[Senate Hearing 112-9]
[From the U.S. Government Publishing Office]
S. Hrg. 112-9
NOMINATIONS OF: KATHARINE G. ABRAHAM, CARL SHAPIRO, AND PETER A.
DIAMOND
=======================================================================
HEARING
before the
COMMITTEE ON
BANKING,HOUSING,AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED TWELFTH CONGRESS
FIRST SESSION
ON
THE NOMINATIONS OF:
KATHARINE G. ABRAHAM, OF IOWA, TO BE A MEMBER OF THE COUNCIL OF
ECONOMIC ADVISERS
__________
CARL SHAPIRO, OF CALIFORNIA, TO BE A MEMBER OF THE COUNCIL OF ECONOMIC
ADVISERS
__________
PETER A. DIAMOND, OF MASSACHUSETTS, TO BE A MEMBER OF THE BOARD OF
GOVERNORS, FEDERAL RESERVE SYSTEM
__________
MARCH 8, 2011
__________
Printed for the use of the Committee on Banking, Housing, and Urban
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COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
TIM JOHNSON, South Dakota, Chairman
JACK REED, Rhode Island RICHARD C. SHELBY, Alabama
CHARLES E. SCHUMER, New York MIKE CRAPO, Idaho
ROBERT MENENDEZ, New Jersey BOB CORKER, Tennessee
DANIEL K. AKAKA, Hawaii JIM DeMINT, South Carolina
SHERROD BROWN, Ohio DAVID VITTER, Louisiana
JON TESTER, Montana MIKE JOHANNS, Nebraska
HERB KOHL, Wisconsin PATRICK J. TOOMEY, Pennsylvania
MARK R. WARNER, Virginia MARK KIRK, Illinois
JEFF MERKLEY, Oregon JERRY MORAN, Kansas
MICHAEL F. BENNET, Colorado ROGER F. WICKER, Mississippi
KAY HAGAN, North Carolina
Dwight Fettig, Staff Director
William D. Duhnke, Republican Staff Director
Brian Filipowich, Legislative Assistant
Lisa Frumin, Legislative Assistant
Andrew J. Olmem, Jr., Republican Chief Counsel
Michael Piwowar, Republican Chief Economist
Dawn Ratliff, Chief Clerk
Levon Bagramian, Hearing Clerk
Shelvin Simmons, IT Director
Jim Crowell, Editor
(ii)
?
C O N T E N T S
----------
TUESDAY, MARCH 8, 2011
Page
Opening statement of Senator Johnson............................. 1
Opening statements, comments, or prepared statements of:
Senator Shelby............................................... 2
Senator Reed................................................. 5
NOMINEES
Katharine G. Abraham, of Iowa, to be a Member of the Council of
Economic
Advisers....................................................... 7
Prepared statement........................................... 20
Biographical sketch of nominee............................... 21
Responses to written questions of:
Senator Reed............................................. 72
Carl Shapiro, of California, to be a Member of the Council of
Economic Advisers.............................................. 8
Prepared statement........................................... 33
Biographical sketch of nominee............................... 34
Responses to written questions of:
Chairman Johnson......................................... 72
Senator Shelby........................................... 73
Peter A. Diamond, of Massachusetts, to be a Member of the Board
of Governors, Federal Reserve System........................... 9
Prepared statement........................................... 49
Biographical sketch of nominee............................... 50
Responses to written questions of:
Chairman Johnson......................................... 77
Senator Vitter........................................... 79
(iii)
THE NOMINATIONS OF:
KATHARINE G. ABRAHAM, OF IOWA,
TO BE A MEMBER OF THE COUNCIL OF ECONOMIC ADVISERS;
CARL SHAPIRO, OF CALIFORNIA,
TO BE A MEMBER OF THE COUNCIL OF ECONOMIC ADVISERS;
PETER A. DIAMOND, OF MASSACHUSETTS,
TO BE A MEMBER OF THE BOARD OF GOVERNORS, FEDERAL RESERVE SYSTEM
----------
TUESDAY, MARCH 8, 2011
U.S. Senate,
Committee on Banking, Housing, and Urban Affairs,
Washington, DC.
The Committee met at 10:05 a.m., in room SD-538, Dirksen
Senate Office Building, Hon. Tim Johnson, Chairman of the
Committee, presiding.
OPENING STATEMENT OF CHAIRMAN TIM JOHNSON
Chairman Johnson. Good morning. I call this meeting to
order.
Today, we consider three nominations. Dr. Peter Diamond has
been nominated to become a member of the Board of Governors of
the Federal Reserve System, and Drs. Katharine Abraham and Carl
Shapiro have been nominated to be members of the Council of
Economic Advisers.
At present, our economy is recovering from one of the worst
downturns in history. We have seen some signs of progress, but
for more than 13 million Americans who are out of jobs and
looking for a job, the recovery cannot come to soon.
Unemployment remains at about 9 percent, and even with hundreds
of thousands of new jobs added every month, it will take years
to get back to precrisis levels.
At the same time, we face daunting long-term budgetary
imbalances, strong foreign competition, rising oil prices, and
the ever present need to maintain low inflation. It is for
these reasons that we need all hands on deck for our Nation's
economy policymaking. I am glad that the President has sent us
three extremely qualified individuals to fill current vacancies
in posts important to our Nation's economic recovery.
Dr. Peter Diamond is a distinguished economist who has
worked on unemployment, economic growth, and the economics of
Social Security and pensions. He has served as President of the
American Economic Association and President of the Econometric
Society. Since his original nomination in 2010, he was awarded,
along with two other economists, the Nobel Prize in Economics.
The models for which Dr. Diamond won the Nobel Prize helped us
understand the ways in which unemployment, job vacancies, and
wages are impacted by regulation and economic policy. His
search theory has also been used to study questions related to
monetary theory, public economics, financial economics,
regional economics, and family economics.
Sir James Mirrlees, a 1996 Nobel Prize winner in economics,
said of Dr. Diamond, ``No economist is smarter. His reasoning
is amazingly accurate. The theories and models he uses are
defined with the greatest precision. More than most economic
theorists, he has always chosen his research topics and
questions for their real importance.''
Dr. Diamond was reported favorably with bipartisan support
by this Committee twice in the last session of Congress by
votes of sixteen to seven.
Dr. Katharine Abraham is a professor in the Joint Program
in Survey Methodology and Faculty Associate in the Population
Research Center at the University of Maryland. Dr. Abraham
served as a Commissioner for the Bureau of Labor Statistics at
the U.S. Department of Labor from 1993 to 2001. She joined the
University of Maryland in 1987, where she served as a Professor
of Economics and she also taught at MIT's Sloan School of
Management from 1980 to 1985. Dr. Abraham received her Ph.D. in
economics from Harvard in 1982 and her B.A. in economics from
Iowa State University in 1976.
Dr. Carl Shapiro is the Deputy Assistant Attorney General
for Economics at the Antitrust Division of the U.S. Department
of Justice, where he supervises more than 50 Ph.D. economists
in the Antitrust Division's Economic Analysis Group. Dr.
Shapiro is on leave from the University of California at
Berkeley, where he is the Transamerica Professor of Business
Strategy at the Haas School of Business and a Professor of
Economics. He earned his Ph.D. in economics from MIT in 1981.
I thank all of the nominees for your willingness to serve
at the Federal level, especially at a time when our country is
trying to overcome significant economic challenges.
Senator Shelby, would you like to give a statement?
STATEMENT OF SENATOR RICHARD C. SHELBY
Senator Shelby. I do. Thank you, Mr. Chairman, for calling
these hearings. They are very important.
Today, we are considering the nominations of three
economists, two to be members of the Council of Economic
Advisers and one to be a member of the Board of Governors.
Dr. Katharine Abraham and Dr. Carl Shapiro have been
nominated to be members of the Council of Economic Advisers,
CEA. The CEA is an agency within the Executive Office of the
President that is charged with providing the President economic
advice. Although I do not share many of the policy preferences
of these nominees, I am inclined to give greater deference to
the President in his choice for his own personal economic
advisers.
I do not believe, however, that the same deference should
be given to nominations for our financial regulators. In light
of the inexcusable failures leading up to the recent crisis, I
believe that the Senate needs to take a much more active role
in ensuring that our financial regulators have the proper
leadership. The poor job our regulators did in supervising our
financial institutions was a key contributor to the recent
financial crisis. If we learned anything, it is that it matters
who serves in these very important positions.
That is especially true at the Federal Reserve. The Fed's
collective authorities make it one of the most powerful
organizations in the world. It supervises our largest financial
institutions and has extensive regulatory authority over our
entire financial system. The Federal Reserve's inherent
independence and the 14-year terms of Governors make it the
least accountable agency in our Government. As a result, Fed
Governors exercise immense power with very little oversight.
It is proper, therefore, that the Senate should take its
constitutional advice and consent duties for Fed nominees very,
very seriously. In my opinion, the nomination of a Fed Governor
is the economic equivalent of a Supreme Court nomination and
should be treated accordingly.
Applying this standard to the nomination of Dr. Peter
Diamond to the Board of Governors, I believe that Dr. Diamond
should not be confirmed. Dr. Diamond is, of course, a very
accomplished academic and economist. Nevertheless, a reasonable
comparison of the qualities a Fed Governor should possess and
Dr. Diamond's background clearly demonstrates that he is not
the right person, I believe, for this particular job.
The Fed's responsibilities cut across three broad areas:
Conducting monetary policy, supervising our financial system,
and responding to financial crises. Any qualified nominee
should have, at a minimum, some level of experience in at least
one of these areas. Let us examine Dr. Diamond's experience in
each of these areas.
Does Dr. Diamond have any experience in conducting monetary
policy? The answer is no. In the written testimony that Dr.
Diamond provided for his nomination hearing last July, he
listed several areas of focus in his teaching and research.
Monetary economics is not on the list. Instead, his academic
work has been one on pensions and labor market theory.
Does Dr. Diamond have any experience in bank management or
supervision? Of course, the answer is no. None of his
professional positions or activities involves working as a bank
regulator or even working in a bank.
Does Dr. Diamond have any experience in crisis management?
The answer is no. While his resume contains an extensive list
of academic and policy activities, none of them suggest that he
has any experience in effectively managing a crisis, let alone
a worldwide financial crisis.
In addition to a nominee's expertise and experience, their
policy preferences also matter. A Fed Governor's economic
philosophy impacts not only how the Fed exercises its vast
regulatory authority, but also the tenor of its policy debates,
because Fed Governors have a very powerful bully pulpit.
What are Dr. Diamond's policy preferences? Let me continue.
He supports QE2. He supported President Obama's $800 billion
stimulus package and has argued for additional fiscal stimulus.
He wrote a paper with President Obama's former Budget Director,
Peter Orszag, arguing for higher taxes to fund Social Security.
He supported bailing out big banks during the financial crisis.
He supports the use of behavioral economics to help bureaucrats
more effectively control the choices that Americans make. He
has even advocated the creation of a GSE modeled after Fannie
and Freddie to subsidize health care.
In short, Dr. Diamond is an old fashioned, big Government
Keynesian. Many of us believe that this is not the economic
philosophy the Fed should be embracing at this point in our
economic history. Our economy is already suffering from
excessive Government debt and misguided regulation. Our
financial regulators should be trying to take steps to
strengthen our markets rather than replace them with new layers
of Government.
