[House Hearing, 112 Congress]
[From the U.S. Government Publishing Office]

IMPROVING THE FEDERAL RESERVE SYSTEM:
EXAMINING LEGISLATION TO REFORM THE FED
AND OTHER ALTERNATIVES

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

HEARING

BEFORE THE

SUBCOMMITTEE ON

DOMESTIC MONETARY POLICY

AND TECHNOLOGY

OF THE

COMMITTEE ON FINANCIAL SERVICES

U.S. HOUSE OF REPRESENTATIVES

ONE HUNDRED TWELFTH CONGRESS

SECOND SESSION

__________

MAY 8, 2012

__________

Printed for the use of the Committee on Financial Services

Serial No. 112-121

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75-727 WASHINGTON : 2012
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HOUSE COMMITTEE ON FINANCIAL SERVICES

SPENCER BACHUS, Alabama, Chairman

JEB HENSARLING, Texas, Vice BARNEY FRANK, Massachusetts,
Chairman Ranking Member
PETER T. KING, New York MAXINE WATERS, California
EDWARD R. ROYCE, California CAROLYN B. MALONEY, New York
FRANK D. LUCAS, Oklahoma LUIS V. GUTIERREZ, Illinois
RON PAUL, Texas NYDIA M. VELAZQUEZ, New York
DONALD A. MANZULLO, Illinois MELVIN L. WATT, North Carolina
WALTER B. JONES, North Carolina GARY L. ACKERMAN, New York
JUDY BIGGERT, Illinois BRAD SHERMAN, California
GARY G. MILLER, California GREGORY W. MEEKS, New York
SHELLEY MOORE CAPITO, West Virginia MICHAEL E. CAPUANO, Massachusetts
SCOTT GARRETT, New Jersey RUBEN HINOJOSA, Texas
RANDY NEUGEBAUER, Texas WM. LACY CLAY, Missouri
PATRICK T. McHENRY, North Carolina CAROLYN McCARTHY, New York
JOHN CAMPBELL, California JOE BACA, California
MICHELE BACHMANN, Minnesota STEPHEN F. LYNCH, Massachusetts
THADDEUS G. McCOTTER, Michigan BRAD MILLER, North Carolina
KEVIN McCARTHY, California DAVID SCOTT, Georgia
STEVAN PEARCE, New Mexico AL GREEN, Texas
BILL POSEY, Florida EMANUEL CLEAVER, Missouri
MICHAEL G. FITZPATRICK, GWEN MOORE, Wisconsin
Pennsylvania KEITH ELLISON, Minnesota
LYNN A. WESTMORELAND, Georgia ED PERLMUTTER, Colorado
BLAINE LUETKEMEYER, Missouri JOE DONNELLY, Indiana
BILL HUIZENGA, Michigan ANDRE CARSON, Indiana
SEAN P. DUFFY, Wisconsin JAMES A. HIMES, Connecticut
NAN A. S. HAYWORTH, New York GARY C. PETERS, Michigan
JAMES B. RENACCI, Ohio JOHN C. CARNEY, Jr., Delaware
ROBERT HURT, Virginia
ROBERT J. DOLD, Illinois
DAVID SCHWEIKERT, Arizona
MICHAEL G. GRIMM, New York
FRANCISCO R. CANSECO, Texas
STEVE STIVERS, Ohio
STEPHEN LEE FINCHER, Tennessee

James H. Clinger, Staff Director and Chief Counsel
Subcommittee on Domestic Monetary Policy and Technology

RON PAUL, Texas, Chairman

WALTER B. JONES, North Carolina, WM. LACY CLAY, Missouri, Ranking
Vice Chairman Member
FRANK D. LUCAS, Oklahoma CAROLYN B. MALONEY, New York
PATRICK T. McHENRY, North Carolina GREGORY W. MEEKS, New York
BLAINE LUETKEMEYER, Missouri AL GREEN, Texas
BILL HUIZENGA, Michigan EMANUEL CLEAVER, Missouri
NAN A. S. HAYWORTH, New York GARY C. PETERS, Michigan
DAVID SCHWEIKERT, Arizona

C O N T E N T S

----------
Page
Hearing held on:
May 8, 2012.................................................. 1
Appendix:
May 8, 2012.................................................. 45

WITNESSES
Tuesday, May 8, 2012

Brady, Hon. Kevin, a Representative in Congress from the State of
Texas.......................................................... 5
Frank, Hon. Barney, Ranking Member of the Financial Services
Committee, and a Representative in Congress from the State of
Massachusetts.................................................. 7
Galbraith, James K., Lloyd M. Bentsen, Jr. Chair in Government/
Business Relations, Lyndon B. Johnson School of Public Affairs,
The University of Texas at Austin.............................. 27
Herbener, Jeffrey M., Professor of Economics, Grove City College. 22
Klein, Peter G., Associate Professor, Applied Social Sciences,
and Director, McQuinn Center for Entrepreneurial Leadership,
University of Missouri......................................... 24
Rivlin, Alice M., Senior Fellow, Economic Studies, Brookings
Institution, and former Vice Chair, Board of Governors of the
Federal Reserve System......................................... 29
Taylor, John B., Mary and Robert Raymond Professor of Economics,
Stanford University, and George P. Schultz Senior Fellow in
Economics, Stanford's Hoover Institution....................... 26

APPENDIX

Prepared statements:
Paul, Hon. Ron (with attachments)............................ 46
Brady, Hon. Kevin (with attachments)......................... 176
Galbraith, James K........................................... 230
Herbener, Jeffrey M.......................................... 240
Klein, Peter G............................................... 256
Rivlin, Alice M.............................................. 272
Taylor, John B............................................... 275

Additional Material Submitted for the Record

Paul, Hon. Ron:
Written statement of Hon. Dennis J. Kucinich, a
Representative in Congress from the State of Ohio.......... 279
Written statement of Hon. Mike Pence, a Representative in
Congress from the State of Indiana......................... 293

IMPROVING THE FEDERAL RESERVE
SYSTEM: EXAMINING LEGISLATION
TO REFORM THE FED AND
OTHER ALTERNATIVES

----------

Tuesday, May 8, 2012

U.S. House of Representatives,
Subcommittee on Domestic Monetary
Policy and Technology,
Committee on Financial Services,
Washington, D.C.
The subcommittee met, pursuant to notice, at 10:05 a.m., in
room 2128, Rayburn House Office Building, Hon. Ron Paul
[chairman of the subcommittee] presiding.
Members present: Representatives Paul, Luetkemeyer,
Huizenga, Hayworth, Schweikert; Clay, Maloney, and Green.
Also present: Representatives Garrett and Ellison.
Chairman Paul. This hearing will come to order.
Without objection, I ask unanimous consent that those
nonsubcommittee members who are present be recognized if they
wish to give opening statements or ask questions.
I now recognize myself for 5 minutes for an opening
statement.
First, I want to thank our two colleagues for being here
today, and they will be recognized shortly.
But as many Members know, the subject of the Federal
Reserve (the Fed) and monetary policy is something I have been
interested in for a long time, believing that it has a great
deal of significance with regards to a healthy economy. Today,
we will be discussing the various proposals to address the
subject of some of the shortcomings of the monetary system.
I think what has happened here in these last 5 years is
that it has been recognized by many that monetary policy and
the Federal Reserve has a lot to do with the creation of some
of our problems and their shortcomings when it comes to solving
these problems. The Federal Reserve has been around for almost
100 years--100 years next year--and, of course, it has gone
generally under the radar. Not too many people have talked
precisely, because it was always said that it should not be
interfered with by the Executive Branch or the Legislative
Branch.
But lately, there has been more concern. With the help of
Congressman Frank, we were able to get some transparency of the
Fed, and he was obviously quite helpful in moving that along.
From my viewpoint, we still have more to do on that, but it is
very clear whether we decide exactly what constitutional money
is and how it comes about. I don't think many people reject the
idea that the Congress does have responsibility of oversight
and figuring out exactly how to handle that.
So with the crisis that came about in the last 5 years ago,
I think an attitude changed dramatically. I think this is the
reason that we had strong support in the last session for
auditing the Fed and more information has come out because of
the lawsuits.
But the way I see the monetary policy, and I think it is
generally neglected, is most people realize how big the economy
is and they know by supply and demand of all products and goods
and services and labor--but, generally, they don't talk a whole
lot about the other half of the equation, and that is the
monetary issue. The monetary issues are one half of all the
transactions. So to duck the issue and pretend it is not
important, I think, has been a mistake.
I personally believe that over these many decades, the
Federal Reserve has gotten a free pass because if we had good
times, if they were able to stimulate the economy and have easy
credit, and we had good times, they got the credit. Then if the
predictable slumps would arrive and something had to be done,
Congress would generally act and the Federal Reserve would act,
and they would get the credit for getting us out of this slump.
But I think that has changed in the last 5 years because of
the seriousness of the crisis, how global it is, and how--one
of the consequences has been this excessive debt, and then the
bailing out that occurred.
And so what the Congress did on the bailouts was
significant but minor compared to how much the Federal Reserve
was able to do. For this reason, so many people want to know a
lot more about what is going on.
Not only do we want to know about policy--and a lot will be
discussed today about the particular policies and how to guide
that policy--but one thing we should not forget about is the
nature of money. If we are trying to describe how we manage a
monetary system, it seems to be most difficult, in my view--you
have to be able to define money, and define the dollar, which
has not been done for a long, long time. We use the Federal
Reserve note as the unit of account, but there is no legal
definition of a Federal Reserve note, and that is a pledge to
pay something.
So a note being something precise, and then you have to
have management and it doesn't work well, then we think, we
just need more regulations and everything will work out
smoothly. I have a lot of reservations about that because I
think we have a lot of inflation, we have a lot of instability
in prices. And even when the reports come out that the prices
are rather stable, they seem to ignore the fact that the cost
of living for many is going up significantly. The price of
energy goes up, the price of medical care goes up, the price of
education goes up.
So even when the CPI and the PPI might not be revealing
what is happening, there still is a lot of destruction of the
value of money. For this reason, now, we have been in a decade
or so where the real wages have not been able to keep up, which
really is the bottom line, I believe--the unemployment factor
and keeping up with the cost of living and keeping up with real
wages.
So I am very pleased to have the various Members here
today, as well as the second panel of witnesses to discuss what
I consider to be a very, very important issue.
Now, I would like to yield 5 minutes to Mr. Clay.
Mr. Clay. Thank you, Chairman Paul, especially for holding
this hearing on improving the Federal Reserve System and
examining today six pieces of legislation to reform the Federal
Reserve System. One piece to abolish the Federal Reserve,
sponsored by our chairman, Mr. Paul, and another one, as
sponsored by Mr. Kucinich, would make the Federal Reserve an
arm of the Treasury.
The other bills would make various changes either to the
mandate or to the Federal Open Market Committee's governance.
As ranking member of this subcommittee, I want to focus on the
Federal Reserve's dual mandate of maintaining stable prices and
full employment for monetary policy.
The Full Employment and Balanced Growth Act of 1978, better
known as the Humphrey-Hawkins Act, set four benchmarks for the
economy: full employment; growth and production; price
stability; and the balance of trade and budget.
To monitor progress towards these goals, the Full
Employment and Balanced Growth Act of 1978 mandated that the
Board of Governors of the Federal Reserve System present
semiannual reports to Congress on the state of the U.S. economy
and the Nation's financial welfare. The Humphrey-Hawkins Act
charges the Federal Reserve with a dual mandate, both
maintaining stable prices and full employment.
Currently, the unemployment rate is 8.1 percent. Since
President Obama took office in January of 2009, the
unemployment rate has gone from 7.8 percent around the
Inauguration, to 10 percent as the impact of the financial
crisis spread, to 8.1 percent today. I do believe that the U.S.
economy is heading in the right direction. With the proper
nudge, it could probably improve even more.
As of March, the consumer price index was 2.7 percent over
the past year, a decline from February of this year of 2.9
percent. During the same period, the energy index had risen 4.6
percent, and the food index had increased 3.3 percent.
Both increases are smaller than last month. In contrast,
the year change in the index for all items, less food and
energy, which was 2.2 percent in February, edged up to 2.3
percent in March.
All of these factors play a very important role in getting
America back to economic growth and prosperity, and I look
forward to the witnesses' testimony.
Mr. Chairman, I yield back.
Chairman Paul. I thank the gentleman.
Now, I yield 5 minutes to Dr. Hayworth.
Dr. Hayworth. Thank you, Mr. Chairman. It is with great
pleasure that I anticipate the testimony from our distinguished
colleagues, and we have a great challenge before us because
obviously a central bank--our central bank, the Federal
Reserve, has--we have cherished its independence in
implementing monetary policy and yet at the same time,
obviously the Congress has to establish monetary goals and hold
the Federal Reserve responsible, and we have obviously, as a
Congress, the express power to coin money and regulate the
value thereof.
There is this dynamic tension, obviously, between the
independence of the Fed and its accountability to us. So it is
going to be very interesting to hear your proposals as to how
we make that--reach that balance.
But in specific, with regard to the dual mandate, Chairman
Bernanke has said many times that he does not perceive--in
effect, he said he does not perceive an inherent conflict, if
you will, in the dual mandate because, as I have understood
him, serving the goal of price stability clearly works
favorably toward having an economy that will work and that will
enhance the employment prospects for all those who need work.
Yet we see that his warning, which he has expressed very
diplomatically regarding our fiscal policy, having implications
for monetary policy that it cannot overcome forever and ever by
accommodation, we see that his warnings seem to be borne out in
the fact that several years of accommodating monetary policy
have not resulted in the kind of enhancement in our economic
statistics that we would like to see.
So I look forward to your testimony and thank you for all
the work that you have done on this very crucial topic. Thank
you, Mr. Chairman. I yield back.
Chairman Paul. I thank the gentlelady.
Mr. Clay. Mr. Chairman, if I may, I would like to ask
unanimous consent that the gentleman from Minnesota, Mr.
Ellison, be allowed to sit in.
Chairman Paul. We already asked for that unanimous consent,
but without objection, it is so ordered.
Now, if the gentleman from Minnesota would like to make an
opening statement, he can do that right now.
Mr. Clay. Thank you.
Mr. Ellison. Very briefly, Mr. Chairman, thank you for your
chance to make an opening statement and to address this really
important topic.
I really don't have so much of a statement as I have some
questions that I would like to just put out on the table for
discussion, and I hope we can resolve them during the course of
our afternoon.
Is the dual mandate the problem? The fact is, to the degree
that we have had challenges to monetary policy, has the dual
mandate been responsible? If not, why the focus? I am curious,
if anybody could point to an instance in the last 30, 40 years
when the dual mandate required the Fed to downplay their
preferred anti-inflation approach to concern about
unemployment?
It seems to me that these are perfect. The dual mandate has
been working. If it hasn't, I would be curious to know when it
has let us down and when the dual mandate has been the cause of
flawed monetary policy.
I am also curious to know, how have we have been doing with
the dual mandate? Have we really been pursuing both, and to the
degree that the statute would call for? Has unemployment gotten
a short shrift?
I am concerned that we live in a time when we are getting
used to an unemployment rate of about 8 percent, and that might
be all we can ever aspire to get down to. I think this is a
national disgrace and an outrage, and I think our country needs
to do much more to pursue both prongs of the dual mandate. I am
concerned that unemployment has not been getting its full due.
So these are some questions that I have, some concerns that
I would like to see addressed. And even though I am not on the
subcommittee, I am grateful to be allowed to be on it today,
and I hope that we can explore these important topics. Thank
you, Mr. Chairman. I yield back.
Chairman Paul. I thank the gentleman.
I now yield time to Mr. Schweikert from Arizona for an
opening statement.
Mr. Schweikert. Thank you, Mr. Chairman, I will try to do
this very quickly.
Since being placed on your subcommittee, this has actually
become an area of great interest to me. One of the sides you
are trying to get your head around--and as we walk through the
pieces of legislation--is what the Fed does in regard to
monetary policy. Has this, as part of unintended or intended
consequences, allowed those of us here in Congress to engage in
really bad fiscal policy? In many ways, is it an institution
through its actions that allows us to get away with bad acts?
And secondly, even though this is one off, but in the
discussions--the Fed is heading, their holdings are heading
towards what, $2.9 trillion? What is the plan? At some point,
when do they move back to normalization of their portfolio, and
what are the potential cascade effects when moving back to a
normalized portfolio?
With that, I yield back.
Thank you, Mr. Chairman.
Chairman Paul. I thank the gentleman. Now, I want to move
to our first panel. First, I want to introduce Representative
Kevin Brady from Texas, an 8-term Republican Congressman
representing the Eighth District. He is the sponsor of H.R.
4180, the Sound Dollar Act of 2012. He is also the vice
chairman of the Joint Economic Committee.
Also with us today is the ranking member of the Financial
Services Committee, Representative Barney Frank, a 16-term
Democratic Congressman representing the Fourth District of
Massachusetts. He is the sponsor of H.R. 3428.
I will now recognize Congressman Brady for his opening
statement.

