[Senate Hearing 113-30]
[From the U.S. Government Printing Office]



                                                         S. Hrg. 113-30

 
               THE FED AT 100: CAN MONETARY POLICY CLOSE
               THE GROWTH GAP AND PROMOTE A SOUND DOLLAR?

=======================================================================

                                HEARING

                               before the

                        JOINT ECONOMIC COMMITTEE
                     CONGRESS OF THE UNITED STATES

                    ONE HUNDRED THIRTEENTH CONGRESS

                             FIRST SESSION

                               __________

                             APRIL 18, 2013

                               __________

          Printed for the use of the Joint Economic Committee




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                        JOINT ECONOMIC COMMITTEE

    [Created pursuant to Sec. 5(a) of Public Law 304, 79th Congress]

HOUSE OF REPRESENTATIVES             SENATE
Kevin Brady, Texas, Chairman         Amy Klobuchar, Minnesota, Vice 
John Campbell, California                Chair
Sean P. Duffy, Wisconsin             Robert P. Casey, Jr., Pennsylvania
Justin Amash, Michigan               Mark R. Warner, Virginia
Erik Paulsen, Minnesota              Bernard Sanders, Vermont
Richard L. Hanna, New York           Christopher Murphy, Connecticut
Carolyn B. Maloney, New York         Martin Heinrich, New Mexico
Loretta Sanchez, California          Dan Coats, Indiana
Elijah E. Cummings, Maryland         Mike Lee, Utah
John Delaney, Maryland               Roger F. Wicker, Mississippi
                                     Pat Toomey, Pennsylvania

                 Robert P. O'Quinn, Executive Director
                 Niles Godes, Democratic Staff Director


                            C O N T E N T S

                              ----------                              

                     Opening Statements of Members

Hon. Kevin Brady, Chairman, a U.S. Representative from Texas.....     1
Hon. Amy Klobuchar, Vice Chair, a U.S. Senator from Minnesota....     4

                               Witnesses

Hon. John B. Taylor, Ph.D., Mary and Robert Raymond Professor of 
  Economics at Stanford University and the George P. Shultz 
  Senior Fellow in Economics at the Hoover Institution, Stanford, 
  CA.............................................................     6
Dr. Adam S. Posen, President, Paterson Institute for 
  International Economics, Washington, DC........................     7

                       Submissions for the Record

Prepared statement of Chairman Brady.............................    26
Chart titled ``When It Comes to Growth 1% is a Big Deal''........    28
Chart titled ``To $3 Trillion and Beyond''.......................    29
Chart titled ``An Average Recovery = 4.2 Million More Private 
  Jobs''.........................................................    30
Chart titled ``Recovery's Growth Gap: Large and Growing''........    31
Chart titled ``Total Growth in Real Per Capita Disposable Income 
  Following Post-1960 Recessions''...............................    32
Prepared statement of Hon. John B. Taylor........................    33
Prepared statement of Dr. Adam S. Posen..........................    37


                  THE FED AT 100: CAN MONETARY POLICY
            CLOSE THE GROWTH GAP AND PROMOTE A SOUND DOLLAR?

                              ----------                              


                        THURSDAY, APRIL 18, 2013

             Congress of the United States,
                          Joint Economic Committee,
                                                    Washington, DC.
    The committee met, pursuant to call, at 9:31 a.m. in Room 
216 of the Hart Senate Office Building, the Honorable Kevin 
Brady, Chairman, presiding.
    Representatives present: Brady, Duffy, Paulsen, Hanna, 
Maloney, and Delaney.
    Senators present: Klobuchar, Coats, Lee, and Wicker.
    Staff present: Corey Astill, Doug Branch, Conor Carroll, 
Gail Cohen, Connie Foster, Al Felzenberg, Niles Godes, Paige 
Hallen, Colleen Healy, Robert O'Quinn, Jeff Schlagenhauf, 
Andrew Silvia, John Trantin.

    OPENING STATEMENT OF HON. KEVIN BRADY, CHAIRMAN, A U.S. 
                   REPRESENTATIVE FROM TEXAS

    Chairman Brady. Well good morning, everyone, and welcome to 
the Joint Economic Committee hearing ``The Fed at 100: Can 
Monetary Policy Close the Growth Gap and Promote a Sound 
Dollar?''
    This year marks the centennial of the Federal Reserve, so 
it is appropriate for the Joint Economic Committee to examine 
the Fed's role in the current economic climate as well as its 
focus for the next 100 years.
    Today's hearing on monetary policy is the third in a series 
that touches on our most vexing economic challenge: the growth 
gap.
    We are all rooting for America to bounce back, but 
regrettably the U.S. economy is missing 4.2 million private 
sector jobs and $1.3 trillion in real output due to the gap 
that exists between this weak recovery and the average recovery 
of the last 70 years.
    For every American, the growth gap means that he or she has 
$2,935 less in real disposable income at this point in the 
recovery.
    This gap persists despite extraordinary actions by the 
Federal Reserve to stimulate growth and employment as part of 
its dual mandate.
    Even more troubling, the Congressional Budget Office 
projects that the future growth rate for America's potential 
real GDP will be a full percentage point below its post-war 
average--which may not sound like much, but the consequences 
are alarming.
    With one percent lower growth, our economy will be $31 
trillion smaller in 2052, and the Treasury will collect $97 
trillion less in tax receipts over the next four decades--
making it significantly harder to balance the budget and reduce 
America's risky level of debt.
    The question before this Committee is whether the 
extraordinary actions taken by the Federal Reserve are capable 
of closing this growth gap, and if a focus instead on price 
stability and establishing a sound dollar will provide a 
stronger foundation for economic growth over the long term.
    Since 2008, beyond the appropriate role of lender of last 
resort to financial institutions and markets, the Federal 
Reserve has selectively bailed out investment banks, maintained 
interest rates at an extraordinarily low level for almost five 
years, engaged in three rounds of quantitative easing by buying 
massive amounts of Treasuries and mortgage-backed securities, 
and indicated that the Fed will continue this accommodative 
monetary posture until the unemployment rate falls to 6.5 
percent.
    But can the Federal Reserve boost real economic growth over 
time through discretionary monetary policy? Or should the 
Federal Reserve adopt a rules-based monetary policy to achieve 
price stability and let Congress and the President determine 
the combination of budget, tax, regulatory, and trade policies 
that will boost real economic growth to close the growth gap?
    In 1977, Congress established a dual mandate for monetary 
policy that gave equal weight to achieving long-term price 
stability and the maximum sustainable level of output and 
employment.
    During the 1970s, as you may remember, the Federal 
Reserve's monetary policy was discretionary and 
interventionist. The results were accelerating inflation, short 
expansions, frequent recessions, and rising unemployment.
    In the early 1980s, Chairman Paul Volcker broke the back of 
inflation. Over the next two decades, monetary policy became 
increasingly rules-based. The results were outstanding: low 
inflation and two long and strong expansions, interrupted only 
by a brief, shallow recession.
    Since the Great Moderation, as it's called, monetary policy 
has again become discretionary and interventionist. Not 
surprisingly, the results are disappointing.
    From 2002 to 2006, Chairman Alan Greenspan kept interest 
rates too low for too long which helped to inflate an 
unsustainable housing bubble.
    Chairmen Volcker and Greenspan correctly believed monetary 
policy could contribute to achieving full employment--if and 
only if--the Federal Reserve focused solely on price stability.
    Beginning in 2008, however, the Federal Reserve explicitly 
deviated from this view, invoking the employment half of its 
dual mandate to justify its extraordinary actions.
    In January 2012, the Federal Open Market Committee 
correctly observed in its ``Longer-Run Goals and Policy 
Strategy'' this statement:
    The maximum level of employment is largely determined by 
nonmonetary factors that affect the structure and dynamics of 
the labor market.
    Despite the clear admission of the limits of monetary 
policy to spur employment, in December of the same year the 
FOMC announced that it would (1) expand its current round of 
quantitative easing, and (2) retain its extremely low target 
range for federal funds for ``at least as long as the 
unemployment rate remains above 6\1/2\ percent.''
    To achieve a policy objective, Nobel Laureate Economist 
Robert Mundell stated: Policymakers have to use the right 
lever. Monetary policy affects prices over the medium and long 
term. In contrast, budget, tax, and regulatory policies are 
what affect real output, real investment, and employment. 
Monetary policy cannot solve the problems that poor fiscal 
policy has helped to create.
    By targeting the unemployment rate, the Federal Reserve is 
attempting to use monetary policy to achieve what the Fed 
acknowledged 11 months earlier that it cannot achieve--full 
employment--while risking what economists acknowledge that the 
Fed can achieve through appropriate monetary policy: long-term 
price stability.
    To close the growth gap, my belief is that we must refocus 
the Federal Reserve on a rules-based monetary policy which is a 
necessary, but not sufficient, condition for robust real 
economic growth and job creation.
    This is not a false choice between jobs or stable prices; 
it is the proven acknowledgement that stable prices and a sound 
dollar create the best foundation for job growth over the long 
term.
    Congress, which has delegated its constitutional authority 
to coin money and maintain its value to the Federal Reserve, 
should provide it with a clear direction to return to an 
achievable mandate for price stability.
    The Federal Reserve should also ensure a soft landing for 
the housing market by initiating a slow and orderly unwinding 
of its $1.1 trillion position in federal agency residential 
mortgage-backed securities.
    Gradually reducing the excess reserves that could be the 
fuel for future inflation will reduce market uncertainty, 
strengthen the foundation for non-inflationary economic growth, 
and reduce the likelihood of undue political interference in 
Federal Reserve policy.
    So looking to the future, today's hearing provides this 
Committee with the opportunity to hear from two of the most 
distinguished monetary economists in the world on their 
recommendations for the role of the Federal Reserve during its 
second 100 years.
    Dr. John Taylor is the creator of ``the Taylor Rule'' which 
central banks have used to implement a rules-based monetary 
policy.
    Dr. Adam Posen served on the Monetary policy Committee of 
the Bank of England, and is a widely acknowledged expert on 
Japan.
    We are fortunate to have them with us today. We look 
forward to their testimony.
    And with that, I would like to recognize the Vice Chairman 
of the Joint Economic Committee, Senator Klobuchar.
    [The prepared statement of Chairman Brady appears in the 
Submissions for the Record on page 26.]

