MONETARY POLICY AND THE STATE OF THE ECONOMY, PART II HEARING BEFORE THE COMMITTEE ON FINANCIAL SERVICES U.S. HOUSE OF REPRESENTATIVES ONE HUNDRED ELEVENTH CONGRESS FIRST SESSION FEBRUARY 26, 2009 Printed for the use of the Committee on Financial Services Serial No. 111-8 U.S. GOVERNMENT PRINTING OFFICE 48-679 PDF WASHINGTON : 2009 For sale by the Superintendent of Documents, U.S. Government Printing Office Internet: bookstore.gpo.gov Phone: toll free (866) 512-1800; DC area (202) 512-1800 Fax: (202) 512-2104 Mail: Stop IDCC, Washington, DC 20402-0001 HOUSE COMMITTEE ON FINANCIAL SERVICES BARNEY FRANK, Massachusetts, Chairman PAUL E. KANJORSKI, Pennsylvania SPENCER BACHUS, Alabama MAXINE WATERS, California MICHAEL N. CASTLE, Delaware CAROLYN B. MALONEY, New York PETER T. KING, New York LUIS V. GUTIERREZ, Illinois EDWARD R. ROYCE, California NYDIA M. VELAZQUEZ, New York FRANK D. LUCAS, Oklahoma MELVIN L. WATT, North Carolina RON PAUL, Texas GARY L. ACKERMAN, New York DONALD A. MANZULLO, Illinois BRAD SHERMAN, California WALTER B. JONES, JR., North Carolina GREGORY W. MEEKS, New York JUDY BIGGERT, Illinois DENNIS MOORE, Kansas GARY G. MILLER, California MICHAEL E. CAPUANO, Massachusetts SHELLEY MOORE CAPITO, West Virginia RUBEN HINOJOSA, Texas JEB HENSARLING, Texas WM. LACY CLAY, Missouri SCOTT GARRETT, New Jersey CAROLYN MCCARTHY, New York J. GRESHAM BARRETT, South Carolina JOE BACA, California JIM GERLACH, Pennsylvania STEPHEN F. LYNCH, Massachusetts RANDY NEUGEBAUER, Texas BRAD MILLER, North Carolina TOM PRICE, Georgia DAVID SCOTT, Georgia PATRICK T. McHENRY, North Carolina AL GREEN, Texas JOHN CAMPBELL, California EMANUEL CLEAVER, Missouri ADAM PUTNAM, Florida MELISSA L. BEAN, Illinois MICHELE BACHMANN, Minnesota GWEN MOORE, Wisconsin KENNY MARCHANT, Texas PAUL W. HODES, New Hampshire THADDEUS G. McCOTTER, Michigan KEITH ELLISON, Minnesota KEVIN MCCARTHY, California RON KLEIN, Florida BILL POSEY, Florida CHARLES A. WILSON, Ohio LYNN JENKINS, Kansas ED PERLMUTTER, Colorado CHRISTOPHER LEE, New York JOE DONNELLY, Indiana ERIK PAULSEN, Minnesota BILL FOSTER, Illinois LEONARD LANCE, New Jersey ANDRE CARSON, Indiana JACKIE SPEIER, California TRAVIS CHILDERS, Mississippi WALT MINNICK, Idaho JOHN ADLER, New Jersey MARY JO KILROY, Ohio STEVE DRIEHAUS, Ohio SUZANNE KOSMAS, Florida ALAN GRAYSON, Florida JIM HIMES, Connecticut GARY PETERS, Michigan DAN MAFFEI, New York JEANNE M. ROSLANOWICK, Staff Director and Chief Counsel (II) CONTENTS Page Hearing held on: February 26, 2009 1 Appendix: February 26, 2009 39 WITNESSES THURSDAY, FEBRUARY 26, 2009 Blinder, Dr. Alan S., Gordon S. Rentschler Memorial Professor of Economics and Co-Director, Center for Economic Policy Studies, Princeton University .. 2 Galbraith, Dr. James K., Lloyd M. Bentsen, Jr. Chair in Government/Busi- ness Relations, Lyndon B. Johnson School of Public Affairs, The University of Texas at Austin 7 Taylor, Dr. John B., Mary and Robert Raymond Professor of Economics and Bowen H. and Janice Arthur McCoy Senior Fellow, Hoover Institution, Stanford University 4 APPENDIX Prepared statements: Blinder, Dr. Alan S 40 Galbraith, Dr. James K 45 Taylor, Dr. John B 56 ADDITIONAL MATERIAL SUBMITTED FOR THE RECORD Posey, Hon. Bill: Additional information provided for the record by Dr. James K. Gal- braith 62 (HI) MONETARY POLICY AND THE STATE OF THE ECONOMY, PART II Thursday, February 26, 2009 U.S. HOUSE OF REPRESENTATIVES, COMMITTEE ON FINANCIAL SERVICES, Washington, D.C. The committee met, pursuant to notice, at 10 a.m., in room 2128, Rayburn House Office Building, Hon. Barney Frank [chairman of the committee] presiding. Members present: Representatives Frank, Waters, Watt, Moore of Kansas, McCarthy of New York, Baca, Miller of North Carolina, Scott, Green, Cleaver, Ellison, Perlmutter, Minnick, Adler, Kilroy, Driehaus, Kosmas; Bachus, Castle, Marchant, Posey, and Paulsen. The CHAIRMAN. The hearing will come to order. I am going to make a brief statement and get right to our witnesses. The Hum- phrey-Hawkins Act calls for semiannual hearings in which the Chairman of the Federal Reserve testifies on the state of the econ- omy and the progress we are making in reaching the goals of low inflation and high employment. It seemed to me that while that ob- viously is very important, there ought to be some comment on it as well. That is probably substantive and something procedural. I have admired the work of Mr. Bernanke. I found a great deal to admire in the work of Mr. Greenspan. But I think we have suffered from excessive deference to the Federal Reserve. And the notion that these were oracular pronouncements not to be questioned is not healthy in a democracy. So we began having