If the Fed was trying to put employment up above full
employment as we did in the 1970s as the things to which
Chairman Brady and Dr. Taylor referred, that would be one
thing. But we are well below full employment. There is no sign
of any inflation. And, all these credit bubbles that we are
concerned about do not correlate with monetary policy.
There is no strong evidence of that. All there is is
evidence that if you let bankers get out of hand, then you will
end up getting a lot of corruption. That is bad. That is
something we need regulation to deal with. But that is not a
monetary policy issue.
The final question which was raised--five seconds--should
we be limiting the Fed to just buying short-term instruments?
The answer is: No. That is what the Bank of Japan did for 10
years, is they only bought things of less than three-year
duration government bonds. They were essentially printing cash
to buy cash. And as you would expect, that has no impact on
other investors' behavior.
If you want to have traction on the economy, you have to
buy something other than cash.
[The prepared statement of Dr. Adam J. Posen appears in the
Submissions for the Record on page 37.]
Chairman Brady. Thank you, Dr. Posen.
Let me start with you, Dr. Taylor. As we discuss the
mandate of the Fed, and as those of us who believe we ought to
refocus it back to rules-based price stability which protects
the value of the dollar over time, good money as it is, should
we have that mandate? Does the Fed ignore employment factors in
pursuing stable prices over time?
Dr. Taylor. No. Absolutely not. The experience, it seems to
me, with this is when the Fed took specific actions to try to
deal with unemployment--the 1970s is an example--it backfired.
Unintended consequences were high inflation, and ultimately
higher unemployment. Higher unemployment got to be 10.8 percent
by the end of that episode.
I think the recent experience is similar. One of the
reasons the Fed held rates low in 2003, 2004, 2005 was a
concern about employment. What has happened? We have had much
higher unemployment than anyone would want.
So the history is pretty clear that there are unintended
consequences of these actions because the policies that are
chosen are counterproductive.
I think the problem with the dual mandate now is it is
really used as an excuse to do more interventions, more
discretion than would otherwise be the case. So my hope is to
put more focus of the Fed to price stability, which would
generate more, overall economic stability that would be quite
positive for unemployment. We would get a lower unemployment
rate, and people are legitimately concerned about it, if you
remove that mandate.
In reality, monetary policy works with lags. It is dynamic.
It takes time. And what we have seen in history is these
efforts go the wrong way, and it is a concern to me.
Chairman Brady. Do you believe the Fed's current
accommodative monetary policy will help close the growth gap?
Or do you view a more rules-based policy as helping remove the
risks that at this point are a roadblock in the economic
growth?
Dr. Taylor. No, I do not think they will help. In fact, the
history of the last four years is that they have not. We have
had really the weakest recovery in history for a downturn like
we have had. And it is good to say positive things, to be sure,
but this is a very disappointing expansion, a very
disappointing recovery.
And there are a lot of reasons people point to, but I think
one of them is the uncertainty, the great deal of interventions
that the Fed has had here. And so to me, and history tells you,
economics tells you, to get back to a more predictable policy.
A policy where there is not so much interference with the
economy would actually help the recovery, and I am hoping they
will do that.
Chairman Brady. Thank you, sir.
Dr. Posen, I read your testimony last night. You touched on
a lot of key points. I want to pursue your first point you
made, which is that there is a right way and a wrong way for a
legislative body to set goals and hold their central bank
accountable.
The approach we are taking is to try to create a
constructive, focused bipartisan approach, in fact a focused
bipartisan approach over the next year to look both backwards
on what is the role of the Fed in the economy in the first 100
years, financial security and all that, and also to create sort
of a level playing field for ideas on what that role should be.
In your view, is that generally the right approach versus,
as you've identified, there are some damaging approaches as
well?
Dr. Posen. Mr. Chairman, no, I am very delighted to be
here. And as I said in my testimony, part of the reason I am
delighted to be here is because you and your colleagues and the
staff of this Committee are framing this in a serious,
objective, and--I don't know partisan/bipartisan, but open to
debate way. And, that you would be open, I would hope, to
evidence. As my colleague, John, talks about history, I
interpret the history a little differently than he does. I
would hope that we could have frank discussion about that.
And I think the key word that I used in my testimony, and
again I know for this Committee I do not need to tell you that,
is you do not want this to be about bullying. You do not want
this to be about we do not like what the Fed is doing right
now, or we are worried that the Fed is not doing enough of X
right now, and therefore we threaten a change in the Reserve
Act, Federal Reserve Act, to get right now what we want.
When you frame it, Mr. Chairman, when you and your
colleagues frame it as a long-term consideration about what for
the next 5, 10, 20 years--I hate to go beyond that--but 5, 10,
20 years should be the Fed's goal, I think that is an entirely
legitimate and constructive focus.
Chairman Brady. Right. Thank you, Dr. Posen.
Vice Chairman Klobuchar.
Vice Chair Klobuchar. Thank you, both of you. I appreciate
your testimony and your comments, Dr. Posen. We truly are
trying to approach these things on a bipartisan basis here in a
civil way as we look at the work that we are going to have to
do together.
I cannot agree with Chairman Brady more than monetary
policy alone cannot return this economy to good health. I think
it has to be a combination of the work that we are doing in
Congress. And, as Mr. Delaney articulately pointed out, there
is a lot of work that needs to be done in Congress that has not
been done.
