[House Hearing, 113 Congress]
[From the U.S. Government Publishing Office]
NEAR-ZERO RATE, NEAR-ZERO EFFECT?
IS ``UNCONVENTIONAL'' MONETARY
POLICY REALLY WORKING?
=======================================================================
HEARING
BEFORE THE
SUBCOMMITTEE ON
MONETARY POLICY AND TRADE
OF THE
COMMITTEE ON FINANCIAL SERVICES
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED THIRTEENTH CONGRESS
FIRST SESSION
__________
MARCH 5, 2013
__________
Printed for the use of the Committee on Financial Services
Serial No. 113-4
U.S. GOVERNMENT PRINTING OFFICE
80-870 WASHINGTON : 2012
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20402-0001
HOUSE COMMITTEE ON FINANCIAL SERVICES
JEB HENSARLING, Texas, Chairman
GARY G. MILLER, California, Vice MAXINE WATERS, California, Ranking
Chairman Member
SPENCER BACHUS, Alabama, Chairman CAROLYN B. MALONEY, New York
Emeritus NYDIA M. VELAZQUEZ, New York
PETER T. KING, New York MELVIN L. WATT, North Carolina
EDWARD R. ROYCE, California BRAD SHERMAN, California
FRANK D. LUCAS, Oklahoma 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 STEPHEN F. LYNCH, Massachusetts
MICHELE BACHMANN, Minnesota DAVID SCOTT, Georgia
KEVIN McCARTHY, California AL GREEN, Texas
STEVAN PEARCE, New Mexico EMANUEL CLEAVER, Missouri
BILL POSEY, Florida GWEN MOORE, Wisconsin
MICHAEL G. FITZPATRICK, KEITH ELLISON, Minnesota
Pennsylvania ED PERLMUTTER, Colorado
LYNN A. WESTMORELAND, Georgia JAMES A. HIMES, Connecticut
BLAINE LUETKEMEYER, Missouri GARY C. PETERS, Michigan
BILL HUIZENGA, Michigan JOHN C. CARNEY, Jr., Delaware
SEAN P. DUFFY, Wisconsin TERRI A. SEWELL, Alabama
ROBERT HURT, Virginia BILL FOSTER, Illinois
MICHAEL G. GRIMM, New York DANIEL T. KILDEE, Michigan
STEVE STIVERS, Ohio PATRICK MURPHY, Florida
STEPHEN LEE FINCHER, Tennessee JOHN K. DELANEY, Maryland
MARLIN A. STUTZMAN, Indiana KYRSTEN SINEMA, Arizona
MICK MULVANEY, South Carolina JOYCE BEATTY, Ohio
RANDY HULTGREN, Illinois DENNY HECK, Washington
DENNIS A. ROSS, Florida
ROBERT PITTENGER, North Carolina
ANN WAGNER, Missouri
ANDY BARR, Kentucky
TOM COTTON, Arkansas
Shannon McGahn, Staff Director
James H. Clinger, Chief Counsel
Subcommittee on Monetary Policy and Trade
JOHN CAMPBELL, California, Chairman
BILL HUIZENGA, Michigan, Vice WM. LACY CLAY, Missouri, Ranking
Chairman Member
FRANK D. LUCAS, Oklahoma GWEN MOORE, Wisconsin
STEVAN PEARCE, New Mexico GARY C. PETERS, Michigan
BILL POSEY, Florida ED PERLMUTTER, Colorado
MICHAEL G. GRIMM, New York BILL FOSTER, Illinois
STEPHEN LEE FINCHER, Tennessee JOHN C. CARNEY, Jr., Delaware
MARLIN A. STUTZMAN, Indiana TERRI A. SEWELL, Alabama
MICK MULVANEY, South Carolina DANIEL T. KILDEE, Michigan
ROBERT PITTENGER, North Carolina PATRICK MURPHY, Florida
TOM COTTON, Arkansas
C O N T E N T S
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Page
Hearing held on:
March 5, 2013................................................ 1
Appendix:
March 5, 2013................................................ 43
WITNESSES
Tuesday, March 5, 2013
Gagnon, Joseph E., Senior Fellow, Peterson Institute for
International Economics........................................ 12
Malpass, David R., President, Encima Global...................... 7
Meltzer, Allan H., Professor of Political Economy, Tepper School
of Business, Carnegie Mellon University........................ 8
Taylor, John B., Mary and Robert Raymond Professor of Economics,
Stanford University, and George P. Schultz Senior Fellow in
Economics, Hoover Institution, Stanford University............. 10
APPENDIX
Prepared statements:
Gagnon, Joseph E............................................. 44
Malpass, David R............................................. 48
Meltzer, Allan H............................................. 62
Taylor, John B............................................... 68
NEAR-ZERO RATE, NEAR-ZERO EFFECT?
IS ``UNCONVENTIONAL'' MONETARY
POLICY REALLY WORKING?
----------
Tuesday, March 5, 2013
U.S. House of Representatives,
Subcommittee on Monetary
Policy and Trade,
Committee on Financial Services,
Washington, D.C.
The subcommittee met, pursuant to notice, at 10:02 a.m., in
room 2128, Rayburn House Office Building, Hon. John Campbell
[chairman of the subcommittee] presiding.
Members present: Representatives Campbell, Huizenga,
Pearce, Posey, Grimm, Stutzman, Mulvaney, Pittenger, Cotton;
Clay, Moore, Peters, Foster, Carney, Sewell, Kildee, and
Murphy.
Also present: Representative Green.
Chairman Campbell. The committee will come to order.
Without objection, the Chair is authorized to declare a recess
of the committee at any time.
The Chair now recognizes himself for 4 minutes for an
opening statement.
I would like to first of all welcome our distinguished
panel of witnesses.
Last week, Federal Reserve Chairman Bernanke testified in
this room during the semiannual Humphrey-Hawkins testimony that
he gives before Congress. He was asked many questions about
quantitative easing, so-called ``QE Forever,'' and the
persistently low interest rates that the Fed is holding, and as
to whether the benefits of this policy still outweighed the
risks and negatives of this policy. Chairman Bernanke quite
vigorously, I would say, defended the policy and defended that
its benefits are still outweighing the risks in spite of some
dissension in the Federal Open Market Committee itself, and
certainly some disagreement here amongst members of this
committee.
The purpose of this hearing today is to find out from you
all, from some of the country's most distinguished economists,
what your view is and whether you believe that the benefits of
this policy equal the risks, exceed the risks, or outweigh the
risks, and what, and if at any point in the future, when those
different metrics might perhaps change to warrant the ending of
QE Forever or a change in the interest rate environment in
which we find ourselves. And so we will look forward to hearing
all of your comments and thoughts on this issue which is
pressing before us now.
And with that, I will recognize the ranking member of the
subcommittee, Mr. Clay from Missouri, for 5 minutes for his
opening statement.
Mr. Clay. Thank you, Mr. Chairman, and thank you for
conducting this hearing entitled, ``Near-Zero Rate, Near-Zero
Effect? Is `Unconventional' Monetary Policy Really Working?''
And also, I want to thank the witnesses for appearing.
Mr. Chairman, I will begin with a short summary of why the
economy is in its current state and what has led to the Federal
Reserve System's use of quantitative easing policy.
The U.S. economy has taken a beating over the past 10
years. U.S. engagement in two unpaid wars, one in Iraq and a
second in Afghanistan, has produced record amounts of
government debt. Also during the past 10 years, bad actors in
the housing and financial industries have contributed to the
problems in the U.S. economy.
According to the Financial Crisis Inquiry report, a
combination of excessive borrowing, risky investments, and a
lack of transparency put the financial system on a collision
course of self-destruction. The Full Employment and Balanced
Growth Act of 1978, better known as the Humphrey-Hawkins Act,
charges the Federal Reserve with a dual Band-Aid, both
maintaining stable prices and full employment.
But during the height of the financial crisis, the Federal
Reserve took major measures to pump more liquidity into the
financial system. In September of 2007, the Federal Open Market
Committee (FOMC) lowered the Federal fund rate from 5.25
percent to between 0 to .25 percent. Currently, the interest
rate on overnight loans between banks has been close to zero
since December of 2008.
To stimulate the economy, the Federal Reserve used two
policies. The first is forward guidance regarding the Federal
Open Market Committee's anticipated path for Federal fund's
rate. According to Chairman Bernanke, ``Since longer-term
interest rates reflect market expectations for shorter-term
rates over time, our guidance influenced longer-term rates and
thus supports a stronger recovery.''
The second type of policy tool employed by the FOMC is
large-scale purchase of longer-term security, which, like
forward guidance, is intended to support economic growth by
putting downward pressure on longer-term interests rates. Also,
the Federal Open Market Committee has indicated that it will
continue purchases until it observes a substantial improvement
in the outlook for the labor market in context of price
stability.
According to the Federal Reserve, these monetary policies
are supportive to the recovery while keeping inflation close to
the Federal Open Market Committee's 2 percent objective. One
example of this policy working is in the housing market.
Low long-term interest rates have helped spark recovery.
With rising employment, family wealth, and the growth in the
housing market, consumer sentiment and spending have been
positive. Currently, the unemployment rate is 7.9 percent, down
from a year ago of 8.3 percent and from 2 years ago of 9.2
percent.
In regards to inflation, the Federal Reserve remains
confident that it has the tools necessary to tighten monetary
policy when the time comes to do so. Currently, inflation is
subdued and the expectations appear well-based.
Again, thank you, Mr. Chairman. I look forward to the
witnesses' comments.
Chairman Campbell. The gentleman yields back his time.
Thank you, Mr. Clay.
The vice chairman of the subcommittee, Mr. Huizenga, the
gentleman from Michigan, is recognized for 3 minutes.
Mr. Huizenga. Thank you, Chairman Campbell and Ranking
Member Clay, and thank you for bringing this distinguished
panel to discuss, ``Near-Zero Rate, Near-Zero Effect.''
Obviously, we know it is an important issue which has
tremendous impact on our economy, and I am eager to hear your
insight.
For too long, I believe, the government in many forms has
looked upon itself as sort of the sole source to solve the
social and economic ills that our country faces, and
unfortunately, the Federal Reserve is no different. The Federal
Reserve has continued to implement government-based solutions,
whether it was prolonged reduction of near-zero interest rates,
sort of, I would argue--excuse me--this artificial lowering of
interest rates with quantitative easing, quantitative, QE2,
QE3, QE Infinity, Operation Twist, and all these other things
that has, frankly, only just led to prolonged high levels of
unemployment, continued lack of consumer confidence, and
frankly, erratic to no growth in the economy.
So what does the Federal Reserve decide to do in December
of 2012? To continue purchasing mortgage-backed securities at a
rate of $40 billion a month and $45 billion in long-term
Treasury securities per month, so these measures must be
working, right? I think that jury is very much out and the
answer seems to be ``no.''
With our GDP stagnant and unemployment even higher than
when President Obama took office in 2009, you don't see many
economists predicting the economy taking off at anywhere near
its historic rates and pace in the past.
So the answer is simple: The policies implemented and
prolonged by the Federal Reserve have failed to deliver as
advertised, and we need to correct that.
Now, when do these failed policies come to an end? The
Federal Open Market Committee, FOMC, says they plan on keeping
these zero rates, or near-zero rates, until at least sometime
in 2015 with a target 6.5 percent unemployment rate. The
ranking member brought up the Humphrey-Hawkins--this dual
mandate; I am looking forward to having that conversation.
But I think the question is, at what cost? We need to
explore that. And if not at what cost then, frankly, what
benefit are we deriving from this?
And frankly, as a proponent of the free market and having a
smarter, more efficient, more effective size of government and
government put in place, let me point out that just one of the
many problems with the Administration's policy, such as
targeting of near-zero rates by the FOMC, it is an abomination,
in my mind, that under this Administration, the new normal for
unemployment has been around 8 percent.
We have seen it higher, and we have seen it just under
that. But we know, frankly, that it is not a success at getting
people back to work; it is a Bureau of Labor and Statistics
that the way they keep their counting of this--and
unfortunately, we have seen people--unfortunately, people do
not becoming employed, but because they are getting discouraged
and leaving the workforce.
So thank you. I appreciate that and I look forward to
learning how we are going to continue to have the private
investment grow our economy.
Chairman Campbell. Thank you.
The gentleman's time has expired.
I now recognize the gentleman from Illinois, Mr. Foster,
for 3 minutes for an opening statement.
Mr. Foster. Thank you, Mr. Chairman.
And I have a couple of slides, if I could have the first
one. There are two slides here that I think will be useful in
framing the discussion of the recovery.
The first one is a comparison of the drop in household net
worth during the Great Depression and during the downturn that
we just went through. When people ask me to reduce to a single
number where are we and where our economy is, I go to household
net worth, which is simply the value of everything owned by
families in America.
And so the top curve that you can see on there is the
fractional drop in household net worth during the first
Republican big financial collapse in 1929, where over the
course of the next 5 years household net worth dropped by
approximately 12 percent. And then when we transition to FDR's
policies, over the course of the next nearly-a-decade, we have
slowly recovered that.
If you contrast that to what we just went through in the
last 15 months of the Bush Administration, where household net
worth dropped by about a trillion dollars a month for the last
15 months, households in America lost a quarter of their net
worth. So what we underwent was a financial drop that was twice
as rapid and twice as deep as the onset of the Great
Depression. It is remarkable, in that context, that we are not
in a great depression today.
