Tuesday, November 15, 2005 12:15 PM
U.S. Senate Committee on Banking, Housing and Urban Affairs
NOVEMBER 15, 2005
U.S. SENATOR RICHARD C. SHELBY (R-AL) CHAIRMAN
U.S. SENATOR ROBERT F. BENNETT (R-UT)
U.S. SENATOR WAYNE ALLARD (R-CO)
U.S. SENATOR MICHAEL B. ENZI (R-WY)
U.S. SENATOR CHARLES HAGEL (R-NE)
U.S. SENATOR RICK SANTORUM (R-PA)
U.S. SENATOR JIM BUNNING (R-KY)
U.S. SENATOR MICHAEL CRAPO (R-ID)
U.S. SENATOR JOHN E. SUNUNU (R-NH)
U.S. SENATOR ELIZABETH DOLE (R-NC)
U.S. SENATOR MEL MARTINEZ (R-FL)
U.S. SENATOR PAUL S. SARBANES (D-MD) RANKING MEMBER
U.S. SENATOR CHRISTOPHER J. DODD (D-CT)
U.S. SENATOR TIM JOHNSON (D-SD)
U.S. SENATOR JACK REED (D-RI)
U.S. SENATOR CHARLES E. SCHUMER (D-NY)
U.S. SENATOR EVAN BAYH (D-IN)
U.S. SENATOR THOMAS R. CARPER (D-DE)
U.S. SENATOR DEBBIE STABENOW (D-MI)
U.S. SENATOR JON S. CORZINE (D-NJ)
NOMINATED TO BE CHAIRMAN OF THE BOARD OF GOVERNORS
OF THE FEDERAL RESERVE SYSTEM
SHELBY: The committee will come to order.
This morning, we're meeting to consider perhaps the most important nomination that ever comes before this committee, that of the chairman of the Federal Reserve System. This will be the first time in nearly 20 years that the Congress has had a new nominee for its consideration.
President Bush has made a superb appointment in naming Dr. Benjamin S. Bernanke to serve as a member and as chairman of the Board of Governors of the Federal Reserve System.
The Federal Reserve would have a big enough job to do if it were tasked with serving only as a central bank for the U.S. However, as the U.S. continues to lead the world economy, sound stewardship of the Federal Reserve affects the global marketplace.
The Federal Reserve also shoulders the responsibility for supervising some of the world's most complex financial holding companies. In addition, as technology continues to evolve, the Federal Reserve must adapt and innovate to provide an effective payment system for our economy.
Chairman Alan Greenspan has been the face and the voice of the Federal Reserve for over 18 years. During his tenure, the U.S. economy and financial system withstood a number of significant challenges, including the stock market crash of 1987 and the Asian debt crisis. His tenure also includes the 1991-2001 economic expansion, the longest in American history.
These are among the reasons Chairman Greenspan is considered by some to be the greatest central banker of all time.
Stepping into Mr. Greenspan's shoes will be a tremendous challenge. While it may seem a daunting task to follow as distinguished a chairman as Alan Greenspan, we should be mindful of two things.
In 1987, many observers were concerned about whether an economist named Alan Greenspan could successfully follow in the wake of the vaunted Paul Volcker. We now know how the experiment turned out. Each person who sits in the chairman's seat has the opportunity to make that position his own and to become a leader in his own right.
Secondly, many have observed that President Bush has selected the best possible candidate to serve as the next Federal Reserve chairman. Dr. Ben Bernanke may well be the finest monetary economist of his generation. With his distinguished career as an academic, he is eminently qualified and extremely well-versed in monetary policy issues.
SHELBY: Furthermore, Dr. Bernanke is more than an esteemed academic. Dr. Bernanke served with distinction as a member of the Board of Governors in the Federal Reserve System. This experience gives him an inside knowledge of the Federal Reserve and also financial markets.
In speaking out on a variety of important economic issues, he earned tremendous respect and confidence from policy-makers in this country and around the world.
Dr. Bernanke's other professional experiences are also significant here. Prior to becoming a member of the Board of Governors of the Federal Reserve, Dr. Bernanke served as chairman of the Economics Department at Princeton University.
Before arriving at Princeton, Dr. Bernanke had been an associate professor of economics and an assistant professor of economics at the Graduate School of Business at Stanford University.
His teaching career also included serving as visiting professor of economics at New York University and the Massachusetts Institute of Technology.
Dr. Bernanke has also served as the director of the monetary economics program of the National Bureau of Economic Research.
He received a B.A. in economics in 1975 from Harvard University summa cum laude and a Ph.D. in economics in '79 from the Massachusetts Institute of Technology.
Dr. Bernanke, this committee knows that you have an important job in front of you, that you have challenges in front of you. We're also confident that you have the right set of skills to lead the Federal Reserve.
We look forward to hearing your statement today and an interesting discussion that will follow.
I want to say at the outset that we have seven roll call votes scheduled, beginning around 10:45, so we're going to continue this hearing until probably 10:55 or something like that and then recess until 3:00 and go forward, if it's OK with you.
DODD: Thank you very much, Mr. Chairman.
And, Mr. Bernanke, welcome to the committee.
And we had a chance to chat on the phone the other day. And this is a challenging opportunity the president has given to you. I know you must be grateful to him. And we're looking forward to your testimony here today.
As my custom is, I'll withhold, as most of my colleagues will, probably, any final judgment on your nomination until we've completed the process here.
But I want to acknowledge at the outset that the president, in my view, has made a superb decision in nominating you. Your academic credentials, as the chairman has pointed out, are tremendously impressive, if not unsurpassed.
In fact, I made the comment to the nominee coming in, Mr. Chairman, that I went over, looking the list of the number of publications the nominee has authored over the years. I suppose you ought to be thankful he's not a nominee for the Supreme Court of the United States. We'd spend a year examining his written credentials of those publications.
DODD: The chairmanship of the Federal Reserve, as the chairman has pointed out, is not just another government job, obviously. It is arguably the most important position in our country with respect to our nation's economy.
The decisions made by the chairman and his colleagues on the board affect every single citizen in a very profound way. The Federal Reserve is responsible, as we know, for setting interest rates ensuring the safety and soundness of financial institutions. It represents U.S. interests in negotiations with foreign and international regulators. And its chairman bears responsibility for protecting consumers from the scrupulous, illegal and predatory financial practices.
As we've seen repeatedly over the years, the opinion of the Federal Reserve chairman on economic policy matters goes beyond the institution's official jurisdiction and carries an enormous amount of weight that can have significant implications.
One need look no further than 2001, when your predecessor, Alan Greenspan's, support for the president's tax cuts, whoever qualified it may have been, was perceived as a major cause for their enactment, which has led to deep budget deficits, I might add, and the widening inequality of wealth in this nation.
We know from the previous experience that the position of the Federal Reserve chairman requires several important qualities, such as, obviously, intelligence, experience and good judgment.
Most importantly, in the face of a crisis, the markets need to know they can trust the chairman of the Federal Reserve, and developing this trust requires an understanding of the need for independence from the president and the administration, particularly from the one run by the president who has appointed the chairman, and especially in your case, Dr. Bernanke, from an administration in which you are still currently employed as a spokesman for a specific economic and political agenda.
Successful chairmen of have also been able to balance the dual mission of the Federal Reserve, as embodied by the Federal Reserve Act, and I quote, "to promote effectively the goals of maximum employment, stable prices and moderate long-term interest rates," end of quote.
DODD: In the 1990s, we had a remarkable period of both price stability and high employment. Obviously that was due in part to technological innovation, the development of the technological sector.
But there's little doubt that the preconditions for economic growth were laid early in the decade, when a newly elected Democratic president joined with a Republican-appointed Federal Reserve chairman to pursue a commitment of fiscal responsibility and effective monetary policy.
The result was a reduction in poverty rates, an increased standard of living for the middle class, and the first budget surplus in three decades.
So, Dr. Bernanke, I look forward to discussing with you today these issues and how we can return to achieving the results that we had only a few years ago.
And again, I welcome your nomination. I congratulate you on having received it. Look forward to working with you.
Thank you, Mr. Chairman.
SHELBY: Senator Sununu?
SUNUNU: Thank you, Mr. Chairman.
It's a pleasure to have you in front of us, Dr. Bernanke.