But I want to get back to the point both of you made about
this idea of setting goals from Congress. But at the same time,
I know, Dr. Taylor, you said that the Congress should not be
getting involved in dictating what instruments are bought and
those kinds of things.
Could you expand on that, about what would happen if we got
too involved in the details of this?
Dr. Taylor. Yes. There are lots of decisions that are made
on a day-to-day basis, the technical decisions. It seems to me
the best thing is for the Congress to delegate those decisions
about the instruments of policy to the Federal Reserve, to our
central bank. You would be exercising your Constitutional
responsibilities that way.
I do think, though, that you have to do more than just,
say, hit an inflation goal. Because, especially in the last few
years, we have seen how a whole wide range of instruments will
be used to try to achieve that.
It is not predictable. They have changed the strategy
several times in the last four years. They are groping for
something that will work. And so that is not a strategy. That
is tactical. It is not something that people can understand--we
are guessing all the time what the Fed is going to do next.
That is not good. That is not predictable.
But the Fed can report to you, report to the Congress more
generally, or to appropriate committee what its strategy is for
the interest rate, or for reserves, whatever it happens to be,
explicitly, as explicitly as it thinks appropriate. And you can
judge that. Other people can judge it and make an assessment.
And we can have a good debate about what it is. But we do not
have that now.
The goal itself, for say price stability or whatever you
want it to be, is not sufficient. Policy works with a long lag.
It is not an accountable way to approach things. So that is why
I think the strategy is so important.
Vice Chair Klobuchar. Okay. And Dr. Posen, do you think it
is the right time to change the mandate of the Federal Reserve
by statute?
Dr. Posen. Madam Vice Chair, no. Full stop. I think it is
both a wrong time to do it because the Fed's policies right now
are constructive in making a positive difference without in any
way imperiling a sound dollar. And I think it would be a
mistake based on the knowledge we have now about how central
banks work, and how economies work, to change the dual mandate
even when we are in recovery, I think it is the responsible and
right thing to do.
Dr. Taylor spoke about instrument changes, and tactical
requirements. I think too much is being made of that. There
seems to be this horror of a central bank that actually tries
to do its job and adapts to circumstances. I think that is a
mistake. Any more than you would tell the military: God
Almighty, you are using tanks and drones rather than foot
soldiers? That must mean you are doing something wrong.
No, that is not how you act. You ask the military: Are you
doing an acceptable job? Are you incurring too many casualties,
causing too many side effects? Those are all reasonable
questions.
But then getting into is this the right way to fight the
fire? Is this the right way to land on the beach? That is not
something Congress should be doing.
If I can make one more point, when you talk about history,
as I said in my written testimony, these kinds of so-called
``unconventional policies'' were what central banks did for the
preceding 200 years. They bought and sold private assets.
Now there were disadvantages to that, but they were small.
And this rules-based period that Professor Taylor and others
invoke as a gold era, the gold standard, for example, was a
period when central banks were buying and selling private-
sector assets with large balance sheets.
And so there was no contradiction between adherence to the
gold standard and price stability, and having involvement in
private markets. So I think we should stop fear-mongering about
that and focus on the goals, rather than the instruments.
Vice Chair Klobuchar. And what do you think the best thing
Congress should do right now? Just take it out of the Federal
Reserve right now in terms of what we should be doing with the
tools that we have, which as Congressman Delaney pointed out
are much more targeted and we can do things more quickly?
Dr. Posen. I fully stipulate to what Congressman Delaney
said. I mean--and this is still in the spirit of bipartisan of
everything everyone has said so far, which is the Fed cannot
really affect the maximum rate of sustainable employment; it is
these longer term structural factors that matter. The Fed can
affect how close we come to that at any given moment.
And so for the Congress to focus on things that would bring
up the rate of sustainable employment would be positive.
Vice Chair Klobuchar. Okay. Thank you, very much.
Chairman Brady. Thank you. Representative Hanna.
Representative Hanna. The Fed has said--the FOMC set a
target employment or unemployment rate, and they have said in
their own words, the maximum level of employment is largely
determined by nonmonetary factors that affect the structure and
dynamic of the labor force.
Knowing that, in terms of America being competitive, in
terms of, as Mr. Delaney said, education, immigration, a very
complicated tax code, exports and a lack of a national energy
policy, how realistic is it for them to have that in writing
and believe that, I think, and set a policy of unemployment,
knowing that all jobs are not the same, and that we have
structural problems that are both long term and short term in
our economy? Do they set themselves up for defeat by saying
that?
Dr. Posen. No. They simply set themselves up for being--
sorry, Congressman Hanna, in my view they simply set themselves
up for being much humbler about what the Fed can achieve and
how they should act than they did in the previous two decades.
I was very struck in Professor Taylor's remarks about how
wonderful these various periods were when the Fed stuck to
rules-based monetary policy, and how bad things are now, as
though the monetary regime was the only thing that determined
these wonderful outcomes, or these terrible outcomes, or at
least was a dominant thing.
And as you just read, and as Mr. Delaney said, that is
exactly wrong. The Fed basically has some control over credit
conditions and over how hot the economy runs versus this limit.
