Congressional Testimony

MONETARY POLICY AND THE STATE OF THE ECONOMY HEARING BEFORETHE COMMITTEE ON FINANCIAL SERVICES U.S. HOUSE OF REPRESENTATIVES ONE HUNDRED NINTH CONGRESS SECOND SESSION JULY 20, 2006 Printed for the use of the Committee on Financial Services Serial No. 109–110 ( U.S. GOVERNMENT PRINTING OFFICE 31–539 PDF WASHINGTON : 2007 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) 512–2250 Mail: Stop SSOP, Washington, DC 20402–0001 VerDate 0ct 09 2002 12:29 Feb 20, 2007 Jkt 031539 PO 00000 Frm 00001 Fmt 5011 Sfmt 5011 F:\DOCS\31539.TXT HFIN PsN: TERRIE HOUSE COMMITTEE ON FINANCIAL SERVICES MICHAEL G. OXLEY, Ohio, Chairman JAMES A. LEACH, Iowa BARNEY FRANK, Massachusetts RICHARD H. BAKER, Louisiana PAUL E. KANJORSKI, Pennsylvania DEBORAH PRYCE, Ohio MAXINE WATERS, California SPENCER BACHUS, Alabama CAROLYN B. MALONEY, New York MICHAEL N. CASTLE, Delaware LUIS V. GUTIERREZ, Illinois EDWARD R. ROYCE, California NYDIA M. VELA´ZQUEZ, New York FRANK D. LUCAS, Oklahoma MELVIN L. WATT, North Carolina ROBERT W. NEY, Ohio GARY L. ACKERMAN, New York SUE W. KELLY, New York, Vice Chair DARLENE HOOLEY, Oregon RON PAUL, Texas JULIA CARSON, Indiana PAUL E. GILLMOR, Ohio BRAD SHERMAN, California JIM RYUN, Kansas GREGORY W. MEEKS, New York STEVEN C. LATOURETTE, Ohio BARBARA LEE, California DONALD A. MANZULLO, Illinois DENNIS MOORE, Kansas WALTER B. JONES, JR., North Carolina MICHAEL E. CAPUANO, Massachusetts JUDY BIGGERT, Illinois HAROLD E. FORD, JR., Tennessee CHRISTOPHER SHAYS, Connecticut RUBE´N HINOJOSA, Texas VITO FOSSELLA, New York JOSEPH CROWLEY, New York GARY G. MILLER, California WM. LACY CLAY, Missouri PATRICK J. TIBERI, Ohio STEVE ISRAEL, New York MARK R. KENNEDY, Minnesota CAROLYN MCCARTHY, New York TOM FEENEY, Florida JOE BACA, California JEB HENSARLING, Texas JIM MATHESON, Utah SCOTT GARRETT, New Jersey STEPHEN F. LYNCH, Massachusetts GINNY BROWN-WAITE, Florida BRAD MILLER, North Carolina J. GRESHAM BARRETT, South Carolina DAVID SCOTT, Georgia KATHERINE HARRIS, Florida ARTUR DAVIS, Alabama RICK RENZI, Arizona AL GREEN, Texas JIM GERLACH, Pennsylvania EMANUEL CLEAVER, Missouri STEVAN PEARCE, New Mexico MELISSA L. BEAN, Illinois RANDY NEUGEBAUER, Texas DEBBIE WASSERMAN SCHULTZ, Florida TOM PRICE, Georgia GWEN MOORE, Wisconsin, MICHAEL G. FITZPATRICK, Pennsylvania GEOFF DAVIS, Kentucky BERNARD SANDERS, Vermont PATRICK T. MCHENRY, North Carolina JOHN CAMPBELL, California ROBERT U. FOSTER, III, Staff Director (II) VerDate 0ct 09 2002 12:29 Feb 20, 2007 Jkt 031539 PO 00000 Frm 00002 Fmt 5904 Sfmt 5904 F:\DOCS\31539.TXT HFIN PsN: TERRIE C O N T E N T S Page Hearing held on: July 20, 2006 ..................................................................................................... 1 Appendix: July 20, 2006 ..................................................................................................... 51 WITNESSES THURSDAY, JULY 20, 2006 Bernanke, Hon. Ben S., Chairman, Board of Governors of the Federal Reserve System................................................................................................................... 6 APPENDIX Prepared statements: Oxley, Hon. Michael G. .................................................................................... 52 Brown-Waite, Hon. Ginny................................................................................ 54 Waters, Hon. Maxine........................................................................................ 55 Bernanke, Hon. Ben S...................................................................................... 57 ADDITIONAL MATERIAL SUBMITTED FOR THE RECORD Board of Governors of the Federal Reserve System: Monetary Policy Report to the Congress ........................................................ 66 Hon. Michael G. Oxley: Chart Depicting Inflation Under Different Federal Reserve Chairmen ...... 96 Hon. Luis V. Gutierrez: June 19, 2006, Open Letter on Immigration to President Bush and all Members of Congress signed by 500 American Economists ...................... 98 July 10, 2006, Open Letter on Immigration with 33 Conservative Signato- ries as Published in The Wall Street Journal ............................................ 104 May 21, 2006, op-ed piece from the Wall Street Journal entitled, ‘‘Reagan on Immigration’’ ............................................................................................ 107 Hon. Barney Frank: June 27, 2006, Floor Remarks of Hon. Ruben Hinojosa in Deference to Hon. Ben Bernanke .................................................................................. 109 June 13, 2006, Remarks by Chairman Ben S. Bernanke at the Fifth Regional Issues Conference of the Fifteenth Congressional District of Texas, Washington, DC ................................................................................ 111 Hon. Ben S. Bernanke: Response to Questions Submitted by Hon. Spencer Bachus......................... 118 Response to Questions Submitted by Hon. J. Gresham Barrett .................. 123 Response to Questions Submitted by Hon. Ginny Brown-Waite .................. 126 Response to Questions Submitted by Hon. Barney Frank ............................ 130 Response to Questions Submitted by Hon. Ruben Hinojosa ......................... 133 Response to Questions Submitted by Hon. Deborah Pryce ........................... 137 Response to Questions Submitted by Hon. Barbara Lee .............................. 140 Response to Questions Submitted by Hon. Maxine Waters .......................... 142 Copies of Speeches in Response to Inquiry of Hon. Maxine Waters ............ 145 (III) VerDate 0ct 09 2002 12:29 Feb 20, 2007 Jkt 031539 PO 00000 Frm 00003 Fmt 5904 Sfmt 5904 F:\DOCS\31539.TXT HFIN PsN: TERRIE VerDate 0ct 09 2002 12:29 Feb 20, 2007 Jkt 031539 PO 00000 Frm 00004 Fmt 5904 Sfmt 5904 F:\DOCS\31539.TXT HFIN PsN: TERRIE MONETARY POLICY AND THE STATE OF THE ECONOMY Thursday, July 20, 2006 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. Michael G. Oxley [chairman of the committee] presiding. Present: Representatives Oxley, Leach, Baker, Pryce, Bachus, Castle, Kelly, Paul, Gillmor, Manzullo, Biggert, Miller of California, Kennedy, Hensarling, Garrett, Barrett, Pearce, Neugebauer, Price, Fitzpatrick, Davis of Kentucky, McHenry, Campbell, Frank, Wa- ters, Maloney, Gutierrez, Lee, Moore of Kansas, Capuano, Ford, Hinojosa, Clay, McCarthy, Baca, Matheson, Miller of North Caro- lina, Cleaver, Bean, and Moore of Wisconsin. The CHAIRMAN. The committee will come to order. Chairman Bernanke, good morning. In February, this committee was proud to be the venue for your first appearance before Con- gress on the conduct of monetary policy. Today marks your second appearance, with many more yet to come. In 2001, shortly after I assumed the chairmanship of this committee, the very first hearing I chaired was to receive the testimony of former Chairman Green- span. We didn’t know it at the time, but we had a very rough patch of economic road ahead with the bursting of the tech bubble; and 9/11 and the resulting insurance crisis and the corporate bank- ruptcies. Back then, we had a weak economy that everyone said was strong. Now we have a strong economy that some are trying to convince us is weak. Some of the credit for the current robust economy goes to the Federal Reserve, of course, where you and Chairman Greenspan have held inflation to lower levels and lower volatility than we have seen in all but 20 years of the life of the Federal Reserve. I would like to enter a chart showing that into the record. The lion’s share of the credit goes to President Bush, who had the steadiness to guide us through recession and the courage to do the right thing in seeking tax cuts to spur growth. Now we see that the biggest spurt in tax revenue growth in 40 years has trimmed our expected 2006 deficit by a third in just 6 months, and is on track to drop the deficit as a percentage of GDP to less than half of the similar share in most European economies. Some of the credit goes to Congress, which made the tax cut stick, although we still have some work to do on making tax cuts permanent, and on spending discipline. (1) VerDate 0ct 09 2002 12:29 Feb 20, 2007 Jkt 031539 PO 00000 Frm 00005 Fmt 6633 Sfmt 6633 F:\DOCS\31539.TXT HFIN PsN: TERRIE 2 But the largest credit of all goes to the American people, who with determination, character, and heart, showed what a great country this really is. America suffered a recession, a massive ter- ror attack, scandals of corporate governance, and a destructive hur- ricane season. Through all of that, we have added 5.4 million jobs in the last 3 years; we have had 34 uninterrupted quarters of growth; we have an unemployed rate lower than that of most of the last 40 years; and we also have growth at or above the average rate for all 6 postwar decades. In June alone, the U.S. economy created 121,000 new jobs, and maintained a low 4.6 unemployment rate. I would be remiss if I did not point out that the unemployment rate is lower than the 6 percent floor that the economists used to call full employment. GDP growth for the first quarter was 5.6 per- cent, stronger than expected, and the fastest growth in two-and-a- half years. That, Mr. Chairman, is something we can all be proud of. This is a remarkable country and a remarkable economy that constantly renews and reinvents itself—the flexibility that Chair- man Greenspan talks so much about. The Federal Reserve has led monetary policy extremely well, and I am certain that will continue to be the case during your tenure. Mr. Chairman, America is doing well, and will continue to do well. Of course, we will continue to have to work and think and in- novate, because other countries have smart people and good econo- mies as well. However, since the recession and the terror attacks, this country’s economy has grown a great deal. In real terms, U.S. growth alone is half as big as the total economy of China. So with that, Mr. Chairman, I thank you and all of the many people at the Federal Reserve, most of whom we have never met, for their insight and experience and dedication. And we look for- ward to your testimony, Chairman Bernanke. And with that, I yield back the balance of my time and now rec- ognize the ranking member, the gentleman from Massachusetts. Mr. FRANK. Thank you, Mr. Chairman. It is true that we have had growth, but we have had the most unequally distributed growth recently in my memory, and the consequences of that are severe. Let’s begin with where we are in America today. The Doha Round is foundering, and there is a desperate need to get it done for those who want it done because of the perception that Congress would not renew the fast track authority to the President. There was a reaction to the Dubai Ports matter that I believe most in the business community, most of the economists and financial people, thought was overdone. The President found—to his surprise, I think—resistance to his approach on immigration. There are resist- ances coming to efforts to implement productivity. What you have is a kind of revolt on the part of the average American against globalization, against the adaptation of new tech- nology, which was kind of summed up somewhat wistfully by Mr. Allan Hubbard, the director of the National Economics Council—a week ago he said, ‘‘Obviously it is frustrating to us that the Amer- ican people don’t recognize how well the economy is doing.’’ Or as Chico Marx said, ‘‘Who are you going to believe, me or your own pocketbook?’’ VerDate 0ct 09 2002 12:29 Feb 20, 2007 Jkt 031539 PO 00000 Frm 00006 Fmt 6633 Sfmt 6633 F:\DOCS\31539.TXT HFIN PsN: TERRIE 3 The reason the American people don’t recognize how well the economy is doing, and the reason they are angry and are balking at many of the things that I believe you would like to see us do, Mr. Bernanke, is that they are not doing well. The economy is, but there is a disconnect between the average American and the econ- omy. First, talking about jobs, it is true we have gotten some jobs; my friend, the chairman, said, ‘‘Look, 120,000 jobs.’’ Only 120,000 jobs used to be a bad thing. What the Administration has given us is the evolution of diminishing expectations. That chart represents their projections of how many jobs will be created each month, be- ginning in 2003, after they said the tax cuts have had an effect and after the recession. There has been a constantly declining pre- diction by the Administration of how many jobs we would create. So it is true that if you define victory low enough, you can often achieve it, except that they haven’t. Even as it has declined, they have rarely met it. The other, of course, is a comparison of job creation on the left side in the Clinton years and in the Bush years. Take comparable periods, 2 years, starting 2 years into each presidency so they are not accused or blamed for what happened before. Two years in each presidency; those are the job numbers. So 120,000 jobs under the Clinton years would have been considered to be a serious problem, but the problem is not just job creation. Yes, unemployment is low, although it is low in large part because of the drop in labor partici- pation, and exactly what causes that, we don’t know. What effects that will have over long-term economic growth, we don’t know. But it is also the case that we have low unemployment because we have the lowest percentage of people in the workforce. But here is the serious problem—real wages. Real wages are the red chart; that is, wages corrected for inflation. Now, we are told that wages go up with a lag in their recovery, but the reverse has happened here. Assuming the recovery begins in 2003, maybe even earlier, real wage growth is very small in 2004—2003. It is nega- tive in 2005—2004 and negative in 2005, and barely there today. That is, real wages are lagging inflation, and I must say, Mr. Bernanke, I was disappointed that in your discussion in the mone- tary report—not your statement—pages 16 and following, when you talk about compensation, it is nominal. It is not real. And I think that talking unadjusted terms about wages unfairly gives people the impression that things are better than they are. I wish that you would have used real wages. And in your statement, part of the problem, frankly, is—and I will ask you about this on page 3 of your statement—you talk about labor costs, but you talk about wages as a cost. Your discus- sion of wages does not address them as the wage families support themselves, but as a constraint in the economy. Let me quickly go to the next chart. Not only have wages lagged inflation, they have lagged productivity. They have lagged cor- porate profits. What we have is a—in this chart on the left, you have what has happened to the share of national income that goes to wages. It has gone from 66 percent to 63 percent. On the other side, you have what has happened—this is from 2002 to 2006, the share that has gone to corporate profits. It has nearly doubled from VerDate 0ct 09 2002 12:29 Feb 20, 2007 Jkt 031539 PO 00000 Frm 00007 Fmt 6633 Sfmt 6633 F:\DOCS\31539.TXT HFIN PsN: TERRIE 4 8.5 percent to 14.4 percent, so real wages have dropped in the last couple of years. Labor’s share of the national income has dropped from 66 percent to 63 percent, and corporate profits have gone way up. And then finally, you do have the question of productivity on the next chart. Here we have productivity compared to real wages, and you look in particular in these last 3 years, productivity goes way up, way above historic trend, and real wages go down. Now, we have—and I will take this 30 seconds, Mr. Chairman, thank you. We have concern that wages will be inflationary. In fact, exactly the opposite has been the case. Where you have a situ- ation where productivity greatly outstrips real wages, you clearly have room—and here is what you have: productivity greatly out- stripping real wages; real wages dropping over the last couple of years; and corporate profits skyrocketing. To continue to treat pos- sible wage increases as a problem for the economy is to perpetuate the growing inequality we have. So when people are concerned that there appears to be too much anger on the part of the public to- ward the best economic decisions, those are the reasons why. Thank you, Mr. Chairman. The CHAIRMAN. The gentleman’s time has expired. The Chair now recognizes the gentlelady from Ohio, the sub- committee chairwoman. Ms. PRYCE. Thank you, Mr. Chairman. And thank you, Chair- man Bernanke, for being with us here today. I was pleased to read in your testimony that you believe that even though the economy is currently in a transition period, that it will continue to expand even under the pressure of increased oil prices, consumer spending, and a slowing housing market. I would like to talk about that just briefly. Studies have shown that housing accounted for more than one- third of economic growth during the previous 5 years. The robust housing market had enabled homeowners to reduce their debt bur- dens and maintain adequate levels of consumer spending by tap- ping into the equity of their homes. Unfortunately in research done by the National Association of Home Builders, they show a serious downtrend in housing demand that many believe correlates with the rise in interest rates by the Federal Reserve. As I have said in the past, I am concerned that this house price boom has been driven far more by investors than ever before, and could lead to a series of mortgage failures, and as the Federal Re- serve tries to balance rising rates with fluctuations in the markets, I don’t need to remind you that your actions have a trickle-down effect to local communities, and losses on housing investments are just one example. A study by the Mortgage Bankers Association puts my own State of Ohio at the very top of the list of foreclosures, and so we are very concerned in the Midwest. Although we would sometimes like to think of our economy as one that stands apart from the rest of the world’s sociopolitical issues, the effect of volatility overseas is reaching into our economy more than we might realize. Just yesterday I held a hearing in my subcommittee on currency issues. We had representatives there from the Federal Reserve and the Mint discussing with us the rising cost of the commodities and VerDate 0ct 09 2002 12:29 Feb 20, 2007 Jkt 031539 PO 00000 Frm 00008 Fmt 6633 Sfmt 6633 F:\DOCS\31539.TXT HFIN PsN: TERRIE 5 materials that make up our coins. We heard these commodities are affected by the volatility in the world or through rising demand in other markets, and are also themselves affecting our inflation here in the United States. The more they cost, the more they drive up the cost to make our currency, and the more it drives up costs over- all. In your remarks at the Senate yesterday, you touched upon a number of issues concerning citizens, such as rising rates, gas prices, and wage earnings. One of the issues that has been impor- tant to me, and a number of other members on this committee, is the ratio of consumer debt to consumer savings in America, and the effects that a slowing economy could have on a more local level. I agree with your statement yesterday that we must be forward-look- ing in our policy actions, and I would appreciate hearing your thoughts on what Congress can do about low savings rates, espe- cially coupled with rising consumer costs. Some of us, Mrs. Kelly, Mrs. Biggert, Mrs. Maloney, and myself, have worked to bring this issue to a national focus for a number of years, and we mentioned it repeatedly, working with the Admin- istration to highlight increasing financial education in the United States, but much more needs to be done. You also talked about an international savings glut that I believe we have here in America, a credit glut. I believe we can say it is almost a national epidemic. Consumer spending is key to our con- tinued growth, but I believe we also need to send a message that consumer savings is just as important, and I appreciate hearing from you what the Federal Reserve and the rest of us can do to help consumer savings become a priority in this Nation. And I want to thank you once again, Mr. Chairman, for your appearance. I look forward to your testimony, and I yield back. Thank you. The CHAIRMAN. I thank the gentlelady. Thank you for your lead- ership on this issue. The gentlelady from New York, Mrs. Maloney. Mrs. MALONEY. Thank you, Mr. Chairman. And welcome, Chairman Bernanke. All eyes are on you and the other members of the Federal Open Market Committee as we reach a critical point in monetary policy. While the U.S. economy was going through its most protracted jobs slump since the 1930’s, the Federal Reserve acted appropriately and kept interest rates very low. And when the economy began to respond, the Federal Reserve told us they were raising interest rates gradually to restore them to a level consistent with stable noninflationary growth. But that process, 17 increases in short-term interest rates, began 2 years ago, and people are naturally wondering when is it going to stop. Ordinary American families should be wondering the most be- cause they are the ones who have been left behind in whatever eco- nomic