I get the sense that you've put on some, sort of, a charm offensive over these past weeks. And I imagine you received a number of awards in your academic career, but you probably were not voted the most likely to conduct a charm offensive on the United States Senate.
Your reviews of the various meetings you've had with members I think have been very positive. And I think it's just a credit to your professionalism in part, because it's not an easy task to come before us and to be prepared to answer all these questions. And people want you to weigh in on all kinds of policy issues, some of which you're probably qualified to comment on; some you may not be.
As the chairman and others have pointed out, you do come with very impressive credentials, a great academic and educational background. Although I think having been educated at both Harvard and MIT is probably a sign of having a conflicted personality to a certain degree.
SUNUNU: We don't have the facts in front of us to support the conclusion that you're the most qualified or finest economist of your generation, but for the purposes of this hearing I'm willing to assume that and to work from there.
I look forward to hearing from you about your approach to monetary policy. Price stability is absolutely critical. I think it's due or has resulted in large measure to the great performance of our economy, cited by Senator Dodd.
And while everyone expects or hopes for a pretty smooth transition, there are differences in approach that you will take relative to Chairman Greenspan. Your support for greater transparency and your success in advocating for real changes that resulted in a more open Fed deserve great commendation and recognition.
I will be interested to hear more about the progress that can be made along those lines and more about any changes that might be made to improve the clarity in the approach that the Fed takes to targeting inflation.
So I certainly wish you well and look forward to your testimony.
Thank you, Mr. Chairman.
SHELBY: Senator Sarbanes?
SARBANES: Thank you very much, Mr. Chairman.
First of all, I want to thank you for scheduling this hearing in a very timely manner.
I join my colleagues in welcoming Dr. Ben Bernanke to the committee. He's no stranger. He's been here before, both to be a member of the Federal Reserve Board of Governors and then to be chairman of the President's Council of Economic Advisers.
Of course, he's now been nominated to a 14-year term as a member of the Board of Governors and also nominated to be the chairman of the Federal Reserve Board of Governors, a four-year term.
As I understand it, Mr. Chairman, we're going to reconvene, because of the series of votes that are scheduled, again in the afternoon.
SHELBY: Three o'clock.
The Federal Reserve Act of 1913, which established the Federal Reserve System, set the 14-year terms for the members of the Board of Governors of the Federal Reserve.
SARBANES: I think that clearly reflected the intention of Congress at the time in enacting this legislation to place the Federal Reserve Board and its individual members beyond the reach of any given administration and the political pressures of the moment.
Actually, the 14-year term is the longest we give to any official in the government other than the lifetime appointments for members of the federal judiciary.
I think it's fair to say, or certainly has come to be the case, that the credibility of the Federal Reserve rests in large part on broad confidence in its independence in the judgments it makes.
And, obviously, if that confidence were to be undermined, the stature of the board would be gravely diminished. And that, in turn, would have serious consequences, I think, not only for our national economy but, indeed, for the world economy.
So, obviously, we're looking forward to hearing from Dr. Bernanke about this important role of the independence of the Federal Reserve in rendering its judgments.
And my colleague, Senator Dodd, has made reference to the other major point I wanted to make. And that was that the Federal Reserve Act provides as the goals that, "The Board of Governors of the Federal Reserve system and the Federal Open Market Committee shall maintain long-run growth of the monetary and credit aggregates commensurate with the economy's long-run potential to increase production so as to promote effectively the goals of maximum employment, stable prices and moderate long-term interest rates."
And this is conveniently referred to as the twin mandates of the Federal Reserve, addressing both maximum employment and stable prices.
That's another issue that I look forward to exploring with Dr. Bernanke in the course of these hearings.
Actually, we had to contend for quite a while with this non- accelerating inflationary rate of unemployment, something that Chairman Greenspan, to his credit, never accepted.
SARBANES: That was the theory that if the unemployment rate got down to a certain level, beyond that you'd have inflation. And therefore, as it approached that unemployment rate, the Fed would have to start raising interest rates to cool off the economy, even if we didn't see manifested inflationary signs.
So it was a preemptive strike against inflation, but it also, of course, ended up being a preemptive strike against employment, if it had been followed.
Fortunately, that was not the case. And we've seen in recent years that we've been able to go down -- and we're now at 5 percent, but we've been able to go down below that to 4 percent unemployment rate without an inflationary problem.
And I'm anxious to explore that with Dr. Bernanke as well, since I think jobs is a very important purpose of economic policy.
Let me just add one other dimension, which is not often talked about when we talk about the Fed, and that is that the board has responsibility, supervisory and regulatory authorities to assure the safety and soundness of the nation's banking and financial systems and protecting the credit rights of consumers.
In the area of consumer protection, the board has broad jurisdiction and authority to implement regulations for a whole host of consumer laws: the Community Reinvestment Act, Truth in Lending, Truth in Saving, Home Mortgage Disclosure, Home Owners Equity Protection Act, the Equal Credit Opportunity Act and a number of others as well.
And while public attention is focused on the board's monetary policy responsibilities, I think it's important to recognize its jurisdiction and authority with respect to these regulatory issues. The board can play a very significant role in improving consumer rights and enforcing consumer protections.
Finally, Mr. Chairman, I noticed that the papers this morning are already setting out an agenda.
SARBANES: I just quote one paragraph to give one example of it.
"If confirmed, Bernanke will take over the Fed at a moment of rising economic unease. The U.S. trade and budget deficits are soaring. The once-blistering housing market may be cooling. Rumors continue to rumble through Wall Street of dangerously overextended hedge funds ripe for collapse. The next Fed chairman could face significant challenge, as Greenspan did, within months of taking office."
Welcome to the committee this morning, Dr. Bernanke.
SHELBY: Senator Dole?
DOLE: Thank you, Chairman Shelby.
I also certainly want to extend a warm welcome to Dr. Bernanke, to his family and his friends this morning.
This is the most significant nomination this committee will consider. The role of the chairman of the Board of Governors holds great influence over our economy and financial system.
The Federal Reserve is charged with conducting the nation's monetary policy with the goals of maximum employment, stable prices and moderate long-term interest rates. These goals can at times conflict, requiring a steady hand at the helm to keep us on a track toward long-term sustainable growth.
Two weeks ago, the Federal Open Market Committee again raised its target for the federal funds rate and the discount rate by 25 basis points. This was the 12th straight increase in the federal funds rate.
The release noted robust underlying growth and productivity and temporarily depressed output and employment due to elevated energy prices and hurricane-related disruptions in economic activity.
These observations reflect how hard we were hit this hurricane season, but they also appear to indicate a positive track for economic expansion in the coming years.
While the outlook is certainly encouraging, I continue to be concerned about the slow pace of job creation, particularly in my state of North Carolina.
North Carolina continues to experience dramatic losses in employment, especially in the traditional industries of textile and furniture manufacturing. The national economy may be trending positively, but we must continue to focus special attention on the areas where folks have lost their jobs with companies that struggle to compete with the dramatically lower cost structures of foreign companies.
Congress continues to debate the pros and cons of free trade, and I believe we must work toward trade agreements that benefit American workers and consumers, and support jobs and growth in our industries.
During my confirmation hearing many years ago to serve as secretary of labor, I spoke about the gap between skilled and unskilled workers. In the changing economic environment, this gap has widened and there are fewer and fewer opportunities for lower-skilled workers. We must do everything in our power to make sure that these folks don't fall through the cracks.
As we discussed in my office, we must focus greater attention on educating our less-skilled workers so they can take advantage of the new jobs that are being created.
To this end, I believe that we should take steps to improve trade adjustment assistance and continue to make strengthening our community colleges a very top priority.
I also remain concerned, of course, about high energy prices, the rising cost of raw materials and the growing size of our trade deficit.
In spite of these concerns, however, I have confidence that the very forces that stimulate economic growth -- free but fair trade, ever-improving global communications, higher education, training for our workforce and, of course, hard work -- these forces, indeed, will put us on a course toward greater opportunity for North Carolinians and for all Americans.
DOLE: Dr. Bernanke, as we've all said, has a keen intellect and impressive credentials, and comes before us, Mr. Chairman, with an extensive list of accomplishments, a wealth of experience and a reputation for consensus building, particularly during his time on the board of the Federal Reserve.
And I tend to think that his good Carolina roots are a great strength as well.