STATEMENT OF THE HONORABLE KEVIN BRADY, A REPRESENTATIVE IN
CONGRESS FROM THE STATE OF TEXAS

Mr. Brady. Thank you, Chairman Paul, Ranking Member Clay,
and members of the subcommittee. Before discussing the Sound
Dollar Act, I would like to acknowledge the work that Dr. Paul
has done on this subcommittee. He is a long-time former member
of the Joint Economic Committee who has worked to bring sound
dollars to the forefront of the public debate.
Inflation has been called many things, a hidden tax, a
government-sponsored reduction in workers' paychecks or, as Dr.
Paul often says, theft, and more and more Americans understand
the absurdity of a monetary policy that ultimately devalues our
own currency.
We agree on three key points: preserving the value of the
dollar is essential to economic growth and prosperity in
America; the Federal Government must not be allowed to monetize
its debt; and our financial system should serve the interests
of all Americans, not just the interests of Washington and Wall
Street.
Again, I would like to thank the chairman for your
steadfast commitment to bringing those issues to the forefront
of the public debate.
I am pleased to testify on behalf of the Sound Dollar Act.
I want to thank the members of this subcommittee who have
already cosponsored this important legislation: Mr. Jones; Mr.
Lucas; Mr. Luetkemeyer; Mr. Huizenga; and Mr. Garrett.
The problem today is that according to some, the 1800s was
the British century, the 1900s was the American century, and
the 2000s, the 21st Century, may well be China's century. Well,
not so fast. But, for America to continue its preeminence in
the global economy, it is important that we get the role of the
Federal Reserve right.
As we know, the Federal Reserve veered from the successful
rules-based policies that brought the great moderation of the
1980s and the 1990s and instead, adopted an interventionist
approach and helped to inflate the unsustainable housing bubble
and led ultimately to a global economic crisis during the last
decade. This interventionist approach, justified by the
unemployment half of the dual mandate, continues today, and I
believe it is a contributing factor to this anemic recovery.
The Federal Reserve's interventionist policies are felt by
the single mom who goes to the grocery store and finds her
paycheck doesn't go as far because inflation is robbing her of
the value of the hard-earned dollar, and she also finds the
same thing as she fills her gas tank.
These interventionist policies are also felt by the
unemployed. The uncertainty generated by the Fed's
unprecedented intervention is discouraging business investment
in new buildings, equipment, and software, which drives job
creation in America.
If you look at the fact of the numbers, government spending
is where it was before the recession, and consumer spending is
where it was before the recession, but business investment is
not and the Fed has played a role in that.
For America to remain the world's leading economy in the
21st Century, Congress must give the Fed a single mandate for
price stability, ensure that it is independent from political
pressure, and hold it accountable for results.
Critics charge that focusing on a sound dollar implies the
Fed will ignore the unemployment needs of America. They are
wrong. America can only maximize our real output in employment
with long-term price stability. Protecting the purchasing power
of the dollar over time provides the strongest foundation for
lasting economic growth and job creation.
Critics also react as if a single mandate is a shocking
proposal, because we know the United States won World War II,
enjoyed 3 decades of prosperity, and put a man on the moon
without the dual mandate. It is not a fundamental part of our
constitutional fabric. It is a 1977 policy directive based on
discredited Phillips curves and Congress can change it.
While it may be politically appealing, the current dual
mandate asks the Fed to do something that it simply cannot do.
Chairman Ben Bernanke has testified before JEC that in the long
run, the only thing the Fed can control is inflation. In the
long run, low inflation is the best thing we can do for growth.
In a Federal Open Market Committee statement, he said basically
the same thing, that the maximum level of employment is largely
determined by nonmonetary factors. Further, using monetary
policy as a short-term tool--the speed growth may actually harm
the economy in the long term.
Let me skip to the end and make the point here that among
other provisions in the Sound Dollar Act, we grant a permanent
vote to all the regional Federal Reserve bank presidents.
Because as important as important as New York and Washington
are, there is much more to America's economy, and therefore,
FMC should better reflect our geographic diversity.
We require the Fed for the first time to articulate this
lender of last resort policy in order to reduce uncertainty and
instance of moral hazard and speed the release of the
transcripts from 5 years to 3 years to create more timely
information and transparency, and we make sure the new Consumer
Financial Protection Bureau is accountable to hardworking
Americans by funding it the same way as other agencies do
during Congress.
Mr. Chairman, I have included my full testimony for the
record as well.
[The prepared statement of Representative Brady can be
found on page 176 of the appendix.]
Chairman Paul. I thank the gentleman.
Now, Mr. Frank is recognized.

STATEMENT OF THE HONORABLE BARNEY FRANK, RANKING MEMBER OF THE
FINANCIAL SERVICES COMMITTEE, AND A REPRESENTATIVE IN CONGRESS
FROM THE STATE OF MASSACHUSETTS