And so I think it is entirely appropriate, but in no sense
inconsistent, to say to the Fed: Don't presume you know exactly
what the top level of unemployment is. Be subject to checking
that, as you failed to do in the 1970s. But your job is, given
whatever Congress decides, given what the elected
representatives of the world leave you with, to try to get the
most stable growth, and the most stable inflation you can,
given those conditions.
And I see no contradiction as long as Congress and the
media do not expect too much to the Fed saying we're creating
jobs; we're getting us back to full employment. These may or
may not be great jobs. That is for elected officials to decide,
not for the Fed.
Representative Hanna. But are they setting themselves up
with a wrong premise, a wrong-headed premise?
Dr. Posen. Not at all. I don't think, as you just read, I
don't think there is anybody at the Fed, from the Chairman on
down, who thinks that by trying to get the economy to grow, to
recover, is doing anything about the long-term structural
issues--except possibly the following: Which is, we know--and I
think you and I discussed this before the meeting--that when
people are out of work for a long time, it sometimes becomes
very difficult for them to get back into work. It is sometimes
very difficult for them to get rehired, whether they are an
older worker who gets labeled, or a younger worker who fails to
get on the ladder.
And so there is an excuse, or a reason for the Fed--I think
it not an ``excuse,'' I think it is a genuine justification,
excuse my language, for the Fed to try to keep the economy
running as close to full employment as possible under serious
conditions because you do not want that to kick in.
Representative Hanna. Dr. Taylor.
Dr. Taylor. I think the Fed now says the long-term normal
unemployment rate is 5.6 percent. I think that is what they
have said. And they are trying to--their goal is to keep the
fluctuations, or the deviations of unemployment from that
number as small as possible.
But of course they have not accomplished that by any means.
The performance is much worse in the period I'm referring to
than it was say in the 1980s and 1990s, a much more stable
economy as measured by their own criteria, the exact criteria
they are using right now.
And I think monetary policy does have an impact. It is one
of the most powerful macro economic instruments there are. And
it can be a force of good, and it can be a force of harm. There
is no question about that. Throughout the history of the
Federal Reserve, I think you can point to more periods where it
has been harmful.
Take the Great Depression. It was terrible economic--
terrible monetary policy. I think the same is true of the
period now. And we have good periods. And we should look at
that history. And there are other things that go on in the
economy. Your responsibility with the budget is very important.
Regulation is very important.
But do not discount monetary policy as not a major factor
in these economic developments.
Representative Hanna. Thank you.
Chairman Brady. Thank you. Representative Delaney.
Representative Delaney. Thank you, Mr. Chairman.
Two quick questions for Dr. Taylor, and then I have one for
both Dr. Posen and Dr. Taylor.
Dr. Taylor, you said something interesting in your
testimony that you think it would be a great opportunity for
the Fed to unwind, or to begin to unwind its position during
periods of growth that we may or may not see during the next
year.
To the extent Congress were to put in place a grand bargain
deal of significance, how much of an opportunity do you think
that would create for the Fed to begin to unwind its position?
Dr. Taylor. Well if such a grand bargain is a responsible
approach to fiscal policy and is positive for the economy, that
would begin to create this good news. And I think it would be
an opportunity for the Fed. But it does not have to be the
Congress's action. It can be other action.
Representative Delaney. In case we needed another reason to
work on something, I thought I would try to get that out for
the record.
[Laughter.]
My second question for you is, you talked about how
oftentimes there is a correlation between the Fed using
monetary policy to stimulate employment and the fact that there
has not been a measurable, immediate change in the trajectory
of employment.
Is that really a fair standard? Because it seems to me the
Fed often uses monetary policy to stimulate employment just at
the time we start seeing accelerating unemployment; and that
the Fed really should be judged based on how much it mitigates
further unemployment, as opposed to holding it to a standard of
achieving its unemployment goals.
Because again I come back to, I tend to think about the
world, or these decisions in the context of the real, practical
world as opposed to kind of abstract or standards in a vacuum.
And I'm not sure it is fair to judge the Fed based on the fact
that they haven't achieved, or we have not achieved what we all
view as optimal employment, and to say that their policies have
not worked.
Isn't there some truth to that statement? That we really
have to look at the mitigation effect as opposed to just
whether they are hitting absolute standards?
Dr. Taylor. It is a very good question. But I think my
characterization of the events is more that the Fed took
action, say in the 1970s, and later on you have these adverse
consequences.
The Fed took actions in 2003, 2004, and 2005 and later on
you have had this crisis.
Representative Delaney. Right.
Dr. Taylor. And so it is not the kind of----
Representative Delaney. But the crisis in 2007-2008, it was
hard to--I mean, I think you could actually make an argument to
the Fed's action after 9/11 did contribute to some of the asset
bubbles that were created in the last 10 years. But it is not
clear to me that the 2003-2004 actions were correlated to that.
Dr. Taylor. Well the evidence I look at says it is more
2003, 2004, 2005, and I think the Fed's provision of liquidity
in 9/11 was appropriate. They provided $60 billion of
liquidity. They removed it right away. I wish that's what had
happened in 2008.
Representative Delaney. And my question for each of you is,
when I think about the Fed's actions recently I view their
actions around the crisis as heroic. I view their actions post-
crisis as appropriate.
I do have questions about their recent actions, QE-3, if
you will. And my concerns are that again it is a blunt
instrument. It is not achieving the results as effectively as
actions of Congress would. And I don't blame the Fed for that
because they do have the dual mandate, and in the absence of
Congress doing something they are compelled to do it.
