Transcript from Federal News Service

Federal News Service

SEN. BENNETT: The committee will come to order. We are starting right on time this morning because the Senate is scheduled for a 10:00 vote. And with apologies to our House members who have joined us, we will try to get the opening statements out of the way prior to the 10:00 vote; break so that senators can come vote, and then return; and hope we can move in as expeditious a manner as possible.

We're pleased to have as our guest today Chairman Alan Greenspan of the Federal Reserve. We always appreciate his views on the current economic situation, as well as his broad perspective on the challenges that we face both as a nation and, increasingly, as a world, with the worldwide economy.

Now, it's particularly interesting because today will be Chairman Greenspan's first hearing since the most recent meeting of the Federal Open Market Committee, and changes in the Fed's statements, as well as substantial consumer and price declines in April—producer price declines in April, have generated many questions about deflation. And I hope today's hearing will serve as a fair and open forum for exploring some of the potential answers.

In my own view, the deflation questions facing the United States are fundamentally different than they are for some economies currently suffering from this condition, such as Japan. We don't face the same deflation risks, but it's worth raising the issue and talking about it. We shouldn't take any chances that might come from ignoring it.

The questions of deflation come in the context of a nation that is still awaiting signs that our economy has fully emerged from the recent recession. Many economists predicted months ago that once the fog of war was lifted and uncertainty resolved, the economy would quickly rebound. However, economic indicators continue to paint only a murky picture, precluding a confident declaration that the economy has turned the corner and has begun to approach full stride. For example, far too many Americans are still out of work.

Congress should not wait any longer for brighter signs from the economy. We should send to the president's desk a bold growth and jobs package. And that is in the province of the Ways and Means Committee and the Finance Committee, and I assume that they are doing their work even as we speak. Final passage of a bold jobs and growth package is an important step, but the next few months will require further activity, and Congress has much to do. We will start the discussion today about what tools we should use, in addition to tax cuts, to grow the economy and prepare for the future.

Now, some might shrug at the idea of giving serious thought to a foggy future, but in fact, the future is clearer than some would lead us to believe.

The biggest feature on the horizon, one that we can forecast with almost a perfect accuracy, is the aging and the retirement of the baby boom generation. In the year 2011, just eight years away, the first of that generation will reach the age of 65. And as these men and women retire, the nation faces the serious challenge of having fewer workers available to support each retiree. And this will put pressure on Social Security and especially on a system of delivering health care that looks much the same as it did when the younger of the baby boomers still wore diapers. Part of the answer, it will be to having a fundamentally stronger and larger economy in place when they retire.

So, we need to think harder about how we tax capital and how we practice in that—how our practice in that area can improve. The tax burden on capital in the United States is higher than imposed by many of our international competitors, and continued high rates of capital taxation would, by discouraging investment in capital formation in the United States, handicap us in our efforts to meet upcoming challenges.

Just last week, 70 senators voted for a "sense of the Senate" amendment instructing this committee, as well as the Finance Committee, to consider tax reforms, specifically including a flat tax. The bipartisan support for this amendment is an encouraging development, suggesting that many members of Congress recognize the need not to just cut taxes, but to reform the tax system.

We have other weapons besides tax policy in our arsenal if we are to continue to flourish in the decades ahead, and we must consider them. Our key strength on which we must draw is our economy's extraordinary flexibility, which has allowed us to weather an unexpected series of shocks over the past few years.

I observed this flexibility in strong financial markets, helping to ensure our nation's financial resources are put to their best use. I see this flexibility, as well, in the vitality and creativity of small and growing businesses. This is a unique American phenomenon, unduplicated in any other industrialized country. The entrepreneurial spirit, while it springs from a French word, is very much an American creation. Thanks to the ingenuity of these small business owners who risk their capital, thanks to the eagerness and the ability of workers to adapt to new challenges, thanks to a pension system that has increasingly made workers mobile and allowed them to move from one entrepreneurial activity to another and quickly respond to the opportunities that they have, instead of tying them to a single job for a lifetime, and thanks to all of these factors, workers go where they are needed most.

On previous occasions, Chairman Greenspan has emphasized the economy's flexibility as the key to its long-run growth prospects, and we look forward to hearing him on this subject again today.

And particularly, I would welcome a discussion about the actions we need to take to enhance and build upon the flexibility in order to grow and meet the upcoming challenges.

With that, I will now recognize Mr. Stark, the ranking member, for an opening statement, and then Mr. Saxton, the vice chairman, for an opening statement. And I would ask the other members of the committee if they would forego their opening statements, so that we could move directly to Mr. Greenspan.

Mr. Stark.

REP. FORTNEY PETE STARK (D-CA): Thank you, Chairman Bennett, for holding this hearing.

And welcome. You're looking chipper after -- (laughter) -- your bout at Johns Hopkins, and I welcome you to the alumni of that -- (laughing) -- auspicious group.

I expect that this morning we'll cover other topics, maybe a couple. In the first group, I expect we'll talk about the critical issue of how to put people back to work, get the economy moving again, when interest rates are so low that many of the tools of monetary policy may not serve us well.

In the next category, we have Congress fussing with a Rube Goldberg contraption of tax cuts that still favor the well-to-do and don't seem to have much to do with creating jobs or laying the foundation for sustainable growth.

