[House Hearing, 111 Congress]
[From the U.S. Government Publishing Office]
THE ECONOMIC OUTLOOK AND BUDGET CHALLENGES
=======================================================================
HEARING
before the
COMMITTEE ON THE BUDGET
HOUSE OF REPRESENTATIVES
ONE HUNDRED ELEVENTH CONGRESS
FIRST SESSION
__________
HEARING HELD IN WASHINGTON, DC, JANUARY 27, 2009
__________
Serial No. 111-1
__________
Printed for the use of the Committee on the Budget
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COMMITTEE ON THE BUDGET
JOHN M. SPRATT, Jr., South Carolina, Chairman
ALLYSON Y. SCHWARTZ, Pennsylvania PAUL RYAN, Wisconsin,
MARCY KAPTUR, Ohio Ranking Minority Member
XAVIER BECERRA, California JEB HENSARLING, Texas
LLOYD DOGGETT, Texas SCOTT GARRETT, New Jersey
EARL BLUMENAUER, Oregon MARIO DIAZ-BALART, Florida
MARION BERRY, Arkansas MICHAEL K. SIMPSON, Idaho
ALLEN BOYD, Florida PATRICK T. McHENRY, North Carolina
JAMES P. McGOVERN, Massachusetts CONNIE MACK, Florida
NIKI TSONGAS, Massachusetts K. MICHAEL CONAWAY, Texas
BOB ETHERIDGE, North Carolina JOHN CAMPBELL, California
BETTY McCOLLUM, Minnesota JIM JORDAN, Ohio
CHARLIE MELANCON, Louisiana CYNTHIA M. LUMMIS, Wyoming
JOHN A. YARMUTH, Kentucky STEVE AUSTRIA, Ohio
ROBERT E. ANDREWS, New Jersey ROBERT B. ADERHOLT, Alabama
ROSA L. DeLAURO, Connecticut, DEVIN NUNES, California
CHET EDWARDS, Texas GREGG HARPER, Mississippi
ROBERT C. ``BOBBY'' SCOTT, Virginia
JAMES R. LANGEVIN, Rhode Island
RICK LARSEN, Washington
TIMOTHY H. BISHOP, New York
GWEN MOORE, Wisconsin
GERALD E. CONNOLLY, Virginia
KURT SCHRADER, Oregon
Professional Staff
Thomas S. Kahn, Staff Director and Chief Counsel
Austin Smythe, Minority Staff Director
C O N T E N T S
Page
Hearing held in Washington, DC, January 27, 2009................. 1
Statement of:
Hon. John M. Spratt, Jr., Chairman, House Committee on the
Budget..................................................... 1
Hon. Paul Ryan, ranking minority member, House Committee on
the Budget................................................. 2
Douglas Elmendorf, Ph.D., Director, Congressional Budget
Office..................................................... 4
Prepared statement of.................................... 7
Alice M. Rivlin, the Brookings Institution and Georgetown
University................................................. 44
Prepared statement of.................................... 46
Mark Zandi, chief economist and cofounder, Moody's
Economy.com................................................ 52
Prepared statement of.................................... 54
Supplemental statement of................................ 55
Laurence H. Meyer, vice chairman, Macroeconomic Advisers..... 72
Prepared statement of.................................... 73
Kevin A. Hassett, senior fellow and director of economic
policy studies, American Enterprise Institute.............. 75
Prepared statement of.................................... 78
THE ECONOMIC OUTLOOK
AND BUDGET CHALLENGES
----------
TUESDAY, JANUARY 27, 2009
House of Representatives,
Committee on the Budget,
Washington, DC.
The committee met, pursuant to call, at 10:05 a.m. in room
210, Cannon House Office Building, Hon. John Spratt [chairman
of the committee] presiding.
Present: Representatives Spratt, Schwartz, Kaptur, Doggett,
Blumenauer, Boyd, McGovern, Tsongas, Etheridge, McCollum,
Andrews, Edwards, Langevin, Larsen, Bishop, Connolly, Schrader,
Ryan, Hensarling, Diaz-Balart, Simpson, Campbell, Jordan,
Nunes, Aderholt, Lummis, Austria, and Harper.
Chairman Spratt. I will call the hearing to order.
Today's hearing comes at a time of severe economic
distress. Unemployment is at a 16-year high. In 2008 alone, 2.6
million jobs were lost. And each week seems to bring even more
gloomy economic news. Whether one looks at the housing starts
or foreclosure statistics or the balance in retirement plans,
there is bad news all around us.
One role of this committee, a traditional role, is to keep
an eye on the bottom line. But getting the economy back on
track must take priority in this instance over getting the
deficit down. We simply cannot afford to let this economy get
away from us, so we must do what is necessary to boost a
weakening economy.
At the same time, over the long run, we must also find a
way to get the budget back on an even keel, on the path to
being balanced again. And that, too, is part of our challenge
today, to find some way to thread that narrow needle, serving
the immediate interest of the country but also laying the
foundation for the recovery and stabilization of the budget and
the economy at this point in time.
Congress is at work on a plan as we speak to provide a
substantial boost to the economy in the form of a strong
economic recovery package. Both Congress and the Obama
administration are looking at other steps that may be needed to
stabilize the economy. Charting the right steps begins with an
understanding of the economy, and that is the purpose of our
hearing today.
As we continue our efforts to understand where things stand
with the economy today and where things are headed, we are
fortunate to have a very distinguished group of witnesses
before us today. We will hear first from our new CBO director,
Dr. Douglas Elmendorf.
This, I believe, Doug, is your first appearance as a
witness for CBO.
Mr. Elmendorf. Yes, sir.
Chairman Spratt. We are glad to have you and glad to have
you at the helm in particular.
Mr. Elmendorf. Thank you.
Chairman Spratt. When this committee met last week, we
recommended to the Speaker of the House that Dr. Elmendorf
become the next CBO director. Thursday afternoon Speaker Pelosi
and Senate Pro Tempore Harry Reid appointed him to that
position.
So we welcome Dr. Elmendorf, and we congratulate him.
We also want to acknowledge the hard work of Bob Sunshine.
Bob, stand up please.
[Applause.]
Chairman Spratt. Over the last couple of months and in
prior years as well, he has acted as acting director of the
CBO, and as Alice Rivlin just reminded us in the back of the
room, he was there when she was first there; he was there at
the creation. And we have been fortunate to have him in his
position as deputy director since 2007.
We are grateful to you, Bob, for your able work in the
transition period and in particular for your service as the
acting director.
On a second panel, we will hear from a number of
distinguished economists: Dr. Alice Rivlin was the founding
director of CBO and served as OMB director under President
Clinton, and she currently serves as a senior fellow at
Brookings. We will also hear from Dr. Mark Zandi, who is the
chief economist and cofounder of Moody's Economy.com; Dr.
Lawrence Meyer, who is a former member of the Board of
Governors of the Federal Reserve, currently vice chairman of
Macroeconomic Advisers; and Dr. Kevin Hassett, who is resident
scholar and director of economic studies at AEI.
But before turning to our witnesses, let me turn to Mr.
Ryan for any opening statement he may wish to make.
Mr. Ryan. Thank you, Mr. Chairman.
I also want to extend a warm welcome to our new CBO
director, Doug Elmendorf.
And I also want to say to Bob Sunshine, thank you for your
service. You did a fantastic job extending the objectivity and
integrity of the Congressional Budget Office during your
tenure. So thank you, Bob.
The need for today's hearing is obvious. Job losses are
mounting each day, and we get fresh evidence of the fact that
we are in the midst of a near economic downturn. Just yesterday
Caterpillar announced they are laying off 20,000 workers this
year.
Clearly, Congress must take action to address this
situation. The hard part is deciding what we should do. The
House will consider this week an $816 billion economic stimulus
legislation advertised as a focus plan to get the economy back
on track and create jobs.
But upon closer examination, it looks more like a
sprawling, bloated spending bill that comes with a huge price
tag with little evidence it will actually have any immediate
impact on our economy.
Please go to chart number 1. Under the guise of stimulus,
this bill includes funding to buy cars for Federal employees,
renovate Federal buildings and bulk up the National Endowment
of the Arts.
Please go to chart number 2. Even if it produces the 3
million jobs that are being claimed by the administration, it
will cost $275,000 per job. Compare that to the average income
of an American or the tax bill that he or she will pay. They
are the ones that will ultimately foot this bill.
According to CBO's data, it will have little impact in the
short run, with only 15 percent of the spending occurring this
year.
Congress should be focusing its efforts on proven, fast-
acting methods for sparking job creation. And frankly, I am not
at all encouraged by the track record of these Keynesian fiscal
stimulus plans. The advertised benefits of government spending
simply fail to play out in reality. The most direct and cost-
effective way to get the economy back on track quickly is to
boost tax incentives for private businesses to expand and
create more jobs. Private capital in investment, not government
borrowing and spending, is the key to restarting the engine of
sustainable job growth in this country.
That is why I am disappointed to see that less than 3
percent of the current economic stimulus package is
specifically aimed at encouraging private sector investment
through tax incentives.
There is a great deal of fear and uncertainty in the
markets right now. A lot of private capital is on the side
lines, and many business investment plans are frozen. This is
not only due to the uncertain economic environment but also to
the highly uncertain tax policy environment. And this is
something Congress can and should address. Big tax hikes on
work, savings, and investment are now less than 2 years away.
At the end of next year, when these tax increases are
slated to come on line, CBO tells us that the unemployment rate
will be at 8.5 percent, which would be the highest jobless rate
in more than 25 years. The huge spending in this package will
inevitably lead to cause for even more tax increases. Allowing
job-killing tax hikes to hit a still weak economy would be
sheer folly.
If we want to help this economy, we can start right now by
giving workers, investors in businesses the certainty that
Congress will not raise their taxes during this period of
economic weakness. Our short-term reaction to the current
economic crisis must not cloud the proven long-term economic
strategies that should guide our recovery and help secure our
renewed prosperity. Instead of the big government borrow, spend
and consume approach of this bill, we should pursue incentives
to put private sector capital to work to create permanent
growth and job creation.
I hope we can learn more today about the effectiveness of
this bill to address our economy. And I look forward to the
witnesses' testimonies, and I yield back the balance of my
time.
Chairman Spratt. Thank you, Mr. Ryan.
Before getting underway, just a couple of housing keeping
details.
First of all, I ask unanimous consent that all members be
allowed to submit an opening statement for the record at this
point.
Without objection, so ordered.
We welcome before the committee our distinguished new
director of the CBO, Dr. Douglas Elmendorf.
I already had the opportunity to read your testimony last
night. There is a lot of good stuff there. All of your
testimony and all of the witnesses' testimony which has been
filed will be made part of the record. You can summarize as you
see fit, but I encourage you to take your time and walk us
through it because there is a lot of very substantive
information and material and analysis in your testimony.
The floor is yours, sir.
STATEMENT OF DOUGLAS ELMENDORF, PH.D., DIRECTOR, THE
CONGRESSIONAL BUDGET OFFICE
Mr. Elmendorf. Thank you, Chairman Spratt, Ranking Member
Ryan, and members of the committee.
I am very pleased to be here today to talk with you about
the state of the U.S. economy and policy options for improving
it. I am especially happy to be here today in my first
testimony as director of the Congressional Budget Office.
I would like to make just three points drawing from the
written testimony. First, in the absence of any changes in
fiscal policy, the U.S. economy is likely facing its most
severe downturn since the Depression of the 1930s.
Second, the bleakness of the economic and financial outlook
has lead the great majority of economists to think that both
large-scale fiscal stimulus and significant new monetary and
financial policies are appropriate and needed to generate a
strong recovery in the next few years.
Third, in CBO's estimation, the American Recovery and
Reinvestment Act of 2009, H.R. 1, would provide a significant
boost to output and employment.
Let me elaborate on these points in turn. First, CBO
projected in early January that in the absence of changes in
fiscal policy economic activity will contract more sharply in
2009 than it did in 2008 and will expand only moderately in
2010. As a result, the shortfall in the Nation's output
relative to its potential, what could be made if we were using
all of our resources fully, will be the largest shortfall in
terms of both length and depth since the Depression. Lost
output will represent nearly 7 percent of potential output in
both 2009 and 2010, amounting to about $1 trillion of lost
output each year and would be almost 5 percent of potential
output in 2011.
Payroll employment declined by 2 and a half million jobs
last year. And CBO projects that, again, without further
action, even more jobs will be lost this year. The unemployment
rate increased by more man 2 percentage points last year,
reaching 7 and a quarter percent and is projected to peak above
9 percent next year.
Data released after this forecast was finalized in mid-
December have been generally consistent with our forecast. In
the financial system, recent data signaled that the improvement
in conditions that began in October have continued thus far
this winter.
Still, for many borrowers credit remains much more
difficult and expensive to obtain today than it was in 2007.
Risk spreads on most types of private lending remain very
elevated. And concern about the health of financial institution
remains widespread.
Meanwhile, data on the wider economy confirm the consensus
assessment that the economy is in sharp decline. The economy
shed more than half a million jobs last month. The unemployment
rate jumped up. Industrial production, our manufacturing output
essentially, fell 2 percent in December, and capacity
utilization and manufacturing reached its lowest level since
1983. Housing construction continues to drop sharply, and real
business spending on equipment and software appears to have
fallen at more than a 20 percent annual rate in the fourth
quarter.
My second point is that the expected severity and
persistence of economic weakness have lead the great majority
of economists to think that both fiscal stimulus and additional
financial monetary policies are needed at this time. As the CBO
has said before, fiscal stimulus policies are most effective if
they are timely, occurring during the period of economic
weakness; are cost-effective, providing the greatest possible
economic impact per dollar of budgetary cost; and do not
exacerbate the Nation's long-run fiscal imbalance.
Moreover, the macroeconomic impact of stimulus is not the
only consideration in designing it. Policymakers and members of
the public clearly care also about who will be helped directly
by the spending increases or tax cuts in addition to all of the
people who will be helped indirectly through a stronger
economy. And they care about what goods and services society
will receive in exchange for the money involved.
Constructing a stimulus package that both is effective in
spurring economic activity and satisfies broader objectives
about who benefits and what society receives in exchange is
very challenging.
Third, H.R. 1 is a massive fiscal stimulus. According to
estimates by the CBO and Joint Committee on Taxation, the
legislation would widen the Federal budget deficit by $170
billion this fiscal year; $356 billion in fiscal year 2010;
$174 billion in fiscal year 2011; and a total of $816 billion
between now and 2019. Details of this cost estimate were
released last night and are on the CBO Web site, and I am happy
to talk about them if you have questions.
The bill includes direct payments to individuals,
reductions in Federal taxes and purchases of goods and services
directly by the Federal Government and indirectly via grants to
State and local governments.
For the payments to individuals and reductions in Federal
taxes, the macroeconomic impact would occur fairly rapidly.
For purchases of goods and services, CBO has estimated
fairly slow initial rates of spending. Of course, these
estimates may turn out to be too low or too high. But here is
why they are as low as they are:
First, the usual process for drafting plans, soliciting
bids and entering into contracts, makes typical spending rates,
the ones we see year in and year out, much slower than one
might think.
Second, enactment of this legislation would occur nearly
halfway through fiscal year 2009. The numbers that we report
for what may appear to be the first year are actually for the
first half-year.
Third, a number of programs in this legislation would
receive funding significantly above their current allocations.
In the past, in all types of Federal programs, a noticeable lag
has occurred between sharp increases in budget outlays, budget
authority, and the resulting increase in outlays.
Fourth, some programs would be essentially brand new. In
this case, agencies would need to develop procedures and
criteria, issue regulations, and review plans and proposals
before money can be distributed.
All that said, CBO estimates that roughly 21 percent of the
total budgetary amount would go out in the next half of fiscal
year 2009 and nearly half next year, for a total over the next
year and a half of roughly two-thirds.
The macroeconomic impacts of any economic stimulus program
are very uncertain. CBO has developed a range of the estimates
of the effects of H.R. 1 on GDP and unemployment that
encompasses a majority of economists' views in our judgment.
According to this analysis, the legislation would have the
following effects relative to our baseline forecast:
In the fourth quarter of 2010, GDP would be higher by 1.2
to 3.5 percent. Employment would be higher by 1.2 to 3.6
million jobs. And the unemployment rate would be lower by .6 to
1.9 percentage points.
In the fourth quarter of 2011, the positive effects in
output and employment would be smaller but still significant
because the spending out of authorized money will be going on
and because the tax changes and some of the mandatory spending
changes will still be in effect.
Thank you, that concludes my prepared comments, and I am
happy to take any questions that you have.
[The prepared statement of Mr. Elmendorf may be obtained at
the following CBO Internet address:]
http://www.cbo.gov/ftpdocs/99xx/doc9967/01-27-StateofEconomy--
Testimony.pdf
Chairman Spratt. Dr. Elmendorf, you have on your testimony
figure one, do you have an electronic copy of that?
Mr. Elmendorf. I do not have it with me, no, sir. I have a
copy I can look at, but I don't have one that I can----
Chairman Spratt. Let me just repeat the numbers you have in
your testimony. To measure the worth and value and
effectiveness of the stimulus program that is now being
packaged and put together to be brought to the floor tomorrow,
one critical way to look at it is what is potential GDP if the
economy were running more or less on even keel, and what is
actual GDP?
Could you sort of translate this chart to us here? What is
the difference today between the gap, performance gap, between
actual GDP and potential GDP if the economy were running in a
stable condition?
Mr. Elmendorf. The potential GDP is a concept economists
use to estimate the output the economy would produce if labor
and capital resources were essentially fully employed. So when
the unemployment rate rises or capacity utilization falls,
output, actual output, is falling below potential output. CBO's
estimate is that without any additional fiscal policy, that
shortfall, the difference between what we could be producing
and what we will be producing will be nearly a trillion dollars
in 2009 and again in 2010.
Chairman Spratt. Each year, a trillion dollars?
Mr. Elmendorf. Each year, and will remain very large in
2011. It is worth emphasizing here that people talk about the
dates of a recession. The way that the National Bureau of
Economic Research traditionally defines ``recessions'' is the
period in which the output of the economy is falling. So if
output turns back up next year some time, the NBER would
consider that to be the end of the recession. But the shortfall
in output from the potential output level will still be quite
large. We are making a big gap, and when we turn the economy
back around again, it will take a considerable amount of time
before actual output rises back to potential output, before the
unemployment rate falls back down to a more standard rate of
unemployment. We have seen that coming out of the last two
recessions, much milder recessions than we are enduring now,
but nonetheless it has taken some time after the official end
of the recovery for the unemployment rate to fall back down
again.
And the principal way to think about that is the actual
output may be rising, but it is still well below the level of
potential. And until it catches up again, we will not see
unemployment back down to its traditional level, and we will
not see employment back up to what it should be.
Chairman Spratt. And potential GDP is not optimum GDP; it
is a reasonable expectation at a normal----
Mr. Elmendorf. Yes. It does not assume completely full
employment. In CBO's case, it assumes an unemployment rate of
about 4 and three-quarters percent, which seems consistent
with--I think 4 and three-quarters percent, which seems
consistent with what we observed in the past as the lowest
sustainable rate of unemployment.
Chairman Spratt. Now, looking at the value of the return
over time, the benefit stream that accrues from the plan, is it
proper to look at the flow over time more than 1 year, not just
next year and the following year, but if it is education, for
example, or if it is infrastructure, it has some lasting
economic productivity improvement?
Mr. Elmendorf. Yes, so there are really two issues there.
The first thing is to say, because this GDP gap will persist
for a number of years, fiscal stimulus to try to narrow that
gap would be appropriate in the minds of a wide majority of
economists for a number of years, not just in 2009 and 2010.
A broader point I think you are making, Mr. Chairman, is
that investments that are made in the economy today will reap
benefits potentially for many years to come. And those
investments can be in the form of physical capital, highways,
broadband, water supplies, or it can be in the form of what
economists call human capital, which are the education and
skills of the workforce.
Chairman Spratt. Now, towards the end of your testimony,
you say all of these things need to be taken into account,
including the long-term impact of having substantial deficits.
And you warn against the accumulation of substantial deficits
beyond the immediate situation. Could you elaborate on that
just a bit, because I think it is very worthwhile testimony.
Mr. Elmendorf. Yes, as you know, the long-run fiscal
imbalance of this country under current policies is quite
severe. If that imbalance is worsened, that has a number of
consequences. One consequence is that, over time, that
government borrowing crowds out a certain amount of private
investment and leaves the economy poorer as a result.
A further possible problem is that anticipation of
government borrowing can push up interest rates. At the moment,
interest rates in the United States on risk-free assets like
Treasury securities are fairly low because foreign capital
views us, despite all of our current problems, as a relatively
safe haven in the world. So interest rates are low because
foreign capital has come to this country.
If we make the long-run fiscal situation worse in the eyes
of people, investors around the world, and they are more
worried about our long-run future and withdraw some of those
funds or stop sending additional funds here, then that could
push up interest rates in the near term and have a detrimental
effect on economic activity now.
I do not think, and most economists do not think, that is a
very large risk at the moment because of the flight to safety
that we see in times of crisis. But I think most economists
would judge that to be an increasing risk as we come out of
this recession in several years. If there isn't a sense at that
point that the long-run fiscal problems are being addressed,
there is a bigger risk at that point of more fear and then an
increase in U.S. interest rates.
Chairman Spratt. So the request before us is how to boost
the economy, pick it up out of the current slump, get it back
on track, but without worsening the long-term outlook for the
budget and, in particular, the deficit and debt accumulation.
Mr. Elmendorf. That is right. And that, as I said in the
testimony, is a challenging task.
Chairman Spratt. We have had recessions in the past. I
guess 10 recessions since the Second World War. Few have
elicited the kind of response we are seeing today. Is this
disproportionate? Are we overreacting? Or would we be risking
some serious downturn and loss of control of situation unless
we acted?
Mr. Elmendorf. I think you are absolutely right. We have
not seen fiscal stimulus on this scale proposed in these past
downturns. There are two reasons why most economists thought
that made sense then, but this makes sense now. One is that
this downturn looks to be more severe. The collapse of leading
financial institutions, the flight from risk-taking has choked
off credit that would normally flow to households and
businesses. Tremendous losses in household wealth are holding
down consumer spending and will do so for some time.
Our overbuilding of housing in the past half dozen years
means that, even at the low level of construction now, we have
more houses than people want, and it will take some time to
work that off. So housing will not provide support in the
recovery.
And moreover, the global economy is weakening. Forecasts of
foreign economic growth in 2009 have been marked down by two
percentage points just since last summer. So there are a number
of reasons why this recession will be particularly deep in most
economists' judgment and why the recovery will be slow in most
economists' judgment. The second general reason why most
economists favor larger fiscal stimulus now than they have in
past recessions is that monetary policy has done a lot already
to try to offset the weakness in the financial system and has
used up all of its principal tool, which is reductions in the
Federal funds rate, since that rate is now essentially at zero.
It does not mean they are out of tools. As Chairman Bernanke
has said very clearly, they have other tools, but these are
untested tools, and they face difficulty in implementation.
So economists see a more severe recession than we have had
in the past and less ability of the Federal Reserve to offset
that. And that has lead many people who did not support large
fiscal stimulus even a year ago to support it today.
There is uncertainty, of course, about these forecasts. CBO
aims to have an economic forecast and budget projections for
that matter for which the risks of the world turning out to be
better or worse are approximately balanced. But most economists
think that now the risk should not be viewed as balanced in a
policy sense because of the limitations on what the Federal
Reserve can do.
If the economy were to boom again, the Federal Reserve
could pull back on its special lending programs and it could
raise the Federal funds rate. If the economy were to turn out
much weaker than we expect, that would put even more pressure
on a Fed that, as I said, is already operating on very
unfamiliar terrain. That uncertainty and taking some insurance
against that uncertainty is a further reason that economists, I
think, on a widespread basis support large-scale fiscal
stimulus now.
Chairman Spratt. One final wrap-up question. In the past
recessions since the Second World War, we typically had certain
sectors that lead us in and lead us out of recession,
automotives, real estate, consumer expenditures. Today
automotives clearly are not going to lead us out of this
recession in their current condition. Real estate is
overhanging the market, and it is not going to lead us out of a
recession. As far as consumer expenditures are concerned, there
is a huge wealth effect, negative wealth effect, due to the
decline in real estate values, which is a principal asset that
households have, and businesses aren't likely to invest in this
kind of scenario, at least not in the near term. What else,
other than our intervention, would begin to give us a kick
start to get out of this slump and back on the road to
recovery?
Mr. Elmendorf. I think you summarized the headwinds very
aptly, Mr. Chairman.
And that is exactly why economists believe that some
combination of additional government demand for goods and
services and additional private demands spurred by tax
reductions are necessary at this time to put the economy back
on a path to recovery.
Chairman Spratt. Thank you very much, sir.
Mr. Elmendorf. Thank you.
Chairman Spratt. Mr. Ryan.
Mr. Ryan. Thank you, Chairman.
Dr. Elmendorf, the last time we had an administration that
believed fiscal spending stimulus was the way to go coming into
an economic downturn was in 1993 when the unemployment rate was
7.3 percent and the Clinton administration then was asking for
a $16 billion stimulus. Now, clearly, the economy is in worse
trouble today than it was then. Even though our unemployment
rate is not quite as high as it was at that specific time, we
believe it will get higher.
So the advocates of this particular stimulus bill say that
the goal here is to get the money out the door as fast as
possible. Let me ask you about that. According to your
analysis, how much of the spending in this bill, not the tax
cuts but the spending in this bill, which actually get spent in
year 1 and in year 2?
Mr. Elmendorf. According to our estimates on both
appropriations spending and the mandatory spending, 15 percent
of the spending would happen in the remainder of fiscal year
2009, essentially the next 7 months.
Mr. Ryan. Next two quarters.
Mr. Elmendorf. And then 37 percent would occur in the four
quarters of fiscal year 2010, for a total over the next six
quarters, not quite the same thing as 2 years, over the next
six quarters of 52 percent.
Mr. Ryan. So half of it is outside of the next six
quarters?
Mr. Elmendorf. Right.
Mr. Ryan. The administration's budget director, your
predecessor, contends at least 75 percent of the spending in
the bill will occur in the next year and a half. Now, CBO, we
pride ourselves here that CBO provides independent objective
analysis, but how do you account for the sizable disparity
between your estimates of spend-outs and the OMB's estimates?
Mr. Elmendorf. So the first thing, as I recall, what Peter
Orzag said it was 75 percent of the total dollars from the
package----
Mr. Ryan. So he was talking, he was throwing, including the
stimulus in with the spending----
Mr. Elmendorf. So I believe that the comparable number from
our estimates is 65 percent.
