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



                                                        S. Hrg. 113-304

 
   UNWINDING QUANTITATIVE EASING: HOW THE FED SHOULD PROMOTE STABLE 
                                PRICES,
                   ECONOMIC GROWTH, AND JOB CREATION

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

                                HEARING

                               before the

                        JOINT ECONOMIC COMMITTEE
                     CONGRESS OF THE UNITED STATES

                    ONE HUNDRED THIRTEENTH CONGRESS

                             SECOND SESSION

                               __________

                             MARCH 26, 2014

                               __________

          Printed for the use of the Joint Economic Committee


                                 ______

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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               Bernard Sanders, Vermont
Erik Paulsen, Minnesota              Christopher Murphy, Connecticut
Richard L. Hanna, New York           Martin Heinrich, New Mexico
Carolyn B. Maloney, New York         Mark L. Pryor, Arkansas
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

                              ----------                              

                     Opening Statements of Members

Hon. Kevin Brady, Chairman, a U.S. Representative from Texas.....     1
Hon. Carolyn B. Maloney, a U.S. Representative from New York.....     3
Hon. John Delaney, a U.S. Representative from Maryland...........    13

                               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
Mark Zandi, Ph.D., Chief Economist, Moody's Analytics, West 
  Chester, PA....................................................     7

                       Submissions for the Record

Prepared statement of Hon. Kevin Brady...........................    20
Prepared statement of Hon. Amy Klobuchar.........................    21
Questions for the Record from Vice Chair Klobuchar...............    22
Response from Dr. Mark Zandi to Questions for the Record 
  submitted by Vice Chair Amy Klobuchar..........................    23
Prepared statement of Hon. John B. Taylor........................    24
Prepared statement of Dr. Mark Zandi.............................    29
Chart titled ``Federal Reserve Balance Sheet: Supplying Reserve 
  Funds'' submitted by Chairman Brady............................    47
Chart titled ``Federal Reserve Balace Sheet: Absorbing Reserve 
  Funds'' submitted by Chairman Brady............................    48
Chart titled ``Financial Repression'' submitted by Chairman Brady    49
Chart titled ``Debt to Cost More Then Defense'' submitted by 
  Chairman Brady.................................................    50
Chart titled ``48 Months of Private-Sector Job Growth'' submitted 
  by Representative Maloney......................................    51
Chart titled ``11 Consecutive Quarters of GDP Growth'' submitted 
  by Representative Maloney......................................    52


                     UNWINDING QUANTITATIVE EASING:
                   HOW THE FED SHOULD PROMOTE STABLE
               PRICES, ECONOMIC GROWTH, AND JOB CREATION

                              ----------                              


                       WEDNESDAY, MARCH 26, 2014

             Congress of the United States,
                          Joint Economic Committee,
                                                    Washington, DC.
    The committee met, pursuant to call, at 2:50 p.m. in Room 
216 of the Hart Senate Office Building, the Honorable Kevin 
Brady, Chairman, presiding.
    Representatives present: Brady of Texas, Paulsen, Carolyn 
B. Maloney, and Delaney.
    Staff present: Doug Branch, Gail Cohen, Carroll Conor, Al 
Felzenberg, Niles Godes, Colleen Healy, Christina King, J.D. 
Mateus, Robert O'Quinn, and Andrew Silvia.

    OPENING STATEMENT OF HON. KEVIN BRADY, CHAIRMAN, A U.S. 
                   REPRESENTATIVE FROM TEXAS

    Chairman Brady. Good afternoon, everyone. I apologize about 
the delay from the vote series. It went so long, it was like 
quantitative easing: I never knew, you know, when it might end, 
but it has.
    [Laughter.]
    Thank you for your patience, to former Chair Maloney, to 
the Members, distinguished witnesses:
    The subject of today's hearings is how the Federal Reserve 
should proceed to normalize monetary policy after the 
extraordinary actions taken during and after the Great 
Recession--consistent with promoting stable prices, economic 
growth, and of course jobs creation in America.
    Three months ago the Federal Open Market Committee began to 
taper its large-scale asset purchase program known as 
quantitative easing. Financial market participants anticipate 
the program's termination before the end of the year. Yet, 
ending quantitative easing is simply the first step toward 
normalizing monetary policy.
    The FOMC will also have to raise its target rate for 
federal funds to a level consistent with long-term price 
stability. And then, as it presumably allows its mortgage-
backed securities to gradually unwind, it will have to deal 
more proactively with its unprecedented build up of excess bank 
reserves--currently at a stunning $2.64 trillion. These excess 
reserves represent the fuel for significant price inflation.
    We truly live in challenging economic times. The United 
States suffers from a massive Growth Gap: missing 5.6 million 
private sector jobs and $1.3 trillion in real GDP as compared 
with the average recovery of the past 50 years.
    Using the same comparison, families are struggling with a 
cumulative loss of $8,961 per person in real disposable income 
since the end of the Recession.
    The slow-growth economic policies pursued by President 
Obama bear responsibility for this Growth Gap--policies such as 
higher taxes on small businesses, capital gains, and dividends; 
the Affordable Care Act; resisting the development of 
traditional energy sources on federal lands; and the onslaught 
of anti-growth regulations.
    The Federal Reserve both contributed to the cause of the 
financial crisis and deserves praise for its extraordinary 
actions at the height of panic in 2008 which helped to 
stabilize financial markets. However, more than four years 
after the recovery began, the benefits from quantitative easing 
and extraordinarily low interest rates have diminished.
    The Fed's policies have boosted Wall Street but left Main 
Street and middle-class families behind. Since the Recession 
ended, the current return adjusted for inflation on the S&P 500 
is 98 percent. Real disposable income per person has risen by a 
meager 3.6 percent.
    Ultimately, though an accommodative monetary policy may 
cushion real output and employment in the short term, it can't 
stimulate real output in employment over the long term. Sound 
monetary policy can't compensate for bad spending, tax, trade, 
and regulatory policies.
    Meanwhile, the benefits are diminishing and the risks are 
rising from quantitative easing and extraordinarily low 
interest rates. I am concerned that the FOMC may be 
unintentionally inflating new asset bubbles and possibly 
setting the stage for significant price inflation and a further 
decline in the purchasing power of the dollar.
    Today's hearing addresses a topic that should be of great 
interest to Americans from all walks of life. The Federal 
Reserve operates under a dual mandate for monetary policy--
established in 1977--which gives equal weight to achieving 
long-term price stability and the maximum sustainable level of 
output and employment.
    Yet as Federal Reserve Chairman Paul Volcker and Alan 
Greenspan correctly foresaw, monetary policy could contribute 
to achieving full employment if, and only if, the Federal 
Reserve focused solely on price stability.
    Under their guidance, the Fed turned to an increasingly 
rules-based monetary policy. The results were outstanding: low 
inflation, and two long and strong expansions interrupted only 
by a brief, shallow recession.
    Since the Great Moderation, monetary policy has again 
become discretionary and interventionist. Not surprisingly, the 
results are disappointing.
    Beginning in 2008, the Fed explicitly deviated from the 
Volcker-Greenspan view, invoking the employment half of its 
mandate to justify its extraordinary actions.
    Now we approach the end of quantitative easing. For three 
consecutive meetings, the FOMC has announced incremental 
decreases of $5 billion in its monetary purchase of both 
federal agency mortgage-backed securities and long-term 
Treasury securities.
    Yet the complex and uncertain task of unwinding 
quantitative easing remains. As of March 19th, the Fed's 
balance sheet was $4.26 trillion--more than quadruple its 
September 3, 2008, level; and excess bank reserves held at the 
Fed is $2.64 trillion, compared with the meager $11.9 billion 
in September of 2008.
    I will be very interested to hear our witnesses' views on 
how monetary policy should be normalized, and I am hopeful that 
they can also help us gain insights on how the FOMC should 
respond if current forecasts are wrong and significant price 
inflation materializes.
    Also I am very interested in our witnesses' thoughts on the 
economic effects of financial repression--particularly paying 
higher interest rates to keep bank reserves from flowing into 
the economy; and any thoughts on the Fed turning toward using 
reverse repos instead of the Fed Funds Rate, as a tool to 
affect interest rates.
    While the Federal Reserve--I say this often--while the 
Federal Reserve is supremely confident that it can end the bond 
buying, normalize interest rates, sell the mortgage-backed 
securities back into the market, and finesse the excess bank 
reserves while improving the economic and avoiding inflation, I 
am not so confident.
    Today we are joined by two very distinguished and veteran 
Joint Economic Committee witnesses. Dr. John Taylor is the 
creator of the Taylor Rule that Central Banks have used to 
implement a rules-based monetary policy, and Dr. Mark Zandi is 
the Chief Economist of Moody's Analytics and highly respected. 
We are fortunate to have them with us.
    With that, I look forward to their testimony and I would 
like to yield to the former Chair of the JEC, Congresswoman 
Maloney.
    [The prepared statement of Chairman Brady appears in the 
Submissions for the Record on page 20.]

