    [House Hearing, 115 Congress]
    [From the U.S. Government Publishing Office]

                       MONETARY POLICY V. FISCAL POLICY:.
                    RISKS TO PRICE STABILITY AND THE ECONOMY

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

                                    HEARING

                                   BEFORE THE

                            SUBCOMMITTEE ON MONETARY

                                POLICY AND TRADE

                                     OF THE

                        COMMITTEE ON FINANCIAL SERVICES

                         U.S. HOUSE OF REPRESENTATIVES

                         ONE HUNDRED FIFTEENTH CONGRESS

                                 FIRST SESSION

                                   __________

                                 JULY 20, 2017

                                   __________

           Printed for the use of the Committee on Financial Services

                               Serial No. 115-34

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                     HOUSE COMMITTEE ON FINANCIAL SERVICES

                        JEB HENSARLING, Texas, Chairman

    PATRICK T. McHENRY, North Carolina,  MAXINE WATERS, California, Ranking
        Vice Chairman                        Member
    PETER T. KING, New York              CAROLYN B. MALONEY, New York
    EDWARD R. ROYCE, California          NYDIA M. VELAZQUEZ, New York
    FRANK D. LUCAS, Oklahoma             BRAD SHERMAN, California
    STEVAN PEARCE, New Mexico            GREGORY W. MEEKS, New York
    BILL POSEY, Florida                  MICHAEL E. CAPUANO, Massachusetts
    BLAINE LUETKEMEYER, Missouri         WM. LACY CLAY, Missouri
    BILL HUIZENGA, Michigan              STEPHEN F. LYNCH, Massachusetts
    SEAN P. DUFFY, Wisconsin             DAVID SCOTT, Georgia
    STEVE STIVERS, Ohio                  AL GREEN, Texas
    RANDY HULTGREN, Illinois             EMANUEL CLEAVER, Missouri
    DENNIS A. ROSS, Florida              GWEN MOORE, Wisconsin
    ROBERT PITTENGER, North Carolina     KEITH ELLISON, Minnesota
    ANN WAGNER, Missouri                 ED PERLMUTTER, Colorado
    ANDY BARR, Kentucky                  JAMES A. HIMES, Connecticut
    KEITH J. ROTHFUS, Pennsylvania       BILL FOSTER, Illinois
    LUKE MESSER, Indiana                 DANIEL T. KILDEE, Michigan
    SCOTT TIPTON, Colorado               JOHN K. DELANEY, Maryland
    ROGER WILLIAMS, Texas                KYRSTEN SINEMA, Arizona
    BRUCE POLIQUIN, Maine                JOYCE BEATTY, Ohio
    MIA LOVE, Utah                       DENNY HECK, Washington
    FRENCH HILL, Arkansas                JUAN VARGAS, California
    TOM EMMER, Minnesota                 JOSH GOTTHEIMER, New Jersey
    LEE M. ZELDIN, New York              VICENTE GONZALEZ, Texas
    DAVID A. TROTT, Michigan             CHARLIE CRIST, Florida
    BARRY LOUDERMILK, Georgia            RUBEN KIHUEN, Nevada
    ALEXANDER X. MOONEY, West Virginia
    THOMAS MacARTHUR, New Jersey
    WARREN DAVIDSON, Ohio
    TED BUDD, North Carolina
    DAVID KUSTOFF, Tennessee
    CLAUDIA TENNEY, New York
    TREY HOLLINGSWORTH, Indiana

                      Kirsten Sutton Mork, Staff Director
                   Subcommittee on Monetary Policy and Trade

                         ANDY BARR, Kentucky, Chairman

    ROGER WILLIAMS, Texas, Vice          GWEN MOORE, Wisconsin, Ranking
        Chairman                             Member
    FRANK D. LUCAS, Oklahoma             GREGORY W. MEEKS, New York
    BILL HUIZENGA, Michigan              BILL FOSTER, Illinois
    ROBERT PITTENGER, North Carolina     BRAD SHERMAN, California
    MIA LOVE, Utah                       AL GREEN, Texas
    FRENCH HILL, Arkansas                DENNY HECK, Washington
    TOM EMMER, Minnesota                 DANIEL T. KILDEE, Michigan
    ALEXANDER X. MOONEY, West Virginia   JUAN VARGAS, California
    WARREN DAVIDSON, Ohio                CHARLIE CRIST, Florida
    CLAUDIA TENNEY, New York
    TREY HOLLINGSWORTH, Indiana

                                C O N T E N T S

                                  ----------
                                                                       Page
    Hearing held on:
        July 20, 2017................................................     1
    Appendix:
        July 20, 2017................................................    33

                                   WITNESSES
                            Thursday, July 20, 2017

    Bernstein, Jared, Senior Fellow, Center on Budget and Policy
      Priorities.....................................................     7
    Leeper, Eric M., Rudy Professor of Economics, Indiana University,
      Bloomington....................................................     6
    Levy, Mickey D., Chief Economist for the Americas and Asia,
      Berenberg Capital Markets, LLC.................................     4
    Selgin, George, Director, Center for Monetary and Financial
      Alternatives, The Cato Institute...............................     9

                                    APPENDIX

    Prepared statements:
        Bernstein, Jared.............................................    34
        Leeper, Eric M...............................................    49
        Levy, Mickey D...............................................    64
        Selgin, George...............................................    74

                  Additional Material Submitted for the Record

    Davidson, Hon. Warren:
        Chart entitled, ``Federal Debt as % of GDP''.................   134
        Chart entitled, ``The `Official Plan' to `Balance the Budget'
          Projected Annual Deficit Spending''........................   135

                       MONETARY POLICY V. FISCAL POLICY:
                            RISKS TO PRICE STABILITY
                                AND THE ECONOMY

                                  ----------

                            Thursday, July 20, 2017

                 U.S. House of Representatives,
                               Subcommittee on Monetary
                                      Policy and Trade,
                               Committee on Financial Services,
                                                       Washington, D.C.
        The subcommittee met, pursuant to notice, at 9:34 a.m., in
    room 2128, Rayburn House Office Building, Hon. Andy Barr
    [chairman of the subcommittee] presiding.
        Members present: Representatives Barr, Williams, Huizenga,
    Pittenger, Love, Hill, Emmer, Mooney, Davidson, Tenney,
    Hollingsworth; Moore, Foster, Sherman, Green, Kildee, and
    Crist.
        Chairman Barr. The Subcommittee on Monetary Policy and
    Trade will come to order. Without objection, the Chair is
    authorized to declare a recess of the subcommittee at any time.
        Today's hearing is entitled, ``Monetary Policy v. Fiscal
    Policy: Risks to Price Stability and the Economy.''
        I now recognize myself for 3 minutes to give an opening
    statement.
        Today is not the first time we have seen a breaching of the
    line between monetary and fiscal policy. Unfortunately,
    Congress has a long history of forcing the hand of the Federal
    Reserve to accommodate its profligate spending.
        However, following the 2008 financial crisis, the Federal
    Reserve needed no prompting by Congress to pursue policies that
    are accommodating Washington's unsustainable fiscal policies
    and distorting the allocation of credit in our economy.
        As Renee Haltom and Robert Sharp explained, ``Prior to
    1951, the Fed's monetary policy was effectively determined by
    fiscal policy.'' That is, the Fed formally agreed to hold
    interest rates down to facilitate the Treasury's financing
    needs during World War II. This policy ended with the Fed
    Treasury Accord of 1951 enabling the Fed to focus solely on
    monetary policy objectives.
        Next came the Interest Adjustment Act of 1966, which
    required the Fed to reduce interest rates through various
    channels. But to the dismay of many in Congress, the Fed
    delayed action on this authority knowing that such actions
    threatened monetary policy independence.
        With more arm-twisting by Congress, the Fed would go on to
    purchase agency debt in the 1970s, mainly through Fannie Mae,
    the Export-Import Bank, and even a $117 million loan to the
    WMATA to build the Metro in Washington, D.C.
        In those days, the Fed was more resistant to political
    attempts to force it to interfere with fiscal policy. It
    recognized the limits of monetary policy and the economic
    damage that follows from using the Fed as a slush fund for
    individual interests.
        Today's Fed has done a 180, initiating on its own several
    rounds of quantitative easing that dramatically increase the
    balance sheet's size in considerable part by paying excessive
    interest on reserves to fund massive purchases of mortgage-
    backed securities.
        Why does this matter? On the one hand, our unsustainable
    fiscal policies threaten price stability. When governments
    cannot pay their bills, they are prone to leaning on their
    monetary authorities for accommodation. On the other hand, the
    Fed's foray into credit accommodation, masquerading as monetary
    policy, only deepens American's distrust in their government.
        Under our Constitution, a Congress that is accountable to
    voters decides how much and where to spend. A Federal Reserve
    that has taken on that authority by itself weakens the
    independence of monetary policy, accommodates our unsustainable
    fiscal policies, and distorts markets.
        A full 8 years out of recession and America's typically
    resilient economy has yet to fully rebound. A more accountable
    and disciplined monetary policy would go far to get us back on
    track.
        The Chair now recognizes the ranking member of the
    subcommittee, the gentlelady from Wisconsin, Gwen Moore, for 5
    minutes for an opening statement.
        Ms. Moore. Good morning, colleagues, and good morning to
    our esteemed panel. I just can't wait to delve into this
    conversation. Although the committee has had several hearings
    on Fed Reserve policy during and post-crisis, my thoughts of
    this are on the record.
        I have just listened to our distinguished Chair talk about
    the sad kind of dippin' into our policies here, and yet, we
    have complained continuously about economic growth.
        And basically saying the Fed should have stayed out of the
    business of trying to right our economy and they have supported
    contractionary fiscal policy here in Congress and then
    complaining about the Fed's policy to try to help stimulate the
    growth. I'm sorry, I just don't get it.
        How can you have any credibility about being pro-growth in
    our economy and then saying the Fed should stay out of it, when
    what we are doing on this side of the capitol is calling for
    government shutdowns, defaulting on the debt, cutting food
    stamps during a recession, cutting PELL grants so our kids can
    have an education, cutting unemployment benefits, and other
    countercyclical safety net programs, slashing budgets, cutting
    things like Medicaid, causing 32 million people to be
    uninsured.
        Now it is just curious, people, that for some reason this
    Congress is talking up the economy despite the job creation
    numbers that are the same, just slightly down from President
    Obama.
        Also, I have asked previous witnesses--and I want to see
    what today's witnesses are going to say--if any of them thought
    raising rates during the recession would have been a good
    policy.
        They didn't wonder what you were going to say. If you want
    to see where Republicans want to take the country, look at
    Kansas. The State was a right-wing Koch-brother economic
    utopia, and it is a mess because of it, with stunted economic
    growth and credit rating downgrades.
        I am hoping to flesh out some of this stuff with the
    witnesses here today. Thank you, and I yield back.
        Chairman Barr. The gentlelady yields back.
        The Chair now recognizes the gentleman from Ohio, Warren
    Davidson, for 2 minutes for an opening statement.
        Mr. Davidson. Thank you, Mr. Chairman. Thanks for holding
    this important hearing. Before serving in Congress, I owned,
    operated, and expanded manufacturing companies in Ohio.
        As a businessman, I knew firsthand the uncertainty and that
    fiscal and monetary policy have substantial consequences for
    small businesses on Main Street. Companies are reluctant to
    trust the Federal Reserve or Congress to steer our country in
    the right direction.
        During the great recession, the Federal Reserve took bold
    steps to manage the crisis. They moved on with mobile rounds of
    quantitative easing and unconventional asset purchases.
        By purchasing trillions of dollars in Treasury bonds and
    mortgage-backed securities, they have kept long-term borrowing
    costs low and enabled the U.S. to finance massive debt while
    distorting asset prices, pension funds, and created even more
    weakness in our banking system.
        As Chair Yellen has indicated in her testimony, the Fed
    will move forward with normalization of its balance sheet, but
    in many ways the Fed's monetary policy has accommodated
    irresponsible fiscal policy by Congress. We are on a collision
    course with a fiscal crisis. As economist Herb Stein said, ``If
    something can't continue, it will eventually stop.''
        The fiscal challenge before us is to grow our way out of
    this debt crisis. Deficits do matter. While our national debt
    is not the sole responsibility for the slow economic growth we
    will highlight in this hearing, it is certainly a factor. To
    bring true long-term growth, Washington must move regulatory,
    fiscal, and monetary policy in the right direction.
        The Federal Reserve needs to unwind its large and
    unconventional balance sheet and return to normal monetary
    policy. Congress must act swiftly with sound fiscal policy that
    promotes growth and does not bankrupt America. I look forward
    to hearing from our witnesses, and I yield back.
        Chairman Barr. The gentleman yields back.
        Today, we welcome the testimony of first, Dr. Mickey Levy.
    Dr. Levy is the chief economist for the Americas and Asia at
    Berenberg Capital Markets, LLC. Previously, he served as the
    chief economist for the Bank of America and Blenheim Capital
    Management.
        In addition to various corporate roles, Dr. Levy advises
    several U.S. Federal Reserve banks. Currently, his research
    focuses on U.S. and global economic and macroeconomic topics.
        Second, Dr. Eric Leeper is a Rudy Professor of Economics at
    Indiana University at Bloomington. His research is focused on
    fiscal and monetary policy analysis and the theoretical and
    empirical study of their interaction.
        Before becoming a professor of economics at Indiana
    University, he worked for 8 years at the Federal Reserve in
    Atlanta and in Washington, D.C., and currently is a research
    associate with the National Bureau of Economic Research. Dr.
    Leeper earned his doctorate in Economics from the University of
    Minnesota.
        Third, Dr. Jared Bernstein is a senior fellow at the Center
    on Budget and Policy Priorities. He served as the chief
    economist and economics advisor to former Vice President Joe
    Biden. He also was the executive director of the White House
    Taskforce on the Middleclass and was a member of President
    Obama's economic team.
        He has worked for the Economic Institute and the U.S.
    Department of Labor. Dr. Bernstein's research focuses on many
    subjects, including Federal and State economic and fiscal
    policies, income equality, and financial and housing markets.
    Dr. Bernstein earned a Ph.D. in social welfare from Columbia
    University.
        And finally, Dr. George Selgin is currently a senior fellow
    and the director of the Center for Monetary and Financial
    Alternatives at the Cato Institute. He also is a professor
    emeritus of economics at the University of Georgia. He
    specializes in monetary history, macroeconomic theory, and the
    history of monetary thought.
        He earned his B.A. in economics at Drew University, and his
    Ph.D. in economics from New York University.
        Each of you will be recognized for 5 minutes to give an
    oral presentation of your testimony. And without objection,
    each of your written statements will be made a part of the
    record.
        Dr. Levy, you are now recognized.

