CONDUCT OF MONETARY POLICY HEARING BEFORE THE COMMITTEE ON BANKING AND FINANCIAL SERVICES HOUSE OF REPRESENTATIVES ONE HUNDRED FIFTH CONGRESS FIRST SESSION JULY 24, 1997 Printed for the use of the Committee on Banking and Financial Services Serial No. 105-25 U.S. GOVERNMENT PRINTING OFFICE 42-634 CC WASHINGTON : 1997 For sale by the U.S. Government Printing Office Superintendent of Documents, Congressional Sales Office, Washington, DC 20402 ISBN 0-16-055923-5 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis HOUSE COMMITTEE ON BANKING AND FINANCIAL SERVICES JAMES A. LEACH, Iowa, Chairman BILL MCCOLLUM, Florida, Vice Chairman MARGE ROUKEMA, New Jersey HENRY B. GONZALEZ, Texas DOUG BEREUTER, Nebraska JOHN J. LAFALCE, New York RICHARD H. BAKER, Louisiana BRUCE F. VENTO, Minnesota RICK LAZIO, New York CHARLES E. SCHUMER, New York SPENCER BACHUS, Alabama BARNEY FRANK, Massachusetts MICHAEL N. CASTLE, Delaware PAUL E. KANJORSKI, Pennsylvania PETER T. KING, New York JOSEPH P. KENNEDY II, Massachusetts TOM CAMPBELL, California FLOYD H. FLAKE, New York EDWARD R. ROYCE, California MAXINE WATERS, California FRANK D. LUCAS, Oklahoma CAROLYN B. MALONEY, New York JACK METCALF, Washington LUIS V. GUTIERREZ, Illinois ROBERT W. NEY, Ohio LUCILLE ROYBAL-ALLARD, California ROBERT L. EHRLICH JR., Maryland THOMAS M. BARRETT, Wisconsin BOB BARR, Georgia NYDIA M. VELAZQUEZ, New York JON D. FOX, Pennsylvania MELVIN L. WATT, North Carolina SUE W. KELLY, New York MAURICE D. HINCHEY, New York RON PAUL, Texas GARY L. ACKERMAN, New York DAVE WELDON, Florida KEN BENTSEN, Texas JIM RYUN, Kansas JESSE L. JACKSON JR., Illinois MERRILL COOK, Utah CYNTHIA A. MCKINNEY, Georgia VINCE SNOWBARGER, Kansas CAROLYN C. KILPATRICK, Michigan BOB RILEY, Alabama JAMES H. MALONEY, Connecticut RICK HILL, Montana DARLENE HOOLEY, Oregon PETE SESSIONS, Texas JULIA M. CARSON, Indiana STEVEN c. LATOURETTE, Ohio ESTEBAN EDWARD TORRES, California DONALD A. MANZULLO, Illinois MARK FOLEY, Florida BERNARD SANDERS, Vermont WALTER B. JONES, North Carolina BILL REDMOND, New Mexico (II) Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis CONTENTS Page Hearing held on: July 23, 1997 1 Appendix: July 23, 1997 113 WITNESSES WEDNESDAY, JULY 23, 1997 Brown, William A., Managing Director and Chief Economist, J.P. Morgan Company 88 Chimerine, Lawrence, Managing Director and Chief Economist, Economic Strategy Institute 90 DiClemente, Robert V., Director, U.S. Economic Research, Salomon Brothers . 94 Eisner, Robert, Professor, Northwestern University 85 Galbraith, James K., Professor, Lyndon B. Johnson School of Public Affairs, University of Texas at Austin 97 Lipsky, John, Chief Economist, The Chase Manhattan Bank 81 McDonough, William J., President, Federal Reserve Bank of New York 19 Meyer, Hon. Laurence H., Member, Board of Governors, Federal Reserve System 21 Ricnards, Gordon R., Chief Economist, National Association of Manufacturers 55 Rivlin, Hon. Alice M., Vice Chairman, Board of Governors, Federal Reserve System 17 Smith, David A., Director of Public Policy, AFL-CIO 58 APPENDIX Prepared statements: Leach, Hon. James A 114 Castle, Hon. Michael N 117 Gonzalez, Hon. Henry B 116 Jackson, Hon. Jesse L Jr 118 Brown, William A 213 Chimerine, Lawrence 222 DiClemente, Robert V 236 Eisner, Robert 194 Galbraith, James K 259 Lipsky, John 188 McDonough, William J 132 Meyer, Hon. Laurence H 142 Richards, Gordon. R 169 Rivlin, Hon. Alice M 119 Smith, David A 178 ADDITIONAL MATERIAL SUBMITTED FOR THE RECORD Brown, William A.: Written answers to questions from Hon. Jesse L. Jackson, Jr 221 Chimerine, Lawrence: Written answers to questions from Hon. Jesse L. Jackson Jr 235 DiClemente, Robert V.: Written answers to questions from Hon. Jesse L. Jackson Jr 258 Eisner, Robert: "Budget Nearly Balanced—But Tax Plans Aren't," Los Angeles Times, July 20, 1997 210 (III) Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis CONDUCT OF MONETARY POLICY WEDNESDAY, JULY 23, 1997 HOUSE OF REPRESENTATIVES, COMMITTEE ON BANKING AND FINANCIAL SERVICES, Washington, DC. The committee met, pursuant to call, at 10:10 a.m., in room 2128, Rayburn House Office Building, Hon. James A. Leach, [chairman of the committee], presiding. Present: Chairman Leach; Representatives McCollum, Roukema, Baker, Lazio, Castle, Snowbarger, Foley, LaFalce, Vento, Frank, Gutierrez, Roybal-Allard, Barrett, Velazquez, Watt, Hinchey, Bentsen, Jackson, Kilpatrick, Maloney of Connecticut, Hooley, Carson, and Sanders. Chairman LEACH. The hearing will come to order. On behalf of the committee, I would like to welcome our distinguished first panel of witnesses. I would particularly like to extend my appreciation to Vice Chairman Rivlin and Governor Meyer for adjusting their vacation plans in order to testify before us this morning. By way of background, the committee has not traditionally held two days of hearings in conjunction with the requirement of the semiannual reports