Fortunately, after roughly the beginning of 2009 we had a
series of changes in policies. There was the big intervention
by the Federal Reserve, probably 2 quarters before the V-shaped
turnaround that you see not only in household net worth but in
business profitability, the stock market, essentially every
financial indicator you can look at.
This also happened, perhaps not as an accident, the quarter
after we passed the stimulus--the so-called ``failed
stimulus.'' And so when you look at these, it is hard to
actually look at this and conclude that there was not a
positive benefit.
Interestingly, if you look at this in terms of just return
on investment--the costs of the stimulus, and so on--it is less
than--it is on the order of a trillion dollars. Household net
worth has rebounded by more than 10 times that, and so you find
a pretty high return on investment from that point of view.
If I could have the second slide, there are a lot of
discussions about what would have happened if we had done
nothing. Many of these get to be partisan. I have chosen here
to put a bipartisan calculation of what would have happened if
we had done nothing. This is by John McCain's financial advisor
and also a Democratic economist who collaborated, and if you
look at what would have happened with no intervention, they
estimate that our economy would simply not have recovered, in
terms of household net worth, and that they apportion roughly
equal share of the credit for the recovery to the actions of
the Federal Reserve and the stimulus.
So, I would like to bring up a lot of these points in the
ongoing questioning. And thanks so much.
Chairman Campbell. Thank you.
The gentleman's time has expired.
Mr. Grimm from New York is recognized for 1 minute for an
opening statement.
Mr. Grimm. Thank you, Mr. Chairman. I appreciate you
calling this hearing, and I want to thank the witnesses for
coming and testifying today.
I am very glad to see that we are devoting our very first
hearing of this subcommittee to a very important, if not
central, topic to the long-term health of U.S. capital markets,
and indeed, the economy as a whole--namely, examining the long-
term risks of the Fed's extraordinarily accommodative monetary
policy over the last 5 years. And I personally am very
concerned about the risks that the Fed's rapid balance sheet
possesses to the stability of the Fed as well as its inability
to possibly unwind its unprecedented asset purchases in a way
that will not do significant damage to U.S. markets or, even
worse, cause world markets to question the very soundness of
the U.S. dollar.
So with that, I look forward to hearing what our witnesses
have to say on these very important topics and I yield back the
balance of my time. Thank you.
Chairman Campbell. The gentleman yields back.
And for the final opening statement, the gentleman from
Indiana, Mr. Stutzman, is recognized for 2 minutes.
Mr. Stutzman. Thank you, Mr. Chairman, for holding this
very important hearing. I want to, of course, welcome the
panel, as well, and I look forward to their comments.
Of course, as we are examining the effects of the Fed's
unconventional approach to keeping interest rates so long is of
great concern for me, and as for as long as they are. I am
extremely concerned about how this market manipulation
invariably distorts private investment decisions in the short
and in the long term.
Furthermore, I look forward to discussing with our
witnesses whether the Fed's market intervention is meeting its
stated goal of creating economic growth and how it may, in
fact, be doing just the opposite.
As a subcommittee, I believe we need to press the Fed to
provide greater clarity on what the economic environment may
need to look like in order for them to roll back some of these
policies. Only then can we provide precise oversight.
Of most recent concern to me has been the Fed's decision to
buy $85 billion a month until the unemployment rate falls below
the largely arbitrary rate of 6.5 percent. To avoid some of the
unconventional approaches discussed today, I remain committed
to focusing the Fed exclusively on price stability by
eliminating its dual mandate.
To do just that, I have introduced H.R. 492, the FFOCUS Act
of 2013. I look forward to the witnesses' testimony and their
expertise today.
Thank you, Mr. Chairman. I will yield back.
Chairman Campbell. The gentleman yields back.
And so, we welcome our panel of distinguished witnesses.
Mr. David Malpass is president of Encima Global, LLC.
Encima Global is an economic research and consulting firm
serving institutional investors. He previously served as the
chief economist at Bear Stearns, as Deputy Assistant Secretary
of the Treasury, and as Deputy Assistant Secretary of State.
Welcome, Mr. Malpass.
Dr. Allan Meltzer is the Allan H. Meltzer professor of
political economy at Carnegie Mellon University. He is also a
visiting scholar at the American Enterprise Institute.
Dr. Meltzer chaired the International Financial Institution
Advisory Commission, also known as the Meltzer Commission--you
get your name on a lot of things--and was a founding member of
the Shadow Open Market Committee. Dr. Meltzer served on the
President's economic advisory policy board and on the Council
of Economic Advisors.
Welcome, Dr. Meltzer.
Dr. John Taylor is the Mary and Robert Raymond professor of
economics at Stanford University. He is also the director of
the Stanford Introductory Economics Center and the former
director--now a senior fellow--at the Stanford Institute for
Economic Policy Research. Previously, Dr. Taylor served as
Undersecretary of the Treasury for International Affairs and as
a member of the President's Council of Economic Advisors.
I welcome my fellow Californian, Dr. Taylor.
And last but not least, Dr. Joseph Gagnon is senior fellow
at the Peterson Institute for International Economics.
Previously, he served as the Associate Director of Monetary
Affairs at the Federal Reserve Board of Governors and as an
economist at the U.S. Treasury Department.
Welcome, Dr. Gagnon.
Each of you will be recognized for 5 minutes to give an
oral presentation of your testimony. Without objection, each of
your written statements will be made a part of the record after
your oral remarks.
I suspect you all know the drill, but I will state it
anyway. On your table, there is a light. It will start out
green. When it turns yellow, you have a minute to sum up. When
it turns red, please suspend.
Once each of you has finished presenting, each member of
the committee will have 5 minutes to ask any or all of you
questions.
With that, Mr. Malpass, you are now recognized for 5
minutes.
STATEMENT OF DAVID R. MALPASS, PRESIDENT, ENCIMA GLOBAL
Mr. Malpass. Thank you very much.
Chairman Campbell, Congressman Clay, Congressman Grimm from
New York, and members of the subcommittee, thank you for the
invitation to testify on the effectiveness of current monetary
policy. It is a great pleasure to join Allan Meltzer, John
Taylor, and Joe Gagnon on this panel.
I think Federal Reserve policies have been weakening and
distorting the economy rather than providing stimulus. The
policies are hurting savers, distorting markets, and
redistributing capital rather than increasing it.
The policies subsidize government, big corporations, big
banks, foreign investment, and gold, none of which is a robust
private sector job creator, and it comes at the expense of
small and new businesses and other job-creating parts of the
economy. The result is a departure from market-based capital
allocation that is contractionary in the same way that price
controls, income redistribution, and industrial policy are
contractionary.
What I would like to do, Mr. Chairman, is walk through some
of the graphs in my written testimony and mention them to you.
I am on page one. What the Fed has done is keep interest rates
very low and then substantially lengthen the duration of its
assets by selling all of its Treasury bills.
So you see the graph at the bottom of one. The Fed is out
of Treasury bills, and that used to be the mainstay of U.S.
monetary policy.
The result of this extreme monetary policy experiment has
been an actual decline in the GDP growth rates. Real growth has
slowed from 2.4 percent in 2010 to 2 percent in 2011 and only
1.6 percent in 2012. So basically, the economy has been going
backward at the time when the Fed is trying to stimulate it.
The Fed itself has had to lower its original growth
projections. That is at the top of three. Each year, they have
started with a projection and then had to reduce it because the
results haven't turned out.
I think there is a problem in the transmission mechanism of
quantitative easing to the economy. It isn't working under
current circumstances of heavily regulated growth in private
sector credit.
Private sector credit over the 3-year period of this Fed
monetary policy, 2010 through 2012, is up only 1.6 percent,
government debt is up 32 percent, and the Fed's liabilities are
up 30 percent. So there is not a transmission from what the Fed
is doing to what the private sector is feeling.
The Fed is setting an artificially low interest rate. What
it hopes is that this will encourage consumer spending, but at
the same time, it is undercutting the normal impetus of the
economy to borrow during a recovery to lock in low rates before
they go up.
The low-rate policy penalizes savers, it distorts capital
allocation, and undermines critical interbank markets. The
graph on page four shows you the paralysis going on in
interbank markets, a point Professor Ron McKinnon has made.
The Fed is also pushing down yields for longer-term credit.
That benefits a select group of favored borrowers, like the
government, at the expense of non-favored borrowers, such as
new businesses, small businesses, and businesses that the
government considers risky.
On page 5 of my testimony, I go through a number of other
problems. The Fed is contracting the economy. In addition, the
Fed has greatly expanded its role in the economy.
The Fed is asserting a legal authority to make unlimited
large-scale asset purchases on its sole discretion when there
is no systemic crisis. That has huge implications for the
future, when each slowdown will cause the markets to believe
the Fed might buy assets.
By using short-term credit, the Fed has created a maturity
mismatch. The result of the Fed policy is a more powerful Fed
and a risk to taxpayers when interest rates go up. The Fed now
owes over $2 trillion in floating rate liabilities to
commercial banks, which itself is a danger.
So in conclusion, Mr. Chairman--and I am going to flip to
the end of my statement here--rather than quantitative easing
providing stimulus, it is compounding the capital misallocation
problem by trying to push more credit into corporate bonds. The
Fed is operating as a speculator, borrowing short and lending
long, while ignoring the conflict of interest this creates when
it sets interest rates.
The best exit, in my view, would be for the government to
adopt growth-oriented tax, spending, and regulatory policies in
parallel with a new growth-oriented Fed resolve to downsize its
role in capital allocation and commit to providing a strong and
stable dollar. The combination would encourage private sector
investment and hiring in the U.S. economy and would meet the
Fed's mandate of maximizing employment while assuring price
stability.
Thank you, Mr. Chairman.
[The prepared statement of Mr. Malpass can be found on page
48 of the appendix.]
Chairman Campbell. Thank you, Mr. Malpass.
Dr. Meltzer, you are recognized for 5 minutes.
STATEMENT OF ALLAN H. MELTZER, PROFESSOR OF POLITICAL ECONOMY,
TEPPER SCHOOL OF BUSINESS, CARNEGIE MELLON UNIVERSITY
Mr. Meltzer. Mr. Chairman and members of the committee, our
Constitution assigns responsibility for monetary policy to the
Congress, that is, to you people. The Federal Reserve acts as
your agent.
The Federal Reserve has expanded bank reserves more than
350 percent in the last few years. This is an enormous and
unprecedented increase, and it continues.
In my opinion, no entity or agent in our government should
have so much unrestrained authority. Current practice violates
all our beliefs about checks and balances. It sets a terrible
precedent that should be avoided and it achieves very limited
benefits to our economy.
Many bankers applaud the current expansive policy. They
profit from it because they can borrow from the Fed or in the
money market at a quarter percent or less and lend to the
Treasury at 1 percent or more. They are able to improve their
stock prices by paying dividends and increase their incomes by
paying bonuses.
Does the Congress approve this transfer from taxpayers to
the owners and managers of financial firms? I doubt seriously
that you would vote for such a policy.
Chairman Bernanke describes the expansive policy as on
balance of benefit to the economy. I disagree for several
reasons.
First, we agree that the low interest rate policy
encourages risk-taking, but among those taking their investment
risk are retirees who cannot live on the income they receive
currently from their usual source of investment, often bank
certificates of deposit. Many are said to seek higher income by
investing in emerging market bonds or domestic junk bonds.
We know from our history how this practice ends. It ends in
losses and tears when interest rates rise, bond prices fall,
and risky assets default. Or note what has happened to the
prices of farmland, in part a result of the ethanol program
that raised agricultural prices. We have seen this pattern of
rising farmland prices many, many times. It ends in tears and
heavy losses to those who invest in it.
These are examples of a general pattern of increased risk.
Increasingly, investors do not want to hold money or low
interest rate bonds. They shift into holding equities, raising
equity prices, and taking the risk of holding high-yield bonds
or claims on farmland, or other risky assets.
Federal Reserve policy is repeating the same mistake that
brought us the great inflation of the 1970s. Then and now, the
Federal Reserve expanded its balance sheet by financing the
government's budget deficit. This time, the deficits are larger
and the Fed's purchases are much, much larger.
And then, as now, the Fed tried to push unemployment rates
down. Doing so, they ignored the lessons that Paul Volcker
repeated here and elsewhere many, many times: expected
inflation is the way to get low inflation.
We know from that experience and repeated experiences all
over the world how highly expansive policy ends. It ends with
inflation, followed by a big recession required to end the
inflation by reducing money and credit growth and raising
interest rates.
Ask yourselves, please, what you expect to happen to all
the low interest rate bonds that the banks and others hold.
Will they have enough equity reserves to absorb the losses that
they will surely take or will there be another debt crisis?
The first Federal Reserve balance sheet expansion in 2008
prevented a breakdown of the payments system. That was the
right thing to do at the time.
The next large balance sheet expansion, called QE2, added
$600 billion to bank reserves and the Federal Reserve balance
sheet. $500 billion went into bank excess reserves. That pays
some interest to the bankers but does absolutely nothing for
employment and economic activity.
Much of the remaining $100 billion went into reserves of
foreign central banks. They bought the dollars to limit the
depreciation of the dollar against their currency. Other
central banks are now expanding reserve growth rapidly. This
prevents their currencies from appreciating.
We are now in the third round of QE expansion.
Let me close with this comment: The Federal Reserve will be
100 years old this year. Its history includes 2 multi-year
periods during which inflation was low--the only two such
periods in its history.