     STATEMENT OF MICKEY D. LEVY, CHIEF ECONOMIST FOR THE AMERICAS
                AND ASIA, BERENBERG CAPITAL MARKETS, LLC

        Mr. Levy. Chairman Barr, Ranking Member Moore, and members
    of the subcommittee, I appreciate this opportunity to speak on
    providing my views on monetary and fiscal policies. Both
    monetary and fiscal policies have gone off course and need to
    be reset.
        Sustained, unprecedented monetary ease has failed to
    stimulate the economy. Aggregate demand has actually
    decelerated since--nominal GDP has decelerated since the Fed
    instituted QE3.
        Fiscal policies have resulted in dramatic increases in
    debt, but they really haven't addressed some of the key
    structural factors that are undercutting economic performance.
    So both monetary and fiscal policies need to be reset, and they
    both involve significant risks that is their paths right now.
        While alarming government debt projection, say by the CBO,
    focused attention on the future, future concerns are becoming
    today's realities. The allocative effects of the government's
    current spending programs and our inefficient tax system are
    harming current economic conditions.
        I fully understand the frustrations about the economy, the
    sizable pockets of persistently high unemployment, the low
    wages, and the weak trends in productivity that have all
    contributed to lower potential growth. We all want better
    performance.
        But the issue is, how to achieve it. As a wealthy nation,
    we are misdirecting resources through fiscal policy and relying
    on monetary policy for the wrong objectives. The reality is,
    monetary policy cannot create permanent jobs. It cannot improve
    educational skills. Monetary policy cannot permanently reduce
    the unemployment of the semiskilled or raise productivity or
    boost real wages.
        Yet all too frequently, observers urge the Fed to ease
    monetary policy, or more recently to delay taking away the
    excessive ease that has stimulated financial markets, but
    hasn't stimulated economic growth. The Fed's $4.5 trillion
    portfolio and low interest rates reduce budget deficits, but
    this is temporary.
        Look at the CBO's forecast. And that temporary reduction in
    deficits encourages undesirable fiscal maneuvers and
    contributes to the Congress' delays in addressing fiscal
    challenges. It involves very high risk and it really does
    jeopardize the Fed's independence and its credibility.
        The Fed must continue to normalize monetary policy by
    increasing rates judiciously. Note that the recent rise in
    rates since December 2015 has had no negative impact on the
    economy. And it must proceed with its plan to begin unwinding
    its massive portfolio, although I think the Fed should move
    more aggressively than their strategy suggests.
        The Fed must step back from its policy overreach, including
    the Fed needs to fully unwind its mortgage-backed securities
    holdings, $1.7 trillion--the largest holder in the world of
    mortgages. It serves no economic purpose. Just think about it.
        The mortgage market is functioning just fine. Housing
    prices are booming. Housing is going up. Why is the Fed in this
    strategy of allocating credit?
        Having said that, the need for fiscal policy--and I know
    this is a money and banking committee--but the need for fiscal
    reform is much, much more pressing. The entitlement programs--
    Social Security, Medicare, and Medicaid--are well-intended and
    they are important programs for the government and for American
    citizens, but their persistent spending increases stemming from
    their flawed structures have clearly impinged on spending for
    other programs including infrastructure, job retraining,
    education, and research and development.
        This in and of itself, the misallocation of resources,
    adversely affects current economic performance. It hurts
    productivity, it constrains wages, it reduces job opportunities
    for many working age people, and it lowers potential growth.
    And I might note these entitlements are the primary source of
    rising debt projection.
        So I know my time is running out. Congress faces two paths.
    It can take one of two. It could avoid reforms, which would
    mean reinforcing continued disappointing economic growth, allow
    large pockets of underperformance and labor markets and slow
    wages to persist. This would generate mounting reliance on
    income support programs and place more strains on the
    government.
        Chairman Barr. The gentleman's time has expired, but just
    quickly finish the thought.
        Mr. Levy. Okay. My thought, alternatively, the only other
    focus is the Fed can pursue meaningful and fair fiscal reforms.
    And by fair, improve the structures of these programs while
    maintaining their intent. That would allow more allocation of
    resources toward government programs that would really enhance
    productive capacity. Now is the time to act.
        [The prepared statement of Dr. Levy can be found on page 64
    of the appendix.]
        Chairman Barr. Thank you. Thank you, Dr. Levy, and we will
    get more testimony from you in the questions and answers.
        Dr. Leeper, you are now recognized for 5 minutes.

       STATEMENT OF ERIC M. LEEPER, RUDY PROFESSOR OF ECONOMICS,
                    INDIANA UNIVERSITY, BLOOMINGTON

        Mr. Leeper. Chairman Barr, Ranking Member Moore, and
    subcommittee members, thank you for inviting me to talk with
    you. The title of this hearing, ``Monetary v. Fiscal Policy,''
    frames the issue in an unfortunate way. The title harks back to
    the unproductive Keynesian monetarist debates of the 1960s and
    1970s.
        As I hope my comments make clear, a more constructive way
    to think about this is as monetary and fiscal policy. This is
    not merely a semantic point, it is fundamental economics. Basic
    economic reasoning tells us that monetary policy actions always
    have fiscal consequences.
        Let's start with something routine. The Federal Reserve
    raises the Federal funds rate in order to reduce inflation. But
    this isn't the end of the story. A higher funds rate tends to
    raise all interest rates, including those on government debt.
    So interest payments on outstanding debt rise.
        Now fiscal policy comes into play. Those higher interest
    payments require higher taxes or lower expenditures in the
    future to service the debt. The message is to successfully
    reduce inflation, tighter monetary policy necessarily requires
    tighter fiscal policy at some point. That fiscal response is
    essential for the Fed to be able to control inflation.
        But what happens if the fiscal response is not forthcoming
    because the fiscal authority never adjusts taxes or spending?
    Well, bondholders will see their interest receipts rise, but
    don't anticipate higher offsetting taxes.
        They feel wealthier and demand more goods and services.
    Higher demand raises prices, counteracting the Fed's original
    intention to lower inflation.
        Appropriate fiscal backing for monetary policy is critical
    for the Fed to achieve price stability. What I have described
    arises naturally from a fiscal policy that aims to stabilize
    the government debt GDP ratio. What is important is that the
    private sector understands and believes that the fiscal
    response will eventually take place.
        Of course when debt levels are low, the changes in debt
    service and therefore taxes are modest. Debt service has also
    been modest during the past decade because interest rates have
    been extraordinarily low.
        The fortuitous fiscal effects of low interest rates,
    however, may be coming to an end. This committee has heard
    previous testimony about the process of monetary policy
    normalization, but there is an important fiscal component to
    normalization that I want to highlight.
        Here is a little accounting exercise. The market value of
    gross Federal debt is now a bit higher than nominal GDP. If
    interest rates on government bonds rise from current levels to
    6 percent, roughly the average in the post-World War II period,
    interest payments will rise over time by 5 percent of GDP. That
    is nearly a trillion dollars.
        Debt service now consumes about 10 percent of Federal
    expenditures. In the late 1980s and early 1990s, at its post-
    war peak, debt service was 20 percent of expenditures, but then
    the debt GDP ratio was below 60 percent. Evidently, interest
    rate normalization carries substantial fiscal implications.
        I end by pointing to recent data that underscore the need
    to look at monetary and fiscal policy together. Short-term
    interest rates have been below 1 percent for a decade.
        Over that period, bank reserves increased by a factor of
    52, yet inflation by any measure has averaged less than 2
    percent since 2008. Meanwhile, long-term Treasury yields have
    been trending down, suggesting that markets don't expect
    inflation is going to pick up.
        How can this happen? When massive growth and bank reserves
    hasn't created inflation because banks happily hold idle and
    safe reserves whose yield exceeds those in the Federal funds in
    the short-term Treasury markets. But here is another fact with
    which you might be familiar. Gross Federal debt has doubled
    since 2008.
        Why hasn't this been inflationary? In a phrase, bond market
    pessimism. During the financial crisis, there was a worldwide
    flight to safety. Investors had an insatiable appetite for
    Treasuries. That appetite continues today, ensuring demand
    absorbs the expanding supply of bonds.
        The question for monetary policy is what happens to
    inflation and the Fed's ability to control it when the thirst
    for safety is quenched? The answer hinges on the fiscal
    response. Thank you.
        [The prepared statement of Dr. Leeper can be found on page
    49 of the appendix.]
        Chairman Barr. Thank you.
        Dr. Bernstein, you are now recognized for 5 minutes.