     OPENING STATEMENT OF HON. CAROLYN B. MALONEY, A U.S. 
                  REPRESENTATIVE FROM NEW YORK

    Representative Maloney. Well thank you, Mr. Chairman.
    I do want to note that Vice Chair Klobuchar could not be 
here today, and I am pleased to stand in for her this 
afternoon. I thank Chairman Brady for calling this hearing to 
continue our Nation's continuing to examine our Nation's 
monetary policy and its effect on the economy.
    We have come a long way since January of 2009 when the 
economy shed 821,000 private-sector jobs a month. And you see 
it in this chart, the deep red valley, and then climbing our 
way out.
    In the Fall of 2009, CEA Chair Christina Romer testified 
before the JEC that the shocks that hit the U.S. economy in the 
Fall of 2008 were larger than those that caused the Great 
Depression, with household wealth falling by more than five 
times the declines seen in 1929.
    A large part of the credit for this turnaround is due to 
actions taken by the Congress, the President, and the Federal 
Reserve. Congress enacted policies that supported struggling 
families and encouraged job creation.
    I only have time to mention a few of them. We provided tax 
relief in the Recovery Act for 95 percent of American families, 
and created jobs while investing in clean energy infrastructure 
and education.
    We extended a host of safety net programs that helped 
struggling families weather the economic downturn. We extended 
the net operating loss carryback provision that helped keep 
small businesses working and allowed them to hire new 
employees.
    We gave tax breaks to businesses that hire unemployed 
workers, and we boosted funding for small business loans via 
the Small Business Administration.
    We are fortunate to have Mark Zandi as a witness at this 
hearing today. Dr. Zandi, along with Dr. Alan Blinder of 
Princeton University, quantified the impact of these policies, 
as well as actions taken by the President and the Federal 
Reserve, and concluded that the U.S. Government's response to 
the financial crisis prevented another Great Depression and 
saved about 8.5 million jobs.
    The Fed responded aggressively with creative and effective 
actions to inject liquidity into our financial system which 
saved our Nation from economic catastrophe. More recently, the 
Fed has used other unconventional means to bolster the economic 
recovery.
    In 1977, Congress enacted legislation that spelled out in 
greater detail the Fed's monetary policy objectives, 
collectively known as ``The Fed's Dual Mandate.''
    These objectives are to, and I quote: ``Promote effectively 
the goals of maximum employment, stable prices, and moderate 
long-term interest rates.''
    While it is true that in recent years the Fed has 
implemented some extraordinary monetary policies, these actions 
were necessitated by extraordinary circumstances. And it has 
helped stabilize our economy during this crisis and its 
aftermath.
    While our recovery from the 2008 financial crisis has been 
long and painful over the last four years, the economy has 
added 8.7 million private-sector jobs.
    The national unemployment rate of 6.7 percent has dropped 
more than 3 percentage points since the height of the downturn. 
The Gross Domestic Product has grown for 11 straight quarters. 
And the Council of Economic Advisers told this Committee two 
weeks ago that they project stronger growth in 2014.
    In addition, the inflation fears put forward by critics of 
the Fed's policies are simply baseless. Inflation is low, about 
1 percent over the past 12 months. And there are no signs of a 
rise in inflation for the foreseeable future.
    The one area of our economy that continues to struggle is 
employment. I commend former Chairman Bernanke, Chair Yellen, 
and the other Federal Reserve Governors for continuing to 
pursue the objective of maximum employment.
    The Fed lowered short-term interest rates to close to zero, 
which helped strengthen the economy by keeping borrowing costs 
affordable for businesses and consumers. This has spurred 
investment and consumer spending.
    The Fed's purchases of Treasuries, mortgage-backed 
securities, and agency debt also known as quantitative easing, 
helped bring down long-term interest rates and lowered mortgage 
interest rates.
    Because the economy has strengthened, the Fed announced in 
December that it was reducing its purchases under quantitative 
easing. Last week the Fed announced that it was further 
reducing its purchases under quantitative easing to $55 billion 
each month.
    I look forward to a discussion on the timing and pace of 
the tapering of the quantitative easing and whether tapering 
has had an impact on mortgage interest rates or on overall 
economic growth.
    Last month I asked Chair Yellen whether the Fed would 
consider a tapering pause, given the relatively weak job 
reports this winter. And although Chair Yellen did not think 
the current data warranted a pause, I would like to discuss 
with our panel what criteria the Fed should be looking for.
    The Fed also changed its forward guidance on short-term 
interest rates. Instead of keeping the Fed Funds Target Rate 
near zero until the unemployment rate reaches 6.5 percent, or 
until a particular date in the future, the Fed recently stated 
that: ``even after employment and inflation are near mandated 
consistent levels, economic conditions may for some time 
warrant keeping the Federal Funds Rate below levels the 
Committee views as normal in the longer run.''
    I would like the panel's opinion on that change, as well. 
Again, I thank the witnesses for joining us, and I yield back 
and look very much forward to your testimony. Thank you both, 
Dr. Taylor and Dr. Zandi, for joining us.
    Chairman Brady. Thank you, former Chair.
    Dr. John Taylor is the Mary and Robert Raymond Professor of 
Economics at Stanford University and the George P. Shultz 
Senior Fellow in Economics at the Hoover Institution. He 
previously served as Under Secretary of the Treasury for 
International Affairs, Senior Economic on the President's 
Council of Economic Advisers, and as a member of the 
Congressional Budget Office's Panel of Economic Advisers. Dr. 
Taylor received a BA in Economics from Princeton University, 
and a Doctor of Economics from Stanford University.
    Welcome, Dr. Taylor.
    Dr. Zandi is Chief Economist for Moody's Analytics. He has 
analyzed the economic effect of various tax and government 
spending policies and assessed the appropriate monetary policy 
response to bubbles in asset markets.
    Dr. Zandi earned his Bachelor's from Wharton School of the 
University of Pennsylvania, and his M.A. and Doctorate at the 
University of Pennsylvania. He is a frequent witness, as Dr. 
Taylor is, to the Joint Economic Committee.
    Welcome to you both. And, Dr. Taylor, let me recognize you.