For those who say that policy preference should not be
considered, I would only point out that the renomination of Dr.
Randy Kroszner to the Fed was blocked by the majority of the
Democratic Party because he was viewed as being too free
market. Unlike Dr. Diamond, Dr. Kroszner is an expert in
monetary policy and banking regulation. Yet, the majority party
never even gave him a hearing. Why? Because they agreed that
the policy preference of Fed nominees do matter.
Although Dr. Diamond is a skilled and accomplished
theoretical economist, it is clear to many of us that he does
not possess the appropriate background, experience, or policy
preferences to serve on the Board of Governors.
Dr. Diamond may be a talented economic theorist and he may
be very well suited for a number of positions in the
Administration, but I do not believe he is the best person for
this position at this time at the Federal Reserve.
Therefore, before I conclude, let me address the issue of
Dr. Diamond's Nobel Prize. Unquestionably, the Nobel is a major
honor. Yet being a Nobel recipient does not mean one is
qualified for every conceivable position. Any private sector
human resource manager would likely say that Dr. Diamond would
not be a good selection for a CEO of a large bank. The skills
needed to win the Nobel Prize are simply not the same as those
required to manage a large financial institution. The same is
true here. The skills needed to win the Nobel are not
necessarily the same as those needed to be a good Fed Governor.
I seriously doubt that many of Dr. Diamond's supporters would
have favored the appointment of Milton Friedman or Myron
Scholes to the Fed simply because they won the Nobel Prize.
Finally, I am compelled to again point out that Dr. Diamond
is legally not eligible to serve. According to Section 10 of
the Federal Reserve Act, no two members of the Board of
Governors can come from the same Fed district. Once again, Dr.
Diamond's nomination papers indicate he is, quote, ``of
Massachusetts.'' Current Board member Daniel Tarullo's
nomination papers also indicated he was, quote, ``of
Massachusetts.'' Dr. Diamond and Dr. Tarullo cannot serve at
the same time and comply with Section 10 of the Federal Reserve
Act. We can debate the wisdom and historical application of
this requirement at a later date, but for now, it is the law,
even if prior Congresses have chosen to look the other way.
There are plenty of good nominees that could be selected
from historically overlooked districts, like the Cleveland and
Minneapolis Districts. In fact, there has not been a Fed
Governor from the Cleveland District in 65 years. I would think
that some of my friends from Ohio might find that a bit
concerning.
Mr. Chairman, I encouraged the President to withdraw this
nomination and look beyond the Boston-to-DC corridor for a new
nominee. Thank you.
Chairman Johnson. Senator Reed.
STATEMENT OF SENATOR JACK REED
Senator Reed. Well, Mr. Chairman, thank you very much. We
have three extremely qualified nominees that are before us
today. I think both Dr. Abraham and Dr. Shapiro have
demonstrated a remarkable record, and we can get into some of
the details of the issues and policies.
Dr. Diamond, I think, is also superbly qualified, and I
think that despite the Ranking Member's comments, I think there
is, I would say, a misperception of the role of the Board of
Governors of the Federal Reserve. No one Governor is a
supervisor, as, for example, the OCC Director or the
Chairperson of the Securities and Exchange Commission, with the
exception of perhaps Chairman Bernanke.
But what the Federal Reserve can do collectively is to
engage in vigorous debate, and that debate, I think, is
enhanced by having individuals of Dr. Peter Diamond's ability
and perspective. One of the critiques, I think, looking back
over the last several years, is a certain group-think at the
Federal Reserve about many different policies. I think Dr.
Diamond's nomination, and I hope confirmation, to the Federal
Reserve will provide an interesting perspective from a very
gifted individual that might challenge some of the orthodoxies
within the Fed, that might force the individual members of the
Fed from different sort of economic perspectives to ask
fundamental questions and re-ask the questions, and in that
sense, I think he will be a very, very valuable contributor to
the Federal Reserve Board.
The issue of the legal status is something that I think we
can address and will address. I am hopeful that that is an
issue that has already been successfully decided by the
Administration.
But I find it just interesting to note that if there is a
general criticism of the role of the Federal Reserve and then
the suggestion is, find people just like the people we have had
on the Federal Reserve for the last 10 years, it seems to me to
be inconsistent and I would hope that we would support and
confirm Dr. Diamond.
Chairman Johnson. Senator Toomey.
Senator Toomey. Thank you, Mr. Chairman. If I could pass
for now, I would like to follow up in a few minutes. Thank you.
Chairman Johnson. Senator Hagan.
Senator Hagan. Thank you, Mr. Chairman. I think we have
three excellent and very well qualified individuals before us
today and I am certainly looking forward to the questions and
their testimony. Thank you.
Chairman Johnson. Before we begin opening statements, I ask
all nominees to stand and raise your right hand for the
swearing in.
Do you swear or affirm that the testimony that you are
about to give is the truth, the whole truth, and nothing but
the truth, so help you God?
Ms. Abraham. I do.
Mr. Shapiro. I do.
Mr. Diamond. I do.
Chairman Johnson. Do you agree to appear and testify before
any duly constituted Committee of the Senate?
Ms. Abraham. I do.
Mr. Shapiro. I do.
Mr. Diamond. I do.
Chairman Johnson. Please be assured that your written
statement will be part of the record, so if you could confine
your remarks to 5- to 8-minutes, that would be greatly
appreciated. Please note, also, that Members of the Committee
may submit written questions to you for the record and you need
to respond to these questions promptly in order that the
Committee may proceed with your nomination.
I invite all witnesses to introduce their family and
friends in attendance before beginning your statement. Ms.
Abraham.
Ms. Abraham. Thank you. I do have some people I would like
to introduce. I will start with my wonderful husband of 25
years, Graham Horkley. My mother, Roberta Abraham, who has been
throughout my life a source of encouragement and support. My
brother, David, his wife, Carol, and their two children,
William and Allison. My sister, Sarah. My childhood friends
from Iowa, Patricia Behneke [phonetic] and Ann Peterson
[phonetic], and Patty's daughter, Laura.
I, believe it or not, have more relatives who would have
liked to be here today and could not. My father, William
Abraham, could not travel to be here. My brother, John, my
sister, Molly, and my two college-age sons, who I hope are hard
at work on their classwork. Thank you.
Chairman Johnson. Thank you, Ms. Abraham.
Mr. Shapiro.
Mr. Shapiro. Thank you. I am really pleased that my parents
are here, Sherman and Ellen Shapiro, sitting in the front row.
And behind them, my children, my daughter, Eva, and my son,
Benjamin, were able to come, as well, from California. My
partner and best friend, Marti Hearst, is sitting next to Eva
here, as well. And I have support from my recent colleagues at
the Justice Department, Christine Varney, who is the Assistant
Attorney General for Antitrust, Gene Kimmelman, Sharis Pozen,
Janet Fikow [phonetic], and Joe Matelis are all from the
Antitrust Division. I really appreciate it. And some older
friends, Steve Salat [phonetic], Joe Farrow [phonetic], and
Dewey Graham [phonetic] are here, as well.
Chairman Johnson. Ms. Abraham and Mr. Shapiro, would you be
seated. And last, but not least, Dr. Diamond.
Mr. Diamond. Thank you, Mr. Chairman. I am traveling very
light, compared to the others.
[Laughter.]
Chairman Johnson. After two tries.
Mr. Diamond. My wife, Kate, is here. My son, Matt, and my
cousin, Burcu Duygan-Bump. Thank you.
Chairman Johnson. Thank you.
Ms. Abraham, proceed with your statement.
STATEMENT OF KATHARINE G. ABRAHAM, OF IOWA, NOMINATED TO BE A
MEMBER OF THE COUNCIL OF ECONOMIC ADVISERS
Ms. Abraham. Thank you, Chairman Johnson, Ranking Member
Shelby, distinguished Members of the Committee. I am pleased
and honored to appear before you today as a nominee to be a
member of the President's Council of Economic Advisers.
Mr. Johnson has already given some of my background. I am
currently a professor at the University of Maryland. From 1993
to 2001, I served as Commissioner of Labor Statistics in the
Department of Labor, where I was responsible for many of the
key economic indicators produced by the Federal Government.
Prior to that, I held faculty positions at the University of
Maryland in the Department of Economics and the Sloan School of
Management at MIT.
I fell in love with economics as a freshman in college and
I have not stopped being in love with economics. What drew me
to economics is the power that I believe economic analysis has
to inform the policy process and contribute to better outcomes
for society.
Something I have also come to appreciate is that economic
analysis can only be as good as the data on which it rests.
That is something that I came particularly to appreciate during
my 8 years as Commissioner of Labor Statistics, and I have
maintained a continuing interest in the quality of our economic
data and the ways in which they might be improved.
My research and writing have examined a variety of labor
market policy issues and relevant economic data on employment,
unemployment, inflation, wages, and national output. It is my
hope that, if confirmed, my expertise can be useful for
interpreting the new data about our economy that will become
available over the coming months and years and for assessing
their implications for important policy decisions.
As has already been alluded to, these continue to be
extraordinary times for our economy. Following the worst
macroeconomic shock experienced in a generation, the economy is
beginning to recover, but for too many Americans, things are
still far from being back to normal. Looking to the future, we
know, I think, that investments in physical, human, and
knowledge capital will be essential to ensuring our Nation's
long-term prosperity.
Should I be confirmed, I look forward to working with other
members of the Administration and with this Committee to
provide economic insights and analysis that will help with the
formulation of policies conducive to broadly shared growth.
Thank you very much. I will, of course, be happy to answer
any questions that you or Members of the Committee might wish
to pose.
Chairman Johnson. Thank you, Ms. Abraham.
Mr. Shapiro.
STATEMENT OF CARL SHAPIRO, OF CALIFORNIA, NOMINATED TO BE A
MEMBER OF THE COUNCIL OF ECONOMIC ADVISERS
Mr. Shapiro. Thank you, Chairman Johnson, Ranking Member
Shelby, and other Members of the Committee. I am pleased and
honored to appear before you today as a nominee to serve as a
member of the President's Council of Economic Advisers.
I already introduced you to my family, but I would like to
pause for a moment to especially note my father, Sherman,
sitting right here behind me. He grew up terribly poor in the
Great Depression. Through hard work and tremendous dedication
to improving himself, he was able to earn a Ph.D. in economics
at the University of Chicago. He had tremendous influence on
me, always has. He taught me the virtues of giving all
Americans the opportunity to make the most of themselves while
always, always, stressing the importance of personal
responsibility.
I was born in Austin, Texas, grew up in South Bend,
Indiana, and Wilmette, Illinois, and went to school at MIT, and
you have described some of my other schooling and
qualifications. I was a professor at Princeton for 10 years
during the 1980s. I have been a professor at Berkeley for about
20 years.
But during the mid-1990s, I came to Washington to serve as
the Chief Economist in the Antitrust Division. My interests
have always gone toward public policy and applying the
economics for public policy. And then I returned 2 years ago,
again as Chief Economist in the Antitrust Division, working
with Christine Varney, who is here, as well, the Assistant
Attorney General for Antitrust. In that role, my job has been
to supervise the economists and give the very best economic
analysis and advice to the Assistant Attorney General in
support of antitrust enforcement.
