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Hearing of the House Committee on Financial Services - Federal Reserve Monetary Policy Report - Part 1

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Location: Washington, DC


Federal News Service July 21, 2004 Wednesday

July 21, 2004 Wednesday

HEADLINE: HEARING OF THE HOUSE COMMITTEE ON FINANCIAL SERVICES

SUBJECT: FEDERAL RESERVE MONETARY POLICY REPORT

CHAIRED BY: REPRESENTATIVE MICHAEL OXLEY (R-OH)

WITNESS: ALAN GREENSPAN, FEDERAL RESERVE CHAIRMAN

LOCATION: 2128 RAYBURN HOUSE OFFICE BUILDING, WASHINGTON, D.C.

REP. OXLEY: (Sounds gavel.) The committee will come to order.

This morning we're pleased to welcome back the chairman of the Federal Reserve, the Honorable Alan Greenspan.

Good morning, Mr. Chairman. We welcome you once again to the Financial Services Committee. Thank you for taking the time to discuss monetary policy and the economy and topics of interest to every member of this committee, and certainly to all Americans.

Chairman Greenspan, I want to congratulate you first on your reappointment and reconfirmation. I know I speak for most Americans and members of this committee when I say we are happy to have your steady hand on the monetary policy tiller. I know that you'd probably like to spend a little more time on your golf game, and it definitely needs it -- (chuckles, laughter) -- but we appreciate your dedication and service to the Fed.

Mr. Chairman, when the uptick in energy prices this spring brought with it a spike in inflation, many imagined that your well- advertised first tightening of monetary policy would be more aggressive than the quarter-point move the Open Market Committee made at the end of June. All spring you said that the tightening would be as swift and strong as necessary, and the second half of your statement was that the tightening would be gradual. As usual, you were correct on both counts.

More important, Mr. Chairman, is an issue you raised at your last appearance before this committee, and that is how we prepare our workers for the jobs of the 21st century. You made the point that the best way to push up wages over time was to make sure that our workers are educated and ready to fill the new, higher-skill jobs this vibrant economy creates as lower-skill, lower-wage jobs cycle offshore. I know that continues to be a strong interest for you, and rightly so.

Creating jobs is a goal we all share. We all like to see lower unemployment than the current 5.6 percent rate and know that lower unemployment also means higher wages. The economy has averaged creating 250,000 jobs a month for this year, and I think the new jobs figure for June of 112,000 was an aberration. I think job creation will pick up, and that the average employment level for this year will be at or higher than the average for 2000 of 131.8 million. It's already at 131.4 million, even with that June low.

Mr. Chairman, we look forward to your testimony and to the discussion today.

With that, I yield to the distinguished ranking member, the gentleman from Massachusetts.

REP. BARNEY FRANK (D-MA): Thank you, Mr. Chairman.

Mr. Chairman, on April 21st you gave very powerful testimony to the Joint Economic Committee in which you noted that the good news was great increases in productivity which were continuing. And you have been proven right against some of the skeptics who thought that the productivity increases in the late '90s were transitory and that we'd slip back to the normal-what had been the normal lower average.

But you also noted-and I was pleased that you did that-that virtually all of the gains from increased productivity had gone to pre-tax profits of non-financial corporate entities. And I would just say as an aside, if they're doing well with pre-tax corporate-or pre-tax profits, these days they're doing even better with after-tax profits. And you noted that virtually none of the increase has gone to people who were getting paid wages. And as a result, the ratio in the economy of wages paid, compensation paid in wages to pre-tax corporate profits was really quite low by normal standards.

In the report today you note that there has been some increase in compensation -- (employment costs ?) as we measure it. But you also note-and I appreciate your being careful to point this out in the statement and the report-that what we've seen is an increase in employer contributions to health plans and an increase in employer contributions to pensions, but wage payments to workers, non- supervisory workers, have in fact lagged inflation. And that is a serious social and economic problem. I appreciate the fact that unlike many others, you have noted that inequality is in of itself a problem, and I thank you for doing that. There are some who try to ignore it. There are people who argue that as long as the absolute level is fine, then inequality is not a problem. But we know in economics that the absolute level that's acceptable is in fact defined by what's available and what others have, and what that does to prices, et cetera.

So this is the dilemma that we have. We have a situation in which we have begun to grow, although there has been some slowing down; we hope it's temporary, and we hope next month will be better. But it has not been as fairly distributed as we would like it to be, and even by historical standards it has lagged. That seems to me to have two problems. First of all is a political problem. You note in your statement and the report that protectionist sentiment is increasing. It will continue to increase. We're not India, but there's a lesson in India. When a government that had done very well in the macroeconomic area through its free-market policies unexpectedly lost an election, in part because they boasted, with their slogan of India Shining, about their success, and a lot of the Indian people in effect said "shine this" because "Where's my piece of it?"

And there was an article in The New York Times a while ago on the front page about how democracy in Latin America is no longer as universally or as widely supported as we would like it to be because people there have seen no connection between democracy that they've been told and some improvement in their lives.