Mr. Ryan. So when you add the tax side of it, that moves
faster than the spending side of it, correct?
Mr. Elmendorf. Correct.
Mr. Ryan. So tax policy, as a rule of thumb here, is faster
deployed in the immediate term than spending policy.
Mr. Elmendorf. That is right, I think, in general. It
depends of course on the specific provisions. But, in general,
for this legislation, the tax provisions pay out faster than
the spending provisions.
Now, recall, though, that when I listed the criteria for
effective fiscal stimulus, timely was one of the criteria, and
the second one cost-effectiveness. And CBO judges and most
economists judge that a dollar of government outlay has a
larger effect on GDP than a dollar of tax cut for the simple
reason that the dollar of extra government spending goes
directly to demand for goods and services, whereas a dollar of
tax cut will be partly saved by households in general and
partly spent. Now depending on just what provisions are
changed, one can obtain different answers.
Mr. Ryan. There is a lot of great research from academics
around the spectrum on multiplier effects. It is clearly, you
know, we are not settled on that debate. I won't belabor that.
Let me ask you about assuming that this $816 billion
package is financed through borrowing, which obviously it will
have to be, what is CBO's estimate of the interest impact of
this bill over the next 10 years.
Mr. Elmendorf. As it turns out, I believe I have that
number here.
Mr. Ryan. We have been asking for it.
Mr. Elmendorf. So I think this letter, if I can actually
find it, yes, I think that you should be this morning in
receipt of our estimate of that. So we did a calculation, at
the request of Congressman Ryan, about the cost of additional
debt service that would result from enacting H.R. 1 under our
current economic assumptions and assuming that none of direct
budgetary effects of H.R. 1 are offset by future legislation.
Under those assumptions, we estimate that the government's
interest cost would increase by about a billion dollars in this
fiscal year and the total of roughly $350 billion over the next
11 years, 2009 to 2019.
Mr. Ryan. Three hundred and fifty? Three-five-zero?
Mr. Elmendorf. Yes, $347 billion.
Mr. Ryan. So we are in excess of a trillion dollar package
here when you count the additional costs.
Mr. Elmendorf. Traditionally the way CBO talks about the
effects of spending provisions, the way the Joint Committee on
Taxation talks about the effects of tax provisions, we talk
about the effect on non-interest spending and revenues. And the
reason for that, I think, is simply that what happens to the
interest costs depends on future policies that we are not
entitled to speculate about. So we report the direct effects of
this legislation.
Mr. Ryan. So we are talking about a $1.2 trillion total
cost when we count the interest into it.
Mr. Elmendorf. If you add up our estimate of interest cost
over the next 11 years with the estimate of the legislation,
which we put at $800 billion roughly, then you get your number.
Mr. Ryan. Thank you.
One other question, because I don't want to belabor this
stuff. We have all these other governments who are considering
the same kind of thing. I guess it is 1936 all over again, and
we are all Keynesians now. So Europe is taking about a big
fiscal stimulus along these lines. You name the country, most
of the industrialized world, China included, is talking about a
large fiscal stimulus which must be financed by borrowing.
So many of the world's nations are going to be going into
the credit markets at the same time. We are all going to go
into the credit markets with our bonds and try to finance this.
What in your opinion is going to be the effect on the yield
curves, on the price of borrowing, and how will that impact the
overall global economy?
Mr. Elmendorf. Most economists will tell you now that it is
advantageous to the global economy for significant fiscal
policy expansions around the world. You raise an important
question about where the funds will come from. I think the
answer to that question is that consumers and businesses are
pulling back in their spending. The essence of fiscal stimulus
is to provide demand for goods and services that private
households and businesses are not providing at this moment. So
the extra saving that they are doing will essentially provide
the funds for the borrowing the governments will be doing.
And the problem arises, as I mentioned earlier, several
years down the road if household and business spending is back
up again and conditions in credit markets, there are less funds
available, and if all of the governments around the world have
set themselves on permanent higher borrowing trajectories, then
I think that problem becomes more acute.
Mr. Ryan. In a number of months you are going to have to
give us another deficit projection. Your current deficit
projection is $1.2 trillion, but that is minus all the other
things we are going to pass just in a matter of weeks here. You
have this stimulus plan with your spend-out rates. You have got
an omnibus spending bill that is going to pass in a week or
two. You have got the supplemental spending, which I think is
something like $25 billion we are projecting. Adding up what
Congress is going to pass over the next few months, stimulus,
omnibus, supplemental, what is the deficit going to look like
this year, later this year?
Mr. Elmendorf. I have not done that calculation, but,
clearly, when you start at $1.2 trillion, if you add the
effects of this legislation under consideration now and other
things you have discussed, the numbers get very, very large.
Mr. Ryan. What kind of ball park do you think?
Mr. Elmendorf. I think if you take this legislation and add
it to the baseline, instead of being at $1.2 trillion, you are
at $1.4 trillion. The $1.2 trillion alone is more than 8
percent of GDP. I think it is entirely possible that when you
finish this year, the deficit will be 10 percent of GDP. That
is an absolutely stunning figure.
But it is also stunning that I sat here and reported our
forecast and we believe the consensus of forecasts that,
without fiscal action, we are entering the most severe downturn
in the lifetime of anybody in this room. And I think the
judgment of most economists is that very unusual circumstances
call for very unusual actions.
Mr. Ryan. I think we would agree; we may just not agree on
how best to achieve it. Thank you.
Chairman Spratt. Ms Schwartz.
Ms. Schwartz. I thank you, Mr. Chairman. And I thank you
for the first hearing of the committee, so we look forward to
an interesting and maybe challenging year before us.
Dr. Elmendorf, given what you have said and what we have
just heard, first, let me just maybe reiterate something that
we all know, but maybe we keep needing to be reminded of, we
are in a dramatically severe economic downturn. I think almost
every economist, as you point out, says we need strong, bold,
clear action. And I will say, what we are trying to do here is
to really take I think some of what you said, and I wanted to
have you elaborate on this, is that the answer here is not any
one single action, which makes maybe the recovery and
reinvestment bill that we are going to have before us to be
more complicated than some people might like.
The Republican side has suggested that there is too much
spending; we call it investment in both Americans and American
businesses. They prefer spending as much money, if not actually
more, but only in one direction, which is tax cuts for the
wealthy and tax cuts for businesses. I think I would like you
to speak to that as to whether that is actually, if we take
just that action, more tax cuts alone, $4 trillion is what they
are suggesting, which is far more than what we are suggesting
in this stimulus and the recovery plan, whether that single
action--actually, we have been doing that for 8 years--whether
that would actually turn this economy around.
Instead, I think what we are trying to do, and I want your
response to this, is to really take what is a substantial sum
of money--all of us are certainly well aware of $825 billion is
a serious, significant investment. But we are trying to do
three things. One is to relieve the burden on working families
that have been hard hit by this economic downturn. We are
talking about 95 percent of Americans getting an individual tax
cut, not a one-time rebate but an ongoing tax cut, that
hopefully will restore their confidence going forward; not a
one-time spending spree one week but actually on ongoing
confidence, education tax credit, the COBRA provisions in
helping families.
And secondly, we are trying to stem the job loss. You heard
the numbers. Yesterday we lost 65,000 jobs in one day. It is
stunning. We have to stem the job loss and begin to rebuild and
stimulate the economy to create jobs. We are doing that through
infrastructure spending. Business tax cuts are certainly an
important part of this package and investments in new
technologies, like green energy.
And the third area is that we are looking to really promote
the kind of investments that will create new jobs for the
future, health IT, information technology, energy efficiencies.
My question to you is, the balance between those three
really targeted ways of spending taxpayer dollars to stimulate
the economy to deal with the really tough situation that
Americans are in and to grow jobs for the future, my question
is, have we gotten the balance right in those three areas? And
do we need to spend all those dollars in 1 year, but don't we
need to actually build the confidence, as the chairman said,
over time to get investor and consumer confidence back up? But,
specifically, could you speak to the balance between these
three areas, tax cuts, serious investments and helping
Americans deal with a tough economy?
Mr. Elmendorf. So, naturally, I can't tell you whether you
have got that balance right. That is a judgment you all will
have to make.
Economists, as I said, are merely united in their
conviction that further fiscal policy actions are appropriate.
But they are much more divided about which actions, what sorts
of actions, should receive the greatest attention.
I think there are a number of reasons why you might choose
a combination of strategies. One is that different policies
have effects on a different time frame. The tax policies and
mandatory spending programs pay out faster, in our estimation.
The appropriations pay out more slowly. That doesn't mean in
fact that they are less useful. As I said at the beginning of
my testimony, we expect to have a very large shortfall in
output relative to potential in 2011. You don't really want to
have a policy that provides a lot of stimulus in 2010 and then
goes away overnight; that risks dropping the economy back into
a pothole.
So in an effort to have stimulus that affects the economy
now and next year and in 2011, you might find a collection of
policies that spend out at different rates to be appropriate.
I think a second reason a combination of policies makes
sense is that there is a lot of uncertainty around the effects
of every provision. We have made our best estimate drawing on
the wisdom of the profession, but to be clear, we don't have
any historical examples of this sort of condition and this
magnitude of fiscal stimulus. So any estimate that we offer you
will be very uncertain. And that is why I presented our numbers
as a very wide range. So the uncertainty is also a reason why
you might favor a combination.
I think a third reason, as I said, is that there are
different sorts of goods and services that are produced
depending on what legislation you pass. Legislation that only
cuts taxes will lead indirectly to the production of a lot of
household demanded goods and services. Legislation that
supports health insurance will lead to more health care being
delivered. Legislation that supports highway building or water
supply renovation will lead to better highways. So, ultimately,
there will also be, in addition to the macroeconomic stimulus
issues, there will be a value judgment about what sorts of
products society should be focused on.
Ms. Schwartz. But the concept of doing a combination, doing
a variety, and stimulating growth in a variety of sectors
rather than just picking one area is something you think will
benefit all of us.
The chairman wants us to move on.
Mr. Elmendorf. I think that makes sense for the timing
reasons and the uncertainty and the question of priorities.
Chairman Spratt. Mr. Hensarling.
Mr. Hensarling. Thank you, Mr. Chairman.
Dr. Elmendorf, in your testimony I believe you said that
CBO looked to the timing of the stimulus legislation, cost-
effectiveness, and that it be consistent with long-term fiscal
objectives. With respect to being cost-effective, we have now
learned that, I think what was billed as an $816 billion
stimulus package, if you add in the debt service, is really
over a trillion dollars.
But before we add in the debt service, which of course does
have to be paid, the proponents of this particular package I
believe have talked in terms of roughly three and a half
million jobs. And as the ranking member put up a chart, I
believe that if those figures are accurate, and since they come
from the proponents, I would assume they would be somewhat in
the mode of a rosy scenario, it comes up to $275,000 per job.
What is the definition of cost-effective by CBO standards?
Mr. Elmendorf. I think we need to be careful in counting
jobs. I think this has been an unfortunate drift in the public
debate toward number of jobs measured at some particular point
in time. What I think we all care about is the flow of jobs
over time. If we can devise a stimulus package that would put a
ton of money out there in the next 6 months, we might find a
big increase in employment relative to what otherwise would
occur. When the package ended, unemployment would fall right
back again. So when we talk about jobs, we have to be careful
not to pick out a particular year or quarter, but to look at
the flow over the next set of years that are affected by
legislation.
Mr. Hensarling. Dr. Elmendorf, has CBO modeled how many
jobs they expect to be created under this package?
Mr. Elmendorf. Yes, and we have----
Mr. Hensarling. How does that differ from the
administration's figures?
Mr. Elmendorf. Let me describe ours first. Our estimate is
that it costs about $140,000 worth of GDP to get an additional
job. How you get that much GDP, how much government spending or
tax cuts you need, depends on the multiplier effects. So you
take some amount of government extra spending or tax cuts,
apply a multiplier effect on GDP, and then from that you can
deduce effect on employment.
Our estimates are about $140,000 per job next year. I think
that is quite consistent, as best I can tell, with the
estimates with the cost per job of the estimates given by
Christie Romer and Jared Bernstein from the administration,
given by some private forecasts.
I think the difference in the forecasts----
Mr. Hensarling. That doesn't answer the question, Dr.
Elmendorf, and unfortunately, my time is running out.
Also in your testimony, again, you talked about a package
being consistent with our long-term fiscal objectives. We have
known that, over the last 2 years, the Federal deficit has gone
from roughly $160 billion to $1.2 trillion, I believe, in rough
figures, an increase of roughly 800 percent. That is before we
add on the cost of this particular package, which we now know
is over a trillion dollars. I assume that you have looked at
the experience of Japan in the early 1990s, their lost decade.
They attempted 10 different stimulus packages over 8 years;
their GDP did not increase. And I believe they took on the
highest per capita debt in the industrialized world, and their
per capita income went from second in the world to tenth in the
world. What can we learn from their experience?
Mr. Elmendorf. I think the principal lesson of the Japanese
experience, and I will be talking about this tomorrow in
testimony before the Senate Budget Committee, is that active
financial and monetary policies are a critically important
compliment to fiscal stimulus. And that is not an idiosyncratic
view of the CBO. I think that is a widely held view; one that,
as I mentioned here, that we need a combination in most
economists' judgment of fiscal stimulus and monetary, financial
policies.
I think the principal view looking back at the Japanese
experience is that they flubbed the financial rescue. Basically
they didn't face up to the extent of the problem. They ended up
papering over the problem in a way that just festered.
Mr. Hensarling. Dr. Elmendorf, how about our own lesson,
and you are speaking of monetary policy, but if we as policy
makers don't get it right--I don't think there is any debate
that we need a stimulus package. There is a debate on whether
or not we should be providing tax relief to families and small
businesses or growing government. But can a case not be made
that we sowed the seeds for this recession by public policy
decisions in the last one, particularly monetary policy, in
creating the easy money that allowed the housing bubble to
occur?
Mr. Elmendorf. In the judgment of most economists, the
principal policy error regarding the housing and financial
bubble was on the regulatory side.
There is some disagreement about when the Federal Reserve
should have stuck to a higher interest rate policy. If they
kept interest rates much higher, that would in fact have choked
off the housing and financial bubble, but it also would have
choked off an awful lot of jobs during that period. The
unemployment rate at the time the Federal Reserve pushed the
Fed Funds rate so low was a very high unemployment rate. So I
think there is disagreement among economists about whether they
should have taken that medicine then or not.
I think it is a more widespread view that our regulatory
policies needed to be stronger.
Chairman Spratt. Mr. Doggett.
Mr. Doggett. Yes, sir. Thank you, Mr. Chairman.
And, Dr. Elmendorf, thank you for your service. I know that
your first report here concerning the effectiveness of this
stimulus has stirred some controversy. And I think that it is
important that we continue to get straight-on, independent
objective reports from you. It is important they be complete,
but I appreciate the analysis that you provided.
Of course, if you make any exception to that, and it is my
bill, it is okay to give the benefit of the doubt to the
author, and I am sure all the other members here feel the same
way.
Seriously, as it relates to this economic recovery package,
I think, given the size of the debt service you are talking
about, that is important, and I believe these are more or less
the words of Dr. Zandi, who we will hear from later, that we
try to get the biggest bang for the buck, the most cost-
effective stimulus because we have, even though it seems, and
it is, a very big package, we need to be getting the most
economic growth we can for every dollar we put in.
Now both you and Dr. Zandi have done some analysis in your
testimony of what type of initiatives provide us the biggest
bang for the buck. And just to summarize that, and of course,
we had this testimony a little over a year ago when some of the
same folks who are complaining about this package were
complaining about our doing anything, in December of 2006,
excuse me, December of 2007, running right on through last
summer. But isn't the economic opinion pretty well united that
at the top of the list of the biggest bang for the buck is to
use extended unemployment benefits and food stamp benefits?
Mr. Elmendorf. Yes. I think most economists view expanded
benefits for low-income households as a particularly effective
form of fiscal stimulus, because the money generally flows
quickly and generally a high share of it is spent, so it
satisfies both the timely and cost-effectiveness criteria.
Mr. Doggett. With a package this big, you will have some
elements that are more cost-effective than others. Clearly,
with a package this big, you couldn't put it all in those two.
But I believe Dr. Zandi's testimony indicates that, for
every dollar that we spend on expanded unemployment benefits,
we get $1.63 back in gross domestic product. For every dollar
we spend on food stamps, we get back $1.73. Are figures in that
range generally where economists come down?
Mr. Elmendorf. I think----
Mr. Doggett. Maybe not to the penny.
Mr. Elmendorf. Yes, I don't want to speak that precise, and
Mark, of course, can talk about them. But I think most
economists view those categories as having particularly high
multipliers.
Mr. Doggett. On the other hand, you and Dr. Zandi have
both, in your testimony, described some of the least effective
ways, the most wasteful and inefficient, weak ways of
stimulating gross domestic product. And at the top of that
list, it looks like, though your estimates are somewhat varied,
the least effective, most inefficient, most wasteful way of
doing this is the loss carryback provisions, in other words,
corporate tax breaks to let those who paid a little bit of
taxes in prior years now get a check back from the government
or credit back from the government at a time that they have a
loss. Is that right?
Mr. Elmendorf. We conclude that the multiplier of that, the
effect on the economy of changes in the tax loss carryback are
likely to be small. But I would emphasize, I think that
judgment is particularly uncertain. In normal times, providing
additional cash flow to businesses is not as effective a way of
stimulating investment as a particular investment incentive.
But we are not in normal times. Companies are having--are
facing cash flow problems, of course, because of the recession
and they are having difficulty borrowing. So that is a type of
stimulus that we think is not likely to have big effects but
where much bigger effects really are possible.
Mr. Doggett. It may be that, for political reasons, just
like we could not get support from the last administration,
which was addicted to tax cuts as the only solution to every
problem, no matter the economic weather, and so we went there
instead of providing the much more effective extension of
unemployment benefits that was really needed early last year,
that we have to include ineffective, wasteful efforts.
But I notice, for example, that Dr. Zandi, in contrast with
getting $1.73 of Gross Domestic Product for every dollar,
precious dollar that we take out of the Treasury for food
stamps, his estimate is that on this loss carryback provision,
this wasteful provision, we get a total of $0.19, only $0.19
for every dollar taken out of the Treasury. Without asking you
to be committed to whether it is 19 or 20 or 30 or 40, it is
substantially less in terms of its economic benefit than doing
some of the other things that are in the stimulus package; and
there is consensus among a broad stream of economists that it
is substantially less.
Mr. Elmendorf. Our assessment is that it is likely to be
substantially less. I think it is an area where consensus is
harder to come by because of the uncertainties.
Mr. Doggett. And he also estimates that a permanent cut in
corporate taxes would only give us $0.30 for every dollar, in
contrast with the higher amounts.
Mr. Elmendorf. I think you will need to ask him that
question. That is not part of this legislation, and we didn't
speak to it in our report.
Mr. Doggett. Thank you, Mr. Chairman.
Chairman Spratt. Mr. Campbell.
Mr. Campbell. Thank you, Mr. Chairman; and thank you, Dr.
Elmendorf.
If we do nothing and if there is no economic stimulus
package, at what point, under your models, would the economy
bottom and/or begin to recover; in other words, positive GDP
growth?
Mr. Elmendorf. We think that the unemployment rate will
peak early next year. That means that--and unemployment tends
to lag the economy, so we are looking at GDP that would bottom
later at the end, perhaps, of this year.
Mr. Campbell. And perhaps the first quarter of 2010, again,
if we do nothing, would have positive--would have some growth,
even if it is a tenth of a percent?
Mr. Elmendorf. Yes. That seems likely.
Mr. Campbell. Okay. So under that scenario then--and I
can't remember the exact percentages--but something like 75
percent of the spending stimulus in this bill will occur after
a recovery has already occurred, even if we did nothing. And I
guess my question is, isn't the purpose of these things
supposed to try and make the recession shorter and shallower,
and how can it do that if the spending comes after the
recovery?
Mr. Elmendorf. I think I need to emphasize here, again, the
importance of the gap between potential output and actual
output. When the economy turns back up, under our forecast,
late this year or early next year, the difference, the
shortfall in output relative to what the economy could produce
at a more traditional unemployment rate and traditional rates
of capacity utilization will be about $1 trillion. And because
we expect the recovery to be slow, GDP growth actually to be,
although growing, to not even be growing as rapidly as the
labor force is for a while, that gap remains very large
throughout 2010 and is larger in 2011 than it has been in
almost all of the postwar years. So, again, whether the
technical definition of recession has been passed, there will
still be, I think, tremendous waste of resources, tremendous
unhappiness.
Mr. Campbell. In the interest of time, we will have to hold
out.
Another question. There was--in 2007, 2008, last year,
there was an economic stimulus plan that involved refundable
rebates to taxpayers with some spending, obviously a small
amount of spending, but that doesn't seem too dissimilar from
the refundable rebates that are in this bill. I believe--and
correct me if I am wrong--but there is kind of universal
agreement that that stimulus was not effective in 2008. Why
would doing the same thing be effective in 2009?
Mr. Elmendorf. I think, in fact, that the economists who
study this question are less sure that last year's rebate was
ineffective than one might think from reading the coverage in
newspapers. Clearly, we have a recession anyway, so it was not
effective in stopping the recession. But I think that is more a
reflection, in most people's view, of the scale of the
financial carnage and not something that speaks specifically to
that tax provision.
People who have looked very carefully at the household
level spending data conclude that there was a real spending
effect of that rebate. Moreover, this legislation does
something a little different. That was really a one-time check.
What this legislation does is to lower taxes for a period of a
few years; and economists will generally conclude that the
longer the tax change is for, that the larger the stimulative
effect would be.
Mr. Campbell. Okay. I am going to, before I run out of
time, shoot you two more questions and then let you answer both
of them so that I don't run out of time.
For the purposes of this question only, I am going to
except Keynesian theory. But even within Keynesian theory,
doesn't infrastructure spending have a greater multiplier
effect? If you build a wireless Internet across the country,
won't that generate a lot more private jobs than spending the
money on government buildings or, frankly, on education in the
short term? So I guess question one is, isn't there a lot
better Keynesian spending than some of what is in here?
Second question, something we haven't talked about. We
talked about Keynesian spending. We talked about the supply
side. What there is hardly any of in this bill is any demand
side incentives, such as large incentives for people to
purchase homes or purchase cars, which are the two industries
that brought us into this recession and perhaps maybe at some
point could bring us out. Could you comment on the efficacy of
any sort of demand side incentives?
Thank you.
Mr. Elmendorf. Thank you.
So, first, on Keynesian stimulus, the principal way to
think about Keynesian stimulus is putting dollars into people's
hands that they then go and spend. So John Maynard Keynes
wrote--and we had this in my prepared testimony today--that you
could hide money in coal mines and then let private enterprises
pay to dig it out. That would be better than doing nothing in a
recession, because it would put money into the hands of those
workers that they would spend. Now, naturally, we would be
better off getting something intrinsically valuable.
So, in general, economists don't think that a dollar spent
in a certain place has a different effect on demand than a
dollar spent somewhere else. The reason the tax cuts are
traditionally viewed as having smaller multipliers is that part
of it is saved. But the basic point of a dollar spent by the
government is that it becomes income to somebody; and if that
somebody is building--is digging a trench for broadband or
digging a trench for a school building, it is basically the
same thing.
This is my time, not your time, I guess. Let me just say
quickly, I think that Keynesian--the term Keynesian is viewed
by some people today more negatively than I think is deserved.
Keynesian economics does not answer all interesting economic
questions. Economists have known for some time that Keynesian
economics did not provide great insight into how to deal with
the wage price spiral of the 1970s. It does not address the
very important question of incentives created by government
taxes and spending programs. But, in the judgment of most
economists, it does provide a very important insight of what to
do when there are vast amounts of unused resources in an
economy. And notwithstanding all the various failings of
Keynesian economics as Keynes understood it or some other
particular professor understood it later, that insight is, I
think, still very widely held among economists.
Now, your second question was about sort of I think more
targeted policies to spur demand for particular items. I think
a good case can be made for that, but so can a good case
against it. It is in some ways effective stimulus to spur
demand where there already is an operation ready to supply it.
So if you can keep auto workers at work, rather than laid off,
that can be very effective.
I think the counter argument is that we generally think
that the government should not be picking which industries
should be doing better or worse. So the risk one finds of
helping demand in particular areas is that those areas, the
areas that are chosen, may offer a role for the government that
we don't normally support and don't think it is effective.
Chairman Spratt. Mr. Blumenauer.
Mr. Blumenauer. Thank you, Mr. Chairman.
Thank you, Doctor. I want to follow up on your response to
my friend from California a moment ago with the notion somehow
that, because we stop the free fall in a year, that
unemployment peaks, that somehow that is tantamount to a
recovery. Now, it may be that our friends, based on the Bush
administration's abysmal record of job creation, have defined
down the definition of recovery, so that if unemployment is
double digit and not getting worse, that somehow we have turned
the corner and we don't have to worry about this stuff.
But I want to--your point about this continuing on through
2010, 2011, I would like to just take it one step further. I
was on the committee 2 years ago. We had your predecessor,
almost as smart and distinguished, before us and a
distinguished array of economic experts of conservative,
liberal, academic. I don't recall a great deal, with a great
deal of precision, their forecasting our falling into this
economic abyss. Is my memory failing me? Or were those
certified smart people kind of missing the trench?
Mr. Elmendorf. So I am one of the certified smart people
who missed the trench.
Mr. Blumenauer. Okay. So the great precision that you are--
not great precision. I mean, you have been very careful in
qualifying this. But when my friend wants to wrap his arms
around the hope that we stop the free fall in a year or two and
that that equates to recovery, wouldn't you say we are, A, in
uncharted waters; and, B, based on our past experience,
Congress might err on the side of trying to help the public and
the economy more rather than less?
Mr. Elmendorf. I spent several years at the Federal Reserve
Board heading up part of their economic forecasting group, and
I think my experience has taught me that to call economic
forecasting an inexact science gives too much credit. It is an
inexact art, and our forecasts can be very wrong, and we
report, in fact, systematically the errors we have observed in
the past so people understand the uncertainty.
As I said earlier, I think most economists' response to the
uncertainty today is to err on the side of providing more
stimulus on the grounds that a stimulus can be withdrawn by the
Federal Reserve more easily than it can be added.
Mr. Blumenauer. Thank you. I appreciate that clarification.
I think it is important as we are going to move forward.
I also appreciated your analogy with burying the money in
the coal mine and putting people to work. I mean, have you
attempted to analyze, in great detail, how much residual
benefit will come?