recovery we have seen. Regrettably, the gap between the haves and the have-nots continues to widen. GDP growth has been satisfactory, although not as strong as in the average postwar busi- ness cycle recovery, and productivity has been very strong. But as Ranking Member Frank has pointed out, what have ordinary American workers gotten in return for their hard work? Paychecks that have not kept up with inflation, much less with their in- creased productivity. And now rising interest rates and a slowing VerDate 0ct 09 2002 12:29 Feb 20, 2007 Jkt 031539 PO 00000 Frm 00009 Fmt 6633 Sfmt 6633 F:\DOCS\31539.TXT HFIN PsN: TERRIE 6 economy may choke off the economic recovery before most Ameri- cans have even had a chance to benefit. It is a challenging time for monetary policy because our fiscal policy is such a mess. The President’s tax cuts were poorly de- signed to produce job-creating stimulus in the short run while add- ing to the budget deficit in the long run. The fiscal discipline built up in the 1990’s has been squandered. Let us remember that Presi- dent Bush inherited a budget surplus of $5.6 trillion over 5 years, but now we are back to a legacy of deficits and debt. We have record budget deficits and record debt, over $8 trillion, and a record trade deficit, the largest in history, $800 billion. Due to the debt, each American owes over $28,000. We are borrowing large amounts from the rest of the world and have had to raise our national debt limit four different times already during this current Administra- tion. The fiscal discipline of the 1990’s allowed the Federal Reserve to pursue a monetary policy that encouraged investment and growth. The challenge is greater now because the Federal Reserve will have to fight the excesses of fiscal policy which have drained our na- tional savings and turned us into a massive international debtor. Chairman Bernanke, I look forward to your testimony and to ex- ploring with you the challenges you face as you try to keep the economy growing and inflationary pressures contained so that ordi- nary Americans can begin to see their standard of living grow once again. Thank you. The CHAIRMAN. The gentlelady’s time has expired. We now turn to the distinguished Chairman of the Federal Re- serve. Dr. Bernanke, welcome back to the committee, and you may proceed. STATEMENT OF THE HONORABLE BEN S. BERNANKE, CHAIR- MAN, BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM Mr. BERNANKE. Thank you. Mr. Chairman, and members of the committee, I am pleased to be here again to present the Federal Reserve’s Monetary Policy Report to the Congress. Over the period since our February report, the U.S. economy has continued to expand. Real gross domestic product is estimated to have risen at an annual rate of 5.6 percent in the first quarter of 2006. The available indicators suggest that economic growth has more recently moderated from that quite strong pace, reflecting a gradual cooling of the housing market and other factors that I will discuss. With respect to the labor market, more than 850,000 jobs have been added, on net, to nonfarm payrolls in the first 6 months of the year, though these gains came at a slower pace in the second quar- ter than in the first. Last month the unemployment rate stood at 4.6 percent. Inflation has been higher than we anticipated in February, part- ly as a result of further sharp increases in the prices of energy and other commodities. During the first 5 months of the year, overall inflation, as measured by the price index for personal consumption expenditures, averaged 4.3 percent at an annual rate. Over the same period, core inflation, that is, inflation excluding food and en- VerDate 0ct 09 2002 12:29 Feb 20, 2007 Jkt 031539 PO 00000 Frm 00010 Fmt 6633 Sfmt 6633 F:\DOCS\31539.TXT HFIN PsN: TERRIE 7 ergy prices, averaged 2.6 percent at an annual rate. To address the risk that inflation pressures might remain elevated, the Federal Open Market Committee continued to firm the stance of monetary policy, raising the Federal funds rate another three-quarters of a percentage point to 51⁄ 4 percent in the period since our last report. Let me now review the current economic situation and the out- look in a bit more detail, beginning with developments in the real economy and then turning to the inflation situation. I will conclude with some comments on monetary policy. The U.S. economy appears to be in a period of transition. For the past 3 years or so, economic growth in the United States has been robust. This growth has reflected both the ongoing reemployment of underutilized resources as the economy recovered from the weak- ness of earlier in the decade and the expansion of the economy’s underlying productive potential as determined by such factors as productivity trends and growth of the labor force. Although the rate of resource utilization that the economy can sustain cannot be known with any precision, it is clear that after several years of above-trend growth, slack in resource utilization has been substantially reduced. As a consequence, a sustainable noninflationary expansion is likely to involve a modest reduction in the growth of economic activity from the rapid pace of the past 3 years to a pace more consistent with the rate of increase in the Na- tion’s underlying productive capacity. It bears emphasizing that be- cause productivity growth seems likely to remain strong, the pro- ductive capacity of our economy should expand over the next few years at a rate sufficient to support solid growth in real output. As I have noted, the anticipated moderation in economic growth now seems to be under way, although the recent erratic growth pattern complicates this assessment. That moderation appears most evident in the household sector. In particular, consumer spending, which makes up more than two-thirds of aggregate spending, grew rapidly during the first quarter, but decelerated during the spring. One likely source of this deceleration was higher energy prices, which have adversely affected the purchasing power of households and have weighed on consumer attitudes. Outlays for residential construction, which have been at very high levels in recent years, rose further in the first quarter. More recently, however, the market for residential real estate has been cooling, as can be seen in the slowing of new and existing home sales and housing starts. Some of the recent softening in housing starts may have resulted from the unusually favorable weather during the first quarter of the year which pulled forward construc- tion activity, but the slowing of the housing market appears to be more broad-based than can be explained by that factor alone. Home prices, which have climbed at double-digit rates in recent years, still appear to be rising for the Nation as a whole, though signifi- cantly less rapidly than before. These developments in the housing market are not particularly surprising as the sustained run-up in housing prices, together with some increase in mortgage rates, has reduced affordability and thus the demand for new homes. The slowing of the housing market may restrain other forms of household spending as well. With homeowners no longer experi- encing increases in the equity value of their homes at the rapid VerDate 0ct 09 2002 12:29 Feb 20, 2007 Jkt 031539 PO 00000 Frm 00011 Fmt 6633 Sfmt 6633 F:\DOCS\31539.TXT HFIN PsN: TERRIE 8 pace seen in the past few years, and with the recent declines in the stock prices, increases in household net worth are likely to provide less of a boost to consumer expenditures than they have in the re- cent past. That said, favorable fundamentals, including relatively low unemployment and rising disposable incomes, should provide support for consumer spending. Overall, household expenditures appear likely to expand at a moderate pace, providing continued impetus to the overall economic expansion. Although growth in household spending has slowed, other sectors of the economy retain considerable momentum. Business invest- ment in new capital goods appears to have risen briskly, on net, so far this year. In particular, investment in nonresidential struc- tures which had been weak since 2001 seems to have picked up ap- preciably, providing some offset to the slower growth in residential construction. Spending on equipment and software has also been strong. With a few exceptions, business inventories appear to be well aligned with sales, which reduces the risk that a build-up of unwanted in- ventories might actually reduce production in the future. Business investment seems likely to continue to grow at a solid pace, sup- ported by growth in final sales, rising backlogs of orders for capital goods, and high rates of profitability. To be sure, businesses in cer- tain sectors have experienced financial difficulties. In the aggre- gate, however, firms remain in excellent financial condition, and credit conditions for businesses are favorable. Globally, output growth appears strong. Growth of the global economy will help support U.S. economic activity by continuing to stimulate demand for our exports of goods and services. One down- side to the strength of the global economy, however, is that it has led to significant increases in the demand for crude oil and other primary commodities in the past few years. Together with height- ened geopolitical uncertainties and the limited ability of suppliers to expand capacity in the short run, these rising demands have re- sulted in sharp rises in the prices of which these goods are traded internationally, which in turn has put upward pressure on costs and prices in the United States. Overall, the U.S. economy seems poised to grow in coming quar- ters at a pace roughly in line with the expansion of its underlying productive capacity. Such an outlook is embodied in the projections of members of the Board of Governors and the presidents of Fed- eral Reserve Banks that were made around the time of the FOMC meeting late last month, based on the assumption of appropriate monetary policy. In particular, the central tendency of those fore- casts is for real GDP to increase about 31⁄ 4 percent to 31⁄ 2 percent in 2006, and 3 percent to 31⁄ 4 percent in 2007. With output expand- ing at a pace near that of the economy’s potential, the civilian un- employment rate is expected to finish both 2006 and 2007 between 43⁄ 4 percent and 5 percent, close to its recent level. I turn now to the inflation situation. As I noted, inflation has been higher than we expected at the time of our last report. Much of the upward pressure on overall inflation this year has been due to increases in the prices of energy and other commodities, and in particular to the higher prices of products derived from crude oil. VerDate 0ct 09 2002 12:29 Feb 20, 2007 Jkt 031539 PO 00000 Frm 00012 Fmt 6633 Sfmt 6633 F:\DOCS\31539.TXT HFIN PsN: TERRIE 9 Gasoline prices have increased notably as a result of the rise in pe- troleum prices as well as factors specific to the market for ethanol. The pickup in inflation so far this year has also been reflected in the prices of a range of goods and services as strengthening de- mand may have given firms more ability to pass energy and other costs through to consumers. In addition, increases in residential rents as well as in the imputed rent on owner-occupied homes have recently contributed to higher core inflation. The recent rise in inflation is of concern to the FOMC. The achievement of price stability is one of the objectives that make up the Congress’ mandate to the Federal Reserve. Moreover, in the long run, price stability is critical to achieving maximum employ- ment and moderate long-term interest rates, the other parts of the Congressional mandate. The outlook for inflation is shaped by a number of factors, not the least of which is the course of energy prices. The spot price of oil has moved up significantly further in recent weeks. Futures quotes imply that market participants expect petroleum prices to roughly stabilize in coming quarters. Such an outcome would, over time, reduce one source of upward pressure on inflation. However, expectations of a leveling out of oil prices have been consistently disappointed in recent years, and as the experience of the past week suggests, possible increases in these and other commodity prices remain a risk to the inflation outlook. Although the costs of energy and other raw materials are impor- tant, labor costs are by far the largest component of business costs. Anecdotal reports suggest that the labor market is tight in some industries and occupations, and that employers are having dif- ficulty attracting certain types of skilled workers. To date, however, moderate growth in most broad measures of nominal labor com- pensation and the ongoing increases in labor productivity have held down the rise in unit labor costs, reducing pressure on inflation from the cost side. Employee compensation per hour is likely to rise more quickly over the next couple of years in response to the strength of the labor market. Whether faster increases in nominal compensation create additional cost pressures for firms depends in part on the extent to which they are offset by continuing productivity gains. Profit margins are currently relatively wide, and the effect of a pos- sible acceleration in compensation in price inflation would also de- pend on the extent to which competitive pressures force firms to re- duce margins rather than to pass on higher costs. The public’s inflation expectations are another important deter- minant of inflation. The Federal Reserve must guard against the emergence of an inflationary psychology that could impart greater persistence than what could otherwise be a transitory increase in inflation. After rising earlier this year, measures of expectations, based on surveys and on a comparison of yields on nominal and in- flation-indexed government debt, have edged down and remain con- tained. These developments bear watching, however. Finally, the extent to which aggregate demand is aligned with the economy’s underlying productive potential also influences infla- tion. As I noted earlier, FOMC participants project the growth in economic activity should moderate to a pace close to that of the VerDate 0ct 09 2002 12:29 Feb 20, 2007 Jkt 031539 PO 00000 Frm 00013 Fmt 6633 Sfmt 6633 F:\DOCS\31539.TXT HFIN PsN: TERRIE 10 growth of potential both this year and next. Should that modera- tion occur as anticipated, it should help to limit inflation pressures over time. The projections of the members of the Board of Governors and the presidents of the Federal Reserve Banks, which are based on information available at the time of the last FOMC meeting, are for a gradual decline in inflation in coming quarters. As measured by the price index for personal consumption expenditures excluding food and energy, inflation is projected to be 21⁄ 4 percent to 21⁄ 2 per- cent this year and then to edge lower to 2 percent to 21⁄ 4 percent next year. The FOMC projections, which now anticipate slightly lower growth in real output and higher core inflation than expected in our February report, mirror the somewhat more adverse cir- cumstances facing our economy which have resulted from the re- cent steep run-up in energy costs and higher-than-expected infla- tion more generally. But they also reflect our assessment that with appropriate monetary policy, and in the absence of significant un- foreseen developments, the economy should continue to expand at a solid and sustainable pace, and core inflation should decline from its recent level over the medium term. Although our baseline forecast is for moderating inflation, the committee judges that some inflation risks remain. In particular, the high prices of energy and other commodities in conjunction with high levels of resource utilization that may increase the pric- ing power of suppliers of goods and services have the potential to sustain inflation pressures. More generally, if the pattern of ele- vated readings on inflation is more protracted or is more intense than currently expected, this higher level of inflation could become embedded in the public’s expectations and in price-setting behavior. Persistently higher inflation would erode the performance of the real economy and would be costly to reverse. The Federal Reserve must take into account these risks in making its policy decisions. In our pursuit of maximum employment and price stability, mon- etary policymakers operate in an environment of uncertainty. In particular, we have imperfect knowledge about the effects of our own policy actions as well as of the many other factors that will shape economic developments during the forecast period. These un- certainties bear importantly on our policy decisions because the full influence of policy actions on the economy is felt only after a con- siderable period of time. The lags between policy actions and their effects imply that we must be forward-looking, basing our policy choices on the longer-term outlook for both inflation and economic growth. In formulating that outlook, we must take into account the possible future effects of previous policy actions, that is, of policy effects still in the pipeline. Finally, as I have noted, we must con- sider not only what appears to be the most likely outcome, but also the risks to that outlook and the costs that would be incurred should any of those risks be realized. At the same time, because economic forecasting is far from a pre- cise science, we have no choice but to regard all of our forecasts as provisional and subject to revision as the facts demand. Thus, pol- icy must be flexible and ready to adjust to changes in economic pro- jections. In particular, as the committee noted in the statement VerDate 0ct 09 2002 12:29 Feb 20, 2007 Jkt 031539 PO 00000 Frm 00014 Fmt 6633 Sfmt 6633 F:\DOCS\31539.TXT HFIN PsN: TERRIE 11 issued after its June meeting, the extent and timing of any addi- tional firming that may be needed to address inflation risks will depend on the evolution of the outlook for both inflation and eco- nomic growth as implied by our analysis of the incoming informa- tion. Thank you. I would be happy to take questions. The CHAIRMAN. Thank you, Mr. Chairman. [The prepared statement of Mr. Bernanke can be found on page 57 of the appendix.] The CHAIRMAN. Again, welcome back to the Financial Services Committee. Your predecessor was always emphasizing price stability as prob- ably the key element to the charge that Congress gave the Federal Reserve way back when the Federal Reserve was created. And ob- viously your statement reflected that continuum on that issue. I have always been struck by the economic analysis of core inflation, minus—or not counting food and energy, and I am wondering if you could share that differential with the committee. I say that because to the average person, when they think of in- flation, they think of going to the gasoline pump, they think of going to the grocery store, probably has more of an effect on peo- ple’s daily lives than any other form of inflation, and yet the Fed- eral Reserve talks about core inflation minus those two compo- nents. Could you share how that affects the decisions by the FOMC and how that is reflected in the policy? Mr. BERNANKE. Yes, Mr. Chairman. First of all, you are abso- lutely correct that what matters to the average person is overall in- flation, including energy prices and food prices, and we take that very seriously. Overall inflation is probably also what guides infla- tion expectations as people think about what inflation rate is likely to occur in the future, and that is another reason to be concerned about overall inflation. There are two reasons why we look at core inflation as well as overall inflation. The first has to do with forecasting. Historically oil prices, energy prices have been rather volatile, and if you look even today at the futures markets, the futures market predicts en- ergy prices will be relatively flat over the next couple of years. If you take that forecast as correct, then today’s core inflation rate is actually a reasonable forecast of tomorrow’s total inflation rate if energy prices do, in fact, flatten out as the markets seem to expect. The CHAIRMAN. Could I interject there? Mr. BERNANKE. Certainly. The CHAIRMAN. Flatten out where; flatten out at $70 a barrel, $80 a barrel? Mr. BERNANKE. Futures suggest they will be a little more in- creased, but roughly speaking, energy oil prices will flatten out be- tween $75 and $80 over the next 2 years. The CHAIRMAN. So there is no expectation at this point—wouldn’t really make any sense that oil prices would slide back below $50. Mr. BERNANKE. Not based on those futures markets quotes. There is also a great deal of uncertainty about where energy prices are going to go. VerDate 0ct 09 2002 12:29 Feb 20, 2007 Jkt 031539 PO 00000 Frm 00015 Fmt 6633 Sfmt 6633 F:\DOCS\31539.TXT HFIN PsN: TERRIE 12 The CHAIRMAN. But the betting would be clearly on the upside as opposed to the downside. Mr. BERNANKE. Well, if you look at the options on futures, which suggest something about the uncertainty the traders feel about oil prices, you see it is