In America you run the risk that there are people who increasingly believe-people who work hard for a living-that they have no real skin in the game of economic advance. Now, you and I don't agree with that, but it's a factor you have to take into account. And indeed, to the extent that we continue to have great progress in the macroeconomy but real wages don't go up-and I suppose workers should be grateful that the boss is now paying more for health care, but the worker's not any better off. The boss is paying more for the same health care, and then the real wages are lagging, and so he and she, understandably, feel worse off.

There is also an economic problem. At some point, insecurity, instability, lack of liquidity there is going to cause some problems for people. And so that is something that I think we need to address.

Last point is this. I want to say that I know you've gotten some pressure to increase interest rates more quickly, the Federal Reserve Open Market Committee. I hope you will continue to resist it. I would just remind people we had this argument to some extent in the late '90s. And I admired the fact then that you were willing to defy what had been sort of conventional wisdom that if unemployment got below 5.5 percent, it would be inherently inflationary. You were given a lot of pressure from a lot of places, editorial pages and elsewhere, to raise interest rates simply because a lower unemployment rate would be inherently inflationary. It got to 3.9 percent without inflation. You argued, I think correctly, that productivity was making this possible.

You are again under some pressure from people to raise rates more quickly. I would just urge people to think about the implications of that. Unemployment is still 5.6 percent. We'd gotten it down to 3.9, but your report says that at the end of 2005, you expect unemployment to be between 5 and 5.25 percent-as much as 1.3 percent higher, 20 percent higher in terms of where they are, 25 percent, than it was. This is not a time to slow down the macroeconomy.

And to people in the business community and elsewhere who focus on the fact that, well, maybe macro growth is too high and we're beginning to see a little bit of inflation, for them to urge on you measures that would slow things down at a time when unemployment is still much higher than it should be at 5.6 percent; when the percentage of Americans working is lower-because part of what we've seen is a lower percentage of adult Americans working; when real wages have lagged, when real wages have been eroded; to argue at this point that you should slow down the macroeconomy is to exacerbate a situation that I think is already socially and potentially economically dangerous for the U.S.

So I urge you not to accept those kinds of pressures, but also I hope you will join with us in thinking of ways-you've documented the problem; you've documented the problem of increasing inequality very well, and it does not appear to me to be getting significantly better on its own. And I would hope you would join with us in figuring out ways to deal with it.

Thank you, Mr. Chairman.

REP. OXLEY: The gentleman's time has expired, and we now turn to the distinguished chairman of the Federal Reserve, Dr. Alan Greenspan. Again welcome, Mr. Chairman, and good to have you back.

MR. GREENSPAN: Thank you very much. I will excerpt from my prepared remarks and request that the full text be included for the record.

REP. OXLEY: Without objection.

MR. GREENSPAN: Mr. Chairman and members of the committee, I'm pleased as always to be here today to present the Federal Reserve's Monetary Policy Report to the Congress.

Economic developments in the United States have generally been quite favorable in 2004, lending increasing support to the view that the expansion is self-sustaining. Not only has economic activity quickened, but the expansion has become more broad-based and has produced notable gains in employment.

The evident strengthening in demand that underlies this improved performance doubtless has been a factor contributing to the rise in inflation this year. But inflation also seems to have been boosted by transitory factors such as the surge in energy prices. Those higher prices, by eroding households' disposable income, have accounted for at least some of the observed softness in consumer spending of late, a softness which should prove short-lived.

When I testified before this committee in February, many of the signs of the step-up in economic activity were already evident. Capital spending had increased markedly in the second half of last year, no doubt spurred by significantly improved profits, a low cost of capital, and the investment tax incentives enacted in 2002 and enhanced in 2003. The renewed strength in capital spending carried over into the first half of 2004. Orders and shipments of nondefense capital goods have been on the rise, and the backlogs of unfilled orders for new equipment continue to build.

A key element of the expansion that was still lacking in February, however, was evidence that businesses were willing to ramp up hiring to meet the stepped-up pace of sales and production. Businesses' ability to boost output without adding appreciably to their workforces likely resulted from a backlog of unexploited capabilities for enhancing productivity with minimal capital investment, which was an apparent outgrowth of the capital goods boom of the 1990s.

Indeed, over much of the previous three years, managers had seemed to pursue every avenue to avoid new hiring, despite rising business sales. Their hesitancy to assume risks and expand employment was accentuated and extended by the corporate accounting and governance scandals that surfaced in the aftermath of the decline in stock prices and also, of course, by the environment of heightened geopolitical tensions.

Even now, following the pattern of recent quarters, corporate investment in fixed capital and inventories apparently continues to fall short of cash flow. The protracted nature of this shortfall is unprecedented over the past three decades. Moreover, the proportion of temporary hires relative to total employment continues to rise, underscoring that business caution remains a feature of the economic landscape.