Dr. Bernanke has my strong support, Mr. Chairman, for chairman of the Board of Governors of the Federal Reserve. While I'm sure the committee does have many questions, I hope he will earn our swift approval.
Thank you, Mr. Chairman.
SHELBY: Senator Johnson?
JOHNSON: Chairman Shelby, Ranking Member Sarbanes, I'm pleased to be here this morning.
And, Dr. Bernanke, welcome. I congratulate you on your nomination and thank you for meeting with me this past week.
Today's hearing is no doubt one of the most important that this committee will hold during this Congress. It's not every day that we consider the nomination for a new chairman of the Board of Governors of the Federal Reserve. In fact, the last such hearing was over 18 years ago.
Therefore, it is critical that we are thorough in our questioning and that we cover a broad range of relevant issues.
The Fed is not only charged with serving as the nation's central bank and lender of last resort, but it also supervises and regulates banks; and, perhaps most important, formulates and executes monetary policy in order to promote stable economic growth, hopefully with an eye toward both inflation and employment.
The Fed chairman is an influential economic figure. He must be attuned to the U.S. economy and the world economy. He holds one of 12 votes and therefore must not only build consensus, but confidence.
It's my expectation that the Fed chair, even when he is a former White House adviser, refrains from being a cheerleader for White House policies of either political party and instead maintains the independence and credibility of the central bank to a greater transparency in its decision-making.
As my colleague Senator Dodd noted, that your predecessor, although properly credited with a great many accomplishments, has been roundly criticized by some for intervening in a tax policy debate in Congress that, in the end, contributed significantly to a transition from enormous budget surpluses to today's massive budget deficits.
It is increasingly apparent how important sound and complementary monetary and fiscal policy is to the U.S. economy as the federal deficit increases, national savings falls, pensions and Social Security become less secure, health care costs skyrocket and energy prices remain volatile.
In addition to the formation of monetary policy, the Board of Governors has a significant bank regulatory and supervisory responsibility, including promoting the safety and soundness of the banking system and ensuring compliance with the nation's banking laws and regulations.
JOHNSON: This committee continues to hear from our nation's financial institutions about the increased and often overwhelming burden of bank regulations. It is the number one concern raised by both small and large banks in my home state. And I hope that the Fed will pay close attention to this issue.
And while I'm interested in your views on rising energy prices and the impact on the trade deficit, I'd also like to hear your thoughts on the role of consolidated supervision in protecting the safety and soundness of the nation's banking system and the longstanding policy of maintaining a separation of banking and commerce.
Dr. Bernanke, your credentials, both academic and professional, are exemplary. I appreciate having had the benefit of meeting with you last week in my office. And I look forward to hearing from you today as we move forward in an expeditious fashion on the nomination process.
SHELBY: Senator Martinez?
MARTINEZ: Thank you, Mr. Chairman.
Dr. Bernanke, welcome, and it's good to see you back in the committee again. I know we've had the privilege of confirming you on two other occasions. And I want to just extend my congratulations to you for the confidence the president has expressed in you by naming you to this very significant post.
When we met last week, I expressed my concerns about the rising interest rate environment and its impact on our nation's housing market. Florida's median housing costs have continued to rise, especially in cities where basic infrastructure is already overwhelmed by population demands.
However, employee wages have not risen in response to the rapidly increasing cost of living.
Additionally, the October report from the Federal Reserve Bank of Atlanta shows increases in fuel and building supply costs, all of which will continue to contribute to the rising cost of housing.
We're facing a housing crisis in Florida and I'm afraid it may get worse before it gets any better. And I don't think Florida really is unique to the nation in this regard.
Pockets of Florida are still recovering from the hurricane season of this year and last. And we're still assessing the damages from the recent Hurricane Wilma.
Across the state, the challenge is always the same: a lack of housing affordable to working families.
Low interest rates over the past several years have created record homeownership rates on the national level, but have also encouraged very creative financing, with interest-only loans and short-term ARMs. Both of these and others make monthly mortgage payments susceptible to increases in the federal funds rate for homeowners, which use these options for financing.
During our conversation, you indicated you commitment to providing more transparency and disclosure to the public to reduce market uncertainty and encourage investment.
MARTINEZ: You also talked about increasing financial literacy and how that may help borrowers and lenders understand the implications and risks associated with varying mortgage products.
This is something I worked very intimately during my time as secretary of HUD. I do believe that financial literacy is crucial to today's consumers.
We also discussed the need to legislate fundamental changes to the regulatory structure of the housing GSEs.
While we agreed that these enterprises play a crucial role in the housing market, they have strayed from their original mission, which is to focus on creating housing opportunity for low- and moderate- income families.
I believe this committee reported out a very good piece of legislation in July that would require fundamental changes in how these enterprises are regulated.
Before we can move a bill to the floor for full consideration, we need to also reach some consensus on the issues of portfolio limitations and the creation of an affordable housing fund. I would be interested in hearing your views on both of these two crucial issues.
I look forward to your tenure as chairman. I do have every expectation of your confirmation and look forward to working with you in your capacity. And I, again, commend you and congratulate for you this fine distinction.
Thank you, Mr. Chairman.
SHELBY: Senator Carper?
CARPER: Thank you, Mr. Chairman.
And, Dr. Bernanke, welcome today. I congratulate you on your nomination. Thank you for the time that you were good to spend with me earlier this month when you were visiting in our office.
You are, I think, two for two, before this committee, two for two before the Senate. And my guess is, before we're finished here, you'll be three for three.
And given your experience, your education, your intellect and, frankly, your demeanor, I think they all combine to prepare you well for the challenges that lie ahead. I would not underestimate those challenges. And I think Senator Sarbanes has alluded to them. They are considerable.
I want to return to a theme that a couple of my colleagues have mentioned and then I'll close. And the theme is the need for independence.
You work for the president. You were chosen by him to head up his Council of Economic Advisers.
CARPER: You've been nominated by him for this post, as well.
But when you are confirmed, as I'm sure you will be, it's critically important that you be independent. And I think you realize that. And we are counting on you to be that independent person.
I thank you for your service to this country and for your willingness to serve.
And for anyone in your family who's here to share you with all of us, we express our thanks, as well.
SHELBY: Senator Bennett?
BENNETT: Thank you, Mr. Chairman.
I will save my comments for the question period.
I join my colleagues, Dr. Bernanke, in welcoming you here and congratulating you on your appointment.
I think the president has made a superb selection, and I look forward to not only voting for you but working with you in the years ahead.
SHELBY: Senator Reed?
REED: Thank you very much, Chairman Shelby.
This is an important confirmation hearing because of the tremendous influence that the Federal Reserve chairman has on economic policy in this country and, indeed, around the world.
And I want to welcome the president's nominee, Dr. Bernanke.
Welcome, Doctor. We look forward, obviously, to hearing your views on many issues.
Chairman Greenspan will be a hard act to follow, and his successor's job will not be made any easier by the state of the economy.
Yes, GDP has grown as the economy has been recovering from a recession and a very protracted job slump. But large structural budget deficits, our record current account deficit, a record low personal saving rate, rising consumer prices, and sluggish wage growth all pose tremendous challenges to setting monetary policy.
Dr. Bernanke is an economist with strong academic and policy credentials who has already pledged to maintain the Greenspan-era commitment to controlling inflation and providing market stability.
I hope that also means maintaining flexibility in pursuing the multiple goals of price stability, high employment and sustainable growth, rather than adopting a rigid adherence to any predetermined policy rule in responding to changing economic circumstances.
Indeed, a critical question for Dr. Bernanke will be how he would balance the goals of fighting inflation with allowing sufficient employment and wage growth.
These are difficult economic times for many Americans who are facing stagnant incomes and rising costs for health care, home heating and education. We need a Fed chairman who will be committed to guiding the economy toward creating broadly shared prosperity.
Strong productivity gains have shown up on the bottom lines of corporations but not on the paychecks of workers. The typical workers earnings are not keeping up with their rising living expenses.
REED: And both earnings and income inequality are increasing in our economy.
Both Chairman Greenspan and Dr. Bernanke have emphasized the importance of education and training for increasing opportunity and reducing inequality over the long run. But rising inequality has been a problem for a long time and is particularly acute now.
