[House Hearing, 111 Congress]
[From the U.S. Government Publishing Office]
PERSPECTIVES ON THE U.S. ECONOMY
=======================================================================
HEARING
before the
COMMITTEE ON THE BUDGET
HOUSE OF REPRESENTATIVES
ONE HUNDRED ELEVENTH CONGRESS
SECOND SESSION
__________
HEARING HELD IN WASHINGTON, DC, JULY 1, 2010
__________
Serial No. 111-28
__________
Printed for the use of the Committee on the Budget
Available on the Internet:
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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 JOHN CAMPBELL, California
BOB ETHERIDGE, North Carolina JIM JORDAN, Ohio
BETTY McCOLLUM, Minnesota DEVIN NUNES, California
JOHN A. YARMUTH, Kentucky ROBERT B. ADERHOLT, Alabama
ROBERT E. ANDREWS, New Jersey CYNTHIA M. LUMMIS, Wyoming
ROSA L. DeLAURO, Connecticut, STEVE AUSTRIA, Ohio
CHET EDWARDS, Texas GREGG HARPER, Mississippi
ROBERT C. ``BOBBY'' SCOTT, Virginia CHARLES K. DJOU, Hawaii
JAMES R. LANGEVIN, Rhode Island
RICK LARSEN, Washington
TIMOTHY H. BISHOP, New York
GWEN MOORE, Wisconsin
GERALD E. CONNOLLY, Virginia
KURT SCHRADER, Oregon
DENNIS MOORE, Kansas
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, July 1, 2010..................... 1
Hon. John M. Spratt, Jr., Chairman, Committee on the Budget.. 1
Prepared statement of.................................... 3
Hon. Paul Ryan, Ranking Minority Member, Committee on the
Budget..................................................... 4
Martin Neil Baily, senior fellow, Bernard L. Schwartz chair,
the Brookings Institution.................................. 5
Prepared statement of.................................... 8
Response to questions submitted.......................... 67
Mark Zandi, Ph.D., chief economist, Moody's Analytics........ 19
Prepared statement of.................................... 24
Response to question submitted........................... 69
John B. Taylor, Mary and Robert Raymond professor of
economics; George P. Shultz senior fellow in economics,
Hoover Institution, Stanford University.................... 43
Prepared statement of.................................... 46
Response to question submitted........................... 68
Hon. Robert B. Aderholt, a Representative in Congress from
the State of Alabama, questions submitted and their
responses.................................................. 67
PERSPECTIVES ON THE U.S. ECONOMY
----------
THURSDAY, JULY 1, 2010
House of Representatives,
Committee on the Budget,
Washington, DC.
The committee met, pursuant to call, at 1:17 p.m. in room
210, Cannon House Office Building, Hon. John Spratt [chairman
of the committee] presiding.
Present: Representatives Spratt, Schwartz, Kaptur, Becerra,
Doggett, Etheridge, Scott, Connolly, Schrader, Moore, Ryan,
Hensarling, Campbell, Lummis, and Djou.
Chairman Spratt. We meet today to discuss the economic
recovery and the challenges that lie ahead of us. We are joined
by three eminent economists to help us take stock of this
situation.
When this Congress, the 111th, took office along with the
Obama administration in January of 2009, the economy was
shrinking at a 5.4 percent negative rate of growth. A year and
a half later, the economy is in its third straight quarter of
economic growth, growing at 5.6 percent in the fourth quarter
of 2009 and 2.7 percent the first quarter of 2010.
A year and a half ago, the economy was losing jobs
massively. In January of 2009, we lost 779,000 jobs in one
month alone. Now, after a year and a half of concentrated
fiscal initiatives, employers added nearly one million jobs
between January and May of this year.
As Chairman Bernanke recently told us in his testimony
before this committee, the Federal Reserve, quote, anticipates
that real-growth domestic product will grow in the neighborhood
of 3.5 percent over the course of 2010, at a somewhat faster
pace, we hope, the next year.
Nevertheless, the economy seldom recovers in a straight
linear fashion. In May, the economy added 431,000 jobs on the
strength of new Census hires, but forecasters anticipate that
tomorrow's job report will show that while we may have added as
many as 100,000 new private-sector jobs in June, a solid
accomplishment, total nonfarm payrolls may still have fallen
due to the end of many of these temporary Census jobs.
The strength of our economy clearly lies in the private
sector, but the action taken by this Congress and this
administration we think have played a significant role. For
example, it is the judgment of the Congressional Budget Office
that the Recovery Act passed in February of 2009 has
contributed significantly to the economic turnaround, raising
GDP by 1.7 to 4.2 percentage points in the fourth quarter of
2010, increasing employment by 1.2 million and 2.8 million jobs
overall.
Meanwhile, the Treasury Department, the Federal Reserve,
and the FDIC have been engaged in unprecedented efforts to
stabilize banks and the financial system by injecting
liquidity, capital, and by securing people's savings and
requiring banks to raise still more capital.
In response to my question last month at the hearing on
whether the TARP and the Recovery Act had been necessary to
rescue the financial system and the economy, Chairman Bernanke
replied, quote, Certainly we have averted what I think would
have been, absent those interventions, an extraordinarily
severe downturn, perhaps as great as the Great Depression.
That from a person who is not known for exaggerated
statements.
The recession and the necessary recovery efforts have taken
a toll on the budget in the short run. We, as Democrats, have
been focused on the economic recovery. We have also pursued and
sought fiscal responsibility for the long term. We want to see
the economy and the budget recover step by step, hand in hand.
Testifying before the President's Fiscal Commission
yesterday, the Director of CBO, Doug Elmendorf, observed that,
once again, there is no contradiction between providing
additional fiscal stimulus today while the unemployment rate is
high and many factories and offices unutilized, imposing fiscal
restraint several years from now when output and employment
will probably be close to the peak of potential.
Earlier this year, we passed statutory PAYGO, requiring
that new mandatory spending or revenue reduction be paid for.
In addition, the President established a bipartisan commission
now at work to make recommendations to bring down the deficit
to a sustainable level by 2015. And, finally, we may be close
to an agreement on an enforcement level for 2011 appropriation
bills. These fiscally responsible policies have been undertaken
by this administration and this Congress to good effect.
At this time, however, our key concern is, over the short
run, what is the economic outlook? What can we expect in the
months ahead of us? And what is the appropriate fiscal response
at this particular point in time?
We have with us today three eminent economists that will
help us sort through the progress the economy has made and look
to the future.
First is Dr. Martin Baily, Senior Fellow at the Brookings
Institution and former Chairman of the CEA under President
Clinton.
Second is Mark Zandi, co-founder of Moody's Analytics and
former adviser to Senator McCain as well as a number of
Democrats.
And, finally, we have Dr. John Taylor of Stanford
University and the Hoover Institution, a former Under Secretary
Treasurer for International Affairs under President Bush.
We look forward to your testimony. We appreciate your being
here. But before giving the floor to you, I want to turn to the
ranking member for any statement he may care to make. Mr. Ryan.
[The statement of Mr. Spratt follows:]
Prepared Statement of Hon. John M. Spratt, Jr., Chairman, Committee on
the Budget
We meet today to discuss the progress of the economic recovery and
the challenges that still lie ahead of us and we are joined by three
eminent economists who will help us take stock.
When the 111th Congress began and the current administration took
office, the economy was shrinking at a 5.4 percent annualized rate. One
year and a half later, the economy is experiencing its third straight
quarter of economic growth, including 5.6 percent growth in the fourth
quarter of 2009 and 2.7 percent growth in the first quarter of 2010.
A year and a half ago, the economy was hemorrhaging jobs. In
January of 2009, we lost 779,000 jobs in one month alone. Now, after
one and a half years of concentrated economic and fiscal initiatives,
employers added nearly a million jobs between January and May of this
year. And Chairman Ben Bernanke told us last month in his testimony
that the Federal Reserve ``anticipates that real gross domestic product
will grow in the neighborhood of 3\1/2\ percent over the course of 2010
as a whole and at a somewhat faster pace next year.''
As Americans and policymakers have come to know all too well, the
economy seldom recovers in a straight, linear fashion, but instead
tends to zigzag. In May, the economy added 431,000 jobs on the strength
of new Census hires. However, forecasters anticipate that tomorrow's
jobs report will show that while we may have added as many as 100,000
new, private sector jobs in June--which would be a solid
accomplishment--total nonfarm payrolls may still have fallen due to the
conclusion of many of these temporary Census jobs.
The ultimate strength of our economy clearly lies in the private
sector, but the actions taken by this Congress and by the
Administration have also played a significant role. For example, it is
the judgment of the non-partisan CBO that the Recovery Act, which we
passed in February of 2009, has contributed significantly to the
economic turnaround, raising real GDP by 1.7 to 4.2 percentage points
in the fourth quarter of 2010, and increasing employment by between 1.2
million and 2.8 million jobs overall. Meanwhile, the Treasury
Department, the Federal Reserve, and the FDIC have engaged in
unprecedented and coordinated efforts to stabilize banks and the
financial system by injecting liquidity, capital, securing people's
savings, and requiring banks to raise still more capital. In response
to my question last month at our hearing on whether TARP and the
Recovery Act had been necessary to rescue the financial system and the
economy, Chairman Bernanke replied ``Certainly we have averted what I
think would have been, absent those interventions, an extraordinarily
severe downturn, perhaps a great depression.''