My research, consulting, and public service have
consistently emphasized the importance of promoting competition
and innovation as drivers of economic growth. I have a special
interest and expertise in the economics of high-tech
industries, intellectual property, some of the other drivers of
innovation. My book with Hal Varian, ``Information Rules: A
Strategic Guide to the Network Economy'', which applies
economic principles to the information economy, has been widely
read by managers and adopted for classroom use. So I have a
business side, if you will, consulting and teaching MBAs, as
reflected in that book, as well as my public policy side of my
background.
If I am confirmed as a member of the CEA, I hope to
contribute my expertise to the development of policies that
promote economic growth by creating a business environment that
encourages private sector innovation and investment.
The CEA has a great tradition, going back 65 years, of
providing high-quality, unbiased economic policy advice to the
President based on the best thinking and scientific evidence
the economics profession has to offer. If I am confirmed, I
look forward to continuing that tradition.
Thank you. I would be happy to answer any questions you
have for me.
Chairman Johnson. Thank you, Mr. Shapiro.
Mr. Peter Diamond.
STATEMENT OF PETER A. DIAMOND, OF MASSACHUSETTS, NOMINATED TO
BE A MEMBER OF THE BOARD OF GOVERNORS, FEDERAL RESERVE SYSTEM
Mr. Diamond. Chairman Johnson, Senator Shelby,
distinguished Members of the Committee, I am honored to have
been nominated by President Obama to be a member of the Board
of Governors of the Federal Reserve System and grateful to this
Committee for having me here today.
If confirmed, I will work to the best of my abilities to
fulfill the responsibilities of this office. Those
responsibilities have always been significant. The experience
of the recent financial crisis and the ensuing financial reform
legislation have underlined the multiple responsibilities of
the Fed in working to foster maximum employment and price
stability. The Fed has much work ahead in order to implement
and fulfill the tasks laid out by the financial reform
legislation. I would be honored and pleased to be part of the
process of responding to this challenge.
I studied both mathematics and economics as an
undergraduate at Yale University. I received my Ph.D. in
economics from the Massachusetts Institute of Technology in
June 1963. Since then, I have been a faculty member, first at
the University of California at Berkeley, and since 1966 at
MIT.
Throughout this period, I have taught and done research in
economics. My primary focus in both graduate teaching and
research has been economic theory, particularly macroeconomics,
search theory, and public finance. Within public finance, my
primary focus has been on taxes, pensions, and social
insurance, particularly Social Security. I have done both
theoretical analyses and policy analyses. At the undergraduate
level, I have taught microeconomics, macroeconomics, public
finance, money and banking, and law and economics. Being a
member of two economics departments with great collegial
interactions, I have gained wide knowledge in a variety of
economics topics, as well as detailed knowledge in my areas of
expertise.
A central theme in my research career has been how the
economy deals with risks, both risks at the individual level
and risks that affect the entire economy. I have thought
extensively and written about the risks in the economy and how
markets and Government can combine to make the economy function
better.
In particular, the research that led to my being a
corecipient of the Nobel Prize in Economic Sciences has
addressed how the costs and delays in learning about market
opportunities affect the workings of the economy. As noted by
the Prize Committee, the basic research on this topic has been
used as a starting place for applied research in a wide variety
of areas, not only the housing and labor markets, where sizable
delays are clearly visible, but also in monetary theory and
finance economics. Indeed, the varying speeds with which
surprises occur to financial firms and their abilities to
respond is a central element in the development of financial
crises, making search theory an important part of understanding
how to avoid and limit future shocks to the financial system.
In sum, I believe my background would prove very helpful at
the Federal Reserve, particularly as a part of the process of
addressing our heightened awareness of the dangers of systemic
risks.
If confirmed, I would welcome the opportunity to help
address the important issues that have been raised by the
financial crisis as well as the longstanding issues and
concerns in monetary policy and bank regulation that the
Federal Reserve faces.
Thank you again for holding today's hearings. I would be
pleased to answer your questions.
Chairman Johnson. Thank you, Mr. Diamond.
Would the Clerk put on the clock 5 minutes.
Mr. Diamond, an article in the Boston Globe stated that
colleagues have said that your work changed the way economists
think about national debt, taxes, risk, unemployment, and
Social Security. What insight on these issues, particularly
unemployment, can you bring to the Federal Reserve Board of
Governors as it sets its economic and regulatory policy?
Mr. Diamond. Thank you, Mr. Chairman, for the question. The
way we teach about markets at the start of economics is demand
and supply and a price clears the market. But if you look at
the labor market, at any point in time, there are unemployed
workers and there are vacancies. So that picture of the stocks
of unemployment and vacancies is an inadequate basis for
thinking about the dynamic process of how the economy goes into
a recession and how it comes out and the role of policy, both
unemployment insurance to help the workers affected and macro
policy generally.
The picture that comes when you look at the flows shows
over the last 20 years, in an average month, six million
workers gain employment and a slightly smaller number lose
employment. The impact on unemployment is the difference
between two large numbers. So focusing on the flows, focusing
on the way that firms find it profitable to seek and hire new
workers and to decide which workers they want to hire and
focusing on how workers decide where to look for jobs, what
kinds of jobs to look at, these are the central elements in
thinking about the dynamic process.
The monetary policy followed by the Fed influences this
process, and conversely, studying this process is essential for
understanding the state of the economy, the risks of inflation,
and how to impact the unemployment that is going on. This
attention to the risks of the economy as a whole, is very
important for going ahead from this terrible crisis we have had
and are still definitely not out of.
Chairman Johnson. Mr. Shapiro and Ms. Abraham, a question
for you both. I believe key investments in innovation,
education, and infrastructure will strengthen our
competitiveness globally. While Congress debates budget and
prioritizes spending, how important is it that we use a scalpel
to make targeted budget cuts to ensure that we protect those
needed investments? Ms. Abraham?
Ms. Abraham. I think that it is very important. I think
that we can all agree that we need to be looking hard at
spending. We need to be looking at ways to bring down the
deficit. But at the same time, we would be harming our future
if we were not making--continuing to make needed investments in
the areas that you have identified. Education, innovation, and
infrastructure are critical to our future.
Chairman Johnson. Mr. Shapiro, do you have any thoughts?
Mr. Shapiro. Yes, along similar lines. I think particularly
investments in basic research and promoting basic research is
something we cannot really count on the private sector to do,
and so there is an important role for the Government there,
after which we then turn it over to the private sector to
commercialize and build the jobs based on that innovation. We
have decades of successful experience in that, and so that is
an example of an area where a meat axe would be unwise. A
scalpel is the way to go.
Chairman Johnson. Mr. Diamond, since the downturn in the
economy, the Fed has managed to keep inflation in check, but
too many Americans remain out of work. Can more be done to
create jobs? What is your view of the Federal Reserve's actions
so far in promoting the recovery?
Mr. Diamond. The traditional tool used by the Federal
Reserve is the short-term interest rate. By lowering short-term
interest rates, they encourage consumers to spend, particularly
on consumer durables. Second, that encourages businesses to
invest because it will be cheaper to do it. And third, there is
the general sense of the economy moving forward because
critical to business is the projection of the ability to sell
things out in the future.
Currently, and for an extended period, we have had a short-
term interest rate that cannot be lowered any more. So the Fed
has had to address how to lower long-term interest rates that
matter for these same phenomena and how to do that in a way
that will encourage both consumption and investment. The action
that the Fed has taken in the asset markets, purchasing assets
to help bring down interest rates to encourage more consumption
and more investment, seems to me to have been an appropriate
way to go, although obviously not being part of the FOMC, I was
not part of the explicit discussions and the working out of
details.
Chairman Johnson. Senator Shelby.
Senator Shelby. Thank you, Mr. Chairman.
Dr. Abraham, the headline number from last week's jobs
report was that total unemployment for February was 8.9
percent. An alternative measure of unemployment contained in
the report, which includes people who have stopped looking for
work or who cannot find full-time jobs, stood at 15.9 percent.
Dr. Abraham, as the former Commissioner of Labor Statistics in
the Department of Labor, what do you think is the best
indicator of labor under-utilization? In other words, is the
unemployment rate closer to 9 percent or is it closer to 16
percent?
Ms. Abraham. Hmm. I appreciate your interest, Mr. Shelby,
in these economic data. That is a hard question to answer.
They----
Senator Shelby. But we need to try to put our hands around
it, do we not?
Ms. Abraham. I think--I guess that what I----
Senator Shelby. Because we are looking for the truth, are
we not?
Ms. Abraham. Oh, absolutely. I guess that what I would say
is that from my perspective, the most important use of these
data is to tell us about how we are doing today compared to how
we were doing in the past, to look at whether things are
getting better or things are getting worse. And a comment about
those numbers is that they do tend to go up and down together.
Whether you look at the narrower unemployment rate or the
broader unemployment rate, they both are telling us that things
are not good now.
Senator Shelby. You do not dispute those numbers----
Ms. Abraham. Oh, no. No, no, no, no----
Senator Shelby. Either the 8.9 or the 15.9?
Ms. Abraham. No.
Senator Shelby. OK.
Ms. Abraham. They are measuring different things and----
Senator Shelby. They are metrics that you are familiar
with.
Ms. Abraham. And the conclusion, the main conclusion I take
from them is that we are not in a good place right now.
Senator Shelby. And what does that mean----
Ms. Abraham. That----
Senator Shelby. ----to us up here and to the American
people?
Ms. Abraham. I think it means that we need to be thinking
hard about how to create more jobs.
Senator Shelby. To build support for the Obama
administration's stimulus bill, the CEA--you were not there, I
understand that--created an estimate of the number of, quote,
``jobs saved'' by the bill--jobs saved. A number of well-
respected economists have criticized the so-called ``jobs
saved'' estimate as being nonmeasurable. For example, Dr. Allan
Meltzer said, and I will quote, ``The Council of Economic
Advisers shamefully invented a number called jobs saved that
has never been seen before, has no agreed meaning, and no
academic standing.'' What is your professional opinion about
the accuracy and validity of the CEA's ``jobs saved'' estimate?
Ms. Abraham. Well, I think that the estimate was an attempt
to answer a really important question, which is how much
difference did the Recovery Act make to the employment that we
saw compared to what we would have had without it. Answering
that kind of question is hard and there are a lot of
uncertainties around the number, so I would not want to pin my
hat on a specific number. But I do think that the estimate is
pretty comparable to what other analysts, private sector
analysts looking at the effects of the stimulus have come up
with, and I am convinced that the Recovery Act had a
significant and positive effect on employment, though I agree
it is hard to quantify.
Senator Shelby. Do you believe that it is appropriate for
the Council of Economic Advisers to create highly speculative
statistics that perhaps are designed solely to support an
Administration's political agenda, be it this one or a
Republican, whatever? In other words, is that not----
Ms. Abraham. You are asking an important question about the
role of the CEA----
Senator Shelby. Sure.
Ms. Abraham. ----and I think that the, from my perspective,
the role of the CEA is to provide the best information possible
to inform policy formation and the evaluation of policy. With
something like this, it is very hard to come up with a precise
number, but I think it is quite appropriate to try to produce
the best number possible as an input into discussion of the
policies that were adopted.
Senator Shelby. Would you agree, though, that basic
economic policy should not be based on speculation, should be
based on hard numbers?
Ms. Abraham. The economic policy should be based on the
best numbers possible.