I also feel like it hurts savers, and it largely helps
people with assets. And to that degree, continues to drive
income inequality in this country. But perhaps my biggest
concern is that, as the Fed's balance sheet grows and it
continues to be long assets, when that time does occur where
rates need to be raised--which there is no evidence that that
has to happen any time soon, based on the inflation data--do
you think that the Fed will be affected in their decisionmaking
process by the impacts that raising rates would have on its own
balance sheets?
In other words, Fed monetary policy, while it is not an
appropriation, does have a cost. And the cost is how we unwind
this. And the Fed is not a traditional financial institution.
It is not at risk based on what happens to asset prices, but it
will create a lot of negative headlines, and there will be a
lot of discussion about the Fed losing money. It may affect
their ability to make payments to the Treasury.
So do you think--and this is a question for both Dr. Posen
and Dr. Taylor, maybe Dr. Posen first, do you think this will
have an affect on their ability to act on appropriate rate
setting measures?
Dr. Posen. Thank you, Congressman Delaney.
I guess you raised an enormous number of issues, so let me
just try to quickly respond. I think the distinction of QE-3
versus the crisis is one that is now becoming popular, and I am
not sure it is entirely justified.
The Fed is continuing to do things that are perfectly
reasonable and in line with central bank practice. More
importantly, I think you are all going to see over the course
of the next year, and in fact are already seeing in some of the
statistics Vice Chair Klobuchar mentioned, the recovery in the
housing market that is being directly fueled by the restoration
of the MBS market through Fed action.
And that is going to be an important driver of growth in
the year ahead, and it is not going to be a bubble because we
have been so low below replacement rate on housing it is
entirely appropriate for the Fed to do that. It is another
example of them buying a non-Treasury asset having the right
impact.
Second, I think you worry about hurting savers. There is so
little private sector savings in this economy, except by rich
people, that unfortunately anything we do that stabilizes the
economy will always disproportionately benefit rich people--
which would not be bad if it did not hurt other people;
however, mass unemployment, mass under-employment, budget
deficits that force cuts in progressive programs, and Head
Start, and education and health, really hurt poor people.
And therefore what the Fed does to keep growth up is
actually far more important than the effect on savers,
including people like my mother who live off of T-Bill
interest. It is still, on net, better for the poor in this
country for the Fed to act.
In terms of the balance sheet issue, this actually raises
something I should have said to Vice Chair Klobuchar when she
was asking what Congress can do vis-a-vis the Fed in general.
I find it----
Chairman Brady. I'm sorry, Dr. Posen, because we're
running--and perhaps we can return to this point with
Representative Maloney as well.
Representative Paulsen.
Representative Paulsen. Thank you, Mr. Chairman.
Actually, I think some of my questions will be able to
allow some of that same line of thought to occur. I was going
to ask just regarding the issue of the impact of the Fed's
policies on savers, on seniors, for instance, and maybe some
folks of higher age category are not making wise asset
allocations, for instance, and they may be pushed more toward
riskier investments because of declining interest rates.
I know that Chairman Bernanke back in February of 2013,
just recently he just testified actually that he said the
notion that savers are harmed by the Fed's current policies are
not really a factor because, he has argued, as much as there is
harm to interest-bearing accounts, savers are also benefitting
from other assets like stocks, and real estate.
He noted that the stock market has doubled in the last few
years, and he has expressed conviction that the economy must
move forward and pick up steam before interest rates are
brought back up.
So it kind of follows--just to follow up, what is the
proper balance for U.S. monetary policy in terms of achieving
that price stability and lower employment in a way that does no
harm to American savers, or to seniors who choose to forego
present income for future security?
And maybe, Dr. Taylor, you can kind of start off and then
go to Dr. Posen.
Dr. Taylor. Well I would say one way to look at this is to
just go back to the 1980s and 1990s until recently. You
basically had a policy which would ease in a recession, and it
would tighten when inflation picked up. It worked very well.
It seems that is the kind of policy you are looking for
now. But a policy that promises a zero short-term rate for
years into the future, that is an interference with the markets
that is very unusual--extraordinarily unprecedented. Don't
think this is not unusual.
And the purchases of mortgage-backed securities is
massive--this is not just a few dollars--is very unusual. And
those create this uncertainty about how it is all going to be
unwound. And the zero rates themselves, they do cause a search
for yield. We have seen that in the past.
There is also an effort to drive down the long-term
interest rates so they don't reflect the information that is
coming into the economy, whether it is a pick up or a slow
down. So it is a massive change in policy. And the effect on
savers and what they do is just one example of this.
So it seems to me that we know how to deal with this. We
have done it in the past, and I think we should try to do that
in the future.
Representative Paulsen. And you have suggested that a
return to a more rules-based monetary policy would result in
normal market-determined interest rates that would reduce those
incentives for pension funds and retirees to take on more
dangerous risks. So are the Fed's policies right now
contributing to a stock market bubble, to a potential housing
bubble down the road? Bubbles burst. I mean, is it a
contributing factor?
Dr. Taylor. One of the problems in economics is we don't
know exactly when it is a bubble and when it is fundamentals. I
think there are some good things going on with respect to
profits. There has been a recovery. It is just terribly weak.