The recession and the necessary recovery efforts have taken an
unavoidable toll on the budget in the short run. While we as Democrats
have been focused on the economic recovery, we have also pursued fiscal
responsibility. We want to see the economy and the budget recover step
by step. Testifying before the President's Fiscal Commission yesterday,
CBO Director Doug Elmendorf observed that ``There is no intrinsic
contradiction between providing additional fiscal stimulus today, while
the unemployment rate is high and many factories and offices are
underused, and imposing fiscal restraint several years from now, when
output and employment will probably be close to their potential.''
Earlier this year we passed statutory PAYGO, requiring that new
mandatory spending on revenue reductions be paid for. In addition, the
President has established a bipartisan commission now at work to make
recommendations to bring the deficit down to a sustainable level by
2015. [[And, finally, we may be close to reaching agreement on a House
budget plan.]] These fiscally responsible policies are in direct
contrast to the actions of the previous administration, which inherited
a $5.6 trillion surplus over 10 years and systematically turned it into
large deficits, handing the current administration trillions of dollars
of deficits for years to come.
We will continue to pursue steps towards fiscal responsibility so
that over the medium and long term we put the Nation on a path that
will provide a foundation for a strong economy in the future. At the
same time, the key concern in the short term remains the economic
outlook. We have with us today, three eminent economists, who will help
us sort out the progress the economy has made. First off is Dr. Martin
Baily, a senior fellow at the Brookings Institution and former Chairman
of the Council of Economic Advisers under President Clinton. Speaking
second will be Dr. Mark Zandi, Chief Economist and Co-Founder of
Moody's Analytics and a former advisor to Senator McCain as well as
Democrats. And finally, we have Dr. John Taylor of Stanford University
and the Hoover Institution, a former Undersecretary of Treasury for
International Affairs under President Bush. We look forward to hearing
your testimony on economic developments and whether you agree with the
Federal Reserve Chairman's take on the economy or whether you see
things differently.
Before we hear from our witnesses, let me also turn to the ranking
member, Mr. Ryan, for any statement he may care to make for an opening
purpose.
Mr. Ryan. Thank you, Mr. Chairman; and thank you to our
three distinguished witnesses for being here with us today. I
know some of you had to travel a great distance, and we are
really grateful for your attendance.
We convene this hearing under renewed concern about the
health of our economy. Experts tell us that we are technically
in the process of an economic recovery, but for too many
Americans it feels more like an economic malaise. Private-
sector job growth has been lackluster. The unemployment rate is
hovering at a 25-year high; and fear and anxiety are, once
again, gripping our financial markets.
Most policymakers here in Congress are asking the right
questions, namely, how do we spark sustained growth and job
creation? But too many are searching for answers in the
discredited economic playbook of borrow-and-spend Keynesian
policies. We have seen this movie before, and we know how it
ends. Ask the Europeans. You can't take money from the private
productive sector of our economy, funnel it through Washington,
and expect to create wealth and sustained economic growth.
Centralizing power in Washington, expanding government's reach
into all sectors of our economy and more and more aspects of
our lives does not create jobs.
Unfortunately, I believe our policy differences center more
on ideology, not on economics. If a debate were purely about
economics, the administration wouldn't be doubling down on the
renewed debt-financed government spending spree. If it was
about economics or even pragmatism, we wouldn't be planning to
hit the economy, struggling to recover from a deep recession,
with a slew of new tax hikes. We wouldn't be shackling our job-
producing businesses with more regulations. But that is exactly
what the administration and the majority in the Congress are
doing.
Americans want their representatives to do what works. They
want common sense pragmatism, not blind progressivism.
I reject the false premise that only forceful and sustained
government intervention in the economy can secure this
country's renewed prosperity. Adherence to this premise has
given us a damaging policy mixture. It has sparked a government
spending spree and borrowing binge with no end in sight. It has
led to a centralization of power in health care, energy,
financial services, the auto industry, and more, tightening
Washington's grip on key sectors of our economy. It has
fostered continued policy uncertainty about tomorrow, which
stifles investment today. It has caused new barriers to growth
that has rationalized the need for more tax hikes in the
future.
This Congress has failed to even produce a budget, and it
has refused to consider the tough choices that deal with our
massive debt burden, a debt burden growing exponentially larger
with each kick of the can further down the road.
Workers, taxpayers, and families across this country have
been Guinea pigs in this neo-Keynesian experiment long enough.
The results are in. Washington's economic experiment has
failed.
Let's try something different. Let's try something that
works. Instead of erecting new hurdles for entrepreneurs, let's
reduce the government-imposed barriers to grow, produce,
create, and innovate. Let's instill a sense of certainty and
confidence for investment in job creation. Let's reform our
anti-competitive Tax Code, restore the promise of our bankrupt
entitlement programs, and work to lift our crippling debt
burden.
We need to chart a new fiscal and economic course,
reforming government and putting in place a plan for growth, a
plan for prosperity.
I hope today's hearing can help inform policymakers as to
why the economy remains sluggish, jobs remain elusive, and the
forecast remains bleak. I believe we can, and must, do better
than this. I appreciate your participation in today's hearing,
and I look forward to your testimony.
Chairman Spratt. Gentlemen, we have framed the issues for a
lively hearing, and we look forward to your testimony.
Before turning to you, a couple of housekeeping details. I
ask unanimous consent that all members be allowed to submit an
opening statement for the record at this point.
Hearing no objection, so ordered.
We recognize you for such time as you need to take. Your
statements previously filed have been made part of the record,
so you can summarize as you see fit. Let's start with Dr.
Baily.
STATEMENT OF MARTIN BAILY, PH.D., SENIOR FELLOW, BROOKINGS
INSTITUTION; MARK ZANDI, PH.D., CHIEF ECONOMIST, MOODY'S
ANALYTICS; AND JOHN TAYLOR, PH.D., SENIOR FELLOW, HOOVER
INSTITUTION
STATEMENT OF MARTIN BAILY
Mr. Baily. Thank you, Chairman Spratt, Ranking Member Ryan,
and members of the committee. It is a great privilege to
testify.
I am very pleased to be part of this very distinguished
panel. I know Mark very well and John, and I am sure we will
have some lively disagreements, but I have a lot of respect for
their views.
I didn't come a long distance here, although, as I noted in
my testimony, since the Recovery Act is digging up every street
in Washington, it sometimes feels like a long distance just to
get from Dupont Circle.
There were many contributors to this crisis. I think there
are folks, and John may be one of them, that sort of focus on a
particular cause in this crisis, that it was the Federal
Reserve interest rate policy. My friend Peter Wallison believes
it was Fannie and Freddie and the GSEs that caused the problem.
But, in my judgment, this really was, to use the cliche, a
perfect storm. We had market failures on Wall Street, and even
some of the Main Street banks did things that were very foolish
in retrospect. I think there were policy failures, a lack of
regulatory watchfulness, and also policy choices that were a
mistake. So it is a variety of things that went wrong, and this
really has been one of the nastiest recessions in history and
certainly since the Great Depression.
I think it is important to stress this multiplicity of
causes. Because when an economy goes into this kind of
recession and we have this kind of financial crisis, we know it
takes a long time to get out. That is the historical record.
And Ken Rogoff and his coauthor have documented that very
carefully. You cannot turn around an economy that quickly and
easily.
I think that there should be a lot of credit given to the
measures that were taken to overcome this crisis. It started,
obviously, under Secretary Paulson and President Bush.
Secretary Paulson asked for the TARP and was eventually given
that, and that was a resource that was absolutely essential to
turn around the financial sector. We really were on the verge
of a huge meltdown.
I think there were some missteps taken on the way to
getting the financial sector back, but eventually that was
sorted out working with Secretary Geithner and Ben Bernanke.
And the Wall Street banks are now, if not healthy, looking much
stronger. I think the immediate crisis, the likelihood that
those institutions are going to fail, has been alleviated.
We have also had a lot of, as I said, smaller banks, and
the FDIC has played a really important role. That has been
expensive, too. That cost is going to be borne by the banks
themselves in terms of higher fees, but for the society it has
been a very expensive business to restore the financial sector.
It has taken a long time. We are still not all the way there.
There are still a lot of banks on the watchlist, between 700
and 800 banks still on the FDIC watchlist.
So we have a ways to go on the financial sector, and that
is restricting lending, and that is one of the factors that is
slowing the recovery a little bit. But we could not have done
this without the aggressive actions of the policymakers,
including those of you here in Congress that somewhat
reluctantly approved this. And the electorate doesn't like it,
I know that, but I think it was to your credit that it was
done.
I think the fiscal stimulus played an important role, too.
I am actually not one of those who think we should use fiscal
policy all the time to try to stabilize the economy. In normal
times, I think the Fed does a good job of keeping the economy
on track, and that is what we should do.
There are, of course, the automatic stabilizers are very
important. I mean, they are very important. So that when we go
into a downturn, tax revenues fall and things like unemployment
insurance rise, and they help stabilize this economy. But given
the situation we were in, which I liken in my testimony to
being in a foxhole with the shells crashing around us, we
really needed additional help; and the fiscal stimulus provided
that.