Real income and employment fluctuations were modest and
recessions were mild. The two periods are 1923 to 1928 and 1985
to 2002. In both periods, the Federal Reserve generally
followed a monetary rule. In 1923-1928, the rule was the gold-
exchange standard; in 1985-2002 or 2003, the rule was Mr.
Taylor's rule.
No rule will be perfect all the time, but the lesson you
should draw is that following a rule gave much better results
for the public and the country than policies based on forecasts
and judgment. That is a lesson you should discuss and implement
as you consider how to get off the path to crisis and improve
on your responsibility for regulating the Federal Reserve and
its monetary policy.
Thank you.
[The prepared statement of Dr. Meltzer can be found on page
62 of the appendix.]
Chairman Campbell. Thank you, Dr. Meltzer.
Dr. Taylor, you are now recognized 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, HOOVER INSTITUTION, STANFORD UNIVERSITY
Mr. Taylor. Thank you, Mr. Chairman, Ranking Member Clay,
and other members of the subcommittee for inviting me to
testify. And also, thank you very much for having this hearing
on a very important topic.
You asked us to review monetary policy before, during, and
after the financial crisis, and some of you in your opening
remarks have already done that. I think to do that you need to
go back almost a decade to the period of 2003, 2004, and 2005
when the Federal Reserve held interest rates very low by any
historical standard, especially the previous 2 decades of the
1980s and 1990s. This caused the housing boom to be much worse
than it otherwise was. It caused the search for yield; it
caused risk-taking; and ultimately, the bust, which brought on
the financial crisis in part.
When the financial crisis first showed up, the Fed
misdiagnosed that. They provided liquidity facilities at a time
where there were problems--credit problems--in the banking
sector. This is how I think helped bring on the crisis part of
the--the panic part of the crisis.
When the panic hit, the Fed did help stabilize things with
their actions--in particular, the commercial paper market and
the money market funds. That particular phase, October,
November of 2008, was constructive.
However, when the emergency ended, the Fed continued with
the emergency operations--quantitative easing and the other
actions that have already been mentioned in this hearing.
My view is if you look at this whole period, it is
characterized by unprecedented actions by the Fed. It has been
unpredictable movements of their instruments of policy, and I
think it has caused harm.
If you think of the Fed's old criteria for performance, it
looks very bad. Unemployment much higher than it needs to be
during this period, and inflation stability no better than in
the past. So by its own methods of comparing and evaluating
itself, the Fed's performance has been very bad.
You can get some sense of this by thinking of what the Fed
has forecast for this recovery. There are some charts in my
testimony, similar to Mr. Malpass', which show that the
recovery has been very disappointing for the Fed.
They thought growth in 2012 was going to be 4 percent on
average. The most pessimistic forecasts were going to be 3.5
percent for 2012. It turned out to be about 1.5 percent.
Why the disappointing performance? Of course you can point
to external factors, and you hear testimony along those lines
from the Fed.
In my view, you can't really explain this by external
factors. It really is related to the policy itself.
And what is so bad about the policy? Think about this. I
have a chart in my testimony, if you can look, perhaps, on page
5, to show how unprecedented what we are doing is. This is not
just normal monetary policy.
The Fed has expanded its balance sheet in ways we have
never even seen before, and it is expected to continue that
with its current Quantitative Easing Infinity, if you like. I
think this caused enormous risks. It is a two-sided risk: one,
inflation may pick up if the Fed can't undo this ease fast
enough; and two, it is a downside. If they bring the funds back
too quickly, that is a downturn. It is contractionary.
So there is this risk overhanging the financial system and
the economy. I think that is a drag on growth. Firms are
sitting on a lot of cash. Actually, some consumers are now
sitting on a lot of cash. They don't want to go out and buy
things with that uncertainty.
I think it is already a drag. This is not our future risk.
This is a current risk.
When you talk about risks and benefits, or costs and
benefits, the costs are now greater than the benefits and it is
a great concern to me. It is one of the reasons unemployment
remains high.
You also have the low interest rates, which reduce income
for savers. And you have this adverse effect in the credit
markets that has already been discussed by Mr. Malpass.
It is nice to be able to borrow at low interest rates. It
is not so great to lend at low interest rates. It is not
surprising that credit flows, especially to less-credit-worthy
borrowers. It is low at this point in time. So I think it is
basically that is a negative, and I--many other reasons why it
is negative.
So on balance, to answer the questions raised in this
hearing, I don't think the unconventional monetary policy is
working. I am very concerned it is having perverse effects.
My hope is the economy will pick up this year, like
everyone hopes, and that will give the Fed the opportunity to
begin to back off some of these extraordinary measures. And if
so, I think the economy will improve, in which case the Fed can
maybe have another reason to back off. I hope that is the case.
Thank you, Mr. Chairman.
[The prepared statement of Dr. Taylor can be found on page
68 of the appendix.]
Chairman Campbell. Thank you, Dr. Taylor.
And now, Dr. Gagnon, you are recognized for 5 minutes.
STATEMENT OF JOSEPH E. GAGNON, SENIOR FELLOW, PETERSON
INSTITUTE FOR INTERNATIONAL ECONOMICS
Mr. Gagnon. Chairman Campbell, Ranking Member Clay, and
members of the subcommittee, I would like to thank you for
inviting me to explain why I believe America needs more
expansionary monetary policy.
There are four major forces holding back our economic
recovery: one, consumers are saving more to make up for losses
in the value of their houses; two, banks are applying tighter-
than-normal standards in lending; three, foreign governments
continue to resist appreciation of their currencies, thus
perpetuating a large U.S. trade deficit; and four, State and
local governments initially, and now the Federal Government,
have been cutting spending and raising taxes.
All of these forces reflect either greater saving or
reduced borrowing, both of which hold down spending in the U.S.
economy. Expansionary monetary policy is helping to offset
these forces.
Low interest rates encourage consumption and investment,
but total spending in the U.S. economy remains too low and most
private sector forecasters expect employment to remain
depressed and inflation to remain low for the next few years.
This suggests strongly that the current stance of monetary
policy is still too tight.
With the short-term interest rate essentially at zero, more
expansionary monetary policy must work through unconventional
channels. One element of unconventional monetary policy is to
use newly printed money to purchase long-term assets.
Another element is to communicate to market participants
that the future path of the short-term interest rate will be
lower than they otherwise might expect. In these ways, the
monetary authority can lower long-term rates of interest, which
are not at the zero bound.
My research shows that the Fed's purchases of long-term
bonds have lowered long-term interest rates not only on the
bonds being purchased, but also on a broad range of long-term
assets. Other researchers have confirmed this result.
I estimate that the 10-year Treasury yield and the 30-year
mortgage rate are at least 1 percentage point lower than they
would have been in the absence of the Fed's unconventional
policies.
Most market participants believe that these policies have
boosted stock prices and helped to keep the dollar from
appreciating. There is no doubt that all of these financial
developments encourage spending, including on consumption,
investment, and exports, and thus support economic growth. I
note in particular that refinancing long-term debts at lower
interest rates goes a long way toward repairing household and
corporate balance sheets that are holding back spending.
Chairman Bernanke has identified four costs or risks that
are of greater concern with unconventional monetary policy than
with conventional policy. In my view, none of these costs is
close to being significant now or at any time in the
foreseeable future.
The first cost of unconventional monetary policy is that
the Fed could become the dominant buyer of long-term Treasury
and agency securities, potentially reducing the liquidity and
efficiency of the market for these assets. So far, this concern
is purely hypothetical. But if it should ever materialize,
there are strategies the Fed could adopt to prevent harm to
financial markets and the economy.
The second cost is that the public might believe that it
will be difficult for the Fed to tighten policy at the right
time to prevent excessive inflation in the future. Such a fear
might increase uncertainty and instability in financial
markets.
The Fed has developed several tools to adjust policy that
provide ample scope for future tightening. However, the real
concern may be more with the Fed's willingness than with its
ability.
Experience shows that inflation fears are highly sensitive
to strong policy actions, or the lack thereof, in response to
observed inflation. It is within the Fed's power to prevent
this cost from occurring by adjusting its policy stance
appropriately and visibly in response to unexpected deviations
of inflation from its target.
The third cost is that low long-term yields may encourage
risky behavior that threatens financial stability. Low long-
term yields are not in and of themselves risky when they
reflect expectations of the path of the short-term interest
rate that are guided by the Fed and are supported by its
holdings of long-term securities. Moreover, by boosting the
economic recovery, increasing corporate profits, and decreasing
the rate of bankruptcies, unconventional monetary policy
reduces risks to the financial sector.
As Chairman Bernanke said last month, the current low level
of interest rates reflects weakness in the economy. The sooner
we can return to full employment, the sooner we will return to
normal levels of interest rates. Premature tightening will only
delay this return.
Indeed, in my view, if the Fed had been more aggressive in
easing earlier, we might already have returned to normal rates
of interest.
The fourth and final cost I will mention is the possibility
that the Fed could incur financial losses on its enlarged
balance sheet. This so-called ``cost'' is a complete red
herring.
Since 2009, the Fed has passed the Treasury record profits
on unconventional monetary policy and it is likely to continue
to do so for a least a few more years. Any losses in the more
distant future must be considered in tandem with the previous
windfall profits. In addition, Treasury has benefited from
higher tax revenues and from issuing debt at lower interest
rates.
On balance, there is no doubt that unconventional monetary
policy lowers the long-term burden of our national debt.
Thank you. This concludes my prepared remarks.
[The prepared statement of Dr. Gagnon can be found on page
44 of the appendix.]
Chairman Campbell. Thank you, Dr. Gagnon.
I will now recognize myself for 5 minutes to ask questions.
My first question is for the three of you who are not fond
of the current monetary policy: Last week, amongst the things
that Chairman Bernanke said was, ``monetary policy must remain
accommodative if it is to support the recovery and reduce
disinflationary risks.'' Clearly, the specter of a Japan-type
scenario is hovering over the Fed currently, and wanting to
avoid deflation. For the three of you, do any of you see that
as a legitimate reason to keep monetary policy accommodative,
as it is?
Mr. Malpass. No.
Mr. Taylor. No.
Chairman Campbell. Dr. Meltzer?
Mr. Meltzer. No.
Chairman Campbell. No. One word. Would anyone like to
elaborate on why the answer is no?
Mr. Meltzer. Yes. I think the evidence goes in the opposite
direction. Since summer of this year--this last year--expected
inflation, measured by the gap between nominal and real yields,
which is not precise but at least indicative, has increased by
about 50 basis points--that is a half a percentage point. It
seems to be headed up, not down, indicating that the market is
beginning to believe that inflation is a problem. And that is
exacerbated by the uncertainty about when the Fed will get off
its current policy.
There is a good deal of resistance to the policy within the
Federal Reserve. Many of them have spoken out about it. One has
dissented from it. So there is a growing internal opposition to
the policy for many of the reasons that we have all elaborated
here.
Chairman Campbell. Mr. Malpass?
Mr. Malpass. I am concerned that as the Fed is setting
artificial interest rates, it causes the rest of the
government, and in particular, the fiscal policy and regulatory
policy, not to take the burden. The Fed is taking too much of
the burden.
If there is a disinflationary risk, then a response to that
would be to create productive growth. Tax reform, for example,
would be a very important policy to stop a Japan-type loss
decade.
Chairman Campbell. Okay.
Dr. Taylor?
Mr. Taylor. I just don't see risk of deflation at all right
now. I would add, though, that it is frequently mentioned by
monetary policymakers as a reason, if you like, for excessively
accommodative policies. And in particular, in the 2003, 2004,
and 2005 period I mentioned, where I think rates were too low,
given what has happened, and one of the reasons frequently
mentioned at that time was concerns about deflation.
It is a very common thing that is said. I think it should
be looked at with some skepticism. Of course, it can occur; it
is not like it doesn't ever occur. But it seems to me it is not
an issue right now.
Chairman Campbell. Let me also ask the three of you--Mr.
Malpass, you mentioned at the end of your remarks that instead
of this monetary policy we should be doing tax reform, various
fiscal matters in order to restore--continue or--or accelerate
economic growth. But that is fiscal policy, that is not
monetary policy.
So now, taking fiscal policy aside and assuming for the
moment that it is what it is, or it will be what it will be,
and so you have only monetary policy--you are at the Fed now
and so you only have that trigger to pull, what should we do?
What would the correct monetary policy be, absent the one that
we have now?
Mr. Malpass. My thought is to stop digging the hole deeper.
The Fed is taking on more and more burden and giving people
longer-and longer-term promises of zero rates. I think those
should be walked back, and that would allow the economy to
begin functioning more naturally and the capital allocation
process to resume.
Chairman Campbell. Dr. Meltzer?
Mr. Meltzer. I think you need a rule. I think you need a
rule for two reasons--two major reasons. Many reasons, but two
major reasons. One is, you need to exercise greater discipline
over the Fed. No one, as I said in my testimony, should have
the authority to increase its balance sheet as much as it does
without any congressional oversight. So you need a rule that
you can enforce on the committee on the Fed.
The second is, you need to give--
Chairman Campbell. Something like the Taylor Rule, perhaps?
Mr. Meltzer. You need to give--the Taylor Rule would be
fine. No rule would be perfect. But a rule will discipline the
Fed and it will give information to the public about the long-
range consequences of monetary policy. Too much of what they do
is aimed at the very near term.