  OPENING STATEMENT OF HON. AMY KLOBUCHAR, VICE CHAIR, A U.S. 
                     SENATOR FROM MINNESOTA

    Vice Chair Klobuchar. Thank you very much, Chairman Brady. 
Thank you for holding today's hearing on our Nation's monetary 
policy and the mission of the Federal Reserve.
    We are fortunate, as you have noted, to be joined by two 
witnesses with deep knowledge of these issues, and I want to 
thank both of you for being here today.
    Since the financial crisis began in 2007, the Fed has used 
many tools to bolster the economy. It has kept short-term 
interest rates near zero since late 2008, and taken action to 
keep longer term interest rates and mortgage interests rates 
low. However, as I have said before, I always believe that we 
can do better, and we have been working in the Senate on a 
number of issues with accountability and greater transparency. 
And I appreciate the fact that Chairman Bernanke will be coming 
before this Committee in May.
    While the economy is not yet out of the woods, and too many 
Americans still struggle to find work or make ends meet, we all 
know that there have been promising signs and that we are a lot 
better off than we were at the beginning of this downturn.
    More than 1.2 million private-sector jobs have been added 
in the past 6 months.
    Unemployment reached a 4-year low last month of 7.6 
percent. I would note that in my own State it is 2 points 
better than that at 5.6 percent.
    Housing, so critical to the construction sector, has begun 
to rebound, with new-home sales exceeding 400,000 for two 
consecutive months for only the second time since the crisis 
hit in September 2008.
    But even with all the progress, we all know families that 
are working several jobs that don't have their employment 
situation back to what it once was; that there are some long-
term unemployment issues; and that there are other problems 
that need to be solved.
    The Fed, which is buying about $85 billion in Treasury 
Bills and mortgage-backed securities each month to further 
reduce long-term interest rates, continues to play an important 
role in the recovery.
    A survey released today by a Minnesota business group shows 
Minnesota manufacturers remain very concerned about the 
economy.
    The impact of the Federal Reserve's past and current 
efforts would have been diluted if the Fed were restricted to 
only purchasing short-term U.S. Government securities, as some 
have proposed.
    In 1977, 64 years after the Federal Reserve System was 
created, Congress clarified that the Fed's mission was to 
promote maximum employment and stable prices. The question 
raised in today's hearing is whether now is the time to change 
the Fed's goals to focus only on price stability. I think now 
is not the time for the Fed to take its eye off promoting 
employment.
    I note that presently inflation is in check--about 1.3 
percent over the past 12 months according to the Fed's core 
measure, and there is no sign of inflation for the foreseeable 
future.
    Additionally, the Federal Reserve has signaled that it has 
an exit plan to change course once the economy is stronger than 
it is today.
    While there have been improvements in the employment 
situation, it is clear that the economy is still healing from 
the downturn. Yet requiring the Fed to focus solely on price 
stability would be directing it to essentially ignore 
employment.
    I believe the Fed does not need a change of mission at this 
time in our Nation's recovery.
    I am looking forward to questioning both of you on this, as 
well as Chairman Bernanke. I believe, though, that Congress 
must do more to bring our debt down in a balanced way. I think 
it is worth looking at the Senate's budget proposal. We did 
pass a budget a few weeks ago, as well as the one that has been 
proposed by the President and the House, and I am hopeful we 
can come together in a bipartisan way to bring the debt down 
without causing what Chairman Bernanke has called ``the sharp 
contraction in the economy'' by setting us back.
    I believe we can bring the debt down with a mix of revenue 
and spending cuts, and at the same time invest in those core 
things that are so important: education, our economy, making 
sure we move forward with exports, doing all the things we need 
to do to train workers for the jobs that are available today.
    With that, I have about a minute left and I would love to 
turn it over to Mr. Delaney to see if he would like to add a 
few words to my opening.
    Representative Delaney. Yes. Thank you, Vice Chair 
Klobuchar.
    I do think in today's discussion, which is important, we 
should also think about it in the context of what is happening 
in the real and political world. Because I agree with the 
Chairman that Congress is a much more precise instrument in 
terms of stimulating growth in our economy through 
comprehensive immigration reform, adopting a national energy 
policy, investing in our infrastructure, improving educational 
outcomes, changing trade policy, and to do many of these things 
we have to address our fiscal challenges, obviously.
    But Congress's inability to use this precise instrument has 
to be considered when we think about changing the Fed's dual 
mandate. Because when we analyze the Fed's dual mandate, it is 
important not to do it in a vacuum but to do it in the context 
of the real world and the political world that we live in. 
Because Congress has been unable to do the things we need to do 
to stimulate economic growth in this country. And I think it is 
important that we evaluate the dual mandate of the Fed in that 
context, not in a vacuum.
    Thank you.
    Vice Chair Klobuchar. Thank you.
    Chairman Brady. Thank you both.
    We are honored to have these two witnesses with us today. 
This is the appropriate time to be asking some constructive, 
thoughtful questions about the Fed's role both in today's 
economic climate, and in its second century.
    With that--and both Dr. Taylor and Dr. Posen are leading 
experts and widely respected in this field. So with that, Dr. 
Taylor, you are recognized for five minutes.

   STATEMENT OF HON. JOHN B. TAYLOR, Ph.D., MARY AND ROBERT 
 RAYMOND PROFESSOR OF ECONOMICS AT STANFORD UNIVERSITY AND THE 
   GEORGE P. SHULTZ SENIOR FELLOW IN ECONOMICS AT THE HOOVER 
                   INSTITUTION, STANFORD, CA