to Congress under the Humphrey-Hawkins Act. Rather, we have held one day of hearings in which Chairman Greenspan has testified before the Subcommittee on Domestic and International Monetary Policy, so ably led by Representatives Mike Castle and Floyd Flake. But, as Members are aware, April 17, I received a letter from the Minority requesting that the committee convene an oversight hear- ing before the next Federal Open Market Committee meeting scheduled for May 20. The purpose of the requested hearing was to examine the rationale and economic assumptions of the Federal Reserve's decision to raise the Federal funds target by 25 basis points from 5.25 to 5.5 percent. As I wrote in my April 17 response—and I ask the indulgence of my colleagues while I quote—"Congress has, by statute, set the goals of monetary policy to be pursuit of maximum employment and stable prices. And through the Humphrey-Hawkins mecha- nism, the Federal Reserve reports semiannually to the committee on the state of the Nation's economy. The precedent of holding a hearing on every quarter-point shift in interest rates is troubling, particularly given that U.S. economic expansion is entering its sev- enth consecutive year with high levels of employment and rel- atively low inflation. Whatever one's view of the threat of inflation at this time, the case for political second-guessing must be viewed (1) Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis against the backdrop of rather impressive Fed monetary policy stewardship developed over the past decade within the constraints of a deficit-ridden fiscal policy." The letter went on to note that there is a tradition of independ- ence at the Fed that has protected the economy; nevertheless, the Fed is accountable to Congress and ultimately the American peo- ple. Fed policy should never be immune from criticism. In this overall context, my sense is that it would be ill-advised to rush to judgment, and that the most appropriate time to express its per- spective on monetary policy is the next regularly scheduled Hum- phrey-Hawkins hearing. The letter concluded in agreement with the Minority's suggestion that outside experts from business, labor, and academia be invited to present their views on monetary policy, and pledged on behalf of the Majority that we would be happy to work with them on de- veloping a witness list. This hearing fulfills that commitment. We have consulted closely with the Minority in selecting witnesses for this hearing. In addi- tion to representatives from the Federal Reserve, we will be hear- ing from two additional panels of distinguished witnesses rep- resenting a wide diversity of views. In thinking through the issue of alternative perspectives, I want the Minority to know that I think Mr. Frank is absolutely correct in suggesting that other views ought to be heard from, especially when a change in Fed policy appears to be underway. I also think that periodically, perhaps every two years, other perspectives should be placed on the table, even when no significant change in monetary policy is contemplated. As for the quarter-point bump-up in the Federal funds rate that took place in March, it is interesting to note that, as reflected in Treasury issuances, 10-year note rates have decreased 43 basis points and 30-year bond rates have decreased 49 basis points since the March decision of the Federal Open Market Committee. In other words, the most meaningful rates in the economy have de- clined significantly as the Fed has made clear that its attention to inflation concerns is vigilant. As for the economy at large, the current economic expansion has been extraordinarily steady, albeit unspectacular. The unemploy- ment rate is down to 5 percent, while inflation is running at an an- nual rate of 1.5 percent in the first 6 months of this year. If the Consumer Price Index does, in fact, overstate inflation by as much as 1 percent, then the United States may well be close to achieving functional price stability, an extraordinary achievement and vindi- cation of almost two decades of restraint of monetary policy. Although short-term interest rates are high in real terms, long- term rates, which affect particularly industries like housing, have fallen from a peak of just over 7 percent to approximately 6.5 per- cent. At the same time, U.S. equity markets are enjoying one of the greatest bull runs in history, with a Dow Jones Industrial Average at a peak of over 8,000, up nearly 25 percent since Chairman Greenspan cautioned about "irrational exuberance" late last year. More broadly, the pessimistic predictions of American economic decline, so much in vogue in the 1980's, have proven to be without merit. Our climate of macroeconomic stability, corporate competi- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis tiveness, worker productivity, modern financial markets, and the culture of entrepreneurship make the U.S.