Chairman Campbell. Dr. Taylor, 10 seconds?
Mr. Taylor. I think we learned so much about what worked in
monetary policy in the 1980s and 1990s until recently, so go
back to that general style of policy as soon as possible.
Chairman Campbell. Thank you.
My time has expired, so I will recognize the ranking
member, the gentleman from Missouri, Mr. Clay, for 5 minutes.
Mr. Clay. Thank you, Mr. Chairman.
Let me start with Dr. Gagnon. Tell me, critics of
quantitative easing have argued that it is incompatible with
the Fed's price stability mandate. However, in discussing
quantitative easing the Fed has consistently noted that the
program is designed to promote a stronger pace of economic
growth and to ensure that inflation over time is at levels
consistent with the Fed's mandate.
To what extent has quantitative easing been effective in
keeping inflation in the desired range of 2 to 2.5 percent, and
is there any evidence whatsoever that the dual mandate creates
a perverse inflation merit base?
Mr. Gagnon. Thank you. I think the dual mandate is in some
sense unavoidable. If you look around the world, whether
central banks have a dual mandate or not, they almost uniformly
act as if they do.
So in the interest of transparency, I think we should keep
a dual mandate. We can't pretend that monetary policy doesn't
affect both inflation and the real economy, employment and
activity, so why not be open about it?
I think the Fed's--we did see a decline in inflation in the
early years after the recession, and the Fed's easy policy, I
believe, has been helpful in preventing that from going lower.
One thing we have learned, though, out of this is that it is
very hard to make prices fall.
Deflation doesn't come easy. We see that in Japan. And so I
don't fear deflation right now. But we would have come closer
to it if we had not had this easy policy.
Mr. Clay. According to Dr. Taylor, the Fed's current
monetary policies perversely decrease aggregate demand and
increase unemployment while they repress the classic signaling
and incentive effects of the price system. Do you agree that
current monetary policies increase unemployment?
Mr. Gagnon. No, I do not. I think a good analogy for where
the economy is right now, we often hear the story that monetary
policy is like driving a car, only with no windshield and only
a rearview mirror. You can just see a little bit of where you
have just been, so you don't know what is going on.
I think we have hit a hill that may be steeper than any of
us have seen in our lifetimes and we didn't know it. When you
hit a hill when you are driving, you step on the accelerator,
and you hope that you will go faster. But if you are starting
up a steep hill, you might go slower.
Then the question becomes, what is wrong? Some people think
that perhaps the car is broken down, perhaps the brake pedal
and the accelerator have mixed up. Maybe if we press on the
brake, we will go faster.
I don't think so. I think if we press harder on the
accelerator, we will go faster; we are just facing a very steep
hill.
Mr. Clay. Anyone can take a stab at this one. What is the
tipping point? What tips us that inflation is about to kick in?
And I will start with you, Dr. Gagnon. What are good
indicators?
Mr. Gagnon. I think you would see--if you see broad and--
measures of prices, sort of--not just a few extreme ones, like
commodities, but broad measures, and especially in the labor
market, if you start seeing large pay increases that were well
ahead of productivity, that would be an early indicator that
maybe this is becoming a problem. I don't see any evidence of
that.
Mr. Meltzer. May I answer that?
Mr. Clay. Each one of you can. I am trying to get to
everybody. Go ahead.
Mr. Meltzer. Asset prices start to rise, money starts--
people start to get out of money and bonds and shift into asset
prices. Farmland prices start to rise. All the things that we
see happening now are happening. The Fed missed that completely
in the run up to the 2007-2008 fiasco because they don't pay
much attention to asset prices, but they should.
Mr. Clay. But does that include housing prices, too? They
are starting to rise. Is that a signal of a recovering housing
market or inflation coming?
Mr. Meltzer. Part of that is people buying houses on
speculation. That is a sign that they expect prices of houses
to rise. When prices of houses rise, don't you think rents are
going to rise?
Mr. Clay. That is not what the housing market is indicating
to us now, is that this is the spring--spring is coming and
people are starting to buy houses.
Chairman Campbell. The gentleman's time has expired, so
maybe someone else can follow up with that.
The gentleman from Michigan, the vice chairman of the
subcommittee, Mr. Huizenga, is recognized for 5 minutes.
Mr. Huizenga. Thank you, Mr. Chairman.
I appreciate you all being here today, and I'm sorry I had
to step out for a quick radio call-in.
But, Mr. Malpass, you hit on something that I exactly used
those words, artificially low rates, and it seems to me--and I
don't want to put words in your mouth; I want a few of you to
address this--but you are saying that these artificially low
interest rates have not spurned economic activity as was hoped,
correct?
Mr. Malpass. That is right.
Mr. Huizenga. Okay. So what you are saying is if I am going
to go buy a house, maybe the make it and break it isn't whether
it is a 3.75 percent interest rate on my 30-year mortgage
versus a 4 percent 30-year mortgage, or maybe, like my family's
circumstance, we own a construction company in Michigan. You
may have noticed that it has been a bit soft in the last few
years.
I have a 12-year-old loader that I need to replace. It
doesn't matter what the interest rate is because banks and,
frankly, their regulators, are coming in saying, ``We don't
want construction equipment on your books.'' So who is going to
give me that loan, because I haven't had a whole lot of time
here to ramp up my savings to try to get enough cash together
to go purchase that?
So I just wanted you to maybe talk a little bit about these
artificially low interest rates.
And then the other thing, this really struck me as--the
best exit, as you were talking about, is not just spending, but
tax as well as regulatory policies. And it seems to me that
those tax and regulatory policies--and I tried bringing this up
with Chairman Bernanke last week at our hearing as well--has a
huge amount of impact. Isn't that true?
Mr. Malpass. Yes. Thank you, sir.
The Fed had the rates at zero for more than 4 years, and
yet the recovery has been very subpar. The reason for that is
because it is an artificially low rate.
Economics is very, very clear. When you set the price of
something too low, you end up with shortages, and that is what
you were describing in Michigan.
The big corporations and the government can get lots and
lots of loans, but smaller businesses can't. That is a natural
part of a price-fixing mechanism, which is what the Fed has
been doing.
What you are describing is logical, that some parts of the
economy are feeling this asset price inflation that Dr. Meltzer
has described, and then other parts are not feeling the growth
at all. That is because the capital is getting channeled and
redistributed.
Mr. Huizenga. I can tell you, the housing prices in
Michigan have bottomed. Raw land has bottomed. There is only
one way to go but up, and people are literally sitting there
saying, ``I don't know if I could buy a home for cheaper than
what I could build a home right now.'' And, lots that used to
go for $75,000 or $100,000 are going for $25,000, maybe
$30,000.
Dr. Meltzer, I do want to--on page 3 you talked a little
bit about being in the third round of quantitative easing, and
I thought you put it beautifully here. Why does the chairman
claim greater benefits than costs? Mainly, he makes the
mistakes of looking only at interest rates, never mentioning
what happens to growth of credit and money.
I am not a Ph.D. economist like you all, all right? But I
did take a few economics classes, and I recall one of my first
economics classes discussed the law of diminishing returns. It
seems to me that is exactly what we are talking about right
here and what we are going after. ``Well, if maybe we just
lower it a little bit more then we will get this greater cost,
or maybe if we spend or stimulate the economy by spending twice
as much we will get double the amount of activity.''
Could you address that a little bit?
Mr. Meltzer. Yes. The only time--I have written the Fed's
history, so I read most of their minutes from the 1920s to the
1980s. There is hardly ever a time when they say the following:
``If we do this today, where will we be a year, or 2 years from
now?'' That is a question because we know that monetary policy
doesn't work quickly.
The one time that they actually discussed the policy that
would relate to your question was at the end of the Volcker
disinflation. They had very high real interest rates. Real
interest rates during that whole expansion were 5 to 7 percent
after allowing for inflation, and money growth was very high.
And they discussed the question, which one of these things
will dominate? Will we have a slow recovery because of the high
real interest rate or a fast recovery because of the fast money
growth and the fast growth of credit?
The answer is pretty obvious now, in hindsight. In 1983,
the economy grew at gangbuster rates despite the high real
interest rates.
That is, the interest rate matters, but so does the money
and credit growth. And we are not getting the money and credit
growth because most of the reserves that the Fed are creating
are going to finance the government's deficit and sitting in
excess reserves.
Chairman Campbell. The gentleman's time has expired.
And you should know, Mr. Huizenga, that Dr. Meltzer and I
both have economics degrees from UCLA. Now, his happens to be a
master's and a Ph.D., and mine is a bachelor's, but I think
that is an insignificant distinction.
Mr. Huizenga. I didn't want to point out anything beyond
that, Mr. Chairman--
Chairman Campbell. Oh, yes. Okay. I just thought that was
an interesting point--
Mr. Huizenga. I will note that he is on that side of the
table, though.
Chairman Campbell. So no, we are basically the same. Yes,
okay.
And now, I recognize the gentlelady from Wisconsin, Ms.
Moore, for 5 minutes.
Ms. Moore. Thank you so much, Mr. Chairman.
And I want to thank the witnesses for appearing.
It is hard to dispute the expertise of this panel with
respect to the Fed policy sort of forcing the investor to chase
the highest yield, and that might have a negative impact on
bonds and so forth. But in an effort just to defend the Chair a
little bit, he is trying to create some kind of economic
activity by lowering the interest rates, maybe trying to
increase some risk-taking so that there is some economic
activity.
I will start with Dr. Gagnon. With those stipulations,
Chairman Bernanke also said that he thought a more direct way
of helping our economy is to deal with people who don't have a
lot of bonds--maybe those mothers who need Women, Infant, and
Children programs, or those seniors who need low-income heating
assistance, or senior meals, that if we were to stop the
sequesters and this cut--cutting--being concerned about the
debt on a short-term basis instead of a more long-term
strategy, that might be more stimulative to the economy than
just continuing to do the quantitative easing.
But to the extent that we keep cutting and cutting and
cutting, the Fed is doing the only thing that it can do.
Mr. Gagnon, would you respond to that?
Mr. Gagnon. Yes, certainly. And I think Chairman Bernanke
himself even would support what you just said. I think this is
not a good time for further cuts right now. We had a big--we
had a tax increase this year. That is, in my view, more than
enough for 1 year.
We don't need any further spending cuts this year. I would
stretch them out in the out years. It is certainly holding back
growth in the economy.
Ms. Moore. Okay.
Dr. Taylor, I wanted to ask you about your economic models
that produced the connection between interest rates and the
housing boom, and I was wondering if you had any models that
demonstrate that the Fed's QE could just briefly in 20 seconds
just sort of outline the models that you have that the Fed
policy is hurting the economy.
Mr. Taylor. The study of quantitative easing that I did was
right after it began in 2009. It focused on the mortgage-backed
securities purchases. I looked at the--tried to control for
other things that affect risk and found that did not reduce the
mortgage interest rates.
That was my main, own research, so it is quite
contradictory to what Mr. Gagnon has stated. That model is
well-documented and published.
The other model used to show that the rates were too low in
2003, 2004, and 2005 was a different model that was simulated,
and I think that has been proven to be pretty accurate.
Ms. Moore. Okay. Thank you, Dr. Taylor.
I guess the question I would like to ask the other two
gentleman in my remaining time is, with respect to, again, the
sequestration and our worry that we are going to have interest
rates which are too low, don't you think it would be very
harmful to the economy to just immediately raise interest
rates? Aren't we concerned about inflation with respect to the
Fed suddenly pulling back from these low interest rates?
Dr. Meltzer?
Mr. Meltzer. Yes. I don't think that we want to go through
a draconian policy of suddenly raising the interest rate a lot.
We want to get on a path toward a long-term, stable policy. We
have to send people a message--
Ms. Moore. Do you think that stopping dramatic cuts and
taking huge sums of money out of the economy immediately is
part of that?
Mr. Meltzer. The money isn't going into the economy. Most
of it is going into bank--
Ms. Moore. I am talking about with respect to consumer
spending, like the sequester.
Mr. Meltzer. There isn't much financing of consumer
spending coming out of the QEs.
Ms. Moore. I understand that.
Mr. Meltzer. I don't question--let me just say, I do not
question Chairman Bernanke's intentions. I question his
results. His results are not nearly consistent with his stated
intentions.
We are not getting growth of money and credit at a very
rapid rate that would stimulate consumption or investment. And
we are not getting a great deal of investment. We need
investment for growth. We need a long-term policy. We are not
getting that.
Chairman Campbell. The gentlelady's time has expired.
But I must say, Ms. Moore, when--at one point there where
you said you wanted to defend the Chair, for a brief instant I
thought you were defending me rather than--
Ms. Moore. Oh, I always defend you.
Chairman Campbell. Oh, okay. All right, rather than
Chairman Bernanke. But then you went on about Chairman
Bernanke, so I am a little hurt. But I will get over it. I will
get over it.
Now, I would like to recognize for 5 minutes the gentleman
from South Carolina, Mr. Mulvaney.
Mr. Mulvaney. Thank you, Mr. Chairman.
Dr. Gagnon, I would like to start with you. You mentioned
in your written testimony a couple of the costs of
unconventional policy. I guess I could ask questions about each
one, but I will go through them very quickly because I want to
talk about the last one more specifically.
The first one, you say that the risk is that the Federal
Reserve would become the dominant buyer and holder of long-term
Treasuries. I think the Treasury bought about 77 percent of all
the debt last year. I wonder what more it would take for them
to become the dominant buyer. But again, that is not my
question.