Senator Shelby. That is right, harder numbers.
Ms. Abraham. And in some cases, coming up with something
that is a precise estimate is going to be impossible, and in
that case, I think you do the best job you can.
Senator Shelby. Dr. Shapiro, I have a question for you, if
I could. In your role as the Deputy Assistant Attorney General,
you recently submitted a Department of Justice letter on a
proposed CFTC rule regarding ownership limitations and
governance requirements for swap clearinghouses. Your letter
has received harsh criticism from academic economists and
market participants. For example, one economist said that the
Department of Justice letter treats safety and soundness
concerns, quote, ``dismissively, cavalierly, and
superficially.'' Those are harsh words.
Explain how your proposed ownership limitations and
governance requirements will affect the incentive of owners to
run well-managed and well-capitalized clearinghouses.
Mr. Shapiro. I would be happy to. The Antitrust Division
takes a competition perspective and we were here attempting to
explain, to give advice to the CFTC and the SEC regarding how
some of the provisions of the Dodd-Frank Act could, indeed,
promote competition in some of these areas, particularly for
the exchanges.
Senator Shelby. Mm-hmm.
Mr. Shapiro. So in terms of the question about the
difference between--about safety and soundness, we were much
more cautious about clearinghouses versus exchanges in terms of
the natural monopoly elements, and I think that is reflected in
the statute. There were certainly some criticisms of what we
put in, but there were also quite a lot of support. It is quite
a controversial area.
Senator Shelby. Do you disagree that what one economist
said, it treats safety and soundness concerns, again,
dismissively, cavalierly, and superficially?
Mr. Shapiro. I strongly disagree with that, and I guess
that was what I was attempting to convey in my previous answer,
which is the safety and soundness concerns, I think, are
critical in the setting up of a centralized clearinghouse,
which was something that was a problem that was missing in
these derivatives areas that contributed to the financial
crisis. And the Treasury and the CFTC and the SEC are all
working together following the Dodd-Frank to improve safety and
soundness by having the clearinghouses set up and have a lot of
the trading go through the clearinghouses.
We were, therefore, though, saying much more--took a
lighter hand in terms of promoting competition in
clearinghouses because the safety and soundness issues are very
important. They are less of an----
Senator Shelby. Very, very, important.
Mr. Shapiro. Extremely important, and the risks are not as
great for the exchanges as they are for the clearinghouse
itself.
Senator Shelby. Thank you, Mr. Chairman.
Chairman Johnson. Senator Reed.
Senator Reed. Thank you very much, Mr. Chairman.
Dr. Diamond, you have done over the course of your career
research in a number of different very critical areas--
taxation, public debt, Social Security, market dynamics, et
cetera. And again, I think, personally, that this will be a
tremendous asset on the Board of Governors because of the
various perspectives you can bring.
Can you give just a brief response to the two areas which I
think are of increasing importance. One is how do we increase
employment opportunities, and second, how do we anticipate
concentration of risk, you know, the bubble phenomenon that we
saw manifested over the last several years?
Mr. Diamond. OK. Thank you, Senator. On creating more jobs,
I think we have the familiar money and fiscal policy elements.
We got a stimulus package on the tax cut and spending side
passed by the Congress in December, and I think that is a
package that will help with this process. Beyond that, trying
to lower the longer-term interest rates to encourage both
consumption and investment is the way to go. The recovery has
been slow. The unemployment rate has come down very slowly and
I think it is quite important to go forward as quickly as we
can.
We know that part of the slow-down process is happening
through the credit markets, that there are a number of small
banks that are not in very strong shape, and as such, are
somewhat limited in their abilities to lend. The role of small
banks is very important, particularly for small business. So as
those banks get stronger, as the supervision encourages them to
do sound lending, that should be a help. And we also know that
with small businesses, often, startup capital, new businesses,
comes by drawing on home equity wealth, both individual and
friends and family who are pitching in to help. So I think as
the housing market gets sorted out, I think that should help,
as well.
I think there is no single tool, no magic bullet. I think
we have to work on all of these pieces.
I am sorry, the second question?
Senator Reed. The second question is that one of the
expectations now is that the Federal Reserve will be much more
sensitive to growing accumulations of risk, bubbles, areas of
economic activity that could present another rapid sort of
breakdown as we witnessed.
Mr. Diamond. I think it is useful here to separate out two
pieces. One is the issue of bubbles, which you have mentioned.
And then the second is the way the creation of a bubble itself
will often lead to misallocation of capital. But it is the
bursting of the bubble that will often ripple through the
financial system and cause great harm, as happened this time.
So these are two separate issues. I think the attention to
bubbles is inherently difficult. Nobody flies a flag and says,
``hey, we have got a bubble.'' There are people who think we
have got a bubble and people who think fundamentals have
changed. I think it is always probabilistic. One forms in a
judgment of how likely something is a bubble or not. I think
monetary policy is a very blunt tool that affects a lot of the
economy, so I think we need to focus in terms of bubbles on the
kinds of tools that will address them directly, particularly in
terms of what the Fed does, making sure the lenders are
applying good standards to the loans to make it less likely
that the loans are only being taken out because there is a hope
of making money out of a bubble.
In terms of what happens afterwards, I think that is where
the issue of how the economy generally responds to risks,
shares risks, spreads risks, when derivatives help in sharing
risks and spreading them more widely and more efficiently, and
when, as we have seen some examples of, derivatives add to
risks. And I think we need to be alert to both the extent to
which different financial institutions are holding very similar
portfolios, and so subject to much more widespread systemic
impact from a bubble bursting, and the connections across
financial institutions, the functioning of capital markets and
finance markets.
So I think it is getting a better understanding of the risk
spreading, the successful part, and the risk concentration, the
unsuccessful part, which is very important going forward on
dealing with these risks. We know there is a long history of
centuries of bubbles. Everyone learned a lot from this one.
That does not mean we will never see one again.
Senator Reed. Thank you. My time has expired, but I will
try to get back, Mr. Chairman, because I have to go to Armed
Services, but I just want to commend Dr. Abraham on her work on
work share, which is an important program, and I would like to
follow up, if I could, in questions, either written or oral.
Thank you, Mr. Chairman.
Chairman Johnson. Senator Toomey.
Senator Toomey. Thank you, Mr. Chairman.
Some questions for Dr. Diamond. I will start by suggesting
that I sometimes wonder how much we learned from the recent
bubbles, and given the current policy, I worry about whether we
are not in the process of creating new ones.
My first question is, is it your view that QE2 constitutes
monetizing a portion of our budget deficit?
Mr. Diamond. No, it does not, because the holding of these
assets is viewed as a temporary phenomenon by the Fed. The
announcement by the FOMC viewed this as a temporary stimulus,
just as doing things at the short end is addressing stimulus or
the need to pull back on stimulus, if we were worried about
inflation. And the portfolio goes up and down, and I think it
should be thought of in that context, that this is not
monetizing the debt. This is a temporary position that will get
unwound when the circumstances are appropriate.
Senator Toomey. Yes, we hope that that is going to happen
and it is going to happen well, but I am not so convinced, and
I think when the Fed, indirectly through bank intermediaries,
nevertheless directly is effectively purchasing the debt that
we are issuing on a massive scale, something on the order of
two-thirds of the deficit that we are running this year, it
certainly looks a lot like monetizing it to me.
The other thing that concerns me is the range of sort of
conventional measures and approaches to monetary policy that
suggest that what we have now is a very unusually
accommodative, and I would fear maybe dangerous accommodative,
policy. The Taylor Rule would call for a Fed funds rate of
about 1 percent right now. We have commodity prices that are
almost uniformly at very high levels. I mean, really, precious
metals, other metals, agricultural commodities, across the
board, commodities are all at very high levels, many at record
high levels. We have money supply by some measures as growing
very rapidly. We have negative real interest rates.
You know, you look at all of these indices and they suggest
generally that our policy is too accommodative, but yet we are
pursuing this huge infusion of cash. Do you not worry that
maybe some--that maybe we are going down the wrong path here,
that with all of these indications that we could very well have
problems in the future, maybe not so distant future, that this
is a dangerous policy to pursue?
Mr. Diamond. First of all, the issue you raised is
critically important. You asked, do I worry, and the answer is
yes. I think it is terribly important for these policies to be
reviewed and reviewed repeatedly, and I have thought of them as
an outsider and I am sure the FOMC is weighing up these issues
as well.
The critical question to my mind is, where are we now
relative to unemployment and inflation? Inflation is
exceedingly low, below the normal 2 percent that people talk
about, and----
Senator Toomey. But----
Mr. Diamond. ----unemployment is very high, and the issue
is, are there signs that inflation might be picking up quickly.
I view the rise in commodity prices as driven by microfactors,
not general stimulation of the economy. We obviously have oil
disruptions in the Middle East----
Senator Toomey. But before the oil--well, we have not
actually had supply disruptions. We have had major political
turmoil that gives rise to worries about potential supply
disruption----
Mr. Diamond. Right.
Senator Toomey. ----but we have not had supply disruptions.
It seems unlikely to me that micro incidents would occur across
the entire range of commodities, everything from corn and wheat
and cotton to gold and silver and aluminum. You know, this
strikes me as something broader than specific narrow micro
effects.
Mr. Diamond. Well, let me continue with my list of the
things that have happened that really matter for some of these
prices. We have had some serious droughts that are affecting a
range of agricultural products.
We have a number of large economies, of which China is the
obvious leader, that are growing very rapidly and boosting
demand across the board for all the inputs into the production
and construction that they do. So that China is growing rapidly
is something that will affect prices around the world. It is
not part of a large stimulus, and at some point, the Chinese
have to address the risk of their economy overheating, but I do
not know that that will trigger our economy overheating. I do
not see that kind of connection.
Senator Toomey. Do I have time for one more quick question,
Mr. Chairman?
Chairman Johnson. One quick question.
Senator Toomey. Thank you very much, and the question is
about the exit strategy. One of the things that concerns me is
that the strategy itself is designed, in part, to raise
inflation expectations. About that, I am afraid it will be very
successful.
If it is successful in that respect, the obvious response
from the market to rising inflation expectation is higher
interest rates, higher bond yields. In the face, therefore, of
higher bond yields, I fear that the Fed could find itself in
the situation where it also has to exit by selling bonds, and I
worry that the process of exit could lead to much higher
interest rates from the combination of these phenomena. Is that
something that you are concerned about, how they can exit?
Mr. Diamond. The exit strategy is obviously terribly
important, and I think it is important to keep in mind that the
Fed has multiple tools. The interest paid on excess reserves
can play a critical role in adjusting the way the exit strategy
is executed so that we do not get a rapid burst of lending and
inflation. I think the combination of tools available will
permit a smooth exit. But the great recession we have had is a
new experience and I think we are looking at trying to respond
to a very major problem and trying to respond to a very high
unemployment rate, which is very harmful, and trying to deal
with it in a way that does not lay down problems for the
future. And I think it is necessarily something that takes
close monitoring and following while laying out a plan and
monitoring it and changing it, as needed.
Senator Toomey. Thank you very much, Mr. Chairman, for your
indulgence on the time, and thank you.
Chairman Johnson. Senator Hagan.
Senator Hagan. Thank you, Mr. Chairman.