quite a wide range. There is a possibility in their mind that prices might fall $20 and a possibility in their mind that prices might rise $20. So there is a lot of uncertainty about what those prices will do. But our best guess is just to look at where the futures quotes are, and that suggests that energy prices should stay roughly in the area where they are today. The CHAIRMAN. Assuming that is the case, and I think that is a fair assumption, at what point does the market mechanism pro- vide the incentive for extra exploration, going into shale—oil shale, all of those things that could be triggered, if there is good news that we triggered by the higher prices, the incentive to go after ter- tiary recovery. Is that correct? Mr. BERNANKE. Mr. Chairman, there are many alternatives to oil that are probably profitable at $40 or $50 a barrel. So if prices stay at this level over a period of time, you would expect to see a num- ber of alternative supplies coming on line. The problem on that side, of course, is that many of these alternatives take some time to become available, and therefore, we don’t get immediate relief. Of course, on the demand side as well there is also an incentive to conserve, reduced usage of oil. That should also provide, I hope, some relief. The CHAIRMAN. Have you seen any indication that at this point that is beginning to take hold? Mr. BERNANKE. We are seeing a lot of activity in drilling and mining, for example. It is very difficult to find petroleum workers or drilling rigs because the activity has risen. We are seeing activ- ity in Canada and elsewhere on sands and shale. We are seeing some reduction in the demand for oil, although perhaps less than we would like. What we saw in the past when oil prices rose very significantly in the 1970’s was that the short-term effect was relatively small, but over a decade or more, we saw a very significant reduction in the amount of oil that the U.S. economy uses per dollar of real GDP. The CHAIRMAN. I know you are not the Secretary of Energy, you are Chairman of the Federal Reserve, but obviously those compo- nents play a large part in their decisions. It struck me, for exam- ple, in the area of natural gas, there were all these dire predictions last winter that the price of natural gas would go through the roof, partly because of a mild winter and so forth. Now we seem to have a surplus of natural gas. Almost impossible, I guess, to predict it with any accuracy, which I guess makes your job that much more difficult. Is that a fair assumption? Mr. BERNANKE. Yes, sir. That is a piece of good news, the natural gas prices have come down from the $12 to $14 level that we were seeing earlier. Natural gas is a bit different from oil in that natural gas is a regional market. We don’t ship it internationally to the same extent that we do oil. And so we are very sensitive to the do- mestic supply-and-demand conditions, such as the effects of Hurri- VerDate 0ct 09 2002 12:29 Feb 20, 2007 Jkt 031539 PO 00000 Frm 00016 Fmt 6633 Sfmt 6633 F:\DOCS\31539.TXT HFIN PsN: TERRIE 13 cane Katrina last year and the effects of the weather over the win- ter. So it is a more volatile price in that respect. The CHAIRMAN. Thank you. My time has expired. The gentleman from Massachusetts. Mr. FRANK. Mr. Chairman, I want to get back to the wage issue because I really am troubled by an inattention to the problems that are there. And I am going to talk now about inconsistency in the language in your report, and I don’t think it was conscious. I think it is more serious than that. It is a mindset where people automati- cally do it. As you seem to be acknowledging, when I was talking about your discussion in wage increases in the monetary report, it is all with- out saying it is nominal. That is when you talk about the wage in- creases, you were talking about increases that are not corrected for inflation. And they look obviously better when they are that way, and you don’t even say that. But I went through the report as we were sitting here, and in every other sector where there is a discussion, you are talking about real. You are talking about real household expenditures. I mean, just—real outlays for goods on page 5. Real outlays for con- sumer services. Housing activity is measured by real expenditures. Real outlays for equipment software, real business fixed invest- ment, real business spending. Real expenditures for nonresidential construction. Federal deficit was real. Real expenditures by State and local governments. Frankly, it is only with wages that you don’t get real, and that is a serious problem because what this does is allows people to— had a debate with a member of this committee in which he was told by Treasury how much wages have gone up, but I am sure they were using nominal wages. When Secretary Snow testified here, he used nominal wages. How can you justify talking about real, i.e., corrected for inflation, numbers in every other sector where there is a sector discussion but not with regard to wages? How do you justify that? Mr. BERNANKE. Congressman, the nominal wage discussions are related to some cost issues, and it is a different topic. I agree with you absolutely that real wages are extremely important. I would also like to add in case there is any confusion that increases in real wages are entirely consistent with low inflation. There is no con- tradiction with those two things. Mr. FRANK. Okay. I appreciate it, but now I will get back to the point in your statement where you talked about wages purely as a cost rather than as the way most people in America support themselves. In the report, you analyze sector by sector by sector, and in every sector you talk about real, and in labor you talk about nominal. That is a mindset that I think is unfortunate. But now let me ask you with regard—and let us go to the pro- ductivity chart, because what you get is—in your statement it is, well, frankly, the tone is almost lucky for us that wages have stayed down. I mean, that is the context of it, because in the con- text of your statement, given the focus on inflation, the fact that wages have lagged both productivity and, in fact, inflation for the last year, that seems to be a good thing. And we have people writ- ing—and you and I talked about this, and you have said that this VerDate 0ct 09 2002 12:29 Feb 20, 2007 Jkt 031539 PO 00000 Frm 00017 Fmt 6633 Sfmt 6633 F:\DOCS\31539.TXT HFIN PsN: TERRIE 14 doesn’t reflect you, but I think we have to make this public—in the financial pages wages are a bad thing, increases in wages are a bad thing. And people will write, the Federal Reserve is worried wages may go up. So let me ask you now, given this chart with regard to real wages versus productivity, and given, as you have acknowledged, that profits are at an all-time high as a percentage of national in- come, do you believe there is room for wages to go up at least— not at least—to the level of productivity increases without that having an inflationary impact? Mr. BERNANKE. Yes, I do. And I do expect nominal wages to rise. Mr. FRANK. You said nominal again. Mr. BERNANKE. Nominal wages and real wages to rise. Mr. FRANK. You expect them, but I don’t mean to be rude, no- body can eat your expectations. We have to eat our own work some- times, but other people can’t get much. And you acknowledge, I guess, in a question, we were told, well—it is the recovery, wages are coming, wage increases are coming. Well, the recovery is now leveling off, and wage increases ain’t been here yet. And this—and by the way, I hear—and here is where I think we have a problem. It is not truly a force of nature. And, I mean, it goes with this. You acknowledge that wages are well below what they could be without there being an inflation effect? Mr. BERNANKE. They could rise without inflation effect. Mr. FRANK. Good. And they are below inflation—below produc- tivity, below inflation. So workers in this great economy that we have had, and in many ways it has been a very good one, most of them—I am not talking about 20 percent, I am talking about 80 percent, the people who get paid by wages, their compensation, their wages have dropped. You are talking about compensation there, but that includes, you know—let’s be careful when we talk about overall compensation in this report. One of the things we are talking about is when the employer pays more for health care, the worker can’t bring that money home. So real wages have lagged. And here is the fact; it is not purely a force of nature. When you refuse to raise the minimum wage so inflation erodes it, when you have an active policy of breaking labor unions, and when you have a tax policy that favors people at the high end, you are reinforcing those tendencies. And so what we have is a national policy which takes advantage of factors that are keeping real wages depressed and keeping productivity way ahead of wages so that all the increase—as Alan Greenspan said 2 years ago and apparently is still the case, virtually all of the increased wealth in this society that comes from increased productivity goes to the owners of cap- ital, and obviously they should be getting some of it, but not all of it. It is not healthy. And so you get that situation, you get a public policy that rein- forces it, and then Mr. Hubbard shouldn’t wonder why the Amer- ican people don’t give him credit for this wonderful economy. They don’t give him credit because they are not getting any cash. Thank you, Mr. Chairman. The CHAIRMAN. I recognize the gentleman from Illinois. Mr. GUTIERREZ. Thank you very much, Mr. Chairman. VerDate 0ct 09 2002 12:29 Feb 20, 2007 Jkt 031539 PO 00000 Frm 00018 Fmt 6633 Sfmt 6633 F:\DOCS\31539.TXT HFIN PsN: TERRIE 15 I intended to ask Mr. Bernanke about the positive effect of immi- gration, but I have a scheduling conflict, so I would like to ask unanimous consent to have some items entered into the record. The first is an open letter on immigration to President Bush and all Members of Congress signed by 500 American economists, Mr. Chairman. The CHAIRMAN. Without objection. Mr. GUTIERREZ. The second is a July 10, 2006, open letter on im- migration with 33 conservative signatories as published in The Wall Street Journal. The CHAIRMAN. Without objection. Mr. GUTIERREZ. And the third, Mr. Chairman, is an op-ed piece from the Wall Street Journal entitled, ‘‘Reagan on Immigration.’’ The article discusses President Reagan’s support for legalization and includes Mr. Reagan’s account of his visit with the President of Mexico to get his ideas on ‘‘how we can make the border some- thing other than a locale for a 9-foot fence.’’ Thank you, Mr. Chairman. The CHAIRMAN. Without objection, so ordered. The gentlelady from Ohio. Ms. PRYCE. Thank you, Mr. Chairman, and you, Mr. Chairman, for your testimony. We have—many of us on this committee have worked very hard on legislation to reform the Committee on Foreign Investment in the United States, the CFIUS process. Yesterday The Wall Street Journal quoted economist Lawrence Kotlikoff’s recent study which said that foreign investment helps offset the low savings rate in the United States and has helped to raise the average wage of Amer- ican workers by increasing productivity. The savings rate in America continues to be terribly low, as I said in my opening statement. Can you discuss your thoughts on if certain pieces of this legislation does become law, and it looks like we in the House will be maybe dealing with that as early as next week, will it make that harder for foreign companies to invest in the United States? Do you believe it will be detrimental to our economy, especially the savings rate debt—rate/credit debt ratio facing Americans? And are you familiar enough with the House and Senate versions of the legislation to be able to comment on ei- ther one of them? Mr. BERNANKE. Congresswoman, I would just make, I think, the general point that keeping our capital markets open to foreign in- vestment is extremely important for the welfare of Americans. Cap- ital that comes in allows us to invest more than we otherwise could. It provides jobs, it provides new technologies that come with foreign investment, at the same time that our open markets give us more opportunity to invest abroad and to achieve those returns. So I think America has one of the most open, free capital mar- kets in the world. It is to our benefit to try to maintain that. I fully recognize that there are circumstances in which national security concerns might come into play. I think we need to walk a very fine line to make sure that we are restricting ourselves to genuine con- cerns and that we don’t, you know, unwarrantedly restrict legiti- mate capital inflows. VerDate 0ct 09 2002 12:29 Feb 20, 2007 Jkt 031539 PO 00000 Frm 00019 Fmt 6633 Sfmt 6633 F:\DOCS\31539.TXT HFIN PsN: TERRIE 16 So I can’t really comment on the two bills. I don’t think it is real- ly even my sphere to do so. But I hope that in thinking about this that Congress will weigh the very important benefits of capital inflows against the also very important concerns about national se- curity. Ms. PRYCE. Thank you. Let me talk a little bit about insurance, and terrorism risk insur- ance specifically. Do you have any thoughts about what the finan- cial mechanisms available are to enhance the private market ca- pacity to take on terrorism risk when TRIA expires? And it seems to be a very difficult problem that isn’t solving itself in the market- place quite yet. And is government intervention stopping the mar- ket from working, or is it just inevitable that it is not possible for the market to absorb this? Mr. BERNANKE. Congressman, I am a member of the President’s Working Group on Financial Markets, as I am sure you know, and we are required to submit a report by September 30th to Congress evaluating the availability of terrorism risk insurance. The staff of the PWG has been exhaustively meeting with various groups. We have solicited comments which have been arriving, but we have not yet come to the point where the staff have summarized and brought the material together and briefed the principals of the PWG on this issue. I assure you when that time comes, we will look at it very seriously, because I understand it is an important issue to many people. Ms. PRYCE. And lastly, for some time we have been discussing the evolving downsizing of the housing market as a moderate and orderly cooling process. I think that is how you have referred to it. Aren’t you concerned about the considerable downside risk to the intrasensitive housing sector over the balance of the year? Can we hear your comments on that? Mr. BERNANKE. Well, as you indicated, the downcurrent in the housing market so far appears to be orderly. The level of activity is still relatively high on an historical basis, but we recognize the risk you are pointing to. We are watching it very carefully. I would just note that there are other aspects of the economy which are to some extent taking up the slack, so to speak, created by a slowing housing market, including investment in nonresiden- tial construction and exports, among others. So we are looking at the overall economy. We are looking at housing. Clearly that is a very important sector we are watching very carefully. Ms. PRYCE. We are very concerned in Ohio, and I appreciate your attention. Thank you. I yield back. The CHAIRMAN. The gentlelady from New York, Mrs. Maloney. Mrs. MALONEY. Thank you. Chairman Bernanke, I have been very concerned about the grow- ing gap between the haves and the have-nots in the American peo- ple. The Federal Reserve has recently published some pretty dis- turbing evidence in this regard in the Survey of Consumer Fi- nances. That survey is similar to others in showing weak growth in median income, but it has unique data on wealth. I have seen figures that the top 1 percent of families hold more wealth than the bottom 90 percent of families combined. Is that true? VerDate 0ct 09 2002 12:29 Feb 20, 2007 Jkt 031539 PO 00000 Frm 00020 Fmt 6633 Sfmt 6633 F:\DOCS\31539.TXT HFIN PsN: TERRIE 17 Mr. BERNANKE. I believe that is correct. Mrs. MALONEY. That suggests that for most families wages are the main source of income, doesn’t it? Mr. BERNANKE. Yes. Mrs. MALONEY. And building on the conversation of Mr. Frank, the employment costs have not been a source of inflationary pres- sure at any point in the current recovery, and so that that may leave room for wages to grow without causing the Federal Reserve any worry. Is that a correct statement? Mr. BERNANKE. As I said to Congressman Frank, I expect wages to rise, and I do think that higher real wages are completely com- patible with low inflation Mrs. MALONEY. Great. Thanks. There are a lot of people who have not benefited from this eco- nomic recovery so far. And aren’t those the people who are most vulnerable to the economic downturn if the Federal Reserve mis- calculates and tightens monetary policy too much? Mr. BERNANKE. Our concern, Congresswoman, is to achieve a sustainable growth path. We don’t want to get into a situation where we get into a boom and bust. We don’t want to get into infla- tion, because inflation also detracts from the buying power of work- ers and the consumers. So we are looking to try and achieve a sus- tainable growth path. We are aware of the risks to that, and we are going to do our utmost to achieve that. Mrs. MALONEY. Following up on Congresswoman Pryce’s com- ments on raising rates and the impact on mortgages, and I want to talk a little bit about the risk of both going too far in raising rates as it pertains to housing. First, aren’t households with adjust- able-rate mortgages the ones who feel the immediate effects of higher interest rates? What percentage of mortgages or home eq- uity loans are immediately affected when interest rates go up? Mr. BERNANKE. Our estimate is that about 20 percent of all mortgages outstanding have variable rates, and we expect about half of those, or about 10 percent, of the outstandings to reprice during 2006. So there will be some effect on variable-rate mort- gages, but it should be a relatively slow process, and that would provide some cushion. Mrs. MALONEY. Many New Yorkers are some of the most vulner- able homeowners. They are the people who made purchases with very little money down and obtained mortgages in a subprime mar- ket. Is there a danger of a wave of foreclosures and people losing their homes if interest rates keep rising? Mr. BERNANKE. We have so far seen very little increase in delin- quencies or problems in the mortgage market, but we will watch that very carefully. Mrs. MALONEY. One of the great benefits of the strong economy of the 1990’s, when the unemployment rate got down to 4 percent, more than half a percentage point lower than it is now, is that a great deal of people who did not have a firm attachment to the labor force got jobs and experience with full-time work, and aren’t those the people who are most vulnerable if an economic expansion is choked off prematurely by tightening monetary policy too much? Mr. BERNANKE. Congresswoman, again, our objective is to achieve a noninflationary sustainable expansion. There are risks to VerDate 0ct 09 2002 12:29 Feb 20, 2007 Jkt 031539 PO 00000 Frm 00021 Fmt 6633 Sfmt 6633 F:\DOCS\31539.TXT HFIN PsN: TERRIE 18 that in both directions. It is possible to overtighten and to have the growth be slower than the potential; it is also possible to not suffi- ciently address inflation problems, and inflation rises. Both cut into buying power and create a risk that the Federal Reserve would have to raise interest rates more later. So there are risks. Again, our objective is to try and create a non- inflationary expansion. With respect to mortgage rates, I would just like to add that one of the best things the Federal Reserve can do to keep mortgages rates low is to keep inflation low. When you look at the 1970’s and early 1980’s, when mortgage rates were in the 18 percent range, we are not seeing anything like that, of course, and it is because inflation is low and expected to stay low. Mrs. MALONEY. And finally, my time is almost— The CHAIRMAN. Your time is up. Mrs. MALONEY. I just want to know, were the markets right when they rallied yesterday after your testimony? Mr. BERNANKE. I don’t comment on the market move. The CHAIRMAN. Nice try, Carolyn. The gentleman from Iowa, Mr. Leach. Mr. LEACH. Thank you, Mr. Chairman. I would like to just make a comment first on your opening state- ment, sir. I appreciate very much the clarity of it, the transparency of it, as well as the modesty of judgment. It is very impressive. In particular, your comments on interest rates are as precise as this committee has ever heard, as well as your predictions on where you think GDP growth is going. I would like to ask about a couple of definitional issues. One is a new economic term that has taken on great import and one that I gave very positive implications to, and I wonder if you would like to suggest whether it is positive or negative, and the term is a one- word term called ‘‘pause.’’ Do you like this idea? Mr. BERNANKE. Do I like the idea? Mr. LEACH. Yes, of a pause. Mr. BERNANKE. Well, as I spoke about in my testimony before the Joint Economic Committee, I raised the possibility that at some point—and I emphasize at some point—the Federal Reserve may want to vary its pattern of policy changes to look to vary the pace of tightening to get more information about the state of the econ- omy. Neither then nor now am I making any specific commitments to future policy actions. Mr. LEACH. Fair enough. But I just want to lay on the table that I think a lot of people in America find this idea of a pause in inter- est rate raising a very attractive idea. The second issue I want to raise is employment, because you were precise—in December it was a little—not perfectly good news because we had about—the last reporting period was 4.6 unemploy- ment. You are predicting for the next year and a half it is going to go between 43⁄ 4 percent and 5 percent, which means a slightly higher unemployment rate. But the definition of unemployment is getting to be more inter- esting, and this contrast between the Household Survey and the numbers that is reported through corporations seems to be at a greater variance than any time in history, with the household em- VerDate 0ct 09 2002 12:29 Feb 20, 2007 Jkt 031539 PO 00000 Frm 00022 Fmt 6633 Sfmt 6633 F:\DOCS\31539.TXT HFIN PsN: TERRIE 19 ployment rates going up substantially higher than the traditional measurements. So I would like to ask you, when you referred to the 43⁄ 4 percent to 5 percent, what unemployment rate are you referring to? And does this relate to the household statistics or the traditional defini- tions? And might one reported rate be actually less optimistic than the situation, or vice versa? Mr. BERNANKE. Congressman, let me just note that when these forecasts were made at the last FOMC meeting, I believe the un- employment rate was 4.7 percent at that point. We are not that precise in our forecasting. I think the thrust of our forecast is that the unemployment should stay at about the same region as it is today. The unemployment rate is calculated from the Current Popu- lation Survey, which is a survey of 60,000 households; that is the one that we are referring to. The discrepancies that have arisen in the past are between the job creation numbers from that survey and the job creation numbers from the payroll survey, which we are perhaps more familiar with. Those two surveys have come clos- er together in recent years, and in the last few months we have seen some divergence again, but they have been somewhat more aligned than they were a few years ago. Mr. LEACH. Fine. I appreciate that and have no further ques- tions. The CHAIRMAN. The Chair recognizes the gentleman from Massa- chusetts, Mr. Capuano. Mr. CAPUANO. Thank you, Mr. Chairman. Mr. Chairman, I am interested in hedge funds and their impact on the economy. As I understand it, it is $1.2 trillion and growing, mostly held by—within 200 hedge funds. Obviously there is a lot more than that, but about 200 hold most of that money. Hedge funds are no longer restricted to the wealthy, so-called so- phisticated investor; they are open to the small investors. They are attracting larger and larger investments from pension funds, both public and private. The growth in hedge funds has resulted in lower returns, on av- erage, which in turn has led to some investment strategies that might be a little bit more risky than they had been in the past. Recently the SEC, as you know very well—the SEC was knocked out in court from their attempt to not regulate, but to simply gath- er data and to make sure that that data was accurate and had the integrity so it could be relied on. It was not an attempt to regulate, yet the SEC was told they couldn’t even gather this data. I am just curious. Do you think the SEC should be gathering this data, or do you think that there is no need to do so? Mr. BERNANKE. I think the SEC has an important role in making sure that the information that the hedge funds provide to their in- vestors is accurate, and I would support their actions to do that. I think, broadly speaking, that the best way to make sure the hedge funds are not taking excessive risk or excessive leverage is through market discipline, and there are two primary mechanisms. First, the SEC and the Federal Reserve supervise the large banks and investment banks which are the primary counterparties of the hedge funds. And ever since the PWG’s report after the LTCM cri- VerDate 0ct 09 2002 12:29 Feb 20, 2007 Jkt 031539 PO 00000 Frm 00023 Fmt 6633 Sfmt 6633 F:\DOCS\31539.TXT HFIN PsN: TERRIE 20 sis a few years ago, we have made very strong efforts to ensure that those banks and investment banks are very carefully moni- toring the risks of the hedge funds that they work with, and are stress testing and are requiring sufficient margin and the like. In addition, I think that the investors in hedge funds, which for the most part should be large and sophisticated investors, are also a source of market discipline. And I would support the SEC’s inves- tor protection activities to make sure that they get the information they need to make those judgments. Mr. CAPUANO. So you would have no objection to this Congress passing a bill that clarified that the SEC’s actions are within the law, or actually making it clear that the law allows them to have done only what they did. I am not suggesting—I would say it is not regulation, but simply gathering information. Mr. BERNANKE. Well, the Board doesn’t really have a position in that specific element. I think there is a trade-off. There are some benefits to the information, but we need to be a bit careful to make sure that the public is not misled into thinking that there is a full- fledged regulatory regime here which would then lead them to be less careful in their dealings with the hedge fund. Mr. CAPUANO. I think that is a very fair statement. I am glad to hear that, because some of the quotes that I read from you got me a little concerned. And I guess—jumping off of that into the next point, at some point regulation—I am not con- vinced it is necessary yet, but I guess I am leaning that way at some point. I have a quote here from you—actually, let me back up. The president of Bear Stearns is—well, he is not quoted, but it is reported that he considers hedge funds risky and have become a focus of concern because of their rapid growth and concentration in the industry. And it is reported that he has suggested that this could trigger a financial crisis. And obviously Bear Stearns, I don’t think anybody would consider them radical left wing, over-regu- lating types of supporters. Here I have a quote from you—and again, maybe misquoted, ‘‘Di- rect regulation may be justified when market discipline is ineffec- tive at constraining excessive leverage in risk taking.’’ Well, I guess the question I have is does this suggest that we shouldn’t even consider regulation until after there is a crisis of some sort, until after we find out that the market forces may not work, until after pension funds are looking to cover my mother’s pension, or—I understand your hesitancy, and I am not suggesting we should rush into it at all, but I also think that there might be a balance at some point as hedge funds grow, that we might want to consider the possibility of reviewing some regulation. Again, I am not suggesting we jump into it headlong, but I think there is something between no regulation and waiting until after a crisis. And I want to see if I can clarify at least that quote that is attrib- uted to you. Mr. BERNANKE. First let me say that hedge funds provide some very important positive benefits. They add a lot of liquidity to mar- kets, they add a lot of efficiency to the markets. We don’t want to do anything that would inhibit those very positive— Mr. CAPUANO. And I agree with that. VerDate 0ct 09 2002 12:29 Feb 20, 2007 Jkt 031539 PO 00000 Frm 00024 Fmt 6633 Sfmt 6633 F:\DOCS\31539.TXT HFIN PsN: TERRIE 21 Mr. BERNANKE. That quote, I think, was a general statement, not referring to hedge funds. The thrust of my speech on hedge funds at Sea Island, Georgia, was to affirm the general principle that the President’s Working Group put forward after LTCM, which is that the best way to achieve good oversight of hedge funds is through market discipline, through the counterparties, through the inves- tors. There are also other ways to try to make sure that hedge funds work better. I would just point to the work that the Federal Re- serve Bank of New York has done to try to improve deferring set- tlement of credit default swaps, for example. And there are inter- national groups like the Committee for Payments and Settlement Systems, which is sponsored by the BIS, which is also looking at this issue quite broadly. But at this point I think that the market discipline has shown its capability of keeping hedge funds well dis- ciplined. The CHAIRMAN. The gentleman’s time has expired. Mr. CAPUANO. Thank you very much, Mr. Chairman. Thank you for those opening remarks. The CHAIRMAN. The gentleman from Louisiana. Mr. BAKER. I thank the chairman. Just to follow up a little bit on Mr. Capuano’s remarks, there was, in 1999, H.R. 2924, which would have required hedge funds above a certain size to disclose information to the Federal Reserve for the intended purpose of identifying potential systemic risk events, and I will forward that over for comment and advisory. I, in retrospect, look at the product and feel that it needs to be made more clear that no proprietary disclosure be made to ensure that it is only a blind view as to who is sitting at what table and—be- yond what the counterparty risk disclosure may give to you now. I wanted to move quickly to the subject of GSE reform. I read with great interest your response to Senate questions on the mat- ter of portfolio limitations wherein I believe you characterized your view to be that no hard dollar amount nor some arbitrary percent- age reduction be made applicable, but rather that some relation- ship between portfolio scale and mission compliance pursuant to charter requirement be made effective. In given conversations I have had with Secretary Paulson and Director Lockhart on the matter, I, for whatever it is worth, share that view—would like to request that you work with the Director and the Secretary to compound some sort of language that you think would be helpful in breaking the last remaining element I be- lieve that is blocking the adoption of significant and, I think, very badly needed GSE reform. There is another issue that I wanted to get on the record that I think is very important. I am concerned not so much about the domestic economic condition and our ability to maintain a reason- able rate of growth, except for the enhanced global competitive market we now face. I believe there are conditions brought on by our own regulatory constraints that may be inhibiting international capital flows which would generate the job opportunities and, hence, the increased wages which some have expressed concern about. VerDate 0ct 09 2002 12:29 Feb 20, 2007 Jkt 031539 PO 00000 Frm 00025 Fmt 6633 Sfmt 6633 F:\DOCS\31539.TXT HFIN PsN: TERRIE 22 The result is that some regulators have suggested actions that might be helpful. Recently the Chair of FASB has indicated that a move toward a more principles-based accounting methodology might be a way to help industries’ current cost of compliance. Chairman Cox has indicated his strong support for the deployment of XBRL to help us move away from the enormous paper-based re- porting methodologies that we now have to deal with. Many in the market have expressed some concerns about some of the compliance cost with the Sarbanes-Oxley Act. My last gen- eral question is to help us going forward and maintain our U.S. competitive edge, are there certain regulatory areas that you could recommend to the Congress to review where, without diminishing transparency, appropriate disclosure, gauging systemic risk poten- tial—are there things that are now on the books that, in light of our current technological sophistication, are no longer warranted and might be worthwhile to set aside? Mr. BERNANKE. Congressman, first, it is important to recognize that these regulations have a positive purpose, that Sarbanes- Oxley has addressed some important issues like corporate govern- ance and disclosures, internal controls and the like. I think it is im- portant that we think hard, particularly at the implementation phase, about aligning the costs and the benefits of individual ac- tions. As you may know, my former colleague Mark Olsen has just left the Federal Reserve to become the head of the Public Company Ac- counting Oversight Board. I have a lot of confidence in Mr. Olsen and in Chairman Cox. I am sure they are reviewing all these issues very carefully. And I think that for the implementation phase, the regulation phase, I think that they will look for areas where cost can be reduced without compromising the overall, in part— Mr. BAKER. Let me jump in before my yellow turns red. I met Mr. Olsen yesterday, and had a great conversation about these general parameters. The last piece of this, I believe, is that the most insidious force in market function were CEO’s and CFO’s trying to beat the street every 90 days with manipulation of the rules to exceed market expectation. Do you support, as I do, and I believe others have expressed, in- cluding the Chamber, encouraging companies to move away from the 90-day reporting, and would that in a way deter investors’ abilities to make proper judgments about economic condition of cor- porations? Mr. BERNANKE. I thought about that issue, Congressman. I think that good corporate governance, though, should establish a longer- term strategic approach rather than meeting short-term earnings goals. The CHAIRMAN. The gentleman’s time has expired. Mr. FRANK. Mr. Chairman, I have a unanimous consent request on behalf of our colleague, the gentleman from Texas, Mr. Hinojosa, who was called away by the little matter of redistricting, which is, as you know, a constant theme of Texas. So he has a unanimous consent request. And he wanted me particularly to express his thanks to the Chairman of the Federal Reserve for addressing the regional issues conference, and particularly on the issue of financial literacy. So VerDate 0ct 09 2002 12:29 Feb 20, 2007 Jkt 031539 PO 00000 Frm 00026 Fmt 6633 Sfmt 6633 F:\DOCS\31539.TXT HFIN PsN: TERRIE 23 these remarks are from Mr. Hinojosa, in which he expresses his gratitude to Chairman Bernanke for his support for the issue of fi- nancial literacy and for his work on that. That is for the record. The CHAIRMAN. Without objection. The gentleman from Missouri, Mr. Clay. Mr. CLAY. Thank you, Mr. Chairman. Mr. Chairman, we have many pension funds that have lost hun- dreds of millions of dollars. We have many citizens who have seen their investments lost whether because of corporate scandals, in- vestment fraud, poor management decisions, or having to cash out and replace lost wages, yet we still hear how great investment re- turns are. Who are these investment returns actually going to? How much of the investment returns is going to individuals not in the top 11⁄ 2 percent of income earners? Mr. BERNANKE. Congressman, you are referring, I think, in part to defined benefit pensions or defined contribution pensions. With regard to defined benefit pensions, we have had some problems, ob- viously, with companies not able to meet their promises. I think it is very important that Congress pass reform that requires compa- nies to meet their promises, provides transparency so their workers can see what the state of the pension fund is, and protects tax- payers as well. So I think that is a very important area. With respect to defined contribution plans, many workers are now moving toward defined contribution. I think they are receiving market returns on average, but one thing I would point out is that what we have learned is that people will not voluntarily join the defined contribution plan unless they are put in there by default. And one of the things that we encourage employers to do is have an opt-out option so that people don’t take an action that they automatically enroll, because one of the important things we need to do is help middle-income and low-income families build wealth, and a 401(k) at work is one important mechanism for building wealth. Mr. CLAY. And you are comfortable with the performance of the defined contributions? Mr. BERNANKE. For 401(k)’s. I am not aware of any information that they have received lower returns than other investments. As Congresswoman Maloney pointed out earlier, there is inequality of wealth in the country, and people in the lowest levels of wealth have, you know, much smaller wealth relative to their income than those in the upper echelons. Mr. CLAY. Thank you for that response. We know that job creation in the Bush Administration does not nearly approach the average job growth monthly rate of the pre- vious Administration. The Clinton Administration outpaced the Bush years by nearly 100,000 jobs a month. And we have seen the effects of this in my State, Missouri, with the loss of jobs. We addi- tionally see that existing wages have not kept pace with inflation. Wages adjusted for the effects of inflation have not risen at all over the past 3 years. We have had an extended period of solid GDP growth, but this has not brought any real benefits to workers in general. VerDate 0ct 09 2002 12:29 Feb 20, 2007 Jkt 031539 PO 00000 Frm 00027 Fmt 6633 Sfmt 6633 F:\DOCS\31539.TXT HFIN PsN: TERRIE 24 What is the direction of the Federal Reserve in addressing this problem? Mr. BERNANKE. Well, we have no objection. You know, as I said, higher real wages are entirely consistent with low inflation. With respect to jobs, there is an issue, I think, that is worth put- ting on the table which relates to some research that has been done by Federal Reserve economists. They have found evidence that for demographic reasons the labor force participation rate, the share of the adult population that is working or looking for work, will be de- clining over time, reflecting such factors of the leveling off of fe- male participation, more young people going back to school, and then particularly the aging population. Older people are less likely to be in the labor force than younger people. Because the labor force participation seems to have a downward trend to it, it probably takes fewer jobs each month to keep the un- employment rate at a constant level. So the job numbers, I think, going forward are going to be smaller, but not necessarily in a way that is going to raise unemployment, because the number of people looking for work is probably going to be growing more slowly in years to come than it was in the past. With respect to wages, there are alternative measures of wages that give somewhat different answers, but I agree that average hourly earnings for production workers, as measured by the Payroll Survey, have not shown real gains. And one of the key problems there I think it is important to note is, in fact, the increase in en- ergy prices, so what people get at the pay stub they lose at the gas pump. That is an issue and a reason for worrying a bit about infla- tion. The CHAIRMAN. The gentleman’s time has expired. The gentleman from Alabama, Mr. Bachus. Mr. BACHUS. Thank you. Chairman Bernanke, I notice that you were confronted with a chart by Mr. Frank, and, in fact, yesterday you were questioned in the Senate about job compensation. Now, I don’t know where he got his chart, there are Democratic charts and there are Repub- lican charts, and then there is actually a chart—and I would like to turn it towards you here a minute if I could. There is a chart— did they hand you a copy of the chart? Mr. BERNANKE. No, sir, but I can— Mr. BACHUS. I had asked them to do that, and I apologize. This is the Treasury Department chart on compensation growth, and it is entitled—and this is from the career people at the Treas- ury Department, this isn’t from the DNC or the RNC or a dueling Member of Congress, and it is titled, ‘‘Compensation Growth Is Better than Comparable Point in Previous Cycle.’’ It talks about real hourly compensation. And as I said, this is a national survey, National Compensation Survey—I am having Members on both sides take a look at it, and I would like unanimous consent to pass it out. The CHAIRMAN. Without objection. Mr. BACHUS. It shows that in the past year real hourly com- pensation has gone up 7.4 percent. Now, Mrs. Maloney and Mr. Frank keep talking about real, real, real. Well, if you will notice— and if you will turn that chart towards the chairman—actually, I VerDate 0ct 09 2002 12:29 Feb 20, 2007 Jkt 031539 PO 00000 Frm 00028 Fmt 6633 Sfmt 6633 F:\DOCS\31539.TXT HFIN PsN: TERRIE 25 am sorry, you have one in front of you, I think. It talks about real compensation per hour is worker pay plus benefits adjusted for in- flation and the number of hours worked. And what it shows is that in this job cycle, as opposed to the previous recovery, that workers are 7.4 percent better off in compensation. I just wanted to give you those talking points—in case you are asked about real numbers again. Mr. FRANK. Would the gentleman yield for 1 minute? Mr. BACHUS. And also, I would like to say that we have created 51⁄ 2 million jobs, and job growth is stronger than it was under the last recovery. But let me ask you this. You have been asked for 2 days—you have heard Members of Congress, you have heard the media talk- ing about the anemic economy and the slow economy and the slow- ing economy. And I think The Wall Street Journal said it best. They called it the ‘‘Dangerfield economy, it is the economy that gets no respect.’’ Bottom line: What is your view about the economy? Is it as strong as some claim? Is it as weak as others claim? Just talk to us about the economy. Mr. BERNANKE. I think the U.S. economy is a very strong econ- omy; it is very resilient. It has passed through a number of very severe shocks going back to the stock market decline in 2000; 9/11; corporate scandals; and Hurricane Katrina. All these things have hit us, and yet the economy continues to grow at a rate that is fast- er than most other industrial countries, so in that respect it is very positive. Mr. BACHUS. Do you know why there is such fear-mongering presently about the economy and about representations—and if you pick up the newspaper, every day you can read an article about how bad the economy is, and this economy is stronger than it has been in previous cycles, it is very strong. Mr. BERNANKE. I would say the most favorable aspect of the economy is that productivity growth has picked up. We saw it pick up from the 1970’s and 1980’s. In the mid-1990’s we saw it pick up, and in the last 5 years or so we have seen an additional pick-up, and that is a very positive feature of our economy, and one that compares well with other industrial countries. Mr. BACHUS. And the fact that you are having to fight inflation is—part of that factor is a strong economy; is it not? If the economy was weak and unemployment was high, we wouldn’t be having in- flationary problems, would we? Mr. BERNANKE. Congressman, I think there are a number of fac- tors affecting inflation, but probably one of the most important is the fact that energy and commodity prices have gone up so much. And that affects, to some extent, the strength of the global econ- omy, which has been very strong for the 3 or 4 years, and the in- creased demand for energy coming from China and other places has driven up those prices, and that has been a contributing factor to our inflation issue. The CHAIRMAN. The gentleman’s time has expired. The gentlelady from New York, Mrs. McCarthy. Mr. FRANK. Will the gentlelady yield? Mrs. MCCARTHY. Certainly. VerDate 0ct 09 2002 12:29 Feb 20, 2007 Jkt 031539 PO 00000 Frm 00029 Fmt 6633 Sfmt 6633 F:\DOCS\31539.TXT HFIN PsN: TERRIE 26 Mr. FRANK. What the gentleman from Alabama completely mis- understands is the distinction between wages and compensation. When he and I were debating this on television, we were talking about wages, and he kept saying that wages were going up. I now understand the source of his error. It was that he has confused wages and compensation. Real hourly compensation—as you will see if you read the Mone- tary Policy Report on page 18—includes employer contributions to health care costs, and, in fact, according to the Monetary Report, the cost of health insurance, which accounts for one-fourth of over- all benefit costs. So, yes, it is true that compensation has gone up if you count the amount of health care increases. What I was talking about was wages, the take-home pay, and that is very different than com- pensation. And, yes, as health care costs have accelerated, more has been paid out for the same health care, but for the worker tak- ing home wages, that hasn’t meant anything. So that is the funda- mental difference. There was also, as the report said, a burst in compensation in 2004 as companies made up for pension deficits, so they put money into the pensions that they were supposed to have had in there, and that also increased. You are talking about compensation, which includes pensions and health care, and I don’t think, for the average worker, knowing that the boss is now paying more for the same health care he or she used to get when the wages in real terms have gone down is of great comfort. The other thing is I am just struck by the timing of the compari- son. You compare two quarters here, two periods, but you leave out the Clinton years. You talk about the Bush years, the second Bush years, and then you compare that to 1990 to 1995. So what is left out here is 1995 to 2000, the main thrust of the Clinton years, when apparently things were better, which is why they were left out. But the fundamental flaw in the gentleman’s reasoning is to equate compensation with wages, and it is wages that are eroding, and that is a real problem— Mr. BACHUS. Point of personal privilege— Mr. FRANK. There is no point of personal privilege for my re- marks. The CHAIRMAN. The gentlelady is recognized. Mrs. MCCARTHY. Thank you, Mr. Chairman. I would like to bring this back down to a little perspective. I hap- pen to think that the average person is having a hard time, and I will just—I know how much money I take out of my ATM. I go to the ATM once a month, and that is my budget, and I have al- ways done it since I have been here, and I have done fine with it. I am a little thrifty, but I have to tell you, I have to go to my ATM machine now twice a month, mainly because the cost of my gaso- line has gone up. In the New York area we have probably gone up a little bit higher; we are probably comparable to New York. But it is also when I go food shopping. Now, I am a single woman. I go food shopping on Saturday morning, and I basically pick up my regular things, with a little bit more fruit. Fruit. The prices of fruit have gone up. This is what VerDate 0ct 09 2002 12:29 Feb 20, 2007 Jkt 031539 PO 00000 Frm 00030 Fmt 6633 Sfmt 6633 F:\DOCS\31539.TXT HFIN PsN: TERRIE 27 the daily life of someone is going through. So I have seen my costs go up. Certainly we in Congress, we get a COLA every year, so our pay increase has gone up 2 point something. But I have to tell you, my fuel costs—and I have gas at my home, and even though it was a mild winter, I ended up paying almost $1,800 more this past win- ter because of the surcharge. So you take that out of my yearly schedule, and you wonder why the middle-income families are hav- ing a hard time. They are; this is not a myth. If I am feeling a squeeze, and I probably make more money than a lot of my middle- income families, then certainly they are feeling the squeeze, be- cause my medications have gone up, certainly dramatically, in the last 6 months. So there is pain out there for my middle-income families, and it is real pain. So with that, though, I actually wanted to talk to you about— we are now in the hurricane season. We suffered a terrible loss fi- nancially here in the Treasury with Katrina. We are predicting more storms this year. And there are many of us who are basically looking at a reinsurance program. And I guess, Mr. Chairman, my question to you is has the Fed- eral Reserve looked at the potential impact of another major nat- ural catastrophe on the U.S. economy? Can the Treasury afford an- other 50- or $100 billion response to any kind of natural disaster? Could a natural disaster reinsurance program protect the economy? And risk management insurance is better than debt. And I guess the final part of the question is, given the limited resources, is the cost of limited insurance better than the cost of unlimited debt? Mr. BERNANKE. Well, of course, as you know, the hurricanes last year did enormous damage and created a very heavy fiscal burden. There is no question about that. I am glad to see that there has been some attention to trying to reform the Flood Insurance Pro- gram, put that on a more sound actuarial basis. You can buy insur- ance, but, of course, insurance will be expensive as well. There is really no free lunch in this case in order to protect against these risks. So my summary is that this is a risk, and if it happens again, it will be a very heavy cost one way or the other to the Treasury. The only silver lining that I can point to is that the U.S. economy as a whole is very resilient, very strong, and we have been through a number of natural disasters, including hurricanes, earthquakes that we had, of course, the terrorist events, and the overall econ- omy has proven to be rather resilient and has been able to continue to grow despite these terrible shocks. But I don’t see any way to avoid the costs, except to try to make provision in terms of, for ex- ample, in the Gulf, providing stronger protections against those po- tential catastrophes. The CHAIRMAN. The gentlelady’s time has expired. Mrs. MCCARTHY. Thank you, Mr. Chairman. The CHAIRMAN. The people indicate there are 10 minutes left in this vote. There is a series of three votes on the Floor. It would be the expectation of the Chair to recognize the gentleman from Dela- ware for questions and the gentleman from North Carolina, and then we will recess and return after those votes. The gentleman from Delaware. VerDate 0ct 09 2002 12:29 Feb 20, 2007 Jkt 031539 PO 00000 Frm 00031 Fmt 6633 Sfmt 6633 F:\DOCS\31539.TXT HFIN PsN: TERRIE 28 Mr. CASTLE. Thank you, Mr. Chairman. Chairman Bernanke, let me just agree with Mr. Baker on the GSE’s and leave that at that. Let me also agree with the gen- tleman from Iowa, Mr. Leach, on the clarity of your comments and on your statements. I spent many a day up here listening to Chair- man Greenspan, trying to figure out what he had written and never quite understanding it, trying to figure out what he had said, but never understanding it, but having great admiration for him because the economy always did well under him. And I understand you with clarity, and I hope this does as well—I don’t know if clar- ity is good or not. But I would like to have some reassurance here, because I lis- tened to and read your comments as you were reading them with respect to the area of inflation, and when it is all said and done, that is what people really look at. And you can’t comment on what seems to drive the stock market, what you are going to do with in- terest rates, or whatever. And I am not saying I see it differently, I just want to be reassured—and you may even say it in the same words, or perhaps in different words—but with energy prices and other commodity prices, even by your statement, we are probably not through with increases. And it is highly unpredictable, as you have indicated and as we all know. But it is beyond just oil prices; I mean, there are a whole lot of commodity prices that are up tremendously, and it is a trickle- down effect. For example, in Delaware we entered into some cockamamie agreement whereby we didn’t increase electric rates for 7 years or something, and now all of a sudden there is about a 50 percent jump at one time. But that is maybe atypical, but those kinds of things are happening out there. So all commodity prices concern me. Labor costs, I think, are definitely—I mean, we see it here— there is definitely going to be a push as far as labor costs are con- cerned, which I think is going to be a major issue before it is all said and done. I am going to ask you a question later if I have time on housing, because I am not sure where that is going with respect to this. Plus this sort of public expectation in terms of inflation is there as well. I am taking most of this, at least I am summarizing, from what is written here. So I am not saying anything is wrong, I just, based on what we see and know and sort of the uncertainty—and I real- ize economics is an uncertain practice, as you also said in your tes- timony. What reassurance can you give us that these projections of inflation being somewhat more in control than they have been in recent months, which has been of—well, maybe not the last couple of months, but before that was pretty significantly higher than an- ticipated, I think, by anybody, what reassurance can you give us that these projections are correct, that the inflation rate will hope- fully stay where it is now or even decline slightly? Mr. BERNANKE. Well, Congressman, as you point out, there is un- certainty. We have a baseline forecast which assumes that energy prices don’t do another big increase, that expectations remain con- tained, as they appear to be currently. We have talked about the cost side of labor costs, which seem not at this point to be a prob- lem from a cost perspective. VerDate 0ct 09 2002 12:29 Feb 20, 2007 Jkt 031539 PO 00000 Frm 00032 Fmt 6633 Sfmt 6633 F:\DOCS\31539.TXT HFIN PsN: TERRIE 29 So from all that perspective, again, we have the baseline forecast that the inflation will gradually decline over the next couple of years. At the same time, we talk about risks, and we think there are some risks. The risk that I talk about in my testimony is that, given the tightening of markets, product markets in particular, that some firms may be better able to pass through those energy and commodity prices that you mention, and that that might be- come possibly embedded in the expectations of the public. So we do see some upside risks, and we have to take that into account as we make policy. Mr. CASTLE. Thank you. It just seems to me there is a little more uncertainty than usual. But let me change subjects because time is going to flee here. I want to talk about—when you talk about the housing market, not just now, but in general, I always get a little confused about what we are specifically talking about. Is it the economic—I know you were talking about the housing market as a whole, and you are going to say all of these components, but is it the new basic hous- ing market, that is, the home builders and the banks and the oth- ers, who would profit from that, or is it the resale? I mean, a lot of people in this room have houses, and they are worried about the resale of their houses going down, which may only benefit a limited number of brokers and a few other people, but not the housing market per se. When we talk about housing, you have indicated a couple of times not housing per se, but other construction, which could be anything, I mean, offices, shopping malls, whatever it may be. My question to you is when you say the housing market having strengthened in recovery of the economy and slowing down, are you talking about all of these items, or are you talking about more spe- cifically the new housing market? Can you break out the housing market a little more? Mr. BERNANKE. Yes. What contributes to GDP is new construc- tion of homes; that has been slowing. Construction of multifamily homes and apartments has been stable. Nonresidential construc- tion has been actually strengthening. As far as existing homes are concerned, that is relevant in two ways; one, commissions that realtors get from buying and selling does enter the GDP; but secondly, and more importantly, if home prices flatten out, it affects the equity that homeowners have, and it may affect their spending pattern, and that is a subsidiary effect that could come from a slowing housing market. The CHAIRMAN. The gentleman’s time has expired. The gentleman from North Carolina. Mr. MILLER OF NORTH CAROLINA. Thank you. Chairman Bernanke, I am very pleased to see a Dillon County, South Carolina, boy doing well. You probably remember that there are a lot of Millers from Dillon County. My grandfather was one of them, moved early in the last century to North Carolina. Actu- ally, my grandmother was also a Miller. The gene pool in Dillon County at the beginning of the last century was not Olympic sized, and if I seem a little quirky, it may be the result of recessive traits. But I am pleased to see you doing well. VerDate 0ct 09 2002 12:29 Feb 20, 2007 Jkt 031539 PO 00000 Frm 00033 Fmt 6633 Sfmt 6633 F:\DOCS\31539.TXT HFIN PsN: TERRIE 30 I do have questions based upon your discussion with Mr. Bachus and with Mr. Frank. Chairman Greenspan always distinguished in his testimony between supervisory wages and nonsupervisory wages, and said supervisory wages, which is only about 20 percent of employees, were going up much more rapidly than non- supervisory wages. Is that consistent with your own observations in the time you have been— Mr. BERNANKE. That appears to be true. The number that Con- gressman Frank is referring to is average hourly earnings, is for production workers, that is, nonsupervisory workers, and that hasn’t grown very quickly in part because of, again, the high en- ergy prices, which have taken away purchasing power. Mr. MILLER OF NORTH CAROLINA. And for those 80 percent of the workforce who are nonsupervisory, in fact, they have not been keeping up with inflation, have they? Or only just barely at best. Mr. BERNANKE. It is about even, yes. Mr. MILLER OF NORTH CAROLINA. Chairman Greenspan, on many occasions before this committee, although undoubtedly a devoted believer, a devout believer, in capitalism, was very concerned about rising income inequality and the effect that it had on democracy. And I understand you addressed that the last time you were here. You said in July of last year that there is a really serious problem here, as I have mentioned many times before this committee, in the consequent concentration of income that is rising. In response to questions that I asked about supervisory and nonsupervisory wages, he said, we are giving a bivariate income distribution. And as I have said many times in the past, for a democratic society this is not helpful, to say the least. And as I have indicated on numer- ous occasions, I believe this is an education problem. Chairman Bernanke, do you also think that the rising income in- equality, the rising concentration of wealth is a problem for our so- ciety and a problem for our democracy? Mr. BERNANKE. The short answer is yes. I would like to point out that the increase in inequality is a very long-term trend. We have been seeing this for about 25 years. I believe it is linked to edu- cation and skills in our technologically oriented society. But Chair- man Greenspan’s point that if the people in the bottom end are not sharing in the benefits of open markets and flexible capitalism, that they are going to react against it politically, I think that is a potential risk, and I agree with that assessment. Mr. MILLER OF NORTH CAROLINA. Well, 80 percent is not just the bottom end. Actually the vast majority of workers are not sharing in whatever economic prosperity may be coming from production increases. Eighty percent is not just the bottom end. That is the vast majority of Americans. Mr. BERNANKE. Well, I do want to point out that it has been very difficult in the past when we have had periods of energy price in- creases as large as we have seen, for example, the 1970’s is another example, it is very hard for wages to keep up with that because it is such a big part of family budgets. Mr. MILLER OF NORTH CAROLINA. Chairman Greenspan did iden- tify, as you just did, education—and, of course, in part of what I read you mention education—he specifically spoke of community colleges. Community colleges is something that I have pushed in VerDate 0ct 09 2002 12:29 Feb 20, 2007 Jkt 031539 PO 00000 Frm 00034 Fmt 6633 Sfmt 6633 F:\DOCS\31539.TXT HFIN PsN: TERRIE 31 the time that I have been here. I know how important they are to my State. Eleven- or twelve million Americans are in community colleges every year; it is where they go to learn job skills to get new jobs and better jobs. In the time that I have been here, I have seen funding, Federal support for community colleges, decrease, not increase, or for some programs not keep up with inflation. The real support has dimin- ished. And the taxes, the tax cuts going to people who receive in- herited wealth. Chairman Bernanke, can you identify a single pol- icy of this Congress or of the Bush Administration that appears di- rected at closing income inequality or the concentration of wealth? Mr. BERNANKE. Well, I could point to the expansion of the child care credit and the earned income tax credit, if you are looking for a single example. I want to agree with you about the community colleges. I think one of the great strengths of our system is that we have a very flexible educational training system; we have community colleges, vocational schools, technical schools, online learning. We don’t have to wait for a whole new generation for people to acquire these skills. I think people can be retrained and can learn even as adults, and lifelong learning is a very important goal. The CHAIRMAN. The gentleman’s time is expired. The Chair would indicate we will go in recess, and the committee will stand in recess until 12:15 p.m.. [Recess] The CHAIRMAN. The committee will reconvene. And the next per- son in line is our good friend from Texas, Mr. Paul. Mr. PAUL. Thank you, Mr. Chairman. Good afternoon, Chairman Bernanke. I have a question dealing with the Working Group on Financial Markets. I want to learn more about that group and actually what authority they have and what they do. Could you tell me, as a member of that group, how often they meet and how often they take action, and have