Now, one can argue about this. I don't think it is rocket
science that if an economy is suffering because aggregate
demand is weak, consumers aren't spending, the housing market
is collapsing, businesses aren't investing, you need to find
some way to keep demand going, to keep jobs, to keep people
employed. In a full employment economy, it is a different
story. And I would point out that when I was chairman of the
Council of Economic Advisers, we had a balanced budget in both
of the years that I was chair.
So I am a believer in balanced budgets, and I am a believer
in keeping Federal spending under control, but, in this
situation, this was the medicine we needed, and I think it was
delivered, and it does seem to have worked.
Let's look at a comparison of where we were in the spring
of 2009.
It was just so dangerous. GDP was falling. We were losing
700,000 jobs a month. The financial sector was on the verge of
collapse. Now, even by late 2009, the whole economic situation
looks so much better. We have economic growth. We are beginning
to get job growth. It is much too slow and much too hesitant,
but it is beginning to happen. So it is just really a night-
and-day comparison.
Again, not to say everything is great. Everything is not
great. Not to say we won't have stumbles along the way. As Alan
Greenspan I think said yesterday, in a normal recovery--and
this is maybe not quite a normal recovery--you are going to get
periods of slower growth. You are going to get hesitations. And
when you get something like the aftershock in Europe, that is
particularly true. So it is not a surprise that we are getting
some weakness now.
You know, the month before, the numbers look good. The last
month, the numbers have looked not so good. That is the way it
is going to go during the course of a normal recovery.
I think Mark is going to talk--and he is one of the best
modelers around--of what his model shows about the effect of
stimulus. But I think one probably needs to go even beyond
those models. When you get really a crisis situation, then the
TARP and the stimulus spending become much more important.
Now, what about going forward, to which Chairman Spratt
referred? What do we need to do going forward?
I guess my own view is sort of hold the course steady. I am
still optimistic that we will get something like 3 percent to 4
percent growth this year. I don't think that is a certainty,
but I am hopeful that we will get that.
What has happened in Europe has given us problems here. It
is one of the main reasons the stock market has been weak just
lately, and there is this sort of effect. It affects our trade,
but it also affects confidence and business confidence. Quite
large corporations are heavily involved in Europe, so some of
their profits, some of their investment is derived from those
markets. So, inevitably, that is having an effect on the U.S.
Now, in the G-20 meeting, the President, President Obama,
said to the Europeans purportedly that they need to keep their
stimulus going. And they said, no, they weren't going to do
that. Was that right or not? I think they are sort of damned if
they do and damned if they don't, if you excuse my language. It
was a situation where their own economies really would call for
more stimulus, that they need that, because they are not
growing rapidly. Even Germany, let's say, which is in good
budget position and their exports are growing, but even its
overall economy is not growing. Certainly the others are not.
So from that point of view, it would be a good idea to keep
the stimulus going. But given the crisis they have on their
financing and with the Euro, I think they probably are making a
wise decision to not try to put in additional stimulus.
Now, what I hope they don't do is try to contract or do
fiscal consolidation too quickly. They do need to do fiscal
consolidation, just as we do here in the United States, but I
think they should do it slowly and not shoot themselves in the
foot. If they push themselves back into another deep recession,
it will affect not only us, but it will give them bigger
deficits. Because, of course, declining tax revenues during a
recession are a big reason why we have had deficits and why
they have had deficits.
In terms of the U.S., we are in a somewhat similar
situation. We really have to weigh off those two forces: Can we
afford to borrow any more or can we afford not to, so to speak,
in order to keep the economic stimulus going? And I think those
things are quite evenly balanced at this point. Again, I would
probably like to see some additional stimulus, except for the
fact that we have this constraint.
As Larry Summers said back in the Clinton administration,
one of the advantages of running a budget surplus is that you
reload the fiscal canon. That means you can use fiscal policy
without being concerned that you are borrowing too much or
going to drive up interest rates or create a financial crisis.
We are not in that situation now. Because we have had deficits
for so many years, we are now somewhat vulnerable. I don't
think we are Greece, because the U.S. is a much bigger and much
stronger economy and our interest rates right now are very low,
but we don't want to push the envelope there.
So I have supported the extension of unemployment
insurance. I think that is a good thing to do. And I think some
additional help to the States is called for, but I would not
institute, in my judgment, another major fiscal stimulus
because of the borrowing constraints. If we end up, towards the
end of this year, going back into a second dip recession, then
I would reevaluate that depending on where financial markets
stood.
Thank you for the opportunity.
[The prepared statement of Martin Baily follows:]
Prepared Statement of Martin Neil Baily, Senior Fellow, Bernard L.
Schwartz Chair, the Brookings Institution
Chairman Pratt, Ranking Member Ryan and members of the Committee,
it is a privilege to testify to this committee on the economy.
key points in this testimony
There were early signs of financial crisis even in 2006 and early
2007, and then financial markets seized up in the summer of 2007.
Initially, the decline in GDP and jobs was mild, but the economy fell
like a stone in the last quarter of 2008 and the first quarter of 2009.
The situation in the spring of 2009 was extremely dire with the risk of
continuing deep declines and collapse of the financial sector.
There were many contributors to this crisis, market failures,
regulatory failures and policy failures. Regardless, given the severity
of the recession and the financial turmoil and the global reach of both
elements, no policies could have restored full employment quickly or
healed the problems in the financial sector rapidly. Financial crises
and the ensuing recessions result in prolonged losses.
The Treasury and the Federal Reserve were slow to react to the
financial crisis, but once its enormity became clear they moved
aggressively to fight it. Secretary Geithner was part of the team at
the Federal Reserve dealing with the crisis from the outset and he
provided continuity as the Obama team took over. The TARP was essential
to restoring the financial sector and the FDIC played a vital role in
resolving small and medium-sized banks. The stress tests in the spring
of 2009 were a turning point in financial recovery in large part
because the Treasury was able to promise bank capital if the private
sector could not provide it.
The fiscal stimulus had to be deployed quickly and the money had to
reach households and businesses as soon as possible. The states were
facing large budget deficits that would trigger sharp cutbacks unless
federal funds could provide emergency relief. The stimulus package was
messy, but it did what it was supposed to do as evidenced by the
recovery of growth in the fall of 2009.
The fact that GDP growth was solid by the end of 2009 and that
employment started to grow in 2010 is a miracle, given how bad the
situation became.
Despite the gains achieved, the jobs picture remains extremely
bleak and the problems in Europe could result in a double dip recession
here at home. Our ability to respond is weakened by the fact that there
were federal budget deficits every year from 2002 on, and because the
deficit ballooned in this crisis.
The European crisis has forced some countries to curtail their
stimulus packages and move towards fiscal consolidation. With the
backing of the IMF, they are making a virtue of necessity and arguing
that fiscal discipline will encourage growth even in the short run. I
agree they should start down a well-marked path to lower deficits, but
they should avoid acting too quickly. An aborted economic recovery will
result in even worse budget deficits.
The US situation is somewhat similar in that we also need to weigh
the need for stronger demand growth against the limits on Treasury
borrowing. The US economy is less constrained and markets are not
flashing warnings about Treasury borrowing, given that interest rates
are at historic lows. That could change, however, and we do not want to
get too close to the edge of the cliff. If the economic recovery peters
out, I would support a further fiscal stimulus, but only if accompanied
by a clear and credible path towards lower deficits in the out years.
Where We Were There were signs in 2006 and early 2007 that
financial markets, particularly housing and mortgage-backed securities
markets, were troubled. With the benefit of hindsight, we can see that
the decline in median home prices that started in 2006, the collapse of
25 subprime lenders in early 2007 and the collapse of two Bear Stearns
hedge funds in July 2007 were early-warning signs of much worse trouble
to come. The financial crisis hit front and center in August of 2007
when wholesale lending markets seized up, making it difficult or
impossible for some financial institutions to roll over their short
term borrowing. Chart 1 shows the ``Ted Spread'' the difference between
the LIBOR interest rate and the 3-month Treasury bill interest rate, an
indication of the willingness of financial institutions to lend to each
other. It spiked up in 2007 as the crisis hit and then went through the
roof in 2008 in the turmoil following the collapse of Lehman.
The financial crisis worsened through 2008 and into 2009 as both
large and small banks failed or were propped up. Wall Street was
reeling but so were a lot of regional and local institutions. Many FDIC
insured banks have failed and the number of banks currently considered
to be problem banks reached 775 by the end of the first quarter 2010.
These banks collectively hold $431 billion of assets, so the
difficulties facing the banking sector are not over yet.
At first, it seemed as if the financial crisis would cause only
modest collateral damage to the Main Street economy of jobs and
production. Real GDP grew at 3.6 percent in the third quarter of 2007
and 2.1 percent in the fourth quarter. Even the first half of 2008 was
not too bad with a small decline in GDP in the first quarter and a
modest increase in the second. By the second half of 2008, however, the
economy went into freefall, particularly in the fourth quarter when GDP
declined by 5.4 percent, followed by a 6.4 percent annual rate of
decline in the first quarter of 2009. Chart 2 shows this pattern.
