[House Hearing, 113 Congress]
[From the U.S. Government Publishing Office]
WHAT IS CENTRAL ABOUT CENTRAL BANKING?:
A STUDY OF INTERNATIONAL MODELS
=======================================================================
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
__________
NOVEMBER 13, 2013
__________
Printed for the use of the Committee on Financial Services
Serial No. 113-50
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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
KEITH J. ROTHFUS, Pennsylvania
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:
November 13, 2013............................................ 1
Appendix:
November 13, 2013............................................ 35
WITNESSES
Wednesday, November 13, 2013
Lachman, Desmond, Resident Fellow, American Enterprise Institute. 5
Makin, John H., Resident Scholar, American Enterprise Institute.. 8
Orphanides, Athanasios, Professor, Practice of Global Economics
and Management, Sloan School of Management, Massachusetts
Institute of Technology........................................ 7
Posen, Adam S., President, Peterson Institute for International
Economics...................................................... 10
APPENDIX
Prepared statements:
Lachman, Desmond............................................. 36
Makin, John H................................................ 49
Orphanides, Athanasios....................................... 62
Posen, Adam S................................................ 68
Additional Material Submitted for the Record
Huizenga, Hon. Bill:
Wall Street Journal article entitled, ``ECB's Praet: All
Options on Table,'' dated November 13, 2013................ 79
Written statement of Lawrence Lindsey........................ 82
Wall Street Journal article entitled, ``Andrew Huszar:
Confessions of a Quantitative Easer,'' dated November 11,
2103....................................................... 98
WHAT IS CENTRAL ABOUT CENTRAL
BANKING?: A STUDY OF
INTERNATIONAL MODELS
----------
Wednesday, November 13, 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 2:27 p.m., in
room 2128, Rayburn House Office Building, Hon. Bill Huizenga
[vice chairman of the subcommittee] presiding.
Members present: Representatives Huizenga, Pearce, Posey,
Fincher, Stutzman, Mulvaney, Pittenger, Cotton; Clay,
Perlmutter, Carney, and Kildee.
Ex officio present: Representative Hensarling.
Mr. Huizenga [presiding]. The subcommittee will come to
order. And without objection, the Chair is authorized to
declare a recess of the subcommittee at any time. It appears
that we will be having votes somewhere around 4:15 or 4:30, is
the indication that we have.
So with that, we are going to get moving, because we have a
lot of very interesting stuff ahead of us as a committee today.
And the Chair is going to recognize himself for 5 minutes for
the purpose of an opening statement.
So we have to ask ourselves, what is central about central
banking? What works? What doesn't? What thinking went into
forming the European Central Bank 80 years after the formation
of our own Federal Reserve and how has it lived up to
expectations so far? Did it perform better or worse among its
peer institutions in the wake of the financial crisis?
It is these questions and others that our committee is
interested in exploring as we consider potential reforms of our
own Federal Reserve System, which is posting its 100th
anniversary this year.
This afternoon, we welcome our witnesses: Dr. Desmond
Lachman from the American Enterprise Institute; Dr. Athanasios
Orphanides from the Massachusetts Institute of Technology; Dr.
John Makin from the American Enterprise Institute as well; and
Dr. Adam Posen from the Peterson Institute for International
Economics.
Gentlemen, thank you very much for being here today. We
appreciate your time.
Today's hearing will examine the central banks of the other
advanced economies around the world, focusing on their
governance and policy tools, as well as their successes and
failures in implementing monetary policy.
The Federal Reserve prides itself on being an independent
central bank here in the United States. However, independence
is hard to measure and even more difficult to demonstrate. The
appointment process of policymakers, reporting requirements,
and policy review processes all play a role in defining the
relationship that central banks have with their own national
governments. Even still, the most independent central banks are
ones where there is very little coordination or interference by
fiscal policy decisions.
In 2009, the Bank of International Settlements (BIS)
surveyed 41 central banks and reported on both the broad
commonalities in the structures and roles of these institutions
as well as the differences among them. The BIS reported that
all the central banks it surveyed have full or partial
responsibility for monetary policy. Over half are given policy
objectives, usually specified in domestic law or international
treaty, but some policy objectives come by published statements
that do not have the force of law. Many have either a ``single
mandate'' of pricing stability or a primary goal of price
stability with secondary macroeconomic objectives. The United
States and Canada are the only two countries identified as
having a price stability mandate equally weighted with other
macroeconomic objectives. I think this dual mandate is what we
will be discussing quite a bit. Nearly all central banks have
full responsibility for formulating and implementing monetary
policy.
Specifically, we will explore today international models of
central banking. Some central bank models, like our own U.S.
Federal Reserve System, have a ``dual mandate'' of enacting
monetary policy with a goal of maximizing employment while
simultaneously minimizing inflation. Other countries' central
banks work under a more focused or prioritized mandate or set
of mandates. And that is what I am hoping to personally hear
today from all of you.
Some, like myself, also believe that the employment
component at a minimum has diverted the Fed's attention from
the more important issue of inflation, which in my opinion
should be the sole focus. In the worst case, an equal price
stability and employment mandate has the potential of a moral
hazard, with the Fed playing off its regulatory role against
its monetary role.
I look forward to hearing from our witnesses today as we
compare and contrast with other international banking models.
What we will learn today should not only inform our own
understanding of the increasingly global and complex
macroeconomy, but should also contribute to our efforts to
enact reforms on our own Federal Reserve System as it hits its
100th anniversary milestone.
And with that, the Chair is going to yield back the rest of
his time.
The Chair now recognizes the distinguished ranking member
of the subcommittee, Mr. Clay of Missouri, for 5 minutes.
Mr. Clay. Thank you, Mr. Chairman, and thank you for
holding this hearing regarding central banks of other advanced
economies and focusing on their governance.
In the United States, the Full Employment and Balanced
Growth Act of 1978, better known as the Humphrey-Hawkins Act,
set four benchmarks for the economy: full employment; growth in
production; price stability; and balance of trade and budget.
Also, Humphrey-Hawkins charges the Federal Reserve with a dual
mandate: maintaining stable prices; and full employment.
The Bank of International Settlements report found that
many nations have either a single mandate of price stability or
a primary goal of price stability with a secondary
macroeconomic objective like full employment. The United States
and Canada are the countries identified as having a price
stability mandate equally weighted with other macroeconomic
objectives. Many central banks have sole inflation targets,
sole exchange rate targets, and others have price stability
targets. Also, asset portfolios of central banks vary
considerably. Some hold foreign assets, government debt, and
claims on financial institutions. And during the financial
crisis, the Federal Reserve purchased commercial paper, made
loans, and provided dollar funding through liquidity swaps with
foreign central banks.
Due to this action, the Federal Reserve Bank balance sheet
has expanded. When you look at the European Central Banks
(ECBs), their main objective for the euro system is price
stability and safeguarding the value of the euro. During the
financial crisis and the euro crisis, the ECB used several
policy tools, including long-term liquidity, refinancing
liquidity swaps with the Federal Reserve, and purchase of the
euro denominating covered bonds and other government bonds on
the secondary market. The ECB's balance sheet has expanded.
The Bank of Japan set monetary policy to achieve price
stability. During the financial crisis, the Bank of Japan
purchased private debt security, offered long-term refinancing
operation, and provided dollar funding through liquidity swaps
with the Federal Reserve. The Bank of Japan's balance sheet has
expanded.
And one more example. The Swiss National Bank's primary
goal is to ensure price stability. During the financial crisis,
its balance sheet has expanded.
Mr. Chairman, I will conclude there with my opening
statement. And I look forward to the witnesses' comments. I
don't know if the gentleman from Colorado wants me to yield--I
yield the rest of my time to the gentleman from Colorado.
Mr. Perlmutter. I thank the gentleman.
Just a couple of points. Listening to the Chair's opening,
I personally think that you can't operate in a vacuum, that you
have to compare your price stability inflation versus how many
people are working and what the economy is doing. And we have
enjoyed a very low inflation rate now for a number of years,
even with pretty expansionary monetary policy. But we have had
very checkered fiscal policy in the process.
And so, I do appreciate the gentlemen for testifying today.
I look forward to your testimony. But I, for one, support sort
of the Humphrey-Hawkins approach, which is you don't look at
just any one thing. And I know certain central banks, that is
their sole focus. I appreciate the fact that the Federal
Reserve in our country gets to look at more than just one thing
and has the responsibility to address more than just one thing.
With that, I yield back.
Mr. Huizenga. The gentleman yields back.
With that, the Chair would like to recognize Mr. Stutzman
from Indiana for 3 minutes for an opening statement.
Mr. Stutzman. Thank you, Mr. Chairman.
And I want to thank each of you for being here, and also
thank the chairman and the ranking member for holding this
hearing to evaluate various central bank structures throughout
the world, many of which look very different than our own U.S.
Federal Reserve System.
I want to thank each of you for being here and for bringing
your expertise in order to examine the ways we might analyze
these different central banking systems. Conducting an honest
evaluation here will allow us to better understand how well our
own systems function.
I remain particularly interested in those governments
without a dual mandate, which is most of the world. As you may
know, Mr. Chairman, I have authored a bill, the FFOCUS Act,
which eliminates the Fed's dual mandate in order to focus on
price stability. I have said before that the American people
can ill afford the inflation, debt, and insecurity that this
misguided approach threatens. Now is the time to repeal the
dual mandate and break this destructive cycle and return to a
predictable, rules-based system.
Numerous economists and scholars have come before our
committee supporting this position and reiterating that the
dual mandate undermines any attempt to fashion predictable
monetary policy. I agree with those who say the dual mandate
underpins the Fed's rationale for greater discretion when
forming monetary policy, creating a troubling lack of
accountability and oversight. Today, I look forward to
examining other global models and how they seek to strike the
right balance of independence and oversight.
Lastly, I remain troubled at the Fed's bloated balance
sheet and I remain unconvinced that there is a viable exit
strategy from the Fed's policy of quantitative easing. So in
this light, I am in interested in how other central banks
handle the makeup of their balance sheets and what lessons we
can take away from them.
Again, thank you for holding this hearing, and I look
forward to the testimony of our witnesses. And I yield back,
Mr. Chairman.
Mr. Huizenga. The gentleman yields back.
And with that, I would like to extend a warm welcome to our
panel of distinguished witnesses today. We are going to be
starting from our left to right here with Dr. Desmond Lachman.
He is a resident fellow at the American Enterprise Institute.