Dr. Abraham, we have been talking about unemployment
numbers and I wanted to raise a particularly concerning labor
market issue that I have been watching closely, and that is the
unemployment numbers for our returning veterans in Afghanistan
and Iraq. They are unacceptably high. Last Friday, the Bureau
of Labor Statistics released the February unemployment numbers
that showed unemployment for these returning service members to
be about 12.5 percent, and that is almost 4 percentage points
higher than the national average.
I am always looking for additional ways to help our
returning soldiers, and my question is, do you have any
insights on why this number might be so high versus the rest of
the employment figures?
Ms. Abraham. Thank you for that question. I also have been
looking at these numbers. It has not been very long that we
have actually had regular unemployment figures for veterans and
so it is welcome that we have them now. I have--I cannot really
say why they are so much higher than for the population as a
whole. The veterans have demographic characteristics that are
associated with somewhat higher unemployment. They are young
men. Young men tend to have higher unemployment rates. But it
is more than that and I think this bears looking into.
Senator Hagan. Thank you. I look forward to working with
you on that issue. And how long have we been keeping numbers on
returning veterans?
Ms. Abraham. It has been a few years now.
Senator Hagan. OK. Dr. Shapiro, America's small businesses
are an essential component of economic growth and these
businesses create a disproportionate share of the net new jobs,
the small businesses. In North Carolina, these small businesses
account for nearly 50 percent of our private sector jobs. But
right now, these companies are having a very difficult time
accessing credit and the capital markets. I hear this
everywhere I go throughout my State. And the economic report of
the President showed that small businesses receive 90 percent
of their financing from banks, community banks, in particular,
and the report cites information asymmetries and other market
frictions as an impediment to small business financing.
Last year, we passed the Small Business Jobs Act that would
help accelerate a return to lending to small businesses, but as
I hear over and over again, that small companies are really
having a hard time accessing these funds. What steps do you
suggest that Congress takes or the Administration takes to
restore the flow of credit to small business? What can we do on
a proactive basis?
Mr. Shapiro. Well, I think your State is not alone in the
small business having a difficult time, both with credit, and
the report concerns about poor sales is the fundamental issue,
that the demand is not there and that, of course, it makes it
harder to get a loan. And we have small business association
programs that help in this regard and the Administration, with
Congress, has pushed those forward.
There is a lending fund to help community banks, OK. So I
think this is part of--because community banks are so important
for small business and they understand the local situation
better, this is some of these informational concerns that a
bigger bank might not know. The support for the community banks
is very important and there is a lending fund that has been set
up for that that seems to be well crafted for that purpose.
There have also been tax cuts that are helping, as well,
for small businesses and large businesses that Congress enacted
and the President signed last December, particularly to be able
to write off more of their investments in 2011.
Senator Hagan. Well, I know the application for the small
business funds that we passed last September is still open for,
I think, until the end of March for small and independent
community banks to file for that, so I am really looking
forward to the change once those funds start getting out into
the market, because my small businesses are really hurting. And
I do think it is an economic driver, especially from the
standpoint of employment opportunities.
Mr. Shapiro. Well, I think it is something we need to keep
a close eye on and watch, and if I am confirmed, I look forward
to doing that with this Committee.
Senator Hagan. OK. Thank you.
Dr. Diamond, also, thank you for appearing today. I know
you have been speaking to this Committee before, but it is my
first chance to have an opportunity to be here and to hear from
you, so I have just got a couple of questions.
There seems to be a divide among economists about whether
the quantitative easing should continue, and some, like the
President of the Federal Reserve Bank of Richmond, Jeffrey
Lacker, argue that the U.S. growth outlook is tilted against
further quantitative easing and that inflation has bottomed and
will only head upward from this point. And then others, like
Christina Romer, former Chair of the President's Economic
Advisers, has advocated for more aggressive quantitative
easing, both in size and scope.
With unemployment around 9 percent, 9.8 percent in North
Carolina, and core inflation around 1 percent, it would seem
inflation expectations are under control for now, but with
commodity prices, as we have been discussing, climbing
steadily. Do you have concerns that the general inflation could
emerge quickly despite continued high unemployment, and what
actions would you recommend the Fed to take should such a
circumstance emerge?
Mr. Diamond. Well, I think you have described the current
situation correctly. The inflation rate is very low. Beyond
that, the studies of inflation expectations show that inflation
expectations are very low. And the primary pusher of inflation
historically has been the state of aggregate demand. When the
state of aggregate demand gets too big relative to what the
economy can produce. Potential output and the labor market in
terms of the availability of workers to fill jobs, that is when
we get inflation that starts to move seriously. We are
obviously in no danger of that process giving us rapid
inflation.
On the prices that have boosted, the question at hand is,
is this part of an inflationary process or have we had a jump
in some prices? Obviously, a drought will leave you a jump in
prices, but it does not tell you that the prices are going to
keep going up.
The Chinese economy expanding so rapidly is going to push
up prices of the inputs they need for their production. The
question of how rapidly they will continue growing, and again,
will their growth speed up? Will that give us rising inflation?
I think there is no reason to think it will grow faster. If
anything, I think they are beginning to worry about the
possibility of overheating.
So I do not see the link between these individual price
problems and a rapid appearance of inflation, given the general
state of the labor market and aggregate demand in the U.S.
Senator Hagan. Thank you, Mr. Chairman.
Chairman Johnson. Thank you, Drs. Diamond, Abraham, and
Shapiro, for your testimony and for your willingness to serve
our Nation.
We are going to submit questions for the record to you by
12 noon this Friday, March 11. Please submit your answers to us
as soon as possible so that we can move your nomination in a
timely manner.
This hearing is adjourned.
[Whereupon, at 11:11 a.m., the hearing was adjourned.]
[Prepared statements, biographical sketches of nominees,
and responses to written questions supplied for the record
follow:]
PREPARED STATEMENT OF KATHARINE G. ABRAHAM
To Be a Member of the Council of Economic Advisers
March 8, 2011
Chairman Johnson, Ranking Member Shelby, and distinguished Members
of the Committee, I am pleased and honored to appear before you today
as a nominee to be a Member of the President's Council of Economic
Advisers.
Before I begin, I would like to introduce several people who are
with me here today. First is Graham Horkley, my wonderful husband of
more than 25 years. Second is my mother Roberta Abraham, who throughout
my life has been a source of encouragement and support. I am also very
pleased to introduce my brother, David Abraham, his wife, Carol Popolow
Abraham, my nephew and niece, William and Allison Abraham, and my
sister, Sarah Abraham. My college-age sons, Ian and Ben Horkley, my
father, William Abraham, my brother, Jon Abraham, and my sister, Molly
Abraham, would very much have liked to be here today, but unfortunately
were not able to attend.
I have been Professor of Survey Methodology and Faculty Associate
of the Maryland Population Research Center at the University of
Maryland since 2002. From 1993 to 2001, I served as Commissioner of
Labor Statistics in the Department of Labor, where I was responsible
for many of the key economic indicators produced by the Federal
Government. Prior to that, I held faculty positions in the Department
of Economics, University of Maryland, and the Sloan School of
Management, Massachusetts Institute of Technology.
I first became enamored of economics as an undergraduate student.
What drew me to economics is the power that economic analysis has to
inform the policy process and contribute to better outcomes for our
society. Economic analysis can be only as good as the data on which it
rests. This is something that I came particularly to appreciate during
my 8 years as Commissioner of Labor Statistics and I have maintained a
continuing interest in the quality of economic statistics and the ways
in which they might be improved.
My research and writing have examined a variety of labor market
policy issues and relevant economic data on unemployment, employment,
inflation, wages, and national output. It is my hope that, if
confirmed, my expertise can be useful for interpreting the new data
about our economy that will become available over the coming months and
years and for assessing their implications for important policy
decisions.
These continue to be extraordinary times for our economy. Following
the worst macroeconomic shock experienced in a generation, the economy
is beginning to recover, but for too many Americans things are still
far from being back to normal. Looking to the future, we know that
investments in physical, human, and knowledge capital will be essential
to ensuring our Nation's long term prosperity. Should I be confirmed, I
look forward to working with the other members of the Administration
and with this Committee to provide economic insights and analysis that
will help with the formulation of policies conducive to broadly shared
growth.
Thank you. I will be happy to answer any questions you or other
Members of the Committee may have.
PREPARED STATEMENT OF CARL SHAPIRO
To Be a Member of the Council of Economic Advisers
March 8, 2011
Chairman Johnson, Ranking Member Shelby, and Members of the
Committee, I am honored to appear before you as a nominee to serve as a
Member of the Council of Economic Advisers.
Before I begin, I would like to introduce you to my family. My
parents, Sherman and Ellen Shapiro, were able to come from California
to be here today. My daughter, Eva, and my son, Benjamin, are also
present. My partner and best friend, Marti Hearst, is also here today.
I am especially pleased that my father Sherman can be here today.
He grew up terribly poor during the Great Depression. Through hard work
and a tremendous dedication to improving himself, he was able to earn a
Ph.D. in economics at the University of Chicago. He taught me the
virtues of giving all Americans the opportunity to make the most of
themselves, while always stressing the importance of personal
responsibility.
I was born in Austin, Texas, and grew up in South Bend, Indiana,
and Wilmette, Illinois. I went to school at M.I.T., earning my Ph.D. in
1981. I was on the faculty of Princeton University during the 1980s,
and have been a Professor at the Haas School of Business and the
Department of Economics at the University of California at Berkeley
since 1990. I was honored with an endowed chair in 1994; since then I
have been the Transamerica Professor of Business Strategy. I served as
the Director of the Institute of Business and Economic Research at U.C.
Berkeley from 1998 to 2008. During 1995-1996 and again during 2009-
2011, I served as chief economist in the Antitrust Division of the
Department of Justice, supervising some 50 Ph.D. economists to provide
sound economic analysis in support of antitrust enforcement.
My research, consulting, and public service have consistently
emphasized the importance of promoting competition and innovation as
drivers of economic growth. I have special interest, and expertise, in
the economics of innovation and high-tech industries. My book with Hal
Varian, ``Information Rules: A Strategic Guide to the Network
Economy'', which applies economic principles to the information
economy, has been widely read by managers and adopted for classroom
use. If confirmed as a Member of the CEA, I hope to contribute my
expertise to the development of policies that promote economic growth
by creating a business environment that encourages private sector
innovation and investment.
The CEA has a great tradition, going back 65 years, of providing
high-quality, unbiased economic policy advice to the President based on
the best thinking and scientific evidence the economics profession has
to offer. If confirmed, I look forward to continuing that tradition.
Thank you. I would be happy to answer any questions you might have.
PREPARED STATEMENT OF PETER A. DIAMOND
To Be a Member of the Board of Governors, Federal Reserve System
March 8, 2011
Chairman Johnson, Senator Shelby, and Members of the Committee, I
am honored to have been nominated by President Obama to be a member of
the Board of Governors of the Federal Reserve System and grateful to
this Committee for having me here today.
If confirmed, I will work to the best of my abilities to fulfill
the responsibilities of this office. Those responsibilities have always
been significant. The experience of the recent financial crisis and the
ensuing financial reform legislation have underlined the multiple
responsibilities of the Fed in working to foster maximum employment and
price stability. The Fed has much work ahead in order to implement and
fulfill the tasks laid out by the financial reform legislation. I would
be honored and pleased to be part of the process of responding to this
challenge.