The second risk you discuss is that the public might
believe it will be difficult for the Federal Reserve to tighten
policy, thus leading to worry of inflation. I would suggest to
you that some members of the Federal Reserve Board, sir, are
doing exactly the opposite, which is that I think late last
year the head of the Minneapolis Fed said that he would be
willing to go above the 2 percent range to 2.5 percent. San
Francisco Fed said they would go to 2.5 percent. And the head
of the Chicago Fed said he would like to go to 3 percent on
inflation. So I would suggest to you that those risks are real
and that certain members of the Federal Reserve are doing the
exact opposite of what you would suggest.
Third, you talk about encouraging risky behavior. The long-
term yields being at a low rate for a long period of time would
encourage risky behavior. And I was stunned here a little bit
ago to see you go into the effects of systemically important
institutions and how risk managers could handle this.
But I think Dr. Meltzer made the excellent point that I am
not really concerned about the important financial institutions
as much as I am about the individuals. And it is the retirees
and the folks living on fixed incomes who are really the ones
we are encouraging to engage in risky behavior. And as Dr.
Meltzer correctly pointed out, I think that ends in no good.
But again, with 5 minutes, I only get one question to ask.
So I want to talk about the last one which you talk about,
which you describe as a red herring, which is the losses that
the financial, that the Federal Reserve could incur on its
enlarged balance sheet. And you go on to say that the Federal
Reserve is--the term, I guess, is remittance--giving a lot of
money back to the Treasury.
Elsewhere in your testimony, you said you thought that the
current interventions policies probably depress interest rates
by about 1 percent. I ran the math on that in the back of my
head and on the tablet in front of me, and that tells me that
if the Federal Reserve gets out of this business tomorrow,
interest rates on a 10-year would go up by 1 percent. If I
translate that into a capital loss on the balance sheet of the
Federal Reserve, which is roughly $3 trillion--I know it is not
all in 10 years but it makes the math easier--roughly you are
talking about a 10 percent loss, $300 billion worth of capital
loss in an instant, which, I would suggest to you, exceeds the
total remittances that the Federal Reserve has given to the
Treasury since 2009.
They gave $90 billion, roughly, last year, according to
Chairman Bernanke's testimony last week. They have given about
$290 billion since 2009. That doesn't include the losses that
they would incur on paying additional interest on the reserves
they hold from the financial institutions.
So I want you to tell me why this is a red herring. A 1
percent increase in interest rates would lead to several
hundreds of billions of dollars of capital losses and operating
losses, perhaps, at the Federal Reserve. So tell me why that is
a red herring.
Mr. Gagnon. Sure. The Federal Reserve has already given
extra profits, above normal profits, that are almost equal to
the costs of $300 billion that you mentioned, and in the next
couple of years, it will have done so. So you will be
subtracting $300 billion from excess profits that exceeded $300
billion--
Mr. Mulvaney. But that is only 1 percent. Let's think about
what happens if we go back at the historical average of 5.5
percent. That is 450 basis points, or 400 basis points over
where we are now.
Mr. Gagnon. It is possible there could be larger losses
than $300 billion, that is correct. But again, profits will be
quite a bit higher than that going in.
Also, what you are not including is the gains to the
Treasury. The Treasury will have issued long-term Treasury
bonds yielding much less, and those gains are locked in
forever, or for the life of the bond, 10 to 30 years. That is
money the Treasury would have had to pay in interest it will
not, and that is hundreds of billions, too.
And on top of that, by getting the economy growing faster,
and more spending, and a bit more inflation than otherwise, tax
revenues will be higher. And that is paying down the debt, too.
So it all adds up. If you add all the pieces together,
there is no way it does not lower the burden of our debt.
Mr. Mulvaney. So several hundred billion dollars,
potentially a trillion dollars of capital losses, an additional
billions of dollars in operating losses is something we
shouldn't be concerned with because it will be, what, made up
someplace else?
Mr. Gagnon. Exactly.
Mr. Mulvaney. Thank you, Dr. Gagnon.
Chairman Campbell. The gentleman yields back.
Mr. Foster of Illinois is recognized for 5 minutes.
Mr. Foster. Thank you, Mr. Chairman.
In Dr. Taylor's testimony, he emphasized the role of
monetary policy in the early 2000s as a real driver of the
housing bubble, presumably. But there are really three legs of
policy. There is monetary, fiscal, and regulatory policy.
And I was wondering how you would apportion the credit or
blame for the financial collapse or the bubble that led to the
financial collapse between those three legs of policy. What
fraction of it was due to each?
Mr. Taylor. I think the regulatory policy is maybe
equivalent and equal to the monetary policy measures. It is
very hard to quantify, to be sure.
But there you had, I think, a situation where certain
entities who should have been not taking the risks they took,
took the risks, and they were overlooked by regulators. Fannie
Mae and Freddie Mac are an example, but in addition, a lot of
the large commercial banks were certainly, in retrospect,
taking risks that the Federal Reserve should have been watching
for--the New York Fed, in this particular case, mainly.
So I think that is very high. It raises questions about the
way that regulators enforced regulations, and that should be
examined. It is not that you need more regulations; just means
the ones on the book need to be taken seriously.
So I would put that up there along with the monetary
policy. It is actually part of monetary policy.
Mr. Foster. So for example, the Fed's apparent refusal to
enforce mortgage origination standards nationwide, which was, I
think, given to them in 1994, sometime in there, and then
despite repeated urging, then-Chairman Greenspan decided not to
enforce that. You view that as a significant driver of the
housing bubble?
Mr. Taylor. I would focus more on the risks that the banks
were taking and holding as securities.
Mr. Foster. And then the other--the third leg of the triad
is fiscal policy, where, of course, during the Republican years
it went from basically a surplus to a trillion dollar
structural deficit by the time President Bush left office. How
would you mix that in, in terms of--
Mr. Taylor. By 2007, the Federal deficit was a little over
1 percent of GDP, and Federal spending had increased to 19.7
percent of GDP. And remember, in the year 2000, Federal
spending was only--
Mr. Foster. But by 2008, when the bubble popped, there was
a huge structural deficit because of all the costs that the
government incurs when household net worth drops by $17
trillion.
Mr. Taylor. I would say that in the year 2007, before--
Mr. Foster. During the peak of the bubble. Right.
Mr. Taylor. --near the end of that year, during that year
you could argue we were close to full employment and the
deficit was a little over 1 percent of GDP, so that would be
one measure, maybe somewhat larger than one measure of the
structural deficit. But I think it is hard for me to see why
that is the cause of the crisis, because--obviously, we would
like to have a smaller deficit, but you can see that 1 percent
is--hard to see why that would drive things.
Mr. Foster. I would like to talk quickly about the rules-
based--Dr. Meltzer has emphasized the need for rules-based
things, and particularly when you look at the housing bubble,
which I view as the main driver--that along with the buildup of
leverage in the financial system. There have been, at the
American Enterprise Institute, as Dr. Meltzer may be aware, a
panel of discussions and there will be a workshop this summer
on countercyclical loan-to-value requirements for real estate,
which other countries very successfully use to fight bubbles.
Israel, for example, and other countries have squelched housing
bubbles by turning up the downpayment requirement at times when
they see bubbles developing.
There are rules-based approaches to this, the simplest
being, for example, just a requirement that federally-backed
mortgages cannot exceed the value the property had 3 years ago,
being one simple example of one. And I was wondering if you
could comment, maybe starting with Dr. Meltzer, on the
feasibility and desirability of having countercyclical elements
in the real estate market, and particularly ones that might
protect for the federally-backed section of the real estate
market, ones that might protect the taxpayer from the sort of
damage they have seen in the collapse of the bubble.
Mr. Meltzer. Most countries have housing policies--housing
without having as many subsidies as we have, and one of the
problems--you mentioned regulatory policy. Regulatory policy
was really a big factor in this crisis.
You had a system in which people like Angelo Mozilo, a
well-known name, could make tens of millions of dollars by just
shoveling bad mortgages onto Fannie Mae and the regulators did
nothing about that except to encourage it. That is a terrible
problem with regulation. Regulation gets captured, it gets
circumvented, it breeds crony capitalism.
I am convinced that the only regulations which are really
effective are regulations which change the incentives of the
people you regulate. You want them to want what you want. You
don't want to give them rules which tell them, ``Be good,''
because they will circumvent them and ignore them.
Chairman Campbell. The gentleman's time has expired.
And without objection--we have three more questioners here
in this round--we will have a second round of questioning, but
I will now move to the gentleman from North Carolina, Mr.
Pittenger, and he is recognized for 5 minutes.
Mr. Pittenger. Thank you, Mr. Chairman.
Thank you, gentlemen, for your assistance to this committee
and your service to our country.
I would like to Dr Meltzer, the central planning model that
this Administration has pursued, albeit through the Fed's
expansionary monetary policy, has clearly not achieved their
desired objectives, trying to find 6 percent unemployment and 4
percent economic growth. But more importantly, of concern to me
is the unprecedented legal authority that has been advanced by
the Fed.
In light of that, we recognize that the Fed is an
independent central bank. However, are there any reforms you
think that Congress should consider as it pursues its
relationship with the Fed and trying to improve the
accountability of the Fed?
Mr. Meltzer. Yes. Absolutely.
I believe the Congress has an obligation, in order to
fulfill its requirement under the Constitution, to adopt a rule
which restricts what the Federal Reserve can do without your
permission. I think the Taylor Rule is an acceptable rule. A
price stability rule would be a fine rule.
No rule will be perfect under all circumstances, so the
rule has to say something about what you do when you don't
think it is appropriate.
Years ago, I made a proposal to the Reserve Bank of New
Zealand. I said, adopt a target. If you hit the target, fine.
If you don't hit the target, you send two messages. One says,
``Here is our resignation; we failed. And here is our
explanation of why we failed.'' And the authorities have a
right to choose among those explanations because there are
legitimate reasons why you may miss.
Now, 20 countries have adopted something which improves on
that rule by adding price stability. The United States has not.
It is time that we adopt a rule for monetary policy to
assure yourself that you can say to the Federal Reserve when
they appear here, ``Look, you told us that in this year, 2
years from when you made--no, 3 years from when you made the
forecast, that we would have this outflow, and this inflation,
and you haven't done it. Explain to us why you haven't done
it.'' That puts the Congress back into the game where it
belongs.
Mr. Pittenger. Thank you.
Mr. Malpass, Chairman Bernanke testified before us last
week that there are not any asset bubbles forming as a result
of his exceptionally accommodating monetary policy. Does this
coincide with what you and your clients are seeing in asset
markets today?
Mr. Malpass. Thank you, sir. Today, the stock market hit a
new all-time high, so there is a levitation going on in equity
prices. We have also seen high-yield markets levitate. The
yields fall, the price goes up, and the Fed has been explicit
in its policy in stating that it is trying to cause asset
prices to go up.
My concern is that tends to be a narrow set of financial
assets and not connected to job growth and small business
growth that would be more desirable in the economy as a whole.
Dr. Meltzer mentioned farmland, and the Federal Reserve Board
itself has talked about asset price bubbles in farmland and
also in the high-yield market. A recent statement by a Fed
official talked about it being a tip of the iceberg in terms of
what banks are now holding on their balance sheet in terms of
appreciated assets.
May I come back to your previous point very briefly?
Mr. Pittenger. Sure.
Mr. Malpass. Sir, there is also the question of whether you
want to leave the Fed with unrestricted asset-buying authority,
which is the implication of the current policy of the Fed.
Apart from our current crisis, 20 years from now I am worried
that the markets and the economy will look to the Fed to keep
buying things and they will expand their desire for the Fed to
buy municipal bonds, or other assets. I am worried about that
open-ended authority.
Mr. Pittenger. Slippery slope. Never ends. Thank you very
much.
Chairman Campbell. The gentleman's time has expired.
The gentleman from Delaware, Mr. Carney, is now recognized
for 5 minutes.
Mr. Carney. Thank you very much, Mr. Chairman.
And I thank the panelists for being here.
Dr. Taylor, it is good to see you again. We met out in
California in your office.
Very interesting, if not a little esoteric, conversation
today for me. I am a first-time member of this subcommittee,
certainly no expert. I don't have the kind of economics
training that you all do, so I appreciate your expertise.
I have just a few questions, if I may. One is about the
dual mandate of Humphrey-Hawkins--price stability and full
employment. Do each of you think that is an appropriate mandate
for the Fed, and if not, I think you have had--we have had some
discussion about maybe how it would be different.
But why don't we start with Mr. Malpass?
Mr. Malpass. If I may defer to Dr. Meltzer or Dr. Taylor--
Mr. Carney. Sure. Please do.
Mr. Meltzer. I find it acceptable because it is politically
desirable, and it is important that what we do is acceptable to
the public. I would prefer a price stability target, because
that is what the Fed is really capable of doing. It is capable
of enforcing price stability, and that is a very desirable
thing.
As Paul Volcker testified many, many times before this
committee and elsewhere, the way to get low unemployment is to
get low expected inflation.
Mr. Carney. Is it your view that has become maybe the
primary focus of the Fed, in terms of price--
Mr. Meltzer. One of the things I object to in the way the
Fed operates is it concentrates on one of the goals in the dual
mandate until the other one gets out of line and then it
concentrates on that. That puts additional variability into the
economy.
Professor Taylor has measured variability several times.