     STATEMENT OF JARED BERNSTEIN, SENIOR FELLOW, CENTER ON BUDGET
                         AND POLICY PRIORITIES

        Mr. Bernstein. Chairman Barr, Ranking Member Moore, thanks
    for the opportunity to testify today. My testimony stresses the
    following points on monetary and fiscal policy, including
    important interactions between the two.
        First, to most effectively pursue monetary policy in the
    interest of American families and businesses, our central bank
    must maintain independence from the political system.
        While Congress should monitor the Fed's pursuit of its dual
    mandate, full employment at stable prices, it must scrupulously
    avoid any micromanaging of the Fed's work in meeting its
    mandate.
        In this regard, the CHOICE Act, associated with this
    committee, creates serious economic risks. By aggressively
    rolling back necessary financial oversight, the Act raises the
    likelihood of return to underpriced risk bubbles, bailouts, and
    recession.
        Title X of the Act, which establishes procedures by which
    Congress would micromanage the interest rate-setting policy of
    the Federal Reserve, threatens to reduce the central bank's
    essential independence and hamstring its ability to respond to
    economic downturns and financial market excesses.
        This is the strongest caution I can offer you today. To
    pursue Title X would ultimately politicize the Federal Reserve
    in ways that would deeply undermine its effectiveness.
        A remarkable aspect of the Title, especially from a
    Congress that claims it wants to reduce unnecessary regulation
    and red tape, is that it demands strict adherence to a policy
    rule, spelling out in detailed language a specific formula that
    the Fed's interest rate-setting committee must follow or face
    burdensome regulatory scrutiny.
        This requirement is unworkable. If the FOMC strays from the
    ``reference formula'' in the Act, their rule change would be
    subject to nine separate burdensome requirements, many of which
    are onerous enough to make deviation from the rule impractical.
        For example, within 48 hours of a policy meeting, the Fed
    Chair must, ``include a function that comprehensively models
    the interactive relationship between the intermediate policy
    inputs.''
        She must, ``include the coefficients of the directive
    policy rule that generate the current policy instrument target
    and a range of predicted policy future values for the
    instrument target if changes occur in any''--and then some.
        And these are just two of the nine requirements. I have
    been studying monetary policy for decades, and I am not sure I
    know what some of these requirements mean. Again, this is an
    astounding read from a Congress that claims to be invested in
    reducing red tape and complex regulation.
        My testimony also explains why a rule-based policy must be
    contrary to Title X applied with discretion. There are many
    variations to Taylor-type rules, all of which differ from the
    reference formula in the bill.
        There are two unobserved variables in the rule, the
    equilibrium real rate of interest and the output gap. And I
    assure you economists are far from agreement on the optimal
    values to use in rule-based monetary policymaking.
        Figure two from my testimony shows what I mean. Using real-
    time data, the Title X rule hits its low point in the fourth
    quarter of 2009 when it recommended a Federal funds rate that
    was negative 1.8 percent. Plugging in variants that mainstream
    economists endorse, however, generates a range of results from
    about negative 1 percent to about negative 7 percent.
        Turning to fiscal policy, the other subject of today's
    hearing, in 2013 Fed Chair Ben Bernanke made the following
    statement to this committee, ``Although monetary policy is
    working to promote a more robust recovery, it cannot carry the
    entire burden of ensuring a speedier return to economic health.
    The economy's performance both over the near term and the
    longer run will depend importantly on the course of fiscal
    policy.''
        There are at least three reasons why Mr. Bernanke was right
    about this. First, once the Federal funds rate hits zero, the
    Fed's firepower is constrained.
        Second, monetary and fiscal stimulus attack different parts
    of the problem in weak demand constrained economies. Monetary
    stimulus works largely through lowering the cost of borrowing,
    but people hurt by high unemployment may have too little income
    to take advantage of low interest rates.
        To the extent that fiscal stimulus puts money in people's
    pockets, say through infrastructure programs, direct job
    creation, temporary tax cuts, increased safety net benefits
    like ramped-up unemployment insurance, people are more likely
    to take advantage of low borrowing costs and to signal to
    investors through increased consumer demand that they too
    should take advantage of low rates.
        Third, monetary and fiscal policies interact in recessions
    to boost fiscal multipliers. My testimony shows that before
    Congress prematurely pivoted to fiscal austerity, the one-two
    punch of fiscal and monetary policy was effectively pushing
    back on the Great Recession and slow recovery that followed.
        I then document the high costs of fiscal austerity,
    including over a million jobs lost and the downshifting of GDP
    levels and growth through scarring effects. Thank you.
        [The prepared statement of Dr. Bernstein can be found on
    page 34 of the appendix.]
        Chairman Barr. Thank you, Dr. Bernstein.
        And Dr. Selgin, you are now recognized for 5 minutes.