Monetary policy alone cannot solve this problem, but I hope the new Fed chairman will recognize the critical importance of fostering a high-employment economy.
I'm also interested in Chairman Bernanke's views on whether the budget and trade deficits are dangerous imbalances that pose a risk to the economic outlook.
I hope that we would all agree that raising our future standard of living and preparing adequately for the retirement of the baby boom generation require that we have a high level of national investment and that a high fraction of that investment be financed by our own national savings, not by foreign borrowing.
We followed such prosperity-enhancing policies under President Clinton, but that legacy of fiscal discipline has been squandered under President Bush.
Financial markets will surely hang on the new Fed chairman's words about monetary policy and interest rates, but the new chairman will not automatically inherit Alan Greenspan's considerable influence over a broad array of economic policy.
While Chairman Greenspan's track record managing monetary policy is very impressive, his role in justifying the 2001 tax cut is problematic, and now we're living with the consequences.
Dr. Bernanke was a respected independent economist long before taking the position as chairman of the Council of Economic Advisers with the administration. He has spent many years building a reputation as a politically independent economist, and I hope he will preserve that reputation if confirmed as Fed chairman.
And one bit of advice, Dr. Bernanke: Don't forget what you learned on the school committee.
Thank you, Mr. Chairman.
SHELBY: Senator Hagel?
HAGEL: Mr. Chairman, thank you.
I, too, welcome Dr. Bernanke to our hearing, and I look forward to voting for his nomination and enthusiastically support the president's wise choice.
Mr. Chairman, thank you for the hearing, and I, too, will reserve any further comments to the questions.
SHELBY: Senator Stabenow?
STABENOW: Thank you, Mr. Chairman.
And welcome, Dr. Bernanke. It's a pleasure to have you with us, and look forward to many opportunities to work with you.
You've heard a lot of important words: transparency, accountability, financial literacy. As the author of the provision on financial literacy and the creation of the new federal commission, I look forward to working with you on those important long-term issues of education and financial literacy.
The position of the Federal Reserve chairman is vital to the quality of life of every single American. It affects interest rates on credit cards, home mortgages, investments. It impacts the safety and the soundness of our financial institutions and may lend stability or instability to global financial markets.
STABENOW: It's a very, very critical position. And there's a reason why many say the position of Federal Reserve chairman is the second-most powerful position in Washington, although some others may want to disagree with that. But it certainly, in terms of impact, affects each and every one of the people we represent, as well as ourselves and our country, in extraordinary ways.
While Dr. Greenspan I believe has done an excellent job, there's no doubt that you bring an academically impressive record. You are eminently qualified to replace him. Dr. Bernanke.
But we have a responsibility to know your views on growing the economy, as a number of my colleagues have talked about today, about maintaining an economy that produces good-paying jobs.
All of your intellectual horsepower is going to be needed to revive what continues to be a struggling economy, particularly in the Midwest, in our manufacturing economy, and in my home state, the great state of Michigan.
Throughout the past six months, Michigan has been in incredible struggle. The high-profile bankruptcies at Northwest Airlines and Delphi have served to emphasize a lack of job security that Americans feel right now. And I believe what's happening in Michigan is very much a wake-up call for the entire country.
Many who have devoted a career to a company are being told that their incomes are too high, their health insurance is too much, their pensions are too costly. Essentially, their way of life is being threatened. And the middle class of our country is being threatened.
One by one, each of these benefits is being cut back. And if the employees protest, the company threatens bankruptcy and unveils the specter of using the judicial process to slash labor costs and, again, the way of life of middle-class Americans.
A healthy economy needs to be based on more than a race to the bottom. And I believe that very strongly and believe that the Fed has an important role in whether or not this is a race up or a race down. A race down is a lose-lose for our country and for every American and we need to change that.
STABENOW: It must produce good-paying jobs. Our economy's got to be dynamic as well, to easily assimilate those who are forced from their old jobs into new jobs.
A healthy American economy must be more than a service economy. We make things and grow things in this country. We make things and grow things in my home state, and we do it very well. I don't believe we should concede in a global marketplace that we no longer make things or grow things. Again, I think we lose our middle class.
A healthy economy must be rooted in reality, as well. Global competition is here to stay, and we must wake up to the reality that China and Japan and others our competitors and treat them like competitors.
As the president begins his tour of Asia this week, I want to reemphasize the need for this country, our country, to insist on fair trade, a level playing field for our businesses and our workers.
Currency manipulation and counterfeiting are destroying jobs in Michigan and in America. It can be fixed, we just simply need the political will to make the changes to do it.
In 2003, Dr. Bernanke, you said that the current account deficit cannot be sustained at its current level. I would agree, and I believe we have the tools to change that.
No matter what the inflation numbers show, no matter what the job numbers show, the current approach that we're taking to our economy is destroying our way of life in Michigan, and I believe is an incredible threat to our country.
As the current chair of the Council of Economic Advisers, Dr. Bernanke, you are the president's point person on economics. It's important for me to know and for the people of the state of Michigan to know that as the Federal Reserve chair you will be your own man and capable of separating yourself from these policies.
They're not working. They are not working. And I welcome you to come to Michigan, and I can show you -- sit you down with the faces of business people and workers and families that can show you that they are not working.
These are difficult times for average Americans. The position to which you've been nominated impacts all of us in very real ways.
STABENOW: Your views on how you will maintain growth is of vital importance to our future as a nation. I look forward to your testimony.
SHELBY: Senator Allard?
ALLARD: Thank you, Mr. Chairman, for holding this hearing. You always make it a priority to move nominations promptly. And I particularly commend you for that policy today.
The position of Federal Reserve chairman is one of the most important in the country and possibly the world. And I appreciate that we're taking up that nomination today.
I was pleased when President Bush announced his intention to nominate Ben Bernanke to chair the Federal Reserve Board of Governors. Dr. Bernanke is widely respected and will maintain continuity with the policies and strategies that have allowed our country to prosper.
The reaction of Wall Street and the investment world would also seem to confirm the positive view of Dr. Bernanke's nomination.
Dr. Bernanke brings a uniquely advantageous mix of both academic and practical experience. After spending 20 years at Princeton, including as chairman of the economic department, Dr. Bernanke is well respected and frequently quoted in academic circles.
He's considered one of the world's leading experts on the subject of how central banks, such as the Fed, should set interest rates and cause the money supply to expand or contract.
Rather than limiting himself to purely academic knowledge and research, Dr. Bernanke also has outstanding real-world credentials that have allowed him a fuller understanding of the job for which he is nominated.
His service as a Fed governor can be viewed as an apprenticeship for the chairmanship. Through his service as a governor, he became aware of the challenges facing the Fed as well as the strategies that have made it successful in meeting past challenges. It will allow him to ease the transition between chairmen.
Additionally, Dr. Bernanke has continued his public service as chairman of the President's Council of Economic Advisers, a position for which I was also pleased to support his confirmation.
I'm encouraged that Dr. Bernanke has indicated the importance of fighting inflation and of increasing transparency at the Fed. I was particularly pleased in my discussions with him that he's going to stress improved transparency.
ALLARD: I also appreciate that Dr. Bernanke has acknowledged that the final determination on debts and deficits rightfully lies with the president and Congress.
Dr. Bernanke, thank you for appearing here today before the Banking Committee. I appreciate this opportunity to, once again, discuss your views on a variety of matters. You've always made yourself accessible to me personally, as well as to this committee, and I'm pleased to support your nomination and hope that the committee will be able to vote promptly.
SHELBY: Dr. Bernanke, would you stand and raise your right hand and be sworn?
Do you swear or affirm that the testimony that you're about to give is the truth, the whole truth and nothing but the truth, so help you God?
BERNANKE: I do.
SHELBY: Do you agree to appear and testify before any duly constituted committee of the Senate?
BERNANKE: I do.
SHELBY: Please sit.
Your written testimony will be made part of the record in its entirety. You can sum up what you want to say here.
Do you have anybody you want to introduce, any family members, anything here this morning? You proceed as you wish.
BERNANKE: No, Chairman. I'd like to briefly read the testimony, if I may.
BERNANKE: Thank you.
Chairman Shelby, Senator Sarbanes, and members of the committee, I thank you for the opportunity to appear before you today and for the expeditious scheduling of this hearing.