Chairman Bernanke, before he was a policymaker, when he was an
academic, measured variability. We could reduce the variability
in the economy, and that would be good, if we didn't shift from
looking at--worrying about unemployment until inflation rises,
and then worrying about inflation and raise the unemployment,
and worrying about unemployment and so--
Mr. Carney. Dr. Taylor, do you have--my time is ticking--
Mr. Meltzer. That is a bad bicycle to ride.
Mr. Taylor. Just briefly, I am concerned about the way the
dual mandate is being used. For most of Paul Volcker's term, he
focused on price stability as the way to get unemployment down,
and it did come down with that.
Recently, the dual mandate is already put forward as a
reason to intervene, a reason for the quantitative easing. We
heard much more about it recently.
I think the reality is when the Fed focuses too much on
that goal, it gets worse. If you think of the 1970s, they
focused on unemployment, and unemployment became high. In my
view, one of the reasons unemployment is high now is because
they focused on that too much in 2003, 2004, and 2005.
Mr. Carney. Dr. Meltzer, and I think Mr. Malpass, both said
that you thought that the focus on monetary policy alone has
taken the focus off fiscal policy. What would be more
appropriate? Do you think the fiscal policy we have now is the
right one, and what would be more appropriate, if not?
Mr. Malpass. The issue is whether monetary policy is going
to carry the burden of stimulus.
Mr. Carney. You said it shouldn't, and so what--
Mr. Malpass. The Fed has taken on too much of that burden.
Mr. Carney. So what should we be doing on the fiscal side
for stimulus?
Mr. Malpass. There should be corporate tax reform. There
should be a streamlining and simplification of the individual
tax system, which is very cumbersome, and costly to the
economy.
And on the regulatory policy side, we have an array of very
costly Federal regulations that are burdensome.
Mr. Carney. Sorry for interrupting, but my time is
expiring.
Dr. Meltzer or Dr. Taylor, on fiscal policy?
Mr. Meltzer. Fiscal policy--I agree with exactly what he
said. And I think I want to emphasize what he said at the end.
Regulatory policy, particularly at the present time, makes
businessmen think that the Administration is hostile. I don't
know whether the Administration is hostile or not, but they
think it is hostile. That deters investment and creates
uncertainty.
Mr. Carney. What about the idea of automatic spending cuts
that are taking effect right now as part of that fiscal policy
equation?
Dr. Taylor?
Mr. Taylor. The Congress has laid out a strategy to reduce
spending gradually over time. I think moving back off of that
would be a mistake. It would reduce the credibility of the
government, so stick to the path that has been agreed to, try
to deal with the sequester itself by giving flexibility to--
Mr. Carney. The problem was that it wasn't quite an agreed-
to strategy. It was the fallback plan, if you will.
But thank you very much, each of you, for coming today and
for your advice.
Chairman Campbell. The gentleman's time has expired.
And now the gentleman from New York, Mr. Grimm, is
recognized for 5 minutes.
Mr. Grimm. Thank you, Mr. Chairman.
I will start off with Mr. Malpass.
Mr. Malpass, you mentioned before and in your testimony
that the policies favor a select group, which would be the
government, but not new businesses, small businesses, et
cetera. Can you expand on that a little bit? Just because the
average person out there would say, doesn't a small and new
business benefit from having very low interest rates? So can
you just explain that a little bit?
Mr. Malpass. Thank you, Mr. Grimm.
The National Bureau for Economic Research has a study out
this morning talking about how banks are actually responding to
the current interest rate policy. It explains a little bit of
what Mr. Huizenga was saying he felt in Michigan, that small
businesses are having trouble getting credit, whereas larger
businesses and, of course, the government are having an easy
time getting credit.
My explanation in the testimony is that this is normal
economic behavior when you fix the price of something. For
example, if the government said that gasoline prices should be
lower and then put a ceiling of $1.50 on a gallon of gasoline,
what would happen? People who were privileged would get the
gasoline. Businesses that were wasteful of gasoline would use
too much. And that is basically going on.
The Fed has set the price of credit artificially low. It is
causing people who don't need the credit--for example, the
government or big corporations--to snarf up the credit and take
too much.
Mr. Grimm. I am sorry, because I have limited time. So
basically what you are saying is, it sounds great in theory
that new businesses and small businesses will also have low,
low interest rates, but the truth is, they don't get access to
the credit--to take--to get the benefits of those low interest
rates.
Mr. Malpass. That is exactly right.
Mr. Grimm. Great. Thank you.
Mr. Meltzer, can you also expand for just 1 minute on why
bankers applaud the current policy? And my question is, is it
similar almost to an arbitrage, where it is a riskless
transaction? I am going to borrow lower, then I know I can give
it back to the government at higher, so there is really no
risk. And if that is the case, if that is accurate, then does
this limit--it goes back to what we just said--the appetite or
the desire for a bank to lend to who they are supposed to be
lending to, which is these businesses that desperately need it?
Mr. Meltzer. Yes. To amplify that, in addition to the
interest rate, there is the risk. The bank looks at the risk
and it says, ``These new startups are a heck of a lot riskier
than lending to the government. So I can make a good profit by
borrowing from the Fed at a quarter of a percent or less and
lending on government bonds at 1 percent or 2 percent, and why
not do that and make a huge profit,'' which is what they are
doing.
That isn't in the public interest and that isn't getting us
toward the goal that we all agree on, which is good growth, a
stable economy, and low inflation.
Mr. Grimm. Dr. Gagnon, you had mentioned before, and I know
it was touched upon when my colleague went into this, but I am
still not satisfied, so I would like to just talk about it for
the last minute. My understanding is that the Fed is buying up
longer-term instruments to push--put pressure on mortgage rates
and the longer-term instruments that have interest rates as--to
go down, as well. But they don't have any T-bills at all in
their balance sheet.
If they don't have short-term instruments and interest
rates do start to rise, the Fed has said that to avoid capital
losses, they will hold them to maturity. But if they hold them
to maturity then they don't have anything to sell to actually
affect the interest rates or the potential for a run on the
bond market. So isn't that dangerous?
Mr. Gagnon. No, because they have unlimited ability to repo
them out to the market at short term--
Mr. Grimm. I am sorry, say--say that one more time--
Mr. Gagnon. They can lend them to the market at short
terms, so it is as if they sold short term--borrowed short term
from the market. They can borrow short term from the market
using them as securities--long-term bonds as securities, so
they can regulate short-term interest rates that way.
And the key thing will be that they need to set interest
rates where they need to be for the economy, and they have the
tools to do that. They can print money; they can repo out
securities; and they can choose whether or not they want to
sell those bonds in their portfolio. I would urge them never to
sell them.
Chairman Campbell. The gentleman's time has expired.
The gentleman from Florida, Mr. Murphy, is recognized for 5
minutes.
Mr. Murphy. Thank you, Mr. Chairman.
And thank you all for being here today. We appreciate your
time.
Similar to many Members of Congress, I came here to talk
about real solutions and what we can do to address the
problems. I have been working very closely with the gentleman
from North Carolina, who is stepping out, on focusing on a
grand bargain, and I think that is perhaps one of the single
biggest things we can do in our country to get our country on
the correct fiscal path and then get out of the way.
In this hearing we have talked about unconventional
monetary policy. What would it mean for unconventional monetary
policy if Congress were to really do its job and get this grand
bargain--in perhaps a perfect world, say we were to get this
grand bargain immediately--what would that mean for monetary
policy? And this is for all of you, starting with Dr. Gagnon.
Mr. Gagnon. I think the Federal Reserve traditionally is
like the second mover in this process. The Federal Reserve
looks at what Congress and the President do with regard to
taxes and spending and then it responds as best it can, and
that is always the way I think it needs to be, because the
Federal Reserve has the ability to move quicker.
I think ideally you would like to delay spending cuts and
tax increases until the unemployment rate had fallen further or
inflation were a risk, neither of which is an issue now, and
that would make the Fed's job easier, yes.
Mr. Murphy. Dr. Taylor?
Mr. Taylor. I think a consolidation plan for fiscal policy
would improve monetary policymaking because it would reduce a
lot of the uncertainty the Fed is trying to deal with. I think
it is quite remarkable to me, a lot of the concerns I have
about monetary policy--the unconventional, the
unpredictability--also characterize fiscal policy. They go
together and it hasn't always been that way. We used to have
regular order for budgeting. We don't have that anymore so it
is unpredictable.
So I think the more that fiscal and monetary policy can get
more predictable, get more sensible, like you are trying to do,
the better off the country will be.
Mr. Murphy. Thank you.
Dr. Meltzer?
Mr. Meltzer. Yes. To your efforts, I say amen and good
luck, because I can't think of any policy operation that would
be more important at the present time than to put us on a
predictable path to a balanced budget achieved over a sequence
of years.
And what would it do for monetary policy? It would make--
hopefully encourage them, make them do the corresponding thing:
put us on a path toward price stability over the longer term.
And the last thing that would need to be done would be to
improve the regulatory policy.
But you are on a great track, and I wish you every good
wish I can.
Mr. Murphy. Thank you.
Mr. Malpass?
Mr. Malpass. I will give a caution on the fiscal policy and
also on the monetary policy, if I may. As I have seen the grand
bargains done in the past, the concern is the taxes go up in
the early years and the spending reductions are put off into
the out years. Try to make sure that there are spending
restraints at the beginning of the process.
I testified last week to the Senate Budget Committee and
talked about the positive impact that has on the private
sector. If the U.S. private sector saw the Federal Government
in a continuous process of spending restraint rather than the
one-off sequester that we are doing, a permanent process that
held back the rapid growth that we keep seeing in government
spending, it would cause a true boom. There would be job
growth.
With regard to the Fed, I am worried that it will have
trouble conducting monetary policy. It is true that they can
repo bonds, but the Fed is right now the dominant player in the
bond market, so it makes it very difficult and distortive to
markets if the Fed were to begin a repo operation in an effort
to conduct monetary policy under the current conditions. I
think it would be disruptive for markets.
Mr. Murphy. The question I propose is under a sort of
perfect scenario. Under the reality of this Congress and the
current dysfunction we have, what do you recommend, Mr.
Malpass, that Fed Chairman Bernanke do in these times?
Mr. Malpass. I mentioned earlier to stop digging the hole
deeper. Because the policy is not working, the Fed's response
has been to double the policy. And that has made it work even
less well, so the growth rate has come down.
I would encourage the Fed to stop making promises about
future interest rates and future bond purchases, to walk back.
Mr. Murphy. Thank you.
Thank you all.
Chairman Campbell. The gentleman's time has expired.
Without objection, Mr. Green of Texas will be recognized
for 5 minutes.
Mr. Green. Thank you very much, Mr. Chairman. Thank you
especially for allowing me to be an interloper, given that I am
not officially a part of this committee.
I would like to thank the witnesses for appearing and to
address Mr. Gagnon.
Sir, you have indicated from your testimony that you
believe that more expansionary monetary policies are necessary.
We do know that the Fed announced on December 12th that it
would keep buying $40 billion in mortgage-backed securities per
month and that it would begin buying $45 billion in long-term
Treasury securities.
I assume that you concur with what the Fed is doing. Is
that a fair statement?
Mr. Gagnon. Yes.
Mr. Green. All right. Given that you concur, will you
elaborate on the type of monetary policies you think would
benefit us, in terms of them being expansionary?
Mr. Gagnon. Sure. Over 3 years ago now, I warned that the
Fed was on a path to being too tight and urged it to do a lot
more in terms of buying long-term assets to hold long-term
rates to get spending up. Over the years the Fed has belatedly,
begrudgingly moved to pretty much do what I had asked 3 years
ago.
At this point, I think what they could usefully do is to
give some more assurance to the housing market that mortgage
rates will stay low for a fixed period of time, perhaps 12
months. That would give banks comfort that if they want to make
a mortgage to a borrower they can sell the MBS to the Fed at a
fixed price, say 2 percent, for 12 months.
It would encourage banks to staff up their mortgage
departments, to make more mortgage loans, and it would give
house buyers that if they go into the market this year, they
would have several months to shop for a house, and the credit
would be there, and they wouldn't have to worry about rising
rates. And it would really, I think, have a nice dynamic for
the housing market. I think that is an important thing the Fed
could do, which would be better than what they are doing.
Mr. Green. You also mentioned other types of refis. Would
you elaborate on some of the other refis that might stimulate
the economy?
Mr. Gagnon. What would really be helpful, and this is sort
of beyond the Fed's ability, would be to really get the housing
agencies to stop discouraging refinancing of old conforming
mortgages. A lot of people still have 6 percent mortgages.
Mr. Green. Just for edification purposes, when you say
``housing agencies,'' would you be more specific? Are you
talking about Fannie and Freddie?
Mr. Gagnon. Yes.
Mr. Green. And that would be under FHFA?
Mr. Gagnon. That is correct.
Mr. Green. And that would be Mr. DeMarco?
Mr. Gagnon. That is correct.
Mr. Green. Continue, please.
Mr. Gagnon. I do not understand why FHFA has been allowed
to not push the agencies harder. A refinance--fairly automatic
refinance of--automatic approval of refinances of existing
mortgages, mortgages that are already guaranteed by Fannie and
Freddie but are paying high interest rates.
Mr. Green. For edification, are you saying an automated
system that would allow FHFA to ascertain which of these
products can be refinanced and streamline a process so that we
can sort of clear out many of the homes where persons are
underwater and would probably walk away from, some of them--I
don't know how many, but a good many might--but if they can
refi they will get a reduced payment and they will stay in that
home. Is that some of what you are saying?