    Dr. Taylor. Thank you, Mr. Chairman and Vice Chair, for 
inviting me to be here. I appreciate it.
    In the invitation letter, it asked me to comment on the 
departure from a more rules-based policy by the Federal 
Reserve. I think there has been such a departure. I think it is 
quite large, especially if you compare it with the type of 
policy of the 1980s and the 1990s until recently.
    In my view, this departure has led to problems. It has led 
to a poorer economy than otherwise, and after all we have had a 
Great Recession and a very, very weak recovery.
    In my view, the departure began around 2003, 2004, and 2005 
where the Fed held interest rates much too low compared to the 
conditions in the economy at the time, and also compared to the 
policy that was followed in most of the 1980s and 1990s.
    This was one of the reasons we had the excesses, the search 
for yield, the risk taking, the boom in housing, and ultimately 
the bust which led to the financial crisis itself.
    In my view, those kinds of actions and interventions 
continued right up until the panic itself, and certainly did 
not prevent the panic. In my view, they were basically harmful.
    During the panic period, I think it is very important to 
point this out, the actions of the Fed in providing liquidity 
were positive. They bolstered confidence. They got markets 
moving again.
    However, when the panic subsided in late 2008, early 2009, 
rather than let those facilities draw down, the Fed continued 
its interventions. We began to see the Quantitative Easing, the 
massive purchases of Treasury Securities, the massive purchases 
of mortgage-backed securities, the Operation Twist, and the 
continued extension of the zero interest rate policy not only 
to the present but into the future.
    It seems to me that if you look at this--and I have for 
this whole period--it should make you worry. Back in 2009, I 
warned that these kinds of policies would cause risks and would 
be harmful to the economy. And, to be sure, the results have 
been disappointing--outcomes have been much lower than what the 
Fed said would happen in this period.
    It is hard to make the case that these policies are 
working.
    It is for this reason that I think it would be appropriate 
for the Fed to begin to consider exiting from these policies. 
Of course it should be done in a gradual, credible way so as 
not to upset markets. And indeed, I believe that if it is done 
in such a way it will remove risks to the economy that are 
currently holding back the expansion.
    I think there is an opportunity to make this exit if in 
fact we have a bit of a growth spurt this year. What it could 
lead to is an extension of a growth spurt, and we have seen 
several of them in this disappointing recovery. But an exit 
would make that growth spurt more sustained so we would get the 
real recovery that we have been hoping for, which will bring 
unemployment down.
    In the invitation letter, I was also asked to comment on 
what kind of rules-based policy the Federal Reserve should 
follow.
    It seems to me we have tremendous experience and things to 
learn from history in this regard. In particular, in the 1980s 
and 1990s, until recently, the Federal Reserve adhered more 
closely than really at any other time in its 100-year history 
to a more rules-based policy. It was not perfect, but it was 
very close.
    The results were dramatic. Unemployment came down. 
Inflation came down. Economists look back on that period and 
see how stable it was. They have a name for it: The Great 
Moderation. Because it was so stable. It worked.
    So in many respects, we need to get back to some kind of a 
rules-based policy for the instruments like that. The world is 
different. Policy does not have to be exactly the same. But 
rules for the instrument are essential.
    It is very important to have a target for inflation, but 
that is not enough if it is accompanied by a do-whatever-it-
takes philosophy, because that will lead to these interventions 
which quite frankly have been disappointing, as we all know.
    One way to integrate a rules-based philosophy into monetary 
policy would be to go back to the requirements that the Fed 
report its strategy for its instruments. Those requirements 
were removed from the Federal Reserve Act in the year 2000. 
Those should be put back in. The Fed would be required to 
report its strategy for its instruments of policy, whatever it 
chooses to do so, and describe how they will follow them. And 
if they deviate for an emergency or for whatever reason, they 
would have to come back and explain this to the Congress.
    I don't think the Congress should tell the Federal Reserve 
what kind of strategy to follow for its instruments. But it 
should ask the Fed to report explicitly on what that strategy 
is. And if the Fed deviates from that strategy, to say why as 
soon as possible.
    It seems to me that way the Congress would be exercising 
its Constitutional authority without interfering with the day-
to-day operations of the Federal Reserve.
    Thank you for the opportunity to testify.
    [The prepared statement of Hon. John B. Taylor appears in 
the Submissions for the Record on page 33.]
    Chairman Brady. Thank you, Dr. Taylor.
    Dr. Posen, thanks for joining us here today. You are 
recognized.