I hope, Mr. Chairman, that you'll be able to reassure us that the Federal Reserve is committed to getting the economy back to full employment as quickly as possible and tell us about what means that you have or we have to do it. We've lost over 2-1/2 million jobs in the private sector since the current administration took office, and things don't seem to be getting any better. We haven't seen such persistent job loss since the '30s. The Federal Reserve has said that the balance of risks is tilted toward continued weakness, and I'd be curious to know what the Fed can do to encourage job creation and growth when interest rates, as I said, are already very, very low.

The question is critically important, because you may be our last best hope when the fiscal policy coming out of Congress seems to be a shambles and the tax cut packages squeeze large tax cuts into a tighter budget, which probably, if you took off the gimmicks of sunsetting, would still be over the 700 billion that was in the original package.

You've said in the past that you believe the financial markets assumed long ago that the 2001 tax cut would not be allowed to sunset, and I doubt if there's any reason to take seriously the sunsets moving through now would not be extended.

So, far from being the best policies to get the economy back to full employment as quickly as possible and enhancing long-term growth, the jobs and growth plans that we're hearing provide little job- creating fiscal stimulus when it's really needed.

The question is whether we pass the future debt for or responsibilities for retirement and health care challenges along to our children and grandchildren just for the sake of some quick tax cuts now.

Secretary Snow, Treasury Secretary Snow said our economy is soggy. I suppose one reason is that the president and the Republicans -- (chuckles) -- continue to believe in trickle-down policies, and that's getting everybody kind of damp, but it doesn't seem to be offering any real jobs or a growth plan that would get the economy back to full employment.

So we have a preoccupation with tax cuts and very little talk about short-term economic stimulus. And I hope you could provide us some guideposts as to what we might look forward to in the year ahead.

Thank you for being with us.

SEN. BENNETT: Mr. Saxton.

REP. JIM SAXTON (R-NJ): Thank you very much, Mr. Chairman.

It's a pleasure to join in welcoming Chairman Greenspan once again before the Joint Economic Committee. Thank you for your continuing interest in our committee.

The latest economic figures indicate that the economy is still expanding, although at a very slow rate, as we all know. In recent years, the economy has been remarkably resilient despite terrorism, war and pervasive uncertainty. However, one of the weakest areas in the expansion has been business investment. And until business investment rebounds, it is my opinion that the economy is not likely to expand at a vigorous rate.

Although it is clear that the persistent weakness in business investment followed the stock-market plunge in 2000, it is not possible to know exactly when it will end. As the New York Fed president has observed, the effects—and I quote—"the effects of the bursting of the stock market have proven to be far more long-term and pervasive than expected," end quote. Some of these effects are readily seen in the weaknesses in the economic and employment conditions that has been apparent for quite some time.

In the last appearance before the committee, last November, Chairman Greenspan stated that the economy was in a, quote, "soft patch," and suggested that when the unusual degree of uncertainty facing the economy was lifted, which certainly existed at the time, the rate of economic growth could be expected to increase. Although some of the uncertainty may have been reduced, at least some of it still remains. The latest data suggests that the economy is still quite weak.

We all hope that the economy is poised for acceleration in the last half of the year. However, there is little compelling hard evidence that a pickup in the economic growth is on the horizon. There has been a recovery in business profits and some other indicators, but there have been many other signals of continued economic fragility.

In the economic environment that exists today, it is reasonable to consider adjustments of economic policy. Congress has responded with tax legislation designed to boost investment and create economic growth, but, given the weaknesses and the downward pressures on prices, the Federal Reserve, in my opinion, should implement another incremental easing of monetary policy. If policy is eased and the pace of economic expansion does not take off in the second half of the year, monetary policy could readily be adjusted to take this into account.

I might note also that low short-term interest rates do not prevent the Fed from easing monetary policy. As Chairman Greenspan indicated in the JEC hearing last fall, if short-term interest rates fall close to zero, the Federal Reserve can still lower long-term interest rates or operate in other markets to expand reserves and thereby further ease monetary policy.

The decline in the value of the dollar, obviously, is a factor to be considered, but it is clear that this decline is not the result of an inflationary monetary policy. In the absence of inflation, the risks of other easing are low, and such a move is already expected in the financial markets and, I believe, has been factored in by many. The risks poised by the weaknesses in domestic and international economy appear to exceed the risk that inflation will emerge as a serious problem in the foreseeable future.

Now Mr. Chairman, thank you for permitting me to make that statement, and I look forward to the chairman's testimony.

SEN. BENNETT: Thank you very much.

Chairman Greenspan, again, we welcome you and look forward to what you have to share with us this morning.

MR. GREENSPAN: Thank you very much, Mr. Chairman. I very much appreciate the opportunity to testify before this committee.

As you will recall, when I appeared here last November, I emphasized the extraordinary resilience manifested by the United States economy in recent years—the cumulative result of increased flexibility over the past quarter-century. Since the middle of the year 2000, our economy has withstood serious blows: a significant decline in equity prices, a substantial fall in capital spending, the terrorist attacks of September the 11th, confidence-debilitating revelations of corporate malfeasance, and wars in Afghanistan and Iraq.

Any combination of these shocks would arguably have induced severe economic contraction two or three decades ago. Yet remarkably, over the past three years, activity has expanded, on balance, an outcome offering clear evidence of a flexible, more resilient, economic system.

Once again this year, our economy has struggled to surmount new obstacles. As the tensions with Iraq increased early in 2003, uncertainties surrounding a possible war contributed to a softening in economic activity. Oil prices moved close to $40 a barrel in February, stock prices tested their lows of last fall, and consumer and business confidence ebbed. Although in January there were some signs of a post-holiday pickup in retail sales other than motor vehicles, spending was little changed, on balance, over the following three months as a gasoline price surge drained consumer purchasing power and severe winter weather kept many shoppers at home.