Mr. Gagnon. That is exactly what I am saying, and I think
it would reduce the risk to the government, because if people
can get a lower payment they are less likely to walk away from
their mortgage. And since the government is already
guaranteeing that mortgage, it is better to reduce the payment
to make it less likely to fail.
Mr. Green. This is not something that the Fed can do; this
is obviously within FHFA's purview.
Mr. Gagnon. That is correct.
Mr. Green. Now, quickly, one more thing: Are you familiar
with the term, ``expansionary fiscal contraction?''
Mr. Gagnon. Yes.
Mr. Green. Would you quickly explain, in your opinion,
whether this term applies to the current economic
circumstances?
Mr. Gagnon. Absolutely not.
Mr. Green. And if you would quickly, I only have 30
seconds, but maybe you will be allowed to go over to give your
explanation.
Mr. Gagnon. One of the things we are learning is that the
effect of fiscal policy on the economy depends a lot on the
state of the economy and it depends a lot on how the Federal
Reserve will react to fiscal policy. And so when the economy is
booming, fiscal policy has a very big effect, because the Fed
tends to offset it. If you cut taxes in a boom, it doesn't
stimulate the economy any more; it just tends to raise interest
rates.
But if you cut taxes or raise spending in a low state of
the economy, the Fed will not react, and it will pass through
to spending much more strongly. So a lot of studies are coming
out and saying that fiscal policy has a big effect on the
economy in a recession, but it has very little effect in a
boom.
Mr. Green. Thank you, Mr. Chairman.
Chairman Campbell. Thank you.
Without objection, we will go to a second round of
questioning now and I will first recognize the gentleman from
South Carolina, Mr. Mulvaney, for 5 minutes.
Mr. Mulvaney. Thank you, Mr. Chairman. I appreciate the
second round of questions.
Dr. Taylor, I would like to talk to you a little bit,
because you have introduced something in your written testimony
and talked a little bit about it briefly today that was news to
me--a new topic. We have talked a little bit here today about
the risks of the unconventional policy, and generally speaking,
a lot of the debate has been focused on how maybe it is not
working as well as it should or it is not working at all.
But you have introduced a new concept, which is that it is
actually making things worse. And in your written testimony on
page 7, you talk about the relationship, you say, ``The
perverse effect comes when the ceiling is below the--what would
be the equilibrium between borrowers and lenders who normally
participate in that market. While borrowers might like a near-
zero rate, there is little incentive for lenders to extend
credit at that rate.'' And then you go on to talk about the
fact that with lenders not supplying enough credit that the
decline in credit availability reduces aggregate demand, which
tends to increase unemployment, ``a classic unintended
consequence of the policy.''
That is the first I have heard of this. Would you mind
exploring that a little bit with us, giving us more detail?
Mr. Taylor. Sure. It is very similar to what my colleagues
over here have indicated, somewhat different words, and maybe
mine is more academic-sounding, but it is very similar.
The idea here is if you think about monetary policy, it is
not simply just the interest rate; it is the credit system. It
is getting the funds from, if you like, the--intermediating
from the lenders to the borrowers. And that credit system is
not taken account of when you are thinking about the low
interest rates. Of course you are going to stimulate some
spending--investing with low interest rates, but if the credit
doesn't come because of the very low interest rate because
people don't want to lend at those rates, the margins are too
small, then you will get--
Mr. Mulvaney. And that impact is immediate, isn't it?
Mr. Taylor. That is credit intermediation, yes.
Mr. Mulvaney. But, for example, we are talking about
certain risks. There is risk of inflation--that is down the
road. There is risk of credit bubbles, or asset bubbles--that
would be down the road.
This depressing impact, the downward pressure on GDP that
you are talking about, is happening right now.
Mr. Taylor. In my view, it is. I think it is something that
isn't emphasized enough. You are thinking about risks in the
future but it is a present issue. I think that is why the Fed
has been disappointed in its policies, is the policies have
been implemented and they haven't worked--that is my
assessment--and so they have actually had more. They have done
more of it, and I hope that vicious circle stops.
Mr. Mulvaney. Mr. Malpass, do you want to add something to
that?
Mr. Malpass. It is, sir, an immediate response because the
market looks forward. In my work on this in 2009, I called it a
rationing process, meaning if the Fed sets an artificial price
for something then the market begins to ration through
shortage, which is a very common economic phenomenon, and it is
exactly what we have seen happen in 2010 in the credit markets
of the United States.
I think as the Fed set this up they didn't think about the
deleveraging going on in the banking system. They were thinking
that if you put in a very low interest rate, it must cause more
credit. Yet, the regulators were causing less credit or the
same amount. So you have a rationing or a redistribution of
credit rather than growth.
Mr. Mulvaney. Thank you, gentlemen.
Mr. Malpass, I want to stay with you on another topic,
because my colleague from New York, Mr. Grimm, asked a question
of Dr. Gagnon regarding exit strategy, and in response to one
of his questions Dr. Gagnon suggested that maybe the Fed could
hold these Treasuries to maturity but enter into the repo
market. You didn't look very satisfied with that answer.
At the risk of asking a question I don't know the answer
to, what were your thoughts on that, sir?
Mr. Malpass. I am not sure I know the answer because we
haven't done this before. The Fed has become an absolutely
dominant player in the government bond market. In the past when
the Fed did repo operations, they were a very small player in a
large market. Now, they are a very large player relative to the
market.
There are unpredictable consequences from the idea of the
Fed lending a bond into a smaller market.
Mr. Mulvaney. Is it possible that the efficacy of that
particular tool has been reduced because of the size of the
balance sheet?
Mr. Malpass. More than possible. It is likely that it has
been reduced and probably wouldn't be very workable when the
Fed gets to that point.
The point Mr. Grimm had made was that the Fed doesn't have
any short-term Treasury bills. Dr. Meltzer is a world expert on
Fed history. In the past, the Fed never used any other
instrument than short-term Treasury bills and repos in a robust
government bond market. We are in unexplored territory.
Mr. Mulvaney. Thank you, gentlemen.
Thank you, Mr. Chairman.
Chairman Campbell. Thank you.
The gentleman from Illinois, Mr. Foster, is recognized for
5 minutes.
Mr. Foster. Thank you, Mr. Chairman.
I would like to return for a moment to the issue of asset
price--bubbles that--and I was interested in your view of the
state of the art of macroeconomic modeling of the housing
market, and in particular, whether various things can actually
be understood in terms of how the housing market in other
countries who have consciously suppressed housing bubbles and
whether those things are accurately modeled. Can we get some
understanding of possible policy or rules we can put in place,
such as the one I mentioned, and how they might have worked and
might work in the future to suppress housing bubbles in an
automatic way. Because I personally, from a political point of
view, am very skeptical that unless we have an automatic
punchbowl retractor, it is going to be very difficult to hold
back.
Anyone may answer.
Mr. Malpass. I will make a brief comment. The point that
you are making is very strong, that we need to have a
countercyclical policy. My one observation is we are actually
going the other way. With each year the Federal Government is
lowering the standards, making the equity requirement less and
less for FHA.
I think you are right in what you are suggesting and I am
afraid we are going the other way.
Mr. Taylor. I also think your concern about bubbles or
excesses is well-taken. I think the experience, though, with
monetary policy is that frequently the bubbles are coming at a
time when policy is, if you like, overly easy. In other words,
it is almost like the central bank is helping to cause the
bubble rather than prevent it. And that is what I think we saw
in 2003 and 2004.
It is also, if you look at Europe, countries which
experience these real bubbles, say Greece and Ireland and
Spain, the same kind of thing. One interest rate for Europe
didn't really handle their situation. Often, it is the monetary
policy that is the cause, so I would address that first.
And with respect to automatic changes in capital
requirements, we haven't seen those work very well yet. But if
it does, if we have something like that I agree 100 percent. It
should be--
Mr. Foster. They were done sort of by fiat. For example, in
Israel, they very aggressively turned up the downpayment
requirements for houses, and you can imagine rules that kick in
that force--at least for the federally-backed part of the
mortgage market, you can imagine rules that would automatically
pull the government out of the housing market when it starts to
heat up.
I think that one of the things we are wrestling with is the
phase lag between--the reason the system oscillates is that you
are trying to regulate on lagging indicators, like
unemployment, which is one of the most--
Mr. Taylor. Absolutely. I couldn't agree more. You need to
work these through with models, and lags, and uncertainty, and
there hasn't been enough of that done, unfortunately, to say
this is what we should do, but I encourage it.
Mr. Foster. All right.
And on a related thing, there are various rules that you
can imagine, and one of them is this so-called ``targeting of
nominal GDP,'' and it is an example of--it is one of the exit
rules. If I remember properly, Dr. Taylor actually testified in
2010 on possible exit rules for--which is actually, the
transparency as we exit I think will be important in getting
business confidence back and the predictability of the system.
And one of those possibilities is simply to target nominal
GDP and say it is simply the sum of inflation and GDP growth.
Or you can obviously sort of feedback and try to regulate any
linear combination of all the variables you can imagine, or
some nonlinear function of them.
I was just wondering what you thought of that as a general
approach.
Mr. Taylor. I think a predictable exit strategy is
essential to lay out what the strategy would be when the time
comes. And everyone wants to have stable nominal GDP growth.
The question is, what should the Fed do to get that? What
should the changes in the instruments be, the changes in the
interest rate? And that is left open when people talk about a
nominal GDP target so it needs to be supplemented with some
other kind of rule, if you like, for what the Fed should do to
get to that target.
Mr. Foster. So the gain of the feedback loop, as it were.
Mr. Taylor. Yes.
Mr. Foster. Okay. I guess that is it.
I yield back the balance of my time.
Chairman Campbell. Okay, thank you.
The gentleman from Indiana, Mr. Stutzman, is recognized for
5 minutes.
Mr. Stutzman. Thank you, Mr. Chairman, and I apologize if
my question maybe repeats some of the questions that were asked
earlier. I had to jump out due to another meeting, but I want
to talk a little bit about the dual mandate, but also how the
Fed's policies are affecting seniors, affecting Main Street,
and what they are seeing and what they are feeling right now.
I have several friends that I spoke to before this hearing
and just asked them what they are seeing and where people are
putting money, and they said other than just the old principles
of a balanced portfolio, there is nothing really out there that
is attracting dollars because of Fed policy, low interest
rates.
People are not putting money into CDs because there is not
much return. Maybe they are getting pushed towards the stock
market but people still are very wary of the stock market. My
wife's grandmother, who lives on Social Security but has her
savings, pulled everything out and is just sitting on it.
What kind of message is that sending from the Fed to Main
Street? People are very skeptical and especially--and Dr.
Taylor, I guess I will ask you this question, that the Federal
Reserve predicted that GDP would be at 4 percent growth in
2012, but it actually just turned out to be 2 percent. Is it
possible that the Fed's policies, whether it is dual mandate,
it is working against American especially seniors right now,
and especially the amount of retirees who are going into
retirement, they are not seeing any growth in their pensions or
their savings.
Mr. Taylor. Absolutely. That is the distributional effect
that we are concerned about with monetary policy. It is helping
some and hurting others.
I think the question about the overall effect being
negative is based partly on that but also on the uncertainty
that the policy is causing, which is a drag on investment.
Remember, firms are sitting on a lot of cash, and they are
holding back, and one reason is the uncertainty about monetary
policy. Other policies too, but that is a big part of it.
And so again, you might think that low interest rates are
good, and it is easy to talk about it and you can try to
convince people, but there is this other side of the coin with
the policy, which is actually, I think, a drag, and makes--one
of the reasons why growth has been slower than the Fed
forecast.
Mr. Stutzman. Mr. Malpass, I don't know if you would want
to comment on that as well? And also, are we pushing more
dollars into the stock market because there is just not the
return on bonds, long-term or short, that could be creating a
bubble here? We are just about to top the old record today. I
haven't seen the numbers if we have, but I fear--
Chairman Campbell. Dow is up 144.
Mr. Stutzman. I am sorry, what?
Chairman Campbell. Dow is up 144, so they have blown
through the record.
Mr. Stutzman. Did they? Okay.
Mr. Malpass. One of the complaints is that the Fed is in so
much control of this. The Fed was somewhat explicit over the
last couple of years that it wanted to see more money go into
stocks. I think that is too broad a role for the Fed.
There have been questions about the dual mandate today. It
seems to me that there is a way to seek maximum employment in
the context of price stability and those go together well
enough. The Fed could go in a better direction. The Fed has
gone way beyond the rules and the thoughts of what the
boundaries should be. That creates risk for financial markets
going forward and for the economy.
Mr. Stutzman. Anyone else want to speak to that or touch on
that?
Let me ask just another question. Going back a little bit
to where people are putting dollars, I don't know if Dr.
Gagnon--what are we seeing internationally? Are we seeing the
same trends internationally? Are we seeing anything that is
different here that we could maybe learn from somewhere else or
learn not to do?
Mr. Gagnon. Actually, that is a good question, because I
think we do see different policies. The only other country that
has really done what the Federal Reserve has done is the United
Kingdom, and I think if you compare them to their neighbors in
Europe, despite being much more the center of the--they had a
much more important financial sector that was much more hurt by
this crisis, and they have equally tough fiscal contraction
right now--tax increases and spending cuts--and yet they are
doing better than the rest of Europe, in part because they have
chosen to do quantitative easing and Europe has not.