 STATEMENT OF DR. ADAM J. POSEN, PRESIDENT, PETERSON INSTITUTE 
          FOR INTERNATIONAL ECONOMICS, WASHINGTON, DC

    Dr. Posen. Thank you, Mr. Chairman. Thank you, Vice Chair 
Klobuchar. Thank you, all. I will try to be very brief and as 
timely as my colleague, John Taylor, in hitting the mark.
    I think it is entirely right and appropriate for committees 
of this Congress to be examining the performance, not only the 
performance but the goals of the Federal Reserve. And I think 
it is perfectly reasonable after five years from the crisis to 
be doing that.
    I broadly support the idea of Chairman Brady that a 
commission about the Fed is--if done correctly, can be a 
productive thing. But let me give you three comments on how I 
think it needs to be done in order to be productive, and about 
what kind of goals need to be set.
    Independent central banks are useful. They keep inflation 
down. They keep the politicians out of monetary policy. As 
Stanley Fischer pointed out 20 years ago, there is a 
distinction to be made between the instrument independence, the 
ability of a central bank to set its policy instruments at any 
given meeting or series of meetings, versus goal-independence, 
the ability of a central bank to say what it cares about.
    I have always believed, along with he and a large number of 
other economists, that it is right for elected officials to set 
the goals, and it is wrong for elected officials to interfere 
with the instruments.
    I think it is entirely viable to make that distinction, 
even though there are obviously specific cases where those 
things can get muddied, but that is no more of a challenge than 
when Congress oversees any other agency, or the military, or 
any other independent group.
    Therefore, I think it is reasonable to speak about 
Congress, looking in a multi-year framework, at what should be 
the targets of the Fed? What should be the goals? As long as 
you don't do it too often--whether it's 100 years or 5 years, 
this Congress has not done it too often, so I welcome that.
    I do think it is important, though, to realize that the 
goals have to be practical. So just to give three recent 
examples, in Japan they just turned over the new central bank 
head and they reaffirmed a stronger commitment to raising out 
of deflation. That was done in full respect of the central 
bank's independence. They waited until the governor's term was 
up before replacing him. They did not change the rules of how 
the Bank of Japan met. They simply asserted you haven't done a 
good job of meeting it, and here is how we are going to hold 
you to account.
    In the UK where I served, they recently announced a review 
of the inflation-targeting regime that had been in place for 15 
years. They did it with a finite length of time, a fixed 
transparent set of reports, and then they immediately said: 
Well, we want to fix this, and this, but we actually are pretty 
happy with the regime.
    I am not going to say whether that was right or wrong, but 
the point was you have to have a commission or an examination 
that is open to making no changes if you come to the 
conclusion. You don't want to simply have threats of changes be 
a way to bully the central bank into doing what politicians 
want.
    Third, we have the contrast with Hungary which right now, 
for a number of fronts, not just monetary, is going in an anti-
democratic direction and they have, rather than examining the 
goals of their central bank, overthrown their central bank 
essentially, packed it with political people, fired a number of 
staff. Obviously no one on this Committee or this Congress 
would do that, but that is an example of how you can interfere 
too much.
    So what in practice are the kinds of goals you might want 
to set? I say ``practical'' because if you just do broad goals 
like price stability, or full employment, it just gets into 
politization, too much vagueness, too much room for 
interpretation and discretion on the part of the central bank, 
and then too much debate about what accounts--what is 
accountability.
    That is why I and Chairman Bernanke and others worked 
together advocating for things like inflation targeting for the 
U.S. some years ago. The point of inflation targeting is not a 
sole focus on inflation. We are very explicit about that. Nor 
am I saying that inflation targeting is necessarily the right 
way.
    What we did say that I think is important is you need to 
have a transparent set of goals, a set of goals that is 
measurable, a set of goals that is subject to review, a clear 
hierarchy but allowing for there to be more than one goal 
depending on what the conditions are, a time framework of say 
two to three years on which progress is evaluated. These kinds 
of practical transparency steps I think are applicable to 
whatever goal the Congress sets the Fed.
    Finally, on the question that has been raised about real 
activity or not, I will have to respond to this more I hope if 
you give me the opportunity in questions, but I see no conflict 
here. If the Fed was trying to put employment up above full 
employment as we did in the 1970s as the things to which 
Chairman Brady and Dr. Taylor referred, that would be one 
thing. But we are well below full employment. There is no sign 
of any inflation. And, all these credit bubbles that we are 
concerned about do not correlate with monetary policy.
    There is no strong evidence of that. All there is is 
evidence that if you let bankers get out of hand, then you will 
end up getting a lot of corruption. That is bad. That is 
something we need regulation to deal with. But that is not a 
monetary policy issue.
    The final question which was raised--five seconds--should 
we be limiting the Fed to just buying short-term instruments? 
The answer is: No. That is what the Bank of Japan did for 10 
years, is they only bought things of less than three-year 
duration government bonds. They were essentially printing cash 
to buy cash. And as you would expect, that has no impact on 
other investors' behavior.
    If you want to have traction on the economy, you have to 
buy something other than cash.
    [The prepared statement of Dr. Adam J. Posen appears in the 
Submissions for the Record on page 37.]
    Chairman Brady. Thank you, Dr. Posen.
    Let me start with you, Dr. Taylor. As we discuss the 
mandate of the Fed, and as those of us who believe we ought to 
refocus it back to rules-based price stability which protects 
the value of the dollar over time, good money as it is, should 
we have that mandate? Does the Fed ignore employment factors in 
pursuing stable prices over time?
    Dr. Taylor. No. Absolutely not. The experience, it seems to 
me, with this is when the Fed took specific actions to try to 
deal with unemployment--the 1970s is an example--it backfired. 
Unintended consequences were high inflation, and ultimately 
higher unemployment. Higher unemployment got to be 10.8 percent 
by the end of that episode.
    I think the recent experience is similar. One of the 
reasons the Fed held rates low in 2003, 2004, 2005 was a 
concern about employment. What has happened? We have had much 
higher unemployment than anyone would want.
    So the history is pretty clear that there are unintended 
consequences of these actions because the policies that are 
chosen are counterproductive.
    I think the problem with the dual mandate now is it is 
really used as an excuse to do more interventions, more 
discretion than would otherwise be the case. So my hope is to 
put more focus of the Fed to price stability, which would 
generate more, overall economic stability that would be quite 
positive for unemployment. We would get a lower unemployment 
rate, and people are legitimately concerned about it, if you 
remove that mandate.
    In reality, monetary policy works with lags. It is dynamic. 
It takes time. And what we have seen in history is these 
efforts go the wrong way, and it is a concern to me.
    Chairman Brady. Do you believe the Fed's current 
accommodative monetary policy will help close the growth gap? 
Or do you view a more rules-based policy as helping remove the 
risks that at this point are a roadblock in the economic 
growth?
    Dr. Taylor. No, I do not think they will help. In fact, the 
history of the last four years is that they have not. We have 
had really the weakest recovery in history for a downturn like 
we have had. And it is good to say positive things, to be sure, 
but this is a very disappointing expansion, a very 
disappointing recovery.
    And there are a lot of reasons people point to, but I think 
one of them is the uncertainty, the great deal of interventions 
that the Fed has had here. And so to me, and history tells you, 
economics tells you, to get back to a more predictable policy. 
A policy where there is not so much interference with the 
economy would actually help the recovery, and I am hoping they 
will do that.
    Chairman Brady. Thank you, sir.
    Dr. Posen, I read your testimony last night. You touched on 
a lot of key points. I want to pursue your first point you 
made, which is that there is a right way and a wrong way for a 
legislative body to set goals and hold their central bank 
accountable.
    The approach we are taking is to try to create a 
constructive, focused bipartisan approach, in fact a focused 
bipartisan approach over the next year to look both backwards 
on what is the role of the Fed in the economy in the first 100 
years, financial security and all that, and also to create sort 
of a level playing field for ideas on what that role should be.
    In your view, is that generally the right approach versus, 
as you've identified, there are some damaging approaches as 
well?
    Dr. Posen. Mr. Chairman, no, I am very delighted to be 
here. And as I said in my testimony, part of the reason I am 
delighted to be here is because you and your colleagues and the 
staff of this Committee are framing this in a serious, 
objective, and--I don't know partisan/bipartisan, but open to 
debate way. And, that you would be open, I would hope, to 
evidence. As my colleague, John, talks about history, I 
interpret the history a little differently than he does. I 
would hope that we could have frank discussion about that.
    And I think the key word that I used in my testimony, and 
again I know for this Committee I do not need to tell you that, 
is you do not want this to be about bullying. You do not want 
this to be about we do not like what the Fed is doing right 
now, or we are worried that the Fed is not doing enough of X 
right now, and therefore we threaten a change in the Reserve 
Act, Federal Reserve Act, to get right now what we want.
    When you frame it, Mr. Chairman, when you and your 
colleagues frame it as a long-term consideration about what for 
the next 5, 10, 20 years--I hate to go beyond that--but 5, 10, 
20 years should be the Fed's goal, I think that is an entirely 
legitimate and constructive focus.
    Chairman Brady. Right. Thank you, Dr. Posen.
    Vice Chairman Klobuchar.
    Vice Chair Klobuchar. Thank you, both of you. I appreciate 
your testimony and your comments, Dr. Posen. We truly are 
trying to approach these things on a bipartisan basis here in a 
civil way as we look at the work that we are going to have to 
do together.
    I cannot agree with Chairman Brady more than monetary 
policy alone cannot return this economy to good health. I think 
it has to be a combination of the work that we are doing in 
Congress. And, as Mr. Delaney articulately pointed out, there 
is a lot of work that needs to be done in Congress that has not 
been done.
    But I want to get back to the point both of you made about 
this idea of setting goals from Congress. But at the same time, 
I know, Dr. Taylor, you said that the Congress should not be 
getting involved in dictating what instruments are bought and 
those kinds of things.
    Could you expand on that, about what would happen if we got 
too involved in the details of this?
    Dr. Taylor. Yes. There are lots of decisions that are made 
on a day-to-day basis, the technical decisions. It seems to me 
the best thing is for the Congress to delegate those decisions 
about the instruments of policy to the Federal Reserve, to our 
central bank. You would be exercising your Constitutional 
responsibilities that way.
    I do think, though, that you have to do more than just, 
say, hit an inflation goal. Because, especially in the last few 
years, we have seen how a whole wide range of instruments will 
be used to try to achieve that.
    It is not predictable. They have changed the strategy 
several times in the last four years. They are groping for 
something that will work. And so that is not a strategy. That 
is tactical. It is not something that people can understand--we 
are guessing all the time what the Fed is going to do next. 
That is not good. That is not predictable.
    But the Fed can report to you, report to the Congress more 
generally, or to appropriate committee what its strategy is for 
the interest rate, or for reserves, whatever it happens to be, 
explicitly, as explicitly as it thinks appropriate. And you can 
judge that. Other people can judge it and make an assessment. 
And we can have a good debate about what it is. But we do not 
have that now.
    The goal itself, for say price stability or whatever you 
want it to be, is not sufficient. Policy works with a long lag. 
It is not an accountable way to approach things. So that is why 
I think the strategy is so important.
    Vice Chair Klobuchar. Okay. And Dr. Posen, do you think it 
is the right time to change the mandate of the Federal Reserve 
by statute?
    Dr. Posen. Madam Vice Chair, no. Full stop. I think it is 
both a wrong time to do it because the Fed's policies right now 
are constructive in making a positive difference without in any 
way imperiling a sound dollar. And I think it would be a 
mistake based on the knowledge we have now about how central 
banks work, and how economies work, to change the dual mandate 
even when we are in recovery, I think it is the responsible and 
right thing to do.
    Dr. Taylor spoke about instrument changes, and tactical 
requirements. I think too much is being made of that. There 
seems to be this horror of a central bank that actually tries 
to do its job and adapts to circumstances. I think that is a 
mistake. Any more than you would tell the military: God 
Almighty, you are using tanks and drones rather than foot 
soldiers? That must mean you are doing something wrong.
    No, that is not how you act. You ask the military: Are you 
doing an acceptable job? Are you incurring too many casualties, 
causing too many side effects? Those are all reasonable 
questions.
    But then getting into is this the right way to fight the 
fire? Is this the right way to land on the beach? That is not 
something Congress should be doing.
    If I can make one more point, when you talk about history, 
as I said in my written testimony, these kinds of so-called 
``unconventional policies'' were what central banks did for the 
preceding 200 years. They bought and sold private assets.
    Now there were disadvantages to that, but they were small. 
And this rules-based period that Professor Taylor and others 
invoke as a gold era, the gold standard, for example, was a 
period when central banks were buying and selling private-
sector assets with large balance sheets.
    And so there was no contradiction between adherence to the 
gold standard and price stability, and having involvement in 
private markets. So I think we should stop fear-mongering about 
that and focus on the goals, rather than the instruments.
    Vice Chair Klobuchar. And what do you think the best thing 
Congress should do right now? Just take it out of the Federal 
Reserve right now in terms of what we should be doing with the 
tools that we have, which as Congressman Delaney pointed out 
are much more targeted and we can do things more quickly?
    Dr. Posen. I fully stipulate to what Congressman Delaney 
said. I mean--and this is still in the spirit of bipartisan of 
everything everyone has said so far, which is the Fed cannot 
really affect the maximum rate of sustainable employment; it is 
these longer term structural factors that matter. The Fed can 
affect how close we come to that at any given moment.
    And so for the Congress to focus on things that would bring 
up the rate of sustainable employment would be positive.
    Vice Chair Klobuchar. Okay. Thank you, very much.
    Chairman Brady. Thank you. Representative Hanna.
    Representative Hanna. The Fed has said--the FOMC set a 
target employment or unemployment rate, and they have said in 
their own words, the maximum level of employment is largely 
determined by nonmonetary factors that affect the structure and 
dynamic of the labor force.
    Knowing that, in terms of America being competitive, in 
terms of, as Mr. Delaney said, education, immigration, a very 
complicated tax code, exports and a lack of a national energy 