Businesses, too, were reluctant to initiate new projects in such a highly uncertain environment. Hiring slumped, capital spending plans were put on hold, and inventories were held to very lean levels. Collectively, households and businesses hesitated to make decisions, pending news about the timing, success and cost of military action, factors that could significantly alter the outcomes of those decisions.

The start of the war and its early successes, especially the safeguarding of the Iraqi oilfields, were greeted positively by financial and commodities markets. Stock prices rallied, risk spreads narrowed, oil prices dropped sharply, and the dour mood that had gripped consumers started to lift, precursors that historically have led to improved economic activity. The quick conclusion of the conflict subsequently added to financial gains.

We do not yet have sufficient information on economic activity following the end of hostilities to make a firm judgment about the current underlying strength of the real economy. Incoming data on labor markets and production have been disappointing. Payrolls fell further in April, and industrial production declined as well. Because of the normal lags in scheduling production and in making employment decisions, these movements likely reflect business decisions that, for the most part, were made prior to the start of the war, and many more weeks of data will be needed to confidently discern the underlying trends in these areas.

One reassuring development that has been sustained through this extended period of economic weakness has been the performance of productivity. To the surprise of most analysts, labor productivity has continued to post solid gains. Businesses are apparently continuing to discover unexploited areas of cost reduction that had accumulated during the boom years of 1995 through 2000 when the projected huge returns from market expansion dulled incentives for a seemingly mundane cost savings. The ability of business managers to reduce costs, especially labor costs, through investment or restructuring is, of course, one reason that labor markets have been so weak.

Looking ahead, the consensus expectation for a pickup in economic activity is not unreasonable, though the timing and extent of that improvement continue to be uncertain. The stance of monetary policy remains accommodative, and conditions in financial markets appear supportive of an increased pace of activity. Interest rates remain low, and funds seem to be readily available to creditworthy borrowers. These factors, along with the ability of households to tap equity accrued in residential properties, should continue to bolster consumer spending and the purchase of new homes.

The recent declines in energy prices are another positive factor in the economic outlook. The price of West Texas intermediate crude oil dropped back to below $26 per barrel by the end of April. But as indications of a delay in the restoration of Iraqi oil exports became evident and geopolitical risks crept back in, prices have risen to near $30 a barrel—a worrisome trend, if continued. Nonetheless, the price of crude oil is still about $10 per barrel below its peak in February. This decline has already shown through to the price of gasoline in May. Some modest further declines in gas prices are likely in coming weeks, as marketers' profit margins continue to back off their elevated levels of March and April to more normal levels.

In contrast, prices for natural gas have increased sharply in response to very tight supplies. Working gas in storage is presently at extremely low levels, and the normal seasonal rebuilding of these inventories seems to be behind the typical schedule—seems to be behind the schedule which we typically perceive during the spring through the fall months. The colder-than-average winter played a role in producing today's tight supply situation, as did the inability of heightened gas-well drilling to significantly augment net marketed production.

Canada, our major source of gas imports, has little room to expand shipments to the United States. Our limited capacity to import liquified natural gas effectively restricts our access to the world's abundant supplies of natural gas. The current tight domestic natural gas market reflects the increases in demand over the past two decades. That demand has been spurred by myriad new uses for natural gas in industry and by the increased use of natural gas as a clean-burning source of electric power.

On balance, recent movements in energy prices seem likely to be a favorable influence on the overall economy. In the short run, lower energy bills should give a boost to the real incomes of households and to business profits. To be sure, world energy markets obviously remain susceptible to politically driven supply disruptions, as has been evident recently from the events in Venezuela and Nigeria.

But even taking account of these risks, futures markets project crude oil prices to fall over the longer run, consistent with the notion that current prices are above the long-term supply price of oil.

As has been the case for some time, the central question about the outlook remains whether business firms will quicken the pace of investment now that some, but by no means all, of the geopolitical uncertainties have been resolved. A modestly encouraging sign is the backlog of orders for nondefense capital goods, excluding aircraft, which has been moving up in recent months. Moreover, recent earnings reports suggest that the profitability of many businesses is on the mend. That said, firms still appear hesitant to spend and hire, and we need to remain mindful of the possibility that lingering business caution could be an impediment to improved economic performance.

One new uncertainty in the global economic outlook has been the outbreak of severe acute respiratory syndrome in Southeast Asia and elsewhere. This epidemic has hit the economies of Hong Kong and China particularly hard, as tourism and business travel have been severely curtailed and as measures to contain the spread of the virus have held down retail sales.

To date, the effects of SARS on the U.S. economy have been minimal. Airlines have obviously suffered another serious blow, and some U.S. multinational corporations are reporting reduced foreign sales. But the effects on other industries have been small. Initially, there had been some concerns that SARS would disrupt the just-in-time inventory systems of U.S. manufacturers. Many of those systems rely on components from Asia, and any disruption in the flow of these goods has the potential to affect production in the United States. So far, however, U.S. manufacturing output has not been noticeably affected.

In recent months, inflation has dropped to very low levels. As I noted earlier, energy prices already are reacting to the decline in crude oil prices, and core consumer price inflation has been minimal. Inflation is now sufficiently low that it no longer appears to be much of a factor in the economic calculations of households and businesses. Indeed, we have reached a point at which, in the judgment of the Federal Open Market Committee, the probability of an unwelcome substantial fall in inflation over the next few quarters, though minor, exceeds that of a pickup in inflation.