He has previously taught at Georgetown and Johns Hopkins
Universities. He served as a deputy director of policy
development review at the International Monetary Fund and has
worked as a managing director and chief emerging market
economic strategist at Solomon Smith Barney.
We also have Dr. Athanasios Orphanides, a professor of the
practice for global economics and management at MIT Sloan
School of Management. He served a 5-year term on the European
Central Bank Governing Council as a governor of the Central
Bank of Cyprus. He also served as a senior adviser to the
Federal Reserve Board of Governors and taught courses at
Georgetown and Johns Hopkins Universities as well.
Dr. John Makin is a resident scholar at the American
Enterprise Institute. Previously, he worked as the chief
economist at Caxton Associates. He has served in capacities at
the Bank of Japan, the U.S. Treasury Department, the
International Monetary Fund, and the Federal Reserve Banks of
both San Francisco and Chicago. He has also taught courses at
the University of Wisconsin, Milwaukee, the University of
Virginia, and the University of British Columbia.
Finally, last but not least, Dr. Adam Posen is president of
the Peterson Institute for International Economics. Previously,
he has served as a member of the Bank of England's Monetary
Policy Committee and also worked as an economist at the U.S.
Treasury Department.
Gentleman, you will be recognized for 5 minutes each to
give your oral presentation of your testimony. And, without
objection, your written statements will also be made a part of
the record.
On your table right in front of you, you see lights. It
will start out green. When it turns yellow, you have 1 minute
to sum up. And when it turns red, you will be hearing my gavel
shortly after that. So we would like you to wrap that up and
pay attention to that timing. And once each of you has finished
presenting, each member of the committee will have up to 5
minutes within which to ask any or all of you questions.
And with that, Dr. Lachman, you are recognized now for 5
minutes. And welcome.
STATEMENT OF DESMOND LACHMAN, RESIDENT FELLOW, AMERICAN
ENTERPRISE INSTITUTE
Mr. Lachman. Thank you, Mr. Chairman, Ranking Member Clay,
and members of the subcommittee for affording me the honor of
testifying before you today. I am going to talk about the four
major central banks of the world: the United States; Japan;
Europe; and the Bank of England.
Over the past 5 years, all of those banks have pursued
unorthodox monetary policies on an unprecedented scale. This
has led to massive expansion in these central banks' balance
sheets and it has taken monetary policy into entirely uncharted
waters.
Since September 2008, with the Lehman crisis, the
motivation for the pursuit of unorthodox monetary policies in
all of the major industrialized economies has broadly been
similar. All of these countries' central banks needed to
intervene aggressively in financial markets to repair the
damage wrought by the Lehman crisis. In addition, with policy
interest rates having reached their zero lower bound, and with
unusually weak economic recoveries and very low inflation,
these central banks have all felt obliged to resort to policies
aimed at reducing long-term interest rates, increasing asset
prices, and encouraging risk-taking.
While unorthodox monetary policies have led to a dramatic
expansion in all four major central banks' balance sheets to a
range of between 20 and 30 percent of the respective countries'
GDPs, there has been a marked difference in the manner in which
these central banks have implemented their policies. Underlying
these differences have been basic differences in the structure
of these countries' financial systems, as well as in the
specific problems that these individual central banks have been
trying to address.
Assessing the relative success of unorthodox monetary
policy pursued by the major industrialized countries is
rendered difficult and subject to debate for two basic reasons.
The first is that we cannot know what the counterfactual would
have been had these policies not been pursued. The second is
that it is still far too early to know what the longer run
consequences of these policies will be since we do not yet know
what will happen once these policies are unwound.
Having said that, there would seem to be little room for
debate about the success of these policies in restoring the
proper functioning of the global financial system in the
immediate aftermath of the Lehman crisis. There also seems to
be little room for doubt that the world's major central banks
have succeeded in lowering long-term interest rates and in
boosting asset prices.
In addition, it would seem that the ECB's Outright Monetary
Transaction program, announced in August 2012, was highly
successful in substantially reducing sovereign borrowing costs
in Europe's troubled economic periphery, while the Bank of
Japan's more aggressive round of quantitative easing, announced
in 2012, has succeeded in substantially weakening the Japanese
yen, thereby increasing Japanese inflationary expectations.
Now, critics of qualitative easing observe that despite the
large decline in long-term borrowing rates and the strong
increasing local asset prices, the economic recovery in
industrialized countries is the weakest of the post-war period.
While true, this criticism would not seem to be a serious
indictment of recent quantitative easing policies. It overlooks
the fact that absent forceful central bank action, it is highly
probable that the industrialized countries would have again
leapt into serious recession.
A more serious line of criticism of the unorthodox monetary
policies being pursued by the world's major central banks is
that too little regard is being paid to the unintended longer
run consequences flowing from these policies. These
consequences could materially compromise the longer run global
economic outlook.
Among these unintended consequences are, first, the risk
that these policies might be giving rise to excessive risk-
taking and to bubbles in asset and credit markets. In this
context, one has to wonder whether historically low yields on
junk bonds in industrialized countries now understate the risk
of owning those bonds and whether yields on sovereign bonds in
European periphery have not become disassociated from those
countries' economic fundamentals.
The second unintended consequence is that there have been
large spillovers to other economies through capital flows and
exchange rate movements that have given rise to the charge of
currency war. This is of particular concern to the dynamic
emerging markets' economies, whose growth prospects have been
compromised.
The third drawback of these policies is the moral hazard to
which they give rise by reducing the urgency of governments to
undertake necessary but painful economic reforms. This would
seem to be particularly apparent in both Europe and Japan.
Since the Lehman crisis, the U.S. economy has performed
relatively well in relation to those of the eurozone, Japan,
and the United Kingdom. Nevertheless, it would seem at least
two lessons for the Federal Reserve can be drawn from the
experience of the central banks in those countries. First,
Europe's particularly poor economic performance in the
aftermath of the Lehman crisis would suggest that a single
inflation objective mandate and a high degree of central bank
independence do not guarantee meaningful economic recovery.
Second--
Mr. Huizenga. I'm sorry, Dr. Lachman, but your time has
expired. So I will let you wrap up with one quick sentence, and
then we are going to have to move on. We can explore that
further in questions.
Mr. Lachman. All right. The final point I would make is
that aside from the experience of other central banks, I think
that the United States' own experience would also caution it
against the danger of running up very large assets and credit
market bubbles, and that in the conduct of this policy, one
really has to be mindful not simply of the short run effects of
policy, but also of the longer run costs that we might yet find
that we are going to pay.
Mr. Huizenga. Thank you. With that, the gentleman's time
has expired.
[The prepared statement of Dr. Lachman can be found on page
36 of the appendix.]
Mr. Huizenga. Dr. Orphanides, you are recognized for 5
minutes.
STATEMENT OF ATHANASIOS ORPHANIDES, PROFESSOR, PRACTICE OF
GLOBAL ECONOMICS AND MANAGEMENT, SLOAN SCHOOL OF MANAGEMENT,
MASSACHUSETTS INSTITUTE OF TECHNOLOGY
Mr. Orphanides. Thank you, Mr. Chairman. I appreciate the
opportunity to testify at this hearing. As requested, my
testimony will focus on differences and similarities between
the Fed and the ECB. I think the 100-year anniversary of the
Fed is an apt occasion for reflecting on the structure of the
institution. Historical experience suggests that a well-
functioning monetary system is a prerequisite for the greatness
of any nation, and this is what has been achieved since the
creation of the Federal Reserve 100 years ago.
Since its founding, the Fed has evolved into a very
powerful central bank and serves a leading role in global
central banking. As a public institution, the Federal Reserve
is unparalleled in the professional integrity, technical
expertise, dedication to public service, and collegiality that
has characterized its staff and leadership.
Over its first 100 years, the Fed has contributed, I
believe, to the welfare of the Nation, but has not always
managed to avoid major errors. The Great Depression of the
1930s and the great inflation of the 1970s are the most
noticeable examples. I am certain that historians will reflect
on the most recent crisis over the next many years. In my view,
the Fed's actions in late 2008 and 2009 were decisive for
averting what could have become an economic collapse of Great
Depression dimensions.
However, the easy money policies that have been pursued do
create additional challenges. And right now we do see that the
central bank's balance sheet and associated continued easing
are unprecedented.
What I would like to draw attention to is three elements
between the Fed and euro system. One is in the decentralized
nature of the institutions. This is a common characteristic
that is quite important in that the inclusiveness and
incorporation of regional perspectives ensures that monetary
policy better reflects the needs of a broad economy, which we
have in both cases.
The second element is the independence of both
institutions. Both the Federal Reserve and the ECB are very
independent central banks, but the ECB is more independent than
the Federal Reserve in that its operations are governed by
treaty and not by law, and as a result it cannot be changed
very easily by modifying a piece of legislation.
There is another difference that has to do with the
appointment process of Board Members. Both in the United States
and in Europe, once appointed, the Board Members are
independent; however, the reappointment process and turnover in
the United States arguably makes that aspect of independence
less in the United States relative to Europe.
I believe that the independence of the Federal Reserve
could be strengthened, and that would be an improvement, if its
Board Members were appointed similarly to the ECB Executive
Board Members for just one nonrenewable 8-year term.
The third element I would like to draw attention to is the
difference in the mandates of the two institutions where, as
has been pointed out already in the introductory remarks, the
Federal Reserve is governed by a dual mandate that emphasizes,
in addition to price stability, full employment. Whereas, in
the case of the ECB, price stability is the primary focus of
the institution. There I believe that the ECB's mandate better
reflects the accumulated knowledge we have had in central
banking experience over the 20th Century. It is generally
accepted that better results, both in terms of economic
stability and in terms of price stability, can be delivered by
a central bank that can focus its attention better and be held
accountable for what it can do, and that is price stability.
So in this sense, I would share concerns that have been
expressed, for instance, recently by Chairman Volcker, who
pointed out that if the Federal Reserve is trying to pursue
multiple objectives, it runs the risk of losing sight of its
basic responsibility for price stability that would end up
delivering worse results in all of its objectives together. I
believe that these risks could be mitigated by Congress with a
clarification that explicitly recognizes the primacy of price
stability as an operational goal for the FOMC. And I believe
that subject to that objective, the Fed would be in a better
position to attain additional objectives such as full
employment for the Nation.
Thank you.
[The prepared statement of Dr. Orphanides can be found on
page 62 of the appendix.]