   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 other Members of 
the Committee, for holding this hearing on monetary policy and 
for inviting me to testify.
    For many years I've been a strong supporter of the Federal 
Reserve, especially during the 1980s and 1990s, until recently. 
And also during the financial panic in 2008, especially October 
and November.
    But I have become critical of the Federal Reserve policy 
regarding its unconventional policies, both before the crisis 
and after. So I welcome the decisions recently to begin to 
intervene less in the markets through the so-called tapering.
    I believe that the quantitative easing that really got 
underway after the panic in 2009 has not been effective. If you 
look at simple measures like interest rate spreads, they've 
gone the wrong direction.
    If you think about in addition the uncertainty that this 
unwinding has caused throughout, I think it has been a drag. I 
have argued that there is a two-sided risk to the quantitative 
easing in its unwinding.
    One, creating a slower recovery.
    The other is the possibility of a higher inflation rate. 
Unfortunately, I think the risk that has actually been realized 
is the slower recovery due to this uncertainty of these very 
unusual policies.
    That does not mean that the risk of inflation is not there; 
it will come if the Fed is unable to adjust the large amount of 
liquidity that's in the system.
    The other part of the unconventional policy is the use of 
forward guidance that Congresswoman Maloney asked about. I 
believe that the forward guidance, for the most part, has also 
caused uncertainty.
    There are two reasons for that. One, it is changed 
constantly. Virtually every year since it began, the Fed has 
changed. It first moved the dates out further. Then, changing 
to the unemployment rate index. And now moving off of that. So 
inherently this has caused unpredictability and uncertainty.
    The second reason for the concern about the forward 
guidance is its inconsistency. And in a way, right now this 
inconsistency is becoming clear as the promises come closer to 
the future, the promise to keep the interest rate lower than 
normal when times become normal. It's very hard to deliver on 
that in the future, and that inconsistency causes uncertainty.
    In my view, policy would have been much better in the past 
and would be better in the future if it was more rules-based 
and more predictable. I think there are some promising signs 
that we can move in that direction. The Fed has chosen a 2 
percent inflation target. Most members of the FOMC see the 
long-term value of the Federal Funds Rate at 4 percent, and 
they see the importance of reacting systematically in their 
interest rate as the economy recovers.
    All of those are very much consistent with the kind of 
rules for policy that have worked well. But there are still 
some concerns about how this will work in the future.
    There is discussion now that we may even have quantitative 
easing forever. In answer to your question, Mr. Chairman, about 
the reverse repos, there are proposals out there to introduce 
reverse repos so that the Fed could set the interest rates even 
with huge amounts of liquidity in the system. And the purpose 
is that the Fed could continue to engage in quantitative easing 
whenever it likes and still maintain an interest rate.
    So for these reasons I think it is very important for the 
Congress to consider requiring the Fed to adopt some kind of a 
rules-based policy. I have argued for that before this 
Committee in the past.
    It would be appropriate for the Fed to choose, itself of 
course, what rule it should follow. That's the Fed's job, not 
the Congress'. But it seems reasonable, especially in these 
days, for the Congress to ask the Fed to follow and decide its 
rule. And if the Fed chose because of an emergency or a change 
in circumstances to deviate from its strategy, all it would 
have to do is report to the Congress about the reasons why.
    I think that kind of consistency and transparency, 
regularity of reporting, would go a long way to restoring the 
kind of monetary policy that worked so well in the 1980s and 
1990s until recently. And could work well again.
    Thank you, very much.
    [The prepared statement of Hon. John B. Taylor appears in 
the Submissions for the Record on page 24.]
    Chairman Brady. Thank you.
    Dr. Zandi.