Mr. Chairman, the economic information received in recent weeks has not, in my judgment, materially altered the outlook. Nonetheless, the economy continues to be buffeted by strong cross currents. Recent readings on production and employment have been on the weak side, but the economic fundamentals, including the improved conditions in financial markets and the continued growth in productivity, augur well for the future.

Thank you, and I look forward to your questions.

SEN. BENNETT: Thank you very much.

Mr. Saxton has to leave; he has an assignment on the House floor. And so, with the permission of my colleagues, I will go out of order and recognize Mr. Saxton—ask the first question and take the first round.

REP. JIM SAXTON (R-NJ): Thank you very much. Let me just ask two questions.

Last November when you were here, Mr. Chairman, we discussed the downward pressure on prices and options available to the Federal Reserve to combat it. Yet, some still believe—seem to believe that low short-term interest rates limit the potency of monetary policy.

As I pointed out in my statement, last time you were here you shed some light on that subject. Could you explain how the Fed could address unwelcome downward pressures on prices and purchase of long- -- to the purchase of long-term Treasury securities?

MR. GREENSPAN: As I and a number of my colleagues have stated recently, we have chosen to act solely in overnight funds, essentially addressing the reserve balances of the banks. There are a number of reasons why we did that, but the point at issue is that there is no legal requirement that we do so, nor indeed an economic one.

And should it turn out that, for reasons which we don't expect but we certainly are concerned may happen, the pressures on the short- term markets drive the federal funds rate down close to zero, that does not mean that the Federal Reserve is out of business on the issue of further easing and expansion of the monetary base. We indeed, as you point out, can merely move out on the yield curve, because, as you're well aware, even though short-term rates are something slightly over 1 percent, longer-term rates are up significantly above that.

And we do have the capability, should that be necessary, of clearly moving out on the yield curve, essentially moving longer-term rates down and in the process expanding the monetary base and the degree of monetary stimulus. And as—since there is such a significant amount of potential in those longer- -- in that longer maturity structure, we see no credible possibility that we will at any point, irrespective what is required of us, run of out of monetary ammunition to address problems of deflation or anything similar to that which disrupts our economy.

REP. SAXTON: Thank you. Mr. Chairman, in your remarks, you talked a good deal about energy prices. In regard to oil prices in particular, I note from our studies that oil prices have not been moving in a straight line. Beginning in about March, we saw oil prices begin to come down significantly, and then they ticked back up. And following that tick, in March or April, they continued on down and then ticked back up. And then they—after that second tick back up, they continued to come down, and now they've ticked back up.

And so I would interpret this as the general direction of oil prices and energy prices becoming lower. Is that a good interpretation?

MR. GREENSPAN: That's certainly what the commodity markets are suggesting—namely, the futures markets. The initial sharp reaction on the downside occurred when it became evident not that the war would necessarily not be associated with significant problems in the oil fields, but that whatever happened, the uncertainty of the mere time frame as to when the war would begin was removed, and there was a general expectation of once the war started, it would end quickly. And as a consequence of that, markets of crude oil fell very sharply.

Then when the oil fields became clearly under control and the expectation of Iraqi—of the resumption of Iraqi crude exports became evident, prices worked their way lower, for fear that there would be some form of glut.

When it became evident, as I mentioned in my prepared remarks, that Iraqi exports were not coming back very quickly—they were coming back, obviously, but not at the pace that the markets had assumed—markets are backed up. And the last I looked, they were somewhat below $30 a barrel for West Texas intermediate crudes.

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

And, Mr. Chairman, thank you for permitting me to go out of order.

SEN. BENNETT: We appreciate your attendance and your participation.

Mr. Stark.

REP. PETE STARK (D-CA): Thank you, Mr. Chairman.

And thank you, Chairman Greenspan. In the conclusion of your remarks, it sounds to me that you're suggesting that the main problem facing the economy is weak demand, therefore, sluggish growth and high unemployment. You say recent readings on production employment have been on the weak side. And you also seem to suggest that our long- term growth prospects are okay. You say, "continued productivity augurs well for the future."

That seems to leave us with the shorter-term stimulus for demand as the—what's left for us to do in the policy field to see whatever we can do to get full employment as quickly as we can without increasing long-term debt by too much.

Is that the dilemma that faces us as policymakers: What can we do to stimulate a short-term demand without borrowing excessive amounts of money? That's my question. It seems to me that's what's left for us to do.

MR. GREENSPAN: Yeah, Congressman, I think that the first decision that any policymaker in this environment has got to make a judgment about is, one, whether the economy is turning, and whether its potential pace on turn and thereafter, is enough to obviate the need for further stimulus.

Clearly, we at the Federal Reserve perceive monetary policy as the primary tool in this government for short-term monetary—for short-term stimulus. It has been the general conclusion of economists over the years that the difficulty in timing fiscal policies, merely because of our congressional structure and the particular procedures which you are far more aware of than I, makes it difficult to calibrate fiscal policy in a timely manner. And therefore, most economists have generally eschewed, in recent years, the use of fiscal policy as sort-term stimulus.