Many of the firms you are looking at, their stock prices
are benefitting from foreign sales. The world, and especially
emerging markets are doing quite well. And so there are lots of
other reasons, more fundamental reasons, but I think you should
be worried about bubbles especially in the fixed-income market.
And to the extent that the Fed is influencing that, I
believe they are, that has to be removed at some time. It can
only be temporary. The Fed cannot do this forever. We cannot
rely on the Federal Reserve for the stock market in the United
States forever.
Representative Paulsen. Dr. Posen.
Dr. Posen. Mr. Paulsen, I guess I am uncomfortable with
your initial statement about the Fed should worry about
inflation, employment, and no harm coming to savers. The Fed's
goal should never be: no harm comes to any one group. Full
stop.
That does not mean we should not be honest and look at
those issues and admit that there are effects, and pluses and
minuses, as I think Chairman Bernanke tried to account for, but
the idea that the Fed should direct its policies towards any
one person or any one type of person I think is a mistake.
To the degree that there are people in savings who have
issues, it is a smaller number than sometimes people think for
the reasons that have been discussed. But it is also a question
of why haven't other assets gone up in value? Why aren't there
other interest rates in the private markets moving? The Fed is
not directly influencing those assets.
And that gets us back to what we were talking about
earlier, which is: There are limits to what the Fed can do, but
that is not the same thing as saying what they are doing is
causing these other problems in the economy. And I think we
have got to make that distinction.
Representative Paulsen. Thank you, Mr. Chairman. I yield
back.
Chairman Brady. Thank you. Representative Maloney.
Representative Maloney. Thank you. And I thank the
witnesses for their testimony.
Since the financial crisis began in 2007, the Federal
Reserve has absolutely used every tool in their arsenal to
stabilize the financial system and prevent another Great
Depression.
The Fed, in my opinion, provided a very much needed
stability during this time. They opened literally an alphabet
soup of lending windows that provided liquidity during this
time. Multiple rounds of quantitative easing have kept interest
rates low, helped small and large businesses access credit, and
spurred economic growth.
Without the Fed's expansionary monetary policy, in my
opinion, our economy would be much worse than we are today. But
unfortunately, the recovery is still very vulnerable. Private-
sector job growth fell below 100,000 last month. Unemployment
is still well above its pre-recession level, and there are more
than 3 unemployed workers for every job opening.
Dr. Posen, do you believe the Fed should continue to use
all the available tools in its arsenal to bolster the economy
and help people get back to work? And also in response to
Senator Klobuchar's question, what should Congress do to
complement the Federal Reserve's expansionary monetary policy?
And could you also talk about the risks of shutting down the
Fed's bond purchases too early?
Dr. Posen. Okay. First, thank you, Congresswoman.
I agree they should be using every tool. I do not believe
yet they have used every tool. There are--the commitments to
low long-term rates I view as marginally cheap talk. I do not
view that as a tool. I am on record suggesting that forward
guidance, as they call it, is really unimportant. So I don't
think it does much harm or much good.
What matters is the actual stance of policy and the actual
purchases and commitments. And what happens in terms of actual
rate decisions. So I think they should be continuing to look at
buying MBS. I think they should be continuing to provide
liquidity. And I think they have no risk in doing so.
In terms of what Congress should do, let me link the risks
back to what Mr. Delaney was saying, and Vice Chair Klobuchar
was saying.
If you are concerned that the Fed may be hesitant about
withdrawing policy, and that is a source of uncertainty, or you
are concerned that they will self-limit policy because they are
worried that people will get agitated about the outstanding
balance sheet, the best thing that the Congress can do is
guarantee the Fed that they will recapitalize the Fed if there
are losses on the Fed's balance sheet, just the same way that
they get all the money back from the Fed when the Fed makes a
profit.
This is all notional. The Fed is not a for-profit
institution. That is not the motivation, nor should it be the
criterion for judging Fed policy. You do not want that
motivating Fed policy. So therefore, if this Congress were to
commit to indemnify the Fed against losses done in its
execution of monetary policy, that would be a constructive step
and would take this issue off the table, which should not be a
consideration of when they decide to exit or not.
Representative Maloney. And also could you talk about the
risk of shutting down the Fed's bond purchases too early?
Dr. Posen. Yes. Thank you. As I mentioned to Mr. Hanna,
there is a problem in this economy that we all recognize, that
the labor market has gone really sour in a way that has not
been seen in past U.S. recessions--at least not for decades.
We have seen participation in the labor force drop by four
full percentage points. You mentioned in your question, in your
statement, the recent poor numbers on the latest month.
If the Fed were to stop its bond purchases--since I don't
believe forward guidance matters very much--I think it would
constitute an insufficient amount of monetary stimulus and
probably be perceived as a tightening, or at least a next step
to a tightening. I believe unemployment would rise
significantly, and we would get the demonstration of the
effectiveness of Fed's policies by the reverse. Its withdrawal
will cause problems.
Representative Maloney. I am interested in your experiences
on the Monetary Policy Committee and the Bank of England. I
know you have been a close observer. I understand you had some
concerns about their austerity measures and the impact on the
economy.
Could you comment on the Bank of England? It only has one
mandate, as I understand it: Managing inflation. And has that
single mandate led to better inflation outcomes than the United
States, or worse?
Dr. Posen. As I say in my testimony, it has actually led to
very similar policies and it has led to slightly worse
inflation performance.