 STATEMENT OF DR. MARK ZANDI, Ph.D., CHIEF ECONOMIST, MOODY'S 
                  ANALYTICS, WEST CHESTER, PA

    Dr. Zandi. Thank you, Chairman Brady, Congresswoman 
Maloney, and Congressman Delaney. Thank you for the opportunity 
to be here today on this very important topic.
    I would like to make three points.
    The first is that, echoing Congresswoman Maloney's 
comments, I think the Federal Reserve did an admirable job 
navigating through the financial crisis and the Great 
Recession. Without the very aggressive and creative efforts 
during that period, the financial system would have likely 
collapsed and the economy would have experienced another 
Depression. And that aggressiveness and creativity came in many 
forms: credit facilities that provided liquidity to different 
corners of the financial system, to the money markets, to the 
commercial paper markets. These programs were designed very 
well to fade away as the financial markets found their footing, 
and they have.
    Bank stress testing put our banking system on solid 
financial footing, which is so key to the provision in the form 
of credit, which is vital to economic growth.
    Zero short-term interest rates. I think that was clearly 
necessary in the context of a peak unemployment rate that was 
close to 10 percent, and very low inflation below target and 
stable inflation expectations in what was going on in the 
financial system.
    And most controversial, but also important, quantitative 
easing. I think it is fair to say there are potential negatives 
from quantitative easing, but on net it has been a meaningful 
plus to the economy. It has lowered long-term interest rates, 
which has helped to support housing values, stock prices, and 
broader economic growth.
    There are negatives. There are positives from QE, but on 
net it has been a plus.
    So my second point is to QE. I think it is fair to say that 
over time the benefits have diminished, and thus it's 
appropriate for the Federal Reserve at this point to begin 
winding down the program.
    But it has worked out quite well in lowering long rates, 
bringing up housing values, and stock prices. And I think it 
has actually helped monetary policy in general, QE, especially 
in reducing volatility in the financial system.
    So if you look at the variability of asset values, of fixed 
income, credit spreads, stock prices, you know, the things that 
you would look at to try to gauge whether uncertainties 
affecting markets and the economy, you do not see it in the 
data. In fact, the stability is quite amazing. The value of the 
dollar has been incredibly stable throughout this period.
    I do worry about potential bubbles. I think that is 
reasonable to be concerned about. And I think the Federal 
Reserve is focused on this, as well. They are scouring the 
financial system for potential bubbles. And at least to this 
point, they feel quite manageable.
    I do worry about future inflation. I think that is a very 
reasonable concern in the context of the liquidity that is in 
the banking system. But clearly to date that is not an issue.
    Inflation expectations, which is the financial market's 
perspective on inflation, they're rock solid. They have not 
moved at all. They are at 2.5 percent, and no movement at all.
    So I think QE has been a plus for the economy on net.
    The third point is, I do agree with the concern about how 
this is going to play out going forward. How do we wind down 
quantitative easing and normalize interest rates? This is not 
going to be easy. It is going to be tricky, and I am sure there 
are going to be a few bumps along the way.
    But I think the Federal Reserve has all the tools they need 
to execute on this. I think they have the ability to manage 
short-term interest rates very well through the interest rate 
on reserves, through term deposits, and I think the fixed rate 
reverse repo program is very effective. The Federal Reserve has 
worked very carefully with money market funds, with primary 
dealers; they are looking to expand counterparties, Federal 
Home Loan Banks, and it seems to be quite effective in terms of 
managing short-term interest rates in the context of a surfeit 
of bank reserves.
    And I think they have the will to do this, and the 
creativity to do it. And so far so good. You know, they have 
begun to taper. They have laid out a path for short-term 
interest rates. And if, I am sure, you asked the Federal 
Reserve Members what they thought about a 10-year Treasury Bond 
at 2-3/4 percent, they would say that sounds pretty good to me. 
That is exactly probably where they would like it in the 
context of the low unemployment or the employment growth is.
    So and even today, you know, with the tapering, long-term 
rates have not risen, and they did not after QE-1 ended and QE-
2. So, you know, I concur that this is going to be--it is not 
going to be easy, and I am sure there are bumps, but I am 
confident that they will be able to pull this off and the 
economic recovery will continue to gain traction.
    Thank you.
    [The prepared statement of Dr. Mark Zandi appears in the 
Submissions for the Record on page 29.]
    Chairman Brady. Thank you both, very much.
    A couple of questions to try to understand better.
    Dr. Zandi, I was concerned about the recent statements by 
the new Chairman about lower interest rates continuing far 
beyond, you know, the lower unemployment rates as well. You 
know, to a layman it seemed as if the Fed simply was not moving 
the goal posts but removing them completely. They were almost 
to the eye of the beholder type of Fed policy going forward.
    So, one, do you think the market has assimilated, 
anticipated the end of quantitative easing?
    Two, do you think the market has done the same for this 
near-zero interest rate approach? I mean, are they starting to 
understand that this cannot continue?
    And then, do you think the market has given any thought yet 
to just the mortgage-backed securities and the excess bank 
reserves that will have to be addressed as the economy starts 
to take off?
    Dr. Zandi. Well I think we can glean expectations in 
financial markets from futures markets. And if you look at what 
the futures markets are saying, the sort of consensus view in 
the financial system is that tapering will end by year's end, 
September, October, November; that interest rates will remain--
short-term interest rates remain at zero for, as they say in 
the FOMC, for a considerable period, and Chairwoman Yellen has 
articulated that's roughly six months, and that is pretty much 
embedded in the futures markets.
    And, that interest rates will--short-term interest rates 
will start to rise in the summer or fall of 2015, and slowly 
normalize over time. So that is what is embedded in the 
financial markets. That is what is in the bond market. That is 
what is in the stock market. That is what is in the currency 
market.
    So I think the Federal Reserve at least at this point in 
time has expectations in the financial markets right where they 
want them.
    Now I do expect that this spring/summer growth will 
reaccelerate. I think the economy was temporarily weakened by 
things like very poor weather--at least where I come from it's 
been--well, here, you know better than anyone. And at that 
point, bond investors are going to start to anticipate an 
earlier tightening of monetary policy, pull forward their 
expectations, and we might see long-term interest rates rise.
    So the Federal Reserve at that point, sometime this spring/
summer, will be tested again. And this will be a very important 
test of whether the new Chairwoman can explain some of the 
thinking behind, you know, the path she has articulated for 
future interest rates. But so far, so far so good.
    Chairman Brady. Dr. Taylor, two quick questions.
    One, why haven't we had significant price inflation? Do you 
think this should be a concern, a threat going forward?
    Dr. Taylor. [Off microphone].
    Chairman Brady. Could you hit that microphone button?
    Dr. Taylor. Sorry, Mr. Chairman.
    The economy has been quite weak. You mentioned that in your 
opening. So the usual kind of pressure you see that raises 
inflation has not been there.
    The second is this liquidity is staying in the banks for 
the time being at least, and so it has not leaked out to the 
money growth as could occur. But I think going down the road 
there is no reason to be complacent about this at all. It is 
kind of what you would expect. If anything, you would wonder 
why there has not been even less inflation. But I think it is 
still a concern going down the road.
    Chairman Brady. As a layman, if you just listen to our 
businesses back home and then throughout the country, I always 
get the sense there is real uncertainty over increased 
regulations, including banking regulations in that area, and 
uncertainty over fiscal policies and about the ability to 