My good friend from Wisconsin flashed on the screen
concerns about replacement of the Federal fleet or weatherizing
Federal buildings, that somehow this is goofy. Doesn't that
carry significant residual benefits for government operation
and long-term cost savings?
Mr. Elmendorf. The right kinds of investments, public or
private, reap dividends over time. The estimates that I have
offered you today do not incorporate any of those effects. We
have focused for this purpose strictly on the demand side
impact, which is likely to be most important in the short run.
Mr. Blumenauer. Right. And I appreciate your clarification,
and I understand that. But I just want to make that part of the
record, as people try and take potshots at something that we
should make more ambitious rather than smaller, that there are
elements here that have residual benefits that are going to
help our work for years to come, save energy, improve
efficiency.
The final point, and I would, if you want to clarify
further, because I appreciate my friend from California
bringing up, what is the difference between this and the last
rebate that we threw out? The rebate that we had to make in
that form because that is what the Republican administration
and the Republicans in the Senate demanded. We would have had
it be a somewhat broader net.
But I want to go to that notion of psychology. If most
people--isn't there evidence to suggest that people getting a
check in a lump sum are more inclined to look at that as a
windfall, they are going to save it, as opposed to something
that people get week after week after week in the take-home
pay. Doesn't that influence purchasing far more?
Mr. Elmendorf. I think, as I said, I think most economists'
view is that the more lasting a tax change is the larger the
effect.
Mr. Blumenauer. But my question was, what is in the check
each week as opposed to a big windfall from the sky.
Mr. Elmendorf. Yes. I think that is the intuition of most
economists. I think there is not a great deal of evidence. I
think there is some evidence about people taking a check as a
windfall, and a change in take-home pay is not.
Mr. Blumenauer. I would respectfully request that you maybe
help us a little bit with that. There was a fascinating little
article in the New Yorker this week that seemed to indicate, I
just read it briefly, that there is some research to that
effect.
Mr. Elmendorf. I think there is some evidence, but I think
we just haven't run every fiscal policy experiment enough times
to be sure.
Mr. Blumenauer. Thank you, Mr. Chairman.
Chairman Spratt. Ms. Lummis.
Mrs. Lummis. Thank you, Mr. Chairman. It is Mrs. Lummis.
Dr. Elmendorf, my question is about cumulative impacts.
When you add servicing our Nation's debt, plus the TARP
payment, plus other spending that this Congress is likely to
pass this year, plus the stimulus package, plus U.S. dependence
on foreign energy, plus global spending by other countries
trying to stimulate their economies, we are looking at, in my
view, an unprecedented issuance of debt financing in the global
markets this year. My question is, is there a saturation point?
Is there a point that bottomless purchasing power by other
countries of U.S. debt, coupled with debt of other countries,
is reached? And is there any good modeling about the concerns
that purchasers for the combined debts of global governments
will dry up?
Mr. Elmendorf. Well, Congresswoman, there certainly is some
point at which it will become increasingly difficult for the
U.S. government to borrow the sums involved. And you are right.
The amount of borrowing is stunning.
In the judgment of most economists, we are not near that
point now, despite the tremendous volume of borrowing. Interest
rates on Treasury securities are low. Interest rates on private
borrowing are not low in general, and that is because of the
flight from risk. But at the moment interest rates and Treasury
securities are low, even though the whole world has seen and
made their own calculations of the anticipated deficits and the
effect of the TARP and so on.
I think the reason that interest rates are not high is that
borrowers, is that spenders are pulling back on their spending
and doing more saving. And among those who are saving, there is
a flight from private assets to less risky government assets,
particularly U.S. government assets. So I think for the
duration of this global recession, the condition is likely not
to be certain but likely to persist.
As I said, I think the bigger risk comes--and this is, I
believe, a consensus view among economists--comes over time, as
the global economy improves, we expect, over the next several
years, and people are more willing to invest in risky assets,
less determined to buy Treasury securities and become more
concerned about the long-run fiscal imbalance. So I think that
risk is present today, but not large, but certainly rising over
time; and that is one of the reasons why a criterion of not
worsening the long-run fiscal imbalance is on our list.
Mrs. Lummis. Thank you. Is there a way to model global
capacity to absorb global debt?
Mr. Elmendorf. Yes, I'm sorry I didn't answer that, but I
didn't have a good answer. I don't think modeling that is
particularly difficult. Economists model lots of things. Lots
of the models are bad. But I think international capital flows
affecting the exchange rate and shifts in portfolio preferences
are especially hard to model. So I don't think we have--and I
will get back to you if I am wrong. I don't think that we at
CBO have, nor have I personally seen, convincing models of
those flows in a way that would add more to our understanding
than the risks that you and I have just discussed. But we will
check, and I will get back to you if we can do better.
Mrs. Lummis. Thank you, Mr. Chairman. I do have one more
question. It is with regard to the multipliers that the
administration is using of 1.5. Is it your position that that
is a correct multiplier, and are you comfortable with that
multiplier?
Mr. Elmendorf. The administration report from Christina
Romer and Jared Bernstein talked about a multiplier on
government spending of 1.5, on tax cuts of about one. We
developed our multipliers on a more granular basis. We have a
set of them listed in my written remarks.
It depends exactly how you apply them to which provisions
of the bill, so it is a little muddy. But our sense of this is
that our multiplier and the multiplier they used are pretty
close, and I think that is a reasonable multiplier.
The difference in our estimates of job creation come, I
think, from differences in spend-out rates. They assume a
faster spend-out rate than CBO has estimated, so they get more
money flowing out at the end of 2010. So if you look at
employment at the end of 2010, that faster spend-out leads to
more jobs.
As I have said a number of times, I think we really want to
look at employment over a period of time. The fact that the
spend-out continues in 2011 under H.R. 1 is not a bad thing
from the point of view of fiscal stimulus. You don't want the
stimulus to go away overnight. You want it to taper down as the
economy recovers. So we would find a substantial jobs effect in
2011 and so on.
So I think the differences that you see from our estimate
to theirs are not particularly in the multipliers or the
macroeconomic dynamics; it is more about when the dollars get
out the door.
Chairman Spratt. Mr. Etheridge of North Carolina.
Mr. Etheridge. Thank you, Mr. Chairman.
Thank you for being with us this morning.
You mentioned to a question earlier, as related to the
debt, the GDP in currently. I would be interested to know what
that was in 2000, when we had projections of a huge surplus
that was building out to as far as the eye could see, versus
where we are and where the protections are now.
And while you look for that, let me add another piece to
that question. Because in the proposed recovery and jobs
creation legislation it is designated to do a number of things,
one of which is to provide for support for school construction
bonds that are in this package plus a number of other public
facility bonds that would create a number of jobs, build new
facilities for growing school districts and those that are
decaying and other health facilities and communities. But it
would also help the economy as a whole by creating jobs and
generating revenue, which is critical as we move across.
My question, tied to my first one, is this, because I sort
of feel like we are arguing above people's heads. Sort of
reminds me of a guy who is standing in a mud hole, and he
doesn't know whether it is a mud hole up to his waist or he is
in quick sand and he is going to keep sinking. And so we can do
nothing, and he can stay there, and when the sun comes out to
get you dry and he would be in bad shape, or if it starts to
rain he is really in a mess. And so the question becomes, do
you do something or nothing? And I think the public is saying
we want something done.
Now, we can argue about how we do it and what we are doing.
So my question as it relates to this piece by creating the
jobs, as you do your modeling, what is the magnitude of this as
we create jobs as the multiplier and the other provisions that
are in this recovery package as you're aware of at this point?
And what are the specific ideas or items that have been
mentioned in the package do you feel have a positive aspect as
it relates to the slumping GDP? I mean, it is easy to figure
out what will happen if you do nothing, I think. We are not
really sure what it would be, but we think it is going to be
bad. What happens if we do this and we start to have an effect,
versus 2000?
Mr. Elmendorf. I didn't find the number. I think that the
debt was about 25 percent of the GDP in 2000. Ending the last
fiscal year, it is about 40 percent of GDP. I think reasonable
forecasts, including some fiscal stimulus, would push the debt
to GDP ratio up toward 60 percent of GDP several years from
now. That is a dramatic and unfortunate reversal in terms of
the long-run growth path of the economy.
Mr. Etheridge. And that was a decision made by people in
charge in 2000.
Go ahead.
Mr. Elmendorf. My tenure only started 3 days ago. But in
the short run we think that all elements of the package,
legislation as introduced, have some stimulative effect. And
the choice among them depends on your judgment about the
relative importance of timing and cost-effectiveness and long-
run impact and who benefits and what society gets. And there
are often trade-offs. Some of the things that are most
desirable in terms of long-run growth may not pay out as
quickly. Some of the things that pay out quickly may not have
as high cost-effectiveness, and that is a balancing act that we
can only provide information about but only you can make the
decisions.
Mr. Etheridge. Let me follow that up, because my question
was we don't have a modeling of that to determine. I recognize
you can't do that until you see the final piece.
Mr. Elmendorf. We have in my written testimony today you
can look at the results of our modeling. So we have taken the
legislation as passed. We have determined a set of multiplier
effects, essentially how much bang for the buck there is across
a number of categories of the package. We have taken every bit
of the categories and put it into one of these categories, and
we have estimated the effects on GDP and then the effects on
employment.
Now we have reported a range because of the great
uncertainty. Our estimate is that we end up with a GDP growth,
GDP by the end of next year, that is, as I said, 1.2 to 3.5
percent higher, employment that is higher by 1.2 to 3.6 million
jobs, and an unemployment rate that is lower, by .6 to 1.9
percentage points. Those are very sizeable effects on the
economy. Whether they are enough, that is a judgment you have
to make.
Mr. Etheridge. Mr. Chairman, I raise that question because,
depending on where you are in the country, it has a greater
impact. For instance, nationwide, your unemployment rates now
are roughly 7.2; and the new numbers have come out. In North
Carolina, they are 8.7; and we are shedding jobs by the
thousands, not by the hundreds Statewide. And it has been in
textiles, it has been in furniture, it is now in high tech,
manufacturing. It goes down the list because we are a heavily
manufacture State. As a matter of fact, 72,000 jobs were lost
between November of 2007 and 2008.
Mr. Elmendorf. As I say, it is a tremendous range in
experiences across States. It is getting worse almost
everywhere but at different rates and from very different
starting points.
Chairman Spratt. Mr. Austria.
Mr. Austria. Thank you, Mr. Chairman. Thank you, Dr.
Elmendorf.
Let me just say that, you know, one of the things, you
testified earlier that stimulating the economy now and reaching
broader expectations is very challenging. And as I travel
across my district in Ohio and I am sure most other areas
across this country, there are real families that are hurting
right now. There are small businesses in particular that I talk
to, business owners that are reluctant to invest back into
their business because of the uncertainty of the financial
market, the uncertainty of the economy. And I think we all
acknowledge that there is considerable weakness and uncertainty
that remains in the economy, but I think what we are hearing
today is the argument of a hefty infusion of government
spending spread across 150 different programs within this
package.
So, focusing on the short term, let me ask you, as far as
fiscal policy, it operates with long and unpredictable lags. We
are hoping, obviously, that the economy will recover quickly.
And since much of the spending occurs far into the future, my
question is, if the economy were to recover before large
amounts of the spending occurs, should we go back and remove
the fiscal stimulus?
Mr. Elmendorf. I think the first recourse, if the economy
recovers sooner than we expect, would be tightening of monetary
policy. As I said, the Federal Reserve is finding increasing
difficulty in easing policy but would not find it hard, I
believe, to reverse course and tighten policy. Beyond that,
certainly tightening of fiscal policy would be an option; and
there would be a strong case for doing that.
One thing that you are seeing here in terms of the spend-
out rates from appropriations bills is that policies set in
motion take a little time to unfold. That would be true in
reining projects back in, of course. Once a project has been
authorized and digging has begun, presumably you would not want
to stop it. But apart from that kind of restriction, I think it
would be quite reasonable to consider tightening policy, yes.
Mr. Austria. Let me ask you, Doctor, if we are looking at
the short term and we are spending a considerable amount of
money in a very short time period, how do we make certain that
this money is spent to deal with those real issues that are the
real crisis that we have right now in creating jobs and improve
the long-term productive capacity of the economy?
Mr. Elmendorf. Well, I think that you could be looking at
the effects on fiscal infrastructure and the effects on what I
call human capital, a whole range of policies for education,
for building of skills, for building of private manufacturing
capacity, new equipment, for building of government and
renovation of government buildings. All those things can reap
benefits over time.
CBO released a study on infrastructure last year that tried
to look category by category at the cost-benefit ratio of
different forms of investment. Concluded, for example, that
tens of billions of dollars of additional highway spending
would pass a cost-benefit test, not that an arbitrary
allocation of that money to highways might pass that test but
that spent in the right places would pass that test. But, in
fact, it is very difficult to do this category by category.
There isn't that much evidence, to be sure. And we can offer
some judgment about that, but also it depends on what your
priorities are.
Mr. Austria. Doctor, let me just kind of follow up. You
mentioned earlier that, you know, digging I think holes for
infrastructure and digging holes for broadband basically give
you the same results; and I think there are some that would
that argue that if you want to create jobs you hire somebody to
dig a hole and then you hire somebody to fill the holes. And
getting back to infrastructure in particular, you know, the
capital construction programs for public infrastructure are
very slow spending, averaging I think it was 25 percent in the
first year.
And then some have suggested that CBO is wrong, that this
money will spend out much faster. I was hoping maybe you could
comment and explain the estimates and how you derived those
estimates.
Mr. Elmendorf. So we have a lot of--``we'', I am new--but
we, CBO, has a great deal of experience watching these
individual budget accounts over time. So a starting point in a
sense is the rate at which money that is authorized normally
turns into outlays.
In highways, for example, 27 percent of new budget
authority is spent or outlayed on average in the first year.
But then, beyond that, we look very specifically as what this
legislation would do; and then we talk with people outside of
CBO to gain more evidence.
In the case of highways, again, as an example, we talked
with people in transportation departments in half the States
representing two-thirds of national highway spending; and we
talked with them about the speed at which they thought they
could implement the legislation and spend the money.
And so, of course, there is a wide range of responses to
that. Some States are more ready to go than others. But we do
that account by account, and we have discussions, and then
people refer to make further rounds of telephone calls.
Now, for all of that, we will undoubtedly be wrong in one
direction or the other, but we try to pick a point where the
odds of our being too low equal the odds of our being too high.
In this legislation, there were a number of themes across
these various forms of increased appropriations. One is just
that normal spend-out rates are not that high. Second is that
we are starting midway through a fiscal year, so one just needs
to be careful in looking at a table for comparison. A third is
that very large increases in allocations--and there are some
very large ones proportionally in this legislation, 10 times
the last year's support for water projects, a much larger
increase proportionally for broadband investment in rural areas
and so on, that those tend to be spent out more slowly. So we
make that sort of adjustment.
Chairman Spratt. Mr. Andrews.
Mr. Andrews. Thank you, Mr. Chairman.
Thank you and welcome, Director.
Could you rank for us the efficacy of the stimulus tools,
giving consideration to which one of those you think would get
us closer to the upper end of your forecast range. In other
words, I think we have a unanimous vote here in favor of a 3.5
percent in GDP instead of 1.2 percent. If you could rank the
four tools, which are purchase of goods and services, grants to
State and local governments, transfers to persons, and the tax
cuts, in terms of efficacy and getting the upper end of that
range, how do they rank?
Mr. Elmendorf. Let me first quickly clarify, when we
report, as we do, the multiplier effects, the bang for the buck
by category, there is a high and low estimate for each
category. For any given type of stimulus, we are quite
uncertain about its effects.
Mr. Andrews. Of course. You are an economist. We understand
that.
Mr. Elmendorf. I mean, economists should be very cognizant
of the uncertainty. Sometimes they aren't sufficiently
cognizant. We--looking across these categories, the types of
stimulus that have the largest bang for the buck are purchase
of goods and services by the Federal Government, transfers to
State and local governments for infrastructure investments and
transfers to persons. As I said, that is just one criterion of
several in making this judgment. But according to that
criterion of bang for the buck----
Mr. Andrews. And that is in rank order.
Mr. Elmendorf. Yes.
Mr. Andrews. Do you know--and, if not, you can supplement
the record, what the actual outlays will be for debt service in
this fiscal year on the national debt versus what we
anticipated in the budget resolution we did last year? I assume
it is considerably lower because of the drop in Treasury bill
rates.
Mr. Elmendorf. We will need to get back to you on that.
I think there are two effects that I think work in opposite
directions. Treasury rates are lower, but we are borrowing more
money because of the worst economy. And I don't know offhand
the balance of that.
Mr. Andrews. I understand. I would be interested on a per
dollar borrowed basis how much lower it is.
And then, have you publicly announced a score yet for the
fiscal year we are in of the TARP? Have you scored on the
credit reform basis the TARP outlays we have done so far?
Mr. Elmendorf. Yes, we have. There was a report--so in our
annual budget economic outlook there was a reporting of that
through the end of the year. And we have since updated that
report, and there is a specific report that we are required by
statute to produce.
Mr. Andrews. And what is that number?
Mr. Elmendorf. The estimate I believe--but, again, this can
change by the day, because we are looking at market valuations
of assets. The latest estimate that I have is that the net
cost, the risk-adjusted present discounted value of the
commitments under the TARP I have is $189 billion.
Mr. Andrews. Is that based on the outlay of $350 billion in
cash?
Mr. Elmendorf. No, that includes our estimate of the use
and potential losses on the entire $700 billion. Because the
legislation for that was passed. Now we will just keep track of
that as it is.
Mr. Andrews. Will that be a recurring number in each year's
budget, or is that a one-shot credit reform entry?
Mr. Elmendorf. It is one shot if we estimated it correctly.
To the extent that we did not, there will be revisions that
will appear in subsequent years. But it is not recurring at
that level.
Mr. Andrews. When the Secretary sells assets, if he should
recover a net profit from the sale of the assets, how will
those revenues be booked for budget scoring purposes?
Mr. Elmendorf. Our approach to this, estimating these costs
under our judgment and under the legislation as it was passed,
is to calculate on a risk-adjusted present-value basis. So the
purchase and sale, per se, have no direct effect on the budget
cost, except to the extent that they demonstrate that our
estimate was wrong.
Mr. Andrews. But if your 189 hopefully underestimated the
revenues, if it was as conservative as it should be, how will
we then get the benefit of that in future years' budgets?
Mr. Elmendorf. What you will see is that the debt of the--
the outstanding Treasury debt will decline. So it has risen
more than the deficit says, because we have been playing this
financial role, and it will decline more as well.
I would just mention, to clarify, OMB has been scoring this
on a different basis. Our reports try to tell you our view as
required by legislation but also to express them on a basis
more comparable to OMB. So far at least, they have done theirs
on a cash basis.
Mr. Andrews. Understandably.
Thank you, Mr. Chairman. Thank you, Director.
Chairman Spratt. Mr. Harper of Mississippi.
Mr. Harper. Yes, sir.
Greg Harper from Mississippi. How are you? And
congratulations. And we don't envy your task that you have, but
we certainly appreciate the effort you made to get the numbers
right.
My question is, are there any things in this package that
you just think shouldn't be in there?
Mr. Elmendorf. That's not a judgment I can reach,
Congressman.
Mr. Harper. Well, from a budget standpoint, are there
things in there you think are not stimulus?
Mr. Elmendorf. Every increase in government spending or
reduction in government tax revenue we think provides some spur
to economic activity. The amounts can differ. But, as I have
emphasized, there are also differences in the timing of the
effects and differences in other characteristics. I don't have
a way to consolidate all of that into a single measure of good
and bad. All I can do is to tell you how these possibilities
rank under the alternative criteria and then different criteria
and then you have to put together.
Mr. Harper. Forgive me for putting you on the spot like
that, but do the deficit numbers, this huge deficit spending,
does that trouble you as an economist?
Mr. Elmendorf. I think that anybody who is paying serious
attention to the U.S. government budget, both the present and
the future, is concerned and has been for some time. I think it
worries me more now because we are adding a lot of debt, even
without additional policy, and I think you are about to
implement additional policy.
But, to be clear, it also worries me a tremendous amount
that we are in a recession the likes of which I have not seen
and hope to never see again in my life and with monetary policy
employing tools that we have never used in at least 75 years
and so on. So a lot of things worry me now. The deficit is one
of them.
Mr. Harper. Okay. Do you anticipate that as we address what
is going to be an incredible growth in the budget deficit, do
you anticipate that tax increases will become necessary down
the line to deal with those issues? And if we do the tax
increases, will that derail the recovery?
Mr. Elmendorf. I won't predict what you will vote for as a
Congress. I will predict that the scale of spending reductions
or tax increases necessary to move the economy, to move the
budget back into balance will be very substantial.
Mr. Harper. Do you anticipate or is it a goal that we have
a balanced budget? Is that--do you see that as a goal we should
have?
Mr. Elmendorf. I think it would be a consensus view among
economists that something much closer to balance than the CBO
currently projects makes sense. Whether zero is the precise
goal you could get more professional arguing about, but the
notion that we should be moving back toward greater balance
than we foresee in the baseline projection, I think it would
receive very little objection.
Mr. Harper. You know, in Mississippi we have had some
problems in the housing market last year and some other
problems that were going on. But the real problem came to bear
when we started paying $4 a gallon for gas at the pump. And it
hurt a lot of students. You know, our State people do have to
drive a reasonable distance to get places; and that had a
profound impact on seniors, people that were on fixed incomes
and workers. It was--it hurt all of the small businesses in a
great way.
Wouldn't it stimulate the economy if we did things to get
our own natural resources, drill for oil in ANWR, drill
offshore? Wouldn't that have an impact on consumer confidence
and gas prices and help us, you know, sell more cars?
Mr. Elmendorf. The decline in the price of gasoline is one
of the few bright spots for the U.S. economic outlooks. Of
course, that is a reflection of weakening global economy. But
just by itself it is a bright spot. Obviously, that is--a
greater extraction of natural resources that you propose has
other, raises other considerations.
Mr. Harper. What happens if we do this plan and then we
have really done nothing to do anything about going to get and
increase our supply of fossil fuels at this point to help us
during that time? What happens if we go to $4 a gallon again 6
months from now in the middle of this attempted recovery?
Mr. Elmendorf. That would be another blow to economic
activity, no doubt. I think unlikely, given the global economic
conditions, but possible; and that would be unfortunate.
Mr. Harper. Thank you.
Chairman Spratt. Mr. Edwards.
Mr. Elmendorf. Dr. Elmendorf, I am glad to hear there is
concern from Republicans as well as Democrats about the
deficit.
I am angered by the level of deficits we are having to
face. But as I listen to the discussion of it, after having
been on this committee for 6 years, I am reminded of the wisdom
of the former Speaker of the House, Sam Rayburn, who said,
there's no lesson learned in the second kick of a mule.
I would apply that to this committee in this sense, that in
1981 President Reagan and Republicans, along with a number of
Democrats in the Congress, bought into the idea and sold the
idea that we could have a massive increase in defense spending,
balance the budget and pass massive tax cuts. David Stockman
later in a moment of honesty wrote a book and admitted that was
a false promise, and he knew that it was. You couldn't do all
that and balance the budget. We ended up with the largest
deficits in American history.
The second kick of the mule was 20 years later when
Republican colleagues, including members of this committee, who
wrote the budgets at the time because they were in the
majority, once against promised us that we could have it all.
We could have massive tax cuts, balance the budget and even
fight a war in Iraq and Afghanistan and balance the budget.
Well, that second kick of the mule resulted in the largest
deficits in American history. I just hope we have learned the
lesson from Mr. Rayburn and don't have to go back to the third
kick of the mule. Because what I am hearing from some of the
very architects of the budgets that I think contributed greatly
to the economic mess we are in today are proposing, all we need
now to get out of this mess that they helped create is more tax
cuts, unpaid-for tax cuts, $4 trillion of unpaid-for tax cuts
that would increase the national debt far more than the
spending in this bill.
I am glad there is bipartisan interest in the deficit
today. I wish some would go back and look at the predictions
some of us made in 2001 and 2003, versus the predictions made
by those that said we could have it all, the tax cuts and
balance the budget, and determine who was right and who was
wrong. But at least we are at a point now where I am very happy
there is bipartisan concern about the deficit.
So let's go directly with that point into the deficit
caused by this stimulus package if we pass it. I wish we didn't
have to increase the deficit this year or next with the
stimulus package. But having voted against the budgets that led
to this mess, I am going to be part of voting for a stimulus
package that hopefully helps us get out of it.
You projected that the CBO says that the stimulus package
could increase the GDP by as much as 3.6 percent in 2009/2010;
on a minimum side, 1.3 percent. Tell us how much the deficit
would be reduced compared to not doing anything if this
stimulus package actually increased GDP by 3.6 percent.
Because, obviously, economic growth and output help reduce
deficits.
Mr. Elmendorf. As we say in the cost estimate, it does not
include the dynamic effects of strong economic growth. We have
done a back-of-the-envelope calculation of that. It is pretty
straightforward to think about. In general, a dollar of extra
GDP reduces the government budget deficit by about $0.20, and
that is mostly through higher tax revenue, a little bit through
lower spending on means-tested programs and so on.
Mr. Edwards. So if you increased the GDP by $1 trillion, as
you projected this package could do, that is in effect reducing
what the deficit otherwise would have been by about $200
billion; is that correct?
Mr. Elmendorf. Yes. So that is closer as you asked to the
high end of the range that we--of economic outcomes, the
average of the high and the low outcomes that we track. The
midpoint of those has a multiplier of about one. In that case,
800 or so billion dollars of extra deficit would lead to a
fifth of that, or about $160 billion of sort of feedback from
the economy and, in fact, would be smaller if we were on the
low end or larger if we are at the high end of our range.
Mr. Edwards. You have also said one of the key criteria in
this package should be not creating long-term additional
structural debt or deficits. Would the $4 trillion that some
have proposed in additional tax cuts that aren't matched by
spending cuts, would that increase the long-term structural
deficits of this country significantly?
Mr. Elmendorf. Yes. Large permanent tax cuts would
exacerbate the long-run fiscal imbalance if they were not
combined with some offsetting change elsewhere in the budget.
Mr. Edwards. Thank you.
Chairman Spratt. Mr. Aderholt.
Mr. Aderholt. Dr. Elmendorf, thank you for being here; and,
of course, congratulations on your new role as Director of the
Congressional Budget Office.
Mr. Elmendorf. Thank you.
Mr. Aderholt. Just one thing that many of us have noted,
that out of the $500 billion in the spending plan that has been
proposed, only about $30 billion will be for highways; and a
lot of--much of the rest of that amount will be for various
government programs in ways that appear, at least on face
value, to not have a stimulative effect, such as maybe the $50
million for the National Endowment for the Arts. How much of
the $500 billion would you say will actually stimulate the
growth and create jobs in the economy?