Mr. Frank. Thank you, Mr. Chairman. I appreciate your
acknowledgment of the work we did together. It actually was
work, as you know, that began with one of your Texas
colleagues, Mr. Gonzalez, who works down with us who was a
pioneer in forcing the Federal Reserve to be open. He made them
release information that they claimed didn't exist. It was kind
of a magical feat.
But one of the things that ought to be noted, in every
instance, beginning with Mr. Gonzalez and maybe before I was
here and the work we did, as the information flow has
increased, it has been beneficial. There have been none of the
negative effects on people they are worried about.
At the same time, it ought to be clear that the release of
all this information has, I think, helped dispel the notion
that there were nefarious things going on. We have gotten a lot
of information out under the legislation we have. There will be
no transactions the Federal Reserve engages in with private
companies that won't, at some point, be made public. I think
that has reflected well on what they have done and again,
suggestions that there was something untoward going on haven't
been proven true.
I filed legislation to remove the regional presidents from
the voting power that they have. It was pointed out to me that
that would have a problem of diminishing geographic
representation. So I submitted an amended version that would
have appointees to the board wanted by the President, confirmed
by the Senate from the various regions.
The problem you have now is this: The regional Federal bank
presidents are picked by bankers. It is an extraordinary power
that the FOMC has, and I think everyone agrees. And I cannot
think of another element in American government where there is
formal, binding, legal power given to the representatives of
the industry that is in question.
I don't think the American people are unaware of the
undemocratic nature of this, to have bankers pick the regional
president, who, in turn, picks boards which are primarily from
industry and with the financial industry dominate them. The
statistics show that. To have them setting the policy seems to
me to be greatly mistaken. So I think you can get to a
presidential set of appointments without diminishing geographic
diversity, and that is what we have done.
Beyond that, I do feel somewhat compelled to come to the
defense of the Bush Administration. The single most important
economic appointment made by President Bush was, of course,
Chairman Bernanke.
Mr. Bernanke was his economic adviser, chairman, and then
he became head of the Fed. And frankly, I think people have
been unfairly critical of Mr. Bernanke. He obviously has been
reappointed and reconfirmed by the Senate.
But once again, there have been predictions that haven't
been borne out. The interventions by the Fed to deal with the
problems that we had from the financial crisis have not led to
inflation. Inflation is not at the point where it has become a
serious problem for people.
The loans that they have made, the intervention they have
made, have actually made money for the Federal Government; they
have not added to the deficit. And as I said, the openness
shows they haven't caused problems in terms of any kind of
conflict of interest.
Now, we did make some changes in the legislation that was
passed. We mandated much more openness. We repealed that part
of the law which said the Fed could give money whenever it
thought it was important to do so if they thought they might
get paid back, and of course, the best example of that was AIG,
a unilateral intervention by the Federal Reserve in 2008. We
still are owed some money. We have replaced that with some
other ways to go.
Finally, I think it would be a grave error to repeal the
dual mandate. Yes, it is true that in the long run, monetary
policy means what people have said. But as we know, the fact
that something means something in the long run does not mean
that is the only run, that there are not times in the shorter
run and the intermediate run when a balance is necessary.
And I would say this: I can make a procedural point. I have
a bill dealing with the presidents. I would be content to see
that put aside because I think we have a central issue here in
the bill that my colleague from Texas has put forward, and I
will agree with him on one point, when he said that the dual
mandate is not in the Constitution. I agree, even with the
Federal Reserve.
We made up, in about 1912--it wasn't in the Constitution.
In fact, Alexander Hamilton tried to put it in there, and got
his brains beat out a couple of time.
But the question is this: There are very big differences,
and to some extent, they are partisan. Partisan differences can
be carried too far and they can become embittering, but they
are also at the heart of democracy. It is entirely legitimate
to have contending groups with different views, and there is
clearly a major party difference in that those of us on the
Democratic side think that unemployment is a very serious
problem that deserves being addressed explicitly.
And so I would urge you, Mr. Chairman, let's take the bill
of the gentleman from Texas. Let's put it out there, let's have
a committee markup. Let's bring it out, and let's debate that
one before the election. Let's have it be a stealth presence to
the American people to take away the concern with employment
after the election.
Chairman Paul. I thank the gentleman.
I thank both Members for their opening statements.
I ask unanimous consent to include in the record written
statements from the sponsors of the legislation being
considered by the subcommittee today. Without objection, it is
so ordered.
I will now yield myself 5 minutes for questions. The first
question I have is for Congressman Brady, and I love the title
of your bill, the Sound Dollar Act. That is something I think
is so important, but it seems to get a sound dollar, we need to
have something we can define. Do you have a definition in order
to give us an idea what our goals are, divorced, maybe, from
the policy? How do we define the unit of account, because it
was precisely defined for a good many years.
As a matter of fact, up until 1971 in a relative way it
always had a precise definition. So do you have, in your own
mind, a definition for a sound dollar?
Mr. Brady. I do, in my mind. We didn't include it in the
legislation. Right now, the Fed has identified a 2 percent
inflation, split inflation target, which seems reasonable over
time. But the truth of the matter is we want a rules-based
inflation targeting.
We want the Fed to stop, the go-stop policies, the
interventionist policies and to focus on staying within the
lines, both on inflation and deflation. Your point, that is the
strongest foundation for economic growth.
Mr. Frank likes to point out this is an either/or. It is
not. The Fed does not do and cannot do a good job at job
creation, as the chairman and the members agree. But over time,
in fact, preserving the purchasing power of the dollar does
create the strongest economy for the United States, or at least
the opportunity for it, the strongest job creation so, no,
there is not an explicit target in the bill itself.
Chairman Paul. So in a way, you defined the dollar by
achieving a price level or price stability?
Mr. Brady. We don't choose a strong dollar or a weak
dollar, a sound one.
Chairman Paul. Consider that there are many free market
economists who don't concentrate on that. They, as a matter of
fact, want a flexible pricing level, not a fixed pricing level.
For instance, how would this have been interpreted, or how
would the monetary policy have been altered, say, in the 1920s
because a lot of people say that there is no inflation because
prices are relatively stable because productivity goes up. So
if prices are relatively stable and due to productivity, but
then there still are distortions in the stock market, say the
stock market that, of course, led to the 1930s, can't you be
deceived if you concentrate on prices rather than looking at
the total picture of the amount of investment?
I know you did mention about not monetizing debt, so how
would you adjust for the fact that the price level doesn't give
you the information because even today, a lot of prices, in
spite of the monetary inflation, some prices are going down
like in electronics. At the same time, the cost of an education
skyrockets. So how would you adjust for that?
Mr. Brady. Thank you. One, I have, long ago, learned never
to discuss Fed history with you, Dr. Paul, since you are as
knowledgeable as anyone on the planet about it.
But looking a little closer in history the last 40 years,
what we saw in the 1970s was a great lesson. We were told we
couldn't have high unemployment and high inflation at the same
time; it couldn't happen. As we know, not only did it happen,
but the Fed's intervention go-stop, go-stop actually created a
very volatile economy with very deep and frequent recessions.
When the Fed focused back on a single mandate of price
stability in 1979, that changed. And for almost 20 years, we
had not only strong economic growth, but we had very short,
very shallow recessions. So we saw the benefits of that focus
on price stability.
In the 2000s, we saw the Fed keep interest rates too low
for too long. It helped to inflate a credit-fueled housing
bubble and helped create a global financial crisis; and, to
sort of wrap that up to your immediate question, within the
Sound Dollar Act, not only do we focus on rules-based inflation
targeting, but we require the Fed to monitor and report back on
these potential asset bubbles, to monitor the price of gold,
other commodities, equities, bonds, commercial real estate,
agriculture, real estate industrial, real estate as well--and
we don't force them to act on that because that circumstance
will vary.
But we want to ensure to your point that not just the price
index of the goods and services, but those potential asset
bubbles would not only be monitored but reported to you and to
me and to the public as well.
Chairman Paul. I have a question for Mr. Frank, but I am
out of time. I think there is going to be a second round, so
hopefully I can get my question asked. I now yield to Mr. Clay.
Mr. Clay. Thank you so much, Mr. Chairman.
Let me ask both witnesses, currently, the unemployment
rate, according to the Labor Department, is 8.1 percent. What
can the Federal Reserve and Congress do to put Americans back
to work? Mr. Brady, do you have any thoughts or views on that?
Mr. Brady. I do. One, I think the Fed is trying to do too
much. They are trying to make up for, I think, some failed
economic policies, in my view, from the White House. And I also
believe they are sort of like the doctor who gives you a pill
every 5 minutes and say how are you feeling? Take another one.
How are you feeling? Take another one, as a result of actually
creating uncertainty.
I believe the more the Fed does, the less responsibility
Congress and the White House are taking for getting the right
fiscal decisions, getting the right tax policy, to balance
regulations, ensuring the right spending levels and entitlement
reforms that actually create that uncertainty.
So I really believe as the Fed does more, Congress is doing
less, and in the long term, that slows our recovery.
Mr. Clay. Don't you think that Congress could be doing
something now as far as passing a transportation bill, which
would be a job starter?
Mr. Brady. Mr. Chairman, Ranking Member Clay, I think it is
important, especially long term to get our transportation
policy right. I think that would be helpful. I also think
taking off the table this discussion of higher taxes, just a
tsunami of regulations hitting these businesses.
The President's health care plan, in my view, is right now
a real deterrent to new job creation in America. So, yes, there
are a lot of things Congress can do right. And there is a
reason the Fed said in the end, we are not setting an
employment target, because in the end we can't control
employment.
Mr. Clay. Mr. Frank, what do you think the Federal Reserve
and Congress could do to put Americans--
Mr. Frank. The Federal Reserve cannot do a great deal more.
I think they have been very helpful, and the policy that I
think Mr. Brady still would prohibit in the future, we would
have been worse off if it hadn't have been for them.
I think the interventions the Fed has taken in two levels
have been helpful to us, first of all in helping to provide the
funding that has helped our economy. Secondly, and I think this
is a real point of difference between the parties, I was
surprised by it, I think the role of the Federal Government, is
the Federal Reserve has been working with the European Central
Bank, has been helpful in avoiding the kind of serious
downturns in Europe which will have negative effects on us.
I think the Federal Reserve--
Chairman Paul. Check your microphone.
Mr. Frank. Thank you, Mr. Chairman. With the European
Central Bank, have been very helpful and to have prevented the
Federal Reserve from that kind of cooperation, increasing the
chances of trouble in Europe would have been, I think, a very
grave error.
Secondly, as far as Congress is concerned, we have the
major activity. We should be following a two-step procedure,
long-term deficit reduction with some shorter-term stimulus.
The fact is that the employment rate is higher than it would
have been if we had not forced, by a variety of fiscal
policies, State and local governments to fire 600,000-plus
teachers and firefighters and public works employees and police
officers.
I think that has been a very, very grave error. They have
been hurt because many of them are financed primarily by
property taxes. Property values went down. I think forcing
those reductions by inappropriate Federal policy is a great
mistake. Yes, it is important for us to reduce a deficit long
term.
Unlike many of my Republican colleagues who think the
President wants to get out of Afghanistan too quickly, I think
he wants to stay there too long. I think there is a great deal
of room for reduction in the military budget.
I think that we should be--and we will be fighting about
this in the budget. Do we cut the military or restrain the
military or do we cut our Medicare and Medicaid? So I would be
for a short-term increase in spending and stimulus at the
Federal level here, including primarily to the States. You give
money to the States, and they are going to hire some people
who, in turn, will be spending money.
As for taxes, I heard the argument that higher taxes were
going to kill the economy in 1993 when I voted for the tax
proposal put forward by President Clinton. And in the years
afterward, we had a very good economy. I don't have to claim
that the higher taxes, and marginal rate increase, a fairly
small amount, caused that good economy, but it clearly didn't
interfere with it.
I think if you talk about people who are making more than a
million dollars a year, that for every thousand dollars they
make over that, tax them $56, it is inconceivable to me, and I
think it has been proven by economic history, that it has no
negative effect and it allows us to do a long-term deficit
reduction with some short-term help for the economy.
Mr. Clay. Thank you so much.
Chairman Paul. I yield 5 minutes to Mr. Schweikert from
Arizona.
Mr. Schweikert. Mr. Chairman, would you like me to yield
you a couple of minutes to finish your previous question?
Chairman Paul. Pardon me?
Mr. Schweikert. Would you like me to yield you a couple of
minutes to finish where you are at?
Chairman Paul. Oh, thank you, yes, absolutely, thank you
very much.
Mr. Brady. Mr. Chairman, I would rather be grilled by Mr.
Schweikert than yourself, if that is okay.
Chairman Paul. No, I saved this one for the ranking member.
Mr. Brady. Okay, go ahead.
Chairman Paul. The big argument is, dual mandate or one
mandate. I am pretty much of a skeptic on what we get from the
Fed, and I think they generally can find an excuse to do
whatever they want to do, so I know that is an important
argument, and it is going to go on for a while. But I am not
hopeful that, in itself, will solve the problem, because I
think they are rather independent in what they do.
And I want to ask--I asked you a question, Mr. Frank, about
the appointees, whether they are approved by the Senate or not,
because a lot of people that I talked to are very interested in
this subject. They are very concerned about the fact that this
isn't a government operation. This is a private operation and
they don't like the private.
Now, do you think you fully answer that, or do you
partially answer the questions by saying people have to be
approved by the Senate? Does this become less private and less
sinister? Or how would you, frankly--
Mr. Frank. Actually, I wouldn't say that, sir. I wouldn't
say ``sinister.'' I don't think the people on the Federal
Reserve regional boards who are predominantly from the
financial industry in terms of influence, when they pick a
president, who in turn picks the new people, it is not
sinister. They are people of good will, but it has an obvious
bias.
Yes, I diminish the sector, which is the private sector, by
not having a vote.
There is another thing we can do, Mr. Chairman. You were
absent--understandably, you had a couple of other things on
your mind when we voted here during the reconciliation markup
on whether or not to subject the Federal Reserve to the
appropriations process, not monetary policy.
But there was a proposal, as you know, to subject the
Consumer Financial Protection Bureau to the appropriations
process. It would seem to be another step that could be taken.
I am not for it myself, but for those who are worried, I would
think consistency would say, why not subject the Federal
Reserve, including the regional entities to the appropriations
process?
So I think that if you said that--now, there is an
alternative in terms of the regional presidents, which would
have them Senate-confirmed, I think that might be worse. So,
yes, I think I partially--I diminish the private sector
element. I think except for people who are concerned about it
more than me, would subject them to appropriations.
Chairman Paul. I am sorry, I don't want to use all of
Congressman Schweikert's time. I yield back my time to David.
Mr. Frank. You aren't going to comment on the
appropriations process, Mr. Chairman?
Chairman Paul. Tomorrow.
Mr. Schweikert. He is just sorry he wasn't here. Thank you,
Mr. Chairman.
One of the things I have been trying to get my head around
is with the dual mandate, and this is for both of our honored
Members here, does it ultimately, do you think, because--okay,
here we are chasing inflation, here we are chasing
unemployment, but through the back door, does that also allow
us, as Members of Congress, often to avoid tough decisions,
whether they be on, particularly on fiscal policy?
Mr. Frank. I don't see how it does. First of all, I reject
the notion that we, as elected officials, should be blaming the
Fed, oh, it is the Fed's fault. No, it is our fault if we don't
step up.
To be honest, I don't think, in fairness to us, that we are
avoiding those. The problem is we have very different views
about how to do it. That is democracy. Some people want to
raise taxes on the wealthy and restrain the military and make
some domestic restraints. Others want to do other things. I
literally don't know anybody who doesn't have views on this.
But, no, I don't see the fact that there is a responsibility
somewhere else in any way allows us to avoid anything. Our
responsibility is the same.
Mr. Schweikert. Ranking Member Frank, thank you. I did say
one truism and that is ultimately, it is our responsibility.
Mr. Frank. Yes.
Mr. Schweikert. And in my, what, 16 months here, I find
policy-wise, we do lots of trying to push it off to regulators
and others. You do the work and that way we have sort of this
plausible deniability.
Mr. Frank. But let me just say, I think that is especially
the case with regard to military activity. In my 32 years here,
when I have seen, I said, get involved in military activity
without congressional authorization, it has been not been so
much executive overreach as congressional ducking.
Mr. Schweikert. Okay. I am going actually agree with you on
that one.
Mr. Brady. The answer is yes, absolutely. As the Fed tries
to do more, Congress, frankly, is using that and the White
House as an excuse not to take the key steps necessary to
create the business climate for recovery.
If, in fact, the dual mandate is the right answer, and the
Fed is in charge of the economy, it is certainly not doing a
good job--the weakest recovery since the Great Depression,
lowest number of workers in the workforce, we, despite the
stimulus, the bailouts, auto bailout, housing bailout, stimulus
to Cash for Clunkers, there are actually fewer Americans
working today than when President Obama took office. At the end
of the day, it is our responsibility.
Mr. Schweikert. Mr. Chairman, thank you for yielding back
to me.
Chairman Paul. I thank the gentleman.
I now yield 5 minutes to Congresswoman Maloney from New
York.
Mrs. Maloney. Thank you very much, and thank you for
calling this hearing.
I would like to ask Mr. Brady to respond to a statement
from Alan Blinder and Mark Zandi. In their paper of 2010, they
argued that the Federal Reserve's actions in the area of
monetary policy during the economic crisis were more powerful
and effective than anything that Congress did fiscally through
the stimulus, and I would argue that the Fed's pursuit of the
dual mandate contributed to avoiding an all-out economic
collapse and helped fuel our economy.
So I would specifically like to ask my colleague, can you
cite any example of how the dual mandate in any way hindered
the recovery? Most economists believe that it was helpful in
the recovery.
Mr. Brady. I think that there are a couple of key issues
here. One, the Fed's actions in the mid-2000s, keeping interest
rates too low for too long helped bring about the crisis in
which they later intervened.
Secondly, I do think--
Mrs. Maloney. But that happened during Chairman Greenspan's
days.
Mr. Brady. We are talking the Fed as it is today and its
actions over the last 4 decades, truly.
Secondly, I think the Fed--
Mrs. Maloney. But we are discussing it, just because I want
to make sure you are answering the question. On this point, if
I could make it clear, what we are looking at now is the
recovery, the actions that took place by Chairman Bernanke and
others in response, and you were saying the interest rates were
too low. Would keeping interest rates high to avoid inflation
have been a sensible policy during the crisis when we were
looking for recovery in 2008 and 2009?
That is the time that we are looking at, how the dual