Employment in this recession has been horrendous. Payroll
employment started to decline by the end of 2007 and the freefall of
GDP that occurred in the second half of 2008 was matched and then some
in the labor market with monthly employment declines of around 700,000.
As Chart 3 shows, the loss of employment in this recession dwarfs
anything in prior recessions in the postwar period. The business
community became very scared by the speed and depth of the recession
and moved very aggressively to cut costs in whatever ways they could
find. Nonfarm payroll employment declined by 8.4 million jobs between
December 2007 and December 2010.
The stock market directly affects households through their wealth
holdings and affects the pension retirement accounts held by
individuals and by companies. In addition, the stock market acts as a
sign of confidence for everyone. If the stock market is plunging,
families become reluctant to spend even if they do not have a
significant stake in the market themselves. Chart 4 shows the movement
of the S&P 500 index over the period 2001 to early 2010. After rising
into the 1,500 to 1,600 range in 2007 it plunged over the next several
months, dropping below 700 before recovering partially. Families that
were counting on a comfortable retirement realized they lacked the
necessary resources and would either have to keep working or adjust to
a much reduced lifestyle.
where we are now
The good news is as follows:
After its frightening freefall in late 2008 and early
2009, the economy slowed its rate of decline in the second quarter of
2009 and resumed growth in the third quarter, averaging a solid 3.6
percent through the first quarter of 2010. A mainstream forecaster
suggests growth of 3-4 percent for the next year or two. This is a
remarkable turnaround with the pattern also shown in Chart 2.
The labor market has stabilized, with unemployment having
peaked at 10.1 percent in October 2009 and now declining slowly to 9.7
percent in May. Payroll employment is rising, at a rate of about
200,000 a month for total payroll \1\ and about 100,000 for private
nonfarm employment for 2010 through May.
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\1\ Total payroll employment received a temporary boost from Census
hiring that will not persist.
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The stock market has partially recovered from its swoon
and is up substantially since March of 2009. Arguably, the high that it
reached at its peak was above its sustainable level and it is now at an
appropriate level in relation to earnings. I do not try to forecast
stock price movements, but if the economy continues to recover, there
is upside potential in the market.
According to the S&P Case-Shiller home price index for
April, the large drop in home prices has ameliorated with the index up
modestly over the prior year.
The bad news is also evident:
The unemployment rate is close to 10 percent while full
employment is thought to be around 5 percent. This means that American
output and incomes are about 10 percent below their potential.\2\
---------------------------------------------------------------------------
\2\ Based on a standard ``Okun's Law'' calculation that each
percentage point decline in unemployment is associated with 2
percentage points of GDP relative to its trend or potential.
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If employment growth continues at the rate of 200,000 a
month it will take around seven years to get back to full
employment.\3\
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\3\ Calculation made by Ezra Greenberg of McKinsey & Company.
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Household wealth, including financial assets and housing
wealth, is $11.7 trillion below its peak as of the end of 2009 and this
decline has erased all of the wealth gains accumulated since the early
1990s.\4\
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\4\ Calculations by the McKinsey Global Institute based on Federal
Reserve Data.
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The federal budget deficit was over $1.4 trillion in 2009
and is forecast to be over a trillion dollars a year through 2019
unless there are major policy changes.
Growth at 3-4 percent is below the usual level achieved in
an economic recovery from a deep recession and there is a danger of a
second dip recession.
Without in any way discounting the economic challenge that remains,
I will make the case in this testimony that the big policy measures
taken to turn the economy around have worked extraordinarily well,
indeed much better than could have been expected. Around the Ides of
March of 2009 the economic situation was truly frightening. Workers had
been laid off at a rate of 700,000 a month for several months, GDP was
plummeting, the housing market was collapsing, and the stock market was
hitting lows not seen for 15 years. At that time, I would have reacted
with disbelief to anyone who had predicted that by the fall of 2009
there would be solid economic growth; that the stock market would have
rebounded; and that employment would start growing by 2010. The natural
resilience of the American economy has, of course, helped this ongoing
recovery, but it would not have been possible without the massive
policy interventions undertaken by Congress and two Administrations.
There were plenty of mistakes made in the period leading up to the
crisis, some of them very serious. And mistakes were made in dealing
with the crisis, some of them also serious. But the simple fact is that
in the end the treatment worked and the economy is recovering.
I read op-eds and hear commentary to the effect: Hey, it has been
18 months since Obama took office, so how come the economy has not
recovered? He should quit blaming Bush for his problems. Such
statements make no sense in terms of economic logic and represent
political posturing. There were many causes of this crisis and plenty
of blame to go around. Yes, the policies of the Bush Administration
bear responsibility because they were based on the belief that
financial markets did not need to be regulated. Federal housing
policies pushed by both political parties, but especially by Democrats,
contributed to the problem by encouraging over borrowing and too much
home building. But, regardless of the causes of the crisis, this was a
terrible global meltdown and recession and could not possibly have been
reversed quickly. Former McCain advisor and Harvard economist Kenneth
Rogoff has shown in his empirical studies with Carmen Reinhardt that
economies always take a long time to recover from financial crises.
Aftershocks of the global crisis, like the sovereign debt crisis in
Europe, have slowed the pace of U.S. recovery and could threaten a
double dip despite the progress to date. There are limits to the power
of policymakers to affect economic outcomes. The policies that were
followed have done what was expected of them; actually, they have
worked much better than could have been expected--except for the fact
that private employment gains are still very slow indeed.
policies used to restore the financial sector
The financial crisis was threatening to pull the U.S. and global
economies into recession or even depression when the Bush
Administration and Secretary Paulson asked for a fund of $700 billion--
the TARP--to stabilize the financial sector. The Emergency Economic
Stabilization Act, signed in October 2008, authorized the Department of
Treasury to spend up to this amount to purchase or insure troubled
assets, but with broad discretionary authority. The Treasury's stated
diagnosis of the financial crisis was that distressed mortgage-related
assets had become impossible to trade and value because of the
breakdown of normal market relationships. The TARP was to be used to
facilitate the return of private valuation of these assets, including
the use of reverse auctions. Treasury was willing to buy distressed
mortgage-related assets on the open market in order to get this process
started. As the crisis unfolded, it became clear that financial markets
were too troubled and many of the assets were so bad that they simply
had to be written down in the books of banks and other financial
institutions. The proposed reverse auctions never got off the ground.
Consequently, the TARP's manner of intervention had to change.
Under the Capital Purchase Program (CPP), one component of the TARP,
money was used to stabilize and reinforce the core capital reserves of
banks, primarily through the purchase of preferred shares. In October
2008, immediately after Congress created the program, the CPP bought
$125 billion of preferred shares from nine of the nation's largest
banks. Hundreds of other banks applied and were accepted into the
program in the following weeks. Ultimately, the TARP would purchase
$205 billion in preferred shares from 707 financial institutions. It is
important to note that the TARP was not simply used as a transfer to
failing institutions. Even healthy banks were forced to accept money in
an attempt to mask government opinions about which banks were healthier
than others.
Beyond the CPP, more extraordinary intervention was provided for
critical and interconnected institutions. AIG received $40 billion from
the purchase of preferred shares, money that was used, in part, to
restructure two Federal Reserve credit lines that totaled $123 billion.
The TARP also extended AIG a $30 billion preferred line of credit.
Citigroup and Bank of America each received an additional $20 billion
capital infusion on top of the $25 billion committed to each bank from
the CPP.
Another problem is that ``runs on banks'' began to occur.
Historically, a bank run occurred when retail depositors feared that
their money in deposit accounts was not safe and they rushed to
withdraw it before the bank went under. During the Great Depression,
deposit insurance and the FDIC were created, and these policy changes
have virtually eliminated the problem of retail bank runs in the United
States. However, FDIC bank guarantees do not cover non-bank financial
institutions, such as investment banks, which comprise the so-called
shadow banking system. These institutions have grown increasingly
important during the last decade, and in the lead up to the financial
crisis they were engaged in a massive game of borrowing short and
lending long. Given the lack of insurance as well as the generally
opaque nature of their operations, brokers trading in derivatives and
other securities were vulnerable to runs as their clients rushed to
withdraw the funds they had deposited with them or avoided entering
into new derivative or repo contracts. Bear Stearns went under as a
result of this, followed by Lehman and then AIG.\5\ It turned out that
money market mutual funds were holding large amounts of repo contracts
as part of their asset portfolios and as they feared losses on these
contracts, they, too, pulled them out of troubled companies like Lehman
and faced losses. One such fund threatened to impose losses on retail
depositors that had accounts with them (break the buck) and this caused
a run on money market mutual funds.
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\5\ AIG, of course was an insurance company not a broker dealer but
it had developed a huge book of Credit Default Swaps through its
operations in London.
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The Federal Reserve acted forcefully to contain the spreading
damage, providing guarantees for depositors in money market funds
(deposit insurance for these non-bank depositors) and guaranteeing
interbank lending in order to stop the payments system worldwide from
freezing up. Even with these measures there were disruptions as global
trade plunged when importers and exporters were unable to obtain
funding.