Mr. Elmendorf. In our estimation and I think the estimation
of most economists, all of the increasing government spending
and all of the reduction in tax revenues provides some
stimulative effect. People are put to work, receive income,
spend that on something else. That puts somebody else to work.
And for short-term purposes, what really matters most is
how many extra dollars get spent, and that is why Keynes used
this imaginary story about putting money in mines and paying
people to dig it up. It is just the act of getting purchasing
power into the economy.
Now, over time, putting money in mines and digging it up
does nothing for our consumption possibilities or the future
growth of the economy. So spending the money on something else
presumably makes much more sense. But in terms of the direct
effect, it is either the spending or the taxes in a variety of
categories, and the differences amount to how quickly it
happens and to the bang for the buck. But nothing really has
the bang for the buck of zero.
Mr. Aderholt. So what percentage of that, out of the $500
billion, would you say actually would stimulate the economy, in
your opinion?
Mr. Elmendorf. I think all of the $800 billion provides
some stimulative effect. The extent of stimulus varies by
categories. But it all matters, all of it.
Mr. Aderholt. The President has talked about saving or
creating three million to four million jobs, with 90 percent of
them in the private sector. About $200 billion to $300 billion
in this proposal, somewhere between 25 and 35, 36 percent, will
be spent on government programs that have very little
connection to the private sector. Even accepting the
administration's estimate, how many government jobs would this
bill be creating?
Mr. Elmendorf. I am sorry, that is a question we have not
tried to answer. It is quite complicated. The estimates that we
have made, as I say, divided all parts of the bill into half a
dozen categories with different multiplier effects, different
bang for the buck. But to address the private sector job count,
we would have to drill down much deeper and really investigate
what happens at a very particular level.
So there will be some highway projects that will involve
private contractors and some that will involve government
employees. There can be school construction done by employees
of the Montgomery County Public School System and some school
construction done by private employees under contract to the
Montgomery County Public School System. So to figure out who is
actually getting a government paycheck and a private paycheck
would be very complicated, and I am not sure we could, and we
have not tried.
Mr. Aderholt. What are your thoughts as far as taking a
government job and stimulating the economy as opposed to
private sector jobs and as far as how those compare and as far
as the overall stimulation of the economy?
Mr. Elmendorf. Again, in terms of the short-term stimulus,
either kind of job works because the people who get those jobs
and receive the paycheck go out and spend it; and that is--or
spend much of it, and that is the multiplier effect that
economists talk about. I think the differences would come down
to what you judged as the most effective in supporting long-run
economic growth more than in terms of short-term stimulus.
Mr. Aderholt. I see my time is running out, Mr. Chairman. I
yield back the rest of my time.
Chairman Spratt. Mr. Scott of Virginia. Mr. Larsen of
Washington had to leave. Mr. Schrader.
Mr. Schrader. Thank you, Mr. Chairman.
I appreciate the discussion here today, and I just wish
some of those that have evinced concern about the deficit that
we seem to be incurring this current year were willing to speak
up over the previous 8 years where we ran a $10 trillion debt.
And I guess if that is the low mark we are aiming for, geez, we
have got a lot of room to work here in the next few years of
this administration.
Having said that, I do have some concerns about the debt we
are accumulating. I agree with Mr. Andrews. And I go to your
figure one that you have in your document; and when I look at
the recovery in the outyears, you paint a linear picture. We
get back to the same linear rate we had prior to the recession.
And I guess my concern--and I would like your opinion. My
concern is that that linear rate is not going to be--is not
going to recur, that indeed the growth rate and our GDP will be
significantly lower than that linear rate because the previous
years were based on the Ponzi schemes of the 1980s, with merger
mania, you know, get-rich-quick schemes that empowered the
wealthy, threw a lot of working men and women out of their
jobs, the dot com bubble of the '90s and here now the thought
that my house is always going to be worth more than I paid for
it.
So those get-rich-quick concepts are no longer there; and
shouldn't we be moderating our GDP expectations, hopefully, in
a more value-based economy where there is real production and
real value to what we are doing? So I am concerned we are not
going to have the tax revenues needed to pay for our programs
and do the things we want to do in the outyears.
Mr. Elmendorf. You raise a number of issues. Let me say,
briefly, the potential GDP line in this picture actually is
affected a little bit by the economic downturn. We have much
lower investment and spending projected for the next several
years. Businesses tend not to invest as much in recessions.
That lowers the amount of capital that we will have down the
road. In fact, if you look carefully, there is a little bit of
flattening of the potential output.
The other issue you raise I think involves the demand, the
potential supply of goods. You also raise questions about the
demand for goods. The bubble economy, the rise in value of
stocks and houses, has encouraged consumer spending in a way
that is not likely to be repeated soon; and the huge losses are
holding down spending by households and will for some time.
Over time, this projection says that the policies under
current law will eventually pull us out. That is a feature of
economies that eventually they tend to right themselves.
Consumer spending adjusts for lower wealth but then will start
to pick up again and so on.
We might be wrong about that, certainly. But we hope to
have balanced the risks. I think--but it is a problem for the
next several years, certainly, of not having sufficient demand
for goods and services to put people back to work; and that is
why I think this consensus has developed on behalf of some form
of fiscal stimulus and some form of financial monetary policies
to try to return people to work more quickly. And I think there
will definitely be less risk taking, less financial engineering
than was the case a few years ago. That should not hinder, if
anything, possibly, by redirecting smart people's attention to
other aspects of the economy, could help long-run growth.
Mr. Schrader. If this package did not include any aid to
our States that basically deliver the education for America,
that provide for the health care of millions of individuals in
our great country and make us safe in our own homes with our
public safety budgets, what would be the effect not just on the
economy at large but on those individuals and those
institutions back home?
Mr. Elmendorf. I believe there is a report from the GAO
that estimates that operating budget deficits of State and
local governments in the next 2 years will exceed $300 billion.
Those governments are under various degrees of pressure to
balance their budgets. That will mean tax increases or spending
cuts and of a scale that we have not seen in some time. With
house prices falling, property tax revenues will go down. With
consumer spending falling, sales tax revenues will go down. The
cutbacks will be large, and the provisions in H.R. 1 would
offset some part of that. That is about as specific as I can
be.
Mr. Schrader. Thank you.
Chairman Spratt. Mr. Simpson of Idaho.
Mr. Simpson. Mr. Chairman, I don't really have any
questions except a couple of statements and I guess to welcome
you to your new position.
Basically, if all government spending is stimulus, why stop
at $825 billion? Why not go to 2 or $3 trillion? I mean, if we
are going to stimulate the economy, let's really do it.
Mr. Elmendorf. Well, sir, there are people who have made
exactly that argument for why this policy is not sufficient.
Mr. Simpson. I was afraid of that.
Mr. Elmendorf. I think the answer--and I am not sure what
the right size of package is. I don't think there is a
consensus among economists about how much to do. I think the
considerations involve the loss of output and income in jobs.
So even with H.R. 1, by our estimates, there is still an
unemployment rate that is substantially above what we have
gotten used to over the last 7 years, lower employment than we
would otherwise have. So even with H.R. 1, a package of that
size, there is still a substantial shortfall in economic
activity relative to what we could be doing. So some people see
that and say that more should be done. People also say that we
are uncertain; and because we are not sure if things got worse,
that might be very bad, another argument for doing more.
On the other hand, people say, look, $800 billion is a lot
of extra debt to incur. It imposes a burden on the future. And
maybe we also need to be working through financial and monetary
policies that might be particularly effective at getting the
economy going again, and that is why some people would say we
should have smaller numbers for fiscal stimulus. And those are
all legitimate arguments.
Mr. Simpson. Let me ask you a question. This gets back to
what Mr. Blumenauer was talking about when we criticize some of
the particular spending proposals that are in this economic
stimulus plan, a lot of them that are spent out in 2 and 3 and
4 and 5 years down the road.
We have a normal appropriation process here. If there is
only so much of this money that is going to be spent this year,
why not go through the normal appropriation process? As an
example, there are something like 32 new programs that have
never been authorized by Congress or anybody else. I don't know
whether they are effective or the right way to be spending
money, other than they were dreamed up in somebody's office and
put into this bill.
Why not--if the money is not going to be spent this year,
why not go through the normal appropriation process and do it
where we have hearings and oversight and determine whether the
money is best effectively spent there or somewhere else? If all
government spending is stimulative, we are operating right now
on a 2008 fiscal year--on a 2008 budget year because of the
continuing resolution. That means that the increases in
spending that we had in 2009, we are a third of the way through
this fiscal year and we are not spending that money because we
are operating at the 2008 level.
Would not having passed the 2009 appropriations bills on
time, as we should have done, not also been a stimulative, that
increase in spending that we would have had.
Mr. Elmendorf. Yes, it certainly would have been.
Mr. Simpson. We have $500 million that we have put into
that stimulus package for EM cleanup. It is very near and dear
to my heart. EM cleanup is spent in different districts around
the State, at the Idaho National Lab. We put $500 million into
EM cleanup. We actually had an increase in the 2009
appropriation. Had we passed that, we probably wouldn't have
had to put $500 million into a stimulus package.
What seems to me is that what we are trying to do is spend
money on every good idea somebody has had in the back of their
brain somewhere for years and years and put it into an
emergency stimulus so that we can pass it, instead of going
through the normal appropriation process. That is what many of
us are complaining about. Not that we don't need a stimulus
package. We all believe we need a stimulus package of some
sort. It is the way we are doing and the way we are avoiding
the rigmaroles of the regular legislative process that concerns
most of us. Most of us, if this money is being spent out there
this year, this is fine.
I will tell that you when the stimulus passed last year the
$500 or $600 checks that went out to everybody, I voted against
it. I reason I voted against it is I didn't think it would have
any very long-term effect. And if you look at the economic
numbers it is barely a blip in the economic scale as to what it
had. I thought we would spend it better by doing infrastructure
projects.
I was told by then OMB Director and by Bernanke that those
projects take so long to get out there that the money won't go
out. And, in fact, we have shovel-ready projects in the States,
some $67 billion, as I understand it, where we are only putting
$30 billion into it, that are ready to go today.
I do not have a problem with that kind of stimulus program.
But when we are sitting there looking at programs that will be
spent 2 and 3 and 4 years down the road, I think we need to go
through the regular legislative process.
The other thing I would note, just because somebody needs
to respond to some of the rhetoric that has been going on, Ms.
Schwartz said in her testimony when she was comparing the
relative value of spending versus tax cuts and so forth and the
balance that ought to occur there, that apparently Republicans
only wanted tax cuts and then only for the wealthy. That was
her exact words.
Apparently, she hasn't read what the Republican proposal
is. We would drop the 15 percent rate to 10 percent, the 10
percent rate to 5 percent. That means anybody on the first 10
percent of their income, on the first $16,700, lowering the
rate to 5 percent. I don't know that I'd call that the
wealthiest individuals in this country. Maybe that fits her
category, but I am tired of the worn-out rhetoric.
We have a legitimate debate about how much of this should
be in tax relief and how much should be in spending, and we
ought to focus on where this ought to be.
Chairman Spratt. Thank you, Mr. Simpson.
We now go back to Mr. Scott.
If you suspend just for a minute, the Republican members
have a meeting with the President at 12:15. We, by all means,
want to accommodate, so we are going to take a break right at
12:15. We will take one more round of questioning to finish
out, if that is agreeable for everybody.
Mr. Scott.
Mr. Scott. Thank you, Mr. Chairman.
Mr. Elmendorf, we have heard a lot about the situation and
need for stimulus. My question is, does the difference between
stimulus priming the pump and expenditures as we have just
heard that go for long periods of time, do we need a stimulus
to just prime the pump or do we need long-term spending to get
us out of the mess we are in?
Mr. Elmendorf. I think most economists expect that in
absence of new fiscal policy the economy will be well short of
the potential number of jobs, amount of income for several
years, 2009, 2010, well below in 2011, and still below in 2012.
The number of forces that I mentioned are leading to a slow
recovery in our estimation and the estimation of most
economists. And that is the case, all else equal, for fiscal
stimulus that lasts for some time.
Mr. Scott. So when we talk about timely, targeted and
temporary, timely and temporary means several years?
Mr. Elmendorf. Yes. So one difference I think now, the
discussion now from the discussion last winter, that last
winter there were people predicting a long, deep recession, but
that was not the consensus. There was much more uncertainty at
the time, much more of a sense of what was needed was a quick
jolt. I think now, with the deterioration we have seen in the
economy and the financial system over the past year, has moved
people to looking over a longer horizon.
Mr. Scott. Would there be an advantage in getting jobs that
could be done extremely quickly? I am speaking I guess
specifically about summer jobs, because people would be hired
in a matter of months.
You have shovel-ready projects for which people have told
us they can get people hired within 120 days. There seems to be
some question about that, but the 120-day figure is something
that a lot of the Departments of Transportation around the
country said they could meet. But summer jobs, they have to be
on the job, and it is temporary. They are off the job by the
end of the summer, and they are relatively inexpensive. A few
hundred dollars, maybe $1,000, $2,000, no more than $4 or
$5,000 per job. You have people up and working.
Would it make sense to increase the number of jobs that you
know will be up and running this summer, education programs,
summer camps, other jobs for youth, youth build and those kinds
of things?
Mr. Elmendorf. It certainly is useful to get money out the
door as quickly as possible. This summer qualifies for that. I
think the greater challenge is in trying to organize the
people, select them, put them to use at constructive tasks. I
think that is a challenge, and I don't know enough offhand to
judge how much of that could be done.
Mr. Scott. Let me tell you, if you give community action
agencies notice, 2 or 3 weeks notice that there are summer jobs
available, they will not run out of young people to take those
jobs. You could do other things like in Federal agencies have
internships and those kinds of things. You can increase funding
for Upward Bound. There are a lot of things that you could do
for which there would not be a lot of confusion in getting
people on the job working, receiving paychecks by this summer.
Mr. Elmendorf. I think the challenge is in getting the
money from here out across the States and across the
communities. So, for example, our conversation with State
Transportation Departments, one of their concerns is the
highway money that is directed to local governments. Not that
the local governments can't use the money, but it is one more
step in the allocation process, and it takes time. And I think
there is some underlying trade-off. The more that you want to
influence who gets the money and what they do with it, the
harder it will be to move very quickly.
Mr. Scott. Something like summer camps run by local
recreation programs, those could be put together fairly
quickly.
Mr. Elmendorf. I agree. I am not an expert at that, as I've
said. I think the issue is you need to decide which summer
camps, where in the country get the money, and then you need a
process for keeping track of whether they deserve the money and
what they do with the money.
Mr. Scott. You tell school systems, local community action
agencies--let me tell you there would not be a problem getting
people hired in programs designed this summer if we act within
the next couple of weeks.
Thank you, Mr. Chairman.
Chairman Spratt. Thank you, Mr. Scott.
Let take one more question from Mr. Langevin, and then we
will recess the hearing for about an hour. We will come back at
1:15.
Mr. Langevin. Thank you, Mr. Chairman.
Mr. Elmendorf, thank you for being here today. Welcome
aboard and congratulations in your new role. It comes at a
challenging time.
Mr. Elmendorf. Thank you, Congressman.
Mr. Langevin. I know we have gone over this a couple of
times, but, again, the difference in GDP if we do nothing
versus enacting the stimulus package as proposed.
Mr. Elmendorf. Our estimate is that in the fourth quarter
of 2010 GDP would be higher by 1.2 to 3.5 percent if we
implemented H.R. 1 relative to doing nothing.
Mr. Langevin. Thank you.
In my State, most of our businesses for job creators are
small businesses; and I know the programs like the 7(a) loan
program through SBA have been highly effective. I am not
certain, as I am still looking over the details of the stimulus
package, I don't necessarily see anything yet that increases
7(a) loan programs. Would that type of investment be a
multiplier that would be worth undertaking and worth investing
in this stimulus package? And at what level should we invest if
we were going to do that?
Mr. Elmendorf. I think--as I said, I think money that gets
pushed out to hire people to do something stimulates the
economy; and for short-term stimulus it doesn't matter much
exactly what they do. But it can matter a lot over time,
depending on whether we want to move the economy in more energy
efficient directions or with different infrastructure or what
have you. And, also, I think the speed varies across sector. It
is more difficult to scale up programs to a very large order of
magnitude or not.
So one constraint--I am not an expert at every possible
part of the economy or every part of this package, to be clear.
But I think it can be a constraint just how much money can go
into some area all at once. And it is a constraint in terms of
what the Federal Government can manage, what State and local
governments can manage and also what the private sector can do.
We need trained workers to do certain tasks. At the end of
last year, a survey of transportation contractors, a quarter of
them reported a shortage of skilled labor, not so much
unskilled labor but skilled labor. So there are going to be
constraints in terms of the real economic activity in terms of
workers and materials and so on that can be an issue.
Mr. Langevin. I don't know if that answers my question. Let
me ask you it a different way.
Would you like to see a greater investment in support of
the 7(a) loan program in the stimulus? Would that be something
that is positively viewed, or should we leave it where things
are?
Mr. Elmendorf. So I think--again, I don't make
recommendations on what I would want, but I think more of that
would provide additional stimulus to the company.
Mr. Langevin. Mr. Chairman, I hope we could encourage that
in the stimulus program. In a State like mine, where small
business accounts for about 95 percent or greater of the jobs
in our State, that is something that would be of great benefit.
My final question really focuses on the national debt, and
this is something that I have been concerned about for quite
some time. I even intend to vote for the stimulus package. I am
of the opinion, as others are, that we have to do this, that
doing nothing is just unacceptable and would make the situation
worse.
At what risk, at what level of debt do we get to the point
where that level of debt is really unsustainable? How much room
do we have really before we have hit a ceiling and can no
longer deficit spend, that the national debt crosses a
threshold that is just at a level that is unsustainable?
And the second half of that is, what tools in the future
would be most effective in paying down the national debt? Even
if they are creative solutions, things we haven't yet thought
of, a national sales tax or something that doesn't even exist
right now, but what tools would be most effective in bringing
down that debt?
Mr. Elmendorf. We are on a path--as I say right now,
Federal debt at the end of the last fiscal year was about 40
percent of GDP. We are on a path to push up it to about 60
percent of GDP several years from now. That would be the
highest ratio of debt to GDP that we would have had in this
country since the early '50s when we were coming down from the
very high debt incurred during the Second World War.
Other countries have operated for years with more debt.
Their excess levels of debt tend to worry people. Their
securities are not viewed as the security you most want to have
in a financial crisis like ours are.
So there are certainly risks. It is very difficult to know
where the tipping point might be. One could go on for some time
accumulating debt. But at some point, as concern rises--and it
is not just the current level of debt but the forecast--at some
point then there could be a rather abrupt reaction, and
economists are not good at predicting what that is.
Policies you could undertake, anything that raises taxes or
cuts spending numerically does the trick. We can talk with you
about the effects of different policies on incentives in the
economy, on long-term economic growth and on the well-being of
particular individuals, but those are really what the choices
will come down to.
Mr. Langevin. Thank you, Mr. Chairman.
Chairman Spratt. Dr. Elmendorf, thank you very much for
your testimony. We have a couple more questions to put to you.
Because of the present situation with the Republican members,
we are going to recess the hearing until about 1:15.
Have we covered all the Republican witnesses? Have we? We
have two more on our side to ask questions. John? Marcy?
Agreeable to you, we will dispose----
Mr. Elmendorf. I am at your disposal, Mr. Chairman.
Chairman Spratt. Two more witnesses. Bear with us just a
moment.
With your understanding, we will go to Marcy Kaptur and
then come back to you; and that will wrap up the round of
questioning.
Ms. Kaptur. Thank you, Mr. Chairman. That shows great
sympathy for our guest and for all of us. We appreciate it very
much.
Let me place on the record that today in Ohio, in Toledo,
my home, unemployment has risen to 10.7 percent, up from 7.0
last year; in Sandusky, Ohio, 11.4 percent, up from 8.4 percent
last your; Lucas County, 9.9 percent, up from 6.5 percent; Erie
County, 9.8, up from 7.3; Ottawa County, 12.4 percent, up from
9.1 percent. According to the numbers we have, there are
currently 11,100,000 Americans unemployed; and by this year's
end we anticipate it could reach over 12 million.
The statement I want to make is that putting people to work
now, applying hands and minds in useful enterprise, is the most
important step we could take, rather than sidelining
individuals to help this economy move forward. And so my
question, Doctor, is, as I look at your testimony, you say even
if we pass this, the number of jobs created this year could be
less than a million or maybe as much as 2 million. That is so
small in terms of the need; and, therefore, I must ask the
question, which programs in the stimulus are best suited to put
to useful work those who are unemployed?
That is my first question.
Mr. Elmendorf. So I think if you look across pieces of the
stimulus legislation there is some trade-off between the
immediacy of the effect and the ultimate bang for the buck. So
the parts of the package that put money into the economy most
quickly are the changes in tax policy and the changes in
entitlement policy. Slower spend-out rates rise in the
appropriations parts of the package in general.
However, our judgment, drawing on the consensus of the
economists you use, is that direct appropriation spending by
the government has a large bang for the buck over time. So
there isn't a single--just looking at those first two criteria
that we talked about, the timeliness and the cost-
effectiveness, there isn't a simple ranking of the pieces of
the package. There are some pieces that are both fast and have
a high bang for the buck. Those tend to be payments to low-
income individuals.
Ms. Kaptur. But that doesn't put people to work if they are
getting an unemployment compensation check.
Mr. Elmendorf. Well, no, it does, because they take the
money and they spend it. And the reason it has more stimulative
effect than a broad-based tax cut would is because, though
people have lost their jobs and are subsisting on an
unemployment insurance check that is a fraction of what their
previous earnings were, are likely to spend a large fraction of
that check. So it doesn't put them back to work, but it does
keep to work the person in the clothing store or the auto
dealership.
Ms. Kaptur. I hear you on that. But one of the difficult
parts on this is people want to work. They don't want to
receive subsidy checks, even though they have earned them
through their years of work.
So my question is, in this program you mention some of the
transportation projects, for example. You know what we need in
our cities right now? We have got to fill potholes. We have to
buy the asphalt to put in the potholes. This is not glamorous.
You were talking about smart people. I think we need
responsible people, we need good people, we need ethical
people, we need people who have experience, and we need to put
people to work.
Sometimes you can be sort of overeducated. My goal is to
get people to work to do useful work that is needed right now.
We need trees cut down. We have got 20 million trees in Ohio
and Michigan that have to be cut down. We could put them to
work tomorrow.
What programs? Can you go through this list? If you can't
do it right now, can you tell me one, two, three, four, five,
which are the ones that can put people to work the fastest?
Mr. Elmendorf. So I will go back--I can't tell you offhand.
I can go back and check which are the specific items in
legislation we think would spend out fastest. But you might be
surprised. So highways is not a category that we think spends
out particularly rapidly. And that is not a judgment that there
are not immediate needs, as you say. The judgment about the
process of getting money all the way through the chain to the
person who needs to get paid to fill in the pothole. And we
have talked with Departments of Transportation in half of the
States accounting for two-thirds of national highway spending,
and some of them were optimistic and some less so about their
ability to put money out the door right away.
Generally when we have seen big increases in spending on
highways, for example, it is not all fancy. Some of it is basic
work. When the budget authority goes up, the outlays follow
with a lag. Between 2006 and 2008, budget authority for
highways rose by 17 percent, but outlays rose by only 10
percent. There are now tens of billions of dollars of
unobligated balances in the highway fund, money that has been
authorized by Congress and not obligated yet by the States. It
is simply takes time, and that is the challenge.
I will go back and check which pieces moves the fastest.
Ms. Kaptur. Yes, because to have that low a rate of
reemployment is very troubling to this Member.
Chairman Spratt. Thank you, Ms. Kaptur.
Mr. Yarmuth.
Mr. Yarmuth. Thank you, Mr. Chairman.
Welcome and congratulations.
Some critics of this proposal have characterized it as
throwing everything against the wall and hoping something will
stick. I think I heard that over the weekend. And you mentioned
before, and I agree with you, that desperate times require
desperate measures. And I actually characterized it as to
pretty much the same thing, that we are throwing everything we
have at our disposal, given that we don't have monetary policy
to use, at this desperate situation.
Mr. Scott has mentioned something that we haven't thrown
yet. Is there anything else that you at the CBO can think of
that we would throw at this situation that we haven't thought
of?
Mr. Elmendorf. I--that is a fair question. Unfortunately, I
don't have a great answer. I don't have offhand in my mind a
list of obviously overlooked opportunities, but I will give
that more thought and let you know promptly if I have further
ideas.
Mr. Yarmuth. Thank you.
We had some discussion earlier about job creation and how
much it was estimated it would cost to create a job, $140,000
to twice that or whatever the discussion was. And you just
alluded to the issue of saving jobs as well as creating them.
Is there any way to estimate how many jobs saved--and,
obviously, I would think it is a much more difficult
assessment--but is there any way to estimate how many jobs
could be saved by this plan, as opposed to created?
Mr. Elmendorf. Our estimate is the difference in the net
total number of jobs in the economy. So it reflects some
combination of jobs saved and jobs created. We don't really
have a way of keeping track of that separately.
As you know, there is a tremendous amount of churning in
the U.S. economy, the labor market on a regular basis. A
tremendous number of jobs created and lost with the net being
the difference between them. And what we have estimated here is
the net difference in jobs under this plan versus without the
plan. I am not really able to do that break down.
Mr. Yarmuth. Well, I asked the question almost rhetorically
almost. Because you mentioned that you were a little bit
concerned about the use of jobs as the one standard in
evaluating the success of this program, and I share that
concern.
You also mentioned--you have used the phrase several time--
the ultimate bang for the buck. In your definition or CBO's
definition, what is ``ultimate''?
Mr. Elmendorf. What I mean by that is, as the dollar goes
out of the Federal budget, what is the effect on GDP? So
whenever the dollar goes out, what does it do to GDP?
Mr. Yarmuth. So the ultimate bang for the buck does not,
for instance, calculate the cost to the economy and society of
neglecting some of these things that will be neglected because
of the desperate situation that we are in?
Mr. Elmendorf. No. This is a much simpler estimate, just
referring to the macroeconomic impact, without taking account
of either the underlying trajectory with or without the plan in
terms of the quality of our public utilities and so on.
Mr. Yarmuth. Right. And the cost to society and to the
ultimate economy, the long-range economy in the cuts in
education that would ensue if we did nothing to support the
States and their efforts.