mandate responded to the economic crisis, and I would argue
that it was helpful.
But my question specifically--
Mr. Brady. I actually wanted to give you a ``yes'' answer
to your question.
Mrs. Maloney. Oh, really.
Mr. Brady. During the financial crisis, I think the Fed
frankly helped fuel it. Some of the actions they took during
the financial crisis truly did calm those waters, but stop
there and look at the economic recovery since. In my view, you
were pursuing the dual mandate, in some ways for the first
time, identifying it as a way to not only intervene, for
example, in the housing market and then continuing to intervene
as well rather than allowing exiting of that market, continuing
to allocate credit around the United States, creating this
uncertainty on what will the Fed do next has actually, in my
view, hindered the recovery.
So if you look at three points: Did they help fuel the
financial crisis? Yes. Were they helpful during it? Yes. Is the
recovery on in truth? No.
In my view, we are not at the job levels we should be, in
part, because it is Congress' role to set the fiscal policy to
create the business climate so recovery can occur.
Mrs. Maloney. If the Fed had been constrained because they
did not have the dual mandate in moderating inflation only, and
would the recovery be what we are experiencing now, they were
able to keep the--if all they had to do was look at inflation,
they would have been raising interest rates.
They lowered them in 2008 and 2009, which was very
important because they had the dual mandate. And if they were
constrained and moderating only inflation, if that was the only
thing they could have looked at, then they wouldn't have been
lowering the rates. Having the dual mandate, most economists
are arguing, gave them the flexibility to react quickly to the
marketplace.
I would also like to hear from the ranking member, Mr.
Frank.
Mr. Brady. At some point, I would like to respond to that,
because I think I can shed a little light on it.
Mr. Frank. First, I want to talk about the comment about
the Fed's role in inflating things during the Greenspan years.
I agree, but not by keeping interest rates in general down, but
by explicitly refusing to follow the mandate this Congress gave
the Federal Reserve in 1994 in the Home Ownership and Equity
Protection Act. And in subsequent efforts, many of us did
believe that loans were being made imprudently to people who
couldn't pay them back.
There were two ways to deal with that. One was, some
argued, to deflate the economy as a whole. I think that would
have been a mistake. There was an option. It was to use the
authority the Fed was given to ban imprudent loans to people
who couldn't afford them, and Mr. Greenspan flatly refused to
do that, and lately acknowledged that was an error in front of
Mr. Waxman's committee. And then in that period, in 2004 and
2005, some of us on this committee--myself, Mr. Watt, and Mr.
Miller--tried to re-legislate that.
So, yes, I do think that there was a problem from the Fed,
but it wasn't for not causing a deflation in the economy or
less economic activity in general. It was refusing to use a
specific tool they were given to stop the bad loans from being
made.
Mrs. Maloney. My time has expired. Thank you.
Chairman Paul. I thank the gentlewoman.
I now recognize Mr. Luetkemeyer from Missouri for his 5
minutes.
Mr. Luetkemeyer. Thank you, Mr. Chairman.
Congressman Brady, thank you for your efforts on this Sound
Dollar Act. I really like some of the things that you have in
there.
I am just kind of curious, do you believe that we need the
Federal Reserve as a lender of last resort? Do we need a lender
like that, some entity that can be the entity that puts the
finger in the dike when something starts to happen?
Mr. Brady. The answer is yes, and your question, in some
regards, addresses Mrs. Maloney's question, which is under a
single mandate, focused on the purchase power of the dollar,
could the Fed intervene in times of emergency? The answer is
absolutely yes. They would still be the lender of last resort,
still provide liquidity to those banks that just have a
liquidity problem but are solvent. And, of course, they have
the ability to increase or decrease the interest rates to
tighten or loosen the money supply.
So they would still be under a single mandate, and have the
ability to intervene in very unusual and exigent situations.
What they would not be allowed to do is to continue to
intervene far beyond that financial crisis which, again, is
contributing to the uncertainty today.
Mr. Luetkemeyer. It would seem that, looking at the last
20, 30 years, their ability to impact our economy is greatly
exaggerated on both ends. It would seem to me that they can
nibble around the edges on these things, but if they actually
had the ability to control unemployment, we wouldn't have the
situation we have today.
If they control inflation, I don't think that we would have
had some of those situations we have had over the last several
years. As long as we have an economy that is rolling along very
stable, it seemed like they can tweak it around the edges, but
it doesn't appear they can do much more than that. So I really
liked your approach here.
One of the questions that I had with regards to title 4 of
your bill, with regard to exchange rate responsibility, can you
explain just a little bit about that section and why you put it
in here and what you want to try to accomplish with that?
Mr. Brady. Is this dealing with the special drawing rights
ending that that slush fund?
Mr. Luetkemeyer. Yes, the exchange rate policy, bringing in
the exchange, to exchange stabilization fund.
Mr. Brady. We have, unfortunately, over time created, in
effect, a slush fund within the Federal Reserve, both from
historical--about $100 billion in there, half of that about
from historical dollars here and the other half, more recent.
And unfortunately, Mr. Luetkemeyer, what has happened is that
both Republican and Democrat Administrations related to the Fed
have used that, in effect, to circumvent the power of Congress.
The Clinton Administration used those dollars to provide a
bailout to Mexico after Congress rejected it. The current Fed
uses the guaranteed money market funds. Those may have been the
appropriate efforts, but those decisions should have been made
by Congress, not by the Federal Reserve.
So under this bill, we end that as a slush fund. We apply
the $50 billion to reduce the deficit and we, in effect, return
the Fed to what the Fed should do and retain for Congress, our
constitutional role, to act in those matters of emergency.
Mr. Luetkemeyer. So what you are trying to do is rein them
in and go back to establish principles or mission of what they
originally should have been and get it more in line with what
most people think the Fed's mission should be?
Mr. Brady. Yes, sir.
Mr. Luetkemeyer. Thank you. Congressman Frank, just quickly
with regard to the bill that you have, why do you believe that
it is important to have--I am kind of curious, all of the Fed
members, the appointees versus the Fed regional president is
going to replace those with appointees. Why do you think that
is important?
Mr. Frank. First, let me just say one thing in response to
your previous question, the biggest power the Federal Reserve
had to intervene freely with Section 13.3 of the Federal
Reserve Act, which actually came from the early 1930s under the
Hoover Administration, and we repealed that in the financial
reform bill. So they can no longer do what they did with AIG on
an entity-by-entity basis.
Secondly, the chairman asked me did I think it should be
less privatized? Yes. I understand the importance of
geographical representation. I think we should have people who
live in the regions be the appointees, but I can't think of a
comparable case of formal governmental power, the right to set
interest rates, and the impact they can have on regulation
where the entity primarily concerned picks its own people.
Mr. Luetkemeyer. Yes, but you are assuming from your
comment there that this is a government entity when it really
is a quasi-government--
Mr. Frank. Oh, I think it should be a government entity.
Mr. Luetkemeyer. --and has a lot of private implications
from its independence. Don't you think it should be more
independent in its structure as well?
Mr. Frank. Independence, independence from the--I think you
get independence with 7-year terms and 14-year terms, but I
don't think that the financial industry, which really dominates
the selection of the regional presidents, should be independent
from the whole society in setting the policy which governs it.
And, no, I think when you talk about setting interest rates,
that is a governmental function, yes.
And I didn't say, by the way, that they don't exist to the
extent that they have some local economic functions; they would
still be there. I specifically say they shouldn't be voting to
set interest rates to the Federal Open Market Committee, and I
would be very surprised if someone thought that was not a
governmental function.
Mr. Luetkemeyer. I see my time is up. Thank you, Mr.
Chairman.
Chairman Paul. Thank you. I now recognize Mr. Ellison from
Minnesota for his 5 minutes.
Mr. Ellison. Thank you, Mr. Chairman.
Congressman Frank, could you describe--and you already have
alluded to it a little bit--but could you elaborate further on
what benefit you see from ensuring greater representation of
people of diverse experience on the Federal Reserve's Open
Market Committee?
Mr. Frank. I have a fundamental belief in the electorate
ultimately making the decisions, and it is very anomalous.
There is nothing comparable.
As a matter of fact, today, with there being some vacancies
on the Board of Governors, half the votes, I think, on the Open
Market Committee are cast by people, and we did a check of who
are the members of the boards? It is a kind of a closed system.
The board members are selected to--with a great input from
the presidents--they, in turn, pick the regional presidents,
and it is private sector governance of an important part of
what we do. And, again, I am not talking about what they do in
their regions and their economic activity.
The bill says they should not vote on monetary policy, and
I just don't understand what the rationale is for letting
private sector people with the financial industry generally,
not in every case, being the predominant influence, pick the
people who come to Washington and vote on one of the most
important governmental policies. That has been the whole
premise of much of what we have been talking about.
Mr. Ellison. Congressman Frank?
Mr. Frank. Yes.
Mr. Ellison. I have some information on the board, by
profession.
Mr. Frank. The regional boards?
Mr. Ellison. Yes. One person from labor. You have four
academics, you have 41 people from banks, and 47 people from
other for-profit corporations.
Mr. Frank. I think that is just a mistake, and it is not
that bankers are bad people or others. It is that we generally
don't say it is kind of a corporatism. It is kind of let the
profession govern itself, and I think that is a mistake when
you have a large number from the financial industry, and they
tend to be very influential in all of this. There ought to be a
broader representation.
Again, in voting on monetary policy, not what is done in
terms of regional economic activity. These people come to
Washington. Now I understand people want some geographic
diversity. We should do that, but it is very surprising to me,
we don't do that for any other Federal agency.
We don't say that the people in the energy industry, or we
don't say that votes on labor policy are set by boards where
unions are the predominant influence. The President appoints
people to the NLRB. A Republican President will appoint people
differently than a Democratic President, but they are
Presidential appointees subject to Senate confirmation.
And I have picked--half the notes on the NLRB don't come
from groups that are dominated by labor unions. That is the
analog to the FOMC votes from the presidents.
Mr. Ellison. Mr. Frank, I have a little time left.
On this issue of more diversity on the board, you just
talked about professional diversity, but also, it seems like
there has been some lack of ethnic and racial diversity too.
Do you think that including more voices from consumers who
are from urban areas, rural areas, people who have dealt with
hard-hit neighbors, neighborhoods with foreclosure, do you
think some, these kinds of experiences are--
Mr. Frank. I think that would be good on the boards. But
even with that, even if I picked the boards personally, I
wouldn't want them voting on Federal Government policy. I do
not think that private citizens should pick other private
citizens with no intervention from any electoral process. There
is no appointment by someone who was elected. There is no
confirmation by the Senate. It is really, as I said, anomalous
for people who believe in democratic self-governance. And, yes,
I would like to have more--better representation on these local
boards, but even with that, I would not want them--and by the
way, they tend to be sort of self-selected. I wouldn't want
them, again, voting to set important national policy. Everybody
acknowledges the monetary policy is very important. Some people
think it has been too loose. I don't understand the
justification for that.
I would say, and I would say again to the chairman, I know
he wasn't here when we were voting on it, but you also have
this situation about whether or not they should be subject to
appropriation.
I think if you had all Presidential appointees and Senate
confirmation, that would be okay. But I think others might say,
well, gee, shouldn't they be subjected to the appropriations
process? But in any case, as I said, I cannot think of a
comparable situation where the people in the industry most
affected by public policy get to pick a significant number of
the formal official policymakers with no intervention by
anybody who is elected to anything.
Mr. Ellison. I yield back
Chairman Paul. Thank you.
I now recognize the gentleman from New Jersey, Mr. Garrett.
Mr. Garrett. Thank you, and I will just run down a series
of questions. Start at the very beginning.
Mr. Brady, the question I'm not sure I heard the answer to,
in my mind, your definition under the bill--I am the
cosponsor--of a sound dollar, is that just the language of
saying that if we hit our 2 percent inflationary, as opposed to
anything else?
Mr. Brady. It doesn't set an explicit target of 2 percent.
It does not.
Mr. Garrett. Is that something that should be looked at and
clarified in the bill before it goes forward?
Mr. Brady. I am very open to that. I would like to see
Congress set that type of target in a rules-based system.
Mr. Garrett. Does the ranking member have a comment on that
point by any chance?
Mr. Frank. No. You mean to define what is the sound--I
don't know how--I would be concerned about how you would do
that statutorily. We are in a world where the dollar has
several roles. It has a domestic role and an international
role. The international role of the dollar is very significant,
especially since we are confronting competitors in the world,
the People's Republic of China primarily, who use the currency.
Mr. Garrett. For other purposes.
Mr. Frank. And I would not want to disable ourselves from
dealing with that aspect.
Mr. Garrett. So that goes to the next question, I guess,
for both of you. If you did pass legislation similar to this,
how do we know whether they are meeting the standard if we
don't set a standard?
And then, secondly, is there a consequence of not meeting
the standard we haven't set?
Mr. Frank. That is a very good question and proves why we
shouldn't pass the bill.
Mr. Garrett. Now, the rest of the story.
Mr. Brady. Yes, for the rest of the story. I think setting
a clear mandate, whether we set the explicit target or not and
it is certainly open to that and then holding them accountable
to that, I think, is key.
And, Mr. Garrett, one point I would like to make, that
going forward, and I think it is a terrible mistake to require
all of the Federal Reserve Bank presidents to be appointed and
confirmed by the Senate. One, it will further politicize the
Federal Reserve Board, including leading to vacancies as we
have today, and it will concentrate more power on Wall Street
and Washington.
I think it will be less independent as a Fed, because as
you know, the regional bank presidents have an independent
staff so they can actually not rely just on the chairman's
staff, but on their own to assess economic policy.
And then, as you know, finally, the Board of Governors
actually approves these regional reserve bank presidents. So we
already have accountability within the system.
Mr. Garrett. I guess I could sit here and wonder, maybe as
the chairman does, what our role is under either one of your
scenarios. You are saying the reason you don't have that
appointment--under the ranking member's position, it would go
through Presidential appointment. I can see some benefit to
that. But then I can also see we in Congress if that is all up
in the Senate as far as monetary policy, we are sort of left
out, except to hear the chairman occasionally come and testify
and say, this is what they are doing and we have no standing--
Mr. Frank. I understand that, but I assume that is what you
wanted when you voted not to subject them to the appropriations
process--may I respond?
Mr. Garrett. Reclaiming my time. On that, I just wanted to
delve into a little bit more than what we just did in the few
minutes that we had there.
Mr. Frank. I did offer an amendment--which I wasn't for
because I wasn't concerned, but you voted against subjecting it
to the appropriations process that would seemingly to have
dealt with the issue you just raised--
Mr. Garrett. I am open to the idea.
Mr. Frank. Open to the idea in the sense that the roof is
off. I mean, open to the idea, I think there is going to be
very much openness for a very long time.
Mr. Garrett. We are just trying to do things a little bit
differently from the last session where we moved hundreds of
pages at a time of a piece of legislation--
Mr. Frank. I move, Mr. Chairman--
Mr. Garrett. Reclaiming my time, Ranking Member Frank, you
did raise one other question that I thought the chairman would
raise in here. You said with regard to the process, and that is
the constitutionality of it. And you had made, I think, a good
point saying that it would make it perhaps more constitutional
if we had the Presidential appointment here that it becomes not
in the private sector but more public sector. But it raises the
fundamental question that I thought the chairman would raise,
which is where is the constitutionality for either one of the
proposals that are before here?
Mr. Frank. First, Mr. Garrett, the suggestion that we
rushed things through 2 years ago, I think we had dozens of
roll calls, a lot of meetings. I gather you have some concerns
about your own vote. But I don't think you should ever be
concerned about the process.
Mr. Garrett. I was never concerned about my own vote, but
rather I was concerned about legislation being dropped in at 3
a.m. in a conference committee that we obviously did not have
any hearings on. That is not the debate we are having here--
Mr. Frank. I understand you don't want to talk about your
vote against subjecting it to appropriations. Let me say this
to the constitutionality--
Mr. Garrett. I only want to discuss what we are supposed to
be discussing here and not the way that things were held in the
past. That is part of the reason why we are here today.
Mr. Frank. I will answer your question. The
constitutionality of my provision is what it says in the
Constitution, that important government officers should be
appointed by the President, subject to confirmation by the
Senate. And I think that voting on monetary policy is
indisputably an important public policy and ought to be
executed by public officers in the constitutional manner.
Mr. Garrett. Mr. Brady, for the last word, do you care to
chime in?
Mr. Brady. Congress holds the constitutional responsibility
for monetary policy. We have, through history, contracted that
out to the Federal Reserve Bank with a clear mandate, now,
lately, a more muddled mandate. And to make the point, first, I
don't think we want to envision a day where 535 Members of
Congress are setting monetary policy in America. Second,
America is really an outlier here. Of the 47 central banks and
monetary authorities around the world, only two give equal
weight to unemployment, only two have, in effect, a muddled
mandate. The others have set price stability as either the
primary or the hierarchically the single mandate for their
central authority.
Mr. Frank. Mr. Chairman, may I have one sentence?
I thought my Republican colleagues were in favor of
American exceptionalism.
Mr. Brady. And I wish we would have dealt with that on
Fannie Mae and Freddie Mac years ago. And I do thank Chairman
Garrett for his efforts to actually solve the problem--
Mr. Frank. Would the gentleman yield?
Mr. Brady. To this crisis--
Mr. Frank. If the gentleman would yield--
Mr. Brady. --in history--
Mr. Frank. The Republicans have been in power since January
2011 and have done zero on Fannie and Freddie. What is holding
you back?
Chairman Paul. I would like to reclaim the Chair's time.
Mr. Brady. You have been in power.
Mr. Garrett. I wish that you wouldn't.
Chairman Paul. But I do. This will conclude the first
panel, and I do want to thank our two colleagues for a lively
discussion. I appreciate you very much for being here. I now
ask the second panel to be seated.
I would like to introduce the witnesses on our second
panel: Dr. Jeffrey Herbener is the chairman of the Department
of Economics at Grove City College; Dr. Peter Klein is
associate professor of applied social sciences, and director of
the McQuinn Center for Entrepreneurial Leadership at the
University of Missouri; Dr. John Taylor is the Mary and Robert
Raymond Professor of Economics at Stanford University, and the
George P. Schultz Senior Fellow in Economics at the Hoover
Institution; Dr. James Galbraith is the Lloyd M. Bentsen, Jr.
Chair in Government/Business Relations, and professor of
government at the Lyndon B. Johnson School of Public Affairs at
the University of Texas at Austin; and Dr. Alice Rivlin is the
senior fellow in economic studies at the Brookings Institution
and is a former Vice Chair of the Federal Reserve Board of
Governors.
Without objection, your written statements will be made a
part of the record. You will now each be recognized for a 5-
minute summary of your testimony.
And we will begin with Dr. Herbener.