One of the biggest turning points of the financial crisis was the
Supervisory Capital Assessment Program (SCAP), informally known as the
``bank stress tests.'' This was a comprehensive, simultaneous
assessment of the capital held by the banking groups of the 19 largest
U.S. bank holding companies which collectively accounted for two-thirds
of all deposits. Conducted by the Federal Reserve and bank supervisors,
the effort was meant to determine if these groups had sufficient
capital to withstand two macroeconomic scenarios, one with baseline
conditions and the other a more pessimistic take on the economy in
which the jobless rate would climb to 10.3 percent. The results were to
be made public so the skeletons were going to be brought out of the
closet.
Taken overall, the stress tests revealed that the banking industry
was not as troubled as many had feared. Among the 19 surveyed, 9 were
deemed to have sufficient capital already. The other 10 were told to
raise a combined $75 billion in equity. The day after results were
published, Wells Fargo and Morgan Stanley raised $7.5 billion and $8
billion, respectively. Goldman Sachs had raised $5 billion before the
results were even released (though the report said they did not need
any). Of the 19 banking groups that underwent stress tests, all but one
were able to raise sufficient capital from issuing stock, selling
business units, and strong earnings. GMAC, the troubled lending arm of
General Motors, was said to need $11.5 billion, the most of any banking
group as a percentage of assets--much of this money would come from the
TARP in two subsequent rounds of funding. In the worst case scenario,
the stress test report predicted losses by the 19 banks could total
$600 billion. Nevertheless, the stock market reacted positively after
the results were announced, with the S&P 500 climbing 2.4 percent that
Friday. Soon afterwards, the strongest banks were able to begin
repayment of their TARP funds.
The TARP and SCAP programs worked. The vast majority of banks
receiving the TARP funding remained open,\6\ and the large banks
returned this funding more quickly than could have been expected from
their problems, becoming much more stable and earning profits. As well
as the capital injections, the low interest rate environment allowed
them to make profits on the lending they made and their trading
businesses were also profitable.
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\6\ Three banks that received TARP money have failed: Midwest Bank
and Trust Company, Pacific Coast National Bank, and United Commercial
Bank. A fourth, CIT Group Inc., filed for bankruptcy. The expected loss
from these 4 institutions is $2.7 billion, $2.3 billion from CIT Group
Inc. alone.
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Various other programs, unrelated to toxic assets, were housed in
the TARP, given its broad mandate and the difficulty of earning new
allocations from Congress. Hence the TARP was involved with the auto
industry, mortgage modification, and providing capital to institutions
that serve underrepresented communities.\7\ The automotive industry--
including GM, Chrysler, and two of their financing arms\8\--has
collectively received $64 billion, which is now held as a mixture of
debt, equity, and preferred shares. The jury is still out on the
sustainability of GM and Chrysler, but so far so good. They are both
making a comeback and their survival prevented what would have been
even more massive job losses.
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\7\ Through the Community Development Capital Initiative.
\8\ GMAC and Chrysler Financial.
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Wall Street has taken the bulk of the criticism in this crisis, but
actually the financial system more broadly contributed to the crisis
and many smaller and regional banks remain troubled. Many of the bad
mortgage loans were originated by state regulated non-bank institutions
and many insured small banks have been troubled. The TARP funds were
used to help smaller institutions as well as larger ones but
nevertheless several hundred FDIC banks have been placed into
receivership and, as noted earlier, 775 are currently problem banks.
The chart below shows FDIC bank failures over time.
The FDIC has been faced with enormous challenges in this crisis
and, under the leadership of Sheila Bair, has shown skill in resolving
failing institutions. Not everything has gone right, and the FDIC
programs have been pretty expensive (the costs will be borne by member
banks in the form of higher deposit insurance premiums not directly by
taxpayers). The FDIC programs to reduce foreclosures and keep people in
houses have not been very successful--although no plan has proven good
at that. Despite these issues, our economy is much, much better off
today for having the FDIC on the watch and ready to deal with failing
banks. It is hard to think how bad the situation would have become
without the FDIC to step in and resolve failing banks.
Costs of the TARP: According to a March 2010 CBO report, the CPP
part of the TARP should earn $2 billion in profit. Net income from
investments in Citigroup and Bank of America will total $5 billion.
That said, total returns will still be negative, largely because of
anticipated losses from the automotive industry ($34 billion), AIG ($36
billion), and a home loan modification program ($22 billion). The total
cost of the TARP program should be roughly $100 billion net, much
smaller than February 2009 forecasts of more than $500 billion. At less
than 1 percent of GDP, that cost is well below historical averages of
13 percent of GDP, according to IMF numbers. As Ben Bernanke, chairman
of the Federal Reserve, said, ``This is a pretty good return on
investment.''
In summary, the policies to restore the financial sector are
working. The recovery of the sector is not complete but the period of
extreme anxiety is over and banks are positioned to lend more as
recovery takes hold. This was done with costs that are large but not
disproportionate to the problems being faced.
fiscal policy used to combat the recession
At the end of the Clinton Administration, the federal budget was in
substantial surplus and one of the many advantages of this was that we
had ``reloaded the fiscal cannon,'' in the words of then Treasury
Secretary Lawrence Summers. This meant that in the event of a serious
recession in the future, expansionary fiscal policy could be used to
mitigate the unemployment and lost output that would result. The Bush
Administration decided that the surpluses should be used to finance
very large tax cuts and the result has been chronic federal budget
deficits from 2001 through the present. I was not opposed to tax cuts
as a way of returning families' incomes back to them and easing the tax
burden, but the size of the cuts was excessive. It is irresponsible for
the United States to run chronic deficits and become reliant on foreign
capital inflows to finance our domestic investment. Moreover, it meant
that we entered the crisis in 2007 in a vulnerable fiscal condition.
The fiscal cannon was short on powder.
Recessions always cause deficits because tax revenues fall, and the
severe recession of the past three years is no exception. Much of the
deficit of $1.4 trillion in 2009 was the result of the loss of tax
revenue that followed the economic decline. The chart below shows that
federal revenues declined $515 billion or 31 percent from their peak to
the trough.
Some expenditures rise automatically in recessions, notably
unemployment insurance benefits, and these also add to deficits. It is
important to note that these ``automatic stabilizers'' are vital to the
maintenance of economic stability. Without any action by Congress, tax
revenues fall and some types of spending rise, cushioning households
and businesses from the downturn. Historically, these stabilizers have
formed the frontline defense against more severe recessions and it is
important that their effect not be offset by ill-timed actions to
reduce the deficit--Herbert Hoover economics. As in other things in
life, timing is everything. Chronic deficits are bad, in fact the
budget should be balanced or even a little in surplus on average. But
at times of recession deficits are a necessary evil.
In an effort to hold off the recession, the Bush Administration had
proposed and Congress had passed a stimulus package in 2007, mostly
consisting of temporary tax cuts. I supported this policy, but it
clearly did not solve a problem that was much bigger than we knew.
During the transition, President Obama and his team proposed a much
larger stimulus package of $787 billion, which was enacted in early
2009 and the chart below shows a breakdown of this spending by
creditloan.com on the basis of who got the money and what was it used
for.
As you can see from the left side of the chart, the largest portion
of the stimulus went to governments--federal agencies, state and local
governments. As you know, states and localities are almost all in
terrible trouble financially and are making cuts in spending. In the
long run it is a good thing that our state and local governments are
forced to operate with balanced budget constraints. But in a recession
like the one we are going through, cuts in such spending contribute to
the recession. In my judgment, it was a good choice to support states
and localities. The spending on infrastructure and energy efficiency
was a mixed bag and not part of a coherent national strategy to deal
with energy or infrastructure problems. Understandably, perhaps, it was
decided to act quickly and avoid political or implementation delays as
far as possible. Judging by the District of Columbia, the
infrastructure spending is being used to dig up every road on my
commute home, but this does create jobs and hopefully is to good effect
in the longer run.
Nearly $300 billion or 38 percent of the total went to individuals,
and that may be a surprise to some. This money was received either in
the form of lower taxes or in higher support payments but, either way,
it was money in the pockets of American families that could be used to
help them through the crisis and add to their consumption. About 17
percent of the total was used for businesses, not an especially large
number.
Overall, the stimulus package was messy, and some of the spending
was wasteful. But the context must be kept in mind. A sizeable stimulus
had to be passed quickly to protect against an even deeper recession
and there were 535 cooks stirring the pot. The stimulus package did add
to aggregate demand and reduced the size of the recession.
Predictions about the Effectiveness of the Stimulus. President
Obama asked his economic team--specifically Christina Romer, now CEA
Chair, and Jared Bernstein, of the Vice President's staff--to prepare
an estimate of the impact of his proposed stimulus package. They
predicted that the package would generate 3.3 to 4.1 million additional
jobs in 2010 and add 3.7 percent to GDP growth, compared to the
counterfactual of no stimulus. Their forecasts have been criticized
because employment was terrible in 2009 and GDP fell sharply in the
first half of that year, but that is a misunderstanding of what they
did. They looked at the incremental effect of the policy, relative to
the no-policy alternative. I note also that their forecasts about the
impact of the stimulus on GDP look reasonable in light of the second
half of 2009 and early 2010.