I studied both mathematics and economics as an undergraduate at
Yale University. I received my Ph.D. in economics from the
Massachusetts Institute of Technology (MIT) in June 1963. Since then I
have been a faculty member, first at the University of California at
Berkeley, and, since 1966, at MIT. Throughout this period I have taught
and done research in economics. My primary focus in both graduate
teaching and research has been economic theory, particularly
macroeconomics, search theory, and public finance. Within public
finance, my primary focus has been on taxes, pensions, and social
insurance, particularly Social Security. I have done both theoretical
analyses and policy analyses. At the undergraduate level I have taught
microeconomics, macroeconomics, public finance, money and banking, and
law and economics. Being a member of two economics departments with
great collegial interactions, I have gained wide knowledge in a variety
of economics topics, as well as detailed knowledge in my areas of
expertise.
A central theme in my research career has been how the economy
deals with risks, both risks at the individual level and risks that
affect the entire economy. I have thought extensively and written about
the risks in the economy, and how markets and Government can combine to
make the economy function better. In particular, the research that led
to my being a corecipient of the Nobel Prize in Economic Sciences \1\
has addressed how the costs and delays in learning about market
opportunities affect the workings of the economy. As noted by the prize
committee, the basic research on this topic has been used as a starting
place for applied research in a wide variety of areas--not only the
housing and labor markets where sizable delays are clearly visible, but
also in monetary theory and analysis of the capital market. Indeed, the
varying speeds between the occurrence of surprises to financial firms
and their abilities to respond is a central element in the development
of financial crises, making search theory an important part of
understanding how to avoid and limit future shocks to the financial
system.
---------------------------------------------------------------------------
\1\ The full name is the Sveriges Riksbank Prize in Economic
Sciences in Memory of Alfred Nobel.
---------------------------------------------------------------------------
In sum, I believe my background would prove very helpful at the
Federal Reserve, particularly as a part of the process of addressing
our heightened awareness of the dangers of systemic risks. If
confirmed, I would welcome the opportunity to help address the
important issues that have been raised by the financial crisis, as well
as the longstanding issues and concerns in monetary policy and bank
regulation that the Federal Reserve faces.
Thank you again for holding today's hearing; I would be pleased to
answer your questions.
RESPONSES TO WRITTEN QUESTIONS OF SENATOR REED
FROM KATHARINE G. ABRAHAM
Q.1. What has your research shown on whether work sharing can
be helpful to stem layoffs and be part of a strategy to help
employers and employees in advance of the next recession? What
thoughts do you have on how to best encourage work sharing?
A.1. My research has examined how employers adjust hours and
employment in response to cyclical changes in demand. In other
countries, more of the adjustment to changes in demand commonly
takes the form of reductions in hours (work sharing) rather
than reductions in employment (layoffs) than is the case in the
United States. Work sharing as opposed to layoffs can have
significant benefits for employers and workers. Companies can
avoid the loss of valued employees who are laid off during a
temporary downturn and the burden of the economic downturn is
spread more equitably.
One factor that has contributed to the greater use of work
sharing in these other countries is that workers whose hours
have been reduced are eligible for prorated unemployment
insurance benefits, referred to as short-time compensation.
Similar prorated benefits are already available in 17 U.S.
States. Changes to the U.S. unemployment insurance system to
encourage work sharing, thereby reducing the need for layoffs,
would be a step in the right direction in terms of mitigating
job loss in future recessions.
Q.2. Can you provide your view of how the Recovery Act
contributed to economic and employment growth and/or mitigated
the effects of the economic downturn?
A.2. In my view, the Recovery Act contributed significantly to
mitigating the effects of the economic downturn that began at
the end of 2007 and worsened during 2008. It is of course
inherently difficult to know exactly what would have happened
had the Recovery Act not been passed. One way to estimate the
effects of the Recovery Act is to predict the path that
employment would have followed absent passage and then to
compare what actually happened to that prediction. Another
approach is to apply fiscal employment multipliers reported in
the economics literature to the different types of spending
under the Recovery Act to estimate the total employment effect.
Previous CEA analyses using these two very different approaches
yield estimates that are broadly consistent, showing employment
as of the end of 2010 to have been roughly 3 million jobs
higher than would have been the case without the Recovery Act.
While it is important to recognize the uncertainty inherent in
any such exercise, this seems to me to be a reasonable estimate
of the Recovery Act's effects. Private analysts and the
nonpartisan Congressional Budget Office have reached similar
conclusions about the positive effects of the Recovery Act.
------
RESPONSES TO WRITTEN QUESTIONS OF CHAIRMAN JOHNSON
FROM CARL SHAPIRO
Q.1. Given your academic and professional background, where do
we find potential changes to current business regulation in
order to spur economic growth? What opportunities are there to
help bolster small businesses?
A.1. Regulations should be carefully tailored to impose the
least burden on society consistent with achieving their stated
goals, such as safety, health, or environmental protection. As
an economist who has studied Government regulation of business
for 30 years, I am a proponent of using economic incentives to
encourage the desired behavior. If confirmed as a member of the
Council of Economic Advisers, I look forward to pursuing these
goals as articulated in the Executive Order issued by President
Obama on January 18, 2011, ``Improving Regulation and
Regulatory Review.''
Small businesses will benefit from the recently released
Presidential Memorandum supporting the Regulatory Flexibility
Act, which requires Federal agencies to consider regulatory
flexibility to reduce the burden on small business. Small
business also will be bolstered by the Administration's
proposal to make permanent the 100 percent tax exemption on
capital gains on qualified small business investments, and by
the Administration's proposal to provide $2 billion of capital
to small businesses.
Q.2. President Obama referenced the need for innovation along
with education and investment as important factors to improve
the economy. How could we incentivize innovation to achieve
this?
A.2. Innovation--broadly defined as the process by which
individuals and organizations generate new ideas and put them
into practice--is absolutely critical to our economic growth
and international competitiveness. One way to incentivize
private-sector innovation is to improve the operation of our
patent system. Administrative and legislative reforms for the
Patent and Trademark Office can reduce the time it takes for an
inventor to receive a patent and improve the quality of issued
patents. A second way to incentivize innovation is to invest in
basic research while facilitating the transfer of research
findings from our universities and research labs into the
private sector. A third way to incentivize innovation is to
provide tax incentives for private firms that engage in
research and development. Expanding and making permanent the
Research and Experimentation (R&E) tax credit would serve this
goal.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR SHELBY
FROM CARL SHAPIRO
Q.1. In your role as Deputy Assistant Attorney General at the
Department of Justice (DOJ), you recently submitted a letter
(DOJ letter) on a proposed Commodity Futures Trading Commission
(CFTC) rule regarding ownership limitations and governance
requirements for designated clearing organizations (DCOs),
designated contract markets (DCMs) and swap execution
facilities (SEFs).
Explain the nature of your personal involvement with the
analyses and recommendations contained in the letter.
A.1. As Deputy Assistant Attorney General for Economics in the
Antitrust Division, I was involved in preparing these comments.
I supervised the staff economists who worked with staff
attorneys to draft these comments. I gave input to the staff
during the process, reviewed drafts, and recommended to
Assistant Attorney General Christine Varney that these comments
be filed at the CFTC.
Q.2. To the best of your knowledge, were there any relevant
communications, written or oral, between the CFTC and DOJ's
Antitrust Division prior to submission of the DOJ letter? If
so, please explain.
A.2. To the best of my knowledge, DOJ staff met with CFTC staff
to discuss the CFTC's proposed rules.
Q.3. Do you believe that impartial access is necessary to
protect consumers and to promote competition?
A.3. Section 733 of the Dodd-Frank Act seeks to provide market
participants with impartial access to SEFs. I believe impartial
access to an SEF promotes competition among market participants
on that SEF, which in turn helps protect consumers.
Q.4. If you do, explain why laws and/or regulations that
require impartial access are not a sufficient solution. Explain
why the DOJ letter advocates a solution that is inconsistent
with American Airlines/British Airways alliance analogy
referenced in your letter.
A.4. In my experience, it is desirable wherever possible to
rely on market competition rather than Government regulations
to protect consumers. Rules mandating access to a dominant
platform can be difficult or costly to enforce, in part due to
disputes regarding what constitutes ``impartial access.'' Here,
competition among SEFs may well provide additional protections
to market participants, above and beyond those resulting from
access regulations imposed on a dominant SEF.
In my opinion, the DOJ letter to the CFTC and the DOJ
comments to the Department of Transportation (DOT) regarding
the Star Alliance are consistent. The DOJ letter to the CFTC
favors certain restrictions on the ownership and governance of
SEFs. The DOJ letter argues that those restrictions will
promote competition among SEFs without undermining the ability
of SEFs to operate efficiently. The DOJ comments to DOT favor
``carve-outs'' on certain nonstop routes. The DOJ comments
argue that these carve-outs will preserve competition on those
routes without undermining the ability of the alliance to
operate efficiently on other routes. In both cases, DOJ seeks
to promote competition without undermining the efficiencies
that can be achieved through a joint venture among rivals.
Q.5. If you do not, explain why your personal belief differs
from the beliefs expressed in the DOJ Letter that you signed.
A.5. Not applicable.
Q.6. The DOJ letter states ``[t]he Department believes that
allowing three to five large participants in the derivatives
sector to control a trading a platform would greatly increase
the risk that those entities will use their control to block or
limit rival dealers' or buy-side firms access to the
platform.'' Do you agree with the belief that voting and
ownership limitations are necessary?
A.6. I support efforts by the CFTC to put in place rules to
mitigate potential conflicts of interest in the operation of
trading platforms. In my opinion, voting and ownership
limitations are important for this purpose.
Q.7. If you do: How do you reconcile this statement with Core
Principle 2 in Section 733 of the Dodd-Frank Act, which states
that a swap execution facility shall establish, among other
things, ``participation rules that will deter abuses . . . to
provide market participants with impartial access to the
market''? Explain why this explicit language does not directly
address your concern that dealers would ``block or limit rival
dealers' or buy-side firms access to the platform.''
A.7. Structural solutions that rely on market competition are
often more effective and less onerous than ongoing oversight
and regulation. In the current context, disputes may well arise
regarding whether a given SEF provides ``impartial access'' to
market participants who are actual or potential competitors to
the entities controlling the SEF. The DOJ comment seeks to
promote competition among SEFs. Effective competition among
SEFs will tend to reduce the frequency and magnitude of
disputes over ``impartial access,'' since a market participant
whose access to one SEF has been limited can trade on another
SEF.
Q.8. How do you reconcile this statement with Dodd-Frank
antitrust core principles for derivatives clearing
organizations, swap execution facilities, and designated
contract markets, which states that each entity ``shall not
adopt any rule or take any action that results in any
unreasonable restraint of trade or impose any material
anticompetitive burden on trading''? Explain why this explicit
language does not directly address your concern that dealers
would ``block or limit rival dealers' or buy-side firms access
to the platform''.
A.8. Structural solutions that rely on market competition are
often more effective and less onerous than ongoing oversight
and regulation. In the current context, disputes may well arise
regarding whether a given SEF has adopted any rule or taken any
action ``that results in any unreasonable restraint of trade''
or imposes ``any material anticompetitive burden on trading.''
The DOJ comment seeks to promote competition among SEFs.