STATEMENT OF JEFFREY M. HERBENER, PROFESSOR OF ECONOMICS, GROVE
CITY COLLEGE

Mr. Herbener. Chairman Paul, Ranking Member Clay, and
distinguished members of the subcommittee, it is an honor to
appear before you.
Left to the market, the production of all goods, including
money, passes the profit and loss test of socially beneficial
production. Like all private enterprises, a gold mining company
produces if the revenue from the sale of its output exceeds the
cost of buying its inputs. Its production is socially
beneficial because the value of inputs in producing the output
to satisfy its customers exceeds the value of those inputs in
producing other goods to satisfy other customers.
In the market, money production is regulated by profit and
loss. Changes in demands bring forth more production. If the
demand for money increases, making the value of gold coins
rise, then minting companies would increase production to
capture the profit. As the supply of gold coins increase, their
value would decline, and as the demands for resources increase,
their prices would rise. The profit would dissipate and
resource allocation into and production of money would be
optimal for society at large.
The production of fiat paper money and fiduciary media
cannot be regulated by profit and loss. It is always profitable
for a central bank to produce more fiat paper money since
larger denomination bills have the same production cost as
smaller denomination bills. It is always profitable for a
commercial bank to issue more fiduciary media through credit
creation since the interest it earns on the loan made always
exceeds the nominal cost of issuing fiduciary media. Although
the production of fiat money and fiduciary media cannot be
justified by passing the market test of optimal production, it
is claimed that an elastic currency will render an outcome
superior to that of a monetary system of commodity money and
100 percent reserve money substitutes.
Let me address three such claims for an elastic currency.
First, that it can keep the price level stable. There is no
social benefit from a stable price level. Entrepreneurs earn
profits and avoid losses by anticipating changes in prices of
all goods, including money, and elastic currency makes the
entrepreneurial task more difficult by adding another dimension
of uncertainty to the purchasing power of money.
Second, it is claimed that an elastic currency can prevent
price deflation. There is no social benefit from preventing
price deflation. Faced with lower prices for their outputs,
entrepreneurs reduce their demands for inputs, and their prices
fall also. This leaves profit production and real incomes
intact.
Looking at the evidence across 17 countries over 100 years,
Andrew Atkinson and Patrick Kehoe in a 2004 American Economic
Review article demonstrated that there is no correlation
between price deflation and economic downturns.
The third claim for an elastic currency is that it can
accelerate economic growth. There is no social benefit from
attempting to accelerate economic growth beyond the rate people
prefer. Instead of building up the capital structure of the
economy more fully, monetary inflation through credit expansion
generates the boom-bust cycle. In the research on the
performance of the Fed published in Cato Working Papers in
2010, George Selgin, William Lastrapes, and Lawrence White
concluded that under the Fed, the economy has suffered more
instability than in the decades before the Fed's establishment,
and that even its post-World War II performance has not clearly
surpassed that of its predecessor, the National Banking System.
Economic theory and historical evidence demonstrate that an
elastic currency system confers no benefit on society at large.
Instead, it causes financial instability and business cycles.
The Fed should be abolished, and a market monetary system
of commodity money and money certificates should be
established. A direct route to achieve this end is to convert
Federal Reserve Notes into redemption claims for gold with a
100 percent reserve of gold and to redeem the portion of
reserve deposits banks hold at the Fed into cash so that banks
hold 100 percent cash reserves against their checkable
deposits. At that point, production of money and money
substitutes should be done by private enterprises under the
general laws of commerce. Thank you.
[The prepared statement of Dr. Herbener can be found on
page 240 of the appendix.]
Chairman Paul. I thank the gentleman.
I now recognize Dr. Klein for his 5-minute opening
statement.

STATEMENT OF PETER G. KLEIN, ASSOCIATE PROFESSOR, APPLIED
SOCIAL SCIENCES, AND DIRECTOR, MCQUINN CENTER FOR
ENTREPRENEURIAL LEADERSHIP, UNIVERSITY OF MISSOURI

Mr. Klein. Thank you, Mr. Chairman, and members of the
subcommittee for the opportunity to discuss such an important
topic.
My testimony analyzes the Fed and the reforms considered
today from the perspective of an organizational economist. How
does the Federal Reserve system measure up as an organization?
Are its objectives, as mandated by current law, achievable and
appropriate for a government agency? Are these objectives
consistent with a healthy and growing economy? Is the Fed
effectively structured, managed, and governed? Do key
decisionmakers have the information and the incentives to make
good decisions? Are they penalized for making mistakes?
My answers to these questions are very strongly negative.
The Fed has been given a task, managing and stabilizing the
U.S. economy, that is impossible for any government planning
board. The Fed has vast authority and very little
accountability. The Fed can take actions that do enormous harm
to the U.S. economy.
Since 2008, the Fed has done exactly that. It has pumped
money into the financial system at unprecedented rates. It has
kept interest rates near zero, thus discouraging prudent
behavior among consumers, entrepreneurs, and government actors,
while encouraging reckless spending and the accumulation of
vast public and private debts.
The Fed has done everything it can to prevent the market
adjustments needed for recovery from the financial crisis. All
of this has happened without oversight, without external checks
and balances, and without public discussion and debate. This
kind of set-up is a recipe for disaster.
Everything we know about organizations with vast authority
and without external checks and balances tells us that they
cannot possibly work well.
Industrial planning fails because planners cannot, and
should not, pick winners and losers among firms and industries.
Likewise, monetary planners lack the incentives and information
to make efficient decisions about open market operations, the
discount rate, and reserve requirements. The Fed simply does
not know the optimal supply of money or the optimal
intervention in the banking system. No one does.
Add the problems facing any public bureaucracy--
inefficiency, waste, mission creep--and it is increasingly hard
to justify giving so much discretion to a single unaccountable
independent entity.
Mismanagement of the money supply not only affects the
general price level, it also distorts the relative prices of
goods and services. This makes it more difficult for
entrepreneurs to weigh the costs and benefits of alternative
actions, encouraging them to invest in the wrong activities,
that is, to make investments that are not consistent with what
consumers are willing and able to buy.
Devaluing the currency and raising prices by injecting
liquidity into the financial system rewards debtors while
punishing savers, just as artificially low interest rates
reward some market participants at the expense of others.
Instead of winner-picking, we should allow market forces to
determine the value of money, the price of loans, the levels of
borrowing and saving, and the direction of investment.
I do support eliminating the dual mandate, getting the Fed
out of the full employment business. But I would drop the price
stability requirement also.
The belief that we need a central bank to fight inflation
is based on a misunderstanding of the nature and causes of
inflation. Price levels rise because the central bank has
created too much money, not because the economy is somehow
overheating, needing the government to cool it off. Central
banks don't fight inflation; they create it.
Nor do we need a lender of last resort, which protects not
mom-and-pop savers and investors but incompetent bank
executives and their financial partners.
I agree with Mr. Brady that a discretionary bailout policy
encourages moral hazard. But an explicit, transparent, and
evenhanded lender-of-last-resort policy has the same result. If
you know the government stands ready to bail you out, you will
take risks you should not take. Instead, we should allow banks
to compete with each other and succeed or fail based on their
ability to satisfy their customers.
Reforms such as increasing the number of Fed Governors,
shortening their terms, or changing how they are selected are
fine but do not get at the root of the problem. Instead, we
should replace the old-fashioned central bank with a modern,
progressive, market-based alternative, such as a commodity
standard or competition among currencies. A market-based system
would free entrepreneurs from the unpredictable and seemingly
arbitrary whims of government planners, unleashing
entrepreneurs to invest, innovate, and grow the economy, not
only in the long run, but now when we so desperately need it.
Thank you.
[The prepared statement of Dr. Klein can be found on page
256 of the appendix.]
Chairman Paul. Thank you.
I recognize Dr. Taylor for 5 minutes.

STATEMENT OF JOHN B. TAYLOR, MARY AND ROBERT RAYMOND PROFESSOR
OF ECONOMICS, STANFORD UNIVERSITY, AND GEORGE P. SCHULTZ SENIOR
FELLOW IN ECONOMICS, STANFORD'S HOOVER INSTITUTION

Mr. Taylor. Thank you, Mr. Chairman, and Ranking Member
Clay for the opportunity and thanks for bringing these
important issues for public discussion.
In your opening remarks, Mr. Chairman, you mentioned that
we have nearly 100 years of Federal Reserve history to learn
from, and it seems to me the lesson is very clear. Highly
discretionary policy leads to problems and poor performance.
More systematic, rules-based policies, steady-as-you-go policy,
leads to far superior performance.
In the Great Depression, the Federal Reserve cut the growth
rate of the money supply. That raised unemployment to
unprecedented levels.
In the 1970s, a discretionary go-stop policy led to double-
digit unemployment, eventually double-digit inflation, low
economic growth, and double-digit interest rates.
In the 1980s and 1990s, a more focused policy, more
systematic, more rules-based, in my view, led to long
expansions, low inflation, declining unemployment, and
eventually, higher economic growth.
And, unfortunately, more recently, we have moved back to a
more interventionist, discretionary policy, much less
systematic, and the results have been a major financial crisis,
a major recession and now an abysmally low-growth recovery.
So you can look at the details, but it seems to me the
evidence is pretty clear that we need to improve the degree to
which monetary policy is rules-based rather than discretion.
I think the legislation to change the dual mandate and
focus on price stability, which is in Congressman Brady's bill,
and also in Congressman Pence's bill, would help in this
regard. So many of these interventions have been based on an
effort to address unemployment, and the result has been exactly
the opposite. It created these discretionary actions, which has
been harmful.
So for those who are worried that removing the dual mandate
will actually increase unemployment, I think the historical
evidence is exactly the opposite. You can look at the 1970s:
This highly interventionist policy, very little systematic
behavior, led to very high unemployment.
You looked at the period in the 1980s and 1990s was less
interventions, less focus, and the Chairman of the Federal
Reserve, at that point Paul Volcker, explicitly tried to
interpret the dual mandate in a way that focused more on price
stability. The results were dramatically better unemployment.
And of course, now you have the Federal Reserve citing the
dual mandate more than it has ever had before to justify these
interventions.
So I think the evidence is clear, and the idea is this
unemployment rate is unacceptable. It is way too high, and I
think part of the reason for that is monetary policy.
Now I agree, Mr. Chairman, that the dual mandate is not the
whole answer. So I would also encourage the Congress to require
that the Federal Reserve go back to the reporting requirements
that were removed in 2000. There were requirements that the Fed
had explicitly to report its goals for money growth and credit
growth. And those were removed for whatever reason. But things
like that could be replaced, a requirement that the Federal
Reserve explicitly report its strategy for setting the
instruments of policy, whether it is money growth or interest
rates, whatever they want to do.
It is their job to determine that strategy, of course, not
yours. And in fact, if there is an emergency, and they want to
deviate from it, that is their business. But they need to
explain why. They need to come back here and say why we
deviated from the strategy which we told you we would follow
earlier.
There seem to be these kinds of changes in addition to the
restrictions that the Federal Reserve not purchase vast
quantities of private securities, or the idea that we balance
the voting responsibility among all the presidents, not just
give special voting responsibility to some of the presidents, I
think those reforms in Congressman Brady's bill would also help
a lot.
And in general, it seems to me these kinds of reforms go a
long way to having the Congress exercise its responsibility for
oversight of an independent agency and at the same time not get
involved in the day-to-day operations, micromanaging that
agency.
Thank you very much, Mr. Chairman.
[The prepared statement of Dr. Taylor can be found on page
275 of the appendix.]
Chairman Paul. I thank you.
And I now recognize Dr. Galbraith for his statement.