Mr. Stutzman. Thank you. I yield back.
Chairman Campbell. The gentleman from Delaware, Mr. Carney,
is recognized for 5 minutes.
Mr. Carney. Thank you, Mr. Chairman. I have come back. I
had a couple other questions I just wanted to ask, now that we
have the distinguished panel before us, and it piggybacks a
little bit on what my friend from Indiana was just talking
about in terms of short-and long-term interest rates. At a
conference in San Francisco recently, the Chairman of the Fed,
in response to questions, said raising interest rates
prematurely would carry a high risk of short-circuiting the
recovery, possibly leading, ironically enough, to an even
longer period of lower long-term interest rates.
The idea that if we short-circuit the recovery now then
that is going to have that negative impact on the long-term.
But Dr. Meltzer or Dr. Taylor, do you have any response or
thoughts on that question?
Mr. Taylor. I think there is just a disagreement, different
views about the impact of the policy. He feels that if he
starts moving off of the quantitative easing or even just
delays it, that is contractionary. I don't agree with that.
I think it is actually going to be a bonus or a benefit if
we go back--it has to be gradual, as Dr. Meltzer indicated--to
a policy that has worked in the past in similar circumstances.
Mr. Carney. What would your rule dictate? Your rule has
been referred to several times.
Mr. Taylor. My rule would not have the quantitative easing.
That is the most important thing right now. The interest rate
would remain low but we wouldn't have the quantitative easing.
Mr. Carney. So the second question really relates to a
statement that Dr. Meltzer made earlier that we are, in some
ways, abdicating our constitutional responsibility for monetary
policy here in the Congress, which suggested to me that somehow
we ought to be, I don't know, involved. It is hard for me to
believe that we could get it right. In fact, it sounds like the
worst possible thing, to involve the Congress in the activities
of the Fed. I just can't imagine.
Dr. Meltzer, I don't--you probably didn't mean that, but
what did you mean by that, because I can't think of a worse
idea, frankly.
Mr. Meltzer. Yes, I can't imagine the Congress doing that
either, not running the policy. Prescribing a rule and
enforcing the rule, that is what you want to do.
Mr. Carney. So isn't the rule--
Mr. Meltzer. So when the Chairman comes in here or the
Members of the Board come in here to testify, you want them to
say, ``Look, in 2 years we are going to have low inflation and
high employment, and these are the numbers that we are aiming
for.''
And then 2 years later when they come in you can say,
``Well, you didn't get there, so what we want you to do is
explain to us why you didn't get there, and if we don't think
the explanation is good, we think you should resign and we will
get people who can do the job better.'' That is what I think is
the Congress' responsibility. It is an oversight
responsibility.
Mr. Carney. Yes, so we--
Mr. Meltzer. What you have now, it is just very difficult
for you to do it because the Chairmen--not just Chairman
Bernanke but Chairman Burns, Chairman Volcker, Chairman
Greenspan--can run circles around you talking about things that
are very difficult to sort out and for you to clearly know.
Mr. Carney. That is a fact.
Mr. Meltzer. Yes.
Mr. Carney. Just like this panel can as well, I might add,
but--
Mr. Meltzer. I don't think we are trying to do that. I
think we are trying--my own view and I am sure the view of my
colleagues here, including Mr. Gagnon, are trying to help you.
Mr. Carney. I appreciate that. And we do, I think, have a
framework anyway. It is called Humphrey-Hawkins. We had a
conversation about that a few minutes ago, and you conceded
that the full employment piece, although it wouldn't be your
preference, it is a political thing, and of course, that is
what drives us. We are driven by the people that we represent
every--
Mr. Meltzer. Yes, and you need to add to Humphrey-Hawkins
something which incentivizes the Fed to pay attention to it,
and that is--
Mr. Carney. In terms of a rule.
Mr. Meltzer. That is the rule and the addition to the rule,
which says if you don't hit the target that you said you were
going to hit, if you don't achieve what we have told you to
achieve or what you have told us you were going to achieve,
then you have to tell us why and offer a resignation, and
political authorities have to be willing to make that choice.
That gives incentives.
Regulation that is goodwill regulation doesn't work.
Regulation works when they incentivize the people who are
regulated. That is what you need to do both in banking and with
the Fed. You have to give them an incentive to follow the rules
which you and they agree upon.
Mr. Carney. I see my time has expired.
Let me thank each of you again for coming and for your
expertise and your advice.
Chairman Campbell. The gentleman from Delaware yields back.
And now, the vice chairman of the subcommittee, the
gentleman from Michigan, Mr. Huizenga.
Mr. Huizenga. Again, thanks, Mr. Chairman, for doing this.
And I want to thank the panel for coming in. I can tell you
that every time I have a conversation with you all, I feel like
I am making significant leaps toward having a Ph.D., or maybe a
master's, in banking and financing and economic theory, so
thank you very much.
I have a couple of very short, kind of quick questions. In
your opinion, who is benefitting the most right now from our
current policy? And I would love to have you just kind of go
down the row. Who is benefitting from it and is this the path
that we need to be on?
Mr. Malpass. My thought is that the government is the
biggest beneficiary because it is the biggest debtor. The
interest rates are being kept artificially low; that helps the
debtor. The cost is borne by the savers, and in the United
States the biggest saver is the household sector. So it is a
direct transfer from the private sector saver to the
government.
Mr. Meltzer. I agree with what he said, the government, but
I would add, would you vote for a policy which said, we are
going to bail out the banks and increase their returns?
But that is what the Fed is doing. It is allowing them to
borrow from the market or from the Fed at a quarter a percent
or less and lend to the Treasury for 1 percent or more, and
they make big profits.
What is the social benefit of that? None, as far as I am
concerned. It has a social cost, and that social cost is high
because it is keeping interest rates too low, and we have
talked about that a lot.
So you wouldn't vote for that policy and yet you have that
policy.
Mr. Taylor. I just think it is focused on the overall macro
effects, which I think are negative, in terms of trying to
figure out who are the winners and who are the losers here. It
is very difficult. But I would say my main concern is that the
overall effect is negative.
Mr. Gagnon. I would say the beneficiaries, as Mr. Malpass
said, are the U.S. Government, the Federal Government
particularly, as I said before, but also, younger people and
people with mortgages are benefitting. I think the people who
are losing are, it is true, older savers are losing something,
and the other big loser is foreign governments who are
investing in our country and getting a low rate of return and I
think that is fine.
Mr. Huizenga. But it is fair to say it is not the mom
sitting around the kitchen table trying to figure out how she
is going to feed her kids and how she is going to put gas in
the minivan, and all those things, right?
Mr. Gagnon. Well, if she has a mortgage and she refinanced
it, she is much better off now.
Mr. Huizenga. If she qualifies, if she can get through the
Dodd-Frank Act.
Mr. Gagnon. Yes, that is an issue--can I make one very
brief--
Mr. Huizenga. Please.
Mr. Gagnon. --point about--one thing I don't understand is
this talk about credit rationing. It seems to me that is
confusing the level of rates with the spread of rates. Banks
charge a spread over what they can borrow at. The Fed sets that
at zero and no one tells the banks how much--limits how much
they can charge on--to borrowers, so there is no rationing
going on.
And if you give banks a lower cost to funds, they can lend
it at a lower rate. So I don't see any way this could hurt--
Mr. Huizenga. That beautifully ties into my next question,
actually, which is, I would like you all to touch on what some
of the effects are of the regulation that has been on there.
And this might be a little outside of what we are specifically
talking about today but it seems to me it is not just our
spending and it is not just monetary policy; it is the
regulatory environment and the tax policy that dramatically
impacts that, and I hear that all the time.
And I used this with Dr. Bernanke. It is not one grain of
sand that is going to gum up the works on that machine, and you
can't--who can argue with, okay, one little grain of sand, a
regulation that is going to be added, but when suddenly it is a
whole handful and suddenly you are using a rubber mallet to
pound it into the gears, now you have a problem, and it seems
to me that we have done that. So that might go to some of my
concern about what you are bringing up, but would anybody care
to comment?
Mr. Malpass. When I say the government is the beneficiary,
I mean in the sense of Washington, D.C., government employment,
and the real estate boom. This is the center of the beneficiary
of these policies, whereas outside of Washington is having a
harder time.
And with regard to the regulatory side, Sarbanes-Oxley and
Dodd-Frank are putting very real costs onto businesses. The
regulators in the banking sector are causing challenges in the
allocation of capital. Some banks are able to make more loans,
but many banks are constrained or scared by the regulators into
not making loans that are considered risky loans.
Mr. Huizenga. I know my time has expired, but I appreciate
that.
And if anybody has any other comments they would like to
share in writing, I think probably, or unless the chairman so
chooses to do something different, I would love to hear your
views, so--
Chairman Campbell. I thank the gentleman.
And the gentleman's time has expired. I saved myself the
final 5 minutes to bat cleanup, and so I will yield myself 5
minutes at this time.
I think this hearing has been very interesting, very
productive, and very helpful. And one of the things that has
come to me from this hearing that I didn't necessarily have
coming in was, the risks of the current monetary policy out--
the sort of tail risks are obvious. The Fed acknowledges them,
et cetera.
What I heard today was a lot of not risks but, in fact,
negatives--current negatives. Things that are from the current
monetary policy that are depressing current employment and
current GDP growth, which--and I would like to just touch on a
few of these.
One we talked about was the loans being priced below where
they should be, and even if milk is free, it doesn't help you
if you can't get it. Now, Dr. Gagnon just suggested that it is
about the spread and not about the price of the loans. How do
those of you who believe that is a constricting factor respond
to Dr. Gagnon on that?
Mr. Meltzer. If a bank can lend to the government and make
quite nice profits, why would it want to take risk that--to a
new, unsecured--
Chairman Campbell. So are you saying, then, that the spread
between a no-risk loan and a risk-loan has compressed?
Mr. Meltzer. And that is what they are doing.
Chairman Campbell. Right. Okay.
Dr. Gagnon?
Mr. Gagnon. I would say that the issue is whether that is
because of monetary policy, or because of regulatory policy, or
because banks have felt they have been burned through their
misbehavior in the past and are overcompensating now, and--
Chairman Campbell. Okay, but it is probably a fact, though,
right, that spread is down and that is going to limit the
availability of loans?
Mr. Gagnon. I don't see it from the point of view of
monetary policy. I do see it from the point of view of
regulatory policy and bank--
Chairman Campbell. However, it may be the--
Mr. Meltzer. Of course, it is due to monetary policy. It is
the monetary policy which is keeping the interest rates down
there and telling banks--Dr. Taylor wrote a piece in The Wall
Street Journal and talked about it here. Sure, the borrowers
want to borrow, but try to get a mortgage if you are an
unsecured, not-well-known borrower coming into the mortgage
market. You just won't find a bank or mortgage company that is
going to want to lend to you when that is the case.
If you are a commercial real estate operator speculating on
the future of asset prices, commercial market prices in New
York or the Silicon Valley, you can get all kinds of credit.
Chairman Campbell. Okay.
We talked about cash on balance sheets not deployed, and it
is not just on corporate balance sheets. Again, I see that
anecdotally all the time--people just sitting on cash because
interest rates are too low, returns are too low now but they
think they are going to go up in the future so they just sit.
And so everybody just sits until the Fed takes action.
Rather than trying to read a market, they are trying to read
what the Fed is going to do, which is very distorting, in my
view.
We talked about banks borrowing at a quarter percent and
selling to the Treasury at a percent. Older people or savers--
and, Dr. Gagnon, you acknowledged this as well--are losing in
this environment. And when I asked Chairman Bernanke last week
about how the benefits of this were going to big banks and
governments, he pushed back hard, saying, ``Oh, no, no, there
is all this employment and stuff that is being created.''
We haven't looked at all the things. What are the cutbacks
of savers? What are they doing differently? What are seniors
who are largely or partially dependent on fixed incomes doing
to cut themselves back on that?
And then, Dr. Gagnon, you said a minute ago that you felt--
you acknowledged that but you felt younger people were getting
some benefit, and I saw a great deal of angst from the other
end of the table when you said that.
So either Mr. Malpass or Dr. Meltzer, I believe both of you
lit up on that?
Mr. Malpass. The unemployment rate for young people is very
high, and that is, I think, in part the result of a
contractionary and distortive monetary policy.
Mr. Meltzer. What Chairman Bernanke never says or discusses
is, why is this the slowest recovery in the whole post-war
period? There hasn't been another one like this since 1937 to
1938. It is very slow, harming lots of people, especially new
entrants to the labor force.
That is a question which the Fed doesn't approach. It is
helping bankers make large profits lending and borrowing with
the government. That is not a policy which gets us substantial
growth and employment.
Chairman Campbell. Thank you.
My time, and all time having expired, I very much
appreciate all four of you coming. And I very much appreciate
the nature and tenor of the discussion, and as I said, I think
it was very helpful.
The Chair notes that some Members may have additional
questions for this panel, which they may wish to submit in
writing. Without objection, the hearing record will remain open
for 5 legislative days for Members to submit written questions
to these witnesses and to place their responses in the record.
Also, without objection, Members will have 5 legislative days
to submit extraneous materials to the Chair for inclusion in
the record.
The hearing is now adjourned.
[Whereupon, at 12:17 p.m., the hearing was adjourned.]
A P P E N D I X
March 5, 2013
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