Effective competition among SEFs will tend to reduce the
frequency and magnitude of these disputes, since any given SEF
will have less market power that could be abused.
Q.9. Did you sign the letter supporting voting and ownership
limitations because you believe that the CFTC will be unable to
enforce this language?
A.9. I believe that structural solutions designed to mitigate
potential conflicts of interest and to promote competition
among SEFs will reduce the frequency and magnitude of disputes
over compliance with the cited language, thereby reducing the
cost and increasing the effectiveness of CFTC enforcement of
this language.
Q.10. If you do not, explain why your personal belief differs
from the beliefs expressed in the DOJ Letter that you signed.
A.10. Not applicable.
Q.11. Provide a real-world case that the DOJ has successfully
argued where an exchange blocked market participants from
trading on its execution platform.
A.11. I am not aware of any such example. Access to execution
platforms is normally addressed by regulators rather than
through enforcement of the Sherman Act.
Q.12. It is my understanding that it has been a long-standing
DOJ Antitrust Division's policy to rely on ``conduct
remedies,'' that are conceptually analogous to Core Principle 2
in Section 733 of Dodd-Frank, as the preferred approach to
deter anticompetitive conduct. ``Structural remedies,''
including divestitures and ownership restrictions, are to be
pursued only where conduct remedies have proven to be
inadequate. Do you have any empirical evidence that conduct
remedies are not adequate for DCMs, SEFs, and/or DCOs?
If you do, provide that evidence.
If you do not, explain how you reconcile the structural
remedies approach taken in the DOJ letter with the DOJ's long-
standing policy of relying on conduct remedies.
A.12. The DOJ does not have a long-standing policy of relying
only on conduct remedies. DOJ approaches remedies on a case-by-
case basis. In many situations, including horizontal mergers,
the DOJ has historically preferred structural remedies to
conduct remedies. The Antitrust Division Policy Guide to Merger
Remedies, October 2004, available at http://www.justice.gov/
atr/public/guidelines/205108.pdf states (p. 7): ``Structural
remedies are preferred to conduct remedies in merger cases
because they are relatively clean and certain, and generally
avoid costly Government entanglement in the market.'' This
policy guide goes on to state (p. 8): ``A conduct remedy, on
the other hand, typically is more difficult to craft, more
cumbersome and costly to administer, and easier than a
structural remedy to circumvent.''
Q.13. Question 2 asks (emphasis added): ``To the best of your
knowledge, were there any relevant communications, written or
oral, between the CFTC and DOJ's Antitrust Division prior to
submission of the DOJ letter? If so, please explain.''
Mr. Shapiro responded in the affirmative, but he did not
provide any explanation. At a minimum, his explanation should
include:
A list all DOJ and CFTC individuals involved in
those communications.
A description of the nature of those
communications.
Answers to the following questions:
Who initiated those communications?
Did anyone from the CFTC or from the
Administration request or direct anyone in the DOJ to
send the letter? If so, please explain.
Did anyone from the CFTC or from the
Administration review and/or edit the letter before it
was submitted? If so, please explain.
A.13. To the best of my knowledge, DOJ staff met with CFTC
staff to discuss the CFTC's proposed rules. However, I did not
personally participate in any of these meetings, and I do not
recall participating in any conference calls, e-mails, or other
communications that may have taken place between DOJ and the
CFTC.
My recollection from staff updates I reviewed at the time
is that the initial recommendation to respond to the proposed
CFTC rules came from career staff members in the Antitrust
Division. Following that recommendation, I recall that DOJ
initially contacted the CFTC to discuss these issues. To the
best of my knowledge, DOJ attorneys Gene Kimmelman and Ihan Kim
were involved in these communications. As the Deputy Assistant
Attorney General for Economics, I was typically not involved in
these sorts of communications. I do not know the names of any
individual CFTC staff members who attended subsequent meetings
with DOJ staff. While I am unaware of precisely which DOJ staff
attended any particular meeting, I do know that DOJ economists
Jeff Wilder, Charles Taragin, and Fan Zhang were studying these
issues and I believe they each attended at least one meeting
with the CFTC based upon the weekly reports I received from
staff economists.
To the best of my knowledge, no members of the
Administration outside of DOJ, or anyone from the CFTC,
requested or directed anyone in DOJ to send the letter.
To the best of my knowledge, no members of the
Administration outside of DOJ, or anyone from the CFTC,
reviewed or edited the letter prior to its submission. As I
noted in my prior responses to the Committee, I was involved in
preparing these comments, and I supervised the DOJ staff
economists who worked with DOJ staff attorneys to draft these
comments. I gave input to the DOJ staff during the process,
reviewed drafts, and recommended to Assistant Attorney General
Christine Varney that these comments be filed at the CFTC.
------
RESPONSES TO WRITTEN QUESTIONS OF CHAIRMAN JOHNSON
FROM PETER A. DIAMOND
Q.1. Dr. Diamond, you have worked on unemployment and economic
growth. The models for which you won the Nobel Prize help us
understand the ways in which unemployment, job vacancies, and
wages are affected by regulation and economic policy.
Can you please explain how your expertise in employment and
the job market is relevant to the mandate of the Federal
Reserve Board of Governors?
What expertise and knowledge can you bring to the Board of
Governors to facilitate the crafting and implementation of job
growth policies as required by the Federal Reserve Act?
In addition to your knowledge of employment and the job
market, what other expertise and skills can you bring to the
Board of Governors of the Federal Reserve to achieve its vital
objectives?
A.1. In turn, I will discuss how my extensive background as an
economist and my expertise should be very valuable to the Fed
in three key areas of its responsibility: monetary policy, bank
supervision and regulation, and crisis prevention and
amelioration. My background can be a helpful complement to the
range of expertise of the current Board members.
It is important that monetary policy decisions reflect
careful analysis of the labor market, along with information on
inflation and inflation expectations and other aspects of
economic performance. The current crisis has resulted in
considerable discussion of the link between labor market
performance--jobs lost, jobs sought, jobs offered--and
desirable monetary policy. The crisis has caused unemployment
to rise to a very high and painful level. With inflation very
low at the same time, an accommodative monetary policy was
implemented. After an extended period of economic decline, the
economy began a slow recovery. For a period the unemployment
rate showed little decline while the job vacancy rate grew,
presenting a critical question for monetary policy of how best
to interpret these developments. Some analysts saw them as
calling into question the appropriateness of continuing with an
accommodative monetary policy.
The framework that has served as the ``industry standard''
for interpreting outcomes in the labor market, referred to as
the DMP model, was the basis for the Nobel Prize that I shared
with Dale Mortensen and Christopher Pissarides. In addition to
my role in creating the DMP model, I wrote a series of papers
together with Olivier Blanchard (currently IMF chief economist)
analyzing the empirical relationship between unemployment and
vacancies over a typical business cycle as well as setting out
a theoretical framework for such analysis. \1\
---------------------------------------------------------------------------
\1\ ``The Beveridge Curve'', BPEA 1:1989, 1-76, ``The Aggregate
Matching Function'', in P. Diamond (ed.) Growth, Productivity,
Unemployment: Essays To Celebrate Bob Solow's Birthday (Cambridge: MIT
Press), 1990, ``The Cyclical Behavior of the Gross Flows of U.S.
Workers'', BPEA 2:1990, 85-155.
---------------------------------------------------------------------------
Relevant to the Fed mandate is my analysis of the current
situation in the labor market in the Nobel Prize Lecture that I
delivered in Stockholm on December 10, 2010, and in a much
longer analysis that will appear in the American Economic
Review in June 2011. This analysis went behind the aggregate
numbers to examine hiring at the level of firms and industries.
\2\ This analysis led me to conclude that there was
insufficient evidence that firms were experiencing increased
difficulty in hiring qualified workers. Thus, I read the
evidence as suggesting that the aggregate behavior of the labor
market does not, in fact, signal a break in the efficiency of
matching jobs and workers. That is, the pattern of hiring would
likely return to normal after the economy had grown
sufficiently to approach its potential output, apart from the
lingering effects of long-term unemployment. As this discussion
indicates, careful analysis of the labor market, an analysis in
which I have considerable expertise and experience, is
essential for setting monetary policy well.
---------------------------------------------------------------------------
\2\ Specifically, I examined the ratios of unemployment to
vacancies across industries and the patterns of hiring relative to
vacancies across industries, across firms of different sizes, and
across firms with different growth rates. Also relevant is the decline
in quits by employed workers, which imply a decline in replacement
hiring.
---------------------------------------------------------------------------
The global financial crisis has added macroprudential
considerations to the list of issues that must be addressed in
the course of conducting supervision and regulation of banks.
That is, it is not sufficient to ask whether the current
position of a bank is sound, but also how the bank might be
affected by adverse economic developments and whether the bank
is at risk of contributing to widespread financial
difficulties. In part, macroprudential issues are being
addressed through the design of financial institution stress
tests. Stress test design is in an early stage and will no
doubt evolve with experience with stress testing itself, and
with further research on the nature of systemic risks,
particularly risks to the financial sector developing through
direct and indirect connections between financial institutions.
Analysis of these connections between firms will draw on models
of the capital market, a subject that I have researched.
Moreover, much of the concern about liquidity comes from the
differences in speed between actions that impact financial
institutions, such as a reduced availability of short-term
financing, and the abilities of the financial institutions to
respond. Analysis of dynamics in markets with direct lender-
borrower relations is naturally built on search theory. While
greatly different in detail, there is a parallel between the
need for time to match workers and jobs and the need for time
to match lenders and borrowers. Indeed, in its scientific
background statement for my prize, the Nobel Prize committee
included financial economics among the wide range of uses that
have been made of search theory. Thus my expertise in both
general equilibrium and search theories should be of great
practical use in the development of bank supervision and
regulation. \3\
---------------------------------------------------------------------------
\3\ I discussed a paper on stress testing banks at the recent
Monetary Policy Forum: Comments on ``Stressed Out: Macroprudential
Principles for Stress Testing'', by David Greenlaw, Anil K Kashyap,
Kermit Schoenholtz, and Hyun Song Shin, U.S. Monetary Policy Forum
Report No. 5, Initiative on Global Markets, University of Chicago Booth
School of Business, 2011.
---------------------------------------------------------------------------
The global financial crisis has greatly increased awareness
of the importance of preserving financial stability. This has
resulted in changes in the regulation of financial institutions
world wide and in efforts by researchers to enhance our
understanding of how crises happen, how to lower their
likelihood, and how to reduce their negative impacts on the
economy. Both regulation and research need to be ongoing
processes. The research process and the analysis of regulatory
rules take time and require feedback. Moreover, ongoing
financial innovation means that the financial markets are
themselves changing. It would be a mistake to limit regulatory
and supervisory changes to the causes of the particular crisis
we have experienced--crises can come in a variety of forms and
the evolution of the economy will change the ways that crises
can occur. My ability to understand how and when basic research
is informative for policy design should be very useful at the
Fed in crisis prevention and limitation. \4\
---------------------------------------------------------------------------
\4\ Also I can draw on my extensive experience studying and
advising about social security systems in many countries. As with the
financial system, social security systems must address individual risks
and aggregate risks, they must function well in ordinary times and must
weather financial crises.