they done something recently? And are there reports sent out by this particular group? Mr. BERNANKE. Yes, Congressman. The President’s Working Group was convened by the President, I believe, after the 1987 stock market crash. It meets irregularly; I would guess about 4 or 5 times a year, but I am not exactly sure. And its primary function is advisory, to prepare reports. I mentioned earlier that we have been asked to prepare a report on the terrorism risk insurance. So that is what we generally do. Mr. PAUL. In the media, you will find articles that will claim that it is a lot more than an advisory group you know, if there is a stock market crash, that you literally have a lot of authority, you know, to impose restrictions on the market. And we are talking about many trillions of dollars slushing around in all the financial mar- kets, and this involves Treasury and, of course, the Federal Re- serve, as well as the SEC and the CFTC. So there is a lot of poten- tial there. And the reason this came to my attention was just recently there was an article that actually made a charge that out of this group came actions to interfere with the price of General Motors stock. Have you read that, or do you know anything about that? VerDate 0ct 09 2002 12:29 Feb 20, 2007 Jkt 031539 PO 00000 Frm 00035 Fmt 6633 Sfmt 6633 F:\DOCS\31539.TXT HFIN PsN: TERRIE 32 Mr. BERNANKE. No, sir, I don’t. Mr. PAUL. Because they were charging that there was a problem with General Motors, and then there was a spike in GM’s stock price. But back to the issue of meeting. You tell me it meets irregu- larly, but are there minutes kept, or are there reports made on this group? Mr. BERNANKE. I believe there are records kept by the staff. There are staff mostly from Treasury, but also from the other agen- cies. Mr. PAUL. And they would be available to us in the committee? Mr. BERNANKE. I don’t know. I am sorry, I don’t know. Mr. PAUL. The other question I have deals with a comment made by one of the members of the Federal Reserve Board just recently. He made a statement which was a rather common statement made. He expressed a relief that the economy was weakening, mainly— inferring that this would help contain inflation. And I hear these comments a lot of times, the economy is too strong, and therefore we need a weaker economy. If this assumption is correct—would you agree that this assumption—that a weaker economy is helpful when you are worried about inflation? Mr. BERNANKE. Congressman, as I talked about in my testimony, we need to go to a sustainable pace. We need to have a pace which matches the underlying productive capacity; that will probably be a bit less robust than the last few years, because over the last few years we were also reemploying underutilized resources, and going forward we don’t have that slack to put to work. Mr. PAUL. But if you accept the principle, as it seemed to be in this quote, that if you are worried about inflation, you slow up the economy, and then inflation is brought down, it is lessened, it in- fers that inflation is caused by economic growth, and I don’t hap- pen to accept that, because most people accept the fact that infla- tion is really a monetary phenomenon. And it also introduces the notion that growth is bad, and yet I see growth as good. Whether it is 3 or 4 or 5 or 6, if you don’t have monetary inflation, we don’t need to worry, because if you have good growth in the marketplace rather than artificial growth, that it is this growth that causes your productivity to increase. You have an increase in productivity, and it does help bring prices down, but it doesn’t deal with inflation. And I think what I am talking about here could relate to the con- cerns of the gentleman from Massachusetts about real wages. There is a lot of concern about real wages versus nominal wages, but I think it is characteristic of an economy that is based on a fiat currency that is just losing its value that it is inevitable that the real labor goes down. As a matter of fact, Keynes advocated it. He realized that in a slump, that real wages had to go down, and he believed that you could get real wages down by inflation, that the nominal wage doesn’t come on and keep the nominal wage up, have the real wage come down and sort of deceive the working man. But it really doesn’t work because ultimately the working man knows he is losing, and he demands cost-of-living increases. So could you help me out in trying to understand why we should ever attack economic growth. Why can’t we just say economic VerDate 0ct 09 2002 12:29 Feb 20, 2007 Jkt 031539 PO 00000 Frm 00036 Fmt 6633 Sfmt 6633 F:\DOCS\31539.TXT HFIN PsN: TERRIE 33 growth is good and it helps to lower prices because it increases pro- ductivity? Mr. BERNANKE. Congressman, I agree with you. Growth doesn’t cause inflation; what causes inflation is monetary conditions or fi- nancial conditions that stimulate spending which grows more quickly than the underlying capacity of the economy to produce. Anything that increases the economy to produce, be it greater pro- ductivity, greater workforce, or other factors that are productive, is only positive. It reduces inflation. Mr. PAUL. Do you see our deficits that we produce—and that you have no control on—as a burden to the Federal Reserve in man- aging monetary affairs and maintaining interest rates as well as maybe even living with a lower increase in the money supply? Mr. BERNANKE. Well, in our short-term monetary policymaking, we are able to adjust for the conditions of fiscal policy, however they may be. I think fiscal issues are more important in the long- term sense because of the long-term obligations we have, for exam- ple, for entitlements. We have not found the fiscal situation to be a major impediment to our short-term management of monetary policy. Mr. PAUL. I guess we can— The CHAIRMAN. The gentleman’s time has expired. The gentleman from Kansas, Mr. Moore. Mr. MOORE OF KANSAS. Thank you, Mr. Chairman. Thanks for your testimony this morning. I am concerned that we have a serious fiscal problem in our country today. Last year our Federal budget deficit was $319 bil- lion, and last week the Administration released its updated Fiscal Year 2006 budget deficit estimate of $296 billion. Isn’t it true that the Fiscal Year 2006 deficit is closer to $477 billion when Social Se- curity is excluded? Mr. BERNANKE. I don’t know the exact number, but it is true that without the Social Security surplus, the deficit would be larger. Mr. MOORE OF KANSAS. And it looks like a smaller number when you take it out, correct? Mr. BERNANKE. That has been the consolidated budgeting cost for some time now. Mr. MOORE OF KANSAS. Should that be changed? Mr. BERNANKE. I think it should be recognized that our budget deficit—and again, this is a practice of some standing—reflects cur- rent revenues and current spending, it doesn’t reflect the unfunded obligations that are arising for future entitlement? Mr. MOORE OF KANSAS. So that can be very misleading then, can’t it? Mr. BERNANKE. It can be misleading in the long-run sense. And as I have said a number of times, and my predecessor said, I think our greatest long-run challenge will be to find ways to meet the promises that we have made to an aging population. Mr. MOORE OF KANSAS. Last week David Walker, the Comp- troller General of the United States, and head of the GAO, deliv- ered a speech in Dallas, Texas, and he said that, ‘‘The United States is now the world’s largest debtor nation. In the last 5 years alone, our Nation’s total liabilities and unfunded commitments VerDate 0ct 09 2002 12:29 Feb 20, 2007 Jkt 031539 PO 00000 Frm 00037 Fmt 6633 Sfmt 6633 F:\DOCS\31539.TXT HFIN PsN: TERRIE 34 have gone up from about $20 trillion to over $46 trillion.’’ Is he cor- rect? Mr. BERNANKE. Those are numbers which I think are consistent with the actuaries for Social Security and Medicare. Mr. MOORE OF KANSAS. Are we the world’s largest debtor right now as a Nation? Mr. BERNANKE. If you are referring to external debt. I don’t think it is true in terms of share of GDP, it would be in terms of actual dollars. Mr. MOORE OF KANSAS. I am talking about actual dollars. Mr. BERNANKE. I believe that is true. Mr. MOORE OF KANSAS. Mr. Walker pointed out that our country today has several serious budget deficits. The first is our budget deficit, the second is our savings deficit, and the third is our bal- ance of payments deficit. Is he correct on these three? Mr. BERNANKE. Those are all issues I think we need to address, yes. Mr. MOORE OF KANSAS. All right. We do, in fact, have a budget deficit, which we have already discussed, and have had for several years, correct? Mr. BERNANKE. Yes. Mr. MOORE OF KANSAS. Okay. And I believe—you didn’t say it in exactly these words, but isn’t it a fact that we are, in effect, mortgaging the future of our children and grandchildren right now by the way we are conducting our fiscal policy now? Mr. BERNANKE. Again, I think the real issue is the long-term en- titlement situation, and that is the one we are going to have to ad- dress better sooner than later. Mr. MOORE OF KANSAS. Are we, in effect, charging new spending and tax cuts on a national charge card and passing the bill on to our kids for payment and our grandkids for payment? Mr. BERNANKE. It would be better if we could be saving more and planning for these entitlement costs that are going to be coming down the pike very soon. Mr. MOORE OF KANSAS. Would it be better if we were living with- in a budget? Mr. BERNANKE. If we were to live within our budget, we would have a higher national saving rate and be better prepared for the long-term fiscal obligations that we have incurred. Mr. MOORE OF KANSAS. So is the answer yes? Mr. BERNANKE. Yes. Mr. MOORE OF KANSAS. Thank you. The CHAIRMAN. The gentleman’s time has expired. The gentleman from Ohio, Mr. Gillmor. Mr. GILLMOR. Thank you, Mr. Chairman. Mr. Chairman, I would like to get your views on ILC’s, industrial loan companies. There has been a tremendous explosion in recent years of commercial firms buying ILC’s in order to get into bank- ing. Congressman Frank and I sponsored an amendment to pro- hibit those ILC’s from branching nationwide, which passed the House, but hasn’t passed the Senate. We now have a bill which would eliminate some future purchases of ILC’s and also provide for the FDIC to regulate the holding companies. VerDate 0ct 09 2002 12:29 Feb 20, 2007 Jkt 031539 PO 00000 Frm 00038 Fmt 6633 Sfmt 6633 F:\DOCS\31539.TXT HFIN PsN: TERRIE 35 I guess my question to you is what is your view on this situation of commercial firms buying ILC’s, and attempting to get into bank- ing? And how should we deal with that; and in particular, in terms of regulation of the holding companies? Mr. BERNANKE. Well, Congressman, the Federal Reserve has tes- tified on this issue. We have broadly two concerns from a public policy point of view. The first is the mixing of banking and com- merce, which occurs when ILC banks are acquired by commercial firms. The Congress, through Gramm-Leach-Bliley, has indicated that it wants to keep banking and commerce separate, and I think this is inconsistent with that general approach. The second concern we have is that the FDIC is only given au- thority to supervise the ILC banks themselves, but not to do con- solidated supervision of the parents. And we feel that safe and sound regulation and supervision requires consolidated supervision that takes into account the financial condition of the parent as well as the ILC itself. Mr. GILLMOR. Let me ask you, should we maintain—is it impor- tant for the health of the financial system to maintain that split between commerce and banking? Mr. BERNANKE. It is a long-debated question among economists. My personal opinion is that it is a good idea to try to keep some separation between banking and commerce. Mr. GILLMOR. Very good. I want to ask you, in terms of mortgages, explosion of different kind of mortgage instruments, or, you know, no money down, a lot of adjustable rates, and those are promoted very heavily, and we now have millions of Americans with them. Those are basically low-interest-rate products, and now we are beginning to see inter- est rates go up. Do you have concerns to the financial system and the ability to repay as interest rates go up and these are reset? Mr. BERNANKE. There might be some risks in some of those situ- ations. The Federal Reserve and the other banking agencies have issued proposed guidance for comment about nontraditional mort- gages and how they should be managed. About nontraditional mortgages and how they should be man- aged, and among other things, we are asking banks to underwrite not just the initial payment, but to underwrite the ability of the borrower to pay even as interest rates rise, as we go to a maximum payment, and we are also asking banks and other lenders to make sure that the consumer understands fully the implications of these sometimes complicated mortgages. So we are trying to address it from a guidance perspective. Mr. GILLMOR. Let me—because I presume I am about out of time. Let me just go back and tie down one thing. In terms of hold- ing companies of ILC’s, would I be misstating it if I said it is your opinion that they ought to be regulated if they are a commercial firm? I guess two questions, one, should a commercial firm be able to buy them at all? And I am guessing the answer is, no. But sec- ondly, if you do have a firm owning an ILC, should the holding company be regulated by the financial regulatory authorities? Mr. BERNANKE. The purchase of a bank by a commercial firm violates the separation of banking and commerce, and so I wouldn’t VerDate 0ct 09 2002 12:29 Feb 20, 2007 Jkt 031539 PO 00000 Frm 00039 Fmt 6633 Sfmt 6633 F:\DOCS\31539.TXT HFIN PsN: TERRIE 36 advise allowing that, but if you do allow it, then it would be better to have consolidated supervision, which includes an overview of the financial condition of the parent, that is, the commercial firm as well as of the ILC subsidiary. Mr. GILLMOR. Thank you very much, Mr. Chairman. I yield back. The CHAIRMAN. Ms. Waters. Ms. WATERS. Thank you very much, Mr. Chairman. And I would like to thank Chairman Bernanke for being here this morning and for staying so long. These hearings just seem to go on and on and on. But I would like to ask you, how do you factor poverty into your work, into your calculations, into your predictions and what you do? How do you consider poverty? And how do you consider the im- plications of your decisions relative to poverty? Mr. BERNANKE. Well, the evidence suggests that when the labor market is strong, poverty tends to fall. And so from the Federal Re- serve’s perspective, our mandate from Congress is price stability and maximum sustainable employment. So from our perspective, of course, ours is not a comprehensive approach to poverty. There are many other issues related to poverty but from our own perspective, if we keep a strong economy, we feel we are doing our bit to help reduce poverty. Ms. WATERS. Have you ever written anything about poverty? Have you ever written a paper, or presented any analysis, or have you done anything to indicate the relationship of poverty to the Federal Reserve’s decisionmaking process on interest rates and monetary policy? Mr. BERNANKE. I have spoken on issues of community develop- ment, on issues of financial asset building by low- and moderate- income families. In some of my speeches and activities, I have been very much interested in economic redevelopment and issues related to low-income communities. Ms. WATERS. Do you have anything in writing? Mr. BERNANKE. Yes, ma’am. They are all on the Federal Reserve Web site, and we would be happy to send them to you. Ms. WATERS. Thank you. And I will ask my staff to check them out. The other thing I would like to ask about is employment opportu- nities at the Federal Reserve. What about minorities? What about African-Americans? Do you have any minorities in high-level posi- tions at all? Mr. BERNANKE. We have addressed this issue. And we have worked to increase the number of women and the number of mi- norities in the Federal Reserve system. I would be happy to provide you with numbers. Ms. WATERS. Do you have any African-Americans that you know about in any high-level managerial positions? Mr. BERNANKE. Until a month or two ago, the Vice Chairman of the Federal Reserve was an African-American, and he just left re- cently to retire from that position. A number of our highest-level economists and policy advisors are African-American or other mi- norities. Ms. WATERS. Do you have—can you talk about the percentages of African-American women, Latinos, and Asians employed at the VerDate 0ct 09 2002 12:29 Feb 20, 2007 Jkt 031539 PO 00000 Frm 00040 Fmt 6633 Sfmt 6633 F:\DOCS\31539.TXT HFIN PsN: TERRIE 37 Federal Reserve? Do you have an assessment in writing anywhere? Where can I find that? Mr. BERNANKE. Vice Chairman Ferguson, I believe, testified on this matter at one point, and we can update that information and send it to you. We have an officer who is in charge of diversity and these types of issues, and I am sure she could provide you with the latest information. Ms. WATERS. Would you please submit that for the record? You can submit it either to the chairman, or to my office. I would like to take a look at it. Mr. BERNANKE. We will do that. Ms. WATERS. To see how well you are doing with diversity at the Federal Reserve. Now, finally, let me just ask you about the deficit. As you know, it was just a few years ago that everyone was so concerned about the deficit. President Clinton did a fabulous job of eliminating that deficit. Now we continue to have a deficit, and all that I hear is, oh, it is 2 percent less than it could have been; deficits are not so bad, particularly when we see some reductions, and we think that it is going in—are you concerned about the deficit? Mr. BERNANKE. Congresswoman, as I have indicated, I think the real fiscal problems are long-term issues. We have some very sub- stantial obligations for Social Security, for Medicare, and for other entitlement programs. They are largely at this point unfunded. And I think that we need to be moving towards a fiscal situation where we will be able to make those payments, we will be able to meet those obligations. I think that is the real long-term fiscal issue right here. Ms. WATERS. I have never heard any alarm or any real concern written about or discussed by you about the deficit. I appreciate the answer that you just gave me, but I guess my question is, are you concerned about the size of this deficit? Mr. BERNANKE. I don’t think you can discuss it in isolation. I think it is part of the— Ms. WATERS. I just want to know how you feel. I really don’t need an intellectual answer. Are you concerned at all about the def- icit? Mr. BERNANKE. I am only concerned in the context of the fact that we need more national saving in the country. We need to work down the current account deficit over a period of time, and we need to prepare ourselves for our long-term transfer obligations. And for all those reasons, I think the fiscal situation ought to be improved. I don’t— Ms. WATERS. Does that spell, ‘‘I am concerned?’’ The CHAIRMAN. The gentleman’s time has expired. The gentleman from Illinois, Mr. Manzullo. Mr. MANZULLO. Thank you very much. Dr. Ferguson visited my Congressional district a couple of years ago. I would extend the same to you. We have one of the most high- ly concentrated areas in the country in manufacturing. I would like to show you some of the exciting things going on. I will give that to you in writing obviously. My understanding is that the core inflation which does not take into consideration food and energy is at 2.6 percent. If you add en- VerDate 0ct 09 2002 12:29 Feb 20, 2007 Jkt 031539 PO 00000 Frm 00041 Fmt 6633 Sfmt 6633 F:\DOCS\31539.TXT HFIN PsN: TERRIE 38 ergy, it is at 4.3 percent. And my question is, do you believe raising interest rates decreases consumption of gasoline for vehicles and oil feedstocks for manufacturing? Mr. BERNANKE. Well, I will answer your question indirectly. One of the reasons we pay attention to the core inflation rate, which ex- cludes energy, is we don’t have a lot of control, obviously, over the price of energy, and so one of our concerns is that higher energy commodity raw materials costs don’t get passed through into other goods and services. If we can sort of stop it at the first round, that will lead us to a more stable inflation situation when energy prices level off. Mr. MANZULLO. But on the other hand, if inflation were at 2.6 percent, you might be raising interest rates. Is that correct? That is a trick question. Mr. BERNANKE. It is a trick question. As I said in my testimony, our expectation is that core inflation will be moderating over the next 2 years for a variety of reasons. However, we do see some risks, and one of the risks would be that because product markets are tight, that there would be ability of firms to pass through en- ergy and commodity prices into other goods. Mr. MANZULLO. Well, it is unfortunately, in manufacturing, you can’t do it, I mean, because of imports. And in the farming sector, you can’t do it either. I have a lot of agriculture in my district, and so I think that the consumers and the farmers and the manufactur- ers are being hit with an additional tax which is the increase of inflation, and we can’t do anything about it. And as I understand it, the reason you raise interest rates is to decrease consumption and cool off the economy. And so I think that raising interest rates, because of the increase in energy, not only is bad economics but it fuels the inflation. For example, most people charge—I think it is 60 percent of the people charge gasoline on their charge cards. And the interest rate on many credit cards is determined by the Federal Reserve. So whenever you increase your interest rate, you increase the interest rate that they are paying on the gasoline that they are charging. So you are actually fueling the problem and making it worse. Now that is not a trick question. Mr. BERNANKE. The increase in energy prices is clearly making the economy worse off, both in terms of real activity and in terms of inflation. There is no question about it. Mr. MANZULLO. Right. Mr. BERNANKE. And we have very little control over energy prices themselves. Our objective is to make sure that it doesn’t get into a wage-price spiral where energy prices spill over into other— Mr. MANZULLO. So, therefore, the answer to your question—my question would be, by raising interest rates, you believe that that will decrease the consumption of energy? Mr. BERNANKE. No. We expect it is going to reduce the ability of firms to pass through those costs to the final consumer prices. Mr. MANZULLO. Why, by making it more difficult for them to bor- row money for the production lines? Mr. BERNANKE. By making product markets less tight. Mr. MANZULLO. Such as— VerDate 0ct 09 2002 12:29 Feb 20, 2007 Jkt 031539 PO 00000 Frm 00042 Fmt 6633 Sfmt 6633 F:\DOCS\31539.TXT HFIN PsN: TERRIE 39 Mr. BERNANKE. Well, again, as I mentioned before, if financial conditions are such that aggregate demand is greater than the un- derlying productive capacity of the economy— Mr. MANZULLO. Right. Mr. BERNANKE. Then you are going to have a lot of power of firms to pass through their cost because high demand means that they will have the power to raise their prices. What we want to make sure is that those high energy prices— Mr. MANZULLO. But what that does is that makes our foreign competitors more competitive, those that have—for example, in Eu- rope and Asia where natural gas is half what it costs here in this country, where natural gas is 80 percent of the feedstock of plas- tics. I just think—that is why I wanted you to come to my district to examine the impact on manufacturing because there is—every time you increase that interest rate, you not only tighten up the ability for these manufacturers to borrow money for the production line, but you make it more difficult for them to export, and that is going to hurt the economy as a whole. The CHAIRMAN. The gentleman’s time has expired. The gentleman from California, Mr. Baca. Mr. BACA. Thank you very much, Mr. Chairman, and Ranking Member Frank, for having this hearing. And thank you, Mr. Bernanke, for being here as well. First, I want to start on the housing crisis. As the housing crisis market slows, areas like California, the Inland Empire where I have quite a few people moving in from L.A., Orange County, into the area, have been heavily dependent on real-estate-related employment will suffer the most. If prices start to drop in San Bernardino County, and homes stay on the market for 5 months instead of the 5 days, it hurts more than just the sellers. It also leads to less work for people, and I state less work for people who build new homes and those who help sell, finance, or insure them. Thousands of people’s jobs are at stake, including home construction, real es- tate agents, mortgage brokers, inspectors, and more. Question number one is what industries of the economy have enough strength to pick up the slack as the housing market continues to cool? And question number two is what will the cooling housing market mean for job growth and unemployment numbers? Mr. BERNANKE. Well, as I indicated in my testimony, there are other sectors that are going to pick up some of that slack, and they include nonresidential construction, which is quite strong, business investment, and exports. And also multifamily housing has re- mained at about the same level as recent years. So I think there are other components of the economy that are picking up some of that slack. Mr. BACA. But at the same time, though, because of the outsourcing that we have done, and we have done quite a lot of outsourcing, that also hurts in that endeavor, too, as well when we look not only at our national deficit, but we continue to do most of the outsourcing. When most of the jobs are done outside, then all we have is distribution centers, and then it becomes a profit for individuals yet jobs are being lost here in the United States, and it is very difficult to pick up. Isn’t that so? VerDate 0ct 09 2002 12:29 Feb 20, 2007 Jkt 031539 PO 00000 Frm 00043 Fmt 6633 Sfmt 6633 F:\DOCS\31539.TXT HFIN PsN: TERRIE 40 Mr. BERNANKE. The labor market has strengthened considerably in the last couple of years. We always want it to be better, but it has been improving. In terms of outsourcing, we don’t want people to lose jobs. And when people are displaced by— Mr. BACA. We are losing jobs when we do outsourcing. We have lost quite a few jobs here in the United States. Mr. BERNANKE. When that happens, I think it is important for us to help people retrain and find new work. Mr. BACA. The labor market, too, as well because the minimum wages are low, and they are not up as well, and so it becomes very difficult. And we have not kept up with inflation, and that makes it very difficult, even for the original question that I asked on hous- ing, is that correct? Mr. BERNANKE. I don’t understand the connection. Mr. BACA. Well, the connection is, with a lot of the outsourcing, we have lost a lot of jobs in the area. And as we have done that, we have not kept up with inflation in terms of even at labor jobs that are even done here because a lot of the labor jobs are at min- imum wage, and we have not even increased the minimum wage to keep up with the inflation and the cost of living. Therefore, it impacts us. Is that correct or not? Mr. BERNANKE. We have a large surplus in trade and services. A lot of people outsource to us—financial services, accounting serv- ices, educational services, and tourism. So it is a two-way street, and our labor markets benefit from transplants from foreign direct investment. I think keeping our economy open to the world is good for our labor market and good for our economy. Mr. BACA. The next question that often runs along the same lines, and the question was just asked about gas pricing in my area or in the State of California, basically the cost of gas, prices have almost escalated to about $4 a gallon, which becomes very difficult for a lot of us, so it has jumped considerably. If the trend of raising gas prices coupled with the stagnated wages continues, how will the impact be felt in our communities across the Nation because it becomes very difficult even with the minimum wage right now that they are earning just to fill a tank of gas. It costs anywhere be- tween $50, $60, and $70, which means that one day’s work pays for a gas tank that only takes them to 2 days work. So it becomes very difficult in terms of—to keep up with their mortgage pay- ments, putting food on the table, and paying their medical ex- penses. Could you reply how it affects us across the Nation? Mr. BERNANKE. I agree absolutely. We have seen about a tripling of energy prices over the last few years. That has raised gasoline prices, raised heating oil and other kinds of energy prices, and it has reduced our growth and been a burden on consumers and firms, and it has been inflationary for us so it has obviously been a problem for our economy. Mr. BACA. Okay. Well, the spending of gas prices growing faster than spending for other basic items such as healthcare, housing and college, what impact will this have on long-term economic growth? And do you believe that there should be a greater sense of urgency for Congress and this Administration to do something to stop the rising gas prices? The CHAIRMAN. The gentleman’s time has expired. VerDate 0ct 09 2002 12:29 Feb 20, 2007 Jkt 031539 PO 00000 Frm 00044 Fmt 6633 Sfmt 6633 F:\DOCS\31539.TXT HFIN PsN: TERRIE 41 The chairman may respond. Mr. BERNANKE. The higher prices have reduced our growth. We have estimates that GDP has been reduced between 1⁄ 2 percent and 1 percent from growth in the last few years, but I think it is impor- tant going forward that we look to other sources of energy and try- ing to diversify our portfolio of energy sources and trying to in- crease our conservation, and doing all that, we will, I think, ulti- mately overcome this problem. Mr. BACA. If I had another question, I would have asked it on higher education, and the cost that has been there, too, as well, and its impact, it has not only on minorities and others getting into an education institution, but I didn’t have time to do that. But I thought I would throw that in. The CHAIRMAN. The gentleman’s time has expired. The gentleman from New Mexico, Mr. Pearce. Mr. PEARCE. Thank you, Mr. Chairman. And thank you, Mr. Chairman. If we are talking about the price of gasoline and the price of crude oil being a component of that, isn’t crude oil simply a function of supply and demand? If we in- creased the supply, then the price would fall? Mr. BERNANKE. Yes, Congressman. There is a global market. Mr. PEARCE. Really affect the price of gasoline if we were to drill in ANWR in the outer continental shelf, if we were able to get those things through legislative bodies in this town, might affect the price of gasoline in some way. Mr. BERNANKE. Yes. Mr. PEARCE. Okay. Just making sure my facts were right. And I am also—as far as labor I would tell you that, in my home coun- ty, we do gas work. Those are basically labor jobs with no high school education required. And a kind of a minimum salary right now in the oil field is about $30,000. If you have some experience, it is up around $50,000. And if you are actually one of the lead forepersons, it is up around $100,000. So I don’t really find any- body even at the Burger King, the entry-level price is $8.50. And I don’t always see that the minimum wage is what is pulling us into financial difficulty as a country. You had made an observation earlier about the price of natural gas not accelerating, and I would point out that nationwide we have got about 1,400 or 1,500 drilling rigs and over 1,000 of those are drilling for natural gas, only about 300 or 400 drilling for oil, which tells us why the price of oil con- tinues to go up. And so, again, we find that the supply and demand actually can be affected right now in today’s current situation. So I continue to be a little bit surprised by our land management agencies that restrict access to the service of them. They restrict access. So if you ever have a chance to comment on that, I won’t ask you to do it at this point, but we are choosing policies which absolutely give us a higher price of gasoline and then cause infla- tionary pressures. I think my question is, what price do you—you have adequately stated that labor is a little bit harder driver in in- flationary pressures. But what price of crude oil would you be very concerned that we have inflationary pressures, significant infla- tionary pressures from energy? Mr. BERNANKE. Well, I don’t have a specific price in mind. The futures markets right now have oil prices rising a bit over the next VerDate 0ct 09 2002 12:29 Feb 20, 2007 Jkt 031539 PO 00000 Frm 00045 Fmt 6633 Sfmt 6633 F:\DOCS\31539.TXT HFIN PsN: TERRIE 42 few months and then stabilizing. If that were to happen, then that source of upward pressure on the inflation rate, and also the ad- verse effect on growth, would be removed over time. Obviously, any significant $10 or $15 increase from where we are now would have significant consequences. Mr. PEARCE. And again, it kind of lets us know that we probably should be doing some things on our energy policies, because of the descriptions in the Middle East, a $10 or $15 increase would be fairly easy to achieve, fairly within reach. The problem in the Mid- dle East then brings us up to a different point, and that is even the availability of crude oil at any price. And could you see a sce- nario that might play out where the lack of energy, the lack of abil- ity to move products around could drive us toward deflation rather than inflation? Would that be a potential scenario if the price—let’s say that there is no price at which the Middle East would ship oil to the rest of the world. Mr. BERNANKE. Well, it is a global market, and there are many different sources. I expect that oil would be available but poten- tially at a very high price, and I would think the primary effects of that would be inflationary because of the impact on costs and impact on the consumer prices at the pump and so on. And also it would be a hit to growth if oil prices were to rise very, very sig- nificantly. Mr. PEARCE. I don’t know that it is correct, but I have heard esti- mates that Saudi Arabia has about 60 percent of the world’s oil and that is probably 15-year-old data. But even if it is 40 percent, I can see where—that it would not be available at any price if you add Iran and Saudi Arabia together, and I worry about the other end. If we faced deflation, what would be your view of responses that we should take? Mr. BERNANKE. Well, deflation is not an immediate issue here in the United States. The Japanese have faced deflation for the last few years, and they used some nonstandard monetary policies, in- cluding what is called quantitative easing and a zero interest rate policy, and that seems to be helping. And their economy is cur- rently growing, and they have recently left that unusual policy and returned to a more normal poll monetary policy regime. The CHAIRMAN. The gentleman’s time has expired. The gentlelady from Wisconsin, Ms. Moore. If the gentlelady would yield, the Chair would like to accommodate the rest of the members here, Mr. Chairman, if that is okay with you. And then we will be finished. We will try to keep the questions as brief as possible. Thank you. Mr. FRANK. Let me join you in thanking the chairman for com- ing. The members really appreciate it. The CHAIRMAN. The gentlelady from Wisconsin. Ms. MOORE OF WISCONSIN. Well, thank you so much, Mr. Chair- man. Thank you, Mr. Chairman. You can feel relief because, when- ever they call on me, it is absolutely the end of the line. I am a new member, and so it is very important to me, sir—and you are a new chairman. It is very important for me to try to understand what the monetary philosophy is, and so as I look through your tes- timony here, you really say that the U.S. economy appears to be in a period of transition that has been growing, and it is robust. VerDate 0ct 09 2002 12:29 Feb 20, 2007 Jkt 031539 PO 00000 Frm 00046 Fmt 6633 Sfmt 6633 F:\DOCS\31539.TXT HFIN PsN: TERRIE 43 And when I compare your optimism about our economy with what is happening to individuals, I see it is a negative savings rate, cer- tainly I am guilty of that. You point out that some of the weakness in our economy prior to the last few years was seen in the lack of productivity of employees, but yet people are working harder, and they are earning less. I have heard numbers of my colleagues have probably complained about no increase in the minimum wage and the flattening of wages and so forth. They have less purchasing power. So they can’t really buy things. You have admitted in your testimony that we are adding jobs at a much lower pace. And of course, we all know that the unemployment rate does not reflect the numbers of people who are eligible to be in the workforce that have just given up. In my own hometown of Milwaukee, Wisconsin, we have a 52 percent unemployment rate among African-American men. But yet, on the other hand, in the last 5 years, we have seen corporate prof- its increase by 69 percent. We have seen executive compensation, which might account for some, you know, some increase in wages, we have seen the increase in corporate wages such that a corporate executive, on January 2nd, by lunchtime, has earned as much as a minimum wage worker will all year. In your testimony, you said you touted business investments and exports. So am I to glean from all this that you really see a shift— that the shift in the economy has been to increase the capital, im- provement of corporations and individuals and investors, and that basically we should just concede the strength of our economy by having people with good jobs and purchasing power and able to go out and buy goods and services, that our strength—that your per- spective of the strength of our economy is in favor of capital; couple that with the cuts in programs that hurt families and all of the tax cuts that this Administration has put forward, should I conclude that strengthening our strong economy is because we prefer the ac- cumulation of capital as opposed to our labor assets? Mr. BERNANKE. Congresswoman, I am taking an overall perspec- tive on the economy. I think that accumulation of capital helps workers. It provides jobs and raises productivity. I think exports provide jobs, give more opportunity. But I have also agreed with the comments made earlier that there is widening inequality in this country. It has been going on for about 25 years. I agree it is a concern. And nothing in my testimony contradicts that. Ms. MOORE OF WISCONSIN. Okay. I do have a few more minutes. Well, I am glad to hear that because, Mr. Chairman, there are peo- ple in jail right now for painting a rosy picture about the value and assets of their companies and painting the rosy picture to their in- vestors and consumers. So I would hope that the Federal Reserve would adhere to the discipline that I think that they are used to, you know, in terms of looking at the economy from both perspec- tives. Our concern, many of our concerns is that, you know, a few rich investors—I mean, they can only eat one hamburger, two ham- burgers if they are really greedy, and it would be so much better to provide enough money in the economy so that thousands, yet millions of people could have a hamburger, could go out and enjoy an evening at the movies. It is not clear that these investors are really investing in American products. Can you comment on that VerDate 0ct 09 2002 12:29 Feb 20, 2007 Jkt 031539 PO 00000 Frm 00047 Fmt 6633 Sfmt 6633 F:\DOCS\31539.TXT HFIN PsN: TERRIE 44 before my time expires? Are they making investments here at home? Because the job growth is slowing. You have admitted that. Or are they making investments abroad? Mr. BERNANKE. Well, we have a global capital market. We have domestic investors investing both here and abroad, and we have foreign investors investing here as well. I think the process of in- vestment, creating more capital is really one of the basic means by which we increase productivity, increase job opportunities. The CHAIRMAN. The gentlelady’s time has expired. The gen- tleman from New Jersey, Mr. Garrett. Mr. GARRETT. Thank you, Mr. Chairman. And thank you, Mr. Chairman, as well. And one of the first com- ments at the very beginning of the day from the other side of the aisle, that all the credit can be given to you for the rise in the stock market yesterday based on your testimony—I think we are about halfway through the trading day. I have not seen whether or not there has been an inflection one way or the other based on testi- mony today. But there was an article in, I think, The Washington Post about a month ago where economists from some investment firm made some sort of comments saying that, well, the chairman is selected by the President, confirmed by the Senate; his real bosses are really in Wall Street. I just wonder how you take that sort of comment or criticism. And then following that, though, a more serious note, and that is the point of the discussion that we have had so far on wages here. You touched part of this with regard to the unemployment rate. My question is two-part. One, what are the impediments, if any, that are holding down a significant or any real increase in wages? As I say, you touched upon the aspect of the unemployment rate being basically at historic lows for the period of time. On the other side of it, what are the impediments on the other side, or what could be pressures that we could use to, if we wanted to, to see a raise of wages? Is there something Congress has done in the past or is there something Congress should be doing in the future in this area? We know that, just a couple of years ago, in light of the economic doldrums that we were in, this Congress passed an economic growth package and—all the markets were going down; we passed the economic growth package, and you had the charts, you would see all the charts were going up in the other