Mr. Elmendorf. Right, we have not looked carefully at that
aspect.
Mr. Yarmuth. One thing--and this is not a question. This is
just illustrative. My brother is in the barbecue business. He
runs a successful chain of barbecue restaurants. And he said to
me not too long ago, he said, I finally determined, if people
can't afford to buy barbecue, it doesn't matter what my tax
rate is.
And I think that in terms of the analysis of what we should
be concerned about is giving people the money to spend,
creating the demand side is much more important than giving
breaks to businesses which, in many cases, will not use them to
create jobs, will use them to pay off debt or sit on the
sidelines until conditions improve.
So I throw that out just as an anecdote that may or may not
be of value.
Mr. Elmendorf. Thank you, Congressman.
Mr. Yarmuth. Thank you for your testimony. I yield back.
Chairman Spratt. Mr. Elmendorf, this is the conclusion of
your part of our hearing. We very much appreciate your thorough
and thoughtful answers, as patiently delivered as they have
been painstaking. I think this all goes well for our working
relationship in the future. Thank you very much indeed.
To our other witnesses, we beg your indulgence until we can
once again get the full committee together. We will go with the
second panel at that time. In the meantime, you are welcome to
use the anteroom just behind me to relax, to have a sandwich,
if you would like, or use the telephone. We will start back up
somewhere around 1:15.
Mr. Elmendorf. Thank you, Mr. Chairman. I look forward to
being back before you again soon.
Chairman Spratt. It won't be long. Thank you very much
indeed for your excellent testimony.
[Whereupon, at 12:30 p.m., the committee was recessed, to
reconvene at 1:15 p.m.]
Chairman Spratt. We will now turn to our second panel. We
are still waiting for the Republican members to come back from
their hearing or meeting with the President, and we are still
rounding up some Democrats, but we think it is important that
we get under way and not ask our second panel to forbear any
longer.
Once again, let me invite all four of you here.
Dr. Alice Rivlin, as I noted earlier, was the founder,
present at the creation of the Congressional Budget Office. She
served as OMB Director under President Clinton. She is
presently at Brookings.
We will also hear from Dr. Mark Zandi, who is the Chief
Economist and cofounder of Moody's Economy.com; and from Dr.
Laurence Meyer, former member of the Board of Governors of the
Federal Reserve and currently Vice Chairman of the
Macroeconomic Advisers; and Dr. Kevin Hassett, Resident Scholar
and Director of Economic Studies at the American Enterprise
Institute.
STATEMENTS OF ALICE M. RIVLIN, PH.D., SENIOR FELLOW, THE
BROOKINGS INSTITUTION; MARK ZANDI, PH.D., CHIEF ECONOMIST AND
COFOUNDER, MOODY'S ECONOMY.COM; LAURENCE MEYER, PH.D., VICE
CHAIRMAN, MACROECONOMIC ADVISERS, LLC; AND KEVIN A. HASSETT,
PH.D., SENIOR FELLOW AND DIRECTOR OF ECONOMIC POLICY STUDIES,
AMERICAN ENTERPRISE INSTITUTE
Chairman Spratt. By common consent, we have agreed that Dr.
Rivlin will go first.
Welcome again to the Budget Committee. How many times you
have testified, I don't know, but we always come away wiser and
better informed because of your contribution. So the floor is
yours, and we look forward to your testimony.
STATEMENT OF ALICE M. RIVLIN, PH.D.
Ms. Rivlin. Thank you, Mr. Chairman. I am very pleased to
be back here. I always enjoy coming before this committee.
I will summarize my testimony fairly briefly, since we
don't have a lot of time. But I would like to emphasize some
points that we have not talked about, particularly the long-run
budget deficits that are looming ahead of us and what I see as
the opportunity for the Congress as they act on the stimulus to
also take action on the long-run budget deficits at the same
time.
On the outlook, the risks, it seems to me, are on the
downside. You are going to hear from modelers who are more
expert in running the models than I am, and you have already
heard from Doug Elmendorf. But I think it is important to keep
in mind that there is just enormous uncertainty at the moment
and I think three reasons, at least three reasons, not only for
their being a great deal of uncertainty but for the risks being
mainly on the downside.
One is that the financial system is still not stable. The
models that people use to make forecasts have been calibrated
on what has happened in the ups and downs of the economy over
the last several decades since World War II. But in that period
we have not had a recession in which the cause was a financial
meltdown. So what you get from models is the answer to the
question here is what we think will happen under these current
circumstances if the financial system is operating normally,
and we know that ours is not.
Second point, we don't want to get back to the overspending
and over-borrowing economy that brought us to this path. We
have been living beyond our means. We must be aspiring to a
new, normal economy in which there is less consumption and more
saving and less dependence on foreign borrowing. That will give
us a more stable long-term situation, but it will make it
harder to climb out of this recession.
Finally, I am concerned about the impact of the very rapid
increases in the U.S. debt on willingness of our creditors,
especially our foreign creditors to keep buying Treasury
securities. They are buying them now because there is nothing
else to buy, and we are the most secure place to put their
money. But I think we have to worry as the world economy
recovers about the magnitude of the debt that we are pushing
out there.
Now, I would like to make a distinction which has been lost
in recent times between a stimulus and an investment plan. I
think we need both. We need in this quite dire situation a
stimulus that is, as we used to say, targeted, temporary and
spends out quickly. And there is much in H.R. 1 that is of that
nature: cash to low and moderate income people, aid to the
States, temporary appropriations for genuinely shovel-ready
projects. All of that I think could spend out quite quickly.
But we also need, in my opinion, a longer-run, very well-
thought-out investment in public infrastructure and in the
skills and capabilities of our economy. That ought not to be
just shoved into a quick stimulus. It should be very well
thought out. It should include transportation projects, mass
transit particularly, communications projects, I think health
information technology especially, and a heavy emphasis on
improving the skills of the workforce.
We need all of that to grow our economy and to be more
productive in the future. But we need to plan it well, and I
think over time we need to pay for it. What we need is a shift
of resources from somewhere else into more public investment,
which we have neglected for a long time. We don't need to worry
right now where the resources are going to come from, but if
this is a well-planned long program over time we are, with any
luck, going to get back to fuller employment, and we will need
to worry about that. So the resources can only come from
reducing other government spending or from additional taxes.
That should not be forgotten.
I believe that we have a serious--much more serious than we
are remembering now--problem of long-term deficits built into
our budget for reasons that are familiar. We have spending
projections rising very rapidly, faster than the GDP will grow,
faster than revenues at any set of tax rates, coming from the
principal entitlement programs, especially Medicare and
Medicaid and, to a lesser extent, Social Security. That used to
be very far in the future. It is not anymore. It is beginning
now and that spending will rise; and, for that reason, I think
we have to now, while we have the chance, take actions that
will bring down those deficits in the future.
You could fix Social Security right now. It wouldn't hurt
the current economy. Nobody is going to do it by cutting
benefits for people who are already retired. But if you did
something like was done in 1983, a package of Social Security
reforms enacted now that could include raising the retirement
age gradually in the future, indexing it to longevity, changing
the indexing so that benefits do not go up as rapidly,
especially for high-income people, raising the cap to which
taxes apply. A package of things like that enacted now could
reassure the world that we are putting our financial house in
order for the future and not do any concurrent damage.
Medical care is harder, but it is not impossible. If the
Congress were to take seriously the mandate to make Medicare
more efficient and put in place the data collection and the
changes in incentives that would make this program more cost-
effective over time, this is the time to do it, because it
takes some upfront investment and the payoff is long term.
Finally, process reform. I know this committee has been
over time committed to caps and to PAYGO. I would encourage you
to stay committed, not to make too many exceptions. But in the
long run, that is not enough. That will keep the deficits from
getting worse, and the getting worse is already built in. So I
think the Congress is going to need to shift to some new budget
process that will put entitlements and taxes into a long-run
structure so that you can actually decide--you are forced to
actually decide on the magnitude of the long-term deficits and
take steps to keep the budget in the range in which you want
it.
Thank you, Mr. Chairman.
Chairman Spratt. Thank you.
[The prepared statement of Alice Rivlin follows:]
Prepared Statement of Alice M. Rivlin,* the Brookings Institution and
Georgetown University
Mr. Chairman and members of the Committee: It is a pleasure for me
to be back at the House Budget Committee. I am especially gratified to
follow my former colleague, Douglas Elmendorf, as he makes the first of
many appearances before this Committee as Director of the Congressional
Budget Office.
---------------------------------------------------------------------------
*The views expressed in this testimony are those of the author and
should not be attributed to the staff, officers or trustees of the
Brookings Institution or Georgetown University.
I will say a few words about the uncertainties of the economic
outlook and then turn to the question of how to deal with the immediate
and longer-run challenges of fiscal policy. The challenge of budget-
making has never been greater. Indeed, I believe that the future
viability of the United States economy depends very heavily on budget
policy-makers' ability to focus on two seemingly contradictory
imperatives at the same time:
The immediate need to take actions which will mitigate the
impact of the recession and help the economy recover--actions that
necessarily require big increases in the budget deficit
The equally urgent need to take actions that will restore
fiscal responsibility and reassure our creditors that we are getting
our fiscal house in order--actions to bring future deficits down.
I stress two sets of actions because I do not believe it will be
sufficient to pay lip service to the long run challenge, while acting
only on deficit-increasing responses to the current financial and
economic crisis. Congress and the Administration must work together on
actual solutions to both problems at the same time.
THE ECONOMIC OUTLOOK
We meet at a time of extraordinary uncertainty about how deep the
recession will be and how long it will last. Forecasters all admit that
they have little confidence in their ability to predict how consumers,
producers, and investors at home and abroad will react to the
cataclysmic economic events that have occurred. But people in the
forecasting business still have to produce forecasts, so they do the
best they can. The Congressional Budget Office (CBO) forecasts that the
recession will ``last well into 2009'' and that the economy will begin
to recover, albeit slowly, in 2010. CBO expects unemployment to peak at
about 9 percent. The CBO is a bit more pessimistic than the Blue Chip
average of commercial forecasters, because the rules of CBO forecasting
do not allow them to take account of likely congressional actions to
stimulate the economy and enhance recovery.
Right now I think we should be skeptical of all forecasts and
especially conscious of the risk that things may continue to go worse
than expected. The current CBO forecast is much more pessimistic than
the one released just last September, and the Blue Chip consensus has
been going steadily south for many months. Additional revelations of
weakness in the financial services sector could further impede credit
flows and produce a continued slide in all forecasters' expectations.
Indeed, uncertainty about the health of the financial sector
compromises all current forecasting efforts. The economic models used
by forecasters are based on the experience of the post World War II
period, especially the last several decades. Not since the 1930's,
however, have we experienced a downturn caused by crisis in the
financial sector. Despite aggressive efforts of the Treasury and the
Federal Reserve to stabilize the financial sector, credit is not
flowing normally, even to credit- worthy borrowers. Continued
instability in the financial sector and credit tightness could deepen
the recession and delay recovery.
Also adding to the uncertainty and increasing the chance that
recovery will be unusually slow is the fact that returning to the pre-
crisis economy is not desirable. Before the current crisis Americans
were consuming and borrowing too much, while saving too little. We had
become an over-mortgaged, over-leveraged society dependent on the
inflow of foreign credit. If recovery from this recession is to be
solid and sustainable, we must stop living beyond our means. We must
transform ourselves into a society that consumes less, saves more and
finances a larger fraction of its investment with domestic saving,
rather than foreign borrowing. This transformation is necessary, but it
will put recovery on a slower track.
Indeed, not since we were a developing country have we been so
dependent on foreign creditors. We are lucky that, even though this
world-wide financial crisis started in the United States, the response
of world investors has been to flock to the safety of U.S. Treasuries,
which makes it possible for our government to borrow short-term at
astonishingly low rates. But we cannot count on these favorable
borrowing conditions continuing forever. Especially if we fail to take
serious steps to bring down future budget deficits, the United States
Government could lose the confidence of its foreign creditors and be
forced to pay much higher interest rates on to finance both public debt
and private debt. Rapid increases in interest rates and a plummeting
dollar could deepen the recession and slow recovery.
AN ``ANTI-RECESSION PACKAGE'' AND INVESTMENT IN FUTURE GROWTH
Despite the uncertainty of forecasts it is already clear that this
recession is bad and that worse is yet to come. Recessions always
increase budget deficits as revenues drop and recession-related
spending increases. These automatic deficits help stabilize the
economy. In addition, since an unusually severe downturn in the economy
is threatening, the government should act quickly to mitigate the
downslide with spending increases and revenue cuts that will stimulate
consumer and investor spending, create jobs and protect the most
vulnerable from the ravages of recession.
What we used to call ``stimulus'' (temporary spending or tax relief
designed to jump-start the economy) has been merged into a broader
concept of ``recovery'' and investment in future growth. However, I
believe an important distinction should be made between a short-term
``anti-recession package'' (aka ``stimulus '') and a more permanent
shift of resources into public investment in future growth. We need
both. The first priority is an ``anti-recession package'' that can be
both enacted and spent quickly, will create and preserve jobs in the
near-term, and not add significantly to long run deficits. It should
include temporary aid to states in the form of an increased Medicaid
match and block grants for education and other purposes. Aiding states
will prevent them from taking actions to balance their budgets--cutting
spending and raising taxes--that will make the recession worse. The
package should also include temporary funding for state and local
governments to enable them to move ahead quickly with genuinely
``shovel ready'' infrastructure projects (including repairs) that will
employ workers soon and improve public facilities. Another important
element of the anti-recession package should be substantial transfers
to lower and middle income people, because they need the money and will
spend it quickly. This objective would be served by increasing the
Supplemental Nutrition Assistance Program (SNAP), unemployment
compensation, and the Earned Income Tax Credit. Helping people who lose
their jobs to keep their health insurance and aiding distressed
homeowners also belong in this ``anti-recession'' package. On the tax
side, my favorite vehicle would be a payroll tax holiday, because
payroll tax is paid by all workers and is far more significant than the
income tax for people in the lower half of the income distribution.
Moreover, a payroll tax holiday would be relatively easy to reverse
when tax relief was no longer appropriate. This anti-recession package
should move forward quickly. Because its components would be temporary,
there would be little reason for concern about its impact on the
deficit three or four years down the road.
The anti recession package should be distinguished from longer-run
investments needed to enhance the future growth and productivity of the
economy. The distinction is not that these longer-run investments are
less needed or less urgent. We have neglected our public infrastructure
for far too long and invested too little in the skills of the future
workforce. If our economy is to grow sustainably in the future we need
to modernize our transportation system to make it more efficient and
less reliant on fossil fuels. We need to assure access to modern
communications across the country and invest in the information
technology and data analysis needed to make medical care delivery more
efficient and effective. We need a well thought-out program of
investment in workforce skills, early childhood education, post-
secondary education, science and technology. Such a long-term
investment program should not be put together hastily and lumped in
with the anti-recession package. The elements of the investment program
must be carefully planned and will not create many jobs right away.
Since a sustained program of public investment in productivity-
enhancing skills and infrastructure will add to federal spending for
many years, it must be paid for and not simply added to already huge
projected long-term deficits. That means either shifting spending from
less productive uses or finding more revenue. Overtime, Congress could
reduce commitments to defense programs and weapons systems that reflect
outmoded thinking about threats to U.S. security, reduce agricultural
subsidies, and eliminate many small programs that have outlived their
original priorities. Reform of the tax system--including making the
income tax simpler and fairer or increasing reliance on consumer
taxation--could produce more revenue with less drag on economic growth.
None of these policies would be easy, but the resources to pay for
large permanent increases in federal spending must be shifted from
somewhere else as the economy returns to full employment. Congress will
only be able to accomplish this reallocation of resources if it
reinstates some form of long run (say, ten year) PAYGO and caps on
discretionary spending.
I understand the reasons for lumping together the anti-recession
and investment packages into one big bill that can pass quickly in this
emergency. A large combined package will get attention and help restore
confidence that the federal government is taking action--even if part
the money spends out slowly. But there are two kinds of risks in
combining the two objectives. One is that money will be wasted because
the investment elements were not carefully crafted. The other is that
it will be harder to return to fiscal discipline as the economy
recovers if the longer run spending is not offset by reductions or new
revenues.
IMMEDIATE ACTION TO BRING DOWN FUTURE DEFICITS
As this Committee knows well, projections of the federal budget
show rapidly rising spending over the next several decades attributable
to three major entitlement programs; namely, Medicare, Medicaid and
Social Security. Under current rules, Social Security spending will
rise rapidly over the next two decades, but level off after the Baby
Boom generation passes through the system. The health care entitlements
are expected to rise even faster. Moreover, they are expected to keep
on rising because they are dominated by continued increases in the
spending for health care in both the public and private sectors. If
policies are not changed Medicare and Medicaid--and to a lesser extent
Social Security--will drive federal spending up considerably faster
than the rate at which the economy is likely to grow. Unless Americans
consent to tax burdens that rise as fast as spending, a widening gap
will open up. We will not be able to finance these continuously growing
deficits.
Because rapidly rising debt threaten our credibility as sound
fiscal managers, we do not have the luxury of waiting until the economy
recovers before taking actions to bring down projected future deficits.
Congress and the Administration should take actual steps this year to
reduce those deficits in order to demonstrate clearly that we are
capable of putting our fiscal house in order. This can be done without
endangering economic recovery.
The crisis may have made Social Security less of a political
``third rail'' and provided an opportunity to put the system on a sound
fiscal basis for the foreseeable future. Fixing Social Security is a
relatively easy technical problem. It will take some combination of
several much-discussed marginal changes: raising the retirement age
gradually in the future (and then indexing it to longevity), raising
the cap on the payroll tax, fixing the COLA, and modifying the indexing
of initial benefits so they grow more slowly for more affluent people.
In view of the collapse of market values, no one is likely to argue
seriously for diverting existing revenues to private accounts, so the
opportunity to craft a compromise is much greater than it was a few
years ago. Fixing Social Security would be a confidence building
achievement for bi-partisan cooperation and would enhance our
reputation for fiscal prudence.
Vigorous action should also be taken to make Medicare more cost
effective and slow the rate of growth of Medicare spending, which
contributes so much to projected deficits. While restraining health
spending growth should be a major feature of comprehensive health
reform, Medicare is an ideal place to start the effort. Medicare is the
largest payer for health services and should play a leadership role in
collecting information on the cost and effectiveness of alternative
treatments and ways of delivering services, and designing reimbursement
incentives to reward effectiveness and discourage waste. Congress has a
history of allowing pressure from providers and suppliers (for example,
suppliers of durable medical equipment or pharmaceutical companies) to
thwart efforts to contain Medicare costs. The government has also not
been adequately attentive to punishing and preventing Medicare fraud.
The United States will not stand a chance of restoring fiscal
responsibility at the federal level unless Congress develops the
political will to hold health providers accountable--whether in the
context of existing federal programs or comprehensive health reform--
for delivering more cost effective care. A good place to start is
Medicare.
PROCESS REFORM
This Committee does not need to be convinced that deficits matter
and that the deficits looming in the federal budget--exacerbated by the
rapid increases in debt associated with recession and financial
bailout--must be dealt with sooner rather than later. You know that
procrastination will make the hard choices harder and make us
increasingly dependent on our foreign creditors and exposed to their
policy priorities. The question is: should you take actual steps now to
reduce future deficits or design process reforms that will force you to
confront viable options and make choices in the future? My answer is:
do both.
Fixing Social Security and taking aggressive steps to control the
growth of Medicare costs would be visible evidence that Congress and
the new Administration have the courage to rein in future deficits. But
the Congress also needs to restore discipline to the budget process--
not use recession or the financial meltdown as excuses for throwing
fiscal responsibility to the winds just when we are going to need it
more than ever. A large temporary anti-recession package is the right
fiscal policy in the face of severe recession and should not be subject
to offsets--that would defeat the purpose. But more permanent
investments in future growth--also good policy--should be paid for and
not allowed to add to future deficits. Caps on discretionary spending
and PAYGO for revenues and mandatory spending should be reinstated and
seriously enforced.
Moreover, PAYGO is not enough, because it only guarantees that
congressional actions with respect to entitlements and revenues will
not make projected deficits worse than they would be under current
policies. But, we all know that deficits projected under current policy
will rise at unsustainable rates. Spending required by Medicare,
Medicaid and Social Security will rise substantially faster than
revenues at any feasible set of tax rates. We will not be able to
borrow that much money--even if we thought it desirable to do so.
The current budget process subjects a declining--discretionary
spending--to annual scrutiny by leaves entitlement programs and
revenues on automatic pilot outside the budget process. Fiscal
responsibility requires that all long-term spending commitments be
subject to periodic review along with taxes and tax expenditures. There
is no compelling logic for applying caps and intense annual scrutiny to
discretionary spending, while leaving huge spending commitments, such
as Medicare or the home mortgage deduction entirely outside the budget
process and not subject to review on a regular basis. I am a member of
a bipartisan group called the Fiscal Seminar (sponsored by The
Brookings Institution and the Heritage Foundation) that addressed this
problem in a paper entitled, Taking back our Fiscal Future, in 2008. We
may not have come up with the right solution, but we certainly
identified a serious problem that stands in the way of getting the
federal budget on a sustainable long run track.
NOT A PARTISAN MATTER
The challenges that face this Committee--mitigating the recession,
enhancing future growth, restoring sustainable fiscal responsibility--
cannot be solved by one political party, but require non partisan
analysis and bipartisan cooperation. Many budget analysts with quite
disparate views on particular policies share the conviction that
Congress and the Administration must meet the double challenge of
reviving the economy and restoring fiscal responsibility at the same
time. I attach a memo to President Obama signed by twelve experienced
budget analysts (including myself) that emphasizes these points.
Thank you, Mr. Chairman and members of the Committee.
ATTACHMENT
January 22, 2009.
To: President Obama
From: Bob Bixby, William Galston, Ron Haskins, Julia Isaacs, Maya
MacGuineas, Will Marshall, Pietro Nivola, Rudy Penner, Robert
Reischauer, Alice Rivlin, Isabel Sawhill, Eugene Steuerle
Subject: A Budget We Can Believe In
Your first budget will be a defining document. It will cast the
basic mold of your administration, highlight your key priorities, and
specify how you are going to deliver on your most important campaign
promises or modify them in light of new developments. The decisions you
make in shaping this budget will be among the most consequential of
your tenure.
In our view, the overriding imperative for your first budget is to
strike a judicious balance between America's short-term and long-term
economic needs. To accomplish this, that budget must be strategic as
well as tactical. The steps you take to address our short-term problems
must not make it harder to achieve our long-term goals. Indeed, they
should set the stage both for steady economic growth and a sustainable
fiscal future. To be a truly transformative president, you must not
allow the urgency of the short-term to crowd out concern for the
country's long-term wellbeing.
As you have noted, the key short-term challenges are:
stabilizing America's financial markets to ensure an ample
and affordable supply of credit, which is the lifeblood of our economy;
and
reducing the severity and duration of the current
recession and getting Americans back to work.
At the same time, your budget must set in motion measures that deal
with two critical long-term challenges to America's economic health:
controlling the growth of health costs and putting Social
Security on a financially sustainable path.
reforming America's tax system to make it more efficient,
fairer and simpler and to raise adequate revenue while maintaining
economic growth.
These short- and long-term economic imperatives are inextricably
linked. The costs of stabilizing the financial markets and stimulating
economic growth will generate a large increase in our national debt. We
will have to borrow money in domestic and international capital markets
to finance this debt, and without a serious commitment to long-term
fiscal restraint, lenders will eventually question the nation's fiscal
credibility. They may respond by reducing the share of their portfolios
devoted to U.S. government debt or by charging higher interest rates.
In the extreme, the reluctance to buy U. S. debt could cause a crisis
in international capital markets. No one can describe the risks
precisely, but Wall Street's recent troubles demonstrate that the
perils of over reliance on debt can come swiftly and in unpredictable
ways. What is predictable is that if the long-term problem is not
confronted, interest costs will absorb a growing proportion of our
budgetary resources and, together with growing health costs and Social
Security, will threaten to crowd out spending on programs for the poor,
children, and improving the nation's infrastructure. Moreover, our
dependence on foreign creditors and the resulting mortgage on future
national incomes will diminish American standards of living for
generations to come.
We understand full well the myriad considerations that will shape
your fiscal proposals for the next fiscal year. We suggest, however,
two criteria that a future-oriented budget for fiscal 2010 should meet.
First, you have pledged repeatedly to scrub every line
item in the current budget with an eye to finding items that are either
ineffective or outdated. We do not believe that this effort will be
credible unless it produces significant savings from both programs and
tax expenditures.
Second, the stimulus package should not worsen the long-
term fiscal outlook. To the extent that it includes items that increase
the long-term budget deficit, offsetting long-term spending cuts or
revenue streams should be proposed.
We believe, moreover, that Congress must re-impose caps on
discretionary spending as soon as the economy begins to recover from
the recession. The budget documents you submit to Congress should make
it clear that you will support such a move.
The long-term budget challenge can be stated succinctly. Three
large programs--Social Security, Medicare, and Medicaid--now constitute
almost one-half of non-interest federal spending and are growing faster
than tax revenues because of soaring health costs and the aging of the
population. If we fail to reform these spending programs and insist on
maintaining the tax burden where it is has been over the past 50 years
(about 18 percent of GDP), deficits will soar, and the public debt is
likely to exceed 100 percent of the GDP within 25 years. That compares
to 37 percent at the end of fiscal 2007.
It's entirely understandable that public concern over the long-term
budget problem has now been swamped by the financial crisis and
accompanying recession. But as President you can't afford to lose sight
of these inconvenient truths. The budget deficit for fiscal 2009 is
estimated at $1.2 trillion by CBO, and this excludes any new spending
as part of a stimulus bill. The federal debt owed to the public may
increase by considerably more than 50 percent over the next two years.
Although large debt increases occurred in the early 1980s, they did not
occur as quickly. Moreover, there are two important differences from
that era. First, we are now more dependent on foreign private and
government investors to buy our debt. Second, relative to the size of
the economy (GDP), Social Security, Medicare, and Medicaid are much
larger now than they were then, and they are expected to grow more
rapidly as the oldest baby boomers begin to retire. Consequently, the
budget deficit will contract more slowly than usual as the economy
recovers.
