[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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