Mr. Huizenga. Thank you, Dr. Orphanides.
With that, we have Dr. John Makin for 5 minutes.
STATEMENT OF JOHN H. MAKIN, RESIDENT SCHOLAR, AMERICAN
ENTERPRISE INSTITUTE
Mr. Makin. Thank you, Mr. Chairman.
I want to briefly review the experience of the Fed and the
experience of other central banks since the financial crisis.
Given that time is somewhat limited, I have tried to lay out
some of the approaches that central banks have taken to the
crisis. I would remind the committee that the Fed was
originally formed after a series of financial crises, the last
of which was the crisis of 1907, which underscored the need for
some kind of an institution to provide adequate liquidity in
order to avoid the negative effects of financial crises, such
as those that followed from the numerous crises that occurred
in the 30 to 40 years before the Fed was formed.
The Lehman crisis was unique. I bring to it the perspective
both of an academic and a think tanker, but also someone who
was in the middle of the crisis, working at a hedge fund at the
time. And I can assure you that the role of the central bank as
an institution designed to avoid a total financial meltdown was
one of the primary activities that emerged. The typical goals
of the Fed, that is price stability and full employment, were
subsumed beneath or among the more primary objective of the Fed
to try to staunch the severe bleeding that had emerged in the
financial sector.
In order to follow up and try to restore the growth of
employment and to maintain stable prices, the Fed extemporized,
using the zero interest rate policy, the quantitative easing,
forward guidance. All of these measures were pioneered by the
Fed in response to the crisis that was facing them. Other
central banks to some degree followed the example of the Fed.
You may remember that initially the European Central Bank felt
that they had avoided the financial crisis and its fallout. And
that outlook was changed in 2009 when it was revealed that the
Greek Government was concealing the amount of fiscal deficits
that it was undertaking.
So basically, central banks have tended to stylize their
responses to the crisis, again, as measures designed to try to
avoid financial meltdowns. The Bank of Japan this year, as most
of you know, initiated measures that were quite similar to what
the Fed had undertaken, that is they set a goal for 2 percent
inflation and they undertook aggressive additions to their
balance sheet in order to try to effect that goal.
The outcomes have varied, and I have tried to actually
summarize them in my testimony in terms of evaluating what
central bank has performed best. In the first figure, I look at
the path of gross domestic product from 2008 to the present,
and the winner is the United States. Although growth has been
slow to somewhat lagging--it is on page 7 of the testimony--the
United States has seen a total increase, cumulative increase in
output of about 8 percent since 2008. The biggest loser is
Spain in this picture because Spain is part of a monetary union
in which it does not belong; that is the ECB sets monetary
policy for Germany, the rest of Europe has to struggle, and the
result is a rapid drop in output.
Inflation has not been a big problem so far. In fact,
disinflation is emerging as a big problem in Europe and the
United States. Figure 2 looks at price levels. The cumulative
increase in the price level in the United States, in spite of
heavy quantitative easing since 2008, is something on the order
of, again, 8 percent. In Switzerland and Japan, prices have
actually fallen. And one of their big problems has been to
intervene heavily to avoid currency appreciation intensifying
their deflation problem.
The second wing of the mandate, that is employment, is
looked at in terms of figure 3. Central banks have not been
terribly successful at engendering growth of employment. And
here again, in terms of what the committee is considering, I,
too, share the idea that it is probably best to have the
central bank target a stable price level. And by that, I mean
that inflation should not be above 2 percent, but it should not
be below 1 percent. And in an environment where you can get
deflation, it is important to put a floor on that range. But in
general, the behavior of employment suggests that the central
banks have not been terribly successful in pursuing that goal.
I see my time is up, so I will stop.
[The prepared statement of Dr. Makin can be found on page
49 of the appendix.]
Mr. Huizenga. Thank you, Dr. Makin.
Dr. Posen, you are also recognized for 5 minutes.
STATEMENT OF ADAM S. POSEN, PRESIDENT, PETERSON INSTITUTE FOR
INTERNATIONAL ECONOMICS
Mr. Posen. Thank you, Mr. Chairman. Since my colleagues,
Athanasios, Desmond, and especially John, have taken you
through the basics comparisons, I am going to make slightly
more pointed remarks. I am going to talk about the operational
structure of central banks and what the Fed is doing right and
wrong in two major areas, The first issue is of governance and
how its goals are set, which goes to the mandate issues and
Humphrey-Hawkins issues that people have raised, and the second
is about the tools that are available for policy
implementation.
I would argue that the differences between central banks
are going to actually become more important in the next couple
of years. In the midst of a crisis, whatever a country's
mandate, whatever a central bank's mandate, everybody is going
in the same direction, pretty much. And if they don't go in the
same direction, they realize very quickly that they have to
catch up, and you throw everything you have at the problem.
And if you look back, particularly at John, but also at the
other testimony, you will see that the central banks did
largely the same thing. All this talk about the difference in
mandate and uncertainty caused by the Fed's dual mandate is
absolute nonsense. There is no evidence econometrically that it
makes a difference either to the perceived uncertainty in
financial markets or to the levels of inflation you see.
So what does matter? Let's talk a bit about goals. The
central banks, as Stanley Fischer has pointed out, should not
have goal independence, but should have instrument
independence. In other words, all of you here as the elected
officials should be setting what the central bank's goals are,
debating them, resetting them as necessary, but then leaving
the central bank alone to get on with the job and not worry too
much about how they get on with it, only checking for
competence and results after the fact.
Perhaps this sounds evident, but this distinction matters
greatly. Athanasios mentioned that the ECB has an extreme form
of independence and insulation from political oversight. Back
in 1993, I predicted that this would be the case and would lead
to excessively rule-based behavior. And that is exactly what we
saw with the ECB running the European economy partway into the
ground.
We know that in the Bank of England, and then more recently
in the Bank of Japan, we have seen resetting of the policy
goals by elected officials in an explicit, transparent manner,
taking advantage of the crisis and saying, what have we
learned? And this has suffered no shock to inflation, nor
stability; it is the way it should work.
So does the Fed have it right? I think largely we can say
yes. But I think there are three points I would make. First, an
atmosphere of extreme distrust from Congress towards the Fed is
harmful and unnecessary. We have the whole notion of auditing
the Fed, which is looking as though the Fed isn't totally
transparent about its balance sheet, which it is. We have the
idea of minutes having to be very explicit and tell you
everything that was said exactly, which has the effect of
making people ashamed to really debate in the FOMC because they
are worried about being caught up. We have the fact that
capital in the central bank is not guaranteed and therefore the
Fed restricts itself from engaging in policies it should, such
as potentially selling off assets, because they don't want to
have to come to you and explain an on-paper loss. You could
indemnify the Fed against losses incurred in the operation of
its duties, as Her Majesty's Treasury does for the Bank of
England.
Most importantly and harmfully, Congress has put increasing
restrictions on what the Fed can purchase. This is a terrible
step backwards in policy. Every central bank in the world
except the Fed can purchase a broader range of assets than the
Fed currently does. Every central bank in the world for
centuries has purchased private assets and a wide range of
assets. It was only this brief interlude from the late 1970s to
the early 2000s when central banks made the mistake of thinking
they could affect the whole economy by playing at the short end
of the yield curve in the government bond market. That has been
demonstrated to be completely wrong by the experience of the
last few years. Look at the fact that in Europe right now, you
have a total crushing of small business credit in southern
Europe because the ECB chooses only to purchase certain things
at the international level.
Let's talk for 1 minute left on tools. Building on this
point about where the central bank--Congress has fruitlessly
and destructively restricted the Fed's purchases. We have the
fact that we get this demonization of purchases and large
balance sheets and so-called unconventional monetary policy.
Now, the fact is, unless you buy the right things, your
policies will be ineffective. The Bank of Japan proved this
with its quantitative easing in the mid-2000s when it only
bought short duration debt and had no effect on the economy.
Once they shifted to buying private and longer term debt, they
have managed to reverse deflation.
It is wrong in the United States to think that there has
been any mistake here. If the United States hadn't been lucky
in the fact that Congress has allowed the Fed to buy guaranteed
mortgage-backed securities, we would not have had an effective
policy response. Had we not had that effective policy response,
we would not have the housing-led recovery, such as it is that
we have today. And that was sheer luck that Congress happened
to have approved of MBS purchases.
To repeat, no other major central bank is constrained the
way Congress has constrained the Fed in its purchases. This is
taking the Fed in exactly the wrong direction.
Thank you, Mr. Chairman.
[The prepared statement of Dr. Posen can be found on page
68 of the appendix.]
Mr. Huizenga. I appreciate that input.
And I need to make sure that I get my notes here for a
moment. Because of the shutdown that had occurred, we had a
well-known expert on the subject who we invited to the original
scheduled October hearing, but he is unable to attend today.
And without objection, I would like to put Dr. Larry Lindsey's
prepared testimony into the record. So without objection, we
will do so.
And with that, the Chair is going to recognize himself for
5 minutes.
Mr. Posen, you are on a bit of a roll against Congress
here, and I would add that you are not unique in that in many
ways lately.
Mr. Posen. My complaints are more narrow, sir.
Mr. Huizenga. Yes, yes. I understand your complaints are
more narrow. Come to a town hall meeting sometime, and you will
have your world broadened.
But I just wanted to make sure that you had a chance to
express that fully about the limits on the purchases and those
kinds of things. And then I would like the rest of the panel to
maybe touch on that and whether they would agree with that.
Mr. Posen. Very kind of you, Mr. Chairman. And again,
obviously, I am working in shorthand; there is no one entity of
Congress, and there are obviously people like you and this
committee who want to thoughtfully try to do the best possible
job. And that is why I am grateful that we are having this
hearing.
Mr. Huizenga. Duly noted, the buttering up. I appreciate
it, though. So I thank you.
Mr. Posen. Transparency. The issue is pretty
straightforward in my eyes. Central banks literally did most of
their operations on private loans and private securities
throughout the 19th Century and throughout much of the 20th
Century. They did so in an environment with many different
things going on, but rarely resulting in inflation, rarely
resulting in hyperinflation, rarely resulting in instability.
And they did this because it had two advantages. First, it
directly went after issues in the markets where there were
blockages in the markets. And second, this helped to make
markets and create more liquid conditions more broadly that you
could intervene.
Now, there are costs to doing this because it does of
course benefit specific holders of given assets at a given
time, which you don't want to do. And there are costs because
if it is a narrow market you happen to buy into, it is not that
easy to get in and out and the Fed can have too large, or
whatever central bank, can have too large an effect on the
asset prices. So it is not costless, but it is a tool.