That said, there have been much clearer indications over recent months that conditions in the labor market are improving. Most notably, gains in private non-farm payroll employment have averaged about 200,000 per month over the past six months, up sharply from the pace of roughly 60,000 per month registered over the fourth quarter of 2003.

The improvement in labor market conditions will doubtless have important follow-on effects for household spending. Expanding employment should provide a lift to personal disposable income, adding to the support stemming from cuts in personal income taxes over the past year.

In addition, the low interest rates of recent years have allowed many households to lower the burdens of their financial obligations. Although mortgage rates are up from recent lows, they remain quite attractive from a longer-run perspective and are providing solid support to home sales.

Despite the softness of recent retail sales, the combination of higher current and anticipated future income, strengthened balance sheets and still-low interest rates bodes well for consumer spending.

Consumer prices excluding food and energy-so-called core prices-have been rising more rapidly this year than in 2003. For example, the 12-month change in the core personal consumption expenditures price index stood at 0.8 percent in December of last year and climbed to 1.6 percent by May of this year.

Core inflation, of course, has been elevated by the indirect effects of higher energy prices on business costs and by increases in non-oil import prices that reflect past dollar depreciation and the surge in global prices for primary commodities. But the acceleration of core prices has been augmented by a marked rise in profit margins, even excluding domestic energy corporations.

Businesses are limited in the degree to which they can raise margins by raising prices. An increase in margins should affect mainly the level of prices associated with any given level of unit costs but, by itself, should not prompt a sustained pickup in the rate of inflation going forward. Indeed, some leveling or downward pressure on profit margins may already be in train, owing to a pickup in unit labor costs.

Although advances in productivity are continuing at a rate above the long-term average, they have slowed from the extraordinary pace of last summer and are now running below increases in hourly compensation. The available information suggests that hourly compensation has been increasing at an annual rate of about four-and- a-half percent in the first half of the year. To be sure, the increases in average hourly earnings of nonsupervisory workers have been subdued in recent months and barely budged in June. But other compensation has accelerated this year, reflecting continued sizable increases in health insurance costs, a sharp increase in business contributions to pension funds, and an apparently more robust rate of growth of hourly earnings of supervisory workers. The larger wage gains for supervisory workers together with anecdotal reports of growing skill shortages are consistent with earlier evidence of rising wage premiums for skilled workers relative to less-skilled workers. As always, considerable uncertainties remain about the pace of the expansion and the path of inflation. Some of those uncertainties, especially ones associated with potential terrorism both here and abroad, are difficult to quantify. Such possibilities have threatened the balance of world supply and demand in oil markets in recent months, especially as demand has risen with the pace of world economic growth. Yet aside from energy, markets exhibit little evidence of heightened perceptions of risk. Credit spreads remain low, and market-based indicators of inflation expectations, after rising earlier this year, have receded.

With growth of aggregate demand looking more sustainable and with employment expanding broadly, the considerable monetary accommodation put in place starting in 2001 is becoming increasingly unnecessary. If economic developments are such that monetary policy neutrality can be restored at a measured pace, as the FOMC expects, a relatively smooth adjustment of businesses and households to a more typical level of interest rates seems likely. Even if economic developments dictate that the stance of policy must be adjusted in a less gradual manner to ensure price stability, our economy appears to have prepared itself for a more dynamic adjustment of interest rates. Of course, considerably more uncertainty and, hence, risk surrounds the behavior of the economy with a more rapid tightening of monetary policy than is the case when tightening is more measured. In either scenario, individual instances of financial strain cannot be ruled out.

In sum, financial markets along with households and businesses seem to be reasonably well prepared to cope with a transition to a more neutral stance of monetary policy. Some risks necessarily attend this transition, but they are outweighed, in our judgment, by those that would be associated with maintaining the existing degree of monetary policy accommodation in the current environment. Although many factors may affect inflation in the short run, inflation in the long run, it is important to remind ourselves, is a monetary phenomenon.

As we attempt to assess and manage these risks, we need, as always, to be prepared for the unexpected and to respond promptly and flexibly as situations warrant. But although our actions need to be flexible, our objectives are not. For 25 years, the Federal Reserve has worked to reestablish price stability on a sustained basis. An environment of price stability allows households and businesses to make decisions that best promote the longer-term growth of our economy, and with it our nation's continuing prosperity.

Thank you very much, Mr. Chairman, and I look forward to your questions.

REP. OXLEY: Thank you, Chairman Greenspan, again for appearing before the committee. We've had this discussion before, but it's one that I'd like to return to, and that is the resilience of our American economy. Considering the fact that we have gone through some remarkable-markedly difficult times over the last, say, three years, with the recession, the tragedy of 9/11, the following need to fight the war on terror with increased defense spending and the like, the business scandals that you referred to in your statement, I've said before that I would doubt there's any country or any economy in the world that could have sustained those kinds of body blows, and yet, three years later be in as strong a position as we are economically.

Were we just lucky, or what is it about our system-monetary and fiscal policy; our overall system, meaning the private sector and government and the like-what is it about the American economy and the American attitude that would allow us to make that kind of recovery in a relatively short period of time?