Although we are rightly absorbed by our short-term problems, the
long-term budget situation ultimately poses graver challenges to the
success of your presidency. Social Security, Medicare, and Medicaid are
expected to constitute 1.8 percent more of the GDP in 2016 than they
did in 2008. That may not sound like much, but if the growth were to be
financed entirely with tax increases, it would imply an overall tax
increase of almost 10 percent above historical levels--and that would
only be the first of many tax increases to follow. If it were financed
by cutting all other non-interest programs including defense, the
across-the-board reduction would have to be more than 20 percent
compared to baseline levels. Even if a number of inefficient and low
priority programs are eliminated, it would not be possible to fulfill
your election promises--to expand health insurance coverage or to
increase public investment in education, infrastructure, and research
on alternative energy sources, among many others--without digging our
long-term fiscal hole even deeper.
Your budget should make it very clear that you take the long-term
budget problem seriously. It must quantify the cost of our long-term
promises and explicitly state the goal of achieving fiscal
sustainability. As a first step, we should stabilize the ratio of debt
to GDP while creating an atmosphere conducive to economic growth. The
budget could, for illustrative purposes, specify two or three
combinations of target revenue and spending paths that would achieve
this initial goal.
We believe you should do more than express your concern about the
danger of escalating future deficits. You should move quickly to reduce
them without endangering near-term economic recovery. First, you should
give high priority to putting Social Security on a sound fiscal basis
to reduce future deficits and show our creditors that we are taking
serious steps to manage our national finances. Second, you should take
quick action to reduce the growth of Medicare by shifting to payment
systems that reward effective treatments and discourage wasteful
spending.
The long-term fiscal problem is complicated by the fact that it is
difficult to contemplate increased revenues being part of the solution
so long as the public rightly remains highly distrustful of our
inequitable and economically inefficient tax system. Tax reform is
always difficult, but it will be necessary to achieve a rational
solution to our long-term problems. Hundreds of billions of dollars
worth of tax expenditures in the federal code must be evaluated and
eliminated where they inhibit economic growth, are inefficient, have
undesirable distributional consequences, or are difficult to
administer.
Throughout your campaign, you pioneered new ways of involving the
American people in our nation's political life, and you have signaled
your determination to continue that commitment as president. Our long-
term economic and fiscal future is an issue that cries out for just
such public engagement. Congress is unlikely to cooperate in
undertaking such painful reforms so long as the general public remains
unaware of the magnitude and urgency of the long-term fiscal challenge.
Therefore, we recommend that you launch an intensive public education
campaign. This could include a series of town hall meetings across the
country or fireside chats to explain the problem and lay out options
for solving it to the American public. Although you could send
surrogates around the country, you should personally take part in some
of these meetings to underscore their vital importance, as President
Clinton did a decade ago. If Americans grasp how essential budget
reform is for the wellbeing of their children and grandchildren, they
will be more likely to accept the sacrifices necessary to get the
budget under control.
One additional (and crucial) point: it makes no sense to undertake
a challenge of such magnitude unless it yields structural changes that
are enduring. To that end, we recommend two key shifts in our budget
procedures.
Once an agreement for tax and long-term spending reform is
in place, it must be enforced by pay-as-you-go rules that require that
all tax cuts or entitlement increases be financed by some combination
of tax increases and entitlement cuts. Without such rules, a painfully
negotiated agreement is likely to erode over time.
In addition, targets for entitlement spending and tax
expenditures should be budgeted for the long run, say, 30 years. If
unexpected events push spending or tax expenditures above targets,
automatic triggers could be used to slow spending growth, increase
revenues, or some combination of the two.
We have outlined a formidable task. It may be possible to muddle
through another eight years without facing the long-term challenge. To
evade it, however, would be to squander an historic opportunity to set
our economy and governing institutions on a sound and sustainable
course. To be remembered as a truly transformative president, you must
boldly confront--and master--the toughest problems of your time.
The signatories to this memo are all members of a group that has
been meeting together for several years at the Brookings Institution
under the auspices of Brookings and the Heritage Foundation. The views
expressed are those of the individuals involved and should not be
interpreted as representing the views of their respective institutions.
Chairman Spratt. Now let's go to Dr. Zandi, and let me say
that there are some votes coming up on the floor. We are going
to finish this one way or the other. We want every witness to
have an opportunity to be on the record.
STATEMENT OF MARK ZANDI, PH.D.
Mr. Zandi. I will keep it to 2 hours. I will stick to that.
Yes, sir.
Thank you, Mr. Chairman for the opportunity and members of
the committee. I am an employee of the Moody's Corporation, but
these are my own personal views.
I will make six points.
First, the near-term economic outcome is grim. The economy
has lost 2.6 million jobs over the past year. I think it is
very possible we lose just as many jobs in the first half of
2009. The unemployment rate is 7.2 percent. It will easily be
over 9 percent by the end of the year. And the downturn has
engulfed every industry, every occupation and every corner of
the country, which is the hallmark of this downturn. It is the
breadth of the downturn.
Consumer spending has collapsed, business investment is
down, exports are falling. The only source of growth at the
current point in time is government spending.
So, first point, the outlook is very dark.
The second point is that this dark economic outlook is
dependent on policymakers doing three broad things very quickly
in the next few weeks:
First, to stabilize the teetering financial system, some of
the remaining TARP money should be used to purchase and then
guarantee troubled assets. This is important to getting the
assets off the balance sheets of these institutions and also
establishing a market for these assets which is necessary to
get private capital back into the financial system.
Second, the TARP money should be used for a very large
foreclosure mitigation plan which includes mortgage
modifications with writedowns. We have learned that
modifications that only include rate reductions and term
extensions are not working. There is a very high redefault
rate. So we need writedowns.
Third and most importantly and most immediately, I think it
is key for policymakers to implement a very aggressive fiscal
stimulus plan. Increased government spending and tax cuts are
necessary to fill the void left by slumping private economic
activity.
Third point, the House Democratic fiscal stimulus plan
which includes $825 billion in stimulus will not reverse the
downturn, but it will provide a very vital boost to a flagging
economy. By my estimates, with this stimulus there will be
approximately 3 million more jobs; and the jobless rate will be
1.5 percentage points lower by the end of 2010 than without any
fiscal stimulus. Without stimulus, the unemployment rate will
rise well into the double digits and the economy will not
return to full employment, which by my estimate is a 5 percent
unemployment rate, until 2014. So very vital to pass the
stimulus plan.
Point four, the economic benefit of the House plan depends
on how quickly the government spending can occur. Of course,
the recent CBO analysis says the spend-out rates can take
years. If the past is indeed prologue, and I think much of
their analysis is based on past historical experience, then I
am overestimating the benefits of the House plan. Policymakers
should therefore fund projects that can be implemented quickly
and should also establish mechanisms that will provide the
necessary oversight to ensure that the projects are conducted
in a timely fashion.
Point five, policymakers may also want to consider
expanding the size of the stimulus. I don't think $825 billion
is enough, and I would increase the size of the package by
including more tax cuts. Tax cuts do not have the same economic
bang for the buck as increased government spending. Some of the
tax cuts will be saved, some of it will be used to repay debt,
not bad things but not good for the economy in the very near
term, and some of it will be used for the purchase of imported
goods that don't help jobs here in the United States. But they
can get into the economy quickly, quickly in 2009.
Two proposals, a refundable tax credit for a home purchased
in 2009, payable at the time of the purchase, would be an
effective way to help stimulate home sales and work off some of
the mountain of inventory. In the current plan, there is a tax
credit, but it is only for first-time home buyers. I would make
it for all home buyers, and I would make the credit payable at
the sale so they could be used for the down payment to
facilitate sales.
The second proposal, a payroll tax holiday for the entire
third quarter of this year for both employees and employers. If
you did that, it would be a tremendous boost to lower and
middle income households and most critically to small
businesses, many of whom are going to fail in this economy if
they don't get immediate help.
The cost of these two proposals would bring the total cost
of the House plan to just over $1 trillion, which I think is
more consistent with the severity of the situation that we are
in.
Point six, final point, there are very reasonable concerns
that the cost of all the actions policymakers are taking to
quell a crisis will overwhelm the government's resources and
further exacerbate the Nation's daunting long-term fiscal
challenges. There is no doubt that the Federal debt will rise
substantially. Doug Elmendorf pointed out that the debt to GDP
ratio is 40 percent. I think a reasonable forecast is when this
is all said and done it will be 60 percent. It is important to
consider, however, that the Nation's budgetary problems would
likely be even worse if policymakers do not respond
aggressively to the crisis, as a sliding economy would
undermine tax revenues and result in much higher government
outlays.
Moreover, while running massive deficits are very
undesirable, the resulting debt load is still manageable. Sixty
percent is still very manageable. Global investors are fully
expecting and remain very avid buyers of our Treasury debt, in
part because the U.S. economy remains the global economy's
triple A credit. For the U.S to maintain its financial
standing, however, policymakers must immediately begin to
address the Nation's long-term fiscal challenges.
Let me say in conclusion that any fiscal stimulus plan in
my view is more than dollars and cents. It has to be effective
in lifting spirits. Confidence hit a new all-time record low in
the month of January. A confidence report survey for January
came out this morning. It hit an all-time new record low.
So the stimulus has to be passed very quickly and, most
importantly, has to be explained very clearly so that
households and businesses are convinced that it is going to
work. Unless the plan helps dissipate the current dark mood of
pessimism, it will do little to stem the current economic
downturn.
Thank you.
Chairman Spratt. Thank you very much.
[The prepared statement of Mark Zandi follows:]
Prepared Statement of Mark Zandi, Chief Economist and Cofounder,
Moody's Economy.com
Mr. Chairman and members of the committee, thank you for the
opportunity to testify on such an important matter in a time of
economic and financial crisis. I am an employee of the Moody's
Corporation, but my remarks today reflect my personal views.
I will make six points this morning:
1. The near-term economic outlook is grim. The economy has already
lost 2.6 million jobs since the current downturn began and will lose
about as many more during the first half of this year. Unemployment,
which is now at 7.2%, will rise to nearly 9% by year's end. The
downturn will engulf nearly every industry, occupation and region of
the country. Consumer spending has collapsed, business investment is
declining, and exports are now falling, as the entire global economy is
suffering a synchronized downturn.
2. Even this dark economic outlook requires that policymakers take
three broad actions in the next few weeks. First, to stabilize the
still-teetering financial system, some of the remaining TARP money
should be used to purchase and guarantee troubled assets on the
system's balance sheet. Second, the TARP money should also be used to
fund an aggressive foreclosure mitigation plan that includes mortgage
write-downs. Without such a plan, foreclosures will continue to surge,
further undermining the financial system and broader economy. And
third, policymakers must implement an aggressive fiscal stimulus plan.
Increased government spending and tax cuts are necessary to fill the
void left by slumping private economic activity.
3. The House Democratic fiscal stimulus plan, which includes some
$825 billion in stimulus measures, will not reverse the economic
downturn, but it will provide a vital boost to the flagging economy if
passed quickly. With the stimulus, there will approximately 3 million
more jobs, and the jobless rate will be 1.5 percentage points lower by
the end of 2010 than without any fiscal stimulus. Without a stimulus,
unemployment will rise well into the double digits by this time next
year, and the economy will not return to full employment until 2014.
4. The economic benefit of the House plan critically depends on how
quickly the government spending can occur. A recent Congressional
Budget Office analysis shows that historical spend-out rates on such
outlays can take years. If past is indeed prologue, then I am
measurably overestimating the economic benefit of the House plan.
Policymakers should therefore fund projects that can be implemented
quickly and should also establish mechanisms that will provide the
oversight necessary to ensure that the projects are conducted in a
timely fashion.
5. Policymakers may also want to consider expanding the size of the
stimulus package with more tax cuts. Tax cuts do not have the same
economic bang for the buck as increased government spending, as
households will save some of the tax cuts or use them to repay debt or
purchase imported goods, but tax cuts can get into the economy quickly.
A refundable tax credit for a home purchased in 2009, payable at the
time of the purchase, would quickly stimulate home sales and reduce the
mountain of unsold homes weighing on house prices and exacerbating
foreclosures and the crisis in the financial system. A payroll tax
holiday for employees and employers in, say, the third quarter of this
year would also provide a large boost to lower- and middle-income
households and struggling small businesses. These two tax cuts would
bring the total cost of the House plan to just over $1 trillion.
6. There are very reasonable concerns that the cost of all the
actions policymakers are taking to quell the crisis will overwhelm the
government's resources and exacerbate the nation's daunting long-term
budget challenges. There is no doubt that the federal debt load will
rise substantially as a result, from about 40% of GDP now to as much as
60% of GDP, as the budget deficit this year and next will collectively
total several trillion dollars. It is important to consider, however,
that the nation's budgetary problems will likely become even worse if
policymakers do not respond aggressively to the crisis, because the
sliding economy would undermine tax revenues and result in much higher
government outlays. Moreover, although running massive deficits is
highly undesirable, the resulting debt load is still manageable. Global
investors are fully expecting this and remain avid buyers of Treasury
debt, in part because there is little private sector borrowing at this
time and in part because the U.S. remains the global economy's Aaa
credit. Reflecting this, Treasury yields remain near record lows. For
the U.S. to maintain its financial standing, however, policymakers must
immediately begin to address the nation's long-term fiscal challenges.
I will conclude by saying that any fiscal stimulus plan has to be
about more than dollars and cents to be effective in lifting spirits
and the economy. It must be passed quickly and explained clearly so
that households and businesses are convinced it will work. Unless the
plan helps dissipate the dark mood, it will do little to stem the
economic downturn.
[The supplemental statement of Mr. Zandi follows:]
Supplemental Statement of Mark Zandi, Chief Economist and Cofounder,
Moody's Economy.com
Mr. Chairman and members of the committee, my name is Mark Zandi; I
am the chief economist and cofounder of Moody's Economy.com.
Moody's Economy.com is part of Moody's Analytics, an independent
subsidiary of the Moody's Corporation. My remarks represent my personal
views and do not represent those held or endorsed by Moody's. Moody's
Economy.com provides economic and financial data and research to over
500 clients in 50 countries, including the largest commercial and
investment banks, insurance companies, financial services firms, mutual
funds, manufacturers, utilities, industrial and technology clients, and
government at all levels.
The new administration and Congress are working to implement a
large fiscal stimulus plan to mitigate the severe economic downturn.
The latest step in this effort is the plan put forth by House Democrats
in mid-January. As laid out in the American Recovery and Reinvestment
Act, the plan would cost $825 billion and include a large number of
spending increases and tax cuts.\i\ The national, industry and state
economic impact of this stimulus plan are assessed in the following
analysis.
The House stimulus plan will not reverse the current downturn, but
it will provide a vital boost to the flagging economy. With the
stimulus, there will be 3 million more jobs and the jobless rate will
be more than 1.5 percentage points lower by the end of 2010 than
without any fiscal stimulus. Without a stimulus, unemployment will rise
well into the double digits by this time next year, and the economy
will not return to full employment until 2014.
The economic benefit of the House plan critically depends on how
quickly the government spending can occur. A recent Congressional
Budget Office analysis shows that historical spend-out rates on such
outlays can take years. If past is indeed prologue, this analysis is
overstating the economic benefits of the House plan. Policymakers
should therefore fund projects that can be implemented quickly and
should also establish mechanisms that will provide the oversight
necessary to ensure that the projects are executed in a timely fashion.
Policymakers may also want to consider expanding the size of the
stimulus package with more tax cuts. Tax cuts do not have the same
economic bang for the buck as increased government spending, as
households will save some of the tax cuts or use them to repay debt,
and purchase imported goods, but tax cuts can get into the economy
quickly. A refundable tax credit for a home purchased in 2009, payable
at the time of the purchase, would be an effective way to quickly
stimulate home sales and reduce the mountain of unsold homes weighing
on house prices and exacerbating foreclosures and the crisis in the
financial system. A payroll tax holiday for employees and employers in,
say, the third quarter of this year would also provide a large boost to
lower- and middle-income households and struggling small businesses.
These two tax cuts would bring the total cost of the House plan to just
over $1 trillion.
There are very reasonable concerns that the cost of all the actions
policymakers are taking to quell the crisis will overwhelm the
government's resources and exacerbate the nation's daunting long-term
budget challenges. There is no doubt that the federal debt load will
rise substantially as a result, from about 40% of GDP to as much as 60%
of GDP, as the budget deficit this year and next will collectively
total several trillion dollars. It is important to consider, however,
that the nation's budgetary problems will likely become even worse if
policymakers do not respond aggressively to the crisis, because the
sliding economy would undermine tax revenues and result in much higher
government outlays. Moreover, although running massive deficits is
highly undesirable, the resulting debt load is still manageable. Global
investors are fully expecting this and remain avid buyers of Treasury
debt, in part because there is little private sector borrowing at this
time and in part because the U.S. remains the global economy's Aaa
credit. Reflecting this, Treasury yields remain near record lows. For
the U.S. to maintain its financial standing, however, policymakers must
immediately begin to address the nation's long-term fiscal challenges.
Any fiscal stimulus plan has to be about more than dollars and
cents to be effective in lifting spirits and the economy, however. It
must be passed quickly and explained well so that households and
businesses are convinced it will work. Unless the plan helps dissipate
the dark mood, it will not stem the economic downturn.
INTRODUCTION
The global financial system has effectively collapsed, undermining
investor, household and business confidence and pushing the economy
into a lengthy and severe recession. Real GDP, employment, industrial
production and retail sales are falling sharply, and unemployment is
rising quickly. Policymakers are working to implement a large fiscal
stimulus package; yet, even with such a stimulus, the economy appears
headed toward its worst downturn since the Great Depression.
The proximate cause of the crisis was the collapse of the U.S.
housing market and the resulting surge in mortgage loan defaults.
Hundreds of billions of dollars in losses on these mortgages have
undermined the financial institutions that originated and invested in
them, including some of the world's largest. Many have failed, and
others are struggling to survive. Banks fear extending credit to one
another, let alone to businesses and households. With the credit spigot
closing, the global economy is withering. Global stock investors have
dumped holdings as they come to terms with the implications for
corporate earnings. A self-reinforcing adverse cycle has begun: The
eroding financial system is upending the economy, putting further
pressure back on the financial system as the performance of assets from
credit cards to commercial mortgage loans sours.
This cycle can be broken only by aggressive and consistent
government action. In the United States, the public policy response to
the financial crisis has been without precedent. The full faith and
credit of the U.S. government now effectively backstops the financial
system, significant parts of which have been nationalized. With the
takeover of Fannie Mae and Freddie Mac, the government makes nearly all
the nation's residential mortgage loans. And as the $700 billion
Troubled Asset Relief Program is deployed, the government is gaining
sizable ownership stakes in the nation's largest financial
institutions.
In an effort to restart money and credit markets, the Federal
Reserve has vastly expanded its role. The Fed has adopted a zero
interest rate policy, and in an attempt to bring down long-term
interest rates, it has made clear that the funds rate will remain there
indefinitely. The Fed is also ramping up a policy of quantitative
easing, in which it effectively prints money to purchase securities and
extend loans to financial institutions that use their securities as
collateral.\ii\ The central bank is already purchasing commercial paper
and debt issued by Fannie Mae and Freddie Mac and the mortgage
securities they insure. If conditions continue to erode, the Fed will
turn to buying long-term Treasury bonds and perhaps eventually
municipal bonds, corporate bonds, and even corporate equity.
Money markets have responded to the Fed's unprecedented actions.
Libor has fallen, suggesting that the interbank lending market is
performing better. Commercial paper rates have fallen, and the volume
of new issuance has increased sharply. Residential mortgage rates have
also declined, with 30-year fixed rates for prime conforming borrowers
falling from above 6% to nearly 5%. Despite the improvement, money-
market conditions remain far from normal, and even after financial
institutions begin lending more freely to one another, they will be
slow to extend credit to households and businesses, considering their
worries about creditworthiness in a severe recession. Moreover, lower
mortgage rates will not quickly revive home sales, given rising
unemployment and plunging house prices. The link between the Federal
Reserve's actions and the economy runs through the financial system.
With that system in disarray, the efficacy of monetary policy has been
significantly impaired.
Policymakers have also worked directly to shore up the housing and
mortgage markets and the broader economy. A number of programs have
been put in place to enable stressed homeowners to avoid foreclosure.
These include FHA Secure, Hope Now, and Hope for Homeowners. Fiscal
stimulus measures, including last summer's refundable tax rebates and
investment tax incentives, have provided some economic support.
Much more needs to be done to quell the financial panic and
mitigate the severe downturn. The remaining $350 billion in TARP funds
must be deployed aggressively and broadly. Most of the initial $350
billion in TARP funds was used to inject equity into the financial
system; although this helped forestall a complete collapse, it did not
significantly improve the flow of credit to households and businesses.
To do this, some of the remaining TARP money must be used to either
purchase troubled assets from distressed institutions or provide
guarantees against losses on those assets, or both. These steps would
help establish a market and prices for these assets. Only then will
private investors be able to determine the value of financial
institutions, a prerequisite for providing them with private capital.
The remaining TARP money should also be used to fund a much larger
and more comprehensive foreclosure mitigation plan. Millions of
homeowners owe more than their homes are worth, and unemployment is
rising quickly. Foreclosures, already at record high levels, are sure
to mount. The Hope Now and Hope for Homeowners programs face severe
impediments, and even under the best of circumstances will likely be
overwhelmed by the wave of foreclosures still coming. No plan will keep
house prices from falling further, but quick action could avoid the
darker scenarios in which crashing house prices force millions more
people from their homes, completely undermining the financial system
and economy.\iii\
The top priority should be the implementation of a large fiscal
stimulus package. The House Democratic plan proposed in mid-January
includes both increases in government spending and tax cuts. The plan
would cost approximately $825 billion, equal to 5.5% of the nation's
gross domestic product. This is not as costly as the public works
projects of the 1930s, but it is costlier than the 3% of GDP spent to
stimulate the economy during the tough downturn in the early 1980s. The
cost of the current package would thus be consistent with expectations
regarding the severity of this downturn. At 5.5% of GDP, the stimulus
would also be about enough to ensure that the economy stops contracting
by the end of 2009 and that GDP returns to its prerecession peak by the
end of 2010--reasonable goals.
The mix of tax cuts and spending increases in the stimulus package
is designed to provide both quick relief and a substantial boost to the
struggling economy. The tax cuts will not pack a big economic punch, as
some of the money will be saved and some used to repay debt, but they
can be implemented quickly. Aid to state and local governments will not
lift the economy, but it will forestall cuts in programs and payrolls
that many governments would be forced to make to meet their states'
constitutional obligations to balance their budgets. Infrastructure
spending will not help the economy quickly, as it will take time to get
even ``shovel-ready'' projects going, but it will provide a significant
economic boost. Because the economy's problems are not expected to
abate soon, this spending will be especially helpful this time next
year.
With government making so many monumental decisions in such a short
time, there will surely be unintended consequences. Some may already be
evident: Nationalizing Fannie Mae and Freddie Mac while not rescuing
Lehman Brothers from bankruptcy may very well have set off the
financial panic. The former Treasury secretary's reversal on the use of
TARP to purchase troubled assets began a chain of events that resulted
in the near failure of Citigroup. And policymakers need to be wary of
the costs of their actions, as global investors will eventually demand
higher interest rates on the soaring volume of U.S. Treasury debt. Any
measurable increase in long-term interest rates would be
counterproductive; its effect on the housing market and the rest of the
economy would offset the economic benefits of the fiscal stimulus.
But policymakers' most serious missteps so far have come from
acting too slowly, too timidly, and in a seemingly scattershot way.
Early in the crisis, there were reasonable worries about moral hazard
and fairness: Bailing out those who took on, originated or invested in
untenable mortgage loans would only encourage such bad behavior in the
future. And a bailout would certainly be unfair to homeowners still
managing to make their mortgage payments. But as the crisis deepened
and continued, those worries hindered policymakers far too long,
allowing the panic to develop. With so many people suffering so much
financial loss, moral hazard is less of an issue. Debate about whether
it is fair to help distressed homeowners stay in their homes appears
quaint. Their problems are clearly everyone's problems. Only concerted,
comprehensive and consistent government action will instill the
confidence necessary to restore financial stability and restart
economic growth.
ECONOMIC BACKDROP
The need for more policy action grows more evident as the financial
and economic backdrop darkens. The financial panic that began in early
September with the nationalization of Fannie and Freddie may have
passed its apex, but the collective psyche remains frazzled. And even
if the panic soon subsides, substantial economic damage has been done.
The collapse in confidence, the massive loss of wealth, and the
intensifying credit crunch ensure the U.S. economy will struggle for
some time.
Money markets are improving thanks to massive intervention by
global central banks but remain far from normal. The difference between
three-month Libor and three-month Treasury bill rates--a good proxy for
the angst in the banking system--is still an extraordinarily wide 100
basis points (see Chart 1).\iv\ This spread is down from the record
spreads of mid-October, which topped 450 basis points, but it is still
very high compared with past financial crises, not to mention the
average 50-basis point spread that prevails in normal times. The Fed's
program to purchase commercial paper directly from issuers has pushed
those short-term rates down as well, but they too are still very high.
Credit markets remain badly shaken. Bond issuance has come to a
standstill. No residential or commercial mortgage-backed securities
have been issued in recent months, and there has been little issuance
of junk corporate bonds and emerging market debt. Asset-backed issuance
of credit cards and vehicle and student loans and issuance of municipal
bonds also remain severely disrupted. Investment-grade bond issuance
has held up somewhat better, but that too all but dried up in October
and early November. Credit spreads--the extra yield investors require
to be compensated for investing in riskier bonds--also remain
strikingly wide as investors shun anything but risk-free Treasury
bonds. The difference between yields on junk corporate bonds and 10-
year Treasuries had ballooned to over 2,000 basis points, and the
difference between emerging debt and Treasuries to over 1,200 basis
points. Historically, yield spreads for both have averaged closer to
500 basis points.
Commodity and foreign currency markets have been roiled. Oil prices
have fallen more than 50% from their record peaks in early July, and
prices for commodities from copper to corn have plunged. The global
recession has undercut the financial demand that had sent prices
surging this past summer. Economies reliant on commodity production
have been hit hard, and their currencies have rapidly depreciated. The
Canadian dollar, which had been close to parity with the U.S. dollar as
recently as this summer, has dropped back to less than 80 U.S. cents,
and the Brazilian real has fallen more than 40% against the U.S. dollar
since the panic began.\v\
Volatility in global stock markets has been unprecedented and the
price declines nerve-wracking. Since the downdraft began a few months
ago, global stock prices are off 30% in local currency terms and more
than 40% from their year-ago highs. No market has been spared. The
declines have been so precipitous that U.S. and European bourses have
tried imposing limits on short-selling, and Russia has suspended
trading for days at a time, but without meaningful effect. Mutual fund,
401(k) and hedge fund investors simply want out of stocks, regardless
of the losses and any associated penalties.