Mr. Huizenga. Would anybody else on the panel care to
comment on that quickly? Dr. Lachman?
Mr. Lachman. I would just make the point that the size of
the asset purchases by central banks is without any precedent.
It is on a scale that is humongous. So I think not to have
congressional oversight on the particular assets that are being
made when you are getting distributional effects, I am not sure
that I would go along fully with Mr. Posen's point.
Mr. Huizenga. Okay. And I would like to just quickly, I am
going to take a moment. I would like to submit this into the
record, without objection.
This is from yesterday's Wall Street Journal, ``Confessions
of a Quantitative Easer.'' This was Andrew Huszar, who is a
senior fellow at Rutgers Business School, and a former Morgan
Stanley managing director. In 2009 and 2010, he managed the
Federal Reserve's $1.25 trillion agency mortgage-backed
securities purchase program. And I don't know if anybody else
has read this. If so, I would love to get a comment on it. But
basically, a little headline: ``We went on a bond-buying spree
that was supposed to help Main Street. Instead, it was a feast
for Wall Street.''
Dr. Makin?
Mr. Makin. The ``feast for Wall Street'' rhetoric is
popular, but I think it obscures a problem that the Fed faces.
And that is, on the one hand, they want to make sure that they
keep the recovery going. And so, they are buying assets. I
agree that they should be able to buy a wider range of assets.
But given the constraints they are facing, they have to buy the
assets in order to keep the recovery going. On the other hand,
they are supposed to avoid affecting asset prices, which of
course is impossible.
And the dilemma they face was highlighted last May when Fed
Chairman Bernanke suggested that perhaps they should taper or
they should reduce the rate at which they are purchasing
securities. The result was a 1.5 percentage point increase in
mortgage borrowing rates. So I think perhaps the author of the
Journal piece, it is easy to criticize, but, on the other hand,
if you withdraw what the Fed is doing, you risk some serious
problems in the financial markets. And so in summary, what the
central bank, especially the Fed is trying to do is to find a
way out of providing a large amount of support for financial
markets without disrupting the behavior of the economy and
causing a sharp rise in interest rates. It is very difficult to
do.
Mr. Huizenga. Dr. Orphanides, for the last 30 seconds.
Mr. Orphanides. Thank you, Mr. Chairman. I would also agree
that it is an unfair criticism both for the Federal Reserve and
for other major central banks to claim that they have been
trying to help the banking system and not Main Street. In order
to best help Main Street, central bank policies often have to
focus on the financial sector. This is what we have seen both
in this country and in other countries.
With regard to the purchases of securities, I would agree
with Dr. Posen that it would be useful for the Federal Reserve
to have the authority to make purchases of other instruments.
This is exceptionally important in times of crisis when even
very small interventions by the central bank could unclog
markets.
In the case of Europe, this proved very important. For
example, in 2008, 2009, the ECB made small purchases in the
covered bond markets just for a short while, and that helped
stabilize the market and restore stability. So you don't need
many purchases, you need it as a crisis management tool. That
said--
Mr. Huizenga. I'm sorry. Unfortunately, my time has
expired. So we are going to have to allow one of my colleagues
to explore that.
The last thing I would like to do, without objection, is
also put into the record an article entitled, ``ECB's Praet:
All Options on Table, Central Bank Could Adopt Negative Deposit
Rate, Asset Purchases If Needed.'' So without objection, it is
so ordered.
With that, I would like to recognize Mr. Clay for 5
minutes.
Mr. Clay. Thank you, Mr. Chairman.
Today, it is widely acknowledged that over the past few
decades the United States experienced a sharp rise in income
inequality, levels of inequality not seen since the late 1920s.
Moreover, a recent study out of Berkeley has shown that most of
the benefits of growth experienced during the recent recovery
have accrued to the wealthiest in society.
And when you talk about Fed policies having important
distributional impacts on society, do you believe these
policies in any way contribute to the problem of growing
inequality? Can you give us some examples of Fed decisions that
have impacted different segments of society differently and
how? I want to start with Dr. Posen.
Mr. Posen. Thank you, Mr. Clay.
The ongoing rise in income inequality, and particularly
wealth inequality in the United States, is largely driven by
the U.S. Tax Code, which you are well familiar with, obviously.
It is secondarily driven by a global trend that low-skilled
Americans and low-skilled workers are getting less and less
ability to bargain for wages, while people at the high end of
the scale in terms of perceived skill or opportunity get to
bargain at superstar status. Those are the two main drivers,
and those continued through the crisis.
The crisis made things worse in the United States and
elsewhere because of course the most vulnerable become
unemployed and you see fiscal cutbacks on the provisions that
go out to them. Particularly in the United States we saw at the
State and local government level, that it was a big cutback and
cutback opportunities through the community college and other
such systems. Again, this committee is well familiar with that.
Where does the Fed come into this? The Fed basically is
contributing to inequality. But similar to what Athanasios, Dr.
Orphanides just said, it is contributing to inequality in a
minor way to prevent a very concentrated blow to inequality in
a major way.
Let me spell that out. The way the Fed policy is working is
it is benefiting stockholders and relatively middle-income
householders, people with mortgages, disproportionately. And
then you hope that by benefiting those, that will lead to
growth in the rest of the economy. And that isn't going for
equality.
Had the Fed not taken the course it did, you would have
seen a much higher increase in small business failures and in
unemployment. And so the overall inequality picture might not
have been that different, but the concentration of very bad
outcomes would have been very high.
Mr. Clay. I see.
Dr. Makin?
Mr. Makin. I agree that the tax system is a much more
effective way to address problems of inequality than the Fed.
The Fed's goals are already perhaps more than instruments they
have to achieve them with, that is to maintain inflation at a
low and stable level and to try to minimize unemployment. To
that extent, they are trying to deal with all sectors of the
economy. But for the Fed to be charged in any specific way, I
don't know what instrument the Fed would use to affect income
distribution. So I would turn to the Tax Code to effect that
outcome, and suggest that perhaps a flatter schedule of tax
rates would be a good idea.
Mr. Clay. Thank you.
Dr. Orphanides, would you have any comment on the income
inequality?
Mr. Orphanides. Thank you. I would like to emphasize that
central banks do not have the tools to achieve all that society
might wish that government institutions might be able to
contribute to. The best way central banks can contribute to
even an element such as the reduction of inequality is by
ensuring stability in the economy, the preconditions for
economic growth that can then allow households and corporations
and businesses to prosper and allow the Congress with fiscal
policy to select distributional policies it would have with
high income.
We cannot expect central banks to deal with this problem. I
believe that in the last few years, we have been overburdening
central banks already. We expect them to keep interest rates
low and help fiscal policy as well. We expect them to
contribute much more than they can to full employment. We
expect them to fix all the problems of the financial system. We
cannot have all of these expectations simultaneously.
Mr. Clay. Dr. Lachman?
Mr. Lachman. Yes, I would basically agree--
Mr. Huizenga. The Chair is going to take a prerogative
here. My time went a little long, so without objection, I will
grant just this answer.
Mr. Clay. Thank you.
Mr. Lachman. I will keep it really brief. I would certainly
agree that you don't want to overburden the central bank with
too many things to do, that price stability is a big enough
task that will do a lot of good. So I would think that other
policies, fiscal policies, stuff of that sort, is a more
appropriate way to deal with the distribution issue.
Mr. Clay. Thank you, Mr. Chairman.
Mr. Huizenga. No problem. Thank you.
With that, the Chair is going to recognize Mr. Pearce of
New Mexico for 5 minutes.
Mr. Pearce. Thank you, Mr. Chairman.
Mr. Makin, you had made a comment there in response to the
gentleman from St. Louis' question about income inequality.
Would you state that again? I am just not sure that I heard the
whole thing.
Mr. Makin. Very briefly, as the other panel members have
suggested, the central bank is really not equipped to address
issues of income distribution. And the tax system is a better
way to do that.
Mr. Pearce. And would you have any ideas, understanding it
is not the Federal Reserve or central bank's job, but what
would you recommend on the tax policy if you were going to make
a recommendation?
Mr. Makin. I would prefer a kind of textbook approach,
which was followed in the 1986 tax reform, which was to have
the lowest possible rate on the broadest possible base. So that
would partly involve financing lower marginal tax rates by
closing loopholes, among other things.
Mr. Pearce. Mr. Posen, the Federal Reserve has driven
interest rates to almost zero--or to actually zero. Is that a
good policy long term for the United States?
Mr. Posen. Congressman, it was a good policy and it remains
a good policy given the economic context in which we find
ourselves, and it is a policy that has very little in the way
of long-term implications. Despite the comments made by Dr.
Lachman earlier, there is no statistically significant evidence
across countries that low interest rates lead to bubbles. It is
just not there in the data. It requires a combination of
regulatory changes and animal spirits to get bubbles. Low
interest rates don't cause them. And if it is not about
bubbles, it is not clear what it does.
There are second order, meaning existing but not huge
distributional effects. My mother, who is a retiree, who has
mostly invested all her savings in government bonds has less
income now because the Fed did that. Other retirees who happen
to have 401(k)s have more income because the stock market went
up. The Fed can't fine tune that without getting into deep
trouble. And I think on net, it is not a big deal one way or
the other. The interest rate only--
Mr. Pearce. If I could take back my time right there, I
would invite you to come to my town halls.
Mr. Posen. Okay.
Mr. Pearce. I have seniors, we have a little bit older
population in New Mexico, they come there for the hot, dry
weather. They say, we lived our life correctly, we paid for our
houses, we have cash equivalents. We used to get 4 percent
income--this statement was made this past week--on our
investments, and now we are getting one quarter of 1 percent.
So for every $16 they used to live on, now they have $1. And
they are spending into their capital.
And to hear you describe that as not significant, I would
like you to use that terminology in front of the hostile people
that I get to face at our town halls. Because I will guarantee
you, my friend, it is a significant impact on the lives of
seniors who have lived correctly, and because of the policies
of this government and this Administration, they cannot even
live in retirement. And to have that described as
nonsignificant statistically just drives people insane when
they hear folks in Washington say crap like that. Statistically
not important.
Do you have a response?
Mr. Posen. Yes, indeed.
Mr. Pearce. Yes?