A financial crisis and recession like the one we are in represents
a discontinuity in our economic path. Econometricians are very skilled
at sorting out the historical patterns of economic data and using them
to say what is the most likely future given past experience. This
crisis is not anything like any recent history and has produced very
severe economic stresses. The employment declines in the United States
in this recession have been much larger than would have been predicted
given the path of GDP and much larger than in European countries with
similar GDP declines. The stimulus package did not preserve as many
jobs as Romer and Bernstein had hoped, but that is because the old
employment patterns broke down, which is not something they could have
predicted. Productivity also soared in 2009, a very unusual occurrence
in a deep recession.\9\
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\9\ GDP is measured with considerable uncertainty, especially data
from recent quarters. There is an alternative way of getting at the
same concept through total income, Gross Domestic Income or GDI. Based
on the income side of the National Accounts, the recession has been
much deeper than is implied by the GDP data. One explanation of the
huge loss of jobs is that the fall in income and output have been
understated by the available GDP statistics.
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I do not support frequent use of active fiscal policy to respond to
the business cycle ups and downs, but in 2008 and 2009 we were stuck in
a foxhole with the shells landing all around and it was a good time to
call for reinforcements. The stimulus package provided that much-needed
help.
today's growth and deficit challenge
In the recent G-20 meetings reportedly there was tension between
the United States and Europe over continued fiscal stimulus.
Understandably, President Obama is worried about the sluggish global
recovery and wants to sustain fiscal stimulus. European countries argue
that the fiscal crisis is too severe to allow continued stimulus and
there must be a clear path to fiscal consolidation. The IMF officials
at the meeting supported this view. The argument is that these
countries do not have the freedom to pursue expansionary fiscal
policies. The debt and deficit problems in Greece and the dangers in
Spain, Portugal, Italy, Ireland and the UK are enough to reduce the
range of policy choices.
Standard economic policy analysis indicates that increases in
government spending or cuts in taxes will stimulate aggregate demand
and hence economic growth in times of recession. I applied this logic
to the U.S. stimulus package in claiming that it helped sustain demand
during the downturn. Another example is China, which introduced a large
stimulus package when the global downturn hit to offset the decline in
their exports. This program has been judged successful and economic
growth in China has been sustained. Does this economic logic break down
when there is a threat of sovereign debt default and a fear of the
financial turmoil that would result from this? Some policymakers in
Europe even argue that fiscal consolidation will provide such great
reassurance to markets and will so increase business and consumer
confidence that the overall effect will be expansionary.
I am not willing to stand the usual economic logic completely on
its head. Fiscal consolidation in Europe will have a direct effect in
taking money out of people's pockets and cutting jobs and this will
reduce demand and economic growth as a first-round effect.
Nevertheless, I am sympathetic to a more moderate version of the
European argument because the fears of renewed financial turmoil are
real and potentially damaging to economic recovery and this must
condition policy decisions. My advice to Europe would be to move as
slowly as they can towards fiscal consolidation. If they act too
quickly, they will shoot themselves in the foot and end up with a
deeper recession and even bigger deficits. But they do have to be
mindful of the limits they face on sovereign borrowing. They should
take moderate but meaningful steps towards smaller budget deficits now
and put in place policies that will continue progress towards budget
balance as their economies recover from recession. Keep in mind also
that European economies generally have much more extensive safety nets
than does the United States. These social programs have created
problems for them in terms of incentives, but they do have the
advantage of providing strong automatic stabilizers to the economy
because consumption is protected in downturns.
To what extent is the United States in the same position? The chart
below shows a private forecast of likely federal deficits in the United
States in the absence of any major policies to change the picture. This
is a very scary picture. A trillion dollars a year is a lot of money to
be borrowing. The U.S. Treasury does have some advantages, however,
relative to Europe because of the size of our economy and the depth of
the financial markets. And even though the projected deficits look
large, the prospects for U.S. growth are pretty good and there are ways
the deficit could be reduced if we only chose to follow them. Today,
the yield on 10-year Treasuries is under three percent, so the market
is saying that there is no problem so far in the ability of the
Treasury to borrow, indeed these rates are among the lowest in history.
Treasury rates are low now because lending to the US government
looks good relative to global alternatives but market views could
change over the next few years and perhaps even sooner. If Treasury
interest rates rise significantly, this will crowd out private
investment or even trigger another crisis if the dollar were to drop
precipitously. No one knows if or when the U.S. Treasury might have its
Greece moment. Surely, this will not happen over the next year or two,
but quite possibly it could happen over the next five years. And it
would be foolish to push the envelope and let a disaster happen.
Given the reality of huge deficits, I do not support major fiscal
expansion measures right now that would increase the deficit. I did
support a continued extension of unemployment benefits and modest
additional help to the states, measures that would not have
significantly worsened the deficit. If the U.S. economy were to slip
back into second dip recession later this year or next year, then my
view would change and I would consider it necessary to provide another
fiscal stimulus to the economy despite the risks to Treasury funding.
Ideally, the Administration and Congress would agree soon on meaningful
policies to reduce the budget deficit in out years (for example, a
measure that put federal health care spending on a balanced-budget
basis over a multiyear period). This would create confidence in global
markets and would allow for further stimulus this year or next, if that
were to prove necessary, but it would not take purchasing power out of
the economy today.
conclusions
You do not expect the bear to dance well; it is a miracle if it
dances at all. The policies that restored the financial sector and
helped turn around this very deep recession were not pretty but they
were the right policies and they helped save the U.S. economy and
indeed the global economy. The high unemployment, fluctuating stock
market, struggling housing market and sluggish recovery that
unfortunately are still with us are making the Administration and many
other policymakers unpopular. It is too bad that the electorate does
not give credit for the turnaround that has happened. It should.
Chairman Spratt. Thank you.
Dr. Zandi
STATEMENT OF MARK ZANDI
Mr. Zandi. Thank you, Chairman Spratt, Congressman Ryan,
and the rest of the committee, for the opportunity to be here
today.
These are my own views and not those of the Moody's
Corporation. I will make four points in my remarks.
Point number one. The recession, the great recession has
given way to an economic recovery, and it is largely due to the
policy response.
The recession ended almost precisely a year ago. GDP growth
over the past year has been approximately 3 percent year over
year, and we have begun to see job growth since the beginning
of 2010. Subtracting from the Census hiring, the temporary
Census hiring and the loss of the Census jobs that are coming,
we have seen average monthly private-sector job growth of about
100,000 since the beginning of the year, and that is what I
would expect to see for the month of June when we get that data
point on Friday, which is an important point. The unemployment
rate has stabilized as a result, obviously very high, close to
10 percent, but it has stabilized at that level since this time
last year.
The recovery is broadening out. It began in manufacturing.
It is now evident in distribution and transportation. We are
seeing growth in various technology industries, some
professional services, a bit in retailing. I would anticipate
leisure, hospitality, financial services starting to hire more
aggressively as we make our way through the year.
The recovery is also broadening out across the country. If
you look at the Nation's almost 400 metropolitan areas, two-
thirds of them, roughly speaking, are now in a recovery. Just
for context, if you go back to the depth of the recession in
late 2008, early 2009, only 10 percent of the Nation's
metropolitan areas were expanding. So that is a significant
improvement.
The policy response has been key to this turnaround. I
think we all can take exception to any individual aspect of the
response. Some folks don't like the bank bailout, others the
auto bailout, the housing tax credit, cash for clunkers. There
were many, numerous policy efforts. Each of us probably didn't
like some aspect of the response.
But the totality of the response I think was unprecedented
and aggressive and ultimately very successful. I don't think we
would be experiencing a recovery at this point without those
efforts; and that includes everything from what the Federal
Reserve has done in providing liquidity to the financial system
and shoring up the banking system, to what the FDIC has done
with respect to insurance limits and guaranteeing bank debt
temporarily, to what the Treasury has done with respect to the
bank's stress testing process, to--as importantly or more
importantly--what Congress has done with respect to all the
elements of the TARP and fiscal stimulus.
In my view, the fiscal stimulus was absolutely vital to
jump-starting this economy. It is no accident that this
recovery began at precisely the same time that the stimulus was
providing its maximum economic benefit to the economy. So,
point number one, we are now in recovery, and it is because of
the policy effort.
Point number two, the recovery is still fragile. The
economic expansion is not in full swing. We are not off and
running yet. There are a number of reasons for concern. Let me
list a few.
First, going back to the job market. Most of the
improvement in the job market is related to an end of
businesses laying off workers. We are not seeing any
appreciable pickup in hiring. Some modest pickup in the last
couple 3 months, but it is very modest.
I think there are a couple impediments to hiring. One is a
lack of credit, particularly to small businesses.
Here is a statistic that is important: Establishments that
employ fewer than 100 employees--let's call it a small
business--employ half of all the workers in our country, and
they accounted for nearly two-thirds of the net job creation in
the last economic expansion. If small business isn't hiring and
if they are not hiring because of credit, we have got a
problem. So that is an impediment.
The other issue is confidence. It was only a year ago that
many businesses were suffering near-death experiences, and I
think it is difficult to--as a businessperson and being a small
business owner myself, I can attest to the fact that you don't
forget something like that quickly.
