Spratt Opening Statement at Hearing with Fed Chairman Bernanke

House Budget Committee Chairman John Spratt made the following opening statement at a hearing today, “Challenges Facing the Economy: The View of the Federal Reserve,” with Federal Reserve Chairman Benjamin S. Bernanke.

“We meet to hear the distinguished Chairman of the Federal Reserve, Benjamin Bernanke, testify on the recession plaguing our economy and on the prospects of recovery.

“Chairman Bernanke testified before our committee on October 20 of last year, as we searched for ways to mitigate, if not avoid, a long recession. The Chairman acknowledged then that monetary policy has its limits, and without being specific, welcomed a fiscal complement.

“Congress had just passed a bi-partisan bill authorizing $700 billion to dispose of troubled assets–so-called TARP. Backed by these funds, the Treasury, Fed, and FDIC made extraordinary advances to banks and other financial institutions, recognizing what Chairman Bernanke told the Joint Economic Committee last month, that ‘a sustained recovery in economic activity depends critically on restoring stability to the financial system.’ This is one question we hope you will address: How strong are our financial institutions?

“By February of this year, it was clear that TARP relief was a necessary but not sufficient solution. So, Congress passed, on a partisan basis, an even bigger boost, the Recovery and Reinvestment Act, which packed $787 billion of fiscal stimuli, in the form of spending increases and tax decreases. We would like to know, Mr. Chairman, whether from the Fed’s viewpoint, this huge counter-cyclical thrust is working.

“Bold action was necessary to head off a collapse of the financial system, but the steps taken also swelled the nation’s deficit and the national debt. It’s all but impossible to balance the budget when the economy is bucking a headwind like this recession, because what we do to make the economy better is likely to make the deficit worse.

“Yet at the same time, we cannot add infinitely to the national debt, without facing the consequences in the global credit markets, or on our future capacity to borrow. One purpose of this hearing is to explore both the advantages and the potential downside risks of our bold and unprecedented response to financial turmoil. Should we be concerned that some of our swelling debt must be financed with foreign credit?

“We hope that most of our outlays are for non-recurring needs, and that much of what has been advanced in recent months will, in time, be recovered, and used to pay down the debt we are incurring. We would like to have your assessment, Mr. Chairman, of that possibility.

“Despite bold, unprecedented action, the Director of the Congressional Budget Office told this committee on May 21st that our economy was still running at 7% or more below capacity, or a trillion dollars per year below its potential. Recently, there have been signs of a turn-around: business inventories are down, the stock market is up, and so to some extent, is the housing market. Our question to you, Mr. Chairman, is whether these are glimmers or hope or flashes in the pan.

“To keep this recession from growing worse, the Fed has pumped enormous liquidity into the money markets, so much that some critics even worry of inflation, just over the horizon. The spread between short and long term Treasuries has widened to more than 2.5 percentage points. We would like to know, Mr. Chairman, if these are salutary signs of recovery or ominous signs of inflation?

“A month ago, Chairman Bernanke told the Joint Economic Committee that ‘we expect economic activity to bottom out, then turn up later this year, but he went on to warn that “even after the recovery gets underway, the rate of real economic growth is likely to remain below its potential for a while...only gradually gaining momentum.’

“The old locomotives that pulled the economy out of the rut in the past — real estate and consumer durables — are unavailing now. This causes us to ask: what will empower a turn-around in this dismal economy? And when can we expect a return to normality?

“Mr. Chairman, we have a lot of grist for our mill. We thank you for being here, but above all, for your service to our nation at a very crucial time. Before proceeding with your statement, let me turn to Mr. Ryan for his opening remarks.”

Avoiding a Liquidity Trap

By E. Ralph Hostetter

The Federal Reserve Bank, in another effort to stimulate the nation's economy, reduced its target range for overnight interest rates from zero to 0.25 percent, the lowest level on record. Reductions in Fed rates are reflected in lower bank rates across the nation. As expected, stock markets have reacted positively overall.

Waiting in the wings may be less good news. Zero-percent interest rates may sound great but they invariably carry very dangerous, unintended consequences, one of which is a condition known as a liquidity trap. The classic definition of a liquidity trap is a condition that occurs when the nominal interest rate is close to or equal to zero. At the zero point, the monetary authority, in this case the Federal Reserve, finds itself unable to stimulate the economy.

Normally, the Federal Reserve can stimulate the economy by lowering interest rates or increasing the monetary base. These actions in turn increase borrowing and lending, spending and investing. However, with interest rates near zero, the Federal Reserve can no longer lower rates to stimulate the economy.

The Federal Reserve is left with one choice: to print more money. The money must now find its way into the economy. Traditionally, this course is through the banking system. However, in a liquidity-trap environment with banks unwilling to lend — as in the case of Japan in the 1990s, where new money went into bank reserves — the newly created liquidity is trapped behind unwilling bank lenders, thus forming the liquidity trap.

Traditionally, the Federal Reserve Bank uses interest rates as one of its monetary tools to stimulate and influence conditions involving the flow of currency. Reductions in interest rates traditionally have created a flow of cash to provide liquidity as banks with cash surpluses make available money for other banks to borrow to improve their balance sheets.

Such transactions virtually have disappeared as lending banks became more aware of problems which may exist on the balance sheets of borrowing banks. Consequently, lending banks are hoarding their cash rather than taking risks.

With the economy entering an uncertain period, other potential problems are arising. Property values are declining. The Department of Labor reported consumer prices dropped 1.7 percent in November 2008, the largest one-month decline in 61 years — since February 1947. According to the Department of Commerce, new home construction was down 18.9 percent in November, the biggest drop since March 1984. Consumer spending is down, particularly on big-ticket items such as automobiles, appliances and electronics. Unemployment has reached 6.7 percent. Job losses totaled 533,000 in November alone.

The risk of deflation has appeared. None of these warning signs has escaped the attention of Ben S. Bernanke, Chairman of the Board of Governors of the Federal Reserve. One could say the present situation is his “cup of tea.”

Described as a student of the Great Depression of the 1930s, as well as of Japan’s lost decade in the 1990s, he is aware of the risks and rewards presented by zero percent interest rates and the resulting liquidity trap. In a paper delivered in 1999, then-Professor Bernanke offered a remedy to the government of Japan, advancing the theory that a “more expansionary monetary policy was needed.” Under what is known as “a policy of quantitative easing,” the banking system of Japan was flooded with money with the aim of easing pressure on banks, persuading them to start lending again and stop a downward spiral in prices.

Since mid-September 2008, as Chairman of the Fed, Bernanke has followed his own advice here in the United States. He has ordered the printing of billions and billions of dollars and has pumped them into the financial system of the country.

The nation awaits the results of Chairman Ben Bernanke’s bold attack on the recession.

E. Ralph Hostetter, a prominent businessman and publisher, also is an award-winning columnist and Vice Chairman of the Free Congress Foundation Board of Directors.