Mr. Posen. I have two responses. First, when I was serving
at the Bank of England I did those town halls myself, without
the protection of some local Congressman or MP. I talked to
over 8,000 individual U.K. citizens while I was there. And I
held myself accountable to people. And I explained to them that
just as you think about the 4 percent you used to have wasn't
controlled by you and wasn't set by the government, it was a
market effect. In reality, if this economy is not growing,
there is no interest rate out there. And it is not for the
Federal Reserve to subsidize people just because they happened
to have done what you call living correctly. Secondly--
Mr. Pearce. I have 24 seconds, sir. And the Federal Reserve
is subsidizing Wall Street, because zero interest rates are a
boon to the big bankers. They get money for free, and they are
able to then charge more.
Mr. Chairman, I yield back my time. Thank you.
Mr. Huizenga. The gentleman yields back his 5 seconds. All
right.
With that, the Chair recognizes--
Mr. Perlmutter. The gentleman from Colorado. Ed Perlmutter,
the gentleman from Colorado.
Mr. Huizenga. Yes, my former neighbor who moved away from
me.
Mr. Perlmutter. How soon you forget.
Mr. Huizenga. Yes. With that, the gentleman has 5 minutes.
Mr. Perlmutter. Mr. Posen, I have a bunch of questions. Do
you want to finish your second point to Congressman Pearce?
Mr. Posen. That is very generous. I will be brief. The
definition of living correctly is in the eye of the beholder.
Most human beings in the United States live correctly. And
whether it is the children of the unemployed; they don't
deserve to bear the burden of the crisis any more than the
people you are meeting with in your town halls. I wouldn't make
a moral judgment.
Mr. Perlmutter. And I thank the gentleman for that. I
thought you might want to say they ought to take a look at the
value of their homes, which had dropped like a rock. And
because there has been some effort to stabilize and grow the
economy again, really only on the backs of monetary policy,
that they can look at their house and see some value returned
to their house that fell like a rock in 2008 and 2009 and 2010.
That is where I thought you might go.
Mr. Posen. That is better.
Mr. Perlmutter. I appreciated a couple of words that were
used. Dr. Lachman, you used one, and, Dr. Makin, you used one.
One was ``humongous.'' I understand the word humongous. And the
other was extemporize. And, through this recession, crash, fall
on Wall Street, whatever you want to call it, we saw some
constrictions in the stock market and in the financial market
that we hadn't seen at least--maybe ever, but certainly not
since the Depression or before then. It was a different kind of
a constriction.
And I appreciated the comments of all the panelists that
some very difficult steps, some new steps were taken by the
Federal Reserve, as well as a number of the other central
banks, because they are looking at the whole economy crashing.
And then it is like, price stability, we saw prices drop in
2008 and 2009, certainly in the real estate market, and in
other markets, oil and gas. It went from $4 during the summer
of 2008 in Colorado down to about $2 or less.
So I guess I would ask just as a general comment, and I
know all of you were focused on this, have we as legislators,
where we really have not had much of a fiscal policy over the
last 2 years except for a very contractionary fiscal policy,
and we put restraints on our Federal Reserve, have we done the
right thing? And I will start with you, Dr. Posen, but I
definitely want to get to the other gentlemen to get their
response.
Mr. Posen. I should defer to the other people's time. Just
quickly, we have basically done the right thing. It doesn't fix
everything. It doesn't fix everyone. But putting the
restrictions on means when the next crisis hits outside the
housing market, we are not going to be able to respond to it,
and you are just going to have very indirect means of
responding to it.
Mr. Perlmutter. Dr. Makin?
Mr. Makin. Yes, let me pick up on the word ``extemporize.''
A financial crisis presents policymakers with unprecedented
problems. We have seen a combination of measures undertaken by
the Fed, as well as fiscal stimulus packages undertaken by the
Congress. Putting it all together, the outcome is okay, the
best, actually, among the industrial countries.
Mr. Perlmutter. And looking at your graphs, I think your
graphs verify that or support that.
Mr. Makin. Right. We have had about 2 percent growth
without a lot of inflation. The employment picture hasn't
improved a lot, but that is partly because of some major
changes that have occurred in the labor market. But so we have
extemporized in a difficult situation and done better than most
industrial countries. We certainly do need to do better. And we
will eventually need to abandon these extreme policies, as the
Congress has already done on the fiscal side. It just takes a
very cautious and gradual approach.
But for example, if we were to want to abandon the
quantitative easing and the zero interest rate policy, interest
rates would shoot up, the stock market would collapse, owners
of bonds would get a higher return on their savings, but they
might be faced with substantial wealth losses in terms of the
value of some of their other assets. So we are in a difficult
period now, but so far we have extemporized and done reasonably
well.
Mr. Perlmutter. Dr. Orphanides?
Mr. Orphanides. Thank you.
Central banks are incredibly powerful institutions,
especially during crises when using the balance sheet of a
central bank can paper over a lot of problems that you wouldn't
have thought about that could be done during the crisis.
I am worried that with the additional restrictions that
have been placed on the Federal Reserve in light of the actions
that they took in 2008, the Federal Reserve may be overly
constrained. And because of the need to coordinate with the
Treasury, and in some instances with Congress, the additional
delay might actually create problems if we had a crisis such as
the one we had in 2008. That is the concern.
Mr. Perlmutter. Thank you, Doctor.
And I'am sorry, Dr. Lachman, that I didn't get to you.
Maybe one of my colleagues can let you respond. Thanks.
Thanks, Mr. Chairman.
Mr. Huizenga. And my apologies to my friend from Colorado
for totally being the deer in the headlights and blanking. So,
2 years of being directly next to each other and I am blank.
With that, we are going to go to Mr. Mulvaney for 5
minutes.
Mr. Mulvaney. Thank you, Mr. Chairman.
Gentlemen, I will read you a statement from last year's
meeting of the Joint Economic Committee. It says, ``With
respect to employment, monetary policy as a general rule cannot
influence the long run level of employment or unemployment.''
That is a true statement, isn't it? That is economic orthodoxy,
correct? Does anyone disagree with that?
Mr. Makin. I will jump in. I essentially agree with that,
that what monetary policy can do is to move employment
increases forward, but they tend to get lost.
Mr. Mulvaney. I think the general consensus is they can
affect short run, but not long run.
Dr. Posen, you had a look on your face like maybe you
disagreed with that statement.
Mr. Posen. I disagree slightly, sir. If you go to the most
recent paper issued by the Federal Reserve by Mr. Wilcox and
co-authors--
Mr. Mulvaney. I am familiar with it.
Mr. Posen. --it talks about the idea of hysteresis, that if
you have a negative shock it could become self-fulfilling; that
people who are out of work for a long time don't get to get
back into work at the same rate, say, of a young person. We saw
monetary policy have a positive lasting effect on employment in
the mid-1990s. We had welfare reform in the United States that
increased the incentives for people to go to work. Monetary
policy was allowed to run hotter for longer than it normally
would have under the leadership of Chairman Greenspan. The
unemployment rate dropped much lower than what people thought
the limit was because of that. So under certain conditions, I
think it can matter.
Mr. Mulvaney. All right. There is another quotation I will
read very briefly: ``In the longer run, increasing the
potential growth of the economy, that is not really the Fed's
job. That is the private sector's job and Congress' job in
terms of things like the Tax Code, investment, infrastructure,
and training.'' That is Chairman Bernanke. Both of those
quotations are from him.
So my question to you is this: Why are we one of the only
two countries that has the dual mandate? Is it because it is
economic orthodoxy that you cannot impact--the Chairman of the
Federal Reserve says that we cannot impact long-term employment
with monetary policy. Yet, it is our mandate. And that is what
I don't understand. Why are we one of two countries that has
the mandate when we know that monetary policy can't influence
it in the long run?
Dr. Lachman?
Mr. Lachman. I think one really has to be cautious. One
really doesn't want to have a single mandate that you pursue
with great vigor to the exclusion of what you are doing to the
economy. That really gives the incentive for being too vigorous
in the pursuit of the inflation. And I would just take a look
at the European experience, where the single mandate right now
is leading them down a path towards deflation--
Mr. Mulvaney. No, I don't know about that, because I went
on to ask Dr. Bernanke on a similar line and what he told me
was very clear. It is actually consistent with what Dr. Posen
said earlier today, which is that the activities of the Fed
over the course of the last several years since the crisis
would have been essentially the same, because you could have
undertaken the same policies for the last 4 or 5 years in the
name of fighting deflation. We happen to be saying we are doing
it in pursuit of full employment, or close to full employment,
but really without the dual mandate, the Federal Reserve would
have undertaken the same couple of steps. So I understand that.
I am just worried about the situation where those two
things diverge. And that is what the paper is about, are we
going to tolerate higher inflation in the future in order to
pursue this lower rate of employment? And I guess my question
is, why would we do that if we know that we cannot impact long-
term employment.
But I am going to move on to my question, because Dr. Posen
said some very interesting things in his testimony, his written
testimony about limiting the tools. If I can very quickly
recognize, we have a minute to cover two very important things.
Limiting the tools. Should we limit some of the tools? If
Detroit comes to Congress and asks for us to lend them money
and we tell them no, shouldn't we restrict the Federal Reserve
from participating in that? Wouldn't that be crossing the line
into fiscal policy?
Mr. Posen. Yes. But I am not sure you need to restrict it
in advance. I think you can afford to wait and then call up the
chairperson and say you made a bad judgment there, I wish you
hadn't done that.
Mr. Mulvaney. Fair enough. I guess the cows are a little
bit out of the barn after that, though, aren't they?
Mr. Posen. No. Because just as happened in Japan, sir, you
can make a major change. Obviously, it is like with the
military, like with the FDA, at some point you let them do
their job, and if they don't do their job right then you hold
them accountable. You have to allow for that.
Mr. Mulvaney. Secondly, and I am sorry to cut you off, you
recognize the fact we are limited on time, you mentioned
indemnifying the Fed against the losses. Your paper says that
of course they have made so much money over their lifetime that
they would never eat into that surplus. I think it was actually
a Bloomberg report recently that projects could lose as much as
$537 billion, which would absorb all of the money that they
have made. Tell me again how this indemnification would work. I
am not familiar with that.
Mr. Posen. Thank you. I will just be very quick. What has
happened in the U.K. and a few other places is they say the
balance sheet, any profits belong to the government, the
elected government, as it should. And we reckon those at a set
term, whether it is once a year, once every 2 years, once every
6 months. There is a fixed, transparent term that doesn't get
played with.