I would also like to express my gratitude to President Bush for nominating me to be a member and chairman of the Board of Governors of the Federal Reserve System.
If I am confirmed, I will work to the utmost of my abilities to fulfill the important responsibilities of this office.
I recently testified before this committee in my capacity as chairman of the President's Council of Economic Advisers. Today, however, I appear before this committee in a different capacity: as the president's nominee to lead the Federal Reserve System.
BERNANKE: In this prospective new role, I would bear the critical responsibility of preserving the independent and nonpartisan status of the Federal Reserve, a status that, in my view, is essential to that institution's ability to function effectively and achieve its mandated objectives.
I assure this committee that, if I am confirmed, I will be strictly independent of all political influences and will be guided solely by the Federal Reserve's mandate from Congress and by the public interest.
With respect to monetary policy, I will make continuity with the policies and policy strategies of the Greenspan Fed a top priority. Several aspects of the policy strategy that has evolved under Chairman Greenspan, and under Chairman Volcker before him, deserve special note.
First, central bankers in the United States and around the world have come to understand that ensuring long-run price stability is essential for achieving maximum employment and overall economic stability.
In recent decades, the variability of output and employment has decreased markedly, and recessions have become less frequent and less severe.
I believe that the Federal Reserve's success in reducing and stabilizing inflation and inflation expectations is a major reason for this improved economic performance.
If I am confirmed, I am confident that my colleagues on the Federal Open Market Committee and I will maintain our focus on long- term price stability as monetary policy's greatest contribution to general economic prosperity and maximum employment.
Second, monetary policy at the Fed has been executed with both careful judgment and flexibility.
To cite one prominent example, Chairman Greenspan's risk- management policy approach attempts to take into account the possible consequences of not only the most likely forecast outcomes but also of a range of lower-probability outcomes.
BERNANKE: Implementing this approach requires sophisticated judgments about possible risks to the economy, as well as the flexibility to respond quickly to new information or unexpected developments. Risk analysis of this type is a necessary component of successful monetary policymaking.
To be sure, the need for flexibility does not imply that a good policy is undisciplined, as Chairman Greenspan himself has emphasized.
Monetary policy is most effective when it is as coherent, consistent and predictable as possible, while at all times leaving full scope for flexibility and the use of judgment as conditions may require.
Finally, under Chairman Greenspan, monetary policy has become increasingly transparent to the public and the financial markets, a trend that I strongly support.
A more transparent policy process increases democratic accountability, promotes constructive dialogue between policymakers and informed outsiders, reduces uncertainty in financial markets, and helps to anchor the public's expectation of long-run inflation, which, as I've argued already, promotes economic growth and stability.
One possible step toward greater transparency would be for the FOMC to state explicitly the numerical inflation rate or range of inflation rates it considers to be consistent with the goal of long- term price stability, a practice currently employed by many of the world's central banks.
I have supported this idea in my academic writings and in speeches as a board member. Providing quantitative guidance about the meaning of "long-term price stability" could have several advantages, including further reducing public uncertainty about monetary policy and anchoring long-term inflation expectations even more effectively.
I view the explicit statement of a long-run inflation objective as fully consistent with the Federal Reserve's current policy approach, including its appropriate emphasis on the role of judgment and flexibility in policymaking.
Most important, this step would in no way reduce the importance of maximum employment as a policy goal.
Indeed, a key justification for this action is its potential to contribute to stronger and more stable employment growth by further stabilizing inflation and inflation expectations.
BERNANKE: In any case, I assure this committee that, if I'm confirmed, I will take no precipitous steps in the direction of quantifying the definition of long-term price stability. This matter requires further study at the Federal Reserve as well as extensive discussion and consultation.
I will propose further action only if a consensus can be developed that taking such a step would further enhance the ability of the FOMC to satisfy its dual mandate of achieving both stable prices and maximum employment.
My comments so far today have focused on monetary policy. Of course, the Federal Reserve's responsibilities extend well beyond this area. Since its founding, the Federal Reserve has been given substantial responsibility for protecting the stability of the nation's financial system, which is a precondition for the stability of the broader economy.
For example, the Fed works closely with other regulators to ensure the safety and soundness of the U.S. banking system. And over the years it has played a constructive role in managing and mitigating diverse types of financial crises.
If I am confirmed, I will work to enhance the stability of the financial system and to ensure that the resources, procedures and expertise are in place as needed to respond to any threats to stability that may emerge.
The Federal Reserve, along with other regulators, is also engaged in trying to ensure that consumers are treated fairly in their financial dealings, that their privacy is protected, that they receive clear and understandable information about the terms of financial agreements, and that they are not subject to discriminatory or abusive lending practices.
The Fed also enhances consumer welfare through programs to promote financial literacy and community economic development. These are important responsibilities and if I am confirmed I will give them my close attention and support.
I have emphasized this morning the importance of intellectual continuity in policymaking. A more fundamental source of continuity, however, is the superb staff and leadership of the Federal Reserve System. If I am confirmed, I will have the privilege of drawing on the great strengths of this institution to ensure a continuity of the policy process that transcends any single person. I very much look forward to this opportunity.
Let me conclude by offering special thanks to Chairman Greenspan for his collegiality and support when I served on the Board of Governors and for his exemplary leadership of the Federal Reserve System. One may aspire to succeed Chairman Greenspan but it will not be possible to replace him.
Thank you. I'd be happy to take your questions.
SHELBY: Thank you, Dr. Bernanke.
It's well-known that you've been a proponent of inflation targeting, which is pleasing to this senator. Have your views on inflation targeting, Dr. Bernanke, as an academic, been tempered by your more recent experience as a policymaker, both at the Board of Governors in the Federal Reserve and in your present job as the top economic adviser to the president of the United States?
BERNANKE: Chairman Shelby, my views on inflation targeting now are that it represents a continuity with the existing approach of the Federal Reserve System.
BERNANKE: The existing approach of the Federal Reserve System focuses on maintaining medium- and long-term inflation stability as the primary contribution that the Fed can make to maintaining stability of the general economy.
We've seen, for example, in the last 20 years, that the economy's become more stable, that employment growth and output growth have been stronger and more stable, that recessions have been less frequent. I attribute that to the maintenance of stable inflation and inflation expectations.
So in that respect, the inflation targeting ideas that I've espoused simply are an attempt to perhaps codify or strengthen this important commitment of the Federal Reserve to maintaining low inflation.
I also think of this as a continuation of the Fed's recent progress toward greater transparency in policymaking. Over the past 10 years, the Fed has become incredibly more open about its processes, about its decision-making. And I believe this is just a single step, and indeed just an incremental step, that would add to that transparency.
But in particular, I'd like to emphasize to those who may be concerned that I do in no way intend to make any significant change in the overall approach to monetary policy that was developed under Chairman Greenspan.
SHELBY: Dr. Bernanke, do you believe an inflation-targeting regime is consistent with the Federal Reserve's other goals; that is, of long-term, sustainable growth and full employment -- full as we can get?
BERNANKE: Chairman Shelby, I subscribe entirely and wholeheartedly to the dual mandate. I believe the Federal Reserve has an important responsibility to maintain strong and sustained employment growth.
I believe, though, that the best way that the Fed can do that -- or one of the best ways -- is to maintain in the medium and long term low and stable inflation and inflation expectations.
To the extent that the inflation-targeting approach, which may not be a good name for the process -- but the extent that naming a long-term inflation objective can help to stabilize those expectations, keep inflation under control, I think it actually significantly advances our ability to meet the dual mandate and to increase employment growth.
SHELBY: Is it your view that price stability is very important to all Americans?
BERNANKE: I certainly agree with that, Chairman.
SHELBY: Thank you.
When your nomination was announced by President Bush, you indicated, and I'll quote you: "My first priority will be to maintain continuity with the policies and policy strategies established during the Greenspan years."
When you're confirmed -- as I predict you will be soon -- as chairman of the Federal Reserve -- you, it will be the Bernanke-led Federal Reserve.
Could you elaborate on your statement for the committee here today? Specifically, can you discuss your views on the importance of price stability that I just referenced? And do you view the pursuit of an inflation-targeting regime, which we've been talking about, as being consistent with the policy strategies of the Greenspan era?
BERNANKE: Yes, Chairman.