invest now without repercussions later.
    I sense the Fed has their foot on the pedal, go, go. I 
think the regulators have their foot on the brake for our 
banks, in addition to the lack of demand that is part of the 
challenge we've got.
    Dr. Taylor, a final question. I have introduced legislation 
to reform the Federal Reserve. And among its major provisions 
is to focus back on price stability, the single mandate versus 
dual mandate, and some other reforms.
    In past discussions there is concern that should we do 
that, that we somehow, the Fed will somehow ignore job creation 
in a disappointing recovery, or that it might not have the 
ability to react to a financial crisis in the future.
    Could you address those concerns for me?
    Dr. Taylor. Well it certainly would have the ability to 
react. There is no stipulation that the Fed could not do its 
lender-of-last-resort activities. So it would be completely 
unchanged.
    I think what is perhaps confusing to people on this issue 
is that when you look at history it is the very extra focus on 
other things besides stable prices that has caused the problem. 
And it has even led to higher unemployment.
    In the 1970s, the Fed drifted away from its price stability 
goal and it actually tried to address the employment issue. And 
look what happened. Unemployment went up and up and up and up. 
Then you had Paul Volcker come in who changed that and focused 
back on price stability. And look what happened? Unemployment 
went down, down, down.
    And then recently we have had this much discussion of the 
unemployment again. What happened to unemployment? It's gone up 
much higher. I was at this committee hearing in 1977 and Hubert 
Humphrey was in your position. And he was outraged that the 
economists were talking about an unemployment rate of 4.9 
percent. That's way too high.
    And so we have had, unfortunately, a policy which has led 
to higher unemployment, even though the statement is to focus 
on it. So that is my concern about this and why I think a 
focused Fed, limited-purpose Fed would work better.
    Chairman Brady. Thank you, Doctor. Thank you, both. 
Congresswoman Maloney.
    Representative Maloney. Thank you.
    At its current rate, the Federal Reserve will finish its 
tapering in October of this year. And I would like to ask you 
first, Dr. Zandi, then Dr. Taylor, when do you think the Fed 
will start to raise short-term interest rates?
    Dr. Zandi. Well I articulated what the markets think. They 
must be listening to me.
    [Laughter.]
    That is my expectation, as well. The Federal Reserve has me 
right in line with their thinking. That would be consistent 
with a steady improvement in the labor market, a decline in 
unemployment, increased labor force growth. It would be 
consistent with inflation below target, 2 percent. Stable 
inflation expectations. And a financial system that is 
performing reasonably well.
    So I think the most likely scenario, I think with as much 
certainty as you possibly can have in any kind of economic 
forecasting, short-term rates will begin to rise in the second 
half of 2015, and normalize over the subsequent two or three 
years.
    Representative Maloney. Dr. Taylor.
    Dr. Taylor. I think that is consistent with what Chair 
Yellen has said, and therefore the intentions of at least the 
Chair of the FOMC and the Fed.
    I think there are differences of opinion within the FOMC at 
this point. You can see that in their own forecasts. Some think 
it will come up earlier. So ultimately I think it's going to 
depend on the balance of discussion in the FOMC, and it could 
occur a little bit earlier than that--again, depending on the 
strength of the economy and the recovery itself.
    Representative Maloney. And, Dr. Zandi, what economic 
indicators do you think the Fed is looking at to determine its 
timing on short-term interest rates?
    Dr. Zandi. I think a plethora of indicators, and they 
articulated some of them in the last FOMC meeting when they 
moved from threshold-based guidance to database guidance.
    So labor market indicators are very important. 
Unemployment, labor force participation, wage growth, all very 
important. Obviously inflation, inflation expectation and 
various measures of financial market and financial institution 
performance are very critical to their thinking about the 
conduct of policy.
    So I think it is a plethora of economic and financial 
market variables they are using.
    Representative Maloney. Well I think all of us would like 
to see the economy improving faster than we are seeing it. It 
is the slowest recovery I have ever seen. And the elephant in 
the room that some economists are beginning to talk about is 
the huge amount of debt that our college students are 
graduating with and not being able to find jobs--$40,000, 
$50,000.
    And this translates into an area that you talk a great deal 
about, Dr. Zandi, and that is the high importance of housing in 
our overall economy. I would also say car sales. These are two 
big areas of jobs, job growth and strength in our economy. And 
people who buy cars and new houses are young people starting 
out in their careers. They buy the cars. They buy the houses. 
They start their families. They move forward.
    But with this huge amount of debt--and I often ask these 
young people. Some of them say they expect to pay it off in 
their 50s, some earlier. But this is a drag on our economy. And 
I would like to ask both of you to comment on it, on any 
reflections that you have on this. And do you believe it is a 
drag on our economy? Housing has improved, but it is nowhere 
what we would expect it to be at. I have heard some economists 
say it's 25 percent of our economy with the related activities, 
and also the purchasing of cars are way below.
    So I would like to hear your comments on the elephant in 
the room.
    Dr. Zandi. Well it is in my household. So the elephant is 
there. You know, I have a 23-year-old boy who graduated from 
Wake Forest and had a happy day two weeks ago when he found a 
job. He did it on his own, so we're happy.
    But the Millennials are struggling in lots of different 
ways. You mentioned student debt. That's obviously the case. 
And actually they did the right thing. I mean, they were told, 
appropriately so, that to advance their financial situation in 
the future they would need to get training, and education, and 
so they went to school. And in many cases you cannot do that if 
you do not have any home equity because of the declining 
housing values and you have to take on student loan debt. And 
they did that.
    For some, it is going to pay off. For others, it is not. If 
you do not graduate, then obviously this is a very significant 
financial weight. The jobs they are getting are paying at lower 
wages.
    So it is very likely that--and there are really good 
studies that show that your lifetime earnings are a direct 
function of your starting salary. So I think the Millennials 
are behind the financial eightball, and that means they are 
going to be getting married later than I did and you did, and 
have children later, start households later, buy homes later, 
and buy cars later.
    So I think this is a very significant longer term issue for 
the American economy, and I think we need to seriously think 
about student lending broadly and really what it is buying us. 
And, whether we shouldn't be redirecting the subsidies we 
provide through the Student Loan Program to expanding the 
availability of educational resources--you know, E-learning, 
universities, community colleges, to bring down the cost of 
education, because that is the way to help these kids have the 
jobs that they are going to need to be able to pay off the debt 
and to do well in the future.
    Representative Maloney. Dr. Taylor, could you comment?
    Dr. Taylor. I think the reasons for the slow recovery are 
more than just a couple of things. The elephant you referred 
to, that's important, but it's a broader issue.
    Just for example, the savings rate that we have is not 
excessively high. It is reasonable. It is much lower than it 
was during the very rapid recoveries in the 1980s. So the 
factors about that couldn't be the whole issue.
    So, when I look at it, I think of some of the things that 
Chairman Brady mentioned: that there's this uncertainty about 
the policies. If you look at fast recoveries in the past, we 
did not have that as much. There are a lot of things that need 
to be done. The Tax Code, for example, is causing a drag.
    So I think of it as the best thing that can be done to get 
a faster recovery is to get policy back into, I guess, a more 
certain, more predictable mode. I think if we were able to do 
that, we would get these growth rates like we saw in the past.
    Representative Maloney. Thank you. My time has expired.
    Chairman Brady. Thank you.
    Mr. Delaney.