If in the operation of your duties, not just benefiting
Detroit because you happen to have a Governor of the Fed from
Detroit, but in the operation of your general duties you take a
loss on the balance sheet, there will be some buffer of the
Fed's capital. You don't want to have that go to zero. It
doesn't really matter if it does in economic terms, but it is
seen as a problem. And so the Treasury or the Congress would
say if that capital drops below a certain number, we will
replenish it.
Mr. Mulvaney. Thank you, sir.
Mr. Huizenga. The gentleman's time has expired.
With that, we go to Mr. Carney of Delaware for 5 minutes.
Mr. Carney. Thank you, Mr. Chairman.
And thank you to each of the witnesses for being here
today. This is a very interesting conversation. But I think at
the end of the day the question is what is the role of
Congress, what is the role of elected officials? Dr. Posen, you
said that elected officials should set the goals and then check
for results. And we have been talking, Mr. Mulvaney has been
talking about the dual mandate of price stability and
employment. Is there a general agreement among the panelists
that ought to be the goals for the Fed?
Mr. Makin. Price stability and employment?
Mr. Carney. Yes.
Mr. Makin. I would disagree. I think I indicated earlier
that price stability is something the Fed can achieve. There is
not much evidence to indicate that they can achieve either a
long-term reduction in the rate of unemployment or a long-term
increase in the rate of employment growth.
Mr. Carney. How do you answer Dr. Lachman's answer to the
last question, where he said if you get overboard like the
European central banks have recently, you very negatively
affect employment and the economy? Dr. Makin?
Mr. Makin. I am not quite sure that I understand Dr.
Lachman's point. In other words, what the central bank is
responding to in that type of a situation, it seems to me,
based on what was happening in 2008, is the situation in the
asset markets where you have a threat to the functioning of the
financial system. So they are stepping in to try to sustain the
financial system.
Mr. Carney. Okay. Fair enough.
How about the other two gentlemen and then Dr. Posen?
Mr. Orphanides. If I may provide my response as well to Dr.
Lachman's remark earlier on, I think that with regard to the
euro area, we should not confuse what is happening, that is
quite dramatic and unfortunate, as a failure of monetary
policy. Unfortunately, it had nothing do with monetary policy.
Monetary policy cannot fix it. We have a governance problem
where the States are essentially fighting with each other and
do not coordinate in a proper manner, because really they do
not have a Federal Government and they do not have the
equivalent of the U.S. Congress that can hold things together.
Mr. Carney. Okay. Fair enough.
Mr. Orphanides. I would not really attribute to mistakes of
monetary policy what we see in Europe. With that said, I would
agree with Dr. Makin that in my view as well, price stability
should be the primary objective of the central bank, because
this is what they can be held accountable for. And then beyond
that, I think what is critical for Congress is to watch the
appointment process so that the independent officials who are
appointed to make the tough decisions are the best possible.
Mr. Carney. Okay. Fair enough.
Dr. Lachman, how about you, where do you fall on this?
Mr. Lachman. I would just say that Europe has just emerged
from its longest post-war recession, that inflation in Europe
has gone down to levels that are now threatening deflation, and
the central bank has been very slow in either reducing interest
rates or taking measures to improve the monetary transmission
mechanism in Europe. So to me it looks like the European
Central Bank, with its single-minded mandate of getting prices
very low, is risking the economy in terms of deflation.
Mr. Carney. So if you have a dual mandate, you are keeping
your eye on two different things. And what does that require
that central bankers do that mitigate against the severe kind
of effect?
Mr. Lachman. I guess if they have a balanced approach
towards meeting their target.
Mr. Carney. Thank you.
Dr. Posen, would you like to weigh in?
Mr. Posen. Yes, really quickly. In an ideal world, it would
be a dual mandate of price stability and avoiding excess
volatility in the real economy, meaning huge swings in
employment and growth, but not a level target for unemployment.
I would still rather have Humphrey-Hawkins and the dual mandate
as it is than a single mandate. I differ with Athanasios
Orphanides on this. I think central banks that have the single
mandate, I am echoing Dr. Lachman here, tend to become
inflation nutters and not live up to their needed role. We also
need to think about financial stability, whether it is said
explicitly or not. Central banks have to worry about that.
Mr. Makin. Could I add a quick--
Mr. Carney. Sure.
Mr. Makin. The problem in Europe is not so much the lack of
a dual mandate as it is that the European Central Bank is the
central bank for over 20 very different countries.
Mr. Carney. So they effectively would have a difficult time
affecting employment across those boundaries anyway.
Mr. Makin. Their policy is fine for Germany; it is terrible
for Spain.
Mr. Carney. Thank you. Thank you all very much. I wish I
had more time to carry on this conversation.
Mr. Huizenga. The gentleman yields back.
The Chair now recognizes Mr. Stutzman of Indiana for 5
minutes.
Mr. Stutzman. Thank you, Mr. Chairman.
I have really enjoyed this conversation. And I appreciate
each of your perspectives.
Dr. Posen, you just made a comment, and I want to see if
you could expound on it a little bit. You said price stability
and then excessive volatility. Could you expound on that a
little bit? Because I agree with you. I think certainty and
stability is what is going to help middle income, help folks of
lower income get to the next bracket, find the next rung on the
ladder. Because right now that is what they don't have. They
don't have certainty. Could you expound on that a little bit?
Mr. Posen. I will try, Congressman. And I know from your
past proposals that you are concerned about uncertainty
generated by monetary policy, and I respect that concern.
Essentially what the issue is, as Dr. Orphanides on this
panel and others have written about, is in the 1970s we made a
huge mistake, as you are well aware, because we assumed there
was this stable tradeoff between inflation and unemployment and
that if we just were willing to accept higher inflation we
would get lower unemployment. And that was doubly mistaken.
First, we underestimated how costly the higher inflation would
be. And second, we didn't get permanent employment gains; we
just got temporary ones.
And so since that time there is a lot of academic work and
a lot of policy work that has tried to get central bankers to
not talk about employment at all. For various reasons that we
have discussed, that seems to be something of a mistake. It
takes it too far. But there is a truth there that if you target
a specific rate of unemployment or you pretend that you can
really control the unemployment rate through monetary policy,
you probably are going to induce either inflation or
uncertainty.
So what I found in practice, and this is something we did
at the Bank of England, and which other central banks have done
in the past, is to say we may not know precisely what the rate
of unemployment is, and we may not be able to push it to where
people beg us to push it, but we can see when there is a big
swing in the economy, a very rapid change, be it a runup
because there is some uncontrolled boom, say, through a housing
bubble, or a rundown like we had in 2008 because of a financial
crisis, and the real economy, meaning real people, real
businesses, real savers are being put through the wringer, we
should try and offset that. And doing that in a short-term way
should not conflict with price stability.
Mr. Stutzman. Thank you. I appreciate that a lot.
I would like to go to Dr. Orphanides. I would like to ask
about some of the experiences that have developed under the
European Central Bank, which is the most recent central bank
that stood up a developed economy or economies. Given your
experience on the ECB Governing Council, what did the
architects look to when determining how to structure the ECB?
And then also, did they look to existing central banks as a
model?
Mr. Orphanides. Indeed, they did. And I have to say that I
believe that the Federal Reserve did have an influence on the
design, institutional design of the European Central Bank in
two ways, both directly--the Fed is the closest they could look
at in terms of a Federal institution that would bring together
Federal Reserves, Federal Reserve banks, and the central banker
in the middle, and coordinate this view--and also indirectly--
so many of the elements that the ECB drew on were from the
Bundesbank that was set up in the 1950s. But the Bundesbank,
when it was set up in the 1950s, actually had a structure that
also drew on the Federal Reserve.
So the ECB did try, and the founders of the ECB did try to
bring the best they could find internationally in their
experience. Indeed, this is why they selected to have the
lexicographic mandate that places price stability first,
because this is what had been recognized as the state of the
art when this was done in the late 1980s and early 1990s. And I
believe that is still the state of the art.
If I contrast that with the Fed, I think that the reason
that the Fed has a dual mandate right now is simply because its
own mandate was written in the 1970s, before we developed a
consensus that suggests that focusing on price stability and
helping central bankers not target real variables is best
practice.
Mr. Stutzman. If I could quickly, Dr. Makin, if you could
comment on Japan's QQE. Will it produce any different results
from just the QE program in Japan?
Mr. Makin. I believe it will. The Bank of Japan has
frequently attempted to get out of their deflationary trap. And
until this year, the bank was very conservative when they
announced more aggressive asset purchases. They said, we will
be very cautious, we are worried about hyperinflation, it
probably won't work.
This year, the Bank of Japan, under new leadership,
undertook to set an inflation target of 2 percent, which is
very important to do when you are trying to end deflation,
which is a very different game, and they have suggested that
they will follow through until they achieve the goal. The
ironic result I think that the Bank of Japan came to realize is
that a necessary condition to end deflation is to promise
inflation, a sufficient condition as to make it happen, and
then have the presence of mind to throttle back when the
inflation actually picks up.
Mr. Stutzman. Thank you. I yield back, Mr. Chairman.
Mr. Huizenga. The gentleman's time has well expired.
I do appreciate everyone's charity as we are getting into
some of these very important issues. And without objection, I
think if the panel is willing to stay, we can maybe do another
slightly quicker, if possible, lightning round of questions. I
know I have some. And with that, I would like to recognize
myself--and I don't anticipate using the 5 minutes--but I will
recognize myself for 5 minutes.
Mr. Makin, I think I got your quote down, and I believe it
was extemporaneous, I don't think it was in your written
testimony, but eventually we need to abandon these extreme
policies--this is the Fed, as you are talking about--just as
Congress has done fiscally. There are a number of us who might
be concerned that we haven't exactly abandoned our extreme
policies on stimulus spending. In fact, we are having this
debate right now dealing with unemployment going to be expiring
at the end of the year, the extended 2 years instead of the
much shorter time of almost a year. We have had that with
additional funding that went into nutrition programs, WIC, and
others.
And the political lesson that I have been learning out of
this is that it is very difficult to extract out of that. And I
think what you might have been hearing from Mr. Pearce and some
of my other colleagues is it seems like we are taking care of
Daddy Warbucks on Wall Street, and with quantitative easing we
are, I think as Dr. Posen was pointing out, oftentimes that
might be the vehicle you need to make sure you have a strong
financial center to let that all trickle down, but there are a
lot of us I think who are questioning, can we ever really get
out of that cycle? And I am curious how the Fed is going to
extract itself out of a QA position when you see markets and
Wall Street and maybe markets around the world say, oh, no, no,
we can't move off of $85 billion a month because that might
mean we are going to have some movement here in a direction we
don't like in the short term.