MR. GREENSPAN: Mr. Chairman, you're raising what probably is the most important issue that has been on the policy agenda for the last number of years. We were quite startled, and I must say pleased, obviously, that this economy was able to absorb the very significant shocks to which you allude without contracting as in most everybody's judgment it almost surely would have, say, had they happened 20 or 30 years ago. It's quite apparent that the most important element in this very evident increasing resiliency of our system is the associated flexibility in both financial markets and in the economy generally.

I tried to address this issue in a number of presentations a few years ago, and it looked to me at the time as though the causes were several. First and quite important was the bipartisan trend towards deregulation, which started in the 1970s, and has indeed expanded to this point. It's got to the point where the notion of economic reform as a concept in the world is usually related to the questions of increasing deregulation and privatization. In a sense, the process that we have been going through is now increasingly being replicated elsewhere in the world.

In addition, obviously there has been a very significant increase in technological capabilities, especially information technologies, which has enabled businesses to respond in a far more expeditious way in response to imbalances in demand and supply. And that has prevented significant problems from emerging before they were addressed.

And the broad areas of increasing globalization, as we have lowered our tariff barriers and broadened our interface with the rest of the world, has also been a major factor here in creating flexibility, because we can interact with our trading partners in the way in which shocks are absorbed by all of us and contained rather readily.

So the general proposition that I think we have learned from this-and indeed we have learned, because it was not something that one would have put high on the agenda three or four decades ago-is that flexibility-anything that improves flexibility in the financial system or the economic system is in and of itself a very important advance to enable the economy to grow and prosper.

REP. OXLEY: The-would you-in terms of fiscal policy, you've-I know you mentioned in your remarks at least twice the tax cuts and their effect on rejuvenating the economy. Was that a-the fiscal aspect and the monetary aspect working together-was that a major factor also in getting us where we are today?

MR. GREENSPAN: I think the tax cuts were effective in stemming the extent of decline in the weakness-in the weakness of the economy several years ago. And indeed I have mentioned it on-in fact, in my prepared remarks-there's no question in my mind that-somewhat to my surprise, that the timing of the tax cuts came in-at a point when increasing effective demand to absorb the adjustments coming from the sharp stock market and capital goods decline of 2000 were necessary. So in that regard, I would say yes.

Clearly there was significant improvement in tax policy over the years, but I think we may have reached the peak in that regard in the 1986 act.

I cannot argue strenuously that we've made all that much improvement since then. Indeed, I think we've had a certain back up in a number of things that we have done. But overall I would say that, looking forward, fiscal policy is going to become a very critical issue on the agenda for macroeconomic policy.

REP. OXLEY: And if I might, I know you've said that you have enjoyed these sessions, partly because you get some feedback from the members all over the country, anecdotal incidents and so forth.

I had an interesting discussion with a trucking executive in my hometown a couple of months ago. And he was last year's chairman of the American Trucking Association, was all over the country. And I asked him how the transportation industry in general was doing, particularly the trucking industry, and he said they were doing very, very well, which is usually a pretty good harbinger of things to come. And I asked him specifically about his own company, and he said he could hire 20 drivers without any problem, he could expand that much. His problem in this case was finding qualified drivers, and I think it does point out perhaps the conundrum we have of trying to fit job skills and background and education with those jobs.

I don't want to get a discussion going now; I just thought I would pass that on. In that regard I'm over my time, and recognize Mr. Frank.

REP. BARNEY FRANK (D-MA): Thank you.

Mr. Chairman, I was actually fascinated by your response on the tax question because I must say it sounded to me like you were giving a pretty good demand-side justification for the tax cuts, but you were ambivalent at best about the supply-side justification. And I must say, to the extent that you said that we had reached good tax policy in 1986, I'm inclined to agree, and I just hope we're not about to make that even worse. So I think there is general agreement in the country that a demand-side stimulus works. And we did, as you say, manage to get the timing right. I think there are other ways to provide that demand stimulus. But I am struck by your being more enthusiastic about the demand-side aspect than the other.

But there's another aspect to the tax cuts that you addressed in the monetary report. Let me read to you, page 9:

"The deficit-the federal unified budget has continued to widen. In large part, the rise in the deficit is attributable to further rapid increase in spending on defense and other programs, and the loss of revenues resulting from the tax legislation enacted in recent years."

You go on to say, on the next page:

"As of the first quarter of 2004, national saving, measured net of estimated depreciation, was still equal to just about 2.5 percent of GDP, compared with a recent high of 6.5 percent of 1998.

If not reversed over the longer haul, such low levels of national savings could eventually impinge on private capital formation and, thus, slow the rise of living standards."

And you do say in here that the major reason for this drop, substantial drop in national saving from 6.5 percent in '98 to 2.5 percent today, is the swing in the federal budget from surplus to deficit.