policy, how realistic is it for them to have that in writing 
and believe that, I think, and set a policy of unemployment, 
knowing that all jobs are not the same, and that we have 
structural problems that are both long term and short term in 
our economy? Do they set themselves up for defeat by saying 
that?
    Dr. Posen. No. They simply set themselves up for being--
sorry, Congressman Hanna, in my view they simply set themselves 
up for being much humbler about what the Fed can achieve and 
how they should act than they did in the previous two decades.
    I was very struck in Professor Taylor's remarks about how 
wonderful these various periods were when the Fed stuck to 
rules-based monetary policy, and how bad things are now, as 
though the monetary regime was the only thing that determined 
these wonderful outcomes, or these terrible outcomes, or at 
least was a dominant thing.
    And as you just read, and as Mr. Delaney said, that is 
exactly wrong. The Fed basically has some control over credit 
conditions and over how hot the economy runs versus this limit.
    And so I think it is entirely appropriate, but in no sense 
inconsistent, to say to the Fed: Don't presume you know exactly 
what the top level of unemployment is. Be subject to checking 
that, as you failed to do in the 1970s. But your job is, given 
whatever Congress decides, given what the elected 
representatives of the world leave you with, to try to get the 
most stable growth, and the most stable inflation you can, 
given those conditions.
    And I see no contradiction as long as Congress and the 
media do not expect too much to the Fed saying we're creating 
jobs; we're getting us back to full employment. These may or 
may not be great jobs. That is for elected officials to decide, 
not for the Fed.
    Representative Hanna. But are they setting themselves up 
with a wrong premise, a wrong-headed premise?
    Dr. Posen. Not at all. I don't think, as you just read, I 
don't think there is anybody at the Fed, from the Chairman on 
down, who thinks that by trying to get the economy to grow, to 
recover, is doing anything about the long-term structural 
issues--except possibly the following: Which is, we know--and I 
think you and I discussed this before the meeting--that when 
people are out of work for a long time, it sometimes becomes 
very difficult for them to get back into work. It is sometimes 
very difficult for them to get rehired, whether they are an 
older worker who gets labeled, or a younger worker who fails to 
get on the ladder.
    And so there is an excuse, or a reason for the Fed--I think 
it not an ``excuse,'' I think it is a genuine justification, 
excuse my language, for the Fed to try to keep the economy 
running as close to full employment as possible under serious 
conditions because you do not want that to kick in.
    Representative Hanna. Dr. Taylor.
    Dr. Taylor. I think the Fed now says the long-term normal 
unemployment rate is 5.6 percent. I think that is what they 
have said. And they are trying to--their goal is to keep the 
fluctuations, or the deviations of unemployment from that 
number as small as possible.
    But of course they have not accomplished that by any means. 
The performance is much worse in the period I'm referring to 
than it was say in the 1980s and 1990s, a much more stable 
economy as measured by their own criteria, the exact criteria 
they are using right now.
    And I think monetary policy does have an impact. It is one 
of the most powerful macro economic instruments there are. And 
it can be a force of good, and it can be a force of harm. There 
is no question about that. Throughout the history of the 
Federal Reserve, I think you can point to more periods where it 
has been harmful.
    Take the Great Depression. It was terrible economic--
terrible monetary policy. I think the same is true of the 
period now. And we have good periods. And we should look at 
that history. And there are other things that go on in the 
economy. Your responsibility with the budget is very important. 
Regulation is very important.
    But do not discount monetary policy as not a major factor 
in these economic developments.
    Representative Hanna. Thank you.
    Chairman Brady. Thank you. Representative Delaney.
    Representative Delaney. Thank you, Mr. Chairman.
    Two quick questions for Dr. Taylor, and then I have one for 
both Dr. Posen and Dr. Taylor.
    Dr. Taylor, you said something interesting in your 
testimony that you think it would be a great opportunity for 
the Fed to unwind, or to begin to unwind its position during 
periods of growth that we may or may not see during the next 
year.
    To the extent Congress were to put in place a grand bargain 
deal of significance, how much of an opportunity do you think 
that would create for the Fed to begin to unwind its position?
    Dr. Taylor. Well if such a grand bargain is a responsible 
approach to fiscal policy and is positive for the economy, that 
would begin to create this good news. And I think it would be 
an opportunity for the Fed. But it does not have to be the 
Congress's action. It can be other action.
    Representative Delaney. In case we needed another reason to 
work on something, I thought I would try to get that out for 
the record.
    [Laughter.]
    My second question for you is, you talked about how 
oftentimes there is a correlation between the Fed using 
monetary policy to stimulate employment and the fact that there 
has not been a measurable, immediate change in the trajectory 
of employment.
    Is that really a fair standard? Because it seems to me the 
Fed often uses monetary policy to stimulate employment just at 
the time we start seeing accelerating unemployment; and that 
the Fed really should be judged based on how much it mitigates 
further unemployment, as opposed to holding it to a standard of 
achieving its unemployment goals.
    Because again I come back to, I tend to think about the 
world, or these decisions in the context of the real, practical 
world as opposed to kind of abstract or standards in a vacuum. 
And I'm not sure it is fair to judge the Fed based on the fact 
that they haven't achieved, or we have not achieved what we all 
view as optimal employment, and to say that their policies have 
not worked.
    Isn't there some truth to that statement? That we really 
have to look at the mitigation effect as opposed to just 
whether they are hitting absolute standards?
    Dr. Taylor. It is a very good question. But I think my 
characterization of the events is more that the Fed took 
action, say in the 1970s, and later on you have these adverse 
consequences.
    The Fed took actions in 2003, 2004, and 2005 and later on 
you have had this crisis.
    Representative Delaney. Right.
    Dr. Taylor. And so it is not the kind of----
    Representative Delaney. But the crisis in 2007-2008, it was 
hard to--I mean, I think you could actually make an argument to 
the Fed's action after 9/11 did contribute to some of the asset 
bubbles that were created in the last 10 years. But it is not 
clear to me that the 2003-2004 actions were correlated to that.
    Dr. Taylor. Well the evidence I look at says it is more 
2003, 2004, 2005, and I think the Fed's provision of liquidity 
in 9/11 was appropriate. They provided $60 billion of 
liquidity. They removed it right away. I wish that's what had 
happened in 2008.
    Representative Delaney. And my question for each of you is, 
when I think about the Fed's actions recently I view their 
actions around the crisis as heroic. I view their actions post-
crisis as appropriate.
    I do have questions about their recent actions, QE-3, if 
you will. And my concerns are that again it is a blunt 
instrument. It is not achieving the results as effectively as 
actions of Congress would. And I don't blame the Fed for that 
because they do have the dual mandate, and in the absence of 
Congress doing something they are compelled to do it.
    I also feel like it hurts savers, and it largely helps 
people with assets. And to that degree, continues to drive 
income inequality in this country. But perhaps my biggest 
concern is that, as the Fed's balance sheet grows and it 
continues to be long assets, when that time does occur where 
rates need to be raised--which there is no evidence that that 
has to happen any time soon, based on the inflation data--do 
you think that the Fed will be affected in their decisionmaking 
process by the impacts that raising rates would have on its own 
balance sheets?
    In other words, Fed monetary policy, while it is not an 
appropriation, does have a cost. And the cost is how we unwind 
this. And the Fed is not a traditional financial institution. 
It is not at risk based on what happens to asset prices, but it 
will create a lot of negative headlines, and there will be a 
lot of discussion about the Fed losing money. It may affect 
their ability to make payments to the Treasury.
    So do you think--and this is a question for both Dr. Posen 
and Dr. Taylor, maybe Dr. Posen first, do you think this will 
have an affect on their ability to act on appropriate rate 
setting measures?
    Dr. Posen. Thank you, Congressman Delaney.
    I guess you raised an enormous number of issues, so let me 
just try to quickly respond. I think the distinction of QE-3 
versus the crisis is one that is now becoming popular, and I am 
not sure it is entirely justified.
    The Fed is continuing to do things that are perfectly 
reasonable and in line with central bank practice. More 
importantly, I think you are all going to see over the course 
of the next year, and in fact are already seeing in some of the 
statistics Vice Chair Klobuchar mentioned, the recovery in the 
housing market that is being directly fueled by the restoration 
of the MBS market through Fed action.
    And that is going to be an important driver of growth in 
the year ahead, and it is not going to be a bubble because we 
have been so low below replacement rate on housing it is 
entirely appropriate for the Fed to do that. It is another 
example of them buying a non-Treasury asset having the right 
impact.
    Second, I think you worry about hurting savers. There is so 
little private sector savings in this economy, except by rich 
people, that unfortunately anything we do that stabilizes the 
economy will always disproportionately benefit rich people--
which would not be bad if it did not hurt other people; 
however, mass unemployment, mass under-employment, budget 
deficits that force cuts in progressive programs, and Head 
Start, and education and health, really hurt poor people.
    And therefore what the Fed does to keep growth up is 
actually far more important than the effect on savers, 
including people like my mother who live off of T-Bill 
interest. It is still, on net, better for the poor in this 
country for the Fed to act.
    In terms of the balance sheet issue, this actually raises 
something I should have said to Vice Chair Klobuchar when she 
was asking what Congress can do vis-a-vis the Fed in general.
    I find it----
    Chairman Brady. I'm sorry, Dr. Posen, because we're 
running--and perhaps we can return to this point with 
Representative Maloney as well.
    Representative Paulsen.
    Representative Paulsen. Thank you, Mr. Chairman.
    Actually, I think some of my questions will be able to 
allow some of that same line of thought to occur. I was going 
to ask just regarding the issue of the impact of the Fed's 
policies on savers, on seniors, for instance, and maybe some 
folks of higher age category are not making wise asset 
allocations, for instance, and they may be pushed more toward 
riskier investments because of declining interest rates.
    I know that Chairman Bernanke back in February of 2013, 
just recently he just testified actually that he said the 
notion that savers are harmed by the Fed's current policies are 
not really a factor because, he has argued, as much as there is 
harm to interest-bearing accounts, savers are also benefitting 
from other assets like stocks, and real estate.
    He noted that the stock market has doubled in the last few 
years, and he has expressed conviction that the economy must 
move forward and pick up steam before interest rates are 
brought back up.
    So it kind of follows--just to follow up, what is the 
proper balance for U.S. monetary policy in terms of achieving 
that price stability and lower employment in a way that does no 
harm to American savers, or to seniors who choose to forego 
present income for future security?
    And maybe, Dr. Taylor, you can kind of start off and then 
go to Dr. Posen.
    Dr. Taylor. Well I would say one way to look at this is to 
just go back to the 1980s and 1990s until recently. You 
basically had a policy which would ease in a recession, and it 
would tighten when inflation picked up. It worked very well.
    It seems that is the kind of policy you are looking for 
now. But a policy that promises a zero short-term rate for 
years into the future, that is an interference with the markets 
that is very unusual--extraordinarily unprecedented. Don't 
think this is not unusual.
    And the purchases of mortgage-backed securities is 
massive--this is not just a few dollars--is very unusual. And 
those create this uncertainty about how it is all going to be 
unwound. And the zero rates themselves, they do cause a search 
for yield. We have seen that in the past.
    There is also an effort to drive down the long-term 
interest rates so they don't reflect the information that is 
coming into the economy, whether it is a pick up or a slow 
down. So it is a massive change in policy. And the effect on 
savers and what they do is just one example of this.
    So it seems to me that we know how to deal with this. We 
have done it in the past, and I think we should try to do that 
in the future.
    Representative Paulsen. And you have suggested that a 
return to a more rules-based monetary policy would result in 
normal market-determined interest rates that would reduce those 
incentives for pension funds and retirees to take on more 
dangerous risks. So are the Fed's policies right now 
contributing to a stock market bubble, to a potential housing 
bubble down the road? Bubbles burst. I mean, is it a 
contributing factor?
    Dr. Taylor. One of the problems in economics is we don't 
know exactly when it is a bubble and when it is fundamentals. I 
think there are some good things going on with respect to 
profits. There has been a recovery. It is just terribly weak.
    Many of the firms you are looking at, their stock prices 
are benefitting from foreign sales. The world, and especially 
emerging markets are doing quite well. And so there are lots of 
other reasons, more fundamental reasons, but I think you should 
be worried about bubbles especially in the fixed-income market.
    And to the extent that the Fed is influencing that, I 
believe they are, that has to be removed at some time. It can 
only be temporary. The Fed cannot do this forever. We cannot 
rely on the Federal Reserve for the stock market in the United 
States forever.
    Representative Paulsen. Dr. Posen.
    Dr. Posen. Mr. Paulsen, I guess I am uncomfortable with 
your initial statement about the Fed should worry about 
inflation, employment, and no harm coming to savers. The Fed's 
goal should never be: no harm comes to any one group. Full 
stop.
    That does not mean we should not be honest and look at 
those issues and admit that there are effects, and pluses and 
minuses, as I think Chairman Bernanke tried to account for, but 
the idea that the Fed should direct its policies towards any 
one person or any one type of person I think is a mistake.
    To the degree that there are people in savings who have 
issues, it is a smaller number than sometimes people think for 
the reasons that have been discussed. But it is also a question 
of why haven't other assets gone up in value? Why aren't there 
other interest rates in the private markets moving? The Fed is 
not directly influencing those assets.
    And that gets us back to what we were talking about 
earlier, which is: There are limits to what the Fed can do, but 
that is not the same thing as saying what they are doing is 
causing these other problems in the economy. And I think we 
have got to make that distinction.
    Representative Paulsen. Thank you, Mr. Chairman. I yield 
back.
    Chairman Brady. Thank you. Representative Maloney.
    Representative Maloney. Thank you. And I thank the 
witnesses for their testimony.
    Since the financial crisis began in 2007, the Federal 
Reserve has absolutely used every tool in their arsenal to 
stabilize the financial system and prevent another Great 
Depression.
    The Fed, in my opinion, provided a very much needed 
stability during this time. They opened literally an alphabet 
soup of lending windows that provided liquidity during this 
time. Multiple rounds of quantitative easing have kept interest 
rates low, helped small and large businesses access credit, and 