STATEMENT OF JAMES K. GALBRAITH, LLOYD M. BENTSEN, JR. CHAIR IN
GOVERNMENT/BUSINESS RELATIONS, LYNDON B. JOHNSON SCHOOL OF
PUBLIC AFFAIRS, THE UNIVERSITY OF TEXAS AT AUSTIN

Mr. Galbraith. Chairman Paul, Ranking Member Clay, it is an
honor to be here, especially given that I am a former member of
the staff of this committee and I served on the team who
drafted the Humphrey-Hawkins Full Employment and Balanced
Growth Act.
I wish to speak mainly today in defense of the dual
mandate, the plural mandate, the flexible and practical
language of present law. That law was drafted at a time of
acute theoretical conflict in economics.
And on the staff. I was a young full employment liberal.
One of our colleagues, James Pierce, former Federal Reserve
Research Director, was a mainstream Keynesian at the time. Two
other colleagues, Robert Auerbach and Robert Weintraub, were
Chicago monetarists trained by Milton Friedman.
We compromised on language that gave clear reporting
transparency and accountability requirements to the Federal
Reserve in the presence of ultimate objectives but that did not
impose anyone's theoretical views. Had we done so, I fear the
oversight process would have failed long ago, perhaps when
mainstream economics adopted the concept of a natural rate of
unemployment in the early 1980s, perhaps when classical
monetarism and the relationship between money and prices fell
apart shortly after that.
Instead, being flexible, the process has survived for over
35 years, even though the theories come and go.
Now price stability is written into current law as an
objective of monetary policy. It is the presence of the maximum
employment objective, alongside price stability, in my view,
that gives the Federal Reserve leeway to pursue inflation
targeting at some rate other than zero if it chooses to do
that.
Similarly, if in some alternate universe, the Federal
Reserve were to pursue a full employment strategy at all costs,
the presence of the price stability language would give you
legitimate cause to question its policy and the reasoning
behind it.
Having price stability alone in the charter would put the
Federal Reserve in the position presently occupied by the
European Central Bank, a very difficult position, obliged to
pretend to ignore unemployment, even as that issue becomes
increasingly important in the politics of the region that it is
responsible for; obliged to pretend to respect its charter when
circumstances dictate that, in fact, it deviate from it; and it
would put the Federal Reserve in a perpetually difficult, I
think false, position before Congress, really make it very
difficult for the Federal Reserve to report forthrightly on
what it is doing; and I think it would equally put the Congress
in an extremely difficult position as, unlike the European
Central Bank, which is an independent entity, the Federal
Reserve is not and cannot be independent of Congress. It is a
creature of Congress under the Constitution.
I think also that creating a single rigid price stability
mandate would bring back the technical difficulties that we
experienced in the 1970s and 1980s over the definition of
money. The definition of price stability would become similarly
problematic. If one looked at the notional definitions of
inflation presently in use, I think you would find that the
Federal Reserve did not, in fact, violate its price stability
mandate in the run up to the great crisis. It would be very
hard to know before the fact when it was doing something that
was not consonant with that mandate.
Finally, this is a time of ferment in economics, once
again, as the 1970s were. The profession fell into complacency
before the great crisis, and the crisis delivered a shock from
which economics has not recovered. Issues of the cost of
resources, of the as yet I think unfinished project of
financial reform, remain unresolved. Unemployment is not going
away as many prominent forecasters believed it would have by
now. And there are limits to what the Federal Reserve can
achieve.
Reasonable price stability, which was the language in the
Humphrey-Hawkins preamble, as I recall, is an important
objective, but so is full or maximum employment. And I think
Congress would be well advised not to commit to either one at
the sacrifice of the other.
I do urge Congress to continue to pursue the goals of
oversight, accountability, and to probe deeply what the Federal
Reserve is doing but within the framework of present law. Thank
you very much.
[The prepared statement of Dr. Galbraith can be found on
page 230 of the appendix.]
Chairman Paul. I thank you.
Now, I recognize Dr. Rivlin.

STATEMENT OF ALICE M. RIVLIN, SENIOR FELLOW, ECONOMIC STUDIES,
BROOKINGS INSTITUTION, AND FORMER VICE CHAIR, BOARD OF
GOVERNORS OF THE FEDERAL RESERVE SYSTEM