This is, arguably, in part because the UK is a much smaller
economy than the U.S. It also has a less well--it is much more
vulnerable to events in the Euro area, which has been a problem
for it. And it has had a less sound currency. The pound came
down 30 percent, or 25 percent, versus where it was, which the
dollar has not.
So I think when you look at the UK monetary policy
experience, it is not the mandate that matters, it is the
nature of the economy. Broadly speaking, we--the Bank of
England did many of the same things as the Fed and, broadly
speaking, we prevented the counterfactual much worse outcomes.
Representative Maloney. Thank you very much. My time has
expired.
Chairman Brady. Thank you. Senator Lee.
Senator Lee. Thank you very much, Mr. Chairman, and thanks
to both of our witnesses for joining us today. We appreciate
your insight, and it is good to have you with us.
Dr. Taylor, I was wondering if I could have you discuss how
some of the following items might add to the cost of an open-
ended quantitative easing process:
Unwinding the enormous Fed balance; investments running
into risky equities to chase return; creating an assumption
that near-term government debt service costs are sustainable;
over-investment in a narrow set of growth assets and the
creation of new bubbles; and misallocation of investments.
Could you just talk to us about those for a moment?
Dr. Taylor. Yes, Senator. Thank you. That list is long but
I agree with each one of the points is a concern.
Unwinding the balance sheet requires selling the mortgage-
backed securities, and selling the long-term assets. To the
extent that the purchases have been beneficial, which is
debatable, that will be counterproductive. It will be a
restrictive in the economy.
It will also be occurring at the same time most likely, as
when the Fed needs to raise the short-term interest rate. It is
always hard to exit from an easy monetary policy. This one will
be harder. So that creates risks.
Another point on your list is important. The policy a
potential for a false hope on the budget because it makes the
interest rate payments so low at this point now, again to the
extent it is holding rates down, and it clearly is holding
short rates down.
I think the search for yield that you mentioned, that
people are going to be taking on risky assets that they
probably shouldn't have, that will come back to be a negative,
as we have seen in the past.
So all these, it seems to me, are serious risks that are
being undertaken. And they may involve unfortunate policies
going forward. For example, if the Fed is concerned about its
balance sheet value, taking capital losses, that may delay its
exit. They may hold onto those securities longer than they
otherwise should. That is a very real possibility.
On the other hand, if they hold onto those securities, it
is going to require that they pay banks huge amounts of money
for the reserves, because they are now paying interest on
reserves. And if they want to have the short-term interest rate
be 1 percent, 2 percent, 3 percent, whatever it will have to be
in the future without reducing the balance sheet, it will have
to pay all that money directly to the banks. That is going to
be a concern, as well.
So I've been studying monetary policy a long time. Exits
are always difficult. And this one is going to be more
difficult than ever. And I believe that is already causing
concerns, about how it is going to unfold, which holds back the
economy itself right now.
Senator Lee. Thank you. Since the Recession's technical
end, now several years ago, there has been some troubling
correlation between the change in unemployment rate and the
size of the labor force. And last week in The New York Times
economist Casey Mulligan noted: As unemployment has gone down,
so has the labor force participation rate.
In the midst of this trend, the Fed has set a new
precedent. It set a new precedent on December 12th of last year
by declaring an official unemployment target of 6.5 percent
based on headline unemployment.
Given these circumstances, how useful do you think the
headline unemployment is as a target?
Dr. Taylor. Well I think it is more suspect than usual as
an indicator of overall demand conditions in the labor markets.
Because as you say, people are dropping out of the labor force
at a much higher rate than you would expect in the current
circumstance.
Awhile ago the CBO estimated that the unemployment rate
would be about 1\1/4\ percent higher if labor force
participation had behaved according to the way it should in
these times.
So it makes the unemployment rate more difficult to
interpret, and it is one of the reasons I think people are
concerned about the focus on a particular number like that. The
Fed has allowed itself wiggle room. It says, well, it is not a
for-sure thing they will change on that basis, but it is one of
the other uncertainties that is making monetary policy
difficult to interpret right now.
Senator Lee. Has measuring price stability changed in a
similar way in recent history?
Dr. Taylor. I don't think so. I think there's always the
question about, for example, should they focus on a core
inflation rate? I've always been worried about a core measure,
because ultimately you are concerned about the ultimate
inflation rate. Another way is you could average the inflation
rate over a few quarters to get a better indicator.
I think the statistical agencies should continue to try to
improve the statistics to get better measures of inflation, but
I don't think that is a major problem with monetary policy
right now.
Senator Lee. And then finally, would any of this--does any
of this suggest that it might be easier from a technical
perspective to enforce a single mandate? I see my time has
expired.
Chairman Brady. Would you like to answer, Dr. Taylor.
Dr. Taylor. I think it would be better because it would
remove a lot of the ways and reasons the Fed moves in these
discretionary ways. As the Chairman indicated, the dual mandate
entered the law in 1977.
It was this period of a highly interventionist mentality
with respect to policy. But as soon as Paul Volcker came in, it
was continued by Alan Greenspan, they basically tried to
interpret that law as get inflation down, get price stability
that will generate more employment. And they were very
successful in doing that.