     STATEMENT OF GEORGE SELGIN, DIRECTOR, CENTER FOR MONETARY AND
               FINANCIAL ALTERNATIVES, THE CATO INSTITUTE

        Mr. Selgin. Chairman Barr, Ranking Member Moore, and
    subcommittee members, in October 2008 the Federal Reserve began
    paying interest on bank's reserve balances with it. My
    testimony today concerns the economic consequences of that
    step.
        The Fed was originally supposed to start paying interest on
    banks' reserves in 2011 to reduce the implicit tax burden
    reserve requirements placed on them. But as the 2008 crisis
    worsened, the Fed received Congress' permission to start paying
    interest on reserves immediately.
        Its goal then was not to relieve banks of a required
    reserve burden, but to get them to hoard reserves it was
    creating by its emergency lending so that lending wouldn't
    result in increased bank lending and inflation.
        To make interest on reserves serve this role, the Fed set
    the rate of interest on reserves above comparable market rates,
    where it has kept it ever since. The Fed thereby ignored the
    law's stipulation that the rate was, ``not to exceed the
    general level of short-term rates.''
        As an anti-stimulus measure (note well) interest on
    reserves worked as expected. In fact, it worked so well that
    within weeks the Fed did an about-face. Now it hoped to
    stimulate the economy by purposefully creating large quantities
    of fresh bank reserves. All told, the three subsequent rounds
    of quantitative easing created another $2 trillion of
    additional bank reserves.
        Yet because reserves still paid an above-market rate of
    interest, banks just kept on accumulating them as they had
    done, and as the Fed had wanted them to do, before Q.E. when it
    was worried about inflation. If insanity is doing the same
    thing over and over again but expecting different results, then
    I fear it must be said that some officials at the time were not
    quite in their right minds.
        Although the Q.E. stimulus was disappointingly small, the
    Fed's actions had other big consequences. By acquiring
    trillions of dollars' worth of Treasury and mortgage-backed
    securities and borrowing from banks to pay for them, the Fed
    dramatically increased its footprint in the U.S. credit system.
        Before interest on reserves and quantitative easing, bank
    reserves were less than 1 percent of bank deposits. Bank loans,
    in contrast, were almost 100 percent of bank deposits. Today,
    bank reserves are 20 percent of deposits and loans are just 80
    percent of deposits. Before interest on reserves in Q.E. the
    Fed's assets were 7 percent of commercial bank assets. Today,
    that figure is 27 percent.
        Commercial banks are expected to invest the public's
    deposits productively, subject to regulatory guidelines.
    Central banks are not. Central banks are tasked instead with
    regulating the scale of commercial bank lending and deposit
    creation. According to the Fed's own guidelines as set forth in
    a pre-crisis publication, it is supposed to, ``Structure its
    portfolio and activities so as to minimize their effect on
    credit allocation within the private sector.''
        The reason the same guidelines state for this is, ``that
    hard-earned experience shows that, in general, market directed
    resource allocation fosters long run economic growth.''
        In fact, there is vast economics literature on what is
    known as financial repression. The term refers to the harmful
    consequences of policies, mainly in less developed countries,
    that divert savings from commercial banks to central banks and
    thus from more to less productive uses. That literature blames
    such policies for much of the world's poverty.
        The Fed's current operating system, with its above-market
    interest rate on reserves and bloated balance sheet, is very
    financially repressive. That is one reason for the continuing
    post-crisis productivity slowdown.
        Yet the same system, far from at least improving basic
    monetary control, has prevented the Fed for 5 years running
    from meeting the 2 percent inflation target it set in 2012.
        Distinguished subcommittee members, Chairman Barr, a
    central bank that cannot control inflation, and especially one
    that cannot make inflation go up, is a central bank that is
    unable to perform its fundamental duties.
        To close, the Fed's new operating system based on above
    market interest on reserves has had disastrous consequences.
    Yet despite these results, the Fed's current normalization plan
    would keep much of the current arrangement in place. I hope for
    the general public's sake that Congress will not let that
    happen.
        [The prepared statement of Dr. Selgin can be found on page
    74 of the appendix]
        Chairman Barr. Thank you, Dr. Selgin.
        And the Chair now recognizes himself for 5 minutes.
        I will stay with you, Dr. Selgin, I appreciate your
    testimony, particularly about interest on excess reserves and
    the associated risks with that as a primary monetary policy
    tool.
        Dr. Selgin, what are the risks and downsides and the
    distortionary impacts of replacing conventional open market
    operations with interest on excess reserves as the primary
    monetary policy tool for setting the Fed funds rate?
        Mr. Selgin. The original means, before the crisis, by which
    the Fed managed the Fed funds rate was through open market
    operations, where it would adjust the quantity of reserves
    available to banks to change the rate at which they would lend
    to each other overnight, which is what we are referring to when
    we speak of the Federal Funds Rate.
        That system worked while reserves were scarce and so long
    as it was worth more to banks to lend funds than to hold on to
    them as excess reserves, and it worked very well. It was the
    system that brought us the so-called great moderation of the 20
    years roughly beginning in 1985.
        In the new system, because banks under it aren't tempted to
    use their reserves but instead hold on to whatever comes their
    way, monetary tightening or monetary control consists of the
    Fed's adjustment of these administered interest rates, the
    interest rate on excess reserves and, lower down, the overnight
    reverse repo rate.
        The problem with that system is, first of all, as I
    mentioned, the Fed has not succeeded using it in gaining the
    control of inflation we normally would want central banks to be
    able to exercise. It simply has not been able to meet the 2
    percent target that it specified. And that is partly because it
    is hard to do that when you can't get banks to lend more by
    creating more reserves.
        Under this arrangement, you have to rely on the so-called
    portfolio balance effect and other effects that work through
    tightening banks' demand for reserves or loosening that demand
    rather than by increasing reserves or changing the supply and
    having banks lend more or less.
        But the other problem is that this new system requires that
    there be a substantial amount of excess reserves in the system.
    And that means that the Fed is, as I said, having a much larger
    role in credit allocation, and that means less productive use
    of credit.
        Central banks are not designed to invest funds
    productively. They cannot make any loans to businesses,
    farmers, or consumers. So their portfolio is necessarily
    limited and that means that the use of funds, when they are
    commandeered by the Fed, is not going to be as helpful for
    economic growth.
        Chairman Barr. Thank you.
        And Dr. Levy, in Dr. Bernstein's testimony he made the
    argument that a Fed reform that has been proposed by this
    committee would involve over-regulation, over-regulation, in
    this case, of the Fed.
        When I think of over-regulation, I think of Washington
    over-regulating actors in the private economy. I don't think of
    Washington trying to keep entities that are part of the Federal
    Government accountable.
        And so regulating and holding accountable the Federal
    Reserve to a strategy-based policy that is transparent and
    accountable, I don't view that, as Dr. Bernstein does, as over-
    regulation.
        Can you comment on that? And also, can you talk about the
    Fed's extension into credit policy as potentially contributing
    to the risk of fiscal inflation, and what the unconventional
    policies the Fed may need for the political independence of
    monetary policy?
        Mr. Levy. Yes. On regulation, it is the role of your
    committee to supervise the Federal Reserve. And I think the
    general thrust of the Financial CHOICE Act provides you more
    ability to properly supervise the Fed.
        In response to issues about the Fed has to respond within
    48 hours, the Fed has hundreds upon hundreds of very capable
    staff members who have already delved into all these issues.
        They have already written up before the meetings their
    approaches to the issues. So I don't think it is asking too
    much of the Fed to respond to questions.
        With regard to rules-based, you want to make the rules-
    based flexible and allow flexibility to the Fed to deviate from
    those rules under abnormal circumstances, such as during the
    financial crisis, but then use that as a framework for
    explaining to the committee why it deviated. So you want a
    rule, but you want it to be flexible.
        Chairman Barr. Thank you. My time has expired. I appreciate
    your responses to those questions.
        And the Chair now recognizes the distinguished ranking
    member of the subcommittee, Congresswoman Gwen Moore, for 5
    minutes.
        Ms. Moore. Thank you so much. This is just the most amazing
    opportunity of my lifetime to be able to sit and listen to
    people with the level of expertise that all of you have brought
    here today, and I have more questions than I have time.
        But let me start out with you, Dr. Bernstein, because I
    think you are sort of outnumbered here on the panel of experts.
    You said in your testimony that there was a high cost of fiscal
    austerity, and I would like you to flesh that out a little bit
    for us. You said that at the end of your testimony.
        Mr. Bernstein. Right. My testimony documents the impact on
    GDP growth, on jobs, on unemployment from a premature pivot to
    fiscal austerity endorsed by Congress starting around 2010,
    particularly in 2012, 2013 to be very specific.
        Congress' failure to renew the payroll tax holiday took
    something like $120 billion out of the economy at a time when
    the recovery was still slow to take off. And this led to the
    loss of about 1.5 percent of GDP, maybe around a million jobs,
    that would otherwise have occurred had Congress not made this
    pivot.
        It is widely understood by economists that this type of
    premature pivot to fiscal austerity has been particularly
    damaging in Europe, where unemployment rates are still highly
    elevated.
        We didn't bite off of as much of it as they did, but I
    present concrete examples of the damage this did to the
    economic lives of working families earlier in this expansion.
        Ms. Moore. I can tell you that the rest of the panelists
    have argued, particularly I think Dr. Levy, and I am going to
    get to him in a minute, about the importance of changing the
    entitlement programs lest we become too reliant upon them, in
    favor of doing other things.
        And I guess I am curious as to what those things will be.
    But right now we are--the latest CBO report says that 32
    million people are going to be kicked off Medicaid. There are
    proposals to structurally change Medicaid.
        We have seen our Speaker in the past talk about vulturizing
    Medicare, changing Social Security. What do you think the
    impact will be? Do you think this will solve our debt problem,
    I guess that is the narrative?
        Mr. Bernstein. Are you asking me?
        Ms. Moore. Yes.
        Mr. Bernstein. I think if the House, particularly
    Republicans, were interested in chipping away at the debt
    problem that Dr. Levy emphasized in his testimony they wouldn't
    be considering trillions of dollars of tax cuts that are unpaid
    for.
        Ms. Moore. Amen. Unpaid for wars, I appreciate that. In
    terms of--I am interested in the fiscal policy, the rules-based
    fiscal policy. What prevents smart people from gaming the
    system, Wall Street wizards, when we have a rules-based Fed?
        First, Dr. Bernstein, and then maybe Dr. Selgin? Quickly?
        Mr. Bernstein. Okay. Quickly, I think that Dr. Levy was
    just saying that you want it to be stated you want a rules-
    based Fed, you want it to have flexibility.
        I would argue very strenuously that is the antithesis of
    Title X in the CHOICE Act. There is a really strong attempt to
    undermine the Fed's discretion, and I think any objective
    reading of the rule would leave you with that impression.
        Ms. Moore. Dr. Selgin, why couldn't a wizard of Wall Street
    game the system with a rules-based approach? Go on, go for it.
        Mr. Selgin. Actually, it is the absence of rules that is
    easily gamed as it allows monetary policy to become a football
    that special interests try to influence--or Congress itself,
    for financing the deficit and any other number of reasons. And
    there is a long history of this kind of influence. A rule can
    be very flexible.
        Ms. Moore. It is an oxymoron to say you are going to have a
    rule and then it is going to be flexible.
        Mr. Selgin. Yes. Let me explain.
        Ms. Moore. They taught me that in algebra.
        Mr. Selgin. Rules can be designed so that they allow for
    reactions to all kinds of circumstances.
        Ms. Moore. Dr. Levy needs my last 20 seconds.
        Mr. Selgin. All right.
        Ms. Moore. How would you change the structure of the
    entitlements?
        Mr. Levy. I would look carefully at the structure of Social
    Security, look carefully at the replacement rates in them that
    haven't been looked at--
        Ms. Moore. Who would be the losers?
        Mr. Levy. --since the early 1980s to be fair and to protect
    older working people and phase things in in a logical way. On
    Medicare and Medicaid, this gets into very difficult, including
    ethical issues.
        Ms. Moore. You brought it up, I didn't. My time has
    expired.
        Chairman Barr. Thank you. The gentlelady's time has