spurred economic growth.
    Without the Fed's expansionary monetary policy, in my 
opinion, our economy would be much worse than we are today. But 
unfortunately, the recovery is still very vulnerable. Private-
sector job growth fell below 100,000 last month. Unemployment 
is still well above its pre-recession level, and there are more 
than 3 unemployed workers for every job opening.
    Dr. Posen, do you believe the Fed should continue to use 
all the available tools in its arsenal to bolster the economy 
and help people get back to work? And also in response to 
Senator Klobuchar's question, what should Congress do to 
complement the Federal Reserve's expansionary monetary policy? 
And could you also talk about the risks of shutting down the 
Fed's bond purchases too early?
    Dr. Posen. Okay. First, thank you, Congresswoman.
    I agree they should be using every tool. I do not believe 
yet they have used every tool. There are--the commitments to 
low long-term rates I view as marginally cheap talk. I do not 
view that as a tool. I am on record suggesting that forward 
guidance, as they call it, is really unimportant. So I don't 
think it does much harm or much good.
    What matters is the actual stance of policy and the actual 
purchases and commitments. And what happens in terms of actual 
rate decisions. So I think they should be continuing to look at 
buying MBS. I think they should be continuing to provide 
liquidity. And I think they have no risk in doing so.
    In terms of what Congress should do, let me link the risks 
back to what Mr. Delaney was saying, and Vice Chair Klobuchar 
was saying.
    If you are concerned that the Fed may be hesitant about 
withdrawing policy, and that is a source of uncertainty, or you 
are concerned that they will self-limit policy because they are 
worried that people will get agitated about the outstanding 
balance sheet, the best thing that the Congress can do is 
guarantee the Fed that they will recapitalize the Fed if there 
are losses on the Fed's balance sheet, just the same way that 
they get all the money back from the Fed when the Fed makes a 
profit.
    This is all notional. The Fed is not a for-profit 
institution. That is not the motivation, nor should it be the 
criterion for judging Fed policy. You do not want that 
motivating Fed policy. So therefore, if this Congress were to 
commit to indemnify the Fed against losses done in its 
execution of monetary policy, that would be a constructive step 
and would take this issue off the table, which should not be a 
consideration of when they decide to exit or not.
    Representative Maloney. And also could you talk about the 
risk of shutting down the Fed's bond purchases too early?
    Dr. Posen. Yes. Thank you. As I mentioned to Mr. Hanna, 
there is a problem in this economy that we all recognize, that 
the labor market has gone really sour in a way that has not 
been seen in past U.S. recessions--at least not for decades.
    We have seen participation in the labor force drop by four 
full percentage points. You mentioned in your question, in your 
statement, the recent poor numbers on the latest month.
    If the Fed were to stop its bond purchases--since I don't 
believe forward guidance matters very much--I think it would 
constitute an insufficient amount of monetary stimulus and 
probably be perceived as a tightening, or at least a next step 
to a tightening. I believe unemployment would rise 
significantly, and we would get the demonstration of the 
effectiveness of Fed's policies by the reverse. Its withdrawal 
will cause problems.
    Representative Maloney. I am interested in your experiences 
on the Monetary Policy Committee and the Bank of England. I 
know you have been a close observer. I understand you had some 
concerns about their austerity measures and the impact on the 
economy.
    Could you comment on the Bank of England? It only has one 
mandate, as I understand it: Managing inflation. And has that 
single mandate led to better inflation outcomes than the United 
States, or worse?
    Dr. Posen. As I say in my testimony, it has actually led to 
very similar policies and it has led to slightly worse 
inflation performance.
    This is, arguably, in part because the UK is a much smaller 
economy than the U.S. It also has a less well--it is much more 
vulnerable to events in the Euro area, which has been a problem 
for it. And it has had a less sound currency. The pound came 
down 30 percent, or 25 percent, versus where it was, which the 
dollar has not.
    So I think when you look at the UK monetary policy 
experience, it is not the mandate that matters, it is the 
nature of the economy. Broadly speaking, we--the Bank of 
England did many of the same things as the Fed and, broadly 
speaking, we prevented the counterfactual much worse outcomes.
    Representative Maloney. Thank you very much. My time has 
expired.
    Chairman Brady. Thank you. Senator Lee.
    Senator Lee. Thank you very much, Mr. Chairman, and thanks 
to both of our witnesses for joining us today. We appreciate 
your insight, and it is good to have you with us.
    Dr. Taylor, I was wondering if I could have you discuss how 
some of the following items might add to the cost of an open-
ended quantitative easing process:
    Unwinding the enormous Fed balance; investments running 
into risky equities to chase return; creating an assumption 
that near-term government debt service costs are sustainable; 
over-investment in a narrow set of growth assets and the 
creation of new bubbles; and misallocation of investments.
    Could you just talk to us about those for a moment?
    Dr. Taylor. Yes, Senator. Thank you. That list is long but 
I agree with each one of the points is a concern.
    Unwinding the balance sheet requires selling the mortgage-
backed securities, and selling the long-term assets. To the 
extent that the purchases have been beneficial, which is 
debatable, that will be counterproductive. It will be a 
restrictive in the economy.
    It will also be occurring at the same time most likely, as 
when the Fed needs to raise the short-term interest rate. It is 
always hard to exit from an easy monetary policy. This one will 
be harder. So that creates risks.
    Another point on your list is important. The policy a 
potential for a false hope on the budget because it makes the 
interest rate payments so low at this point now, again to the 
extent it is holding rates down, and it clearly is holding 
short rates down.
    I think the search for yield that you mentioned, that 
people are going to be taking on risky assets that they 
probably shouldn't have, that will come back to be a negative, 
as we have seen in the past.
    So all these, it seems to me, are serious risks that are 
being undertaken. And they may involve unfortunate policies 
going forward. For example, if the Fed is concerned about its 
balance sheet value, taking capital losses, that may delay its 
exit. They may hold onto those securities longer than they 
otherwise should. That is a very real possibility.
    On the other hand, if they hold onto those securities, it 
is going to require that they pay banks huge amounts of money 
for the reserves, because they are now paying interest on 
reserves. And if they want to have the short-term interest rate 
be 1 percent, 2 percent, 3 percent, whatever it will have to be 
in the future without reducing the balance sheet, it will have 
to pay all that money directly to the banks. That is going to 
be a concern, as well.
    So I've been studying monetary policy a long time. Exits 
are always difficult. And this one is going to be more 
difficult than ever. And I believe that is already causing 
concerns, about how it is going to unfold, which holds back the 
economy itself right now.
    Senator Lee. Thank you. Since the Recession's technical 
end, now several years ago, there has been some troubling 
correlation between the change in unemployment rate and the 
size of the labor force. And last week in The New York Times 
economist Casey Mulligan noted: As unemployment has gone down, 
so has the labor force participation rate.
    In the midst of this trend, the Fed has set a new 
precedent. It set a new precedent on December 12th of last year 
by declaring an official unemployment target of 6.5 percent 
based on headline unemployment.
    Given these circumstances, how useful do you think the 
headline unemployment is as a target?
    Dr. Taylor. Well I think it is more suspect than usual as 
an indicator of overall demand conditions in the labor markets. 
Because as you say, people are dropping out of the labor force 
at a much higher rate than you would expect in the current 
circumstance.
    Awhile ago the CBO estimated that the unemployment rate 
would be about 1\1/4\ percent higher if labor force 
participation had behaved according to the way it should in 
these times.
    So it makes the unemployment rate more difficult to 
interpret, and it is one of the reasons I think people are 
concerned about the focus on a particular number like that. The 
Fed has allowed itself wiggle room. It says, well, it is not a 
for-sure thing they will change on that basis, but it is one of 
the other uncertainties that is making monetary policy 
difficult to interpret right now.
    Senator Lee. Has measuring price stability changed in a 
similar way in recent history?
    Dr. Taylor. I don't think so. I think there's always the 
question about, for example, should they focus on a core 
inflation rate? I've always been worried about a core measure, 
because ultimately you are concerned about the ultimate 
inflation rate. Another way is you could average the inflation 
rate over a few quarters to get a better indicator.
    I think the statistical agencies should continue to try to 
improve the statistics to get better measures of inflation, but 
I don't think that is a major problem with monetary policy 
right now.
    Senator Lee. And then finally, would any of this--does any 
of this suggest that it might be easier from a technical 
perspective to enforce a single mandate? I see my time has 
expired.
    Chairman Brady. Would you like to answer, Dr. Taylor.
    Dr. Taylor. I think it would be better because it would 
remove a lot of the ways and reasons the Fed moves in these 
discretionary ways. As the Chairman indicated, the dual mandate 
entered the law in 1977.
    It was this period of a highly interventionist mentality 
with respect to policy. But as soon as Paul Volcker came in, it 
was continued by Alan Greenspan, they basically tried to 
interpret that law as get inflation down, get price stability 
that will generate more employment. And they were very 
successful in doing that.
    Now really for the first time since the 1977 Amendments to 
the Federal Reserve Act, the Fed refers to the dual mandate all 
the time as reasons to do this, and reasons to do that. That I 
think is problematic. And that is one of the reasons I would 
think it would be better to try to focus on a single mandate, 
not to ignore what is happening in the economy but to simplify 
what the Fed is actually doing.
    Senator Lee. Thank you, very much.
    Chairman Brady. Thank you. Senator Coats.
    Senator Coats. Thank you, Mr. Chairman.
    Let me divert if I could just a little bit from what the 
chosen topic is today. But in response to the question that 
Congresswoman Maloney asked, what should Congress do? Two 
question. One for both of you, and one for Dr. Taylor. Let me 
start with Dr. Taylor.
    Dr. Taylor, Dr. Posen's response to that was--first 
response to that was that the Congress should guarantee the 
Fed--that the Fed will be recapitalized if it has losses, given 
its current policies. Would you like to respond to that? I 
would like to get your take on that question and that answer.
    Dr. Taylor. No, I don't think that is necessary or 
appropriate for the Congress to do. In that respect the Federal 
Reserve Act is just fine the way it is. It delegated some 
responsibility without backstopping the Fed in that particular 
way.
    Senator Coats. My second question is relative to timing. 
The tools of the Fed versus the tools and the need for Congress 
to address fiscal policy issues.
    There is growing consensus, if not full consensus, that the 
current situation relative to our debt and deficit is such that 
we are reaching a tipping point. The mandatory spending, it is 
pretty simple arithmetic, is simply running away with our 
revenues causing a lot of borrowing, and squeezing the 
discretionary side of the budget, which we have control over 
and which, as Dr. Posen said, there are things that ought to be 
addressed that may not be addressed simply because we do not 
have the resources to do so.
    Now relative to timing, many are now saying that we have 
been talking about this for several years but there has not 
been significant structural changes proposed or enacted 
relative to this runaway mandatory spending. And, that if it is 
not done this year, the political process will potentially push 
this decision to the point where it can be actually 
accomplished through a political process to 2017. And therefore 
I think even the White House has acknowledged, the Executive 
Branch has acknowledged along with Congress, that it has got to 
be done now or we flip into 2014, an election year, then we 
flip into a new Presidential election process, and it may be 
2017.
    It seems to me two results can happen from that. It is 
either four more years muddling through, four more years of 
tepid growth, less than satisfactory, high unemployment, more 
squeeze on discretionary spending; or we reach that tipping 
point during this period of time, which brings another 
financial crisis.
    Could each of you just briefly address that question and 
that issue?
    Dr. Taylor. Well I will be very brief. I think it is very 
important to address these budget issues now. It is a good time 
to do it. I see some momentum. There is an orderly process on 
the budget that is finally coming back. The Senate has a 
budget.
    I think the proposal to try to get the budget into balance 
in 2023 makes sense. That is possible to do with the gradual--
it's not austerity, it's a gradual, credible plan. But at the 
same time, as you say, and is most important, for the long term 
to get the entitlement spending in line with the growth of GDP. 
It is exploding, and that is the problem.
    So by all means, that is one of the most important policy 
issues we are all facing.
    Senator Coats. And the possibility of this tipping point 
debt to GDP occurring in that period of time, if we don't take 
action now?
    Dr. Taylor. Well I think the evidence should make you 
worry; that if you don't address it now it is going to be 
harder, and there will be a tipping point. But unfortunately I 
can't say what that time of tipping point will be. We don't 
know for sure. But why take the risk? It would be better for 
the economy if we take the action now. So why take the risk of 
a tipping point?
    Senator Coats. Thank you. Dr. Posen.
    Dr. Posen. Thank you, Senator.
    What is striking I think about your set of questions and 
Professor Taylor's response on my issue about backstopping the 
Fed is that it illustrates how much this conversation is 
focused on the supposed uncertainty caused by the Fed; whereas, 
everyone has known what the Fed is doing. It has been very 
clear. They have precommitted. They have said, and there has 
been enormous uncertainty generated by the budget process 
between the Congress and the White House.
    I know none of you deny that, and you are trying to fix 
that. I am just saying I think it is a very misleading 
statement to talk about the Fed being the cause of uncertainty 
that harms the economy, whereas the main source of uncertainty 
certainly for the last year-and-a-half has been the obscene 
budget back-and-forth between the Congress and the White House.
    In that spirit----
    Senator Coats. I don't disagree with you.
    Dr. Posen. I know you don't. I just want to be clear that 
when we--if you start saying ``uncertainty'' is part of the 
problem here, that to me is the big source of uncertainty and 
therefore I support the responsible budget measures that are 
going forward.
    Senator Coats. Thank you.
    Thank you, Mr. Chairman.
    Chairman Brady. On behalf of Vice Chair Klobuchar and 
myself and the Committee, I want to thank both of you for being 
here today, and your insight on monetary policy matters.
    This is an appropriate and I think a critical time to be 
reviewing the role, both today and in the future. We will be 
calling on both of you in the future, as we pursue this issue 
and how we best close this growth gap, and how we return to and 
create a sound financial dollar, sound dollar over time, as a 
foundation for economic growth.
    So again, thank you very much for being here. The hearing 
is adjourned.
    [Whereupon, at 10:40 a.m., the hearing was adjourned.]
                       SUBMISSIONS FOR THE RECORD