Now, it turned out with the 2001 tax cut that, indeed, the actual implementation of the tax cut did come at a time when it seemed to be propitious for short-term stimulus, and that has apparently revived some views about the use of fiscal policy as short-term stimulus. And there are arguments, I must say, in favor of it. I still think that monetary policy should take the lead in the short run, largely because we can move on 20 minutes' notice, and 10 minutes, if necessary, whereas that is, obviously, not feasible in the fiscal (ring ?).

Having made the judgments, then the question is: To do what? And there is the obvious problem of short-term fiscal stimulus, which -- (inaudible). In other words, you can get a very significant short- term surge, perhaps in retail sales, with a very marked short-term decline in taxes, for example. The problem is that if you succeed, the difficulty is that it is short term and it tends to fade. And if it creates levels of production which reduce unemployment as a consequence, over time, it reverses; I mean, it's not a longer-term phenomenon.

And therefore, you have to make the judgments as to whether fiscal stimulus should be directed at consumption or investment. My own view is I would much prefer the latter, because I have always perceived fiscal stimulus as an intermediate-to-longer-term policy tool. But these are judgments that very thoughtful economists disagree on. I mean, there's not a uniform view which you'll get a collective wisdom on in these areas.

REP. STARK: Well, as a thoughtful economist -- (chuckles) -- let me ask you, faced—and here's the question—faced with, perhaps, capacity at 60, 70 percent—wherever it is; we have access capacity to manufacturing --

MR. GREENSPAN: In manufacturing.

REP. STARK: -- and faced with high unemployment and an expiration of unemployment benefits, for example, what are the pros and the cons of saying—wouldn't extending unemployment benefits to a couple of million people send them right out to Wal-Mart to buy the shoes and food that they need, and give us at least a short-term boost there, with some social benefits?

MR. GREENSPAN: Mr. Stark, I've always been of the opinion, and stated before this committee previously, that our unemployment insurance system seems to work rather well. It is not overly generous, which would induce the type of increased levels of structural unemployment, which we see in other countries which have these types of things—these types of structures. But unemployment insurance is essentially restrictive because it's been our perception that we don't want to create incentives for people not to take jobs. But when you are in a period of job weakness, where it is not a choice on the part of people whether they're employed or unemployed, then obviously, you want to be temporarily generous. And I think that's what we have done in the past, and I think it's worked well.

With respect to the immediate future, I don't have a judgment on any particular program, but I would suggest that if you go forward with additional extensions, I would be careful to keep the extensions relatively short and renew them again if necessary, because we're not quite clear at this stage what the path of short-term economic activity is. A number of major economic forecasters have forecasts for the third quarter, which is just about in front of us, of 4 percent growth at an annual rate, and that is a relatively long list. Now, anybody with a little arithmetic will tell you that that means that this economy has to start to move fairly quick to get (there ?).

REP. STARK: I don't know if you know how happy you've made Chairman Bennett and myself, but by saying two 13-week periods, instead of one 26 (-week period) -- just think—we get to announce twice and get twice the accolades for doing it. (Laughter.) What a great idea! Thank you, Mr. Chairman.

SEN BENNETT: We get to argue about it twice. (Laughter.)

There are roughly five minutes left on the vote on the Senate floor. For those that are watching the clock in the back, it is 13 minutes slow. (Laughter.) So, we won't do that.

I will turn the gavel over to Mr. Ryan, who is the most senior Republican here, and encourage the House members to remain and continue the questionings while the senators go over and save the republic, or whatever it is we do -- (soft laughter) -- while we vote.

And Mr. Ryan, Mr. Putnam was the first member of the House to show up, if you want to honor the early bird rule.

REP. PAUL RYAN (R-WI): Great. Mm-hmm.

SEN BENNETT: And if you want to wait until we get out and use your vast power to question yourself --

REP. RYAN: (Laughs.) I guess that means I have to ask questions last if I want to honor the early bird rule, doesn't it?

Mr. Putnam?

REP. STARK (?): (Chuckling.) Do the right thing.

REP. ADAM PUTNAM (R-FL): I thank the distinguished elder chairman -- (laughter) --

REP. RYAN: You're welcome.

REP. PUTNAM: -- anchoring the 20- and 30-something of the House Caucus.

Mr. Chairman, I want to address briefly the issue of the housing sector. The consumer confidence has been all over the map, but appears to be on the rise right now. A great deal of our reliance on the fundamentals of the economy thus far, as we have gone through this soft patch, have been as a result of continued consumer spending and the money that they have been able to extract from the value of their home and continued strong real estate prices.

What is your outlook for the continued explosion of refinancing and the extraction of equity from the housing market and the continued strong home sales for the remainder of this year?

MR. GREENSPAN: First, let me stipulate that while cash-outs, extraction of monies in the process of refinancing, have become a very big number in recent quarters, they still fall short of the equity extraction that occurs as a consequence of the sales of existing homes, when obviously the seller of a home cancels a mortgage which is much smaller than the mortgage taken out by the buyer, and the difference between those two numbers is, by definition, the net increase in debt on that home and the extraction of equity, essentially, by the seller.

Having said that, it's important to recognize that a goodly part of the extraction of equity has been an ongoing issue related to a very high level of existing home sales, which has not deviated very much, as you well know, in recent quarters.

What has changed is a very extraordinary shift in the way the mortgage market functions. We had a huge surge in refinancings late last year, as the mortgage rate on—I'd say the fixed 30-year mortgage rate fell significantly below the average coupon on existing mortgages, meaning that the gap was widening and therefore the presumption would be—as indeed it was—that a very large number of refinancers would come into the market. And we had a huge number of refinancings and very large cash-outs.