    expired.
        The Chair now recognizes the Vice Chair of the
    subcommittee, Mr. Williams from Texas.
        Mr. Williams. Thank you, Chairman Barr, and thank all of
    you for being here today.
        Dr. Selgin, I wanted to talk a little bit about the Fed's
    plan to begin unwinding its balance sheet. I think in your
    testimony you call it a recipe for failure. Why is that? And
    how should the Fed proceed so that its normalization plan has a
    meaningful impact on the balance sheet?
        Mr. Selgin. Thank you. As I mentioned in my testimony, the
    Fed has for some years now failed to reach its inflation
    target. I believe its plan for normalization will only make it
    more likely to fail again and by a larger margin in the future.
        The reason is that the plan the Fed has announced involves
    two things: shrinking the balance sheet, which is itself a
    tightening measure, of course; and raising the interest rate on
    excess reserves that I have been complaining about, in the next
    several years to over 3 percentage points, which is, of course,
    more than twice its current level. That is tightening as well.
    So you have a lot of tightening going on by a Fed that is
    already too tight, according to its own inflation target.
        The Fed has also said, though, that if things get bad under
    its current normalization plan, it will consider abandoning the
    shrinking of the balance sheet it has announced, and may even
    turn to expanding it again.
        This seems to me, all told, to be a recipe for failure. And
    I am sorry to have to say that I believe that the Fed is
    perhaps not all that keen on actually succeeding in becoming
    small again.
        Mr. Williams. Okay. Thank you. Staying with you, I want to
    quote Mr. Bernanke. Of course, we have all heard him say,
    ``Banks are not going to lend out the reserves at a rate lower
    than they can earn at the Fed.''
        Well, I am a borrower. I borrow all the time, and I can
    certainly appreciate a good rate. But the Fed's policy of
    giving above-market rates to banks that hold excess reserves
    that we have already talked about is troubling.
        A couple of weeks ago, this subcommittee had a hearing
    called, ``The Federal Reserve's Impact on Main Street,
    Retirees, and Savings.'' So in your opinion, how has this
    policy affected Main Street America, which I am and most of us
    are, and small businesses who want to gain access to capital,
    which is important in expansion?
        Mr. Selgin. Banks ultimately pick their portfolios,
    reserves, loans, whatever other assets they can acquire, so
    that the tendency is for them all to be worth the same amount
    at the margin, as we economists like to say.
        When you make it more worthwhile for banks to hold reserves
    by raising the rate on reserves, and particularly when you
    raise that rate above comparable market rates, the first thing
    that happens is banks don't make any short-term loans. They
    pull out of the wholesale markets.
        But in the long run, these adjustments include adjustments
    to other kinds of lending. And, in fact, that is why lending is
    now, as I said, about 80 percent of total bank deposits,
    whereas for years before the crisis, total lending and total
    deposits moved together. So that difference between 100 percent
    and 80 percent, there is your small town lending loss.
        Mr. Williams. Along those same lines, you also talked in
    your testimony about removing inefficiencies--
        Mr. Selgin. Yes.
        Mr. Williams. --and improving the environment for economic
    expansion. As it relates to our current debate on reforming the
    tax code, do you have any specific tax policy reforms Congress
    should focus on?
        Mr. Selgin. No, sir. I am not an expert on tax policy. I
    would be offering my private citizen's guesses on that subject,
    and I would rather not.
        Mr. Williams. Less tax would be good though. You would
    agree with that, wouldn't you?
        Mr. Selgin. Well, if it were less for me, yes.
        [laughter]
        Mr. Williams. Thank you. All right. Dr. Levy, in your
    testimony, you state that sound monetary policy ultimately
    relies on sound fiscal policy. Many of us in this room continue
    to be concerned about the long-term implications that our
    national debt will have on future generations.
        So you talk about monetary policy and government finances
    being interconnected. Can you go into greater detail on why
    policymakers, i.e. Congress, should not continue to ignore our
    national debt, and what are the long-term consequences it could
    have on monetary policy?
        Mr. Levy. It is not just the deficit spending that
    increases the debt, it is what you are deficit spending for.
    When you look at how the budget has evolved, a large and rising
    share of it is being allocated toward income support.
        A lot of that is good, but a shrinking portion is being
    allocated toward policies like infrastructure, job retraining,
    and research and development, that would add to long run
    productive capacity. Therefore, the increase in the debt and
    the allocation of the national resources, generated by the
    structure of the spending programs, is basically borrowing from
    the future and from future generations.
        And so the problem you face is under current law, the
    policies, the tax policies, the structure of the spending
    policies will reinforce disappointing economic growth and only
    add to debt.
        Chairman Barr. The gentleman's time has expired.
        The Chair now recognizes the gentleman from Michigan, Mr.
    Kildee.
        Mr. Kildee. Thank you, Mr. Chairman. And to the panel,
    thank you so much for your testimony.
        Dr. Levy, I would just like to pick up where Ms. Moore left
    off. She asked about specific structural changes in Medicaid/
    Medicare, Social Security. And I wonder, without going too
    deep, because I don't have a lot of time, if you could just
    give examples of what you mean by that, more specific examples
    of what you might mean by changes? And if you could just
    quickly identify changes in each of those three important
    programs?
        Mr. Levy. Social Security, you have to look at the internal
    structure of the benefits, what is called the replacement rate,
    which hasn't been changed in forever. You have to look at rates
    of return. People who are older and retire much earlier are
    getting extremely high rates of return on their Social Security
    contributions.
        You should treat Social Security income as an insurance
    policy and tax the extent to which it exceeds your inputs.
        By the way, I testified many decades ago, and encouraged
    the Congress to tax a certain portion of Social Security
    benefits, and that is happening. So you really need to look at
    the underlying structure.
        Medicare and Medicaid are much more difficult. You start
    out with asking the question, why is the U.S. allocating about
    18 percent of its GDP toward medical care without getting the
    results?
        And you have to look at the structure of these programs,
    including, as I was starting to mention to Congresswoman Moore,
    you need to get into this ethical issue.
        Are we appropriately allocating resources when so much of
    Medicare goes to the last 18 months of life, and in some cases,
    with very good examples, prolongs lives in ways that aren't
    positive. So--
        Mr. Kildee. Right. And, sir--
        Mr. Levy. --these are ethical issues. I understand. But if
    you really address the structure of the programs without just
    talking about big numbers and--we are a wealthy Nation. If we
    restructured these programs, there would be more than enough
    resources to insure the indigent, the poor, et cetera, et
    cetera.
        Mr. Kildee. I appreciate that. The difficulty that I am
    having, and you referenced it, and I would ask Mr. Bernstein to
    comment specifically on this, the frustration that I have is
    that, for a lot of folks, and this applies to both sides of the
    aisle, dealing with this question is sort of like in Washington
    like the weather. Everybody complains about it, but nobody ever
    does anything about it.
        The issue that I am concerned about is where we seem to see
    a willingness, at least with this Congress, to push down on
    public investment.
        It is in those areas where you would expect the greatest
    return, in the development of skills, in the kind of income
    support that is absolutely necessary to keep a family from
    completely tipping over and going into a tragic death spiral.
        Mr. Bernstein, I wonder if you might comment on how you
    think the current budget proposals might impact both larger
    economic performance, but specific issues that relate to
    families and communities?
        Mr. Bernstein. I would underscore the points that you were
    beginning to get at there, Congressman. If you look at the part
    of the budget that is non-defense discretionary, that is
    actually where a lot of the functions that you are describing
    live. And I actually agree with Micky Levy's points.
        So take education, for example. Take access to college. The
    budgets that Republicans and President Trump have been sending
    up, take those levels of funding, a share of GDP down to
    historical lows that we have never seen anything like before,
    lower than any point on record, going back to the 1960s when
    the modern data series begin.
        Whether we are talking about infrastructure, education,
    childcare, helping people get back to work, investing in
    communities, that is where that lives. And just briefly on the
    social insurance programs, on Medicaid, Medicare, remember
    Social Security reduces elderly poverty from 40 percent to 9
    percent.
        About two-thirds of Social Security recipients depend on
    that income for half or at least half of their income. So this
    is a--the average benefit is $16,400 a year. Okay? We are not
    talking about lavishing money on retired people.
        So instead of chopping away at these programs, we should
    look at them as investments in our future. And I am afraid that
    the current budgets that we have seen go exactly in the
    opposite direction.
        Mr. Kildee. All right. Thank you. It seems that my time has
    expired.
        I yield back. Thank you very much.
        Chairman Barr. The Chair recognizes the chairman of our
    Capital Markets Subcommittee, Mr. Huizenga from Michigan.
        Mr. Huizenga. Thank you, Mr. Chairman. And quickly, this
    isn't the main part of what I wanted to talk about, but Dr.
    Bernstein brought up Title X and his concerns. I think they are
    unfounded, being intimately involved with the creation of the
    FORM Act, which then was put into the CHOICE Act.
        Page 503, Line 1, Subtitle C, Requirements for a Directive
    Policy Rule shall, and it goes through seven, eight, nine
    various things. Of that, it says, ``The Fed needs to just
    describe what it is doing.''
        Down at number 6, it says that, ``They need to include a
    statement as to whether the directive policy rule substantially
    conforms to the policy rule that they wrote, and, if
    applicable, A, an explanation to the extent in which it departs
    reference rule that, again, it wrote, not us; B, a detailed
    justification for the departure from the rule that it wrote; C,
    a description of the circumstances under which the directive
    policy may be amended in the future,'' that they wrote; and
    then ``7, include a certification of the directive policy rules
    expected to support the economy in achieving stable prices and
    maximizing natural employment for long term.''
        For a body that created the Fed, I think it is completely
    applicable that they explain it. I have to move on, though, to
    Dr. Levy.
        Mr. Bernstein. But can we argue about that for a minute?
        Mr. Huizenga. Well, no, because I have 3 minutes and 30
    seconds to get to another point.
        Mr. Bernstein. It is going to--
        Mr. Huizenga. But we can take that up--
        Mr. Bernstein. Let's take that up.
        Mr. Huizenga. --at another time. Monetary policy, I believe
    Dr. Levy, you had said, ``Monetary policy has stimulated fiscal
    markets, but has not stimulated economic growth.'' And I agree.
    And you later then said something about large pockets of
    underperformance versus meaningful and fair fiscal reforms.
        That was in your opening statement. And we ran out of time.
    I wanted you to explain a little bit of that, because I have
    done research into my own district here.
        My home county is at 2.6 percent unemployment. However, I
    have pockets, including in Muskegon County, which houses a
    place called Muskegon Heights, predominantly African American,
    about 10,00 people located within another city, where the
    official unemployment rate is in the low teens.
        That is not U6 numbers. That is the official unemployment
    rate. I have the poorest county in the State of Michigan, Lake
    County, again, heavily minority.
        I have the largest Hispanic district in the State of
    Michigan. And what we are seeing is those minority communities
    being left behind in unprecedented numbers compared to where
    the rest of the economy and society is accelerating.
        And I think it is exactly as you were headed towards. Wall
    Street is doing just fine. If you are a qualified investor, an
    elite citizen, you are doing more than just fine.
        If you are Joe and Jane IRA, you are struggling, because
    you are not able to get into it. And if you don't even have
    that investment account, you are really struggling. So I would
    like you to expound on that, please?
        Mr. Levy. Thank you. I give the Fed credit for the
    aggressive stimulus during the financial crisis and recession.
    That was 8 years ago. The effectiveness of its subsequent
    quantitative easing programs and low interest rates is highly
    questionable.
        Since QE3 in the fall of 2012, and the implementation of
    forward guidance and sustained negative real policy rates,
    nominal GDP growth has decelerated. It has stimulated financial
    markets, it has not stimulated economic growth.
        I emphasize that monetary policy is incapable of addressing
    some of the pockets of under-economic performance and
    underperformance in labor markets in your district and
    nationally. Those need to be addressed with the proper policy