comments on the state of the economy right after the Federal Reserve testimony and on the testimony and what the Federal Reserve is doing. I think this is an important thing for us to continue, and that is this hearing today. With that, we are going to proceed right to our witnesses. The ranking mem- ber has graciously agreed with me that we don't need to do sub- stantive statements now. There was a small enough membership. So I will announce that the 5-minute rule does not have to be strictly adhered to so that we can have some more rational con- versation. And we will have perhaps 8 or 9 minutes or so each. We will just tell members that we don't want to abuse it. But the 5- minute rule has always been one of the obstacles to intelligent dia- logue, and we can relax it some. We will begin, in no particular order, just the way I am facing, with Dr. Alan Blinder, who is the Gordon S. Rentschler Memorial Professor of Economics at Princeton and Co-Director of the Center for Economic Policy Studies, as well as a former Vice Chair of the Board of Governors. (l) Dr. Blinder. STATEMENT OF DR. ALAN S. BLINDER, GORDON S. RENTSCHLER MEMORIAL PROFESSOR OF ECONOMICS AND CO-DIRECTOR OF THE CENTER FOR ECONOMIC POLICY STUDIES, PRINCETON UNIVERSITY Mr. BLINDER. Thank you, Mr. Chairman, Ranking Member Bach- us, and other members of the committee. I have read Mr. Bernanke's last two testimonies before this committee. I have not had the benefit of all the Q&A that went on. But based on that, I would like to say that I agree with the Chairman, that is the Fed- eral Reserve Chairman, on almost every particular that he men- tioned in those testimonies. Indeed, I feel the country is fortunate to have somebody as creative and thoughtful as Ben Bernanke sit- ting in that very difficult chair right now. Now to specifics. Regard- ing conventional monetary policy, I think the Fed got off to kind of a slow start when the crisis first broke in 2007. But it has more than made up for lost time. I was especially pleased and I applaud its decision to, first of all, reduce the Fed funds rate to zero in December, and then to state that it would continue to hold it there "for some time," a vague pe- riod to be sure, but I would guess that probably means a year, maybe more. The Fed has not said that. Nevertheless, the economic outlook, as Chairman Bernanke said yesterday, is quite bleak. I would like to underscore two of the points that he made. First- ly, he suggested very strongly, I thought, that his own view of the economy was weaker than the FOMC consensus, and mine is too. The bottom end of that range is a IVi percent decline during the four quarters of 2009. I think we will lose 1^4 percent in the first quarter alone. And I certainly don't expect the next three to be on a break even level. So I think we will probably do worse than that. Second, he emphasized that even that forecast was predicated, I think his words were, on the actions taken by the Fed, the Admin- istration, and the Congress to try to get out of this mess. And I cer- tainly agree with that. I would like to emphasize that I think it is important for congressional and public thinking to conceptualize this as fighting a two-front war. And as with most two-front wars, you have to win both fronts, otherwise you lose the war. One front is restoring aggregate demand. And that is what the stimulus and low interest rates and so on are about. The other front is reviving what is a pretty wounded, if not dead—dead in pieces, wounded elsewhere—financial system. And that is where TARP and the var- ious bank bailouts and many of the extraordinary things that the Fed has done come into the picture. So let me turn to the unconventional monetary policy which, these days, is much more important. I would like to especially praise the Fed for moving away to the maximum possible extent— which is not 100 percent—from going institution by institution with ad hoc rescue measures that while they solve an existing problem, don't take us even a baby step toward a solution, and also sometimes sow more confusion than clarity because there are no clear rules of who gets what when. And moving instead to a market by market approach, which the Fed has been doing since it inter- vened so heavily in the commercial paper market, where the objec- tive is to restore a once moribund market to life. And it has already succeeded with CP. This approach has many advantages, including that it really gets to the root of the problem. It takes us some steps toward a cure and, importantly, is roughly speaking, though not literally, rules based. There are rules to the game. There are procedures that are set up for doing these things.