Even if the global financial system stabilizes soon, substantial
damage has already been done. The U.S. economy was struggling before
the financial panic hit; it has been in recession for over a year. Real
GDP fell in the last quarter of 2007 and again in the third quarter of
2008.\vi\ Some 2.6 million jobs have already been lost so far on net,
and the unemployment rate has risen nearly 3 percentage points to 7.2%.
The downturn is broad-based across industries and regions, with 38
states now in recession (see Chart 2).\vii\ Data since the panic hit
have been uniformly bad, suggesting the downturn is intensifying.
Retail sales, vehicle sales and industrial production have plunged, and
the increase in unemployment insurance claims in January is consistent
with another monthly job loss of 500,000.
The panic's most immediate fallout is the blow to confidence.
Consumer confidence crashed in October to its lowest reading since the
Conference Board began its survey more than 40 years ago. This is all
the more surprising given the plunge in gasoline prices during the
month; cheaper motor fuel in times past has always lifted households'
spirits. Small business confidence as measured by the National
Federation of Independent Businesses has also plunged to a record low
(see Chart 3). Current events have so soured sentiment that they are
sure to have long-lasting effects on household spending and saving, as
well as on business decisions regarding payrolls and investment.
is the house stimulus plan the appropriate size?
The $825 billion, two-year fiscal stimulus plan proposed by House
Democrats is large enough to provide a substantive near-term boost to
the economy, but not so large as to result in measurably higher
interest rates. Global investors remain avid buyers of U.S. Treasury
bonds despite fully anticipating the costs to the Treasury of
responding to the financial and economic crisis. Investors have
discounted a stimulus plan whose costs are similar to those proposed by
the House. This is not say the U.S. government can borrow unlimited
amounts without pushing interest rates higher, but with little
corporate and household borrowing, the government is able to borrow at
very low interest rates.
The costs of the House plan are approximately equal to the
estimated direct net cost to the economy of the financial panic. The
hit to household wealth is among the most significant costs. Net worth
has fallen close to $12 trillion since peaking a year ago. Of that, $4
trillion is due to the 25% decline in house prices, while the rest is
due to the 40% decline in stock prices (see Chart 4). Every dollar
decline in household net worth reduces consumer spending by 5 cents
over the next two years.\viii\ If sustained, the wealth lost over the
past year could thus cut $300 billion from consumer spending in 2009
and a like amount in 2010. More than in past recessions, the financial
pain of this recession is being felt by all Americans, from lower-
income households losing jobs to affluent households with diminished
nest eggs.
The financial panic has also significantly impaired the
availability of credit and increased its cost. Credit growth was
weakening rapidly even before recent events. The Federal Reserve's Flow
of Funds shows that debt owed by households and nonfinancial
corporations actually fell in the second and third quarters of 2008
after inflation for the first time since the savings and loan crisis of
the early 1990s. To date, weakening credit growth is largely due to
disruptions in the bond and money markets. Lending by banks, S&Ls and
credit unions has remained sturdy. But this is probably because nervous
borrowers have pulled down available credit lines, and with banks now
tightening underwriting standards and cutting lines, this source of
credit is drying up. According to the Fed's senior loan officer survey,
lenders have tightened credit over the past year as aggressively as
ever. The net percent of loan officers who say they are willing to make
a consumer loan is the lowest on record, with the exception of 1980,
when the Carter administration briefly imposed credit controls (see
Chart 5).\ix\
The impact of a credit crunch is difficult to quantify, but the
economy's performance during the early 1980s and early 1990s suggests
it can be substantial. The downturn in the 1980s was the most severe in
the post-World War II period, and although the downturn in the 1990s
was not as bad, the economy struggled long after the recession formally
ended. Using these two periods as a guide suggests that for every 1
percentage point decline in real household and nonfinancial corporate
debt outstanding, real GDP declines by approximately 35 basis points.
Thus, if real debt outstanding declines 12.5% from its early 2008 peak
to a trough in late 2010, which seems plausible, this credit effect
will cut approximately $325 billion from GDP this year and a similar
amount next year.
The only significant positive for the U.S. economy out of the
financial panic is lower energy and commodity prices. With oil now
trading at nearly $50 per barrel, a gallon of regular unleaded gasoline
should cost about $1.75. Gasoline prices peaked last summer above $4
per gallon and have averaged closer to $3 last year. Every penny per
gallon decline in the cost of gasoline saves U.S. consumers just over
$1 billion a year. Assuming gas remains below $2 per gallon through the
coming year, Americans will save well more than $100 billion in 2009
compared with fuel costs in 2008. There will also be measurable savings
on home heating and food bills as agricultural and transportation costs
fall. Total savings in 2009 compared with 2008 will thus approach $200
billion.
Calculating the costs to the economy from the wealth and credit
effects, less the benefits from lower commodity prices, puts the net
direct cost of the financial panic this year at $425 billion in 2009
and a like amount in 2010 (a $300 billion wealth effect plus a $325
billion credit crunch effect minus $200 billion in savings due to lower
commodity prices). That is about the cost of the House stimulus plan.
This is a simplistic analysis; it does not account for all the indirect
costs of the panic to the economy and the multipliers, but it gives a
sense of the fallout's magnitude.
WHAT IS IN THE HOUSE STIMULUS PLAN?
The plan includes a reasonably designed mix of about $550 billion
in government spending increases and $275 billion in tax cuts. Although
the timing of the stimulus has yet to be determined, the tax cuts are
expected to occur largely in 2009-2010, and much of the spending would
begin in 2010 (see Table 1). A recent Congressional Budget Office
analysis raised the significant concern that if experience is a
reliable guide, then much of the spending may not occur until well
after 2010. The economic benefit will be measurably diluted if indeed
past is prologue. Policymakers will need to choose projects that can be
implemented quickly and establish mechanisms to provide the oversight
necessary to ensure that these projects are done in a timely fashion.
For the purposes of this analysis, it is assumed that approximately 80%
of the stimulus in the package will be provided to the economy by the
end of 2010.\x\
Increased government spending provides a large economic bang for
the buck and thus significantly boosts the economy. The benefits begin
as soon as the money is disbursed and are less likely than tax cuts to
be diluted by an increase in imports. The most effective proposals
included in the House stimulus plan are extending unemployment
insurance benefits, expanding the food stamp program, and increasing
aid to state and local governments. Increasing infrastructure spending
will also greatly boost the economy, particularly because the downturn
is expected to last for an extended period. Most of the infrastructure
money will be spent to hire workers and buy materials and equipment
produced domestically.
Tax cuts generally provide less of an economic boost, particularly
if they are temporary; on the other hand, they can be implemented
quickly. A particular advantage of the individual tax cuts in the House
stimulus plan such as the payroll tax and earned income tax credits is
that they are targeted to benefit lower- and middle-income households,
which are more likely to spend the extra cash quickly. Investment and
job tax benefits for businesses are less economically effective but are
not very costly, and they more widely distribute the benefits of the
stimulus.
INCOME SUPPORT
The plan includes some $100 billion in income support for those
households under significant financial pressure. This includes extra
benefits for workers who exhaust their regular 26 weeks of unemployment
insurance benefits; expanded food stamp payments; and help meeting
COBRA payments for unemployed workers trying to hold onto their health
insurance.
Increased income support has been part of the federal response to
most recessions, and for good reason: It is the most efficient way to
prime the economy's pump. Simulations of the Moody's Economy.com
macroeconomic model show that every dollar spent on UI benefits
generates an estimated $1.63 in near-term GDP.\xi\ Boosting food stamp
payments by $1 increases GDP by $1.73 (see Table 2). People who receive
these benefits are hard-pressed and will spend any financial aid they
receive very quickly.
Another advantage is that these programs are already operating and
can quickly deliver a benefit increase to recipients. The virtue of
extending UI benefits goes beyond simply providing aid for the jobless
to more broadly shoring up household confidence. Nothing is more
psychologically debilitating, even to those still employed, than
watching unemployed friends and relatives lose their sources of
support.\xii\ Increasing food stamp benefits has the added virtue of
helping people ineligible for UI such as part-time workers.
AID TO STATE AND LOCAL GOVERNMENTS
Another potent tool in the plan is some $200 billion in aid to
state and local governments in the form of a temporary increase in the
Medicaid matching rate to ease the costs of healthcare coverage; help
for school districts; and broader fiscal relief to states to prevent
cuts in key programs.
More than 40 states and a rapidly increasing number of localities
are grappling with significant fiscal problems. Tax revenue growth has
slowed as home sales, property values, retail sales and corporate
profits have all fallen. Personal income tax receipts have begun to
suffer as the job market slumps. Big states including California and
Florida are under severe financial pressure, and smaller states
including Arizona, Minnesota and Maryland are struggling significantly.
The gap between state and local government revenues and expenditures
ballooned to over $100 billion--a record--in the third quarter of 2008,
according to the Bureau of Economic Analysis (see Chart 6).
Because most state constitutions require their governments to
eliminate deficits quickly, most have drawn down their reserve funds
and have already begun to cut programs from healthcare to education.
Cuts in state and local government outlays are sure to be a substantial
drag on the economy in 2009 and 2010. Additional federal aid to state
governments will fund existing payrolls and programs, providing a
relatively quick boost. States that receive checks from the federal
government will quickly pass the money to workers, vendors and program
beneficiaries.
Arguments that state governments should be forced to cut spending
because they have grown bloated and irresponsible are strained, at
best. State government spending and employment are no larger today as a
share of total economic activity and employment than they were three
decades ago. The contention that helping states today will encourage
more profligacy in the future also appears overdone. Apportioning
federal aid to states based on their size, rather than on the size of
their budget shortfalls, would substantially mitigate this concern.
INFRASTRUCTURE SPENDING
The increased infrastructure spending in the House plan is also a
particularly effective way to stimulate the economy. The plan includes
$160 billion in such spending, with $90 billion in more traditional
infrastructure projects such as highway construction, public transit
and waterways; and $70 billion for a variety of energy, science and
healthcare projects. The boost to GDP from every dollar spent on public
infrastructure is large--an estimated $1.59--and there is little doubt
that the nation has underinvested in infrastructure for some time, to
the increasing detriment of the nation's long-term growth prospects.
The argument against including infrastructure spending as a part of
any fiscal stimulus plan is that it takes substantial time for the
funds to flow into the broader economy.\xiii\ Infrastructure projects
can take years from planning to completion. Moreover, even if the funds
are used to finance only projects that are well along in their
planning--so-called shovel-ready projects--it is difficult to know just
when projects will get under way and when the money will be spent.
These are reasonable concerns in most recessions, but the economy's
current problems appear likely to continue for some time. It is also
reasonable to be worried that this money will be spent on pork-barrel
projects chosen for political rather than economic reasons. To address
this worry, policymakers plan to put in place tight controls to monitor
the spending.\xiv\
TAX CUTS
The House stimulus plan includes an estimated $165 billion in tax
cuts for individuals and $110 billion in business tax cuts. The largest
part of the individual tax cut is a permanent payroll tax credit for
workers, amounting to as much as $1,000 for married couples. The earned
income tax credit will also be expanded. Business tax provisions
include bonus depreciation allowances and a five-year carry-back of net
operating losses, which allows firms to convert losses into cash by
claiming a refund of taxes paid in previous years.
The payroll tax credit will be particularly effective, as the
benefit will go to lower-income households that do not necessarily earn
enough to pay income tax. These households are much more likely to
spend any tax benefit they receive. There has also been concern that
the tax benefit will do little to stimulate spending, that most of it
will be saved or used to meet debt payments. Fueling this concern is
the apparently small lift to consumer spending that occurred last
spring and early summer, when households received more than $100
billion in tax rebates as part of last year's stimulus plan. The
consumer spending impact of that earlier tax stimulus was larger than
generally believed, however, as higher-income households that did not
receive that rebate significantly curtailed their spending at the same
time that lower-income households spent their rebates.\xv\ Total
consumer spending rose only modestly as a result. Households would also
be more likely to spend the payroll tax benefit in the House stimulus
plan, since it is a permanent reduction in their tax liability.
The temporary tax incentives to support business investment and
hiring in the House stimulus plan do not provide a particularly large
economic benefit. Accelerated depreciation by large businesses and
expensing of investment by small businesses lowers the cost of capital
only modestly and is not a critical factor in businesses' investment
decisions, particularly when sales and pricing are so weak. The carry-
back of business losses helps cash-strapped businesses, perhaps
forestalling some cuts in investment and jobs, but it is unlikely to
prompt much additional business expansion, as it does not improve
businesses' prospects. However, including business tax cuts in the
stimulus plan is not very expensive, and they do distribute the
benefits of the stimulus more widely. This will be useful if it expands
political support for the stimulus plan and thus accelerates its
adoption. Moreover, the depreciation benefits included in last year's
fiscal stimulus have expired, and extending them through 2010 would
forestall a badly timed additional factor, however small,depressing
business investment.
THE NATIONAL ECONOMIC IMPACT
Implementing the House Democratic fiscal stimulus plan in early
2009 would substantially benefit the economy. The stimulus will not
keep the downturn from becoming the worst since the Great Depression,
but it will ensure that it remains a recession and not a
depression.\xvi\
This assessment is based on simulations of the Moody's Economy.com
macroeconomic model system. Assuming no added fiscal stimulus except
for that provided by the automatic stabilizers already in place, real
GDP would decline for eight straight quarters, falling by a stunning
4.2 % in 2009 and another 2.2% in 2010. This would be more severe than
the early 1980s recessions, which, combined, were the worst since the
Depression. Some 8 million jobs would be lost from the peak in
employment at the start of 2008 to the bottom in employment by late
2010, pushing the unemployment rate to well over 11% by early 2011.
The House plan would not forestall a sizable decline of 2.5% in
real GDP in 2009, but it would ensure that real GDP returns to its
previous peak by early 2011 (see Table 3). The stimulus limits the
peak-to-trough decline in jobs to some 5.5 million, and the
unemployment rate peaks at nearly 9.5% in summer 2010. With the
stimulus, the unemployment rate falls back to its full employment rate
of close to 5% by early 2013. Without the stimulus, the unemployment
rate rises to well over 11% and ends 2012 at a still-extraordinary high
of nearly 8% (see Chart 7).
Despite the added federal government borrowing necessary to finance
the stimulus, it will not lead to excessively higher long-term interest
rates. Considering the current demands on the Treasury, total bond
issuance with the stimulus will rise to a record of more than $2
trillion in fiscal 2009 and about the same in fiscal 2010, but private
bond issuance will remain extraordinarily depressed during this period.
Now moribund, the flow of corporate, emerging market, and private-label
mortgage and asset-backed debt will eventually revive. However, total
credit market needs including the Treasury's issuance will remain
modest, so that the 10-year Treasury yield would remain below 4%
through 2010. It is now nearly 2.5%. Other long-term rates, including
corporate bond and mortgage rates, would rise even less as credit
spreads narrowed, reflecting the stronger economy and reduced credit
concerns.
INDUSTRY AND REGIONAL ECONOMIC EFFECTS
All major industries stand to benefit from the House Democratic
stimulus plan. There are 3 million more jobs with the stimulus than
without it by the fourth quarter of 2010, equal to 2.3% of the job
base. The largest boost to employment from the stimulus is in the
construction trades, with employment in the industry 6.6% higher with
the stimulus by the end of 2010 than without it (see Table 4).
Manufacturing employment is also significantly lifted by almost 2.4%.
Construction and manufacturing benefit substantially from the plan's
infrastructure spending.
Employment in the retail and leisure and hospitality industries,
including restaurants, is lifted by the stimulus. This comes in part
directly from the individual tax cuts but more importantly from the
indirect impact of increased employment and income that the stimulus
provides in the rest of the economy. It is also important to note that
part-time employment is much higher in retailing than in other
industries, increasing the measured employment impact of the stimulus
on retailing.
State and local government and education and health services
benefit significantly from the stimulus plan, but the lift to
employment is not as pronounced as in other industries. Employment in
these areas is approximately 1.4% higher with the stimulus than without
it, about half the percentage boost to employment experienced in the
broader economy. Some of the aid to state and local governments in the
stimulus will fund activities--and thus jobs--in the private sector.
All regions of the country will benefit from the fiscal stimulus,
but some will benefit more than others. The most significant boost is
provided to states now hit hardest by the housing and foreclosure
crises such as Florida and Nevada, those that rely heavily on the
financial services industry such as New York and New Jersey, and those
that depend on the auto industry such as Michigan and Ohio (see Tables
5 and 6). Without a fiscal stimulus, the job market would suffer
significantly, inducing more foreclosures in those parts of the country
where house prices have fallen most sharply and undermining demand for
big-ticket items such as vehicles and discretionary activities such as
travel and tourism. Layoffs on Wall Street will also intensify as
financial markets and institutions are hammered.
The benefits of a fiscal stimulus are less pronounced in the
nation's agricultural and energy-producing regions. These areas are
boosted by more infrastructure spending and the increased federal aid
to their state governments, but agricultural and energy prices will
remain low, as they are determined in global markets and not materially
changed by the fiscal stimulus.
SUGGESTIONS TO IMPROVE THE HOUSE STIMULUS PLAN?
The House plan will measurably boost the flagging economy, but
policymakers may want to consider expanding it with more tax cuts. The
most significant stimulus from the plan will likely occur during the
first half of 2010, but the downturn will be at its most intense in
2009. Tax cuts do not provide the same economic bang for the buck as
increased government spending--some of the tax cuts will be saved or
used to repay debt or to purchase imported goods--but they can help the
economy this year.
A refundable tax credit for a home purchased in 2009, payable at
the time of the purchase to help with the downpayment, would quickly
stimulate home sales and reduce the mountain of unsold homes weighing
on house prices and exacerbating foreclosures and the crisis in the
financial system. The current House plan does provide some direct
support to the housing market by removing the current repayment
requirement on the $7,500 first-time home buyer credit for homes
purchased after 2008 and before termination of credit on June 30, 2009.
The credit could be increased and expanded to all buyers of owner-
occupied homes, not just first-time homebuyers, in 2009.
A payroll tax holiday for employees and employers in the third
quarter of this year would also provide a large boost to lower- and
middle-income households. Households with very high incomes will have
already stopped making payroll tax contributions by this time during
the year and would not benefit. It would also provide much-needed
support to cash-strapped small businesses and reduce the cost of their
workforces and perhaps stem some layoffs.
The cost of these two tax cuts would bring the total cost of the
House plan to just over $1 trillion. Since both proposed tax cuts would
be temporary, however, they would not add to the nation's long-term
fiscal problems.
CONCLUSIONS
A long history of public policy mistakes has contributed to the
financial and economic crises. Although there will surely be more
missteps, only through further aggressive and consistent government
action will the U.S. avoid the first true depression since the 1930s.
In some respects, this crisis has its genesis in the long-held
policy objective of promoting homeownership. Since the 1930s, federal
housing policy has been geared toward increasing homeownership by
heavily subsidizing home purchases. Although homeownership is a worthy
goal, fostering stable and successful communities, it was carried too
far, producing a bubble when millions of people became homeowners who
probably should not have. These people are now losing their homes in
foreclosure, undermining the viability of the financial system and
precipitating the recession.
Perhaps even more important has been the lack of effective
regulatory oversight. The deregulation that began during the Reagan
administration fostered financial innovation and increased the flow of
credit to businesses and households. But deregulatory fervor went too
far during the housing boom. Mortgage lenders established corporate
structures to avoid oversight, while at the Federal Reserve, the
nation's most important financial regulator, there was a general
distrust of regulation.
Despite all this, the panic that has roiled financial markets might
have been avoided had policymakers responded more aggressively to the
crisis early. Officials misjudged the severity of the situation and
allowed themselves to be hung up by concerns about moral hazard and
fairness. Considering the widespread loss of wealth, it is now clear
that they waited much too long to act, and their response to the
financial failures in early September was inconsistent and ad hoc.
Nationalizing Fannie Mae and Freddie Mac but letting Lehman Brothers
fail confused and scared global investors. The shocking initial failure
of Congress to pass the TARP legislation caused credit markets to
freeze and sent stock and commodity prices crashing.
Now, a new policy consensus has been forged out of collapse. It is
widely held that policymakers must take aggressive and consistent
action to quell the panic and mitigate the economic fallout. An
unfettered Federal Reserve will pump an unprecedented amount of
liquidity into the financial system to unlock money and credit markets.
The TARP fund will be deployed more broadly to shore up the still-
fragile financial system, and another much larger and more
comprehensive foreclosure mitigation program is needed to forestall
some of the millions of mortgage defaults that will otherwise occur.
Finally, another very sizable economic stimulus plan is vitally needed.
Although there will be much more discussion about the appropriate size
and mix of government spending increases and tax cuts, the House
Democratic plan is a very good starting point. This is important, for
although such debate is necessary, it must be resolved quickly. Unless
a stimulus plan is implemented beginning this spring, its effectiveness
in lifting the economy will be significantly muted.
The fiscal stimulus does carry substantial costs. The federal
budget deficit, which topped $450 billion in fiscal 2008, could top
$1.5 trillion in fiscal 2009 and remain as high in 2010. Borrowing by
the Treasury will top $2 trillion this year. There will also be
substantial long-term costs to extricate the government from the
financial system. Unintended consequences of all the actions taken in
such a short period will be considerable. These are problems for
another day, however. The financial system is in disarray, and the
economy's struggles are intensifying. Policymakers are working hard to
quell the panic and shore up the economy, but considering the magnitude
of the crisis and the continuing risks, policymakers must be
aggressive. Whether from a natural disaster, a terrorist attack, or a
financial calamity, crises end only with overwhelming government
action.
ENDNOTES
\i\ The House Democratic stimulus plan can be found at: http://
appropriations.house.gov/pdf/RecoveryReport01-15-09.pdf
\ii\ Federal Reserve Chairman Bernanke has recently labeled the
central bank's policy, which some would describe as quantitative
easing, as ``credit easing.'' For a more complete description of how
the Fed is responding to the crisis, see ``The Crisis and the Policy
Response,'' a speech at the London School of Economics, January 13,
2009. http://www.federalreserve.gov/newsevents/speech/
bernanke20090113a.htm
\iii\ A foreclosure mitigation plan that includes mortgage write-
downs that I have proposed is the Homeownership Vesting Plan. See
``Homeownership Vesting Plan,'' Regional Financial Review, December
2008.
\iv\ The London interbank offered rate is the interest rate at
which major banks lend to one another.
\v\ Currency swings have been wild enough to prompt discussion of
coordinated government intervention. This seems unlikely, in part
because the currency moves until recently have been largely welcome. A
stronger U.S. dollar means global investors still view the U.S. as a
haven, which is important as the Treasury ramps up borrowing. Nations
whose currencies are falling against the dollar are hopeful that this
will reduce pressures on their key export industries.
\vi\ When all the GDP revisions are in, they are expected to show
that real GDP also fell in the first quarter of 2008. Second quarter
growth was supported by the tax rebate checks as part of the first
fiscal stimulus package.
\vii\ State recessions are determined using a methodology similar
to that used by the business cycle dating committee of the National
Bureau of Economic Research for national recessions.
\viii\ For a more thorough discussion of the wealth effect, see
``MEW Matters,'' Zandi and Pozsar, Regional Financial Review, April
2006. In this article, the housing wealth effect is estimated to be
closer to 7 cents while the stock wealth effect is nearer to 4 cents.
\ix\ This was part of a failed effort to rein in the double-digit
inflation of the period.
\x\ This spend-out rate would be consistent with the
Administration's commitment of a 75% spend-out rate by the end of
fiscal year 2010 as stated in a January 22, 2009 letter from OMB
Director Peter Orszag to House Budget Committee Chairman John Spratt.
\xi\ The model is a large-scale econometric model of the U.S.
economy. A detailed description of the model is available upon request.
\xii\ The slump in consumer confidence after the recession in 1990-
1991 may have been due in part to the first Bush administration's
initial opposition to extending UI benefits for hundreds of thousands
of workers. The administration ultimately acceded and benefits were
extended, but only after confidence waned and the fledgling recovery
sputtered.
\xiii\ The economic bang for the buck estimates measure the change
in GDP one year after spending actually occurs; they say nothing about
how long it may take to cut a check to a builder for a new school.
\xiv\ Spending safeguards proposed in the House stimulus plan
include requiring governors and mayors to certify that expenditures
under their jurisdiction are appropriate; program managers will be
listed online so the public can hold them accountable; and a special
board will monitor spending.
\xv\ This analysis is based on a calculation of personal saving
rates by income group using data from the Federal Reserve Board's Flow
of Funds and Survey of Consumer Finance. Saving rates for those in the
top quintile of the income distribution, most of whom did not receive a
rebate check, rose significantly during this period as these households
were already responding to their declining net worth. Saving rates for
those in the bottom four quintiles did not increase significantly
during this period suggesting they spent most of the tax rebate their
received.
\xvi\ There are no formal definitions of recession and depression,
but the current period will likely be considered a depression if the
nation's jobless rate rises into the double digits for more than two
quarters.
Chairman Spratt. Dr. Meyer, Laurence Meyer.
STATEMENT OF LAURENCE MEYER, PH.D.
Mr. Meyer. Thank you, Mr. Chairman.
Mr. Chairman, members of the committee, thank you for
giving me this opportunity to share with you Macroeconomic
Advisers' forecast of the economy over the next 2 years.
Chairman Spratt. Would you pull the mike up?
Mr. Meyer. Our forecast incorporates a fiscal stimulus
package that we designed to resemble very closely the plan that
was proposed by the President-elect's then transition team. We
think the effects of the House plan would be very similar.
Before proceeding further, let me remind you of what I am
sure you already appreciate: Forecasting in the best of times
is very challenging, and it is even more so today, given the
uncertainties associated with the unprecedented shocks to the
financial and real sector, uncertainties about the timing,
aggressiveness and effectiveness of further non-conventional
monetary policy actions and uncertainty about the size, timing
and aggressiveness of the fiscal package.
Notwithstanding this uncertainty, we have to sort of begin
in a disciplined fashion by trying to assess what the economy
would most likely look like in the absence of fiscal stimulus
and then offer a disciplined analysis of that stimulus, and
that's what I hoped to offer today.
We are today almost certainly in a very deep recession,
possibly the worst of the postwar period. We expect that real
GDP declined at a 5\1/2\ percent rate last quarter. It is
declining at about a 4 percent rate this quarter. In the
absence of the fiscal stimulus, we expect that growth will
remain weak for the rest of this year and then the economy will
grow somewhat more strongly next year. The unemployment rate,
which is now 7.2, would peak out at above 9 percent in the
middle of next year and still be close to 9 percent at the end
of next year.
By the way, we are viewed as optimists.