That number dipped a bit in the first quarter, but in recent weeks it's come back up again. Refinancings in the second quarter look to be very large.

The cash-outs, however, are not as large relative to refinancings as they've been. That is, there's some evidence that there's—while the refinancings have gone up dramatically in order to reduce the average coupon, we have not seen a major increase in cash-outs as a result.

Let me also point out that surveys by the Federal Reserve indicate that equity extraction from homes, especially under—in refinancings, tend to be very significantly employed to repay other debt. And first of all, they're a major source of repayment on home equity loans, but they have also shown up as a major factor in reducing the burden of consumer debt.

So all in all, it's turning out that the technology, which is obviously at the base here of what—where this refinancing is coming from, has changed the housing market in a rather fundamental—or, I should say, the financing of the housing market. And it has made it a vehicle for liquefying household wealth, and it's been a major factor in consumer activity. And I might say to you that my suspicion is that it's going to increase, rather than decrease, as a factor in the American consumer markets as homeownership continues to increase.

REP. PUTNAM: That technology that you refer to has fueled a historic growth in productivity across all sectors of the economy, and you have been an eternal optimist about the continued ability of our economy to produce productivity gains.

Does that situation then yield another jobless recovery, where these continued productivity gains will not put more people back to work as we emerge from this soft patch?

MR. GREENSPAN: No, Congressman. It does, however, raise the hurdle of what the rate of increase in GDP must be in order to get employment rising, because clearly—the arithmetic is straightforward—productivity is essentially the rate of growth in GDP minus the rate of growth in hours. And in the most recent period what we've seen is a modest, sluggish increase in real GDP and a decline in hours. And one could argue that if productivity were weak, American business would have to employ more people to meet the demands of the marketplace, weak as it is. As it's turning out, what we are finding is that American business is increasingly being able to meet what has been a tepid rise in sales with an ever-lower workforce, which means either the use of technology or restructuring in manners which employ improved productivity.

We should never look at productivity growth as anything negative, because that's where standards of living come from, that's where real wealth comes from, that's what indeed has made this economy the most extraordinarily productive in the world. But it does raise the hurdle of what the growth rate overall must be if we're going to keep our labor force employed.

REP.PUTNAM: I thank the chairman very much.

REP. RYAN: Mr. Hill?

REP. BARON HILL (D-IN): Mr. Chairman, thank you for being here this morning.

In listening to your testimony, you made the statement that monetary policy should lead in terms of stimulating the economy; that a short-term stimulus package—I'm assuming you mean through tax cuts—tends to fade.

MR. GREENSPAN: Unless it is incentivizing investment. Then it's a different deal.

REP. HILL: The tax cuts that were proposed in the House, as a member of the House I voted against because I believe that deficits matter, and I think that the tax cuts are only contributing to the deficit problem that we have. On February the 15th of this year, you said, and I quote, "Contrary to what some have said, when deficits go up, it does affect interest rates; it does have a negative impact on the economy." We're about to make some decisions in Congress, maybe this week, about whether or not we should have a tax cut. Now, in my view we shouldn't because it contributes to the debt. What's your view? What should we do?

MR. GREENSPAN: I think what is required in doing any sort of analysis is to, on the one hand, try to evaluate the gross positive impact from any fiscal program: one, for example, that is budget neutral, on the one hand, and one which may be contributing to budget deficits. If it's the latter, then the issue I was raising with respect to interest rates is that in order to get the net impact plus or minus, it's important to reflect the fact that indeed changes in the longer-term fiscal outlook are very clearly a factor in the level of long-term interest rates today.

And as a consequence, if you engage in a program which significantly alters the long-term deficit outlook to a point that long-term rates are raised, it may or may not be curtailing economic output, it—let's put it this way; it requires an analysis of what the extent of the curtailment in economic output would be as a consequence of higher long-term interest rats, to net it against the gross incentive flows and productive flows that occur from some form of tax cut, long-term tax cut program.

The point I was making is deficits do matter, and that in any evaluation of a program, what happens to deficits is an integral part of the analysis.

REP. B. HILL: I want to make sure that I heard you right. Did you say that any kind of tax cut should be revenue neutral?

MR. GREENSPAN: Not necessarily revenue; budget neutral. In other words, I'm—I must admit that in the debate that's been going on on the issue of fiscal policy, it really is a debate between whether or not deficits are increased by spending or by tax cuts. I'm waiting to hear the third stool—the third—I was going to say the third foot, and I was wondering what kind of an animal this is. (Laughter.)

But what is missing here, and was never missing in previous discussions, is restraint on spending. I am increasingly of the view that the huge surpluses which we created in our budget, which were wonderful things to observe, have severely undercut fiscal restraint, the type of restraint that existed before the surpluses emerged. And as our chairman indicated, we are looking at the potentials of a significant demographic problem as we get beyond 2011, and it's something which requires a really very close look at the size of the commitments for spending that we're making. And I think that I would very much like to see that issue addressed far more than it is. And I must say, the silence is deafening.

REP. B. HILL: I couldn't agree with you more, Mr. Chairman. I got the red light on me just now, so maybe I'll ask another question later. But thank you for your answer.

REP. RYAN: Although it's very tempting to want to follow up on what Mr. Hill just said, I shall recognize Mr. Paul.

REP. RON PAUL (R-TX): Thank you, Mr. Chairman.

Good morning, Mr. Greenspan. I have two questions; one is generalized and it deals with the dollar system and the monetary system that you're required to operate, and then one more specific, a factor that affects the strength of the dollar.