    tools.
        One of the critical points I emphasize is that if we
    identified the sources of the increase in debt and ask how can
    we restructure those while maintaining the intent of the
    programs? If we did that properly, that would free up resources
    for us to spend on areas like you have mentioned and in
    programs that would increase productive capacity.
        And I think that is critically important. Congress and the
    Fed need to understand the proper roles of monetary and fiscal
    policies, identify the sources of our underperformance and
    frustrations about the economy and address them with the proper
    policy tools.
        Chairman Barr. The gentleman's time has expired.
        The Chair recognizes the gentleman from Illinois, Mr.
    Foster, for 5 minutes.
        Mr. Foster. Thank you, Mr. Chairman. And thank you to our
    witnesses. I would like to quickly touch on one thing, which
    actually was the subject of a recent Wall Street Journal op-ed,
    talking about repealing the debt limit, in which a pair of very
    respected Democrats and Republicans made the case, and a number
    of interesting--well, besides just going over the history--they
    made the interesting point that at present the debt limit
    negotiations are being used by Democrats to increase spending,
    which is sort of contrary to the intent, certainly of
    Republicans who typically talk about and attempted to use it as
    as a cap on spending.
        And so I would first like to just ask anyone who would like
    to opine, whether this is a useful mechanism? It is often
    compared to refusing to pay your credit card after you have
    made the purchase, and that we would be much better off taking
    seriously the budget process and controlling the spending at
    the level of budget resolution and so on. And I wonder if any
    of you--Dr. Leeper?
        Mr. Leeper. Yes. I think that the debt limit is
    anachronistic and is almost counter-productive for what you
    want to do. It ends up increasing uncertainty about fiscal
    policy. As you say, it gets used as a political tool in a
    variety of ways. I think you would be much better off if you
    were to adopt some clear fiscal objectives.
        This is happening broadly in Europe now where they may pick
    a debt GDP ratio that they try to aim for. They may build in
    limits on spending that are bound by revenues and so forth. And
    I think what all of that does--
        Mr. Foster. Sir, that is the point of a budget resolution.
    That is the way it should be properly enforced.
        Mr. Leeper. Let me just add one thing. I think one of the
    key points is that in a lot of these European economies, there
    is an outside entity that evaluates policy.
        And the CBO, for all the good that it does do, can't play
    that role. And so there are these fiscal councils that I think
    actually have been very constructive in Europe.
        Mr. Bernstein. I think Eric's point about the anachronism
    is exactly on target. I think your point--and there is a great
    deal of confusion about this, that failing to raise the debt
    limit is failing to pay for spending that this body has already
    approved. And so it is much like saying I have decided not to
    pay for the meal I just ate.
        But third, it was interesting, I think it was Mr. Davidson,
    I don't know if he is still here, earlier talked about the
    damage to the economy of uncertainty in our policy environment.
    Fooling around with the debt ceiling, which has become kind of
    unfortunately a Washington tradition, absolutely boosts that
    kind of uncertainty in a way that I would think this committee
    would consider to be anathema.
        And I would also say the same thing, by the way, about
    healthcare. I can think of almost no way to further increase
    uncertainty in health insurance markets than by continually
    failing to nail down what it is this country wants to do with
    healthcare reform.
        Mr. Foster. Yes, Dr. Levy?
        Mr. Levy. I think it would be much more constructive if
    Congress really reassessed its budget processes. What I have
    seen over the last couple of decades is what started out as
    identifying entitlement programs as entitlement versus
    discretionary programs that have to be appropriated through the
    appropriation committees every year.
        This has evolved into entitlement programs are mandatory
    and then you have discretionary and non-defense discretionary.
    So as Dr. Bernstein noted, the current budget proposal for
    Fiscal Year 2018 really proposes significant cuts to non-
    defense discretionary programs.
        And the reason why it does that is because the entitlement
    programs, which are mandatory, are just psychologically thought
    of to be off the table. And so I recommend really, really re-
    thinking the budget process rather than hanging your hat on the
    debt ceiling.
        Mr. Foster. And one of the key elements that is missing in
    the U.S. budget process is something present in many
    parliamentary systems, which is that if you fail to pass a
    budget by a certain date, that forces, calls a new election.
    And if we had a mechanism like that, I think the dynamic would
    change.
        Chairman Barr. The gentleman's time has expired.
        The Chair recognizes the gentleman from North Carolina, Mr.
    Pittenger.
        Mr. Pittenger. Thank you, Mr. Chairman. And I thank each of
    you for being here today and for your expertise.
        Dr. Selgin, we are 8 years out of the recession. In great
    measure, the American households and businesses have certainly
    not been able to climb back to their full economic potential.
        We have the largest demographic group in the country, low-
    income minority people today. Is the Federal Reserve's
    accommodation of unsustainable fiscal policies and favoring
    some sectors over others in credit markets holding our economy
    back?
        Mr. Selgin. Yes, Congressman. As I said, to the extent that
    the Fed is shunting savings into the mortgage market, the
    market for mortgage-backed securities, and into the Treasury,
    which savings might be instead employed for productive bank
    lending where that includes not just lending to businesses but
    to farmers and consumers (because consumer lending is also
    productive or can be). To that extent, the Fed is
    constraining--its policies are a drag on economic growth.
        We have always depended heavily on bank lending as one of
    the important contributors to economic growth. And even though
    it must be said that banks sometimes do very bad things when
    they are lending and we saw plenty of that in the last crisis,
    nevertheless, without robust bank lending policies we will have
    less economic growth. And that harms everybody.
        Mr. Pittenger. Thank you, sir.
        Dr. Leeper, would you concur that unsustainable fiscal
    policies and favoritism of certain sectors work against what
    the Fed has fought so hard for throughout the history and that
    is monetary policy that is independent of the distributional
    politics?
        Mr. Levy. Yes, I generally agree. And the best--oh, was I
    supposed to--
        Mr. Pittenger. Dr. Leeper, I asked him but I will ask you
    to comment.
        Mr. Levy. Oh, I apologize.
        Mr. Pittenger. That is all right.
        Mr. Levy. I am truly sorry.
        Mr. Leeper. I guess that I have a somewhat different view
    about this. Whether we want to call what the Fed did fiscal
    policy or not seems fairly arbitrary. The point of my testimony
    was that monetary policy always has fiscal implications.
        And so, do we want to say that, and what I mean by
    ``that,'' is that it has implications for tax and spending
    policy. And so by that definition, we could say that everything
    the Fed does is fiscal policy.
        So I am not sure that I see that as as a useful label. But
    beyond that, I think that the biggest issue that is happening
    now is take what I was saying about when the Fed tries to
    reduce inflation by raising interest rates and turn it on its
    head.
        It is a symmetric argument. So when the Fed reduced the
    funds rate dramatically and kept it near zero for many years,
    the kind of fiscal backing that was necessary for that to have
    beneficial effects on the economy was to run higher deficits.
        And while there was the ARRA, that petered out and it is
    not clear that the fiscal backing that the Fed needed for that
    interest rate policy to be effective was forthcoming or that
    people expected it would be forthcoming.
        Mr. Pittenger. Thank you.
        Dr. Levy, you are welcome to respond?
        Mr. Levy. I agree with Dr. Leeper, and let me just add this
    point that the Fed's holdings of mortgage-backed securities has
    clearly stepped over the boundaries into credit allocation, and
    maybe we could legitimize it, the purchases during the height
    of the financial crises.
        A week after the Fed started QE1, Chairman Bernanke stated,
    ``This is an extraordinary emergency measure and we are going
    to unwind it on a timely basis.'' Well, they haven't unwound
    it. It has even gotten bigger.
        The Fed shouldn't be involved in credit allocation issues,
    and I think their strategy to unwind its portfolio should go
    much further to go back to an all Treasuries portfolio.
        Mr. Pittenger. Thank you, my time has expired.
        I yield back.
        Chairman Barr. The gentleman from Texas, Mr. Green, is
    recognized.
        Mr. Green. Thank you, Mr. Chairman, and I thank the
    witnesses as well. Mr. Chairman, I have been here long enough
    to remember when the contention was that Q.E. was going to
    create runaway inflation. The contention now seems to be that
    Q.E. has been the reason for our not having the inflation that
    we have targeted.
        I can also remember when we had this theory presented to us
    of expansionary fiscal contraction. And that expansionary
    fiscal contraction was going to be the means by which we would
    save the world.
        Let's just examine some of this, and I would like to talk
    to Dr. Bernstein, if I may? Dr. Bernstein, expansionary fiscal
    contraction contemplates layoffs, contemplates cuts, and to a
    certain extent does not allow for the infrastructure projects
    needed at a time when the country could afford them, when
    interest rates were low. It didn't allow for that.
        And my friends who are pushing expansionary fiscal
    contraction don't seem to think that has an impact on economic
    policies that are perpetuated, perpetrated, if you will, by the
    Fed. These things work hand-in-hand.
        So Mr. Bernstein, if you would, talk for just a moment
    about how the impact of expansionary fiscal contraction to the
    extent that my colleagues have engaged in it and they have done
    everything that they can it seems to me to cut and gut--the
    infrastructure programs haven't come online. Would you talk for
    just a moment about it?
        Mr. Bernstein. What you are calling expansionary fiscal
    contraction, I called austerity measures, and in fact, aptly
    described these would be contractionary fiscal measures.
        Simply by that definition, an increase in government
    spending increases GDP. That is arithmetic. However, there are
    many moving parts. And the Federal Reserve, if they believe the
    economy is too close to full employment, will offset fiscal
    stimulus at times like that.
        The quote that I presented in my written and spoken
    testimony was Ben Bernanke coming to this body a few years ago
    when the expansion was proceeding at too slow a pace, saying,
    ``not only will the Federal Reserve not increase interest rates
    to offset fiscal stimulus, but it will use it as
    complementary.''
        We have seen in Europe the damage that fiscal austerity has
    done to growth when the pivot deficit consolidation has
    occurred too soon, and we have seen it in this country as well.
    It is one of the reasons why it took so long for the output gap
    to close. And in fact it has barely closed now 8 years into the
    expansion.
        Mr. Green. And if you would, explain to us some of the
    things that could have been done that would have complimented
    the Q.E. of the Fed?
        Mr. Bernstein. I think the most important types of fiscal
    complements would have been in the area of infrastructure
    investment, increased unemployment insurance compensation at a
    time when the job market wasn't where it is now, when the job
    market was still having trouble closing in on full employment.
        And I thought the payroll tax holiday, as I show in my
    testimony, I have a graphic of the impact of GDP shaved about
    one and a half points off GDP in 2013 by prematurely ending
    what we called the payroll tax holiday.
        I do want to make one quick other point if I may, which is
    that there has been a considerable amount of criticism of some
    of the work that the Federal Reserve was doing in this period.
    Eric said earlier something to the--George said something early
    to the effect that the Fed had an increased footprint in the
    credit system.
        In 2008, and I often think that we do have some economic
    amnesia around these points, the credit system was completely
    shut down.
        Mr. Green. If you would let me just assist you with this,
    it was shut down to the extent that banks wouldn't lend to each
    other. That is pretty significant. Continue.
        Mr. Bernstein. So the Federal Reserve simply was
    manifesting its role of lender of last resort in the way that
    the Congress created it precisely to do so. Now, we can have
    arguments about how quickly they have unwound.
        I think it was interesting to hear Dr. Levy say that the
    housing market is booming and then be so critical of the MBS
    program. There is no question either in my mind or in the
    research that I would be happy to share with the committee that
    those two phenomena are related.
        Mr. Green. Let me make one quick point. We have had CEO
    salaries increase greatly. Last year, the number one person on
    the top 10 CEOs in terms of salaries had about $98 million as a
    salary, a 499 percent increase.
        Question for you, increasing the minimum wage, the impact
    of that, please, on the economy?
        Chairman Barr. Quick answer. The time has expired, so a
    quick answer.
        Mr. Bernstein. Moderate increases in the minimum wage
    consistently have their intended effect of boosting the