So what you're saying is that while the tax cuts had some positive, near-term demand-side impact, we also have to deal with the fact that they contributed substantially, according to the report-not alone, but substantially-to an increasing deficit, which has, in fact, been a major reason for a substantial drop in the saving rate. And you note that if this is not reversed over the longer haul, it could impinge on private capital formation and slow the rise of living standards.

I agree with you. What are we going to do about it?

MR. GREENSPAN: Well, first of all, let me just say that, as I've indicated before this committee before, I do think that the partial elimination of the double taxation of dividends was an important long- term structural supply side change. So I'd like to amend your remarks in that context.

The issue in the short run, with respect to the fiscal policy, is unlikely to be a problem largely because increasing revenues --

REP. FRANK: That's why I asked about the long run. We only have five minutes, as you know, Mr. Chairman. I'm interested in your-you had sketched out that this is a long-range problem; that the tax cuts had a short-term stimulative effective, with a little bit of supply side capital gains, and they are having a longer-term, potentially negative effect. What I'm asking is, is there some way that we can deal with this negative effect without undoing some of the good? So I am interested in the long haul.

MR. GREENSPAN: Well, I think that there's a much broader question, which comes down to fiscal policy at this stage, and it relates to the fact that unlike the way budgets were put together 30, 40 years ago, where we had very few programs which extended beyond a few years-we would have, for example, an aircraft program which would be a three- or four-year program; we'd have some agricultural programs, but long-term commitments, either on the tax side or on the expenditure side, were rare.

This has turned around 180 degrees. And what we are missing is a process which essentially can address a long-term outlook, where the ability to forecast either revenues or, mostly, expenditures of key programs is clearly quite poor. This means, in my judgment, that you need a mechanism which adjusts programs as you move forward. And therefore, I would say not only do we need PAYGO, which is an important-in my judgment, critical-issue in budget programming, as well as discretionary spending caps, but I think we also have to begin to think of how we nudge programs back to where we thought we were pushing them in legislation, either through triggers or sunset legislation --

REP. FRANK: Well, my time --

MR. GREENSPAN: -- or other process methods.

REP. FRANK: But you ignore the tax side, and that disappoints me, Mr. Chairman. I mean --

MR. GREENSPAN: Well --

REP. FRANK: First of all-let me just summarize. You said that you thought, (for example, on the ?) tax policy, with the exception of the capital gains, we were better off in '86 than we've been since in terms of the structure of tax policy. You've also said that these tax cuts that we had, while they had a demand-side impact when we were in some trouble, presumably we don't need that now, that they have a long-term-they've been a significant contributor to this deficit, the swing from positive to negative, a reduction in the savings rate. What about the question of tax policy going forward? We're about to talk about another major tax cut, dealing with the world trade decision but going much beyond that. Have you nothing to say about tax policy?

MR. GREENSPAN: Well, I will say this. I'd say, as I said it to you before, I mean, I think it was a mistake not to extend PAYGO, both for tax and expenditure programs, and let it expire in September 2002; and that I myself, as you know, prefer a lower tax burden in general because I think it assists economic growth and increases the revenue base. But ultimately that determination is the Congress's. And the question that I think that is necessary to focus on is to put a structure out where the Congress can make those decisions, where I don't think you can at this --

REP. FRANK: I'll close-the gentleman. I thank you.

Mr. Greenspan, I appreciate this rare burst of deference to us on the tax issues. You haven't been reticent about making recommendations that are within our constitutional jurisdiction in a lot of areas, and you shouldn't be. So when you suddenly decide that it would somehow be inappropriate for you to recommend tax levels, I'm a little bit puzzled.

MR. GREENSPAN: I'm just essentially saying-I've stated before, and I haven't changed my view-I prefer lower taxes, and --

REP. FRANK: Even if it means deficits.

MR. GREENSPAN: -- for economic reasons.

REP. FRANK: Even if it makes the deficit worse.

MR. GREENSPAN: I'm sorry?

REP. FRANK: But even if it makes the deficit worse and has this long-term negative effect on the national savings rate?

MR. GREENSPAN: Well, then you get a trade-off. I would prefer lower spending and lower taxes and lower deficits.

REP. FRANK: And more inequality is the problem.

REP. OXLEY: The gentleman's time has expired.

The gentleman from Iowa, Mr. Leach.

REP. JAMES A. LEACH (R-IA): Thank you.

Mr. Chairman, in your statement today and in speeches in the last month, you've dwelled on a macroeconomic phenomenon that I've never heard discussed by the Fed, and that's this issue of-that there is greater cash flow in the economy, at least in the business side of the economy, than investment. And you describe this as a risk-averse kind of corporate America today. Could you mete that out a bit?

And then, you've indicated in prior speeches that one aspect of this is that it looks like the economy, coming through this year, looks like it's going to be pretty steady growth. But the fact that there is less investment than might be the case probably implies that coming into next year we're going to have a sustained economic growth, and that's probably pretty good for whatever administration takes place, whether it be the lower-tax administration of today or perhaps a higher-tax administration of tomorrow, but that the basic underpinning of the economy looks pretty good going into next year. Is that a valid observation or a valid conjecture on your part?