But the big debate now in financial circles is the weak dollar, whether it's good or bad, versus what a strong dollar should do to us, or for us. And I would like to suggest that there should be another alternative; rather than arguing a temporary case for a strong dollar to help us, which it seemed to in the latter part of the 1990s, versus whether the weak dollar will now help us on our exports. Rather than this manipulation of the value of the dollar, I would hope some day that we will talk about a stable dollar; one that does not fluctuate so readily.

We deal in the world today with fluctuating exchange rates and all currency are inflated at different rates. And nobody advocates that we have 50 different currencies in this country. That would be totally chaotic. And yet the world is required to operate, and there is—there's no soundness to it, no restraint on the monetary authority.

And the other challenge I think we have to look at some day is whether or not we should continue to accept this notion that we can achieve positive, central economic planning through the monopoly control of money and credit, and setting of interest rates, which is really contradictory to true capitalism. And I think that's where part of our problem is. The Austrian economists for years—Mises and Hayek and Rothbart—have argued that this is the source of our problem; that the manipulation of interest rates too low causes the boom, and then eventually the bust has to come. And we see this over and over again.

But we talk about productivity and other events that are important, but we fail to talk about the initial cause of the malinvestment, the overcapacity and the—which then requires the correction.

Because we are the—we operate the reserve currency of the world, we have the advantage of others taking our money and our dollars and holding them. But currently, the expectations are that our current account deficit may soar to $600 billion next year, and we do know that throughout history, and most economists agree, that these current account deficits cannot be maintained; that will eventually lead to a weaker dollar and higher interest rates.

So, I think you're under the gun. In one sense, you want to stimulate the economy with low interest rates, which weakens the dollar; at the same time, the weak dollar will eventually push up the interest rates. And my question there is when do you think—or do you think we will ever talk once again about sound, stable currency?

And the other question is more specific, because even though what the Fed does in the creation of new money is the key element, other things do have factors; the jawboning and this so-called speculators—for a day or two, they have an effect. But they really can't change it. Jawboning doesn't work. Ultimately, in 1979, interest rates had to go to 21 percent to restore some order to the dollar. But you talked about the war and the supposed benefits after the war was over and after it started, but I think what has not been recognized is the ongoing foreign policy of our adventurism and our plans—really, those same people who planned and argued the case for Iraq are arguing the case for Syria, and they're arguing the case for Iran. At the same time, we don't have our allies close to us, we don't have people pouring in the dollars like we did in the 1990s. So, that in itself has a subjective relationship to the perceived value of the dollar. And I want to know whether or not you think that element in foreign policy today specifically has effected the future perceptions of what the dollar's value is going to be.

MR. GREENSPAN: Well, Dr. Paul, first, let me address the last question first. As I think you may remember, that we in the United States government have made a decision in which the value of the American currency will be discussed only by our chief economic spokesman, which is the secretary of the Treasury. And we at the Fed have adhered to that for quite a good, long period of time, and think it's important to have one voice speaking on that issue.

With respect to the more general question about the issue of sound, stable currencies, this, as you know, is a very fundamental debate amongst economists. And you point out quite correctly that there is a single currency in the 50 states of the United States. The reason why we are able to function in a manner which others are not is that an exchange rate that is a currency—a unit—a specific currency tends to bring together all of the imbalances in an economy in the exchange rate's price. In other words, at the border, the exchange rate essentially re-balances all of the imbalances between two contiguous countries, or it might have been in the United States, between two states. If you lock the currency in, and you cannot adjust at the border—you cannot adjust the currency at the border, then the adjustments must occur in capital flows or in labor flows, the only two other ways in which you can get major adjustments that are required between two disequilibrium economies.

The advantage of the United States is that because we've stripped out all barriers to interstate commerce, essentially—I should say most—we are able to get equilibria adjusted solely through capital and labor market flows, and we have a fixed currency.

The reason why it is not at this moment feasible in a lot of other areas of the world is that capital and labor flows are not adequate to pick up the full adjustment process. And an endeavor to fix exchange rates in the face of imbalances induces financial breakdowns (as ?) occurred.

REP. PAUL: May I just interject? I'm not talking about fixing these rates; I'm talking about a single currency that could be universalized.

MR. GREENSPAN: That's the algebraic equivalent of fixing the rates. In other words, if you lock in legally all rates, it's irrelevant what you call the currency in one nation and another; it's the lock that matters. And if you have, for example, as we did, the gold standard, which for a very substantial period of time was the single currency of the world, it didn't matter what you called the other currencies, because they were all locked in in units of gold. And so the notion of a stable world currency requires a degree of flexibility in capital and labor flows which we do not yet—we have not yet achieved.

REP. BENNETT: Mr. Chairman, the press has made a great deal out of your use of the word "deflation" the last time you appeared before the --

MR. GREENSPAN: Did I use the word "deflation"? I thought I said (laughter) -- I may --

REP. BENNETT: You kind of danced around it, but that's the way it came across. And --

MR. GREENSPAN: It was my interpreter.

REP. BENNETT: It was your interpreter. All right. I'd like to put the word right smack in the middle of the table and give you an opportunity to talk about it so that we can address the speculation, sometimes wild speculation, that has gone on in many of the columns that say we are on the verge of becoming Japan, if we are not in fact Japan; Greenspan warns of deflation; and we're looking at 10 years of falling prices and sluggish economy and all of the rest of that.