So if you care to answer that, and then Dr. Lachman, I
would like you to, really quickly.
Mr. Makin. Mr. Chairman, you have certainly hit the nail on
the head in terms of the dilemma. When I was thinking of fiscal
policy, I was thinking that in spite of many complaints the
Congress has managed to reduce the budget deficit by about a
third over the past year through a combination of the
sequestration cuts and the tax increases. And I was thinking of
that progress.
The Fed's problem is perhaps just as difficult. And as I
mentioned earlier, it is highlighted by what happens in the
marketplace when, as Chairman Bernanke did in May, they hint
they might buy less, and interest rates go up and security
prices go down, and everybody gets very nervous. So the short
answer is I don't know exactly how to do this. But neither
does--
Mr. Huizenga. I think part of the problem, exactly right,
is that neither does the Fed. Now, we are caught in this
hamster wheel.
Mr. Makin. Nobody does. So I think in terms of being very
practical, slowly and cautiously, and having reversibility as
you go along, which is what I think the Fed is trying to
engineer here. There is no book that tells you how to exit the
Fed's current strategy.
Mr. Huizenga. Dr. Lachman?
Mr. Lachman. Yes, I would agree that we are in uncharted
waters. But I think a crucial point is that the longer that we
delay the decision, the bigger the chance that we get asset
price bubbles, credit bubbles. We are at some point going to
have to exit. By delaying it, we just are going to make the
exit all the more difficult. We have been to this dance a
number of times before.
So my fear is that if you keep printing $85 billion a
month, and you have the Japanese printing $70 billion a month,
what you are going to do is you are just going to create a very
large asset and credit bubble that when you unwind it is going
to be all the more difficult. So I think that you really have
to be mindful that the benefits you get from the short run you
might be getting at the price of large costs in the longer run.
Mr. Huizenga. I think I will do this in writing, because,
Dr. Posen, we only have a minute left. But I would love to get
a reaction from you at some point of how you envision that we
are going to pull this liquidity out.
As Dr. Lachman is pointing out, Japan is at $70 billion a
month, and we are at $85 billion a month. We don't know what
the ECB is going to do. But apparently they are prepared to do
something as well. And how do we extract ourselves.
I do want to ask a very specific question, and maybe we can
get some answers in writing as well on that. What are those
reforms that you would like to see us do as we are approaching
this 100th anniversary? I think it was Dr. Posen, I am not
sure, but there was some discussion about an 8-year--is this
what the European Central Bank--maybe it was Dr. Orphanides--
European Central Bank you get an appointment for an 8-year
period, and then you are cycled out, correct, you are done?
That to me sounds like something that might be a positive. I am
curious if anybody has a reaction?
Mr. Orphanides. There are two suggestions I would make. One
is on the appointment process, that it would simplify and
reduce the political battles we have right now with multiple
rounds of potential appointments if you have a one-term,
nonrenewable, longer term for all Board Members. Eight years is
what is being done at the ECB. I think that would work better
in the United States as well.
The most important change, however, I think is to clarify
the mandate. I am concerned that the lack of clarity of the
mandate will be creating difficulties going forward precisely
because we have the uncharted territory and the humongous, I
think was the technical term used earlier, size of the balance
sheet of the Federal Reserve.
Mr. Huizenga. All right. Thank you.
Mr. Carney is recognized for 5 minutes.
Mr. Carney. Thank you. I am not sure I will need the whole
5 minutes. But I do want to go back to--
Mr. Huizenga. That is what I thought, too.
Mr. Carney. --our discussion again.
Not long after our discussion, Dr. Posen, you made an
argument against the dual mandate I think when referring to the
experience of the 1970s. Was that what that was?
Mr. Posen. It was an argument, sir, against setting a
specific level of unemployment target. So, I am in favor of the
dual mandate that there has to be concern for the real economy
for growth and employment as well as price stability.
Mr. Carney. Because it creates a sense of balance in the
thinking of the Members?
Mr. Posen. Exactly. And it gives you room to respond to
very large short-term fluctuations in the economy. And I would
still, as I said to you, I would still rather have a dual
mandate with an unemployment level than a single mandate.
Mr. Carney. Great.
Dr. Lachman, in your testimony you talk about the Lehman
crisis and what you considered the effective response of the
central banks and the Fed and how it avoided a global meltdown
and a lot worse conditions than we saw. And you reference
certain programs, including TARP. Have we eliminated tools that
the Fed needs to address a crisis in the future?
Mr. Lachman. I don't know whether you have eliminated them,
but I think that the Dodd-Frank Act might put certain limits on
what they can do or that their room for maneuver isn't quite as
what it would be prior to the Lehman crisis.
Mr. Carney. Notwithstanding some of the rhetoric in this
committee, we can't bail out banks in the way that was done in
2008. There is an orderly liquidation process, as you may know,
that banks are required to go through once it is determined
that they are dying, I guess. Is that a good thing or a bad
thing from the perspective of the broader economy? Forget about
the politics of it.
Mr. Lachman. My concern is that if we really do build up
very large credit and asset bubbles, we have a chance that we
are back into the kind of situation that we were at the Lehman
crisis, in which case you would want a Federal Reserve that had
wide capabilities of dealing with the mess when it occurred.
Mr. Carney. Lastly, what should our role be as a
subcommittee of Congress? Or what should Congress' role be?
Just, in a sentence or two each, each of you.
Dr. Posen?
Mr. Posen. As I tried to say in my written testimony, which
I apologize for delivering so late, I think Congress' role
should be very aggressive control of two things. First, what
the stated goals of the Federal Reserve are, and changing those
every couple of years as needed. Not, obviously, every day.
That would be counterproductive. But as needed. And second, as
I tried to say to the gentleman--sorry, I don't remember what
State you are from, I apologize.
Mr. Carney. New Mexico.
Mr. Posen. Thank you. The gentleman from New Mexico, the
Congressman from New Mexico, that you need to have much more
retrospective accountability of holding Fed officials, did you
do your job well or not? What specifically did you do? And are
you accountable for that? But doing it in a holistic,
retrospective way, not a starting off and saying there are
things we want the Fed to do and not do. It has to be context
and results based.
Mr. Carney. Dr. Makin?
Mr. Makin. Yes, I would like to see a directive for the Fed
to pursue price stability, but not to ignore other goals. In
other words, to emphasize that the Fed consistently pursues
price stability and minimizes uncertainty, and thereby helps to
improve the picture for employment and asset prices. In other
words, I don't think the Fed should be seen as saying, hey, we
don't care what happens. But they should be seen as saying, we
want to continue to maintain low and stable inflation. There is
a lot of empirical evidence to suggest that the economy
performs better under those circumstances and that labor
markets perform better as well.
Mr. Carney. Dr. Orphanides?
Mr. Orphanides. I am a supporter of the primacy of price
stability as an objective. And something we did not discuss
sufficiently today, I believe, is that financial stability
should be elevated as one of the explicit secondary mandates of
the Federal Reserve rather than growth and employment. Those
come naturally once you have price stability and financial
stability.
Mr. Carney. Dr. Lachman, a last word?
Mr. Lachman. Yes. I agree with the way Dr. Posen posed the
idea that the dual mandate should be working without a specific
unemployment target. I am not sure that Congress should limit
itself to retroactive review of the purchases that the Fed is
doing given the scale of the purchases and given that it does
have a distribution effect. I would think that Congress should
have some input into those decisions.
Mr. Carney. Thank you.
Mr. Huizenga. The gentleman's time has expired.
With that, we will go to the gentleman from New Mexico, Mr.
Pearce, for 5 minutes.
Mr. Pearce. Thank you, Mr. Chairman.
So we began this process--and Dr. Lachman, I am probably
going to come to you--of quantitative easing, printing money,
whatever you are going to call it, and now it looks like we
have initiated maybe that kind of an effect worldwide, that if
it is good for us, everybody can do it. What are the downside
effects of everybody beginning to create money out of thin air?
Mr. Lachman. I think the reason that everybody has to do it
is it does have impact on their currencies. That cheapens
certain currencies, puts countries at a disadvantage. They will
find themselves in the same position, so they go ahead with
doing it.
My view is that if all of us do this to a very large
degree, and we have global financial markets, the risk is that
what you get is you get global bubbles, and that when you begin
withdrawing from that policy you are going to be paying a heavy
price. I am not saying that quantitative easing wasn't the
right thing to do at the time that it was initiated. But I am
saying that now that the balance sheets are so large and it
looks like there is froth in the markets, I think that there
has to be pause as to whether you just continue this
indefinitely or do you start the process of unwinding.
Mr. Pearce. But then when we started unwinding we had one
Member of the Federal Reserve saying at one point the same day
we need to start tapering, and another Member of the Federal
Reserve shrieked that we can't start tapering. And so you get
this mixed signal, and the markets are a little bit volatile.
What is going to happen, Dr. Orphanides, if we get dropped
as the world's reserve currency? What will the effect of the
quantitative easing be on the currency inside the United
States?
Mr. Orphanides. I would put this in reverse. Of course, it
would be catastrophic for the United States if the dollar loses
the status of reserve currency.
Mr. Pearce. And so, it would be catastrophic.
Mr. Orphanides. This is one of the risks of continuously
expanding the balance sheet of the Federal Reserve without
having--
Mr. Pearce. If I can reclaim my time, it would be
catastrophic. You can look at Argentina. They don't have a
currency. They can't export inflation like we do. We get to
export to 200 other countries, and so we diminish the effects
inside. And so Argentina a couple of years ago had a 1,500
percent inflation rate, and so your statement that it would be
catastrophic. So it really got my attention this year, maybe it
was late last year, that the BRIC nations said they were going
to start trading in other currency--Brazil, Russia, India, and
China--and then two of them actually did that.
So we are getting these warning signs from the rest of the
world that you are creating some very unstable things with very
catastrophic effects. We have started a printing war. And
nobody knows the way out. Any hope? So what stops it all?
Anyone? Dr. Makin, I will just come to you next. Dr. Posen, I
give you the last shot to wrap it up.