In my statement, I emphasize three elements of the Greenspan strategy. They are, first of all, maintaining low and stable inflation in the medium term; secondly, the use of flexibility and judgment in making monetary policy -- I do not subscribe to any rigid or mechanical rule in policymaking; and the third is the use of transparency to inform the public and to inform the markets about policy and its intentions.
In all these respects, I intend to be continuous with Chairman Greenspan. I expect also, though, not to be static; to evolve over time.
In the case of Chairman Greenspan, transparency changed over time. It became a greater degree of transparency. I expect, going forward, to look for other opportunities to increase the transparency of the Federal Reserve.
Naming the long-term inflation objective -- which I agree emphasize would be done only if there's a broad consensus that is appropriate -- would be one potential step for increasing that transparency.
So good monetary policymaking evolves over time as we learn, we learn from the experience of other countries and from our own experience. I intend to be flexible and to learn from experience.
But I believe the right starting point is the point where we currently are, that Chairman Greenspan has demonstrated in his policymaking.
SHELBY: Dr. Bernanke, you've spoken before of transparency at the Fed and so forth. Do you believe that there would be a point at which transparency would be or could be counterproductive to effective implementation of monetary policy?
BERNANKE: Yes, Chairman Shelby, I do.
Transparency has an important role in helping the public understand policy intentions and policy goals. However, transparency should not be allowed to interfere with the decision-making process itself.
To the extent that, for example, some have suggested that the FOMC meetings be televised...
SHELBY: FOMC, tell the public what that is. We know.
BERNANKE: I don't think that, for example...
SHELBY: Open Market Committee.
BERNANKE: Sorry. I'm sorry. The FOMC, the Federal Open Market Committee.
BERNANKE: That's the decision-making body that determines monetary policy.
One extreme form of transparency would be simply to televise the meeting at which the discussion takes place. My concern about that suggestion is that it would inhibit discussion, that it would affect the decision process, that it would create volatility in financial markets.
So I believe that's an example of a transparency which might take a step too far in terms of affecting the decision process itself.
SHELBY: Thank you.
SARBANES: Thank you very much, Mr. Chairman.
Let me continue on the inflation-targeting issue, since it's been put into play here right at the outset.
In 2000, you and several colleague wrote an opinion piece in the Wall Street Journal entitled, "What Happens when Greenspan is Gone?" You were certainly looking ahead, I must say.
In that article, you stated, "We think the best bet lies in a framework known as inflation targeting, which has been employed with great success in recent years by most of the world's biggest economies except for Japan," end of quote.
The European central bank uses inflation targeting and they set the target at 2 percent. But most observers see their experience has been one of slower economic growth and higher unemployment and usually, actually, although not always, higher inflation than what we have achieved in the U.S. without an inflation target.
And I just want to show three charts in that regard. One is GDP growth in the U.S. versus Europe. And this yellow line is the U.S. The red line is Europe, so our GDP growth, as a general proposition, has done better.
The next is inflation, U.S. versus Europe. And, again, the red line is Europe and the yellow line is the U.S. And except for this period here -- and we're on the way back down -- we've done a better job.
And then the final chart is unemployment rate, U.S. versus Europe. And there, as we see, the U.S. has consistently had a substantially lower unemployment rate than the Europeans have.
So on unemployment rate, inflation and GDP growth, we're doing better than the leading practitioner, I would guess, of inflation targeting.
David Wyss, Standard & Poor's chief economist, summarized the lesson of these charts this way: "The experience of the European central bank does not give people a lot of confidence about inflation targeting."
SARBANES: That was in a BNA report just a few weeks ago.
If inflation-targeting has worked so poorly in Europe compared to our performance, why should we go down that path here?
BERNANKE: Senator, just as a preliminary remark, it is certainly the case the United States economy has outperformed the industrial economies of Europe in the last decade or so. And I would ascribe that primarily to a set of structural differences: the flexibility of our labor markets, for example, compared to European labor markets; regulatory tax policies and other types of policies.
So I don't ascribe the very real differences that you point to as being primarily related to monetary policy.
Having said that, I think it's important to note that the European central bank itself does not describe its own policy as inflation-targeting.
And its policies are very distinct from ones I would advocate in one very important sense: that the mandate of the European central bank is for price stability and price stability only, with other considerations to be taken account of only insofar as price stability is met.
SARBANES: Now, what do you think of that?
BERNANKE: I disagree with it entirely.
SARBANES: All right.
BERNANKE: I believe...
SARBANES: Now, let me ask you the next follow-on -- and I'm hurrying along because we got limited in the time we have to ask questions.
Of course, Chairman Greenspan publicly opposed inflation- targeting. In the book on inflation-targeting that you edited several years ago, some academics recommended that the Federal Open Market Committee unilaterally establish inflation targets.
Former Fed Governor, Edward -- Ned Gramlick, has argued that any move toward inflation-targeting would require the approval of the Congress. And he made this statement: "The question of whether the United States does or does not adopt a formal inflation-targeting regime is not up to the Federal Reserve. The Federal Reserve Act now requires the Fed to strive for maximum employment and balanced growth along with price stability and moderate long-term interest rates. Until the Congress changes these guidelines, the Fed will continue to pursue these goals."
Do you agree with Governor Gramlick?
BERNANKE: I disagree somewhat with his premise, Senator.
Inflation-targeting comes in many flavors, as some countries have taken a more hawkish stance in terms of putting inflation first among equals or even first among the objectives of policy.
As I said, I subscribe entirely to the Humphrey-Hawkins mandate, which puts employment growth and output growth on fully equal footing with inflation in terms of the Federal Reserve's objectives.
BERNANKE: I believe in the types of changes that I'm proposing. I'm not proposing any major change in the way policy is conducted or any change in its objectives. Rather, it's a modest bit of additional transparency which I believe would help the Federal Reserve achieve its stated, mandated objectives as currently written into the Federal Reserve Act.
Since this is not a change in objectives or a change in fundamental operating procedure, in my view, the kinds of suggestions I am making would not require a change in the law. If I thought they did, I think I believe I would not follow them through, because I'm not interested in changing the mandate of the Federal Reserve.
SARBANES: Well, you certainly couldn't do it unilaterally. You have to come to the Congress in order to do that, would you not?
BERNANKE: To change the law, certainly. Of course.
SARBANES: Yes, yes.
BERNANKE: So I would not be interested in pursuing that matter with Congress if I thought that it involved changing the mandate of the Federal Reserve.
SARBANES: E.J. Dionne wrote, just a few weeks ago, "A Fed chairman who beats inflation at the cost of middle-income living standards will not be regarded as a success."
What do you think about that observation?
BERNANKE: Senator, I think it's a false dichotomy. I think that middle-income living standards and poverty, for that matter, are best addressed through strong, stable employment growth.
It's low-income people who suffer most from recessions. It's low-income people who suffer most from high levels of inflation.
The understanding that central banks currently have is that, by maintaining inflation at a low and stable level, avoiding a situation where inflation gets out of control -- as it did, for example, in the 1970s -- you can create more stable, more polished (ph), more substantial growth in employment.
I'm entirely in favor of maximum employment. I believe this is a method to achieve it. If I did not think it was, I would not pursue it.
SARBANES: Well, my time is expired.
I would just want to leave you with the impression of these two charts again. This is the unemployment rate in the U.S. versus Europe. And, of course, the Europeans are the ones who are -- the central bank is the ones that are cited for using inflation targeting. They set a 2 percent figure.
This is the unemployment rate -- this is 4 percent here, this is 6 percent there -- in the United States; substantially and consistently below the unemployment rate in Europe.
BERNANKE: Senator, it was below that rate 20 years ago before ECB was even created.
BERNANKE: I believe there are other factors that contribute to that difference.
SARBANES: Well, we'll have to separate them out.
But a number of people think that the European central bank focus on inflation-targeting as it's only objective, which is what it's been given, has led to a loss of economic growth, GDP growth and to the unemployment situation, without getting a particularly better performance on the inflation front compared to the United States.
BERNANKE: Senator, I disagree with that objective. I think the dual objective is the correct one.
Thank you, Mr. Chairman.
SHELBY: Senator Sununu?
SUNUNU: Thank you, Mr. Chairman.
Let me begin with an observation about your concern with regard to having cameras in Open Market Committee proceedings. We've had televised Senate debate for some time now, and I think you'll find political posturing for the benefit of the cameras is practically unheard of.