MR. GREENSPAN: Well, Congressman, you raise an interesting aspect of this issue with respect to the obvious reluctance on the part of the business community to be aggressively expansionary at this stage of the business cycle as they have typically been in the past. There has usually been advance hiring, advance capital investment, notions of restructuring companies to be prepared for increasing market shares; in other words, all in anticipation of significant improvement.

The fact that for the first time in three decades we are getting in an expansion period-indeed, almost in any case-a very significant shortfall in the level of capital investment plus inventory accumulation relative to cash availability says that we are far-we are far from behaving the way we typically did, and as you point out, the reasons that I presume are the cause of it is a number of caution-creating factors. But to the extent that these are capable of being assuaged, what it probably will be doing is, rather than creating a large surge in economic activity, is to gradually stretch it out if indeed a degree of confidence gradually returns. And that would be one of the reasons why a gradual expansion, which we now seem to be experiencing, does bode well for next year.

REP. LEACH: Let me raise one final question, and it's an issue of priorities and advice to Congress. For three or four congresses now, this committee has passed a bill on the orderly unwinding of contracts, a netting bill. And it's been tied up with another committee, the Committee on Judiciary, and on bankruptcy provisions, which are quite controversial. Would you advise the Congress to go ahead with the netting provision, unrelated to the bankruptcy bill, in order to get this underpinning of financial stability out of the way in a legal sense?

MR. GREENSPAN: I most certainly would, Congressman. We have been concerned for quite a while that the failure to include a number of these newer instruments into netting legality, if I may put it that way, puts us at risk in the event of some untoward event which would create significant financial problems.

I know of no resistance in the Congress to netting per se. And, of course, as you point out, the reason why the bill has not been moved forward is it's been tied to the bankruptcy bill with its other problems. And it strikes me that we are taking undue risk, and really unnecessary risk, in allowing that tie to exist rather than breaking the bill out from the bankruptcy bill and, I would presume, passing it very readily in both houses of the Congress.

REP. LEACH: Thank you very much, Mr. Chairman.

REP. OXLEY: I'd just say hear, hear to that. Thank you, Mr. Chairman, that's a great idea.

The gentlelady from New York, Ms. Maloney.

REP. CAROLYN MALONEY (D-NY): Welcome, Mr. Greenspan. Your remarks today provide support for an argument that the economy is recovering from the recession of the last few years. But that may not be the picture from the point of view of the American worker.

The latest figures for job growth show only a small increase, much less than would be expected if, as you suggest, the economy is growing significantly. There are 1.2 million fewer jobs now than there were at the official start of the recession in March of 2001. This is the worst job deficit since the Great Depression. The unemployment rate is 5.6 percent nationally. This is a 1.3 percent higher than when the recession officially began. And in New York, my hometown, it is now a 7.4 percent, up almost a half of a percent from last month.

If we look at jobs, as most Americans do, as a measure of our economy, things have been getting generally worse over the span of the last three and a half years. We still have not made up for the jobs lost in this administration. If you include workers who are working part-time because they cannot find a full-time job, and workers who want to work but are not in the labor force, the unemployment rate is roughly 9.6 percent.

This is perhaps the worst figure of all, is the number of long-term unemployed. Twenty-two percent of unemployed workers, 1.8 million people, have been jobless over half a year. This is a record-setter, the longest period of such high long-term unemployment since this statistics was first collected over 50 years ago.

I would like to hear about who has benefitted from the improved figures that you cite. It is certainly not the workers.

Real average weekly earnings have fallen by 1.4 percent over the past year. Wages are not keeping up with inflation. We're setting records on low wages, too. The share of aggregate wages and salaries in national income is the lowest it has been in over 50 years. And the data shows that profits in businesses have soared while wages have not. Aggregate wages and benefits of workers have grown only 8 percent, while business profits have increased 62 percent and after- tax profits 83 percent. This might be very good news for shareholders, but for workers, it is pretty depressing.

My question is, why has recent economic growth not translated into robust job growth and wages keeping pace with profits?

MR. GREENSPAN: There are basically two reasons why the level of total employment has lagged in this recovery relative to previous recoveries. The first is that we've had a historic rise in productivity, which means that even though the economy was rising, that most of the rise was supplied by increasing efficiencies, rather than new employees.

Secondly, the extent of the recession in 2001 was the shallowest in post-World War II history. And as a consequence of that, you don't get the usual rebound that we historically have had.

As I point out in my remarks and indeed I said-as I think I said in February, as Congressman Frank had indicated, that all of the increase in productivity, which has been a factor in the last year or so in an acceleration in economic growth, has been reflected in profits, increasing profit margins, rather than an acceleration of real wages.

Nonetheless, real wages have been rising, but as I pointed out in my remarks, my prepared remarks, that-there's been a disproportionate rise in the 20 percent of the-of payrolls which were supervisory workers, relative to nonsupervisory.