Can you just take that particular topic and deal with it in a way that we hope will—I hope will put some of these specters to rest?

MR. GREENSPAN: It's a very serious issue and an issue which we at the Federal Reserve are paying extensive attention. And the reason, basically—and this, indeed, follows on naturally from my conversation with Congressman Paul—with the elimination of the gold standard in the 1930s and the development, essentially, of worldwide fiat currencies, almost no economists believed that you could create deflation with fiat currencies, because the ultimate supply of those currencies, by definition, comes from government fiat.

We went through most of the post-World War II period with the expectation that fiat currencies were essentially inflation ridden and that the major focus of central banks was to suppress inflation. The notion that deflation would emerge just never entered our minds until the Japanese demonstrated to us otherwise.

As a consequence of that, not having had any experience in the modern world with dealing with deflation and fiat currencies, our knowledge base was virtually nonexistent, in the sense that—we know how to deal with inflation. Inflation obviously is something that for a half-century we've been struggling with.

We know how to suppress it. We know the consequences of suppressing it. We know the impact of various monetary policy decisions on the levels of output growth and unemployment. So we are familiar with the mechanism. It's not that we can very easily and automatically just suppress inflation. It has been a struggle of very great dimensions for most central banks in the world.

What's happened now is that since the mid- -- I guess the middle of the 1990s, we're beginning to see that it is possible and—for deflation to exist with a fiat currency. And in a way it's, I suspect, credit to central banks, which essentially have restrained the expansion of credit enough that many aspects of the gold standard which induced deflationary patterns in past periods have been replicated in our monetary systems. And that, frankly, is quite good.

We at the Federal Reserve recognize that deflation is a possibility. Indeed, we now have been putting very significant resources in trying to understand, without actually seeing it happen, what this phenomenon is all about.

We cannot say that—in the marketplace that there is a severe increasing concern of deflation. Indeed, the various expectations of price by both business and consumers has been relatively flat for recent years. And the so-called TIPS inflation premium—that is, the implicit forecast of the consumers' price index, which is embodied in our TIPS Treasury yields—has not changed much over the last three or four years.

So this is not something which the markets are beginning to sense is about to erupt and something which we must address.

Nonetheless, even though we perceive the risks as minor, the potential consequences are very substantial and could be quite negative. So we have created fairly significant resources to try to address this problem, increasing our knowledge of what actually happens, what's the process and what tools are necessary to fend it off. I think we've made very substantial progress in that intellectual endeavor.

We do, obviously, have a problem that we never dealt with this before. We know, as a consequence, that when we don't deal with something, we have a large element of uncertainty, which strangely we do not have with the implementation of policies against inflation, because we've dealt with it over so many decades.

We believe that because in the current environment the cost of taking out insurance against deflation is so low, that we can aggressively attack some of the underlying forces, which are essentially weak demand, and indeed we've done that since we started a very aggressive easing in monetary policy in early 2001. So long as the costs of engaging disinflation are so low, we have moved fairly considerably, and in statements we have made—specifically, as you point out, the statement we made at our last FOMC meeting—to recognize this not as an imminent, dangerous threat to the United States, but a threat that, even though minor, is sufficiently large that it does require very close scrutiny and maybe—maybe—action on the part of the central bank.

SEN. BENNETT: Thank you very much. I'm told there is another 10-minute vote that started at 10:32. So, Mr. Ryan, you're back in charge and --

REP. RYAN: Thank you, Mr. Chairman.

I believe Ms. Dunn is up.

REP. JENNIFER DUNN (R-WA): Thank you very much. Thank you, Mr. Ryan, my more senior member. It's delightful to meet you and to have you in charge of this panel.

It's nice to see you, Mr. Chairman. I have a few questions I would like to submit to you in writing. They have to do with the WTO and how United States tax laws could potentially put our exports at a disadvantage. I would appreciate your comments, as I submit those questions, on how we can find an approach, as we iron out the FSC/ETI WTO problem, that will result in some compatibility with the obligations I certainly feel to some of my employers, who are United States-based manufacturers. So, with your approval, I'll get those questions to you.

I do have a couple of questions—and depending on time—on your testimony; a few others that have popped up as my colleagues have asked you questions. You mentioned in your statement, on page four, that geopolitical uncertainties have been resolved. So one question that I have, because of my involvement as vice chairman of the Homeland Security Committee on the House side, is whether uncertainties here at home are having an effect on the economy. Mr. Ridge, as you well know, has just raised the threat level to orange. Has the economy adjusted, since 9/11, to the threat to homeland security, or is there some underlying drag on business investment that's caused by security warnings that are issued by the government?

MR. GREENSPAN: Congresswoman, this is a very difficult question to get a handle on because we don't have enough history, we don't have any hard data. As you're aware, the financial markets took a very severe shock as a result of September the 11th. And we were most concerned of the stability of the system, and pumped in huge amounts of reserves, and engaged in many different activities to make sure we could stabilize the system.

One concern that we had was that a follow-up of terrorism would occur two, three, four weeks after September the 11th, and we were worried about the fragility of the system at the time. In retrospect, that did not happen. And indeed, nothing has happened since in the United States.

Nonetheless, there's got to be some residual overhang in longer- term expectations, but it is very difficult to ferret it out of the financial data. So one can conclude that, yes, it seems most likely that there's got to be some residual concern, but it is not, at least as of the moment, of an order of magnitude which becomes a major factor in economic or in, for that matter, homeland security policy, so far as the economy is concerned.