    earnings of low-wage labor diminishing the inequality you are
    talking about without substantial job loss effects.
        Mr. Green. Thank you.
        Mr. Chairman, I yield back.
        Chairman Barr. Thank you. Time has expired.
        The Chair recognizes the gentlemen from Arkansas, Mr. Hill.
        Mr. Hill. Thank you, Mr. Chairman. And thank you for this
    continuing set of hearings on monetary policy and fiscal policy
    today. I appreciate having such a distinguished panel joining
    us. I appreciate everyone's time and your excellent testimony.
        We have talked about fiscal policy and monetary policy, the
    topic of the hearing, but I would like to raise another
    constraining factor I think was at work during this period,
    which I would like, maybe, Dr. Levy for you to start out with.
    And that is the non-monetary policy structural impediments of
    our regulatory system and how, I think, that has constrained
    growth to some degree.
        We have talked a lot about across the economy, not just the
    Dodd-Frank Act, this is not a Dodd-Frank comment, but labor
    market regulation, environmental regulation. These all were on
    the upswing during this contractionary period where we were
    trying to get the economy growing again.
        But certainly in the credit allocation aspect, Dodd-Frank
    did have an impact on certain aspects of credit and not making
    it flow as well. Would you address sort of that administrative
    state of non-monetary policy, non-fiscal policy aspect of
    constraint on growth?
        Mr. Levy. Yes. I believe that one of the factors that has
    led unprecedented monetary ease not to stimulate the economy
    has been some of the inhibiting factors on both aggregate
    demand and supply and production due to the growing web of
    regulations that you mentioned not just on the Federal level,
    but on the State and local levels in the non-financial sectors.
        The list goes on. It is expanding and what it does as well,
    the Fed has been very, very successful through its policies to
    lower the real cost of capital.
        Businesses, when they think about investment projects and
    hiring, they think about the regulatory environment, the
    current and expected tax environment, and their hurdle rate for
    taking on projects stays very high and they put a wide band of
    uncertainty about it. So I think these are definitely having an
    impact on the non-financial sector.
        It is also clear that the implementation of portions of
    Dodd-Frank, particularly the stress test and some of the
    micromanagement, is clearly affecting banks' willingness to
    lend, so both in the financial and non-financial sector.
        Mr. Hill. Yes.
        Mr. Levy. I think this regulatory environment is very, very
    important.
        Mr. Hill. I appreciate that--
        Mr. Levy. It has slowed potential growth and it has
    inhibited the Fed's policies from working.
        Mr. Hill. Thanks. That is my view as well. I think it is a
    good area for research for our Ph.D. community to really look
    at that both in labor policy and financial allocation policy.
        Dr. Selgin, let's talk about the balance sheet. Governor
    Powell has laid out a long-term normalization process for the
    Fed. And to me that is very important, and we were at about 6
    percent or so of GDP in terms of Fed size.
        We got up. We are up around 24 percent of GDP. Chair Yellen
    was here, and she talked about, ``Well, we are not ever going
    to go back to kind of where we were,'' but if we look at 6
    percent or 8 percent of GDP for total Fed balance sheet
    footings, that would be, I don't know, a trillion to a trillion
    four up from, say, $900 billion before the crisis.
        Do you see any reason for the Fed balance sheet to be
    larger than where it was in the range before the crisis?
        Mr. Selgin. Yes, there is a reason, but it isn't a reason
    for it to be as large as they are planning to make it when they
    are done with normalizing. And the reason is the Fed is the
    sole supplier of currency. If we allow for the trend of
    currency growth to that extent, the balance sheet today would
    have to be bigger than it was in 2000.
        Mr. Hill. What about as a percentage though? Do you see--
        Mr. Selgin. Oh, I'm sorry. As a percentage, no--
        Mr. Hill. --that is why I am saying between a trillion and
    a trillion four would be the same.
        Mr. Selgin. I apologize. As a percentage of GDP, there is
    no reason. I would like to address Dr. Bernstein's remark about
    the footprint. Let me be clear. The reason the wholesale
    markets shut down in October 2008 was because the Fed purposely
    shut them down using interest on excess reserves. It wanted to
    keep its loans from spilling into the wholesale market.
        You cannot celebrate the Fed for saving the wholesale
    market in the banking system when in fact it did the opposite.
    I quite agree that it should have been a hero, but it wasn't.
    It was the villain in this story, and even if it was justified
    in expanding its balance sheet back then, it certainly isn't
    justified 8 years afterwards, 9 years afterwards.
        Mr. Bernstein. I guess I would just ask, what about the
    housing bubble?
        Mr. Selgin. What about the housing bubble?
        Mr. Hill. I yield back, Mr. Chairman.
        [laughter]
        Chairman Barr. Time has expired.
        The Chair recognizes the gentlemen from Minnesota, Mr.
    Emmer.
        Mr. Emmer. Thank you to the Chair, and thanks to this
    fantastic panel for this discussion.
        Dr. Levy, You were talking--it just interested me this
    morning when you said, ``Sustained monetary easing has failed
    to stimulate the economy. In fact, what it has done is it has
    stimulated financial markets, but hasn't stimulated economic
    growth.'' And then you commented that, ``Fiscal policy has
    created this huge debt.''
        And your testimony is that both need to be reset. You think
    the Fed should be more aggressive in the unwinding, was your
    other piece. Could you just comment on that?
        Mr. Levy. Certainly.
        Mr. Emmer. Its balance sheet is what you were talking
    about.
        Mr. Levy. Certainly. For a variety of reasons, the Fed's
    maintaining a $4.5 trillion economy, over $2 trillion is
    basically at sitting as excess reserves. The banks are not
    lending it out, so--
        Mr. Emmer. I understand that. I don't mean to interrupt,
    but I want to keep this on track because what I am going at is
    Chair Yellen has suggested kind of a 5-year. When you talk
    about aggressive, what do you think should be done? Is that the
    right timeline? Should it be shorter?
        Mr. Levy. I actually think 4 or 5 years is just fine
    because then most of it could be unwound in a passive way. They
    wouldn't have to sell it. It could just unwind through
    amortization, but I do take issue with the Fed on a critical
    point.
        It should be going back to an all Treasuries portfolio.
    Yes, the Fed subsidies of the mortgage market are helping
    housing, but that bids up prices of housing. And it is high-
    income people who own housing, and it also bids up rental
    prices and exerts duress on low-income people.
        Mr. Emmer. Yes. Dr. Leeper, I was interested when I read
    your testimony before the hearing today. You go back to the
    1930s, and you talk about what those of us who don't have your
    background, but we are just from Main Street, USA, and not from
    the coasts, we already think the Fed has hurt its credibility.
        And, quite frankly, the government, because of a story that
    you tell with President Roosevelt, where he changed monetary
    policy purposely because he was going to inflate the currency
    and reduce his debt, our debt, I guess. But you talk about this
    unwinding. We have a big problem as we raise interest rates.
    How do you do this and survive?
        Mr. Leeper. I think that is a very good question, and my
    feeling about that is for you to understand that through that
    fiscal channel, in other words, if the Fed starts to normalize
    interest rates and debt service rises and Congress doesn't
    respond by adjusting taxes or spending to accommodate that,
    those increases in interest rates are likely to end up in
    higher inflation rather than lower inflation.
        Mr. Emmer. Right.
        Mr. Leeper. And so understanding the nature of those
    interactions is what it is about.
        Mr. Emmer. And you may not be able to control that.
        Mr. Leeper. Right.
        Mr. Emmer. This is the issue we had.
        Mr. Leeper. It is within your control, because you control
    the budget.
        Mr. Emmer. I understand that, but once this gets away from
    them, that is what they are desperately trying to maintain is
    make sure that--you want a certain amount of inflation, but you
    can't have it run away.
        And by the opposite side, if you do the wrong things, you
    could encounter deflation, which would be every bit as
    damaging. Dr. Selgin, why don't you talk about that a little
    bit. Address how we get out of the place that we are in?
        Mr. Selgin. Sir, what we need to do is to get back--
        Mr. Emmer. And by the way, Dr. Selgin, the one thing I do
    want to ask you, because I get this mixed testimony is, what
    has the Federal Reserve done in the last 3 decades that has
    worked? Let's reduce it. What have they done in the last decade
    that has worked, sir?
        Mr. Selgin. In the last decade?
        Mr. Emmer. Yes.
        Mr. Selgin. Oh, not much. Not much.
        Mr. Emmer. Can you point to anything that--
        Mr. Selgin. As I said, the problem is the Fed undermined
    its own operating mechanism with this interest on excess
    reserves policy. It put the monetary transmission mechanism, as
    we call it, in neutral. It steps on the gas, nothing happens.
        Mr. Emmer. Right.
        Mr. Selgin. Reserves pile up. The Fed is its own worst
    enemy as far as being able to affect total spending in the
    economy and control inflation, because of policies it
    implemented in 2008. It has wrecked its own transmission.
        It did it at first because it was worried about inflation.
    Now, with the same setup in place, it can't get the inflation
    it wants. This is not surprising really.
        Yes, quantitative easing had some effect, but much less
    than it would normally have had because the reserves were made
    to pile up in banks. I don't want to say that the Fed has never
    had some relatively-sound policies, but I do say that the
    change in their monetary control mechanism implemented since
    the crisis has been a disaster. We need to go back to the old
    control--
        Chairman Barr. Your time--
        Mr. Selgin. --mechanism or something not too dissimilar
    from it.
        Chairman Barr. --has expired.
        Mr. Selgin. And that is the key.
        Chairman Barr. Thank you.
        Mr. Bernstein. Chairman Barr, could I make, let's say, one
    sentence?
        Chairman Barr. The time has expired, and--
        Mr. Bernstein. Okay.
        Chairman Barr. --and Mr. Sherman may give you that
    opportunity.
        And I now recognize the gentleman from California, Mr.
    Sherman.
        Mr. Sherman. I have my own questions. I am looking up at
    that debt clock, quantitative easing raised--Mr. Bernstein
    maybe you have the number. I believe it was many tens of
    billions of dollars for our country last year, that is to say
    the amount the Fed turned over to the Treasury. Do you happen
    to have the figure?
        Mr. Bernstein. Off the top of my head, $500 billion
    cumulatively.
        Mr. Sherman. Well, not all in 1 year.
        Mr. Bernstein. No, no. I am talking about--
        Mr. Sherman. Dr. Levy, do you have the 1-year number?
        Mr. Levy. The Fed remitted in Fiscal Year 2015, $117
    billion. That number has come down to about 85, largely because
    of the amount it has the raised rate, so it has paid excess
    reserves.
        Mr. Sherman. So we have a debt clock up there, and we would
    be hundreds of billions of dollars higher if the Fed had not
    remitted the money.
        And we are told that we have a disaster. We have one of the
    longest periods of time with economic growth quarter after
    quarter. The number I have for 2016, by the way, is $92
    billion, which is very close to what Dr. Levy had to say.
        We are told that we can't get the job-producing benefits of
    low interest rates for too long under too many different
    circumstances, otherwise, we will have inflation.
        Dr. Bernstein, is inflation a big problem?
        Mr. Bernstein. No. First of all, the remittances I was
    talking about were cumulative, so about $100 billion a year
    over the last 5 years or so is off the top of my head.
        Mr. Sherman. Yes.
        Mr. Bernstein. No. And let me just correct the record. I
    think you would be very hard-pressed to find an economist from
    any side of the aisle who would assert as strongly as George
    just did that the Fed played no role in helping to offset the
    damage of the Great Recession.
        We can have really good nuanced arguments, and we are
    having those arguments today, about how effective it was and
    the roll-offs and things like that. But the Federal Reserve
    was, in my view, and I have evidence in my testimony--
        Mr. Sherman. Dr. Bernstein, let's go to the benefits of the
    Fed giving $100 billion to the United States Treasury. I am
    told by those in the field, that this is extraordinary, not,
    shouldn't be the real focus of things. It is just $100 billion.
    Do not pay attention to it because the Fed has other
    objectives. And I am looking at a debt clock.
        And to me, $100 billion a year is not something I am going
    to ignore just because the tradition in the field is to ignore
    it, and say that is not the objective. The objective should be
    the $100 billion. What would we do to turn it into $200
    billion? Please don't miss the goal.
        Mr. Bernstein. These remittances have certainly been
    important. They are a residual--
        Mr. Sherman. Dr. Bernstein, I asked you a question. What
    would we do to--
        Mr. Bernstein. We would have to increase the level of the
    Fed's balance sheet. And, in fact, they are going in the other
    direction, obviously.
        Mr. Sherman. And they know they are going the other
    direction, because we had Janet Yellen in here tell us, ``Oh,
    that isn't important. That isn't our mission. That is not what
    we focus on.''