And indeed, as I point out, this is consistent with other evidence that suggests that the skill premium for skilled workers versus lesser-skilled continues to widen, and it's showing up in a distribution of income which is reflected in the long-term rise of average hourly pay of supervisory workers relative to the average hourly earnings numbers to which you were alluding. This, as I've I think argued in the past, I think is a major problem of matching skills of workers to the technological base of the economy, which I believe is an education issue and requires that we address that as quickly and broadly as we can.

REP. OXLEY: Gentlelady's time has expired.

The gentleman from Louisiana, Mr. Baker.

REP. RICHARD BAKER (R-LA): I thank the chairman.

Chairman Greenspan, I've noted that historians often critique the general's battle plan after the hostilities have ceased, but historians notably remain awfully quiet during the heat of the battle. With that observation having been made, when you testified before the committee in February, many signs of the step up in the economy were already evident. Renewed strength in capital spending apparent in 2003 carried over into the first half of 2004.

Going on, and with your testimony, "there have been much clearer indications over recent months that conditions in the labor market are improving. Most notably, gains in private nonfarm payroll employment averaged about 200,000 per month over the past six months, up sharply from the pace" of the fourth quarter of 2003.

You go on: "the combination of higher current and anticipated future income, strength in balance sheets, and still-low interest rates bode well for consumer spending."

"Profits of nonfinancial corporations rebounded to 12 percent in the first quarter of 2004, a pace of advance not experienced since 1983," as "consolidated unit costs for the nonfinancial corporate business sector actually declined during the same period."

In general, "financial intermediaries are profitable, well- capitalized, and appear to be well positioned to manage in a rising rate environment. In short, financial markets along with households and businesses seem to be reasonably well prepared to cope with the transition to a more neutral stance of monetary policy."

I consider this not to be just good news, but excellent news. I think the generals at the Federal Reserve have conducted a battle plan that has shown to be highly successful, moving us in a very stable and methodical direction. And for that, I just want to publicly commend you and those at the Fed for your leadership in this matter.

I wish to, however, move to an area of examination pursuant to the adoption of Sarbanes-Oxley, which was generated in an environment where many of us shared great disappointment in our free-enterprise professionalism, where it was apparent that there were those in positions of responsibility that did not meet either their professional or fiduciary responsibilities.

To that end, after the implementation of a higher disclosure standard, higher accountability, independence of audit committees, there still remains one area not addressed by the Congress, which I am reluctant to bring up, but would welcome your thoughts, and that is the tone at the top. I recently reviewed a report of diversified financial institutions where, on average, the CEO was compensated at a basis of $12 million a year, and the average value of stock held in the institution they managed-not net worth-was reported to be $800 million. Now, that in itself is not troubling to me because I believe, as a free-enterpriser, innovative, bright people should be rewarded in accord with their success.

What was troubling about the report is these average levels of compensation appeared to have no relationship to the profitability or losses of the corporation being governed. Compensation in itself does not indicate a problem, but it does indicate what the tone of management is with regard to their fiduciary obligations to shareholders.

In his appearance before the committee just last month, Chairman McDonough, chairman of the Public Corporation Accounting Oversight Board, indicated that compensation committees should act; if not, boards should act; if not, shareholders should act. But failing that, the Congress may at some time find it appropriate to act in this arena, not necessarily to regulate or establish some formula by which one is compensated, but at least to provide additional notice, earlier awareness by shareholders of plans to be taken by boards. In fact, the gentleman from Alabama, Congressman Terry Everett, has recently submitted legislation to me which he's contemplating introducing relative to prior notice with regard to pension plan adjustments which may be adopted by a board in a public operating company.

I think this is just a first step in a very long discussion about how we incent CEOs, CFOs and managers at the very highest levels to invest for the long term; to not be so concerned about beating the street every 90 days; to in fact build value for shareholders and not be so concerned about the value of shares they own, but the value of the corporation they are charged with leading.

I don't have a specific question to pose this morning, but merely wanted to have on the record my concerns about these matters in the context of our overall long-term economic fortune, and would ask and request the Fed's counsel and advice, as we move forward in this very difficult area, as to whether any action might be justifiable, whether examination over the course of the coming months is warranted, or any direction which you or the board may choose to advance in this arena.

And I yield back the balance of my time.

MR. GREENSPAN: Well, to the extent that we have expertise in that area-and in some areas we do, in some we do not-we'll be glad to prepare-to make available to you what it is we have.

But fundamentally, these are value judgments as to how you want corporate governance to behave, and shareholders still own the corporation and it's their money that is being employed for purposes of CEO and general executive compensation.

And if government gets too heavily involved in that transaction, I'm fearful that in an endeavor to improve corporate governance, we may in fact go in the wrong direction.

REP. BAKER: Often mere examination is very helpful. Thank you, sir.

REP. OXLEY: The gentleman's time has expired.

The gentleman from New York, Mr. Meeks.