---------------------------------------------------------------------------
In sum my extensive background as an economist, and high
level of expertise, should be very valuable to the Fed in three
key areas of its responsibility: monetary policy, bank
supervision and regulation, and crisis prevention and
amelioration.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR VITTER
FROM PETER A. DIAMOND
Q.1. The Wall Street Journal reported this week that PIMCO, the
world's largest bond investor, has divested all holdings in
U.S. treasuries. Fund managers pointed to potential bond price
declines as the U.S. Government approaches the statutory debt
limit and the approaching end to the Federal Reserve's second
round of quantitative easing (QE2). This was followed by the
following two comments:
``U.S. Government bonds are not a safe haven,'' Jim
Rogers, the global investor who predicted the 2007-2009
housing-market crash, said in a telephone interview
from Singapore. ``I cannot conceive of lending money to
the U.S. Government for 30 years.''
``Pacific Investment Management Co. said yesterday
that Bill Gross, who runs the $237 billion Pimco Total
Return Fund, eliminated Government-related debt from
his flagship fund last month as the U.S. projected
record budget deficits.''
What do these comments say to you about QE2?
A.1. These comments seem to have been spurred mostly by three
concerns: normal recovery from the recession, inflation risk,
and the long-run fiscal challenge.
At present, the interest rates on longer-term Treasury debt
are very low, and QE2 has contributed to these low rates. Once
the recovery is far along and growth has picked up interest
rates will rise, and QE2 will be unwound. Of course, the timing
and magnitude of a rise in interest rates is uncertain. To help
minimize uncertainties regarding the future course of long-term
interest rates, the Federal Reserve has indicated that the
eventual unwinding of its asset purchases will be done
gradually, and will be carefully communicated in advance.
Regarding the prospects for inflation in the near and
intermediate term, the Federal Reserve remains committed to its
statutory objectives of maximum employment and stable prices.
At present, underlying inflation remains low and inflation
expectations have been stable. The Federal Open Market
Committee (FOMC) has noted that it will regularly review the
asset purchase program in light of changes in the economic
outlook and that it will use its policy tools to support the
economic recovery and help ensure that inflation, over time,
remains at levels consistent with its mandate.
Regarding the fiscal outlook in the United States and the
potential for inflation that could impair the value of
investments in long-term Treasury securities, the Congress and
the Administration will need to make tough decisions in coming
years to address the Nation's fiscal challenges.
Q.2. Bill Gross also wrote that, ``Yields on Treasuries may be
too low to sustain demand for U.S. Government debt as the
Federal Reserve approaches the end of quantitative easing.'' Do
these comments give you pause about your previous support for
QE2? If so, why? If not, why not?
A.2. The quotation suggests a concern that the demand for
Treasuries may fall sharply as the QE2 program nears an end.
However, Federal Reserve asset purchases appear to affect
interest rates primarily by reducing the total stock of long-
term securities available to the public rather than through the
anticipated flow of new purchases. Thus, the effect of the
purchases should not diminish as the program is wound down.
Experience with the conclusions of Federal Reserve asset
purchase programs conducted over 2009 and early 2010 generally
supported this view; aggregate demand for securities did not
fall and long-term interest rates did not increase sharply as
those programs came to a close. Consistent with this historical
experience, the term structure of interest rates suggests that
most market participants do not expect a sharp increase in
longer-term interest rates over coming months, even though
investors do appear to anticipate that the asset-purchase
program will be completed early this summer.
Q.3. What is the dollar value of U.S. Treasuries currently held
by the Federal Reserve?
A.3. The Federal Reserve publishes information on its balance
sheet weekly in the Board's H.4.1 statistical release (http://
www.federalreserve.gov/releases/h41/). As of March 9, the
Federal Reserve's holdings of U.S. Treasury securities stood at
$1.27 trillion or about 14 percent of total marketable Treasury
debt outstanding. By way of comparison, the Federal Reserve's
holdings of U.S. Treasury securities in June of 2007, prior to
the onset of the crisis, stood at about $0.79 trillion or about
18 percent of total marketable Treasury debt outstanding at the
time.
Q.4. How does this compare to the amount of U.S. Treasury
securities held by China or Japan?
A.4. According to the Treasury International Capital (TIC) data
collected by the U.S. Department of the Treasury, mainland
China and Japan held $1.16 trillion and $0.88 trillion of U.S.
Treasury securities, respectively, as of December 2010.
Q.5. Given that QE2 is not yet halfway finished, what do you
think will happen to the demand for Treasuries over the next
few months?
A.5. U.S. Treasury securities are widely regarded as a safe and
highly liquid financial instrument in global fixed income
markets. The global demand for U.S. Treasury securities is
likely to remain solid over coming months.
Q.6. Are you concerned that since QE2 other central banks and
purchasers of Treasury securities have scaled back their
purchases?
A.6. The Federal Reserve's purchases have been largely
concentrated in previously issued Treasury securities. As a
result, global investors have continued to be the primary
source of demand for new Treasury securities. Demand at recent
U.S. Treasury auctions has been solid, and market participants
generally do not appear to be anticipating any significant
waning in the global demand for Treasury securities over coming
months.
Q.7. What, in your mind, are the potential long term risks with
the QE2 strategy?
A.7. The Federal Reserve's asset purchase program is intended
to put downward pressure on long-term interest rates. Lower
long-term interest rates reduce the costs of borrowing for
households and businesses and boost asset prices, thereby
providing impetus to spending. The potential risks associated
with this program are similar to the risks associated with
monetary policy stimulus provided with conventional monetary
policy tools. An accommodative policy stance that is maintained
for too long could result in excessive growth in aggregate
demand that would put upward pressure on prices, and could, if
unchecked, result in an increase in long-term inflation
expectations that could prove costly to reverse. The Federal
Reserve will need to continue to monitor economic developments
very carefully and can change policy if that is warranted, just
as it can change interest rate policy using conventional
monetary policy tools.
Q.8. How can we be confident that those who used to purchase
Treasury securities, but have withdrawn due to the dramatic
increase in Federal Reserve purchases, will return once QE2 is
ended?
A.8. The Federal Reserve purchased $300 billion of Treasury
securities in 2009, and markets adjusted readily to the
conclusion of that program. In addition, the Federal Reserve
purchased $1.25 trillion of agency MBS over 2009 and the first
quarter of 2010, and markets again adjusted smoothly to the
conclusion of that program. The level of activity in Treasury
markets currently remains very high and the Federal Reserve's
asset purchases represent only a modest proportion of total
trading volume in U.S. Treasury securities. I see no reason to
question the view that market participants generally expect a
smooth conclusion to the Federal Reserve's current asset
purchase program. Moreover, forward 10-year yields at horizons
beginning beyond June do not suggest that investors see any
special strains associated with the conclusion of the asset
purchase program, and uncertainty about long-term Treasury
yields embedded in options prices has actually moved lower over
recent weeks.
Q.9. What are the implications of the Federal Reserve being the
chief purchaser of our Nation's debt?
A.9. Since the stated intention of the FOMC is to continue the
high level of purchases on a temporary basis and to unwind the
holdings after that, I see no long-run implications of this
program and a short-run implication of helping the economic
recovery. Of course, care must be taken to monitor the economy
to make sure the policy remains appropriate while it is in
effect.
Q.10. In an Op-Ed entitled, ``Health Care for Everyone'', you
suggested bundling families together into groups which private
insurance companies would provide coverage too in the way that
Fannie Mae and Freddie Mac bundle individual mortgages
together. You have supported the bailouts of the megabanks
during 2008 and the President's ``stimulus'' effort. Can you
cite some instances where you don't believe that direct
intervention of the Federal Government is the best policy
answer?
A.10. Like most American economists, I begin with the
presumption that the basic system of free enterprise is the
most efficient way to organize economic activity. One of the
great strengths of the American economy is the widely shared
understanding that markets work and work well. Absent
compelling evidence of market failure, intervention by the
Federal Government would not benefit our economic functioning.
Indeed, our own governmental experience--and much of the
academic literature published during the past century--can be
seen as working to identify and refine a list of conditions in
which Government intervention might be capable of improving a
purely market-based outcome. By now, the basic outlines of
those conditions are well understood. Unless a given situation
meets a well-understood test of market failure, most economists
would counsel against Government intervention, and I share that
consensus view. For example, policies of Government price
regulation in competitive settings do not enhance market
efficiency.
Q.11. On National Public Radio last October you said that
investing in public works is worth the risk of increasing the
deficit. Despite the fact that we are facing our third trillion
dollar deficit in American history and in December Moody's
warned that it may downgrade the U.S. credit rating do you
still feel that investing in public works is worth the risk?
A.11. Projections of U.S. debt show an unsustainable path, and
I strongly favor putting in place reforms that would move the
U.S. to a sustainable fiscal path. Investing in public works,
done right, can be an economically smart decision because the
benefits of a well-designed investment can far outweigh the
costs, thereby contributing to long-term economic growth. In
light of the fiscal pressures that the country faces, it is
important that each commitment of taxpayer resources be
undertaken with careful thought to both costs and benefits.
Moreover, while unemployment remains very high, it is
particularly advantageous to put in place reforms that address
the long-term trajectory of the debt while avoiding a
combination of actions that risk slowing or reversing the
current economic recovery.
Q.12. Mr. Diamond, as you may be aware, since the Federal
Reserve lowered the Federal Funds rate to ``0 to \1/4\
percent'' the FOMC statement has included the following
statement, the Fed ``continues to anticipate economic
conditions . . . are likely to warrant exceptionally low levels
of the Federal funds rate for an extended period of time.'' Do
you support the continued inclusion of that sentence in future
FOMC statements?
A.12. I have not been part of the FOMC and have not received
the detailed evaluations of the performance of the economy that
members of the FOMC receive. If confirmed I will have an open
mind to evaluate policies in light of the information and
discussion that surrounds and occurs at FOMC meetings. While
labor market conditions have improved somewhat of late, the
unemployment rate remains very high and underlying inflation
has declined over the last 2 years and is currently at a low
level. Thus, I consider it worthwhile to encourage investments
in both consumer durables and production assets. Sustaining low
levels of the Federal funds rate for an extended period is one
way to encourage such investments. As the economy recovers, the
statement language will eventually need to change to be
consistent with the Committee's developing assessment of the
economic outlook and the appropriate stance of monetary policy.
Q.13. Would you vote against the inclusion of that sentence at
the next meeting of the FOMC?
A.13. Without the benefit of participating in previous FOMC
discussions of this issue, and without the information and
discussion that will occur in the next FOMC meeting, I cannot
say how I would vote if I did attend the next meeting. The
evolution of the sentence noted, along with many other elements
of the stance of policy, must be carefully evaluated in light
of changes in the economic outlook.
Q.14. Many economists believe that dropping the ``extended
period'' language from the FOMC would provide a crucial signal
to the markets that the time of excessive, cheap liquidity will
be coming to an end soon. What would it take for you to support
removing that sentence from the FOMC statement?
A.14. The extended period language and other aspects of the
current stance of policy reflect the current view of the FOMC
on the needs of the economy. As such they will need to be
adjusted as there are changes in the FOMC's assessment of the
outlook for its dual mandate of maximum employment and price
stability. Since the Committee, appropriately evaluates a very
wide range of economic data in making its assessment, and I
have not been party to the range of assessments considered at
FOMC meetings, it is not possible to state precisely what
changes in which variables would make a specific adjustment to
the statement seem appropriate.