Ms. Rivlin. Thank you, Mr. Chairman.
I am happy to have this opportunity to testify before this
subcommittee as you consider the diverse set of bills about the
Federal Reserve.
I will concentrate my remarks on the dual mandate. I
believe that the dual mandate has served the United States well
and that it would be a mistake to restrict the Fed's policy
actions to fostering stable prices alone.
I would like to make clear at the outset, Mr. Chairman,
that I believe in a strong, independent central bank. Without a
strong, independent central bank functioning to mitigate
economic and financial instability, I believe the United States
would have a weaker, far more chaotic economy, and would lose
its leadership position in the global economy.
The objective of economic policy, including monetary
policy, should be a rising standard of living for most people
over the long run. Controlling inflation is a crucial element
of the larger objective because high and especially rising
inflation is a serious threat to sustained growth.
I believe the dual mandate is simply a reflection of what
average citizens ought to expect their central bank to do: Let
the economy create as many jobs as possible, but don't let
inflation interfere with that job growth.
Economists translate that commonsense exhortation into a
monetary policy aimed at keeping the economy as close as
possible to its long-run potential growth without seriously
overshooting in either direction. This concept is enshrined in
Professor Taylor's famous rule.
The problem for the Federal Reserve decisionmakers is that
the potential growth is not observable because it depends on
trends and productivity growth, which can shift unexpectedly.
In the stagflation of the 1970s, hindsight indicates that
monetary policymakers overestimated potential growth and did
not tighten soon enough to avoid the acceleration of inflation
at the end of the decade.
In the 1990s, when I was at the Fed, we faced a happier
version of the same uncertainty. We had unemployment that was
very low but no inflation. We held off tightening the
presumption, which proved correct, that accelerating
productivity growth had raised potential growth and reduced the
risk of inflation.
Partly thanks to the Fed, we had a very good decade in the
1990s. We also balanced the budget. The sooner we get back to
those conditions, the better.
But the late 1990s also illustrated the inadequacy of the
Fed's tool kit in response to asset price bubbles. The dot-com
bubble, if the Fed had raised interest rates to deal with the
dot-com bubble, I think it would have tipped the economy into
recession, punishing workers and companies across the country
for no good reason.
Influencing the Federal funds rate through open market
operations is simply not an effective way of calming an asset
price bubble. We learned that lesson again in the early 2000s.
While we should not have needed a catastrophe to learn this
lesson, the Dodd-Frank Act gives the Fed and the Financial
Stability Oversight Council responsibility for financial
stability and new tools with which to help achieve it.
The dual mandate is not inconsistent with strong emphasis
on controlling inflation when appropriate and even with an
explicit target for inflation. Indeed, last January, the Fed
confirmed a long-run inflation goal of 2 percent.
Operating under the dual mandate, the Fed has successfully
controlled inflation for 3 decades. To change the language of
the law to imply that the Fed's only concern should be
inflation would send a misleading signal to a public rightly
concerned with jobs and growth as well as inflation. It would
imply that inflation is a serious current threat to American
prosperity, which seems to me unwarranted.
What we need now is a continuation of accommodative
monetary policy plus fiscal policy that combines additional
investment in long-run growth in jobs with credible long-run
action to stabilize the debt.
In short, monetary policy, as executed by the Fed under the
dual mandate, has a positive track record and is currently
appropriate. I would urge the Congress not to tamper with
legislative language that has served us well. Thank you.
[The prepared statement of Dr. Rivlin can be found on page
272 of the appendix.]
Chairman Paul. I thank the panel, and I now yield myself 5
minutes for questioning.
First off, I would like to address my question to Dr.
Herbener and Dr. Klein.
Today, with our previous panel and this panel, we have
heard a lot about the dual mandate, and it seems like that is
what we have spent most of our time on today.
Could you put that in perspective? How crucial is that? How
much difference would it make? I know you have a different
opinion about the overall picture and the monetary system, but
if we are--we are not on the verge of having a commodity
standard and restraint on the authorities, but how crucial do
you think this debate is, and how much difference does it make
whether there is a single or a dual mandate?
Dr. Herbener?
Mr. Herbener. I don't see too much evidence--
Chairman Paul. Make sure I can hear you.
Mr. Herbener. I don't see too much evidence that in the
performance of the Fed, the concentration on one wing of the
mandate or another has changed their actual performance. So the
Fed was in the 1980s concentrating on price stability more than
the unemployment mandate, and yet they inflated to the extent
of creating the bubble, the stock market bubble of 1987 that
burst and gave us a recession in 1990, 1991.
In other eras where they have concentrated more on
unemployment, their performance likewise has not been
spectacular. It has been somewhat similar, I think. And so, I
don't think in practice that the dual mandate has been
effective in restraining the Fed's monetary policy or improving
it one way or the other.
Chairman Paul. Dr. Klein, do you have anything to add on
that?
Mr. Klein. I agree with that.
I would add that if you look at the incentives of the
central bank, the central bank always has a stronger incentive
to increase, to be accommodative and increase credit rather
than to be contractionary. So I would be more concerned about
an emphasis on full employment, which sort of encourages the
Fed to go in the direction that it wants to go anyway, and I
would be less concerned about it, relatively speaking, on an
emphasis on price stability, which would tend to constrain the
Fed and go against the direction that it naturally wants to go.
Chairman Paul. Of course, the argument that it didn't
restrain them is precisely the reason they like the mandate
because it allows them to expand money at will and of course we
see this as a problem.
Quick question for Dr. Taylor, you are emphasizing some of
these monetary rules, and even more monetary statistics, would
you be in favor of the Fed once again issuing a report on the
size and growth of M3?
Mr. Taylor. I would be in favor of the Fed doing that. I
think the more emphasis on money statistics, the better, in my
view. They didn't pay enough attention to that.
But I would say from the point of view of the Congress, it
seems to me you want the Fed to report on its strategy, not to
dictate exactly what the strategy should be. So that is the
Fed's job. You come to this hearing and report the strategy
explicitly like they did about the M3, which was I think
constructive. But it also requires the Congress, this
committee, to ask the questions about the strategy. I think
that dialogue is very important. I wish we would go back to
that.
Chairman Paul. Dr. Galbraith, I tend to agree with you
about the constitutionality of appointments to the Federal
Reserve Board. We always have a different opinion about what we
should be doing, monetary policy and the Federal Reserve. But
where does this authority come from, constitutional authority,
since you addressed the Constitution, the constitutional
authority to actually emit the bills of credit, which is
prohibited by the Constitution, the creation of a fiat monetary
system. Where does that authority come from exactly?
Mr. Galbraith. I believe, Mr. Chairman, and I would be
cautious about tangling with you on this, but the authority for
the Federal Reserve Act simply comes from the authority given
to Congress to coin money and regulate the value thereof and
that the Federal Reserve Act has been a functional piece of
American law for over a century now, so it would be a surprise
to me if it were, per se, unconstitutional on that ground.
Chairman Paul. Of course, if there is a prohibition in the
Constitution, you can't change the Constitution by the Federal
Reserve Act.
But Dr. Rivlin, I think the removal of the report on M3
came after you left the Fed, I am not sure. But why was that
dropped? What would it have harmed us to know a little bit
about the broad money supply? It seemed like it emphasizes a
point of money growth and many believe still that the true
price inflation is a consequence of money growth. Is there any
reason that we shouldn't have that figure presented to us? Why
was it canceled out?
Ms. Rivlin. I don't know. I believe that was after I left.
But I am always in favor of more information rather than less.
But the emphasis on the monetary aggregates was declining,
for a good reason. They weren't stable with respect to
anything, and we have had all sorts of different kinds of money
created in the last few decades, and the idea that it was
mostly checking accounts and savings accounts has just
disappeared.
Chairman Paul. I, of course, would like to see more
attention given to the stableness or the definition or
explanation or defining what the monetary unit is rather than
trying to concentrate on the consequences of an unstable
currency. But we don't have much time to get into that, so now
I am going to yield 5 minutes to Mr. Clay.
Mr. Clay. Thank you, Mr. Chairman.
Welcome back, Dr. Rivlin.
Dr. Rivlin, at any time during your tenure on the Board of
Governors, did the dual mandate interfere with the Board's
ability to set monetary policy?
Ms. Rivlin. No, I don't believe it did, Mr. Clay.
Setting monetary policy is really difficult. And you are
always weighing different considerations. But we were very
focused, when I was there, on what was happening to
productivity growth, which was something of a mystery. We
weren't very worried about inflation because it was falling,
and so we continued, I think, thinking we were in conjunction
with both mandates to keep interest rates relatively low.
Mr. Clay. And inflation was falling because the economy was
robust. It was growing jobs, and that was because the
Administration was working with Congress to help the economy
along. Is that correct?
Ms. Rivlin. We had strong growth in the economy. We had a
restrictive fiscal policy in that period. We were trying to get
back to a balanced budget, which sounds like a fantasy now, and
we did it. So the Fed's job was easier at that moment because
the fiscal policy was quite restrictive.
Mr. Clay. Thank you for that response.
And Dr. Galbraith, as an architect of the dual mandate, can
you share with this committee the vision and the need that the
two legislative authors had for the dual mandate then, back
then, Senator Humphrey and Congressman Hawkins?
Mr. Galbraith. Yes, Congressman. I had the privilege of
working directly with Congressman Hawkins at that time. Of
course, an economic policy mandate was not a new thing for the
United States. We had the Full Employment Act of 1945, which
stipulated maximum employment production and purchasing power
as the goals of United States economic policy for the whole of
the government.
The Humphrey-Hawkins Full Employment and Balanced Growth
Act sought to modernize and to make a little more ambitious and
a little clearer the objective, particularly with respect to
employment. And it also ended up clarifying what was meant by
purchasing power, that is where the reasonable price stability
came into the preamble. So it was a way of broadly specifying
economic policy objectives for the entire government. But also
with respect to the Federal Reserve, this was the moment that
codified what we had set up through H. Con. Res. 133, in 1975,
a process of dialogue with the Federal Reserve, regular
oversight hearings, which goes on. And the Humphrey-Hawkins Act
Federal Reserve provisions placed those into law and set a
regular procedure, and that included, of course, as Professor
Taylor said, goals for the growth of various monetary
aggregates, which over time, as Dr. Rivlin has just said,
became less useful because the relationship between those
objectives or those statistics and anything you ultimately
cared about became much noisier and less reliable.
Mr. Clay. Thank you for that response.
Dr. Klein, being from Missouri, my home State, let me ask
you about something that Americans are concerned about, and
that is the rise in gasoline prices at the pump, especially the
working class.
What measures could the Federal Reserve take to stabilize
the recent rise in gas prices? Any suggestions?
Mr. Klein. The price of gasoline and the price of oil fall
a little bit outside the mandate of the monetary authority. So
certainly rising energy prices is one manifestation of a
monetary policy that is overly accommodative. But on the whole,
energy prices, especially for oil, gas, and so forth are set
primarily in global energy markets over which U.S. policymakers
have relatively little control. There are measures about
increasing supply and so on that might be within the purview of
Congress or the Executive Branch, but in my view, there is not
much that the Federal Reserve System can or should be doing
about that.
Mr. Clay. Thanks for your response.
I yield back.
Chairman Paul. I now recognize the gentlelady from New
York, Dr. Hayworth.
Dr. Hayworth. Thank you, Mr. Chairman, and thank you again
for holding this hearing and for your leadership on this
crucial question.
I would like to ask this question of the panel: Is it fair
to say that we probably would not have to debate as vigorously
and as urgently as we do, and legitimately so, under these
circumstances, the role of the Fed were it not for the fact
that the Fed has, as our central bank, had to contend over the
decades with an increasingly incontinent Federal fisc? To me,
it strikes me that we talk about the mandates for the Fed and
the way in which it operates, and again thinking about our
conversations with Chairman Bernanke, that so much of what the
Fed has felt compelled to do, if you will, I realize I am using
a somewhat loose interpretation, has been in response to the
fact that we have a Federal Government that fundamentally has
continued, and at an accelerating rate over the past few years,
to mismanage, if you will, large segments of the economy.
Dr. Klein, perhaps you could start with that, please?
Mr. Klein. I certainly think it is the case that the job
that is given to the Fed becomes more difficult under the
circumstances that you describe. But I am not sure it is right
to think of other branches of the Federal Government, the
Treasury, Congress and so on, and the Fed as being sort of
antagonists, competing against each other or playing off each
other.
One of the major functions performed by, in open market
operations, is, as has already been discussed earlier this
morning, monetizing the debt, so the Fed facilitates government
expenditures and government borrowing that otherwise would not
be politically feasible if the Fed were not there to monetize
the debt.
I think the Fed and the rest of the Federal Government are
much more likely to be seen as working hand-in-hand than
opposing each other.
Dr. Hayworth. Which actually, is exactly what I meant. The
Fed has been the government's enabler to a certain extent, the
Federal Government's enabler, and that is part of our problem.
It is very difficult to use monetary policy to endlessly
accommodate what we have taken on.
Mr. Klein. Yes, I agree with that.
Dr. Hayworth. Thank you sir. Dr. Herbener?
Mr. Herbener. Yes, I agree, as well. It creates a certain
type of moral hazard to be able to appeal directly to a
printing press or to some agency that would monetize debts that
are issued. I would be profligate as well, anyone would,
relative to not having that kind of accommodation.
Dr. Hayworth. Absolutely.
Dr. Taylor. Thank you.
Mr. Taylor. Yes. I think, if you hold out your shingle and
say you are open for business, then people will come. I think
that is what basically has happened. The Federal Reserve has
provided what you describe as an alternative to some actions.
It bought 77 percent last fiscal year of the debt issued by the
government. That is a big, big intervention.
I think monetary policy is itself part of the problem now,
given what it has done, but fiscal policy obviously is a
problem, as is regulatory policy. So there is a whole gamut of
policies. I think each of those should be addressed separately.
Monetary policy can be improved and so can fiscal policy and
regulatory policy. But the idea of working hand-in-hand, I
think, leads to the kind of problems we have seen already. That
is why I think questions about the mandate are important.
Dr. Hayworth. That indeed is why I myself have become a
cosponsor of Representative Pence's bill, because of that moral
hazard issue.
I am eager to hear from Dr. Galbraith and Dr. Rivlin.
Mr. Galbraith. I think many of our problems now are due to
a disastrous deregulation and desupervision of the financial
sector which led to a catastrophic meltdown of that industry
and of the solvency of much of the American middle class, and
the consequences, the effects that we see in the Federal budget
are largely a consequence, not a cause, of that phenomena--tax
revenues fall. Unemployment payments go up. Other kinds of
stabilizing payments go up. We are much better off actually for
having a large Federal Government, a Federal budget that can
stabilize the economy in this situation than we would be if we
didn't have it.
We didn't have it in the 1930s, and our output fell by
about one-third. The overall decline was much less this time
around, and that was because incomes were substantially
stabilized by the fiscal actions of the government.
Dr. Hayworth. Wow, we have a lot of food for thought there,
Dr. Galbraith. You have defined the crux of the contrast
between the two sides of this dais, and I realize we are out of
time.
Thank you, Mr. Chairman, very much. I yield back.
Chairman Paul. I now recognize the gentleman from Arizona,
Mr. Schweikert.
Mr. Schweikert. Thank you, Mr. Chairman.
First, forgive me, but this is sort of an esoteric
question, and no pointing and laughing, particularly for all of
you with Ph.D.s. We take a look back over the last 30 years at
many of the different asset bubbles, whether it be real estate
or even certain commercial bubbles, whether it be the Internet
bubble, where it was often large amounts of resources going in
and inflating value beyond.
Is it theoretically possible to have a bubble on the Fed's
balance sheet by acquiring so much U.S. sovereign paper, so
much mortgage backed, MBS? At some point, does it create a type
of distortion in the market, either by creating dramatically
artificially low interest rates over here, and at some point,
that is a bond bubble--it is a cascade effect--or actually on
their own holdings itself? And is that just as--right now, we
have the discussion about, are we heading towards a student
loan bubble because we are $1 trillion there? We are heading to
$3 trillion on the Federal balance sheet. It is a little
esoteric, and it is not as--but is it one off?
Dr. Herbener, please, share with me, is my concern just
sort of unfounded?
Mr. Herbener. I think the Fed balance sheet, of course,
exhibits the source of the bubbles that manifest in the
economy. So when we see the Fed's balance sheet, they engage in
open market operations, or they buy mortgage-backed securities
from the banks and so on and generate reserves in the banking
system, then it creates the possibility of the banks just
creating credit on the basis of these reserves and channeling
this credit into particular lines of activity where the bubbles
arise. And so this is the very process by which the asset-
priced bubbles are generated in the economy. We can't always
tell exactly what lines they will be generated in just by
looking at the Fed's balance sheet because the banks, of
course, can generate credit in different lines.
Mr. Schweikert. Dr. Rivlin, I owe you--you will not
remember, but many years ago, I ran into you walking down the
street and you were very, very kind to me. You spent literally
10, 15 minutes just talking to me on the street about a couple
of esoteric issues, so I have always been very appreciative of
your time.
Ms. Rivlin. Thank you. I am glad you have that memory.
I think asset bubbles are a real problem for the Fed, but
not because of the balance sheet effect. Because monetary
policy is not a good tool for dealing with asset price bubbles.
It is a good tool for dealing with general price inflation.
So the Fed needs different tools, credit, specific credit
controls and controls on excessive leverage to deal with
bubbles. And the Dodd-Frank Act does put them in that business,
and I think that is good.
Mr. Schweikert. Could current Fed action, and I would like
Dr. Galbraith's opinion, could the current Fed sheet balance
sheet, the mechanics there, could it also be leading to a bond
bubble right now if we start to move toward more normalized
interest rates, have we created so much paper that that is in
many ways artificial rates? Does it create a cascade when we
start to move?
Ms. Rivlin. I don't think it has to. I think the Fed can
get its balance sheet down quickly. It is always much easier
for the Fed to be less accommodative than more. And I am not
worried about this astonishing balance sheet. It is very big,
but right now, the reason to worry would be to, that we had
general inflation, and we don't.
Mr. Galbraith. I think it would be very hard for the
Federal Reserve to raise interest rates rapidly. And I don't
think it is likely to do so. One way to interpret your question
is to ask whether there is a situation in which the markets
might sell off U.S. bonds rapidly without that being
controllable by monetary policy action. I think that is also
unlikely under present conditions.