Now really for the first time since the 1977 Amendments to
the Federal Reserve Act, the Fed refers to the dual mandate all
the time as reasons to do this, and reasons to do that. That I
think is problematic. And that is one of the reasons I would
think it would be better to try to focus on a single mandate,
not to ignore what is happening in the economy but to simplify
what the Fed is actually doing.
Senator Lee. Thank you, very much.
Chairman Brady. Thank you. Senator Coats.
Senator Coats. Thank you, Mr. Chairman.
Let me divert if I could just a little bit from what the
chosen topic is today. But in response to the question that
Congresswoman Maloney asked, what should Congress do? Two
question. One for both of you, and one for Dr. Taylor. Let me
start with Dr. Taylor.
Dr. Taylor, Dr. Posen's response to that was--first
response to that was that the Congress should guarantee the
Fed--that the Fed will be recapitalized if it has losses, given
its current policies. Would you like to respond to that? I
would like to get your take on that question and that answer.
Dr. Taylor. No, I don't think that is necessary or
appropriate for the Congress to do. In that respect the Federal
Reserve Act is just fine the way it is. It delegated some
responsibility without backstopping the Fed in that particular
way.
Senator Coats. My second question is relative to timing.
The tools of the Fed versus the tools and the need for Congress
to address fiscal policy issues.
There is growing consensus, if not full consensus, that the
current situation relative to our debt and deficit is such that
we are reaching a tipping point. The mandatory spending, it is
pretty simple arithmetic, is simply running away with our
revenues causing a lot of borrowing, and squeezing the
discretionary side of the budget, which we have control over
and which, as Dr. Posen said, there are things that ought to be
addressed that may not be addressed simply because we do not
have the resources to do so.
Now relative to timing, many are now saying that we have
been talking about this for several years but there has not
been significant structural changes proposed or enacted
relative to this runaway mandatory spending. And, that if it is
not done this year, the political process will potentially push
this decision to the point where it can be actually
accomplished through a political process to 2017. And therefore
I think even the White House has acknowledged, the Executive
Branch has acknowledged along with Congress, that it has got to
be done now or we flip into 2014, an election year, then we
flip into a new Presidential election process, and it may be
2017.
It seems to me two results can happen from that. It is
either four more years muddling through, four more years of
tepid growth, less than satisfactory, high unemployment, more
squeeze on discretionary spending; or we reach that tipping
point during this period of time, which brings another
financial crisis.
Could each of you just briefly address that question and
that issue?
Dr. Taylor. Well I will be very brief. I think it is very
important to address these budget issues now. It is a good time
to do it. I see some momentum. There is an orderly process on
the budget that is finally coming back. The Senate has a
budget.
I think the proposal to try to get the budget into balance
in 2023 makes sense. That is possible to do with the gradual--
it's not austerity, it's a gradual, credible plan. But at the
same time, as you say, and is most important, for the long term
to get the entitlement spending in line with the growth of GDP.
It is exploding, and that is the problem.
So by all means, that is one of the most important policy
issues we are all facing.
Senator Coats. And the possibility of this tipping point
debt to GDP occurring in that period of time, if we don't take
action now?
Dr. Taylor. Well I think the evidence should make you
worry; that if you don't address it now it is going to be
harder, and there will be a tipping point. But unfortunately I
can't say what that time of tipping point will be. We don't
know for sure. But why take the risk? It would be better for
the economy if we take the action now. So why take the risk of
a tipping point?
Senator Coats. Thank you. Dr. Posen.
Dr. Posen. Thank you, Senator.
What is striking I think about your set of questions and
Professor Taylor's response on my issue about backstopping the
Fed is that it illustrates how much this conversation is
focused on the supposed uncertainty caused by the Fed; whereas,
everyone has known what the Fed is doing. It has been very
clear. They have precommitted. They have said, and there has
been enormous uncertainty generated by the budget process
between the Congress and the White House.
I know none of you deny that, and you are trying to fix
that. I am just saying I think it is a very misleading
statement to talk about the Fed being the cause of uncertainty
that harms the economy, whereas the main source of uncertainty
certainly for the last year-and-a-half has been the obscene
budget back-and-forth between the Congress and the White House.
In that spirit----
Senator Coats. I don't disagree with you.
Dr. Posen. I know you don't. I just want to be clear that
when we--if you start saying ``uncertainty'' is part of the
problem here, that to me is the big source of uncertainty and
therefore I support the responsible budget measures that are
going forward.
Senator Coats. Thank you.
Thank you, Mr. Chairman.
Chairman Brady. On behalf of Vice Chair Klobuchar and
myself and the Committee, I want to thank both of you for being
here today, and your insight on monetary policy matters.
This is an appropriate and I think a critical time to be
reviewing the role, both today and in the future. We will be
calling on both of you in the future, as we pursue this issue
and how we best close this growth gap, and how we return to and
create a sound financial dollar, sound dollar over time, as a
foundation for economic growth.
So again, thank you very much for being here. The hearing
is adjourned.
[Whereupon, at 10:40 a.m., the hearing was adjourned.]
SUBMISSIONS FOR THE RECORD
Prepared Statement of Hon. Kevin Brady, Chairman, Joint Economic
Committee
This year marks the centennial of the Federal Reserve, so it is
appropriate for the Joint Economic Committee to examine the Fed's role
in the current economic climate as well as its focus for the next 100
years.
Today's hearing on monetary policy is the third in a series that
touches on our most vexing economic challenge: the growth gap.