Let me engage you in a modest hypothetical.
It's the end of December 2007 and we're into the second year of the Bernanke Fed. The charm offensive has continued, the titans on Wall Street are wearing tan socks in deference to the intelligent but very plain-spoken chairman of the Fed.
For the past six months, the announced target rate has been 1.5 to 2.5 percent inflation as a target for the Fed. But for the final quarter of 2007, inflation has been running at an average of 4.2 percent.
What do you say, what do you do and how do the markets respond?
BERNANKE: Well, Senator, depends on the circumstances and where the inflation came from and the like.
The inflation objective is explicitly a long-term or medium-term objective. It focuses, for example, on core inflation to avoid getting involved in short-term fluctuations in energy prices and the like.
My principle concern at that point would not be that inflation had temporarily risen above its normal range. For example, currently inflation is above the range that in the long run would be desirable. But the concern would be that expectations about inflation and going a year or two in the future had become unhinged or unanchored so that the public was losing its confidence in the Federal Reserve to maintain low and stable inflation.
I believe that maintaining that confidence is extremely important. It's important whether you have an explicit target or whether you don't have an explicit target.
Under Chairman Greenspan, talk and action were combined to ensure the markets that over a period of time -- not necessarily within a quarter or two-quarters, but over a period of time, perhaps lasting several years, the Fed would ensure that inflation was stabilized in a region that was consistent with the objective of price stability.
BERNANKE: So that is the approach I would take. I would certainly not try to return inflation to a target within a short period of time. I would simply try to assure the markets that over a long period of time that the Federal Reserve was committed to price stability as a central part of its monetary strategy.
SUNUNU: What can you do to provide that long-run, longer-term assurance? And do you think that markets are sophisticated enough, rational enough, intelligence enough to recognize this difference between the longer-term objective with regard to core inflation and what you might perceive in your capacity as Fed chairman as being a shorter-term anomaly?
BERNANKE: I think the markets are quite able to distinguish. They pay a lot of attention now to core measures. They understand that the Fed is interested not in short-term inflation fluctuations, but rather in the long-term trends of inflation and making sure that that stays under good control.
Again, I think the primary means of winning inflation credibility is by demonstrating over a long period of time that the Fed is committed to maintaining price stability and by doing that.
By naming a potential range -- which I emphasize is no fait accompli; it's something that's going to be discussed and will be consulted with with members of Congress -- but naming such a range doesn't change the underlying dynamic. It's only an attempt perhaps to provide a bit of additional confidence, a bit of additional assurance, or a bit of additional certainty to the markets about the Federal Reserve's long-term objective.
SUNUNU: Has there been any attempt or any success at measuring improvements or the beneficial impact on stability or volatility in those central banks that have used targeting?
BERNANKE: Yes, Senator, there's an extensive literature. I could talk about it for quite a while.
SUNUNU: You have 22 seconds.
BERNANKE: It's not quite definitive, because, of course, every country is different, but there is recent evidence by board research, for example, from the United Kingdom and Sweden, which shows greater stability in their long-term interest rates after they became inflation targeters because the market has more confidence that inflation and long-term interest rates will remain stable and less concern about short-term fluctuations.
SUNUNU: Thank you very much.
Thank you, Mr. Chairman.
SHELBY: Thank you.
DODD: Thanks, Mr. Chairman, very, very much.
And let me thank our witness again for your presence here this morning.
Let me not go quite as far in advance as my colleague from New Hampshire has (inaudible) couple of years, but let me talk about something that's looming, I think maybe in the next few weeks or months, and that is an energy shock which we may witness here.
I don't know whether you'd agree or not, but I suspect you might agree, that handling an energy shock is one of the most difficult problems that the Federal Reserve has to respond to.
Last year as a member of the board you gave a speech in which you said, and I'll quote you here, you said, "Monetary policy cannot offset the recessionary and inflationary effects of increased oil prices at the same time.
"If the central bank lowers interest rates in an effort to stimulate growth, it risks adding to inflationary pressure. But if it raises rates enough to choke off the inflationary effect of an increase in oil prices, it may exacerbate the slow-down in economic growth.
"But if the monetary policy eases or tightens following an increase in energy prices ultimately depends on how policy-makers balance the risks they perceive to their employment and price stability objectives."
DODD: I bring up this dilemma because in a piece this morning in -- the New York Times ran an article about the potential threat of an energy price shock to our nation's economy.
An the article reads: "Unexpectedly warm weather has bathed much of the United States in recent weeks but fears persist that a classic energy shock may be unfolding as the nation heads into winter."
The article goes on to quote the owner of a business whose monthly natural gas price -- and it's the natural gas price here I think we're looking at the major problem here -- but they cite a business that doubled its natural gas bill from $700,000 to $1.4 million as an example of the threat posed by high energy prices to our larger economy.
I point out, in my state, 51 percent of my consumers use natural gas. And they're looking at about a $270, $276 increase, or 27 percent increase this winter.
After the last major price shock hit our nation's economy in the 1970s, it took a painful recession, that had deep and lasting consequences for many people, to bring inflation back under control.
Given the soaring prices of oil and gas over the past few months and the possibility of further supply disruptions, what type of monetary policy prescription would you apply?
I mean, I appreciate your article in which you cite the balancing things here, but then you were writing an article. Now, you're going to become the chairman of the Federal Reserve. You don't have the luxury of telling us, on the one hand and on the other. We want Harry Truman's economist here and that is a one-armed economist here.
What is the answer of the chairman of the Federal Reserve if we face this kind of a shock?
BERNANKE: Senators, I also discussed in that particular speech the oil price impacts on the economy. And the monetary policy response is an excellent illustration of the importance of having low, stable and well-anchored inflation expectations.
The contrasts between the 1970s and today, with an energy price shock of a similar magnitude, is very instructive.
During the 1970s, inflation expectations were very poorly anchored. There was very little confidence that the Fed would keep inflation low and stable. When oil prices rose, those price increases fed through quickly into other prices and began to raise the general rate of inflation quite quickly.
BERNANKE: The Fed responded somewhat in a panicked way by raising interest rates enormously, which then contributed to the deep recessions of 1975 and 1981-'82.
In a more recent episode, we've had extensive increases in energy prices, but outside of the energy sector, if you look at core inflation, core inflation remains very well controlled. And as a result, the Fed Reserve has been able to raise interest rates from its low accommodative level, but to only 4 percent at this point. And the economy is growing strongly.
So I think this is an enormously good illustration of why keeping inflation low, stable and keeping expectations well-anchored is of tremendous benefit, not just on the inflation side, but also on the employment and growth side.
DODD: So you wouldn't anticipate taking any precipitous action here in light of these price increases.
BERNANKE: I believe that inflation expectations remain well- anchored. I believe it's important to ensure they remain well- anchored. But as long as they remain well tied down and low and stable, I imagine that the economy will be much better able to absorb any further increases in energy prices than they were 30 years ago.
DODD: Any indications you have and as a result of your present employment that the anecdote cited here in the New York Times article about the business virtually is doubling its energy costs as a result of price increases is more than just anecdotal?
BERNANKE: There are real problems in the energy sector. And natural gas in particular, there have been substantial increases in prices, largely because the United States is somewhat isolated in terms of natural gas. We don't have the capacity to import large amounts. And therefore, when we lose domestic production, as we did following Katrina, the shortage of supply drives up prices.
Natural gas prices have been rising for some time. And it's proved a very heavy burden to chemical manufacturers, alumina, other manufacturers in the United States. That's a real problem. I don't want to understate that problem at all.
But, obviously, monetary policy, per se, can only try to avoid having those price increases spread into general inflation. Monetary policy can't create more energy. It can't really solve the energy problem.
DODD: Let me jump quickly -- the time is short here -- to another quick area of questioning, if I can, although that is, obviously, a looming problem here, and if you're confirmed, we're going to want to talk with you about this, this energy potential shock.
Let me address the issue of fiscal responsibility, deficit- financed tax cuts.
You wrote in your macroeconomic textbook that you co-authored with Andrew Abel, you discussed the negative effect of budget deficits in, I thought, a rather good paragraph here. DODD: You said: "The tendency of government budget deficits to reduce investment spending is called crowding out," and you use that line many, many times in your book.