What the markets have shown us is that in adversity, people
want to hold U.S. bonds. They want to hold U.S. bonds over
practically any other asset because we are the largest, most
liquid, and completely reliable market in the world for safe
liquid asserts.
Mr. Schweikert. I am sorry, but how much more capacity do
you believe is pragmatic for the Fed to continue to grow at? Do
they go to $4 trillion, $5 trillion? How big do these balance
sheets get?
Mr. Galbraith. That is a very interesting question for
which, Congressman, I have to tell you, I don't have an answer.
Mr. Schweikert. Thank you for yielding to me, Mr. Chairman.
Chairman Paul. We are going to have a brief second round if
you are able to stay.
But I have a question for Dr. Rivlin and also for Dr.
Klein. I don't want to get into so much on the cause, but I am
trying to get an assessment of how serious you think the world
financial crisis is? A lot of us put a lot of blame on monetary
policy and the Federal Reserve and the dollar reserve standard
and excessive debt and these issues. We are not going to
resolve that today, who is to blame.
But do you consider the world financial situation to be a
mess or just something that will be taken care of soon and
there is not that much to worry about?
Ms. Rivlin. I am very worried about Europe. I think the
austerity policies are the wrong policies at the moment, that
they--and they will make the situation worse, and that could be
bad for us. The long-run debt situation in Europe is serious,
but at the moment, I would focus attention on their getting out
of the recession.
For us, I think we have to get out of this recession too,
but we have to get our long-run debt under control. I think we
can, but we haven't.
Chairman Paul. Could you follow up, Dr. Klein, give me your
assessment?
Mr. Klein. I think it is a huge crisis, both in Europe and
in the United States, with tremendous consequences, not only
the crisis itself but in my view, the response to the crisis by
the monetary authority. The hugely accommodative policy, the
zero interest rates and so on have taken a bad situation and
sown the seeds for making that situation much, much worse. Of
course, we haven't seen substantial rises in the overall price
level since 2008. But if you look at the amount of money that
has been pumped into the system, the increase in bank reserves
and so on, there is simply no theoretical model of which I am
aware, no empirical study that I can cite, in which those kinds
of actions do not have very serious, long-run consequences on
price inflation. So I think we haven't seen the worst of the
results that our current policy is bringing about.
Chairman Paul. Thank you, and I yield to Mr. Clay.
Mr. Clay. Thank you, Mr. Chairman. I would like to start
with a panel-wide question. Perhaps you can briefly try to
answer it, starting with Dr. Herbener, do you think the Federal
Reserve's monetary policy execution would be more effective if
it set explicit inflation targets and was held accountable to
those targets?
Mr. Herbener. Not really. I think when the Fed engages in
any kind of expansionary monetary policy, they always generate
the same ill effect in the economy. They always generate some
kind of credit expansion, which leads to a pattern of
malinvestments, even when they keep overall price levels
stable. They generate asset price inflation within the general
price level, and these lines of malinvestment is the sort of
thing that we saw in the 1920s, very similarly also in the
1980s.
So even if there were stable price-level targets that the
Fed could hit, they would still generate the same kind of
financial instability and patterns of malinvestments and then
the necessary liquidation that we see in the bus.
Mr. Clay. How about, Dr. Klein, your opinion?
Mr. Klein. Yes, sir, I think posing the problem as a trade-
off between, say, inflation targeting as opposed to targeting
nominal income is sort of a false dichotomy. Something that
Representative Paul mentioned in the first round was the idea
of increased productivity resulting in decreases in prices as,
of course, we see in many industries, computers, information
technology and so on.
There is no reason that we should expect or desire,
``stable price level'' of 2 percent a year or whatever. In a
growing economy, we might easily expect the price level to
fall. That is exactly what happened during the 19th Century in
the United States, which is the period of the strongest
sustained economic growth in U.S. history, that increased
growth, which was driven by productivity improvements resulted
in a decreasing, and decreasing average price levels. There is
no reason for policy to try to prevent that.
Mr. Clay. Thank you, Dr. Taylor.
Mr. Taylor. We already have an inflation target that is
announced, 2 percent. But in the meantime we continue to do
this highly interventionist policy, so it seems to me that is
not enough, and that is why people are talking about the dual
mandate. That is why I am talking about returning to reporting
about the strategy of the Fed. So I think you need more than
that to get out of the terrible situation we are in now.
Mr. Clay. Thank you. Dr. Galbraith?
Mr. Galbraith. I think explicit targets can be useful. In
the Humphrey-Hawkins law, there was an interim target for 4
percent unemployment, 3 percent inflation to be achieved after
4 years. It took 22 years until Alice Rivlin was running things
and it actually happened. But the difficulty, I think, was in
setting too ambitious a target and allowing too long a
timeframe for there to be real accountability.
If you are going to set targets, it should be on an
interactive basis and something where you can come back in a
year and say, look, how did you do in relation to those
targets, and what have you learned about the world from your
experience? That would make a useful contribution, it seems to
me.
Mr. Clay. Dr. Rivlin, your opinion?
Ms. Rivlin. I would agree with that. I think that the 2
percent target is about right. I wasn't a big enthusiast of
setting an explicit target, but 2 percent is about right as
long as you don't take it too seriously, because there might be
reasons to deviate in one direction or another.
Mr. Clay. Thank you so much.
Mr. Chairman, I yield back.
Chairman Paul. I now recognize the gentleman from Arizona
for a follow-up.
Mr. Schweikert. Thank you. We were sort of heading on the
question, I was going to start with Dr. Taylor and then move to
Dr. Klein. How big can the balance sheet get?
Mr. Taylor. I already think it is too big. I think the
quantitative easings, QE-1 and QE-2, are not appropriate, and
that is why the balance sheet is as big as it is. If we had
just done the interventions during the panic period, the
balance sheet would already be back to normal.
I don't think see any evidence that those have been
helpful, I have done research on QE-1, and I think that it is
already too big. I do worry about the size of it already
because it has to be pulled out, or there will be a bubble. In
fact, right now we are already running the risk of a bubble
because of the commitment to hold rates so low for so long.
I think, when you talk about bubbles, and we talk about the
Fed's efforts to stop bubbles, I think the problem really is
more is the Fed causing bubbles rather than the responsibility
to deal with them.
So that, I see that concern in the housing bubble, I see
some other bubbles in the past, and when you think about
bubbles, let's not forget the fact that the Fed itself can and,
in fact, has in the past caused bubbles and it may be doing
that again right now.
Mr. Schweikert. Dr. Klein?
Mr. Klein. Yes. I agree strongly with what Dr. Taylor has
said about the Fed being the cause of bubbles and the idea that
the Fed needs additional tools to be able to pop bubbles when
they emerge is taking the wrong view of the nature and sources
of those bubbles. But as to your question about the balance
sheet, I agree with Dr. Taylor, but would add that it isn't
just the overall size of the balance sheet that matters, it is
the composition of the balance sheet.
And my concern, as a microeconomist in looking at
quantitative easing and other interventions by the Fed, is not
so much their effect on the Fed's overall balance sheet, but
the effect on particular firms and industries. The winner
picking, preventing restructurings that are needed to get the
economy back on the right track is just as important as looking
at the overall size of the balance sheet.
Mr. Schweikert. Dr. Galbraith, and then we are going to
bounce back. Do you have a comment on, first, how big the
balance sheets can get, and second, does the mix or the size or
both create a distortive effect on the allocation of capital?
Mr. Galbraith. As I said earlier, I don't have a clear view
on how big the balance sheet might get. I do think that as one
looks at the composition of the balance sheet, what is in the
portfolio, one has to evaluate the quality of the assets. And
that is a process which has ramifications for the financial
structure going forward. There comes a point when you do need
to address those questions.
Mr. Schweikert. Okay. Dr. Herbener?
Mr. Herbener. I would just add one thing. I think most of
us would agree that the real problem is how exactly is the Fed
going to unwind the balance sheet, not how big is it going to
get, but what will be the process by which they take these
assets off of their books, and what will the repercussions be
in the markets when they begin this process seriously of
unwinding things?
Mr. Schweikert. There goes my bond bubble concern. That is,
what do I know. Dr. Rivlin, you also have been outspoken both
on fiscal policy and that has always been appreciated to have
other voices out there saying we are--we have some great
difficulties.
Has the fact that the Fed has been able to grow its balance
sheets to such extraordinary levels, has, in many ways, has
that been a way to help Congress avoid fiscal policy?
Ms. Rivlin. I don't think so. I think the Congress has not
wanted to face up to the hard choices.
Mr. Schweikert. It is the same thing.
Ms. Rivlin. And the Fed's buying bonds is a small part of
the whole world buying bonds. As Dr. Galbraith said, counter to
reality, the world believes that we are a very safe investment.
Mr. Schweikert. But in U.S. sovereign debt issues over the
last 24 months, hasn't the Fed represented close to half?
Ms. Rivlin. I don't know exactly what the figure is, but
right now, we can't have a rapid reduction in our national
borrowing because it would derail the recovery.
So I don't think the Fed has much of a choice. I would be
cautious about increasing the balance sheet much further. I
don't think there is an answer to your very good question about
how big can it get, but right now, I think we need a double
kind of fiscal policy.
It shouldn't be too severe in the short run, but we have to
get the long run debt under control.
Mr. Schweikert. Mr. Chairman, thank you so kindly.
Chairman Paul. I now recognize Mr. Green from Texas.
Mr. Green. Thank you, Mr. Chairman. I thank you and the
ranking member for calling this hearing today, and I thank the
witnesses for being in attendance.
Mr. Chairman, I also want to thank you because I am one of
the Members who signed the letter requesting such a hearing,
and I thank you for honoring the request to the witnesses.
Let's start with something very basic.
The bills that we have range from tweaking to the
abolishing of the Fed, and I am curious as to how many of you
are of the opinion that we should totally eliminate the Fed? Is
there anyone who thinks that it should be abolished, one, two
persons think we should abolish the Fed. And, if you could,
just give me a quick, if you can, summary of why you think the
Fed should be abolished. And then I would like to hear from
your colleagues as to why you think we should maintain it, just
quickly, because obviously time is of the essence.
And I will start with you, Dr. Herbener.
Mr. Herbener. The Fed should be abolished because the
conduct of monetary policy under the Fed can bring no benefit
to society at large, as I mentioned in my previous remarks.
Mr. Green. The Fed will make bad decisions every time?
There will be no good decisions made? It just can't have the
positive impact on the economy?
Mr. Herbener. Yes. I would say that there is no other
instance where the government has completely monopolized the
production of something on the market to impact society at
large.
Mr. Green. All right. I am going to take that as your
answer and move on to the next person. Dr. Klein?
Mr. Klein. Yes. We can talk about the Federal Reserve
System per se as an example of the central bank or the
institution of central banking more generally. And in my
written testimony, I give some reasons why the institution of
central banking is not only unneeded, but is also harmful to a
market economy.
Mr. Green. But in your opinion, there should not be a
central bank in the United States of America?
Mr. Klein. Yes, sir, we don't have a central automobile
manufacturer or a central dairy or a central computer company.
Mr. Green. How do you juxtapose that with the central banks
around the world, where major countries in the world all have
central banks?
Mr. Klein. What I am expounding is certainly not the
majority view among policymakers, but that hardly makes it
incorrect.
Mr. Green. I think that is a fair statement. Dr. Taylor?
Mr. Taylor. Continuing, I think we should reform the Fed. I
think the evidence, especially in the last few years, is that
the policy is not working. I look back in history, and I see
the 1980s and 1990s, a part of the time where Alice Rivlin was
on the Fed and things worked pretty well.
They had--it wasn't intervening like it is doing now. It
had a more steady-as-you-go policy. It had a lot of focus on
the overall stance of policy, and it worked.
So I think we need to get back to that. I call it a rules-
based policy, not a more systematic policy, and I think some of
the reforms we are discussing today will help us get back to
that.
Mr. Green. Dr. Galbraith?
Mr. Galbraith. I think on the whole, Congressman, that the
20th Century was better than the 19th Century, and that having
a central bank was a modest, useful part of the institutional
structure that gave us a very successful century.
I am very cautious about taking radical institutional steps
when there is very little going on in the world that would give
us confidence that they would be stabilizing rather than
destabilizing.
Mr. Green. Dr. Rivlin?
Ms. Rivlin. I feel strongly that we need a strong and
independent central bank. I think the evidence of the 19th
Century is not as encouraging as some would think, and the idea
that the world's greatest economy could make due without a
central bank, without a lender of last resort, without a
monetary policy seems to me quite bizarre.
Mr. Green. Thank you. Let me go back now in reverse order.
I will start with you, Dr. Rivlin, first.
The question is, would we be at a disadvantage if we had no
central bank and other major economic powers have central
banks?
Ms. Rivlin. I think we would be, and I think we would lose
our preeminence as a great--
Mr. Green. Currency supremacy. The dollar, as you know, is
a fairly well-accepted currency around the world. Would it have
an impact on the dollar?
Ms. Rivlin. Yes. I think it would.
Mr. Green. Okay. Let me go to the next person please.
Mr. Galbraith. Yes, I think it would clearly have an
impact. It would make the dollar, U.S. Treasury bonds much
riskier.
Mr. Green. Mr. Taylor, and then I am going to go quickly
because my time is about up.
Mr. Taylor. I don't recommend abolishing the Fed, I would
recommend reforming the Fed.
Mr. Green. Would we be at a disadvantage, sir, Mr. Klein,
if we had no central bank and other countries did?
Mr. Klein. Of course, it would depend on how such a reform
would be implemented but, look, right now people are fleeing
from the dollar and heading toward hard assets, like precious
metals.
Mr. Green. Dr. Herbener?
Mr. Herbener. If the dollar was backed by gold, I don't see
how that could harm our--
Mr. Green. But you would back the dollar with gold?
Mr. Herbener. Yes, sir.
Mr. Green. Thank you, Mr. Chairman.
Chairman Paul. Thank you.
I now recognize the gentlelady from New York.
Dr. Hayworth. Thank you, Mr. Chairman.
I have a thought for us as we conclude, and I thank you so
much for your insights, each of you. It strikes me that the
size of the Fed's balance sheet is going to be largely
determined given the structure of our representative democracy
by the will of the American people to take in hand what we have
created for ourselves at this juncture in our history.
Is there any sense that it is really going to take a lot of
political will, if you will, to get our fisc in order for us
really to, unless there is some significant change in the role
of the Fed or the structure of the Fed. I think so much of it
is going to lie in how we manage our Federal budget going
forward.
Dr. Rivlin, since I missed you last time?
Ms. Rivlin. I strongly agree with that. I served on the
Simpson-Bowles Commission and the Domenici-Rivlin Commission
and there have been other groups that have all come to the
conclusion that we really need to get our fiscal house in order
so that the debt is not rising faster than our economy can
grow, and that is going to take hard decisions, but we have to
do it.
Dr. Hayworth. Thank you, Dr. Rivlin. Thank you for your
service. It is much appreciated.
Dr. Klein, I will flip back around.
Mr. Klein. Of course, I agree, this is a tremendous
political challenge. Whether it takes a major crisis to bring,
call forth the political will to make the necessary changes, I
don't know, but I would hope that this body and others would be
able to push things in the right direction without waiting for
the bottom to fall out.
Dr. Hayworth. Right. Now, Dr. Herbener, do you think what
we are viewing in Europe, we should take as a portent of things
to come if we don't do something?
Mr. Herbener. I think our situation is perhaps even more
precarious than theirs, given what the Fed has done in the wake
of the crisis to bail out the banking system. So, again, it is
going to take strong action against some of the political
interests that exist here to turn things around before. As Dr.
Klein said, there is a crisis, and then we have to do
something.
Dr. Hayworth. All right. Dr. Taylor, your thoughts?
Mr. Taylor. Fiscal policy is certainly a mess right now,
and it has to be fixed, or we will be like Europe. But please
don't forget about monetary policy. It tends to be arcane, it
tends to be too narrow, it is difficult, but it is essential
right now to get it right.
I don't want to see a future where quantitative easing
becomes the new monetary policy. When the economy slows down,
we do gigantic quantitative easings. We don't even know their
effect. We don't even know how large it should be; it is very
dangerous. I think it will take some oversight exercise by
Congress to prevent that in the future.
Dr. Hayworth. In view of what you have said, Dr. Taylor,
regarding the Fed's purchase of Treasuries and the proportion
of Treasuries that have gone to the Fed, is there a certain
crowding-out effect that we might also be witnessing.
Mr. Taylor. Eventually, of course, but in the meantime,
actually, the figure is 77 percent.
Dr. Hayworth. Yes.
Mr. Taylor. The amount of debt increase in Fiscal Year
2011, 77 percent of that was the Fed and that is a gigantic
amount. And so crowding out, I believe there is crowding out
about that, even though the economy is weak. Yes, crowding out
in a weak economy.
Dr. Hayworth. So there are Federal budget concerns and the
Federal investments are crowding out the private markets.
Mr. Taylor. Crowding out occurs because of the deficits and
the borrowing. And even in a weak economy, I believe it occurs,
but as the economy picks up, it will be even more of a concern.
Dr. Hayworth. And more so artificially, if you will, in a
sense because of what the Fed is endeavoring to do or
artificially making the picture for Treasuries look perhaps a
bit rosier than it would be if we had a real marketplace for
them.
Mr. Taylor. Actually, the way I think about what the Fed is
doing now with respect to oversized balance sheets and
effectively dictating what the short-term interest rate will
be, it doesn't set it in the market. It dictates by telling
what the Reserve's interest rates will be on reserves.
So it is effectively, as the Fed has replaced the entire
money market with itself, and I tell you, we just don't know
all the implications of that. Nobody on this panel knows the
implications of that.
So the sooner we get back to normal where the supply and
demand for money is dependent to determine that interest rate,
and the interest rate is set according to reasonable
methodology and reported to the Congress, the strategy for
doing that, the better off we will be.
Dr. Hayworth. It is not really a central bank, it becomes
an uber bank in a sense.
Mr. Taylor. Yes.
Dr. Hayworth. Thank you. Thank you all. Thank you again,
Mr. Chairman.
Chairman Paul. Thank you very much. I want to thank the
panel today for your time and your testimony. I found the
hearing very fascinating because even though we might not agree
on the cause and exactly what we have to do, it seemed like
there was a general consensus that we do have a problem and we
have to deal with it. It is not just the United States; it is
worldwide.
And my guess is that someday we will seriously not only
look at the management of a central bank or whether or not we
really need a central bank, but ultimately I think what we will
have to do is talk about the nature of money, the definition of
money, because it is pretty hard to manage something you can't
even define. But, once again, thank you very much for coming
today.
The Chair notes that some Members may have additional
questions for this panel, which they may wish to submit in
writing. Without objection, the hearing record will remain open
for 30 days for Members to submit written questions to these
witnesses and to place their responses in the record.
[Whereupon, at 12:30 p.m., the hearing was adjourned.]

A P P E N D I X

May 8, 2012

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