 OPENING STATEMENT OF HON. JOHN DELANEY, A U.S. REPRESENTATIVE 
                         FROM MARYLAND

    Representative Delaney. Thank you, Mr. Chairman, for 
holding this hearing. And I want to thank our witnesses for 
being here.
    I will comment briefly on the Fed and then just ask a 
couple of questions. I actually think the Fed's actions around 
the crisis were heroic, which I think both of you have 
acknowledged. And I actually think QE-1 and QE-2, QE-1 in 
particular, QE-2 to a lesser extent, were important.
    I was of a view that QE-3 was unnecessary, and we were at a 
point of diminishing returns. If you look at where rates had 
been and how long they had been there, and if you look at the 
amount of investment they made for QE-3, it really did not do 
anything other than raise asset prices. And it 
disproportionately benefitted wealthy Americans, and to some 
extent it hurt middle class Americans who were savers and have 
a larger percentage of their savings in cash, and CDs, and 
things like that.
    So I was fairly critical of that policy, but I think on 
balance you have to give the Fed very high marks for their 
performance across the cycle, which I think both of you on 
balance seem to--Dr. Zandi in particular.
    And I think this notion about tapering, I think they have 
been pretty clear what they are going to do. And it also seems 
to me, and the thing that is not talked about enough, is I 
think the Fed balance sheet will be the size it is now for 10 
years.
    The probability of them shrinking the balance sheet to me 
is almost nonexistent. And I think that will be a permanent 
state for awhile. They will stop growing it, but the notion 
that they are going to shrink it any time soon seems to me to 
be very low probability.
    I am interested in your views about--Dr. Zandi, Dr. 
Taylor--what do you think the Fed's balance sheet will be in 5 
or 10 years?
    Dr. Taylor. I have the same concerns as you do that the 
balance sheet will remain high. Remember, it is still rising.
    Representative Delaney. Right.
    Dr. Taylor. And if it stops rising in October, I think it 
is going to remain. And it concerns me because that is a 
situation which is loaded with risk--inflationary risk, or if 
they try to undo it in a way, contractionary risk. Withdrawing 
liquidity is always hard for a Central Bank, and this makes it 
even harder.
    Just if I could add, I also worry that if it's a 10-year 
proposition, it is a forever proposition. You are talking about 
a different kind of Central Bank than ever we had before.
    Representative Delaney. Arguably if it stays the same size 
in 20 years, it's a smaller issue because the economy is much 
bigger, right? So you ultimately, if we can have some decent 
growth, we grow ourselves out of all these problems. But I tend 
to think--and so we should just come to grips with the fact 
that we're going to have a big Fed balance sheet.
    Dr. Zandi, do you have a view?
    Dr. Zandi. No, I don't think that's the case. What is going 
to happen, I think, is they are going to stop QE bond buying, 
and then they are going to let the balance sheet mature.
    Representative Delaney. They will let it run off.
    Dr. Zandi. Oh, yeah. And if you let it mature, it is back 
to where it should be in 10 years, roughly 10 years. So they're 
not going to sell------
    Representative Delaney. You think they can take that much 
liquidity out of the system? Because it seems to me the average 
life of their investments are probably 5 to 7 years.
    Dr. Zandi. Well the QE has its impact on long-term interest 
rates.
    Representative Delaney. Right.
    Dr. Zandi. So they are slowly going to let that come out of 
long-term interest rates. So by my calculation, QE all in has 
lowered long-term interest rates by 75 to 100 basis points. 
That comes out of long-term interest rates over a 10-year 
period.
    Representative Delaney. Right.
    Dr. Zandi. That's the thinking. And I think that's the 
theory.
    Representative Delaney. Right.
    Dr. Zandi. So far that's been the empirical evidence.
    Representative Delaney. Yes.
    Dr. Taylor. So if I could add?
    Representative Delaney. Yes.
    Dr. Taylor. I really disagree about the empirical evidence. 
It is based on very unusual kind of studies. And if you just 
look at the basics, when QE started, QE-3 started, the 10-year 
rate was 1.7. It is now 2.7. How can you say that this is 
having an impact?
    If you look at spreads, before we started quantitative 
easing they were smaller than spreads now. It is very hard to 
find effects of these things that hold up to scrutiny.
    Representative Delaney. Right. I mean, there are a lot of 
other variables that go into how people think about spreads. 
It's their view of risk. Their view of the taper in and of 
itself caused credit spreads to widen because they view it as a 
risk factor that they want to underwrite.
    But it seems to me QE-3 was really in many ways the Fed's 
response to Congress's inability to do things, right? Because 
the Fed is a blunt instrument, as we know, and early on in the 
crisis, and even QE-1 and QE-2, they were doing what they 
needed to do. QE-3 was their attempt to do things in a very 
imprecise way that Congress would do better.
    What worries me, if you look at what's really caused the 
unemployment challenges we have in this Nation, they really 
started before the crisis. They were just masked by a lot of 
debt.
    You know, we had a very large credit bubble obviously 
before the crisis, and that created artificial employment in 
the system mostly around housing but in other ways. So some of 
these structural employment issues we have--not structural in 
terms of people being unemployed for a long period of time, but 
structural in terms of what is going on in our economy--
probably started a long time ago.
    And they are really related to globalization and 
technology, two very disruptive forces that have affected the 
workforce.
    I worry significantly that there is another shoe to drop in 
this, and that we are not prepared for this. I know I am out of 
time, but I am just interested in your views as economists how 
big of a threat do you think we have for more disruption in the 
employment market based on continued technological innovation?
    Dr. Zandi. Well first, globalization I think--I agree with 
your assessment that globalization and technological change has 
had a very disruptive effect on the labor market, particularly 
middle and low-income households.
    Representative Delaney. Right.
    Dr. Zandi. Globalization, though, is I think, we're right 
at the tipping point from where it goes to being a problem to a 
big plus.
    Representative Delaney. Yes, yes.
    Dr. Zandi. A big plus. So----
    Representative Delaney. We can't stop it. I am not arguing 
to stop it.
    Dr. Zandi. But we should be working really hard to----
    Representative Delaney. Equip ourselves.
    Dr. Zandi. Yes. Because we are going to benefit enormously 
going forward, because the emerging world is now in our 
sweetspot. We are going to sell to them, and that is going to 
be key.
    Technology, that is an issue. So if you look at, you know, 
you line up occupations by pay scale and you relate that to 
technological innovation, you quickly see actually the folks in 
the bottom part of the payscale, they're okay.
    Representative Delaney. They're fine. They are actually 
doing better because as you get better at the top you create 
more jobs at the bottom.
    Dr. Zandi. Yes. It is the middle that gets coded out 
effectively.
    Representative Delaney. Right.
    Dr. Zandi. And this is----
    Representative Delaney. You've got a barbell economy.
    Dr. Zandi. And this is the policy challenge because you 
have to raise their educational attainment so they move up and 
not down, and we are not very good at that. We haven't been, 
historically.
    Representative Delaney. Right. I know I'm out of time, but 
there's no one else in the queue.
    Chairman Brady. Dr. Taylor.
    Dr. Taylor. Yes. So I think the globalization has always 
been there. It's growing. You can point to globalization 
aspects, many people did, in the 1980s when we had a strong 
recovery.
    The extra exuberance we got before the crisis I would also 
point to the Federal Reserve was very low rates in 2003, 2004, 
and 2005. It wasn't just the other factors coming from abroad.
    So that is why I say if you could get the policies right, 
our policies right. And when you say the Fed responded because 
the Congress wasn't doing anything, that is not a good position 
to be in. If the Central Bank is going to hold out its shingle 
saying we will take care of this, they are going to be asked 
all the time. And that is kind of the worst situation.
    Representative Delaney. And it is not just the Congress. 
It's Congress and the Administration------
    Dr. Taylor. Absolutely.
    Representative Delaney [continuing]. Together. So I want to 
make sure. Okay, thank you.
    Chairman Brady. I know we are out of time. Can I do a 
follow-up question on the side of the balance sheet? I think it 
is important.
    I think it is encouraging that tapering is occurring. The 
Fed is only serving four desserts after each meal rather than 
seven. You know, next month it will be three. It still leaves 
it with a huge balance sheet, as Congressman Delaney made the 
case.
    We have got a ton of mortgage-backed securities that at 
some point have to be unwound. But on the issue of inflation, 
if the economy starts to take off clearly banks are going to 
begin lending. And if inflation emerges, the Fed is going to 
want to respond either by reserving--increasing reserve 
requirements, or paying more interest on the excess reserves.
    One, how effective a tool is that in dealing with inflation 
at that point? Are there other viable options for the Fed? What 
is the economic impact?
    Dr. Taylor. So the Fed can raise rates by paying interest 
on reserves, even with the balance sheet so big. I think it is 
important for them to also be reducing the size of the balance 
sheet as they do this.
    There are two things that are going on, and I think it is a 
question about whether they will be able to. It is always hard 
for a central bank to withdraw liquidity, every time. And there 
are a million excuses not to do it. So that is the main concern 
I have, that they will end up being behind the curve. And once 
inflation gets picked up, it is very hard to reverse.
    Dr. Zandi. Can I just say, in terms of managing short-term 
interest rates in the context of this surfeit of bank reserves, 
the fixed-rate reverse repo program is working very, very well.
    You talk to dealers, you talk to the large money market 
funds, it is working incredibly well. They have got a floor 
under--they've got to make some tweaks to the program. They 
need to increase the counterparties. They have to bring in the 
Federal Home Loan Bank System, and then they're golden. They've 
got it.
    So I think they will be able to manage the short-term 
interest rates higher.
    The other constraint on credit, though, it's not only 
liquidity but more importantly in the context of the current 
environment it's capital. So they are going to be able to 
control the flow of credit through capital, and in fact they 
are doing it through the bank stress testing process.
    They can manage the aggregate credit flows very, very 
precisely, and also where the credit goes, by the way. So 
actually I think the stress testing process gives the Federal 
Reserve much more power over the banking system and the economy 
than monetary policy.
    I mean, they can manage things very, very precisely with 
that tool. And no one is paying attention to that.
    Representative Delaney. So you're saying--it's really a 
good insight--they could just say, well, I think there is too 
much real estate credit so we are going to say----
    Dr. Zandi. Yes.
    Representative Delaney [continuing]. For cumulative losses 
on real estate, we are going to double our downside case, run 
the numbers, and everyone will pull credit or capital out of 
real estate.
    Dr. Zandi. Everybody.
    Representative Delaney. That's a really good point.
    Dr. Zandi. Everybody will, by definition, because you have 
just raised the cost of capital for every bank.
    Representative Delaney. Right, right.
    Dr. Zandi. I mean, overnight.
    Representative Delaney. They are setting the rules 
basically on how banks have to think about risk.
    Dr. Zandi. I really think this should be----
    Representative Delaney. Do you think that's a good thing?
    Dr. Zandi. Well that's a great question. That's a really 
good question.
    Representative Delaney. Yeah. Sometimes the regulators are 
the best assessors--they haven't proven to be the best 
assessors of risk.
    Dr. Zandi. Well I think it needs oversight. So, you know, I 
hear the committees talk about monetary policy, quizzing them 
on interest rates; no one is quizzing them on this regulatory 
tool, and I think it is key that there is oversight here.
    Representative Delaney. That is a really good point.
    Chairman Brady. Dr. Taylor.
    Dr. Taylor. Just to say, when the Fed moves beyond monetary 
policy to credit allocation, which is what you are talking 
about, it is a different type of institution. And I think for 
the most part it was set up as a limited-purpose institution; 
it gets into credit allocation? It affects fiscal policy. It 
affects your job, as you were talking about a few minutes ago. 
But the responsibility of Congress is appropriation and things 
like credit allocation, not the Federal Reserve.
    Chairman Brady. And the concern there is credit allocation 
invites political interference. You know, as that price list 
goes on, the Fed did contribute to the credit bubble and we 
don't all have the same level of confidence going forward. But 
this is the conversation that we hope to have on monetary 
policy, an adult conversation on what is the best role for the 
Fed? What are the real concerns and threats out there? What do 
we need to be aware of from this Committee and its economic 
impacts.
    So I want to thank the Members who were here today. Dr. 
Taylor, Dr. Zandi, thank you again for always being available 
to have this conversation. With that, the hearing is adjourned.
    (Whereupon, at 3:39 p.m, Wednesday, March 26, 2014, the 
hearing was adjourned.)