direction in a positive direction because of that. We passed tax cuts in this Congress which basically shifted the tax burden. There was a pro- gressive tax cut, basically shifted the tax burdens so those who were making at the higher end of the income range are now paying a bigger, a larger percentage, a larger portion of the pie of the en- tire tax burden than they did before. So is there anything that we have done in the past that has been a negative impact, if you will, if that is the correct term, as far as the wage growth or lack of wage growth? And conversely, is there something we haven’t done because we have heard from several members already with regard to the minimum wage, and we haven’t moved on that in maybe over a half dozen years but maybe just comment what impact that would have anyway just considering the size of the population that is currently at the minimum wage and whether that would have any significant impact overall on wage growth? VerDate 0ct 09 2002 12:29 Feb 20, 2007 Jkt 031539 PO 00000 Frm 00048 Fmt 6633 Sfmt 6633 F:\DOCS\31539.TXT HFIN PsN: TERRIE 45 Mr. BERNANKE. Well, on the slowing, the fact that real wages have not grown as quickly as we would like, there are a number of factors. Again, energy prices are very important. They have raised the cost of living. Congressman Frank talked about the dif- ference between compensation and wages. Some parts of benefits are in fact useful to workers, but some of it reflects higher costs, for example, the medical insurance and the like, and they may not perceive that as being an increase in their standard of living, and then there is the fact that real wages have lagged to some extent behind productivity. I believe that will improve, but it hasn’t en- tirely done so yet. I think the best thing that can be done to in- crease real wages and reduce inequality, and it has been said be- fore, but I remain convinced, is upgrading skills and training. If we look at the labor market today, we see people with skills, gen- erally—of course, there are always exceptions, but generally—not having difficulty finding jobs, and those with the lower levels of skills are the ones who are having the most difficulty finding good jobs. On the minimum wage, I think the statistic is about 2.5 per- cent of the labor force is actually at the minimum wage. Whether a raise in minimum wage would assist is a controversial issue. Clearly, those who kept their jobs and had a higher wage would be better off. The question is whether or not some people would lose their jobs because of a higher wage. I have in the past, and I think it makes sense, suggested that perhaps a more tar- geted way to help lower-income people would be through the earned income tax credit, which doesn’t have these negative em- ployment effects and provides direct assistance to people who are low-income working families. Mr. GARRETT. Switching subjects now quickly over to the GSE’s, you made a comment on that earlier, you made some comments yesterday in your testimony in that regard, looking for a com- promised solution, a middle ground, so to speak, on the portfolio limitations, and you are suggesting that may be one that goes up if the market is down—or if the economy is down, giving the rate a flexibility for them to come in and conversely restricting at other times, if I am understanding your testimony. Is the history, though, of GSE’s, of Fannie Mae and Freddie Mac, have we seen them be able to do that in the past and do so appropriately? Be- cause some critics say, in past crises, instead of what we ask them to do, what we expected them to do, actually what they did instead was basically take the cream of the crop and just basically take their own advantage as opposed to helping the economy. So would this be something to just benefit the GSE’s if we did that com- promise? The CHAIRMAN. The gentleman’s time has expired. The chairman may respond. Mr. BERNANKE. Our research at the Federal Reserve has not found a significant impact of interventions by the GSE’s in terms of assisting the housing market during difficult times. Mr. GARRETT. Thank you. The CHAIRMAN. The gentlelady from California, Ms. Lee. Ms. LEE. Thank you, Mr. Chairman. Good to see you again Mr. Chairman. VerDate 0ct 09 2002 12:29 Feb 20, 2007 Jkt 031539 PO 00000 Frm 00049 Fmt 6633 Sfmt 6633 F:\DOCS\31539.TXT HFIN PsN: TERRIE 46 I don’t want to have to get back on my soap box on this, but I guess I will because I have been trying to get, since Chairman Greenspan, some real answers to this issue so that we can move forward. So in the past, and I think I have talked to you a little bit about this the last time you were here, I have sought to work with Chairman Greenspan to address the obvious racial and ethnic disparities in small business lending and home mortgage lending as well as I have talked with the CEO of our local Federal Reserve, Janet Yellen. Now, unfortunately, the response that I have received in each case has been totally inadequate. And this has been going on for several years. Mr. Greenspan suggested that the cost to busi- ness would prohibit stronger data collection, discounting the posi- tive effects to the economy of increasing minority homeownership and small business lending. And Ms. Yellen also indicated that it would be way beyond the capacity of the Federal Reserve to under- take a community survey of minority homeownership and sug- gested that we wait until the 2010 Census. I think the Federal Reserve must do more to ensure account- ability to these unfair lending practices and to meaningfully ad- dress the tremendous gap, and it is tremendous in minority home- ownership. Toward that end, I am interested in looking at ways to link the Community Reinvestment Act ratings with lending prac- tices, and I have written you a letter—you probably haven’t seen it yet—on July 12th, summarizing all this. CRA, of course as you know, was written to address how banking institutions meet the credit needs of their low- and moderate-income neighborhoods and ensure that banks invested in and strengthened the communities in which they were doing business. And part of this goal also was to reach out to traditionally underserved communities and provide them with access to capital if they needed it so that they could grow with their community bank. But disappointingly, according to much of the data that we have received, and I am sure you know this data, most banks provide on average—now this is on aver- age—about a 1 to 2 percent conventional loan rating to their—in terms of home loans to African-Americans and to Latinos and yet the CRA ratings are ‘‘A’s’’, and ‘‘outstandings’’, and what have you. And so what I am trying to figure out is, understanding the CRA doesn’t currently focus on lending to minorities, don’t you think that it makes sense to strengthen the statute to do so or at least to increase the amount of data, just increase the amount of data that is collected based on race and ethnicity because I believe—and I wanted to get your sense of this—that the potential economic ben- efits would definitely outweigh the minimal costs posed to busi- nesses for collecting such information. And again, I hope to hear from you in writing because I did write this up again on July 12th. And just the second question is—or well, yes, it is a question. I wanted to get your sense of the Wachovia regulatory approval of its acquisition of World Savings. That is located in my district, and we, since I have been in Congress, haven’t been through this type of acquisition, and I wanted to hear what the underlying factors are in the Federal Reserve’s decision and what your timetable is for the approval. Mr. BERNANKE. I can answer the first three at least. The Federal Reserve has recently expanded the data collection under HMDA, VerDate 0ct 09 2002 12:29 Feb 20, 2007 Jkt 031539 PO 00000 Frm 00050 Fmt 6633 Sfmt 6633 F:\DOCS\31539.TXT HFIN PsN: TERRIE 47 the Home Mortgage Disclosure Act, which collects data on every single home mortgage loan essentially made in the country includ- ing pricing, including denial rates, and including ethnicity. So we have a great deal of data on that issue, and we are using it as an initial screen to check for fair lending violations. With respect to CRA, it is absolutely correct that if the purpose of CRA is to get banks and other institutions to reach out to underserved commu- nities, and they get credit for doing that when they do, and if they violate the fair lending laws, that’s a debit in their CRA rating. Ms. LEE. But that is not so at this point. Mr. BERNANKE. I believe it is. But we will get back to you on your letter and give you exact information about that. You are cor- rect that the CRA talks about underserved communities and lower- to middle-income communities. It doesn’t specifically talk about race and ethnicity, and that is in the statute, and that would be, of course, up to Congress if they wanted to make that change. Ms. LEE. But if we wanted to make the change, could we get your support for that? Mr. BERNANKE. I would have to discuss it with other board mem- bers and the like, but I would certainly think about whether it makes sense in this context. Again, there are other ways to address the issue, through fair lending, for example, but I would certainly be willing to consider that issue. The CHAIRMAN. The gentlelady’s time has expired. The gentleman from Texas, Mr. Hensarling. Mr. HENSARLING. Thank you, Mr. Chairman. And, Mr. Chairman, the good news is I think I am the second to the last. In listening to some of the questions and some of the comments on the other side of the aisle, it would lead us to believe that we were on the verge of a great depression. I think what I have observed in our economy is that we have more Americans working now than ever. We have created—we, the economy, cap- italists have created over 5 million new jobs in the last several years. We have a lower unemployment rate than we had in the 1970’s, 1980’s, and 1990’s. Homeownership is at an all-time na- tional record. Household wealth is at an all-time national record. Inflation adjusted after tax income is up. And then I know that you do not have a perfectly clear crystal ball, and I understand that economic forecasting is an imprecise science, but if I heard your testimony right, barring unforeseen circumstances, I think you said employee compensation is likely to rise over the next couple of years. You predict a gradual decline in inflation in coming quarters and that the economy should continue to expand at a solid and sus- tainable pace. Given where we have been, given where—given the facts that are available to the extent that you can forecast, my pre- cise question is, what is your opinion of this economy relative to U.S. history? And what is your opinion of this economy relative to the Western industrialized world, say the EU and Japan? Mr. BERNANKE. It is a very strong economy. Two very impressive aspects of it are, first, the very high productivity gains. We didn’t see that in the 1970’s and 1980’s. We are now seeing productivity gains which are the envy of the industrialized world. The other thing about our economy which is impressive is its resilience. We have been through a number of very severe shocks in the last 5 or VerDate 0ct 09 2002 12:29 Feb 20, 2007 Jkt 031539 PO 00000 Frm 00051 Fmt 6633 Sfmt 6633 F:\DOCS\31539.TXT HFIN PsN: TERRIE 48 6 years, and the economy has managed to continue to grow. It is certainly not a perfect economy, but there are some very strong ele- ments, and I think those are two that I would point to. Mr. HENSARLING. Much of the questioning has had to do with near-term economic and monetary policy. Let me turn our attention long term. I have a great concern over the spending patterns of the Federal Government, and I am sure you have probably poured over some of the similar reports that I have poured over and GAO and OMB and CBO that essentially lead me to conclusion, and I think others, and I am paraphrasing from a recent GAO report, that within one generation, America is facing a rather nasty fork in the road. One fork is going to lead to a Federal Government consisting of almost nothing but Medicare, Social Security, and Medicaid. The other fork in the road is going to lead to doubling taxes in real terms for the American people in one generation from roughly $22,000 for a family of four to $44,000. Assuming you have seen similar data and concluded to be accurate, there has been a lot of talk here of the economic implications of certain policies on low-in- come people. If we do not change the growth rates in the big three entitlement programs and we double taxes on the American people, what does the American economy look like in the next generation? And precisely what is its impact on low-income people? Mr. BERNANKE. Well, your numbers are correct. We currently spend about 8 percent of GDP on those three programs, and accord- ing to the actuaries, by 2045, we will be spending about 16 percent. Since the Federal revenue collection is about 18 percent histori- cally, that would be essentially the entire government. And this is the point I have been addressing that we need really to make up our minds about how we want to proceed. I do think if the taxes were to be raised to the level that you are describing, I think it would be a drag on growth and a drag on the efficiency of the econ- omy. So Congress needs to think about what size government it wants and what the appropriate tax rate is that is associated with that government. Mr. HENSARLING. There have been a couple of questions on GSE’s, and forgive me if I am applying some old ground. But your predecessor had a rather high anxiety level about the GSE’s hold- ing their own debt in their portfolios. I know there has been a cou- ple of questions about it, but if I decide to toss and turn tonight, how much time should I spend worrying about portfolio limitations on the GSE? To what extent on the anxiety barometer, how much time should we worry about the systemic risk that that poses? Mr. BERNANKE. Well, I think there is a risk there. And indeed the recent report from OFHEO about some of the inadequacies of the GSEs’ internal controls and their accounting makes us wonder about their ability to manage these very large and complex port- folios. I am not saying there is anything immediately about to hap- pen, but I do think that these portfolios do present a systemic risk and that it would be in our interest to try to address that issue. The CHAIRMAN. The gentleman’s time has expired. The gentleman from California, Mr. Miller, to wrap up. Mr. MILLER OF CALIFORNIA. Thank you. Welcome. I always enjoyed Mr. Greenspan when he was here, and I come from the building industry, about 35 years involved in VerDate 0ct 09 2002 12:29 Feb 20, 2007 Jkt 031539 PO 00000 Frm 00052 Fmt 6633 Sfmt 6633 F:\DOCS\31539.TXT HFIN PsN: TERRIE 49 that. I enjoyed your testimony. I listened to it from my office. I ac- tually had to write some of this down because I wanted to make sure I get everything correct and get a response on what you had been saying. You said in the hearing today that one of the best things to keep mortgage rates low is to keep inflation under con- trol. And that in and of itself sounds reasonable, but you say in your testimony that increase in residential rents as well as in the imputed rent on owner-occupied homes has recently contributed to higher core inflation. You have also indicated in testimony that there has been a gradual cooling in the housing market, and I think that might be an understatement, but that is a statement. But I believe this cooling in the housing market is due to interest rate hikes. Every time you raise interest rates, you reduce the number of qualified buyers on the market. Kept out of the housing market due to a lack of affordability, these individuals turn to the rental market. This contributes to the increase in rents which you say is an indicator of inflation. In a way, it is kind of a circular reasoning. Affordability decreases when interest rates rise; rents rise due to lack of affordability in the housing market. This in- crease in rents leads you to determine the higher core inflation, so you increase rates. Some have said that the Federal Reserve has been relying too heavily on owner-equivalent rents to nationalize the interest rate hikes. The owner component of the core inflation is an imputation made by government statisticians to determine in- flation. In essence, a weakening of home buying is increasing the demand for rental units, and the firming of rents translates into sizable increases in homeowner equivalent rents. You are saying there is a problem in rents rising, but aren’t you really creating the problem in rents rising by increasing rates? Mr. BERNANKE. Congressman, we are aware of the issues associ- ated with this imputed rent. On the one hand, I am a little bit re- luctant to look at an inflation indicator that takes out energy, food, and shelter. At that point, we are looking at a very narrow meas- ure of inflation, but the point you make has some validity. It is one reason why we tend to focus more on the core PCE deflator—rather than PCI. And I would say also that, as I mentioned in the testi- mony, that the pickup in core inflation is much broader based than this imputed rent component. Mr. MILLER OF CALIFORNIA. Significant factor in your determina- tion; am I not correct? Mr. BERNANKE. What is significant is that this increase in core inflation seems to be a broadbased phenomenon, and so we don’t think it is a statistical illusion. Mr. MILLER OF CALIFORNIA. But when interest rates go up, any person who owns an apartment complex looks at demand, and what they are paying for cost of funds. And when you have a mar- ket that is being impacted because affordability has decreased, every time you raise it a quarter percent, ‘‘X’’ amount of people are driven out of the marketplace. Not only are people building homes impacted, the people who own homes are impacted. In California, it seems, after the recession we experienced in the 1990’s as you recall, after 1989, some people in California had to wait until 2000 to have their home be worth what it was in 1989. So California is rather trying to catch up on the stagnant 11 years we experienced VerDate 0ct 09 2002 12:29 Feb 20, 2007 Jkt 031539 PO 00000 Frm 00053 Fmt 6633 Sfmt 6633 F:\DOCS\31539.TXT HFIN PsN: TERRIE 50 there, and you have had a robust housing market that has, in my opinion, based on people I know in industry, has solely been im- pacted recently because of the rise in interest rates. People are being forced out of the market. And as that happens, not only are they impacted trying to sell their home, the cost of land has re- mained consistent. The cost of government process remains con- sistent, but this equation you are using on rents is just making the situation worse than it otherwise would have to be. And not only just rising rents, but you have discussed other factors that you think have contributed to this cooling in the market. What might those be? Mr. BERNANKE. Well, the main factor is that housing prices have risen at double-digit rates for about 5 years. I think that quan- titatively is the main reason that people have been getting priced out in some markets. And, you know, that obviously can’t go on for- ever because affordability begins to bite and— Mr. MILLER OF CALIFORNIA. Well, when supply and demand equal each other, that is true, but right now, the demand is huge. Rates being reasonable, they are having trouble producing enough product out there to meet that demand. But every time you raise these rates, more people are forced out of the marketplace that oth- erwise—you know, if you go back a year, year and a half, people who qualified to buy a home today can’t even dream of it because the interest rate hike. And I am not trying to be argumentive, but you trying to stop inflation is absolutely devastating to the housing market and devastating to individuals who own homes who want to sell to relocate. They are unable to do that. The CHAIRMAN. The gentleman’s time has expired. This con- cludes the hearing. Mr. Chairman, this will be our last hearing together. As I leave the Congress, I just want you to know how much we have appre- ciated your excellent testimony two times before the committee and look forward to—my successor, I am sure, looks forward to your continued cooperation and appearances on a regular basis before the Financial Services Committee. Again, thank you for your serv- ice. Mr. BERNANKE. Thank you, Mr. Chairman. 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Ben S. Bernanke (2006, July 19). Congressional Testimony. Testimony, Federal Reserve. https://whenthefedspeaks.com/doc/testimony_20060720_chair_monetary_policy_and_the_state_of_the

@misc{wtfs_testimony_20060720_chair_monetary_policy_and_the_state_of_the,
  author = {Ben S. Bernanke},
  title = {Congressional Testimony},
  year = {2006},
  month = {Jul},
  howpublished = {Testimony, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/testimony_20060720_chair_monetary_policy_and_the_state_of_the},
  note = {Retrieved via When the Fed Speaks corpus}
}