We're all rooting for America to bounce back, but regrettably the
U.S. economy is missing 4.2 million private sector jobs and $1.3
trillion in real output due to the gap that exists between this weak
recovery and the average recovery of the last 70 years.
For every American, the growth gap means he or she has $2,935 less
in real disposable income at this point in the recovery.
This gap persists despite extraordinary actions by the Federal
Reserve to stimulate growth and employment as part of its dual mandate.
Even more troubling, the Congressional Budget Office projects that
the future growth rate for America's potential real GDP will be a full
percentage point below its post-war average--which may not sound like
much, but the consequences are alarming.
With one-percent lower growth, our economy will be $31 trillion
smaller in 2052, and the Treasury will collect $97 trillion less in tax
receipts over the next four decades--making it significantly harder to
balance the budget and reduce America's risky level of debt.
The question before this Committee is whether the extraordinary
actions taken by the Federal Reserve are capable of closing the growth
gap, and if a focus instead on price stability and establishing a sound
dollar will provide a stronger foundation for economic growth over the
long term.
Since 2008, beyond the appropriate role of lender of last resort to
financial institutions and markets, the Federal Reserve has selectively
bailed out investment banks, maintained interest rates at an
extraordinary low level for almost five years, engaged in three rounds
of quantitative easing by buying massive amounts of Treasuries and
mortgage-backed securities, and indicated that the Fed will continue
this accommodative monetary posture until the unemployment rate falls
to 6.5 percent.
But can the Federal Reserve boost real economic growth over time
through discretionary monetary policy? Or should the Federal Reserve
adopt a rules-based monetary policy to achieve price stability and let
Congress and the President determine the combination of budget, tax,
regulatory and trade policies that will boost real economic growth to
close the growth gap?
In 1977, Congress established a dual mandate for monetary policy
that gave equal weight to achieving long-term price stability and the
maximum sustainable level of output and employment.
During the 1970s, as you may remember, the Federal Reserve's
monetary policy was discretionary and interventionist. The results were
accelerating inflation, short expansions, frequent recessions, and
rising unemployment.
In the early 1980s, Chairman Paul Volcker broke the back of
inflation. Over the next two decades monetary policy became
increasingly rules-based. The results were outstanding: low inflation
and two long and strong expansions, interrupted only by a brief,
shallow recession.
Since the Great Moderation, however, monetary policy has again
become discretionary and interventionist. Not surprisingly, the results
are disappointing.
From 2002 to 2006, Chairman Alan Greenspan kept interest rates too
low for too long which helped to inflate an unsustainable housing
bubble.
Chairmen Volcker and Greenspan correctly believed monetary policy
could contribute to achieving full employment--if and only if--the
Federal Reserve focused solely on price stability. Beginning in 2008,
however, the Federal Reserve explicitly deviated from this view,
invoking the employment half of its dual mandate to justify its
extraordinary actions.
In January 2012, the Federal Open Market Committee correctly
observed in its Longer-Run Goals and Policy Strategy statement:
The maximum level of employment is largely determined by
nonmonetary factors that affect the structure and dynamics of
the labor market.
Despite the clear admission of the limits of monetary policy to
spur employment, in December of the same year the Federal Open Market
Committee announced that it would (1) expand its current round of
quantitative easing, and (2) retain its extremely low target range for
federal funds for ``at least as long as the unemployment rate remains
above 6\1/2\ percent.''
To achieve a policy objective, Nobel laureate economist Robert
Mundell stated, policymakers must use the right lever. Monetary policy
affects prices over the medium and long term. In contrast, budget, tax,
and regulatory policies are what affect real output, real investment,
and employment. Monetary policy cannot solve the problems that poor
fiscal policy has helped create.
By targeting the unemployment rate, the Federal Reserve is
attempting to use monetary policy to achieve what the Fed acknowledged
eleven months earlier that it cannot achieve through monetary policy--
full employment--while risking what economists acknowledge that the Fed
can achieve through appropriate monetary policy--long-term price
stability.
To close the growth gap, my belief is that we must refocus the
Federal Reserve on a rules-based monetary policy, which is a necessary,
but not sufficient, condition for robust real economic growth and job
creation. This is not a false choice between jobs or stable prices--it
is the proven acknowledgement that stable prices and a sound dollar
create the best foundation for job growth over the long term.
Congress, which has delegated its constitutional authority to coin
money and maintain its value to the Federal Reserve, should provide it
with a clear direction to return to an achievable mandate for price
stability.
The Federal Reserve should also ensure a soft-landing for the
housing market by initiating a slow and orderly unwinding of its $1.1
trillion position in federal agency residential mortgage-backed
securities. Gradually reducing the excess reserves that could be the
fuel for future inflation will reduce market uncertainty, strengthen
the foundation for non-inflationary economic growth, and reduce the
likelihood of undue political interference in Federal Reserve policy.
Looking to the future, today's hearing provides this Committee with
the opportunity to hear from two of the most distinguished monetary
economists in the world on their recommendations for the role of the
Federal Reserve during its second 100 years.
Dr. John Taylor is the creator of the Taylor rule, which central
banks have used to implement a rules-based monetary policy. Dr. Adam
Posen served on the Monetary Policy Committee of the Bank of England
and is a widely acknowledged expert on Japan. We are fortunate to have
them with us today.
With that, I look forward to their testimony.
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