The economy is being weighed down by three powerful and
interrelated shocks. The first is the housing correction,
including the sharp decline in home prices. The second is a
dramatic deterioration in credit conditions, including a sharp
rise in credit risk spreads in the corporate bond and mortgage
markets and a tightening in bank lending standards. The third
is the very weak state of the banking system, with large
losses, pressure on balance sheets and a potentially diminished
flow of credit to households and businesses. The impact of
these three weights has been amplified by the accompanying
sharp decline in equity prices.
Now I would like to say we know why the economy will
recover, we just don't know when. The recovery story has two
parts. The first is an overwhelming policy response, fiscal as
well as monetary. The second is diminished drag from the three
weights discussed above: stabilization and then a rebound in
housing from an extraordinarily low level, gradually improving
credit conditions and some improvement in the health of the
banking system.
The fiscal package we incorporate this forecast assumes a
cumulative stimulus of $775 billion by the end of next year,
including an increase in discretionary spending of about $250
billion and a cumulative increase in mandatory spending of
about $200 billion and a cut in tax revenues of more than $300
billion.
To incorporate the fiscal stimulus into our forecast, we
have had to assume spend-out rates for the various spending
provisions, determine whether households and businesses will
perceive the tax cuts, and indeed spending increases, as
temporary or respond as if they are permanent, and let the
model determine the expected effects on spending, employment
and inflation.
We set the spend-out rates consistent with what we believed
the transition team was aiming for. At the time, we didn't have
the CBO spend-out rates. So we will certainly assess the spend-
out rates in our forecast in light of the CBO's analysis, and
presumably we will stream them out a little longer.
The effects on aggregate spending determined by the model
are often described in terms of multipliers, that is, the
increase in real GDP per dollar of spending or revenue loss. I
note, however, that because almost all of the provisions in the
fiscal stimulus package are temporary, it has a peak effect on
the level of GDP, in 2010 in our forecast, and then the fiscal
effects of the stimulus begins to slow growth relative to what
otherwise would have been.
The effect of the fiscal stimulus, based on the assumed
size, spend-out rates and model multipliers, is to raise the
level of real GDP by about 3 percent by the end of 2010, to
lower the unemployment rate by about 1\3/4\ percentage points
by the end of 2010, and to create 3.3 million jobs. This is at
the upper end of the range that Doug Elmendorf talked about.
The projected stronger growth this year and next year
allows the unemployment rate to peak at about 8\1/2\ percent at
the end of this year and then to decline to about 7\1/2\
percent by the end of next year. While this is still well above
estimates of the sustainable rate of full employment, the
effect of the fiscal stimulus is still to speed the return to
full employment and protect against the possibility that the
economy will slip into deflation as early as next year.
Thank you.
Chairman Spratt. Thank you very much for your excellent
testimony.
[The prepared statement of Laurence Meyer follows:]
Prepared Statement of Laurence H. Meyer, Vice Chairman, Macroeconomic
Advisers
Chairman Spratt, Ranking Member Ryan and, and Committee members:
Thank you for giving me this opportunity to share with you
Macroeconomic Advisers' assessment of the near-term outlook for the
economy. The forecast incorporates a fiscal stimulus package that we
believe closely resembles the plan initially set out by the then
President elect's transition team and we believe the plan being
considered by the House would have a very similar impact. I have
submitted for the record two reports that provide detail on our
forecast and our analysis of the prospective fiscal stimulus.
Before proceeding further let me remind you of what I am sure you
already know: Forecasting the macro economy in the best of times is
challenging, but this is even more so today, given the unprecedented
nature of shocks to the financial and real economy and uncertainties
about the aggressiveness and effectiveness of non-conventional monetary
policy options being pursued by the Fed and about the size,
composition, and effectiveness of a prospective fiscal stimulus
package. Nevertheless, in deciding whether to implement a fiscal
stimulus package and how to calibrate its appropriate size, the point
of departure should in our view be a disciplined assessment of how the
economy would likely behave in the absence of the fiscal stimulus,
followed by a disciplined analysis of the impact of the fiscal
stimulus. This is what I hope to offer the Committee this morning.
We are today, almost surely, in a deep recession, possibly the
worst in the postwar period. We expect that real GDP declined at about
a 5\1/2\% annual rate in the fourth quarter of last year and will fall
at about a 4\1/4\% rate in the current quarter. In the absence of
fiscal stimulus, we expect the economy would continue to decline
slightly in the following two quarters, and begin to move to stronger
growth next year. The unemployment rate, which is currently 7.2%, would
peak at above 9% in the middle of next year and still be close to 9% at
the end of next year. And, by the way, we are viewed as optimists.
The economy is being weighed down by three powerful and
interrelated shocks. The first is the housing correction, including the
sharp decline in home prices. The second is a dramatic deterioration in
credit conditions, including a sharp rise in credit risk spreads in the
corporate bond and mortgage markets and a tightening in lending
standards at banks. The third is the very weak state of the banking
system, with large losses, pressure on balance sheets, and potentially
a diminished flow of credit to households and businesses. The impact of
these three weights has been amplified by the accompanying sharp
decline in equity prices.
I like to say we know why the economy will recover, we just don't
know when. The recovery story has two parts. The first is an
overwhelming policy response, fiscal as well as monetary. The second is
diminished drag from the three weights discussed above: stabilization
and then a rebound in housing from an extraordinarily low level;
gradually improving credit conditions; and some improvement in the
health of the banking sector, reflected in an and improved flow of
credit to households and businesses.
Even with the assumed fiscal stimulus and diminishing drags, we
expect a tepid recovery in the second half of this year, but a rebound
to above trend growth in 2010. The unemployment rate in this case is
expected to peak at about 8\1/2\% at the end of this year and decline
to about 7\1/2\% at the end of 2010.
The fiscal package we incorporate into the forecast assumes a
cumulative stimulus of $775 billion by the end of next year, including
increase in discretionary spending of about $250 billion through 2010,
a cumulative increase in mandatory spending of about $200 billion, and
a cut in tax revenue of more than $300 billion.
To incorporate the fiscal stimulus into our forecast, we had to
assume spend out rates for the various spending provisions, determine
whether households and businesses will perceive the tax cuts (and
indeed spending increases) as temporary or respond as if they are
permanent, and then let the model determine the expected effects on
spending, employment and inflation.
We set the spending pay-out rates consistent with what we believed
the transition team was aiming for. We will reassess this in our next
forecast round, in light of CBO's apparently lower assumed spend out
rates for discretionary spending.
The effects on aggregate spending determined by the model are often
described in terms of ``multipliers'', that is, the increase in real
GDP per dollar of spending or revenue loss. Note however that, because
almost all of the provisions in the fiscal stimulus package are
temporary, it has a peak effect on the level of GDP, in 2010 in our
forecast, and then the fiscal ``stimulus'' begins to slow growth
relative to what it otherwise would have been for a period of time. I
will be happy to elaborate on the multipliers for our model during the
discussion that follows the opening statements, if the Committee
wishes.
One important consideration in affecting the size of the
multipliers is whether households and firms treat the tax cuts (and
indeed spending increases) as transitory or permanent. We assume
households respond to the increases in spending and to the cuts in
personal taxes as if they were permanent, while businesses respond to
the business tax cuts as if they were transitory. Given time, I would
be happy to explain our treatment, but the decision here will have an
important effect on the effectiveness of the stimulus package.
The effect of the fiscal stimulus, based on the assumed size,
spend-out rates, and the model multipliers, is to raise the level of
real GDP by about 3\1/4\% by the end of 2010, to raise the growth rate
over each of the next two years by about 1\1/2\ percentage points, to
lower the unemployment rate by about 1\3/4\ percentage points by the
end of 2010, and to create 3.3 million jobs (that is, comparing the
level of employment at the end of 2010 with what it would have been in
the absence of fiscal stimulus).
The projected stronger growth both this year and next allows the
unemployment rate to peak at about 8\1/2\% at the end of this year, and
then to decline to about 7\1/2\% by the end of next year. While this is
still well above estimates of the sustainable rate at full employment,
the effect of the fiscal stimulus is still to speed the return toward
full employment and protect against the possibility that the economy
will slip into deflation as early as next year.
Chairman Spratt. Our fourth witness is Kevin Hassett from
the AEI.
Thank you very much for coming in. The floor is yours.
STATEMENT OF KEVIN A. HASSETT, PH.D.
Mr. Hassett. Thank so much, Mr. Chairman. It is surely an
honor to be here. I have submitted written remarks, and I will
dance quickly to the highlights, knowing that it is a late
hour.
I think that the headline of my remarks might be that I
agree quite a bit with Mr. Blumenauer and with Ms. Rivlin, and
I am going to explain why.
The NBER told us that the recession began in December of
2007. I think that we need to begin our discussion of where we
are and where we might go from here with an acknowledgment that
it is quite likely that that is a little bit early. And indeed,
as I lay out in my testimony, I think that a model that has
been really reliable in the past has called every recession
correctly and never given a false signal suggests that the
recession might have begun a little bit later.
The NBER itself has acknowledged that when in its
announcement it said, and I quote now, ``The committee found
that the economic activity measured by production was close to
flat from roughly September, 2007, to roughly June, 2008.''
The reason that I mention June as a potential start for a
recession is that when we are in a recession you kind of know
what to expect. Mr. Chairman, you have been through some. And
maybe a good one will last a year or a little bit less and a
bad one will last a year and a half. I think that your mental
clock should run from June, not from last December, as we look
ahead.
Now if the recession truly began in June, then even if we
receive a favorable draw, then we are talking something that is
going to last well into the fall.
There is a strong reason to believe that we should count
ourselves fortunate if this recession resembles anything like
the typical recession, though. A new study by an economist at
the IMF, which is cited in detail in my testimony, gathered
data on 122 recessions in OECD countries between 1960 and 2007.
The authors found that there had sadly been many historical
precedents for the current crisis if you look at other
countries. The recessions have been preceded by credit crunches
before. Recessions have also been preceded by home price
collapses and by equity price collapses. As you can see in
figure 2 in my testimony, it has usually been the case that
these negative forces have occurred in isolation.
Of the 18 recessions that followed credit crunches, three
saw coincident housing price collapses and one saw a coincident
equity price collapse and four saw all three negative factors,
which is what we are looking at right now.
The key finding in the paper, however, is the significance
of these factors in determining the outcome. Figure 3 shows how
credit crunch recessions have differed over time from normal
recessions, and news is not good. The typical decline and
output during severe crunches and this episode again certainly
qualifies as severe.
The last 4.3 quarters, which would take this one, if you
believe it began in June, close to the end of the summer and
post the GDP decline of more than 12 percent. Now these numbers
might be large because of outliers. If one uses the median
rather than the mean as the guide, then the average crunch
lasts a little less than a year and posted about a 6 percent
decline in GDP.
While this outlook is sobering, it is, if anything, a rosy
scenario compared to other analyses. For example, a recent
paper by economists Carmen Reinhart and Kenneth Rogoff focused
exclusively on what could be called severe financial crises.
Their key results are depicted in the next two charts.
Figure 4 looks at the typical unemployment experience for
countries that have been through severe financial crises, and I
think ``severe'' is probably an accurate description of the
current one here. On average, the unemployment rate increased 7
percent and the downturn lasted a whopping 4.8 years.
If this chart characterizes the experience we are likely to
have, then the unemployment rate in the U.S. would increase to
about 12 percent. Employment is often slow to respond to
improving economic conditions. Jobless recoveries are far too
common. Thus, the unemployment rate may tell too negative a
story.
However, figure 5 indicates that the record of GDP growth
after financial collapses is also startlingly negative, with a
typical decline in GDP being 9.3 percent and the typical
downturn associated with financial crisis lasting almost 2
years.
And, again, figure 6 shows that this bad economic news has
been very bad news for budget authorities. On average, a
financial crisis has led to almost a doubling of outstanding
government debt. It would take the 40 percent of GDP up to 80
percent almost or 70, 75 if we were to have a typical
experience.
In this most recent budget outlook discussed by Mr.
Elmendorf this morning, the CBO forecasts that GDP will decline
2.2 percentage points. I think that, given the history of
financial crises, it seems that this estimate is probably more
like a best-case scenario. Accordingly, I do encourage the
members of this committee to be cognizant of the fact that the
budget outlook is likely to deteriorate significantly as the
year progresses and that it is going to look a lot worse maybe
than the estimate right now by the end of the year.
Now that realization should not discourage this body from
supporting fiscal policy action, but it is important to note
that the average experience discussed above, those really bad
numbers we just walked through, it is taken from a sample of
countries that were governed by highly motivated policymakers
dedicated to do everything they could to soften the economic
downturn. Stimulus packages were probably passed in every data
point that we saw there; and even with the shrewdest policy
action the governments were able to devise, the experience was
a lengthy and deep downturn far worse than what we see in the
current CBO forecast.
I think there is a genuine concern that the economy will
continue to be soft past the time when this year's stimulus
efforts have had their effect and that deficits could be much
larger than those currently forecast. We have not yet reached
the point where skyrocketing debt levels have caused heightened
concerns among investors in U.S. Treasuries, but I think that
there is a chance that we could push the envelope on it.
I am concerned that--and I am not one of those who thinks
Keynesian stimulus has no effect and so on. But I am concerned
that we might replace something like a slightly longer version
of last year, where I do believe the second quarter GDP was
stimulated by the stimulus package, that it did slow the onset
of recession, but then the second half of the year we had a
recession nonetheless. I am concerned that we could replay a
similar episode, perhaps stretched out a little longer, and
wake up and find the economy is still weak, given past history
that would suggest the risks are significant.
So what does that make me want to do? I don't want to go
into specific policy proposals. It is beyond the purview of my
testimony. But I would like to say that I think and I agree
with Ms. Rivlin that we shouldn't take long-run changes off the
table, and the really obvious place to start is to give people
some sense that in the long run we are going to return to
fiscal discipline. But, also, there are other changes that one
could make; and these are not things that I want to advocate in
a way that creates a contentious conversation. But there are
also permanent changes that one could make that could be good
in the near term and the long term.
Now I will list two and close my testimony.
The first is that if you were to announce that a few years
from now that you are going to have a value-added tax in the
U.S.--this is a hypothetical--then today consumption might go
up because people want to consume before the value-added tax
happens. And in the long run you have extra tax revenue, given
how high government spending to GDP is likely to be. It is
probably the case that you will be looking for new sources.
Chairman Spratt. Leave enough leave time and those who are
opposed to it will all rally to support those who voted for it,
and that day will never come.
Excuse me. Go ahead.
Mr. Hassett. The second one, and then I will finish, sir,
is if you were to announce that the corporate tax were going to
be reduced in the future, something perhaps you wanted to head
towards a target, as was in Mr. Rangel's bill last fall, of 31
percent, then if you were to reduce the corporate tax gradually
over time, say a percent or two a year, then firms would deduct
their capital spending today at the high rate and get their
profits tomorrow at the lower rate. You would get a double
positive effect from a long-run change.
And so I encourage you to think that, well, if this thing
lasts longer than a few more quarters, then what would we wish
that we had done? And I think that putting longer run things on
the table, as Ms. Rivlin and I have suggested, is something
that you might want to consider.
Thank you, sir.
[The prepared statement of Kevin Hassett follows:]
Prepared Statement of Kevin A. Hassett, Senior Fellow and Director of
Economic Policy Studies, American Enterprise Institute
Chairman Spratt, Ranking Member Ryan and other members of the
Committee, it is an honor to be afforded the opportunity to appear
before you today at this critical moment in our nation's history.
The purpose of my presentation is to review the state of the
economy, and to draw historical lessons from the academic literature to
help sketch out the range of possibilities going forward.
It is always a perilous thing to opine on the state of the economy.
The data that we use to assess the economy are published with
significant lags. While we can now feel fairly certain about the
character of the fourth quarter of 2008, the current quarter is still
underway, and economies can and do change direction rapidly.
Accordingly, discussion of the current state of the economy should
be cautious. However, there is one thing that is well established at
this point. There is no debate among economists that we are currently
in a recession. The National Bureau of Economic Research is the
official arbiter of such matters, and they have dated the beginning of
this recession to December 2007.
This determination is important, because economists have
established that the economy tends to proceed in a ``nonlinear''
fashion; that is, we can think of history as having consisted of
discretely different ``good'' times and ``bad'' times. When we are in
good times, good quarters tend to follow good quarters. When we are in
bad times, bad quarters follow one another.
The fourth quarter of last year was one of the worst quarters in
memory. It is likely that GDP declined at an annual rate of around 6
percentage points. While there is little data in hand for the current
quarter, a decline of a similar scale seems to be in order.
Bad times are here. But it is worth noting that declines of
approximately this scale have been posted before. The economic data
available do not suggest that we are in something fundamentally
different from past recessions. It would not be unprecedented for GDP
to decline six percentage points a quarter or two from the beginning of
a recovery. For example, in the first quarter of 1958, GDP declined
well over 10 percent at an annualized rate. In the second quarter of
1980, GDP declined by an annual rate of 7.8 percent.
How long will the recession continue this time? Is the outlook so
negative that policy action is urgent and necessary?
At first glance, the history of recessions might provide some cause
for optimism. The typical recession in post-war U.S. history lasted
about 10 months. The worst two recessions, that of 1973 and that of
1981, both lasted about 16 months. If the recession truly began in
December 2007, then one might expect that the recovery would be near.
There is cause, however, to be reluctant to accept such a rosy
view.
The first cause is an important qualification to the NBER
announcement. There is a good deal of uncertainty surrounding the
precise start date of this recession. An alternative econometric
approach pioneered by University of California economist Marcelle
Chauvet, uses economic data to estimate the real-time probability that
we are in a recession.\1\ Her estimates clearly indicate that we are
now in recession, but the start date may have been much later.
---------------------------------------------------------------------------
\1\ See Figure 1.
---------------------------------------------------------------------------
This latter possibility was acknowledged by the NBER when it
announced that a recession had begun, writing that, ``The committee
found that economic activity measured by production was close to flat
from roughly September 2007 to roughly June 2008.'' \2\
---------------------------------------------------------------------------
\2\ http://www.nber.org/cycles/dec2008.html
---------------------------------------------------------------------------
But if the recession truly began as late as June, then even if we
receive a favorable draw and have an average recession by historical
standards, then we can expect it to last into the summer. If this
recession matches in duration the two worst post-war recessions, then
it will last until October 2009.
There is a strong reason to believe that we should count ourselves
fortunate if this recession resembles anything like a typical
recession. A new study by economists at the IMF gathered data on 122
recession episodes in OECD countries between 1960 and 2007.\3\
---------------------------------------------------------------------------
\3\ Claessens, Stinj, M. Ayhan Kose and Marco E. Terrones. ``What
Happens During Recessions, Crunches and Busts.'' IMF Working Paper, WP/
08/274, December, 2008, http://www.aei.org/docLib/20081212--IMF.pdf.
---------------------------------------------------------------------------
The authors found that there have, sadly, been many historical
precedents for the current crisis. Recessions have been preceded by
credit crunches before. Recessions have also been preceded by home
price collapses, and by equity price collapses as well. As can be seen
in figure 2, it has usually been the case that these negative forces
have occurred in isolation.
Of the 18 recessions that followed credit crunches, three saw
coincident housing price collapses, one saw a coincident equity price
collapse, and four saw all three negative factors. The key finding of
the paper is the significance of these factors in determining the
outlook. Figure 3 shows how credit crunch recessions have differed over
time from normal recessions.
The news is not good. The typical decline in output during severe
crunches, and this episode certainly qualifies as severe, lasts 4.33
quarters, and posts a GDP decline of 12.38 percent. These numbers may
be large because of outliers. If one uses the median, rather than the
mean, as a guide, then the average severe crunch recession lasted 3
quarters, and posted a 6.15 percent decline in GDP. In comparison, the
four recessions containing a house price bust, equity price bust and a
credit crunch had an average duration of four quarters and a decline in
GDP of 9.15 percent.
While this outlook is sobering, it is, if anything, a rosy scenario
compared to other analyses. For example, a recent paper by economists
Carmen Reinhart and Kenneth Rogoff focused exclusively on what could be
called ``severe financial crises.'' Their key results are depicted in
the next two charts.
Figure 4 looks at the typical unemployment experience for countries
that have seen severe financial crises. On average, the unemployment
rate increased 7 percentage points, and the downturn lasted a whopping
4.8 years.
If this chart characterizes the experience we are likely to have,
then the unemployment rate in the United States will increase to about
12 percent.
Employment is often slow to respond to improving economic
conditions. Jobless recoveries are far too common. Thus, the
unemployment data may tell too negative a story. However, figure 5
indicates that the record of GDP growth after financial collapses is
also startlingly negative, with the typical decline in GDP being 9.3
percent, and the typical downturn associated with financial crisis
lasting 1.9 years.
Figure 6 shows that this bad economic news has been very bad news
for budget authorities. On average, a financial crisis has led to
almost a doubling of outstanding government debt.
In its most recent budget outlook, the CBO forecasts that GDP will
decline 2.2 percentage points. Given the history of financial crises,
it seems that this estimate is probably more like a best case scenario.
Accordingly, I encourage the members of the committee to be cognizant
of the fact that the budget outlook is likely to deteriorate
significantly as the year progresses.
That realization should not discourage this body from supporting
fiscal policy action. But it is important to note that the average
experience discussed above is taken from a sample of countries that
were governed by highly motivated policymakers dedicated to doing
everything they could to soften the economic downturn. Even with the
shrewdest policy action that governments were able to devise, the
typical experience was a lengthy and deep downturn.
There is a genuine concern that the economy will continue to be
soft past the time when this year's stimulus efforts have had their
effect, and that deficits could be much larger than those currently
forecasted.
We have not yet reached the point where skyrocketing debt levels
have caused heightened concerns among investors in U.S. Treasuries. If
this Committee wishes to avoid testing those waters, it should consider
tying stimulus efforts with genuine steps toward long run deficit
reduction.
Figure 1.
Copyright (c) 2008 CREFC--Center for Research on Economic and
Financial Cycles. All rights reserved worldwide
Figure 2.
Associations between Recessions, Crunches and Busts (number of
events in each event category) Claessens, Stinj, M. Ayhan Kose and
Marco E. Terrones. ``What Happens During Recessions, Crunches and
Busts.'' IMF Working Paper WP/08/274, December, 2008, http://
www.aei.org/docLib/20081212--IMF.pdf.
Figure 3.
Recessions Associated with Credit Crunches (percent change unless
otherwise indicated) Claessens, Stinj, M. Ayhan Kose and Marco E.
Terrones. ``What Happens During Recessions, Crunches and Busts.'' IMF
Working Paper, December, 2008, http://www.aei.org/docLib/20081212--
IMF.pdf.
Figure 4.
Reinhart, Carmen M. and Kenneth S. Rogoff. ``The Aftermath of
Financial Crisis.'' National Bureau of Economic Research Working Paper
14656. January, 2009, www.nber.org/papers/w14656.
Figure 5.
Reinhart, Carmen M. and Kenneth S. Rogoff. ``The Aftermath of
Financial Crisis.'' National Bureau of Economic Research Working Paper
14656. January, 2009, www.nber.org/papers/w14656.
Figure 6.
Reinhart, Carmen M. and Kenneth S. Rogoff. ``The Aftermath of
Financial Crisis.'' National Bureau of Economic Research Working Paper
14656. January, 2009, www.nber.org/papers/w14656.
Chairman Spratt. Well, you gave us some very dire
descriptions of the current economy. Where do you stand or
would you stand if you had a vote to cast tonight on the
stimulus legislation before us?
Mr. Hassett. Without having read the whole thing, sir, I am
sorry, I can't say. I support and agree that a Keynesian
stimulus right now would have a positive effect.
Chairman Spratt. Your testimony was a little elliptical,
but I kept sensing you were coming around to that point of
view. Thank you for your testimony.
Mr. Blumenauer has a couple of questions.
Mr. Blumenauer. Actually, I just wanted to follow up
particularly on what Ms. Rivlin mentioned but also Mr. Zandi
and our final witness.
We have got a situation now where the notion of having
entitlement reform, if we are going to, for example, tying the
notion of a tax holiday, a payroll tax holiday, but 4 or 5
years out we will lift the ceiling. We will make some other
adjustments so that it looks like we are moving.
The other that I would welcome your thoughts and perhaps
follow up at a later date, because I don't want to keep you
trapped here, deals with a package for funding long-term
infrastructure. We have a Highway Trust Fund that is in deficit
for the first time in its history. There seems to be a growing
consensus from the private sector and the public sector for
making some adjustments for road-related or transportation-
related fees,that we might be able to use that to enact and
have a long-term reauthorization that might be twice the size
that it is now but paid for, for transportation. Do a couple of
bites of the entitlement reform tied with a tax, a payroll tax
holiday. Any sense on the transportation package or tying those
two together moving forward?
Ms. Rivlin. Well, let me take a stab at it.
I hadn't thought of tying entitlement reform to the payroll
tax holiday, although I favor both, so I think this is a good
idea. The payroll tax holiday I think gets money to the right
people quickly and is clearly reversible because, unless you
are going to go to some totally different way of financing
Social Security, you need to get it back. And so for that
reason I think it is a very good idea.
And I think you could tie it to long-run entitlement reform
in the form of the package of things that I mentioned that
would be out in the future, some of them quite far in the
future. We haven't finished with the reforms we did in 1983.
And so I think that is a good idea. Now the payroll tax holiday
makes it necessary to do even more on the long-run changes.
Funding for long-term infrastructure, I am one who thinks
we need something like a carbon tax. And, again, we don't want
to raise taxes. Right now would be a bad moment. But I have
thought for years that doing something that was a scheduled
long-term increase--I had been thinking in terms of the gas
tax--but whatever tax scheduled out in front would be a very
sensible thing to do, because we want to encourage conservation
over time.
And the other piece of that I think can be a serious effort
to fund metropolitan transportation infrastructure with
congestion fees.
Mr. Blumenauer. Mr. Chairman, I appreciate your courtesy. I
look forward to following up with some of our panelists how
this might be packaged. Thank you very much.
Chairman Spratt. We now have a series of votes, four votes,
unfortunately; and I am not going to ask you for further
forbearance.
I want to thank you for coming. I assure you that what you
said will be put to use. In fact, if you listen to the debate
tonight and tomorrow, you may hear yourself repeated without
acknowledgment. Who knows? In any event, you have helped us
understand the situation of the choices before us; and we look
forward to working further with you on the solutions to the
problems that confront us. Thank you very much for your
patience.
I ask unanimous consent that members who did not have an
opportunity to ask questions of witnesses be given 7 days to
submit questions for the record. You don't have to answer them.
Thank you very much indeed.
[Whereupon, at 2:10 p.m., the committee was adjourned.]