                       SUBMISSIONS FOR THE RECORD

   Prepared Statement of Hon. Kevin Brady, Chairman, Joint Economic 
                               Committee

    Vice Chair Klobuchar, Members, and Distinguished Witnesses:
    The subject of today's hearing is how the Federal Reserve should 
proceed to normalize monetary policy after the extraordinary actions 
taken during and after the Great Recession--consistent with promoting 
stable prices, economic growth, and job creation for America.
    Three months ago the Federal Open Market Committee (FOMC) began to 
taper its large-scale asset purchase program, known as quantitative 
easing. Financial market participants anticipate the program's 
termination before then end of the year. Yet ending quantitative easing 
is simply the first step toward normalizing monetary policy.
    The FOMC will also have to raise its target rate for federal funds 
to a level consistent with long-term price stability; and then as it 
presumably allows its mortgage-backed securities to gradually unwind, 
it will have to deal more proactively with its unprecedented build-up 
of excess bank reserves--currently at a stunning $2.64 trillion. These 
excess reserves represent the fuel for significant price inflation.
    We truly live in challenging economic times. The United States 
suffers from a massive Growth Gap--missing 5.6 million private-sector 
jobs and $1.3 trillion in real GDP as compared with the average 
recovery of the past 50 years. Using the same comparison, families are 
struggling with a cumulative loss of $8,961 per person in real 
disposable income since the end of the recession.
    The slow-growth economic policies pursued by President Obama bear 
responsibility for this Growth Gap--polices like higher taxes on small 
businesses, capital gains, and dividends; the Affordable Care Act, 
resisting the development of traditional energy sources on federal 
lands, and the onslaught of anti-growth regulations.
    The Federal Reserve both contributed to the cause of the financial 
crisis and deserves praise for its extraordinary actions at the height 
of panic in 2008, which helped to stabilize financial markets. However, 
more than four years after this recovery began, the benefits from 
quantitative easing and extraordinarily low interest rates have 
diminished.
    The Fed's policies have boosted Wall Street but left Main Street 
and middle-class families behind. Since the recession ended the current 
return adjusted for inflation on the S&P 500 is 98%, but real 
disposable income per capita has risen by a meager 3.6%.
    Ultimately, though an accommodative monetary policy may cushion 
real output and employment in the short term, it cannot stimulate real 
output and employment over the long term. Sound monetary policy cannot 
compensate for bad spending, tax, trade and regulatory policies.
    Meanwhile the benefits are diminishing and the risks are rising 
from quantitative easing and extraordinarily low interest rates. I am 
concerned that the FOMC may be unintentionally inflating new asset 
bubbles and possibly setting the stage for significant price inflation 
and a further decline in the purchasing power of the dollar.
    Today's hearing addresses a topic that should be of great interest 
to Americans from all walks of life. The Federal Reserve operates under 
a dual mandate for monetary policy-- established in 1977--which gives 
equal weight to achieving long-term price stability and the maximum 
sustainable level of output and employment.
    Yet as Federal Reserve Chairmen Paul Volcker and Alan Greenspan 
correctly foresaw, monetary policy could contribute to achieving full 
employment--if and only if--the Federal Reserve focused solely on price 
stability.
    Under their guidance, the Fed turned to an increasingly rules-based 
monetary policy. The results were outstanding: low inflation and two 
long and strong expansions, interrupted only by a brief, shallow 
recession.
    Since the Great Moderation, monetary policy has again become 
discretionary and interventionist. Not surprisingly, the results are 
disappointing. Beginning in 2008, the Fed explicitly deviated from the 
Volcker-Greenspan view, invoking the employment half of its mandate to 
justify its extraordinary actions.
    Now we approach the end of quantitative easing. For three 
consecutive meetings, the FOMC has announced incremental decreases of 
$5 billion in its monetary purchase of both federal agency mortgage-
backed securities and long-term Treasury securities.
    Yet the complex and uncertain task of unwinding quantitative easing 
remains. As of March 19th the Fed's balance sheet was $4.26 trillion--
more than quadruple its September 3, 2008 level of $945 billion, and 
excess bank reserves held at the Fed is $2.64 trillion--compared with 
$11.9 billion on September 3, 2008.
    I will be very interested to hear our witnesses' views on how 
monetary policy should be normalized, and I am hopeful that they can 
also help us gain insights on how the FOMC should respond if current 
forecast are wrong and significant price inflation materializes.
    Also I am very interested in our witnesses' thoughts on the 
economic effects of financial repression--particularly paying higher 
interest rates to keep bank reserves from flowing into the economy; and 
any thoughts on the Fed turning toward using reverse repos instead of 
the Fed Funds rate, as a tool to affect interest rates.
    While the Federal Reserve is supremely confident that it can end 
the bond buying, normalize interest rates, sell the mortgage backed 
securities back into the market and finesse the excess bank reserves 
while improving the economy and avoiding inflation, I am not.
    Today we are joined by two very distinguished and veteran JEC 
witnesses. Dr. John Taylor is the creator of the Taylor rule that 
central banks have used to implement a rules-based monetary policy, and 
Dr. Mark Zandi is the chief economist of Moody's Analytics. We are 
fortunate to have them with us.
    With that, I look forward to their testimony.
                               __________

  Opening Statement of Hon. Amy Klobuchar, Vice Chair, Joint Economic 
                               Committee

    Thank you Chairman Brady for holding today's hearing on monetary 
policy. We're fortunate to be joined by two witnesses with a deep 
understanding of these issues, Dr. Mark Zandi and Dr. John Taylor. I 
want to thank both of you for being here today.

                          STATE OF THE ECONOMY

    Chairman Brady held a hearing of this Committee on monetary policy 
and the mission of the Federal Reserve about a year ago. Since then, 
the labor market has strengthened, inflation has remained in check, the 
economy has continued to grow and the Fed has begun to wind down its 
quantitative easing program.
    While we are still not where we would like to be, we have continued 
to make real progress recovering from the recession. The economy has 
added jobs for 48 consecutive months. It has now regained 8.7 million 
of the 8.8 million private-sector jobs lost during the recession.
    The national unemployment rate of 6.7 percent has dropped more than 
three percentage points since the height of the downturn. In my state, 
the unemployment rate is better than the national average at 4.7 
percent. Inflation is low, about one percent over the past 12 months, 
and there is no sign of a rise in inflation for the foreseeable future. 
Gross Domestic Product (GDP) has grown for 11 straight quarters and the 
Council of Economic Advisers told this Committee two weeks ago that 
they project stronger growth in 2014.