Mr. Makin. There would be much more cause for urgent
concern if we were seeing all this money printing and observing
a big pickup in inflation. In fact, we are seeing the reverse,
that inflation is actually slowing down. It is below 1 percent
in Europe. It is about 1.2 percent in the United States. And
so, you have a deflationary situation that was kind of akin to
what was happening in the early 1930s, and central banks tend
to want to export deflation by printing money, causing their
currencies to depreciate, which means other currencies
appreciate.
So we have to avoid a kind of overt currency war of that
type and at the same time try to get past a situation where
everybody is using easy money to get a bigger piece of world
trade. In other words, avoid a trade war, which is one of the
things that made the Depression worse.
Mr. Pearce. Thank you.
Dr. Posen, I assume that was your saying. You didn't really
have a comment to make on this.
I guess the final thing is, what does this look like to the
American family? My dad raised 6 of us on $2.62 an hour, the
entry level in the oil field. Today, what his dollar would buy
it takes $12 to buy. I think that is one of the reasons we are
having such great stress in the American economy, that the
value of what people make is being diminished radically by
policies that the government is setting.
I yield back, Mr. Chairman.
Mr. Huizenga. The gentleman yields back.
Seeing none on my over side of the dais here, we will go to
Mr. Mulvaney for 5 minutes.
Mr. Mulvaney. Thank you.
Mr. Huizenga. And I should also announce we have just
gotten notice that we will have votes at about 4:15. So if it
is all right with you gentlemen, we will be wrapping up shortly
after this round.
Mr. Mulvaney. Thank you, Mr. Chairman. And thank you for
the opportunity to do a second round of questions.
Dr. Posen, this gives us an opportunity to spend a little
more time on the last topic we had to sort of rush through at
the end. I think I misspoke on a couple of numbers. And I want
to give you the opportunity to speak at some length as well. We
are talking about losses on the Federal Reserve's balance
sheet. I asked you previously about the concept of
indemnification. I want to point out in your testimony the
thing that caught my attention and re-ask my question.
It is on page 10, the last paragraph: ``Worries about
losses on risky assets are nothing but a distraction. Whether
the Fed temporarily loses money on a small portion of its
portfolio or temporarily distorts a hypothetical pure market
outcome for a particular asset class in service of that greater
good should not be a constraint on doing the right thing.''
You go on to close by saying, ``And of course, the
cumulative gains that the Fed has transferred to the U.S.
Treasury over the decades outweigh by two orders of magnitude
any potential losses on the Fed's balance sheet.''
I guess we could have had a long conversation of a day
about whether or not losses that the Fed faces now, the
potential losses, and the number was actually $547 billion that
Bloomberg estimated the Federal Reserve could lose in a higher
interest rate environment, whether or not that is a temporary
loss on a small part of its portfolio or whether or not we are
simply seeing a temporary distortion in the pure market for,
say, mortgages, or whether or not there is a larger, more
significant distortion.
I want to come to the issue about the cumulative gains and
losses. The point that I was making is that I think of the
cumulative gains last year, the combined earnings of the Fed,
out of the combined earnings they were able to return back to
the Treasury about $89 billion, $90 billion. And this is, as
you mentioned, the case with other central banks, the policy,
which is they take much of their combined earnings, they give
it back to the Treasury.
But now we are facing, and I had several Members of the
Federal Reserve actually admit that they were facing the
likelihood of large losses over a longer period of time. In a
higher interest rate environment and a $4 trillion balance
sheet, these losses could be substantial. Again, as Bloomberg
estimated, on the order of half a trillion dollars.
So I would ask you again to walk me through this process of
indemnification. And I am seriously asking a question to which
I don't know the answer, which is a dangerous thing to do in
Congress, but I have not heard that before. And I would like
you to walk me through it. Maybe we can talk about it a little
bit.
Mr. Posen. Thank you, sir. I will try to be responsive.
Just one note on the numbers. I don't remember the
particular Bloomberg report you are discussing. You can create,
and I don't mean that in a bad way, you can on some reasonable
assumptions create loss numbers that big. I would suggest that
those loss numbers are pretty much the upper bounds.
Mr. Mulvaney. I will tell you, and I don't mean to cut you
off, but I will tell you that we actually had witnesses in
another hearing say that 100 basis points would lead to roughly
$100 billion in losses.
Mr. Posen. That sounds about right. But again, you have to
spread that over several years probably. But, yes. I think that
is fair.
So onto the point of the indemnification. The idea is not
that the Congress and therefore the American people are writing
a check to the Fed to fill up its balance sheet in total.
Mr. Mulvaney. That is what it sounded like, so I am glad
you went there first.
Mr. Posen. I tried to say, and I apologize for being
unclear or too cryptic, there is a core level of the balance
sheet, just like with a private business, that is essentially
the Fed's capital. It needs a certain amount of equity in order
to conduct its operations. That amount is a tiny fraction of
the $2 trillion balance sheet we now have. The Fed was able to
do its operations back before 2008 with a balance sheet that
was a very small portion of what it now is.
Mr. Mulvaney. Balance sheet is $4 trillion, right?
Mr. Posen. Sorry, $4 trillion.
Mr. Mulvaney. $2 trillion, $4 trillion, pretty soon it is
real money. Right. I get it.
Mr. Posen. The point being that all you would be
indemnifying the Fed for is that it wouldn't have to at some
point under duress come to Congress or come to the executive
and say, we have no money left in the kitty.
Mr. Mulvaney. Can't they just conjure it up?
Mr. Posen. They can, but that would be inflationary. And
then also there would be room for people to say, oh, the Fed is
a rogue entity. It is just making up its own policy. It is
unconstrained. I think it is legitimate for Congress to have
the control of saying we own, in some sense, the Fed. We own
the equity. But the amount you need to identify, again, I want
to stress this, is a very small amount. I don't know what the
exact number is, but it would probably--
Mr. Mulvaney. If the Fed were to lose $100 billion, Dr.
Posen, who loses that money? I understand who gains. They make
$100 billion, their combined earnings are $100 billion, they
remit that to the Fed, the deficit goes down, the taxpayers are
better off. When they lose that same $100 billion, who loses?
Mr. Posen. Unless and until they run out of money for their
operations, on paper they lose that asset. Right? So the
balance sheet of the Fed shrinks. And that is it. The balance
sheet of the Fed shrinks.
Mr. Mulvaney. Thank you. Again, I appreciate the
opportunity for the longer discussion. Thank you, Mr. Chairman.
Mr. Huizenga. I appreciate that.
And with that, we will recognize Mr. Stutzman for the last
5 minutes.
Mr. Stutzman. Thank you, Mr. Chairman.
Dr. Makin, I would like to come back to you about the
Japanese policy and quantitative and qualitative easing. How is
it that the Japanese Government can be so involved in the Bank
of Japan's policy decisions?
Mr. Makin. The Bank of Japan is not that independent. And
so the Prime Minister--it is a parliamentary government--was
very clear when he was elected that he was going to appoint
people at the Bank of Japan who would be very aggressive about
pursuing an inflation target, and did appoint Mr. Kuroda, who
promptly followed that line. So the Bank of Japan is obviously
not independent, because we wouldn't see in the United States,
for example, a similar directive.
Mr. Stutzman. Okay.
Dr. Lachman, how does the Bank of England or the Swiss
National Bank remain accountable to their national government
if they are an independent entity? There has to be some sort of
expectations and accountability between the two at some point,
doesn't there?
Mr. Lachman. Absolutely. And Dr. Posen can probably talk
better to it with the Bank of England. But the government is
very much involved in setting what the goals are for the Bank
of England in terms of an inflation target. And the Bank of
England has to report at regular intervals on how it is doing
with respect to the inflation target. So you are granting them
what one would call instrument independence, but you are
setting for them what the goals are.
Mr. Stutzman. And, Dr. Posen, if you would want to comment
on this as well, because it just seems to be fascinating,
especially even with the European Central Bank, the challenges
that they would have within the European Union could be even
greater. But, Dr. Posen, if you could maybe talk a little bit
about the Bank of England and how their government relates to
the different committees that they have structured?
Mr. Posen. Thank you. My colleague, Dr. Lachman, has it
essentially right. There is an explicit inflation target set
for the Bank of England. That target is set by the elected
government. They can review it at any time, although for
practical reasons of not wanting to seem too inflationary or
too disruptive to markets, they generally review it every few
years.
Mr. Stutzman. And you mentioned that earlier. Is that
something that appears to work for them?
Mr. Posen. A colleague of mine, Kenneth Kuttner from
Williams College, and I just did a paper in which we showed
that there is really no difference in inflation performance
between central banks like the Bank of England, but not just
the Bank of England, where the target gets reset by Parliament
or the executive, versus central banks like the ECB, where you
have very little control. It is just a question of legal
structure.
And if I may, I had the privilege to co-author with current
Fed Chairman Bernanke a book on inflation targeting that came
out back in 1999. And one of the main arguments we made for it
was not to solely focus on inflation, because that would
provide more accountability for the Fed.
Mr. Stutzman. So you think that creates not only
accountability for the Fed, but you think that by resetting
they can refocus on what the environment is for the day. How
often would they potentially or have they historically reset,
maybe at the Bank of England or some other--
Mr. Posen. Let me give you just three quick examples. At
the Bank of England, they have reset it approximately 4 times
in 16 years. One was a purely definitional thing. There was a
particular inflation series. They switched the inflation
series. Actually, it is only 3 times. And the most recent one
was explicitly telling the bank not to worry about fluctuations
in output as long as you don't really imperil inflation. So,
that was a change in focus.
The Swiss National Bank, which is very independent, had a
reset. There is a speech the current Swiss Bank Governor gave
at our institute that is available on our Web site, they were
facing, as I think Dr. Makin mentioned, huge capital inflows
out of Europe that were driving up their currency and causing
them deflation. And they explicitly changed their goal to doing
with the exchange rate to try to keep a lid on that imported
deflation. And that required parliamentary approval.
Mr. Stutzman. Thank you. I find it very fascinating.
I yield back, Mr. Chairman.
Mr. Huizenga. The gentleman yields back. And I, too,
actually sat down with the Swiss Ambassador right about that
time. And it was interesting. It was a flight of capital.
Mr. Posen. Yes.
Mr. Huizenga. Flight of capital to something that was
solid, the Swiss franc, and that was the reaction that they
were having to deal with.
All right. I would like to thank each one of our witnesses
again for your testimony today. This was I think very helpful,
very illuminating.
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.
This hearing is now adjourned.
[Whereupon, at 4:13 p.m., the hearing was adjourned.]
A P P E N D I X
November 13, 2013
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