        I am looking at the debt clock. I don't know what they
    focus on. I don't know what--you can't focus on it because you
    would have to turn around, but I am focused on it, and it--
        Mr. Bernstein. I--
        Mr. Sherman. --was put up there by the Majority.
        Mr. Bernstein. I am well aware of what the debt clock is
    ticking away there.
        Mr. Sherman. Why shouldn't we give a very high priority to
    hundreds of billions of dollars?
        Mr. Bernstein. Because you have to ask yourself, is
    increasing the Fed's balance sheet the right monetary policy
    right now? Now, you can go--
        Mr. Sherman. No. Okay. That--
        Mr. Bernstein. You can make the case--
        Mr. Sherman. There are tremendous benefits from that as a
    monetary policy now.
        Mr. Bernstein. There have been many more benefits than my
    colleagues on the panel have acknowledged. And, in fact, I was
    just looking at--
        Mr. Sherman. Without that policy, we wouldn't have as flat
    a debt curve.
        Mr. Bernstein. Yes.
        Mr. Sherman. We wouldn't have as much investment in the
    economy. Property values would decline--
        Mr. Bernstein. But if I--
        Mr. Sherman. Jobs would decline.
        Mr. Bernstein. Yes.
        Mr. Sherman. People would go hungry, and that debt clock
    would be going faster.
        Mr. Bernstein. Those are--
        Mr. Sherman. So exactly what is bad with a bigger balance
    sheet again?
        Mr. Bernstein. First of all, let me just say that if this
    body really wanted to get that debt clock going in the other
    direction, then we wouldn't be looking at budgets that
    continually pursue trillions of dollars of unpaid-for tax cuts.
    To me, it is the fiscal policy--
        Mr. Sherman. Dr. Bernstein, this is the Financial Services
    Committee. If I wanted to get on Ways and Means, I should have
    cut a different deal.
        Again, what--oh, okay. So we could--
        Mr. Bernstein. Okay. So if your point is--
        Mr. Sherman. So let me just--wait. If we enlarge the
    balance sheet, we can slow that debt clock and instead of doing
    what the Fed is doing, which is taking away the $100 billion,
    we could add another $100 billion in debt relief. I don't know
    whether Dr. Levy is going to be called on or not, but--
        Chairman Barr. The gentleman's time has expired.
        And in addition to the debt clock, we have another clock
    that we are focused on, and that is the clock of the remaining
    time to vote. We are going to clear these last two Member's
    questions, and then we are going to have to adjourn.
        The gentleman from Ohio, Mr. Davidson, is recognized.
        Mr. Davidson. Thank you, Mr. Chairman.
        And thank you to our witnesses. I really appreciate your
    testimony. And I note that as is normal in these hearings, we
    hear folks from the other side of the room talk about this
    period of austerity. It is occasionally that we have a witness
    on the panel also reference austerity.
        And I just want to ask you, Dr. Leeper, does the trend that
    we have been on since 2010 represent a period of austerity
    fiscally?
        Mr. Leeper. I think that what we have done is very much
    what lots of other countries have done, which is, in response
    to the crisis we did a fiscal stimulus, and then we immediately
    began to wring our hands and talk about how don't worry about
    this fiscal expansion, because we are going to contract.
        Within 6 days of passing the ARRA, President Obama was
    pledging that he was going to reduce deficits by half.
        Mr. Davidson. Right.
        Mr. Leeper. I think this is very confusing to people.
        Mr. Davidson. Yes. So thanks. And I take a little bit of
    exception with the idea that somehow my reality of the small
    business guy not having confidence in Congress or the Fed, to
    be somehow we need to provide certainty in the market.
    Certainty is something I will talk about in a bit.
        Certainty of bad outcomes is not a good thing. Certainty of
    good outcomes is great. And when you look at the markets, in
    the year, you talk about Obama, there was some doom and gloom.
    There was a lot of uncertainty. There was a lot of regulatory
    uncertainty.
        And with the change of Administration, what you have seen
    is still some uncertainty, but a lot more confidence--a 3-year
    high in business confidence, the markets are rallying, because
    people believe there is going to be a change. I would say the
    simple answer is no, that does not represent austerity. It
    represents an awful lot of spending.
        If I could go the next slide on mine, I cycled it a bit ago
    to show, this is the net result of all of the tax revenue we
    collect and all of the money that we spend. This year, we are
    on a path to spend roughly $700 billion more dollars than we
    collect.
        Unfortunately, at the start of the year, the plan was to
    continue on this path. As Herb Stein said, and I referenced
    earlier, ``If something can't continue, it will eventually
    stop.''
        Dr. Selgin, when will this no longer be sustainable? When
    will it stop? This is the uncertainty we are all looking for.
        Mr. Selgin. I once again defer to the others. That is not
    my expertise. I have heard a million predictions about this,
    and I don't dare say which, if any of them, is correct.
        Mr. Davidson. Dr. Levy, would you like to comment?
        Mr. Levy. The answer is, nobody knows when things become
    unsustainable. I want to hit on a critical point you made,
    Congressman Davidson, this term, ``austerity.'' I will just ask
    in lay terms, how can you say the budget is austere, when year
    after year you are spending more than you are taxing?
        And I might note, the European example was used earlier.
    The austerity in Europe hurt those economies because 80 percent
    of the budget deficit reductions were through tax increases
    that harmed economic activity.
        So I think we need to think seriously about, once again,
    what we are deficit spending for? And can we achieve the intent
    of those programs, but just restructure them so that they are
    more efficient? But the bottom line is, the answer to your
    question is that nobody knows.
        Mr. Davidson. But no one knows precisely when. We just know
    that it is not possible. So if you look at our debt-to-GDP
    ratio, as the slide that I started out on, that is not
    sustainable. At some point we see what happened in Greece. I
    don't have their slide. Eventually, people lose confidence in
    our debt market.
        And in fact, part of the reason that the Fed's balance
    sheet grew is we didn't have a place for some of the debt to
    go. No one had confidence to buy the assets, in this case,
    mortgage-backed securities, and it would triple the
    macroeconomy if we didn't do something. That was the fear.
        You could do something. Was it the right thing? It seems to
    have worked so far. I think it is unconventional, and we should
    have changed course. We are unwinding it, and as we are
    unwinding that, my time is unwound. So I would love to talk to
    you more, but my time has expired.
        Mr. Chairman, I yield back.
        Chairman Barr. The gentleman yields back.
        The Chair recognizes the gentleman from Indiana, Mr.
    Hollingsworth.
        Mr. Hollingsworth. Hearing my colleague talk, I am often
    reminded of that old adage when somebody was asked how they
    went bankrupt: slowly at first, and then suddenly. And so, like
    you said, no one knows when it might happen, but it might
    happen suddenly.
        And I would like to welcome all the panelists here, but
    certainly, Dr. Leeper, who comes from the most beautiful
    district in the country, I like to say, Indiana's Ninth
    District, and I appreciate you being here.
        Reading through your testimony, one of the things that I
    wanted to talk about was the combination of unwinding the
    balance sheet at the Federal Reserve and large fiscal deficits
    that are expected to expand over the next couple of years
    during that 5-year period and just the amount of capital that
    it going to soak up and what that implies for crowding out
    investment in the private sector and other issues? And kind of
    just share your general views on the combination of those, too?
        Mr. Leeper. Oh, wow. I actually would like to think about
    these separately--
        Mr. Hollingsworth. Okay.
        Mr. Leeper. --to tell you the truth. No doubt there will be
    some interactions, but I don't think that it is something that
    we understand terribly well.
        My points about the interactions between monetary and
    fiscal policy are really independent of the size of the Fed's
    balance sheet. That the magnitude of the Fed's balance sheet
    per se doesn't affect, for example, how much--
        Mr. Hollingsworth. I guess it is hard for me to recognize--
        Mr. Leeper. --interest payments--
        Mr. Hollingsworth. Right. So as they shrink the balance
    sheet, private capital is going to have to come in to fund the
    rolling over of those Treasuries.
        And then in addition to that, new Treasury issuance on
    account of current deficits, the combination of those two gets
    to be a pretty sizable amount of capital that is going to fund
    deficits and fund previous deficits that used to be held at the
    Federal Reserve.
        Mr. Leeper. Yes. but there doesn't seem to be any shortage
    of demand for Treasuries.
        Mr. Hollingsworth. Today.
        Mr. Leeper. Well--
        Mr. Hollingsworth. Yes, which kind of gets to my question
    about--
        Mr. Leeper. Yes. Today, but a lot of that demand is coming
    from overseas.
        Mr. Hollingsworth. Right.
        Mr. Leeper. So I don't think there is any reason to think
    that there is going to be a huge crowding out that occurs
    during the unwinding.
        Mr. Hollingsworth. Okay. One of the other things that we
    have talked about several times in committee, and you have
    heard it here today, is interest on excess reserves.
        Now, Chair Yellen has made the frequent argument that the
    Fed itself is incapable of controlling the Fed funds rate
    without paying this interest on excess reserves. Is that
    something that you believe or buy into?
        Mr. Leeper. As a matter of public policy, I have yet to
    hear a persuasive argument for paying above-market rates on
    excess reserves.
        Mr. Hollingsworth. Great. Fantastic. And then one of the
    other things I wanted to talk to you about, and I certainly
    know the dual mandate that the Fed has right now, but just
    clean slate, what is your view on maybe an increasing academic
    literature around targeting nominal GDP or nominal GDP growth
    versus a dual mandate of price stability and full employment?
        Mr. Leeper. That is a good question, and I think it cuts
    on--
        Mr. Hollingsworth. Finally found one.
        Mr. Leeper. I think it cuts on the issue of whether the Fed
    ought to be held accountable to a Taylor Rule or something like
    that.
        Mr. Hollingsworth. Right.
        Mr. Leeper. What the academic literature tells us is that
    something like an inflation-targeting rule or a nominal GDP
    rule is actually far superior to a Taylor Rule. And the reason
    for that is Taylor Rules can instruct the Fed to do strange
    things, depending on what shocks hit the economy.
        Mr. Hollingsworth. Right.
        Mr. Leeper. So, for example, if you get a spike to oil
    prices--
        Mr. Hollingsworth. Transient price shocks, yes.
        Mr. Leeper. It raises prices and it lowers output, and the
    Taylor Rule is going to tell the Fed to contract.
        Mr. Hollingsworth. Right.
        Mr. Leeper. And so, whereas if you have an inflation-
    targeting rule--
        Mr. Hollingsworth. Right.
        Mr. Leeper. --you would be able to avoid that kind of
    instruction.
        Mr. Hollingsworth. For clarity, in the previous legislation
    that we passed out of this committee, the Taylor Rule is
    frequently talked about. There is no specific rule that is
    demanded, but just a more rules-based monetary policy regime.
        The second piece that I wanted to ask about, and my
    colleagues might be annoyed at the number of times I ask about
    this, but something I am increasingly concerned about is the
    relationship between full employment and wage growth and how
    anemic wage growth has been despite, I guess, approaching full
    employment.
        And something that I worry about is that--in fact, the
    Phillips curve turns out to be nonlinear or might be nonlinear,
    and we might be approaching a time period where the Fed will be
    far behind the curve, because they have pushed full
    unemployment and pushed unemployment lower and lower, only to
    find ourselves now behind the curve as the part of the Phillips
    curve that is nonlinear begins to take over.
        Is there something to worry about there? Is that something
    that some of the academic literature has talked about and been
    concerned about?
        Mr. Leeper. I think there is nothing to worry about there.
        Mr. Hollingsworth. Okay.
        Mr. Leeper. I don't think there has ever been a time when
    there was a stable relationship between unemployment and
    inflation, and there certainly are likely to be nonlinearities.
        Mr. Hollingsworth. Yes.
        Mr. Leeper. But the idea that suddenly inflation is going
    to shoot off, I think is really nothing to be concerned about.
        Mr. Hollingsworth. Wonderful. Well, thank you so much for
    being here and for traveling all the way from Indiana. I yield
    back.
        Chairman Barr. The gentleman yields back. And I would like
    to thank our witnesses for their testimony today.
        The Chair notes that some Members may have additional
    questions for this panel, which they may wish to submit in
    writing. Without objection, the hearing record will remain open
    for 5 legislative days for Members to submit written questions
    to these witnesses and to place their responses in the record.
    Also, without objection, Members will have 5 legislative days
    to submit extraneous materials to the Chair for inclusion in
    the record.
        Thank you all for your excellent testimony today. This
    hearing is now adjourned.
        [Whereupon, at 11:16 a.m., the hearing was adjourned.]

                                A P P E N D I X

                                 July 20, 2017

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