I also think policy uncertainty is an issue. I do think we
are having very significant policy debates that are very
important. We need to have them. But it is important to
recognize that when you are having them it does create angst
among the business community. And that is everything from
health care reform to financial regulatory reform to energy
policy to immigration policy.
And I would have to say, just based on my experience just
talking to business people in my work, they are very nervous
about tax policy, that the tax rates are going up at the
beginning of next year if there aren't changes, and that needs
to be nailed down quickly, I think. That would make a big
difference.
A second issue with respect to the recovery is what is
going on in State and local government. That is a problem.
State and local governments have very large budget holes. Those
budget holes are smaller today than they were this time last
year, but last year's budget hole was filled largely with the
stimulus money. So that forestalled the most Draconian budget-
cutting job loss and tax increase.
It didn't forestall those budget cuts. There were very
significant cuts. In fact, State and local government
employment is down 190,000 jobs from where it was 1 year ago.
That is significant. But the job cutting was modest. It was not
an overwhelming economic problem. If State and local
governments do not get more help, they will have no choice but
to significantly cut payrolls, cut other programs, which means
a loss of private-sector jobs, and raise taxes at just the
wrong time when the economic recovery is fragile. So reason
number two for concern is what is going on at State and local
governments.
Third, the foreclosure crisis is ongoing. It is not over.
There are 4.3 million first-mortgage loans that are in default
or headed in that direction, 90 days and over delinquent. For
context, there are 49 million first-mortgage loans outstanding.
That is a lot of loans. Those loans have been piling up in the
foreclosure process because of the various loan mitigation
efforts. Servicers, mortgage servicers are now figuring them
out. They will begin to start pushing these loans that don't
qualify for a modification through the foreclosure process to a
sale, either short sale or foreclosure sale.
That will begin hitting the housing market this summer and
fall. House prices are going to continue to decline. Nothing
really works well in our economy if house prices are falling.
It is still the largest asset in most people's balance sheet,
and financial institutions aren't going to extend credit if
house prices are falling.
Going back to small business. Small businesspeople put up
their homes as collateral for loans. Banks aren't going to make
a loan if they are unsure of the value of the home underlying
that loan.
So point number two, broadly, is that the recovery is still
very fragile. We are not off and running yet. We still have
work to do.
This goes to point number three, and that is I think it
would be premature for policymakers to exit out of their
support for the economy too quickly. For the Federal Reserve,
that means not raising interest rates. But the Federal Reserve
shows no inclination to do that at any time in the near future.
With unemployment where it is and unlikely to move lower any
time soon, I don't anticipate that.
Unfortunately, the Federal Reserve can't do much more than
what it is doing. It could restart credit-easing efforts to try
to bring down long-term interest rates, but long-term interest
rates are already at record lows and it is not having much of
an impact on housing demand and other activities. So I don't
think that that would be of measurable help.
So this puts more pressure on you, as fiscal policymakers.
And I think it is important--in fact, I would say it is vital--
that you continue to provide some additional temporary stimulus
to the economy, and I would recommend three things.
First, I would extend emergency unemployment insurance
benefits. Two to three hundred thousand folks are running off
those rolls every week; 1.3 million are already off the rolls
because those benefits have not been extended. This is going to
hurt personal income and consumer spending very quickly,
because these folks get the money and they spend it.
Moreover, it is very difficult to gauge how this is going
to affect consumer confidence, which, as we can see, is
incredibly fragile. So I think it is vital to extend UI.
Second, I would provide more help to State and local
government. They have a budget hole, by my reckoning, that is
close to $100 billion. I think it would be appropriate to fill
about a third of that budget hole. That means they still have
to go through very significant cutting and restructuring, but
it would reduce the impact that would have on our job market in
the next few months and on the broader economy in the next few
months.
And, third, I would expand out the ability of the Small
Business Administration to make more credit available to small
business. That was shown to be a very effective part of the
fiscal stimulus. That should be renewed and expanded. That is a
good mechanism for getting cash out to small businesses
quickly.
So, point number three, I think it is very important for
policymakers, fiscal policymakers, for you to remain aggressive
until the coast is, in fact, clear, until the unemployment rate
is definitively moving lower.
Finally, point number four goes to our fiscal situation,
which is indeed very serious. And, as such, I think it is
entirely appropriate--in fact, it is desirable--that this
additional stimulus that I have recommended is paid for not
this year, not in 2011, but when the economy is off and running
and the unemployment rate is moving south, let's say 2012,
2013, 2014. So I think it should be paid for.
Now, having said that, I don't think paying for it should
be a precondition for this stimulus that I have recommended,
that it is too important to the economy in the near term to get
done. So I would suggest that it is okay, fine, to run a larger
budget deficit than otherwise would be the case in the near
term to make sure that we do jump-start this economy and we get
going here.
Finally, let me say this. I do think once the economy is on
a sound footing it is critically important that you do pivot as
quickly as possible and address the long-term fiscal situation.
I think without those efforts our long-term economic prospects
will be significantly diminished.
Thank you.
[The prepared statement of Mark Zandi follows:]
Chairman Spratt. Thank you, Dr. Zandi.
Dr. Taylor
STATEMENT OF JOHN TAYLOR
Mr. Taylor. Thank you, Mr. Chairman, Ranking Member Ryan
for inviting me to testify. I appreciate the opportunity.
I think the economic recovery has slowed significantly, if
you look at the numbers carefully. Just, for example, in the
fourth quarter of last year we had growth at 5.6 percent. That
has slowed by more than half, to 2.7 in the first quarter of
this year and probably around 3 percent the rest of the year.
So it is what economists think of as a U-shaped recovery, not
the V-shaped, and some are even worrying about a double dipper
or W-shaped recovery.
In my view, the problem here is largely a great deal of
uncertainty about what is happening with economic policy. I
think there is also uncertainty about how some obvious
inconsistencies in policy are going to be resolved. There is
uncertainty about tax increases, there is uncertainty about
regulatory reform, there is uncertainty about how the Fed will
unwind its operations, and perhaps the biggest uncertainty now
is what is going to happen with the rapidly growing debt.
In this respect, I think that CBO's release yesterday of
their annual long-term budget outlook is quite of concern. I
had some charts in my testimony which try to illustrate this.
If you have a chance to look on page 1, there is a chart
which I put together from the data reported in the CBO long-
term outlook. It reports debt as a share of GDP in the United
States. We used to think that the gigantic increase in World
War II was about as much as we would ever have. If you look at
this chart, it looks like a small blip compared to where we are
going, according to CBO, if we don't do something about it. 947
percent of GDP. It is just astronomical. Obviously, the United
States of America will not be the United States of America if
we let this happen. So resolving this inconsistency I think is
one of the biggest drags on the economy at this point.
On the other hand, if we address it, address it in a
sensible way, I believe we can start to restore confidence,
start to grow more robustly again, and ultimately get that
unemployment rate declining back.
So what is holding us back? What is holding us back from
just moving ahead right away? I think the main factor is people
are worried about removing stimulus, so to speak. And my
distinguished colleagues on this panel have already referred to
that. In my view, there shouldn't be much worry from either
ending or even removing some of the so-called fiscal stimulus,
and my written testimony tries to describe why.
I basically, respectfully, but also strongly, disagree with
the view that the stimulus has been a big factor in the
recovery. And there are various ways to think about this. I
think one is to try to realize that those who argue--those
economists who argue that it was a big factor are using models
about which there is not a large degree of agreement. I try to
illustrate this on some charts on page 3 of my testimony, if
you would look at those.
I took some charts which were originally published in the
New York Times which purport to show that the stimulus was
effective, and they look at three different models. Actually,
one of the models is from Mark Zandi's group. And you can see,
if you just glance at the black line, that is sort of what has
happened or what is forecast to happen, and the gray line is
what the models say what would have happened without the
stimulus, and the three models in the left which were in the
New York Times show a big effect.
The problem is, those aren't the only models around. To
illustrate this, I took another model, actually, one that me
and my colleagues at Stanford have looked at quite a bit. It is
a model developed by the European Central Bank. It is also a
quite common kind of model that academics use in their own
research, and you can see there is very little effect. In fact,
to make the point completely, if you take the view of the
modeling of Professor Robert Barro at Harvard, there is
actually no effect of the stimulus, using exactly the same
reasoning that people who use models of this kind.
So the bottom line here is I view the right model as
something where there is very little impact of the stimulus.
But at least you have to recognize there is a tremendous amount
of disagreement.
I think in terms of understanding what has happened, it is
important to go beyond models, quite frankly. Models have their
problems, I can speak to that as an economic modeler, and look
at actually what happened. So the other charts in my testimony
try to look at what actually happened, and page 4 is one
example.
We have actually had a couple stimulus packages in this
downturn. One was back in 2008 and the other in 2009. And if
you look at my chart, you can see that part of those packages
were to send checks to people, rebate checks or advance tax
cuts. And, in both cases, in 2008 and 2009, you can see from
the red line personal income rose substantially. But if you
look at the lower line and see what people spent, look at their
consumption--remember, these were supposed to jump-start
consumption--you see very little impact whatsoever. So I think
if you look at the data, look what actually happened, stop
simulating models and look at what actually happened, you see
very little impact of this part of the stimulus packages.
