Chairman Sarbanes, Senator Gramm, and members of the Committee, I am deeply honored to appear before you today as the President's nominee to serve on the Board of Governors of the Federal Reserve System. If I am confirmed to this important position, I will do my utmost to advance the economic well-being of all Americans.
The opportunity to serve at the Federal Reserve would be a great privilege, as it would allow me to apply in the public interest the fruits of a lifetime of thinking and writing about central banking and the economy. In my academic career of nearly twenty-five years, I have written widely on topics relating to monetary policy, banking and credit markets, economic growth and business cycles, macroeconomic history, and the statistical analysis of the economy, all of which bear directly on the work of the Federal Reserve. Moreover, over the years I have maintained close contact with the Federal Reserve System, as a consultant, visiting scholar, and advisor; and I have visited and advised the central banks of many other industrialized and developing countries.
In various roles during my career, I have also learned how to work with people and to get things done. Among other duties, I have served for the past six years as chair of the Princeton University economics department. I also served as the first Director of Princeton's new center for the study of financial markets; as the Director of the Monetary Economics program of the National Bureau of Economic Research; as the editor of the economics profession's leading research journal; and-last, but certainly not least-as a two-term elected member of the Montgomery Township (New Jersey) Board of Education.
One of the remarkable features of the Federal Reserve System is the wide range of its responsibilities, including not only the making of monetary policy but other important areas such as financial regulation and supervision, consumer protection, payments systems, international finance, and others. Although at present my greatest expertise is in monetary policy and macroeconomics, I am keenly interested in and broadly familiar with each of the Fed's other areas of responsibility, and if I am confirmed I look forward to learning a great deal more. I particularly look forward to interacting with, and learning from, both colleagues on the Board and the Federal Reserve's able staff.
Let me turn briefly to issues of policy and the current economy.
The Federal Reserve has considerable operational independence but ultimately derives its legitimacy and powers solely from its legislative mandate. I would like to take this opportunity to strongly affirm my support for the monetary-policy goals set for the Federal Reserve by Congress in the Federal Reserve Act: maximum employment, stable prices, and moderate long-term interest rates. While one can always hope to do better, I think the Federal Reserve has on the whole done a remarkably good job of promoting these three objectives over the past twenty years or so.
In my view, a key operational element in the Fed's success at achieving its tripartite objective has been the Federal Open Market Committee's emphasis on keeping the rate of core inflation low and stable. Low and stable inflation is intrinsically beneficial, as it reduces the need for households and firms to expend time and resources to protect themselves from the adverse effects of rapidly and erratically changing prices. Consistently low inflation also directly promotes the objectives of high employment and rapid economic growth, by providing a stable monetary environment in which firms and markets can function most efficiently. In a low-inflation environment, lenders are less concerned about erosion of their principal, and so nominal interest rates tend to be low. Finally, a strong commitment to low and stable inflation, by moderating and anchoring the public's inflation expectations, actually enhances the ability of monetary policy to respond actively to short-run economic disturbances when necessary. For example, during the past year the Federal Reserve was able to cut interest rates quite aggressively without engendering significant inflationary pressures or igniting a wage-price spiral. Public confidence that inflation would be kept under control was essential to giving the Federal Reserve this heightened flexibility.
In my academic writings, I have argued that the efficacy of monetary policy at achieving its mandated objectives could be further improved by the Fed's adoption of an approach known as inflation targeting. In anticipation of possible questions, let me say a bit more about this proposal. The main operational change under inflation targeting would be that the Fed, in consultation with the executive and legislative branches, would announce an explicit numerical objective core inflation over the medium term, say one to two years. For example, allowing for the upward biases in inflation measurement and a zone of safety to avoid accidental deflation in prices, an inflation target in the range of 1-2% per annum for the core PCE deflator might be a good initial choice, although some might reasonably disagree about either the number or the choice of index. As part of the targeting process, the Federal Reserve would report to Congress its expectations for future inflation, its reasons for any target misses, and its projected trajectory for bringing inflation to its targeted level.
It is important to stress that inflation targeting, as I interpret it, would not represent a major departure from the current practice of U.S. monetary policy or a change in policy objectives. Rather, its primary goal would be to build on policy successes of the past two decades by strengthening the Federal Reserve's institutional commitment to the approach used by the Fed under Chairman Volcker and Chairman Greenspan. As I discussed a moment ago, the centerpiece of this approach is an emphasis on keeping the rate of core inflation low and stable. Based on the experiences of a number of other countries that have adopted this model, I believe that an explicit inflation target would improve further the Fed's ability to reach all three of the goals set forth in the legislative mandate for monetary policy. Among the potential advantages of an explicit inflation target are increased stability of the public's inflation expectations, lower economic and financial uncertainty, increased central bank credibility, greater continuity and consistency of policy, and, importantly, enhanced accountability of the Fed. Although I am favorably disposed toward these incremental changes in the current framework of U.S. monetary policy, I know that not everyone agrees with this view, and that there are important, substantive arguments to be made on both sides of the issue. I look forward to discussing these ideas with Federal Reserve colleagues and others interested in the making of monetary policy.
Turning finally to the current economic situation: In recent months, investors have been battered by sharp declines in equity prices, not only in the United States but in many other countries as well. The losses in wealth are large and serious indeed. Equally serious and disturbing is the rash of corporate and accounting scandals that have certainly played a role in the stock market's plunge. Financial markets cannot do their job of efficiently allocating capital and sharing risk if investors do not feel that they are receiving accurate and timely information, or if they fear that those who should be stewarding their funds cannot be trusted to do so honestly. I fully support the efforts of Congress and the President to restore investor confidence in the accuracy and reliability of financial statements and in the trustworthiness of those who manage our corporations and financial institutions.
Although the fall in equity prices is frightening and dispiriting for many, I do think distinctions need to be made. Saturation coverage by cable-TV networks notwithstanding, the stock market is not the whole economy. While the gyrations of the Dow or NASDAQ attract the most attention, the broader economy-as reflected in the daily activities of American workers, managers, business owners, and entrepreneurs-has overcome a significant part of the effects of last year's recession and the September 11 terrorist attacks, and by most indications is continuing to grow. Most impressive is the fact that worker productivity continues to expand rapidly-at more than an 8% rate in the first quarter-despite adverse cyclical conditions. New capital and innovative technologies have both played an important role in this resurgence. To be sure, the cumulative decline in the stock market poses risks for economic growth over the rest of the year. Despite our current difficulties, however, we should not lose sight of the underlying strength of our economy.
To conclude, I am grateful for this opportunity to appear before this committee. These are indeed challenging times for the United States, for our economy, and for the Federal Reserve itself. I look forward to contributing to the making and implementation of sound economic policies. If I am confirmed, I will devote myself to becoming a constructive and effective member of the Board of Governors of the Federal Reserve.
Thank you. I will be pleased to answer any questions.
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