                       FEDERAL RESERVE'S ACTIONS

    Actions taken by the Fed and Congress helped bring about the 
economic recovery. The Fed lowered short-term interest rates to near 
zero at the end of 2008 and stated last week that it will keep those 
rates low for a considerable period of time as the economy continues to 
recover.
    Low interest rates have helped strengthen the economy by keeping 
borrowing costs affordable for businesses and consumers. This has 
spurred investment and consumer spending. Because the economy has 
strengthened, the Fed announced in December that it was reducing its 
purchases under quantitative easing. A further reduction to $55 billion 
each month was announced last week. It has always been understood that 
these efforts would be scaled back as the economic recovery 
strengthened. The Fed's tapering is a sign that the recovery has gained 
traction.

             THE FED MUST REMAIN FOCUSED ON FULL EMPLOYMENT

    In 1977, Congress clarified that the Fed's dual mandate is to 
promote maximum employment and stable prices. Even with the progress we 
have made, we all know families who are working several jobs to get by, 
as well as workers who can't find a job after months and months of 
searching. Though the short-term unemployment rate has already declined 
to close to its pre-recession level, the long-term unemployment rate 
remains at 2.5 percent, nearly triple what it was before the recession 
began.
    Now is not the time for the Fed to take its eye off promoting 
employment. Requiring the Fed to focus solely on price stability would 
be directing it to essentially ignore employment at a time when the 
labor market is still recovering.

                         CONCERNS ABOUT THE FED

    Under Chairman Bernanke, the Fed also improved its communication 
about the policy-making process. This was movement in the right 
direction. I believe the Fed needs increased transparency and 
accountability. I will encourage the Federal Reserve Chair Janet Yellen 
to build on the steps taken by her predecessor and I look forward to 
our witnesses' views on this as well. Finally, the Fed has kept 
interest rates low to strengthen the economy, which is hard on savers. 
Yet, in the past four years, Americans have saved well over four 
percent of their incomes.

                             FISCAL POLICY

    While my focus this afternoon has been on monetary policy and the 
role of the Fed, Congress has a critical role to play in boosting our 
economy in the short term while laying a stronger foundation for growth 
in the long term.
    We have taken steps to put our country on a sound fiscal path. The 
deficit has been cut by more than half since the end of 2009. We've 
passed the bipartisan Murray-Ryan budget agreement, which led to 
passage of the Omnibus spending bill this year and sets us on a clear 
path for spending next year. We reached an agreement through March 15, 
2015 to ensure our nation will pay its bills on time. And finally, we 
passed the Farm Bill, which saves $23 billion over the last bill and is 
vital to many states in this country.
    As we pursue smart fiscal policy, we must continue to press 
policies that will help the economy --immigration reform, which saves 
$158 billion over 10 years and over $800 billion over 20 years, 
training our workers, making sure we move forward with exports and 
growth in the manufacturing sector, and comprehensive tax reform.

                               CONCLUSION

    Over the past five years, we've seen the impact monetary policy can 
have on the economy. Monetary policy can support business investment, 
manufacturing and consumer spending --accelerating economic growth.
    To get the biggest bang for the buck, monetary and fiscal policies 
should complement each other. In recent years, monetary policy has 
contributed to growth while unnecessary and shortsighted cuts in 
spending have made it more difficult for the economy to grow.
    Thank you again to our witnesses for being here.
                               __________

         Questions for the Record from Vice Chair Amy Klobuchar
                           FOR DR. MARK ZANDI

Question 1:
    Last week, the Fed decided to change its ``forward guidance'' for 
when it will consider raising interest rates. Previously, the Fed had 
said a 6.5 percent unemployment rate was a level that might make it 
consider raising rates.
    Now the Fed says it will consider a wide range of economic 
indicators, not just the unemployment rate. This new guidance is not 
tied to specific numbers, making it more ambiguous but also perhaps 
more flexible and effective.
        a) What are the benefits of the new approach to forward 
        guidance the Fed decided to take last week?
        b) Are there any drawbacks to moving away from specific 
        numerical thresholds?
Question 2:
    Low interest rates have helped spur the economy by promoting 
investment by businesses and households. And, low mortgage interest 
rates have helped both new and existing home owners. But lower interest 
rates have hurt older Americans who live off fixed incomes and are 
relying on the safe return they can get from the savings they keep in 
government bonds.
    Could you describe the overall impact you think low interest rates 
have had on U.S. households?

                          FOR DR. JOHN TAYLOR

    Low interest rates have helped spur the economy by promoting 
investment by businesses and households. And, low mortgage interest 
rates have helped both new and existing home owners. But lower interest 
rates have hurt older Americans who live off fixed incomes and are 
relying on the safe return they can get from the savings they keep in 
government bonds.
    Could you describe the overall impact you think low interest rates 
have had on U.S. households?
                               __________
Response from Dr. Mark Zandi, Chief Economist of Moody's Analytics, to 
     Questions for the Record Submitted by Vice Chair Amy Klobuchar
Question 1:
    The recent change to the Federal Reserve's forward guidance is 
intended to provide policymakers with greater flexibility to respond to 
economic and financial market conditions. The previous explicit 6.5% 
unemployment rate threshold for raising short-term interest rates 
proved to be inadequate in measuring the health of the labor market 
given declining labor force participation and the large number of 
underemployed workers. Financial markets have responded well to the 
shift in guidance, at least so far. Long-term interest rates have not 
changed appreciably since the announced change in forward guidance.
    The increased ambiguity in the Fed's forward guidance may make it 
less effective in keeping long-term rates from rising more quickly than 
desired once the economy reaccelerates in earnest. At that time, bond 
investors may begin to anticipate that the Fed will begin raising 
short-term rates sooner than the currently strongly held view of next 
summer. Or that short-term rates will rise more quickly than currently 
anticipated by bond investors once the Fed does begin increasing them. 
It is likely the Federal Reserve will have to change its guidance once 
again to align bond investors' expectations regarding the path of 
short-term interest rate with their own.
    It is unlikely that the Fed would re-adopt time dependent or 
numerical dependent guidance. More likely would be the release of an 
explicit forecast for a wider range of economic variables and short-
term interest rates that reflects policymakers' outlook, collectively, 
and perhaps even individually. Policymakers have shown a high degree of 
creativity as forward guidance has evolved, and to date they have been 
largely successful in managing long-term rates higher consistent with 
conditions in the job market, inflation, inflation expectations and 
financial market conditions.
Question 2:
    The lower short and long-term interest rates resulting from the 
Federal Reserve's aggressive monetary policy actions since the Great 
Recession have been a significant financial net positive for U.S. 
households. Not all households have benefitted from the low interest 
rates, but most have.
    The largest beneficiaries of the low interest rates are homeowners 
and stockholders. Two-thirds of American households are homeowners, 
with the home being the most important asset for most middle-income 
households. Approximately one-half of households own some stock, 
although households in the top one-fourth of the wealth distribution 
benefit significantly from rising stock values.
    Bond holders have also benefitted significantly from the lower 
rates, which have lifted bond prices. Owners of agency mortgage backed 
securities have been substantial beneficiaries given the Federal 
Reserve's purchases of these bonds via quantitative easing. Most 
households who own bonds do so via their pension plans and insurance 
products. And like stockholders, they are predominately higher wealth 
households. Lower wealth households have not directly benefited 
significantly from the Fed's low interest rate policy, but they have 
been significant indirect beneficiaries as the low rates have supported 
businesses and thus the job market. Unemployment would be measurably 
higher today if not for the Fed's aggressive actions.
    Many older non-working Americans with their savings in deposits and 
other cash-like instruments have been hurt by the low rates. They are 
appropriately reluctant to put their savings into riskier stocks and 
real estate investments, and the interest income they receive has 
declined with the lower rates. There are no good investment options for 
this group. This group has been hurt financially by the Fed's 
aggressive actions.

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