   Prepared Statement of Hon. Kevin Brady, Chairman, Joint Economic 
                               Committee

    This year marks the centennial of the Federal Reserve, so it is 
appropriate for the Joint Economic Committee to examine the Fed's role 
in the current economic climate as well as its focus for the next 100 
years.
    Today's hearing on monetary policy is the third in a series that 
touches on our most vexing economic challenge: the growth gap.
    We're all rooting for America to bounce back, but regrettably the 
U.S. economy is missing 4.2 million private sector jobs and $1.3 
trillion in real output due to the gap that exists between this weak 
recovery and the average recovery of the last 70 years.
    For every American, the growth gap means he or she has $2,935 less 
in real disposable income at this point in the recovery.
    This gap persists despite extraordinary actions by the Federal 
Reserve to stimulate growth and employment as part of its dual mandate.
    Even more troubling, the Congressional Budget Office projects that 
the future growth rate for America's potential real GDP will be a full 
percentage point below its post-war average--which may not sound like 
much, but the consequences are alarming.
    With one-percent lower growth, our economy will be $31 trillion 
smaller in 2052, and the Treasury will collect $97 trillion less in tax 
receipts over the next four decades--making it significantly harder to 
balance the budget and reduce America's risky level of debt.
    The question before this Committee is whether the extraordinary 
actions taken by the Federal Reserve are capable of closing the growth 
gap, and if a focus instead on price stability and establishing a sound 
dollar will provide a stronger foundation for economic growth over the 
long term.
    Since 2008, beyond the appropriate role of lender of last resort to 
financial institutions and markets, the Federal Reserve has selectively 
bailed out investment banks, maintained interest rates at an 
extraordinary low level for almost five years, engaged in three rounds 
of quantitative easing by buying massive amounts of Treasuries and 
mortgage-backed securities, and indicated that the Fed will continue 
this accommodative monetary posture until the unemployment rate falls 
to 6.5 percent.
    But can the Federal Reserve boost real economic growth over time 
through discretionary monetary policy? Or should the Federal Reserve 
adopt a rules-based monetary policy to achieve price stability and let 
Congress and the President determine the combination of budget, tax, 
regulatory and trade policies that will boost real economic growth to 
close the growth gap?
    In 1977, Congress established a dual mandate for monetary policy 
that gave equal weight to achieving long-term price stability and the 
maximum sustainable level of output and employment.
    During the 1970s, as you may remember, the Federal Reserve's 
monetary policy was discretionary and interventionist. The results were 
accelerating inflation, short expansions, frequent recessions, and 
rising unemployment.
    In the early 1980s, Chairman Paul Volcker broke the back of 
inflation. Over the next two decades monetary policy became 
increasingly rules-based. The results were outstanding: low inflation 
and two long and strong expansions, interrupted only by a brief, 
shallow recession.
    Since the Great Moderation, however, monetary policy has again 
become discretionary and interventionist. Not surprisingly, the results 
are disappointing.
    From 2002 to 2006, Chairman Alan Greenspan kept interest rates too 
low for too long which helped to inflate an unsustainable housing 
bubble.
    Chairmen Volcker and Greenspan correctly believed monetary policy 
could contribute to achieving full employment--if and only if--the 
Federal Reserve focused solely on price stability. Beginning in 2008, 
however, the Federal Reserve explicitly deviated from this view, 
invoking the employment half of its dual mandate to justify its 
extraordinary actions.
    In January 2012, the Federal Open Market Committee correctly 
observed in its Longer-Run Goals and Policy Strategy statement:

        The maximum level of employment is largely determined by 
        nonmonetary factors that affect the structure and dynamics of 
        the labor market.

    Despite the clear admission of the limits of monetary policy to 
spur employment, in December of the same year the Federal Open Market 
Committee announced that it would (1) expand its current round of 
quantitative easing, and (2) retain its extremely low target range for 
federal funds for ``at least as long as the unemployment rate remains 
above 6\1/2\ percent.''
    To achieve a policy objective, Nobel laureate economist Robert 
Mundell stated, policymakers must use the right lever. Monetary policy 
affects prices over the medium and long term. In contrast, budget, tax, 
and regulatory policies are what affect real output, real investment, 
and employment. Monetary policy cannot solve the problems that poor 
fiscal policy has helped create.
    By targeting the unemployment rate, the Federal Reserve is 
attempting to use monetary policy to achieve what the Fed acknowledged 
eleven months earlier that it cannot achieve through monetary policy--
full employment--while risking what economists acknowledge that the Fed 
can achieve through appropriate monetary policy--long-term price 
stability.
    To close the growth gap, my belief is that we must refocus the 
Federal Reserve on a rules-based monetary policy, which is a necessary, 
but not sufficient, condition for robust real economic growth and job 
creation. This is not a false choice between jobs or stable prices--it 
is the proven acknowledgement that stable prices and a sound dollar 
create the best foundation for job growth over the long term.
    Congress, which has delegated its constitutional authority to coin 
money and maintain its value to the Federal Reserve, should provide it 
with a clear direction to return to an achievable mandate for price 
stability.
    The Federal Reserve should also ensure a soft-landing for the 
housing market by initiating a slow and orderly unwinding of its $1.1 
trillion position in federal agency residential mortgage-backed 
securities. Gradually reducing the excess reserves that could be the 
fuel for future inflation will reduce market uncertainty, strengthen 
the foundation for non-inflationary economic growth, and reduce the 
likelihood of undue political interference in Federal Reserve policy.
    Looking to the future, today's hearing provides this Committee with 
the opportunity to hear from two of the most distinguished monetary 
economists in the world on their recommendations for the role of the 
Federal Reserve during its second 100 years.
    Dr. John Taylor is the creator of the Taylor rule, which central 
banks have used to implement a rules-based monetary policy. Dr. Adam 
Posen served on the Monetary Policy Committee of the Bank of England 
and is a widely acknowledged expert on Japan. We are fortunate to have 
them with us today.
    With that, I look forward to their testimony.

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