"Reduced investment spending implies lower capital formation and, thus, lower economic growth. The adverse effect of budget deficits and economic growth is probably the most important cost of deficits and a major reason why economists advise governments to minimize their deficits."
Because the negative effect of budget deficits was so eloquently described, isn't it possible that the cost of running a budget deficit could outweigh any benefit to be gained by a tax cut?
BERNANKE: Senator, I agree that budget deficits are a problem. I think it's important to continue to reduce budget deficits.
I'm going to begin now, I think, a practice of not making recommendations on specific tax or spending proposals...
DODD: I didn't ask for that here. I'm just asking whether or not the negative implications of a budget deficit could outweigh any benefits. Not getting into any specifics; I said I don't want to talk about any specific tax cut. Just as a general proposition.
BERNANKE: As a general proposition, it's possible. It depends on the scale of spending, the size of the deficit and whether or not the deficit -- the debt-to-GDP ratio -- is thought to be stable.
DODD: So it could be more damaging to our...
BERNANKE: It's possible.
DODD: Let me ask you quickly as well, are you concerned at all about the record levels of debt being held by foreign creditors? We are now talking in numbers that get close to $1 trillion, I think it is.
Does that worry you at all, as the potential chairman of the Federal Reserve?
BERNANKE: Well, Senator, given that we have a large current account deficit, which is a complex issue that I'm sure I'll be asked to address and I'll be glad to address, and given that we have the current account deficit, and given that that deficit needs to be financed, we are fortunate that foreigners seem quite willing to hold U.S. Treasury debts and other financial instruments, including foreign central banks.
So it's like asking how it feels to be very old: you consider the alternative. It's better to have willingness to hold our financial assets than not, given that we have a large current account deficit.
DODD: But certainly better off if we didn't have to have them hold it at all? Better to be young.
BERNANKE: The issue is what to do about the current account deficit, and I would argue that we need, over a period of time, to reduce the current account deficit. And I believe that's a possible thing to do.
Once the current account deficit comes down, then the need to have foreign financing will therefore be reduced.
DODD: So you're not alarmed about this at all?
BERNANKE: I believe that the current account deficit needs to come down over a period of time.
DODD: But you're not alarmed about foreign creditors holding this debt?
BERNANKE: I think that it's an essential implication of the fact that we have the current account deficit, that it needs to be financed, that we are better off with willing lenders than we are with unwilling lenders. If they were not willing to hold our obligations, interest rates would be higher and the economy would not be as strong.
DODD: Thank you.
Thank you, Mr. Chairman.
SHELBY: Senator Bennett?
BENNETT: Thank you, Mr. Chairman.
Back to your comments to Senator Sununu, Dr. Bernanke, and both of you talk about inflation here or inflation there and you use numbers. That assumes that we know what inflation is. That assumes that our measuring device is accurate. And I'm not sure that's true.
Do we use CPI? Do we use chained CPI? Do we use the PCE price index, the CPIU? Various measures of inflation.
Then the tax code has provisions that are indexed to CPIU. And let me ask you: Do you believe that CPIU is the appropriate measure or would you rather move to something like the chained CPI or the PCE price index?
BENNETT: Your predecessor always insisted that CPI was overstated. And I'd like your reaction to that, because we're talking about pegging to a number or trying to find a number or trying to hit a goal. But if the goal is measured improperly, we need X number of touchdowns and the touchdowns are only worth four points, and we're counting them at six, well, we end up the wrong kind of strategy.
A very bad analogy; I apologize for it.
BERNANKE: That's a very good question, Senator.
As you know, Senator, there was a commission some years ago headed by Michael Boskin with a number of other distinguished academics that reviewed the consumer price index as a measurement of inflation and it found, for a number of reasons, that it overstated inflation: quality adjustment bias, substitution bias and other technical matters were involved.
For that reason, for purposes of thinking about inflation, for purposes possibly even of indexing in the government, I think consideration should be given to measures of inflation which adjust for some of these concerns.
For example, chain-weighted measures of inflation tend to reduce the substitution bias that the Boskin commission pointed to.
With respect to choosing a inflation objective in the medium term, there are many considerations one would want to take into account: familiarity by the public, for example.
So that I think would be something that would need to be discussed by the Federal Open Market Committee and in our general consultations.
To the extent that, say the CPI overstates inflation by an approximately known amount, one could simply adjust the range of inflation rates that define price stability to allow for that bias.
So I think there are many considerations to be taken into account there. And I don't want to prejudge that issue.
BENNETT: OK. Well, as I say, the tax code has provisions that are tied to CPI. Would you recommend that we change the tax code if we come to the conclusion that it's overstated, which Chairman Greenspan believes, and thus affects bracket creep and all of the other things that occur there?
BERNANKE: Well, Senator, of course, this is ultimately Congress's decision. But from a purely technical perspective, I believe there are better measures of inflation than the CPIU. In that respect, one might want to consider alternatives.
BENNETT: Well, that was at the heart of my proposal with respect to Social Security, was looking at the way the inflation is measured.
Let's go to tax reform. Two versions of tax reform were forwarded by the president's tax reform commission to the Department of Treasury for review. Frankly, I was a little disappointed. I was hoping for a clean-sheet-of-paper approach and I feel that they were, kind of, nibbling around the edges.
I think the current tax code, which has its philosophical basis in the 1930s, is no longer applicable to the 21st century. I have a novel and radical idea that the purpose of taxes should be to raise money to run the government and not to direct economic activity toward or against any particular bias.
We then run into the question of how much money does the government need. And historically I've felt comfortable with 20 percent of GDP as the absolute top ceiling. And we've gotten by regardless of where the tax code is; a combination of payroll taxes and income taxes, have produced revenue somewhere in a band of 18.5 percent to 19.5 percent of GDP.
With the river of revenue that came in when we changed the capital gains tax rate as part of the agreement made between Congress and President Clinton following the 1996 election, where the capital gains realizations were five times as much as CBO had projected that they would be, the federal revenue went up to 22, 22.5 percent of GDP. And that was one of the figures that caused some of us to feel we could support a reduction in tax burden, to come down below 20 percent ceiling.
BENNETT: Then we had 9/11, we had the recession, we had the war, and the economy went into the tank so that we feel down to about 16.5 percent of GDP.
We're now rising comfortably back toward the 18.5 percent to 19.5 percent band when last year tax revenues were up 14 percent over the previous year, showing that these policies were working.
Where would you put the ceiling regardless of what the tax structure is? Are you comfortable with saying 20 percent of GDP is all the federal government ought to be taking out of the economy, or would you go with some of our friends who say, "No, it should be as high as 25 percent or 28 percent, 29 percent of GDP, and then we can pay for all of the wonderful things Congress wants to enact"?
Do you have an opinion as to where that number ought to be?
BERNANKE: Well, Senator, I just noticed in empirical fact, that over the last 40 years, the share of GDP collected as federal taxes has been pretty stable, about 18.2 percent, something in that range. And you're right, that we're not much below that at this point.
No, I would not be inclined to pick a specific number other than to note that historically we have been, sort of, stable around this 18 percent rate.
The choices the Congress will face are really cost-benefit choices, looking at individual programs -- do they meet the cost- benefit test, and when you include in the cost the fact that the higher the share of GDP that you collect in taxes the greater are the so-called dead-weight losses or excess burdens associated with the inefficiencies of high taxes?
So I don't think that one can necessarily point to a single number but I do believe that a rigorous cost-benefit analysis ought to be applied to different programs.
I would point out a concern, which may be what you're alluding to, which is that on current plans, the three major entitlement programs -- Medicare, Medicaid and Social Security -- are slated to take up about 16 percent of the GDP as of 2045. Together with the interest on the national debt, that would be pretty much the entire share of GDP that we are currently spending on the government.
BENNETT: It would be higher than that according to the projections I've seen.
BERNANKE: So in any case, it would involve either radical increases in taxes, radical cuts in other spending programs, or some combination. And so I do believe that if that's what you're alluding to, that certainly is a looming issue that needs to be addressed sooner rather than later.
BENNETT: Thank you.
SHELBY: Senator Bennett, thank you.
We have about three minutes left on this series of votes.
Dr. Bernanke, we will recess until 3 o'clock.
To continue to Part 2 of the transcript, click here.