REP. GREGORY W. MEEKS (D-NY): Thank you, Mr. Chairman.

Let me do this first, just following up on Mr. Frank when he talked about tax policy, et cetera.

You know, some people are born on top of the mountain, and some people are born on the rough side of the mountain. I happen to-grew up on the rough side of the mountain, had to climb up. And when you look at the tax policies that we're talking about, sometimes when they just benefit 2 percent of America and doesn't consider individuals who have grown up on the rough side of the mountain, you know, where hope and opportunity-I would not be here if it was not for public education, public housing and some-health care that my parents had. And when you talk about the tax policies that we're putting forth, I don't-never hear the considerations that are taken in place in regards to that so that we don't have to worry about countries, as the report recently indicated, in South America who no longer want to be part of a democracy.

That being said-and I would like sometimes, not today-you know, when we talk about the tax policy, the effects that it may have on individuals who are on the rough side of the mountain who may need a hand up-let me ask these questions, and I'll try to just ask three questions, different subject matters, real quick-because I know time expires real fast-just so that we could try to get some answers.

The first question is whether or not comparative advantage still holds true for the American economy, because you know one of the biggest issues that we're talking about now is outsourcing. And traditional economic theory supports free trade based upon the concept of comparative advantage. We thought that the service jobs, the technological jobs would stay here in America. We're now finding that they're going overseas out to individual countries where there are highly educated but less expensive workers.

So my first question is do you believe that we need to rethink our ideas about free trade, and in light of what might be diminishing comparative advantage and technology and education in the United States? That's number one.

And then I want to switch to just a question in regards to what's taken place in the Senate committee with Richard Shelby, who's planning to introduce legislation that would create a stand-alone regulator for GSEs that would be completely separate from Treasury and HUD, and that the new regulator would have the authority over mission, goals and products and risk-based capital. I just wanted to get your thoughts on such a proposal, particularly in light of the fact that the Federal Reserve has moved to strip Fannie Mae and Freddie Mac and other government-sponsored enterprises of their ability to obtain daily interest-free loans from the Fed.

And lastly, if we get a chance to-on another topic that's been very much before this committee-and I know that you're a bank regulator, but I wanted to ask you a question about the securities industry because both John Reed, as interim chairman of the New York Stock Exchange, and now John Thain as CEO, are making various changes to their structure, particularly in relation to separating the regulatory structure from running the securities auction.

Nevertheless, there are some who will say that the era of self- regulation is over. And I want to know that-whether or not do you believe that self-regulation should end and be replaced by direct federal regulation, and what do you think about the trade-through rule? Should it end or be expanded?

MR. GREENSPAN: I'll try to answer those fairly quickly. Each one is a 20-minute lecture, as you well know.

I would merely repeat, on the first question of free trade, I think the United States has immeasurably gained from the opening up of markets in the post-World war II period, and we more than anybody have gained by the tremendous rise in trade throughout the last half- century. And I think were we to start to pull in our horns in any way because we're fearful of competition, which we seem to be handling rather well, I think we'll find at the end of the day that it will diminish our growth in standards of living and we'll likely find that a number of consequences which we hadn't expected would have created a far more negative view of the way the world was working than we would like. So I would emphasize, as I did to the chairman, that the advantages of globalization have been profound for the United States and I hope we carry them forward.

We do have problems with the distribution of income, which I've addressed with-previously, but that's a different issue and does not relate to the question of whether we have free trade or not.

With respect to the GSE regulator issue, I have not or any of my colleagues have commented on the specific structure of the form of the regulator. I in testimony have argued the necessity of increasing the share of purchased home mortgages by the GSEs which are securitized rather than kept in portfolios at-we at the Fed perceive is a significant subsidized rate, but we haven't thought through any of the issues with respect to the structure of where the regulator is located and what he does.

With respect to what the Federal Reserve federal-the so-called overdrafts that the Federal Reserve essentially has been changing, what happened was that we perceived that as a matter of convenience, it was quite helpful to treat GSEs differently from other private corporations in the payment of-in various different payments of principal and interest to the banks.

What occurred as a consequence of our veering from how we handle other corporations, other private corporations, was to create a huge increase in what we call daylight overdrafts, which were very large intra-day lending. And what we chose is that as these drafts got very large and these institutions got very large and the amounts got very large-was to effectively handle these issues of payments exactly the way all private organizations do. We will be working in that direction, and I think it's very much to the advantage of the financial system as a whole. But that, in of and itself, has got nothing to do with the regulator question, in any sense.

For your final question, I think self-regulation is an extraordinarily important issue, or-and the more general private- sector regulation, essentially counterparty regulation or self- regulation, is in-a very important element in the regulatory structure generally. And I trust that we, in our endeavor to get the proper balance between federal, state and private regulation, keep in mind our purpose is to get the optimum functioning of our particular financial and in fact, in this case, business organizations as well.

REP. OXLEY: The gentleman's time has expired.

The gentleman from California, Mr. Royce.

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