But, of course, the stimulus packages have more than just
sending cash to people. They actually have to do with changing
government purchases. As Martin indicated, you can see some of
this when you drive around Washington. But let's look at really
what happened in terms of government purchases. So if you look
at page 5 of my testimony, I think it is a pretty simple
illustration of this great recession, the recovery, the
weakening of the recovery, and what are the factors.
So the chart at the very top is a picture of real GDP
growth. And you can see the blue line, it comes down, goes
about down to pass minus 6, and you have this recovery up to
5.6, and then the slowdown, as I mentioned in my introduction.
You can find out how much of that growth is due to different
parts of GDP, investment, consumption, government purchases,
net exports. So I did that.
And you can see, if you look at the contribution of
investment, private investment, the private economy, it almost
tells the whole story: a huge decline in investment in the
panic, a huge increase in investment after the panic, a
slowdown in investment now. So it is the private sector that is
driving this.
And to actually illustrate this further, look at the chart
at the bottom of page 5, and you can see that, through these
ups and downs in the economy, changes in government purchases
have played almost no role whatsoever. Now, this doesn't prove
anything, but it certainly convinces me that one should be wary
about claims that this fiscal stimulus did very much. In fact,
my view is that it has done remarkably little.
So where does this lead me? It seems to me the conclusion
is that we should focus on this problem of the debt and the
deficit, address the consolidation issues now. Don't delay.
Because concerns about either ending or not continuing with
stimulus packages, get started now, orderly way. It doesn't
have to be Draconian. But I think that as soon as people
realize that this is what you are trying to do confidence will
be restored and you can see the recovery picking up again.
Thank you very much.
[The prepared statement of John Taylor follows:]
Prepared Statement of John B. Taylor, Mary and Robert Raymond Professor
of Economics; George P. Shultz Senior Fellow in Economics, Hoover
Institution, Stanford University
Thank you, Chairman Spratt, Ranking Member Ryan, and other members
of the House Committee on the Budget for inviting me to testify on
``Perspectives on the U.S. Economy.''
The recovery of the U.S. economy has slowed significantly since the
start of this year. After rebounding to 5.6 percent in the fourth
quarter of last year, real GDP growth slipped to 2.7 percent in the
first quarter and is expected to remain in the 3 percent range for the
rest of the year. In the lingo of economics it is a U-shaped recovery
rather than a V-shaped recovery and some economists are now predicting
a double dip, or a W-shaped recovery. As a result of the slower
economic growth unemployment remains high and is expected to decline
slowly.
uncertainty and fiscal policy inconsistencies
In my view the weakness in the recovery is mainly due to
uncertainty about economic policy and concerns about how large policy
inconsistencies will be resolved in the future. The long term budget
outlook released yesterday by the Congressional Budget Office (CBO) is
a timely reminder of these inconsistencies as this alarming chart of
past and future federal debt illustrates.
The chart shows the federal debt as a share of GDP going back to
the beginning of the United States and continuing into the future
assuming that fiscal policy is not changed as defined by the CBO's
alternative scenario. You can see the increase in the debt ratio during
World War II, which fortunately was reversed in the years after the
war. The CBO's projection through the next decade shows a similar
increase in federal debt as a share of GDP as in World War II. The
projections for future decades then explode. According to the CBO, the
debt reaches an unbelievable 947 percent of GDP by 2084 which dwarfs
the peak debt incurred during World War II. So something has to give,
and people are beginning to wonder what.
The near term increase in the debt is due to the recession, the
stimulus packages, and other recent expansions in government spending
growth. The longer term increase is due to the inability to rein in
spending on entitlement programs. Thus it is not only the fiscal
response to the crisis that has caused debt problems for the United
States. But the response to the crisis has distracted us from efforts
to address the problems. Adding to the uncertainty is that many tax
provisions are scheduled to expire in just 6 months, and without
legislative action, there will be substantial tax increases on all
Americans. There is also a looming change in financial market
regulations which add uncertainty to a financial system still
recovering from the crisis.
A clear and credible path of fiscal consolidation is clearly needed
and would do much to remove uncertainty about future policy and thereby
build confidence. The reason why such a plan is not being articulated
and carried out now is an apparent concern that such a consolidation
would remove needed stimulus from the economy. In my view, the fiscal
stimulus packages did not stimulate very much if at all and ending them
would not have such negative consequences. But the debate is a serious
one and for this reason I want to devote the rest of my testimony to
explaining why I disagree with those that claim the stimulus has
worked.
evidence from the models: no consensus that the stimulus had a
significant impact
Unfortunately most attempts to answer the question ``What was the
impact of the fiscal stimulus?'' are still based on economic models in
which the answer is built-in, and was built-in well before the stimulus
package was enacted. Frequently the same economic models that said, a
year and half ago, that the impact would be large are now used to show
that the impact is in fact large. In other words these assessments are
not based on the actual experience with the stimulus. I think this has
confused public discourse.
An example is an article in the New York Times (11/21/2009) with
the headline ``New Consensus Sees Stimulus Package as a Worthy Step,''
which states that ``accumulation of hard data and real-life experience
has allowed more dispassionate analysts to reach a consensus that the
stimulus package, messy as it is, is working. The legislation, a
variety of economists say, is helping an economy in free fall a year
ago to grow again and shed fewer jobs than it otherwise would.''
As evidence the article includes simulation results from three
models, which are reproduced in the three charts on the left below.
Each of the three graphs on the left corresponds to a model maintained
by the group shown above the graph. All three graphs show that without
the stimulus the recovery would be considerably weaker. The difference
between the black line and the gray line is their estimated impact of
the stimulus. But this difference was built-in to these models before
the stimulus, and in this sense there are no new hard data or
experiences here.
In fact other economic models predicted that the stimulus would not
be very effective, and, using the same approach those now say that it
has not been very effective. To illustrate this I show two other graphs
on the right-hand side of the chart which did not appear in the New
York Times article. The first one is based a model estimated by Frank
Smets, Director of Research at the European Central Bank, and his
colleague Raf Wouters. The difference between the black and the gray
lines is what is predicted by that model. Note that the impact is very
small. The second additional graph on the right is based on the
research of Professor Robert Barro of Harvard University who reported
in an article in the Wall Street Journal ``when I attempted to estimate
directly the multiplier associated with peacetime government purchases,
I got a number insignificantly different from zero.'' So according to
that research, the difference between the black and the gray line
should be about zero, which is what that graph shows. So there is no
consensus among models or theories that the stimulus had a significant
impact.
Other evidence from models comes from an International Monetary
Fund study which reports estimates of government spending impacts which
are much smaller than those previously reported by the Administration.
The IMF uses a very large complex model called the Global Integrated
Monetary and Fiscal (GIMF) Model. It shows that a one percent increase
in government purchases (as a share of GDP) increases GDP by a maximum
of 0.7 percent and then fades out rapidly. This means that government
spending crowds out other components of GDP (investment, consumption,
net exports) immediately and by a large amount. The IMF estimate is
much less than the impact reported in a paper released last year by
Christina Romer of the Council of Economic Advisers and Jared Bernstein
of the Vice President's Office.
John Cogan, Volker Wieland, Tobias Cwik and I raised questions
about the Romer-Bernstein estimates soon after they were released in
January 2009 because the estimates seemed to be much different from
comparable estimates based on more modern models. In fact, we found the
economic impacts to be much smaller. Since then many technical papers
have been written on this subject and in my view the consensus is that
the impacts are much smaller than originally reported by Romer and
Bernstein.
evidence from the facts: the stimulus did not have a significant impact
Now let me go beyond the models and look at the direct impacts
using data. Consider first the 2008 discretionary countercyclical
fiscal stimulus--the Economic Stimulus Act of 2008--in which checks
were sent to people on a one-time basis and aggregate disposable
personal income jumped dramatically though temporarily. The objective
of the stimulus was to jump-start consumption demand and thereby jump-
start the economy. However, aggregate personal consumption expenditures
did not increase by much at all around the time of the stimulus
payments. For the discretionary fiscal stimulus which was passed in
February 2009--the American Recovery and Reinvestment Act of 2009--
checks were also sent; they were smaller and more drawn out than the
2008 stimulus, but the impact was about the same: no noticeable effect
on consumption. Both cases are illustrated in the chart below. This is
what basic economics--in particular the permanent income theory and the
life cycle theory of consumption--would predict from such temporary
lump-sum payments.
In addition, my analysis of the government spending part of the
stimulus suggests that it had little to do with the turnaround in
economic activity. Indeed the swings in economic growth from positive
to negative during the recession and again to positive during the
recovery (including the slowdown to 2.7 percent growth rate of real GDP
in the first quarter) provides evidence that changes in government
spending had at best a very small contribution to the recovery. Most of
the recovery has been due to investment--including inventory
investment, which was positive in the first quarter after declining for
all of last year--and has little to do with discretionary stimulus
packages. The two charts show the percentage contribution of investment
and government purchases to real GDP.
The charts clearly indicate that the changes in real GDP growth
have been mostly due to changes in investment and little to changes in
government purchases. In fact, government purchases were a drag (a
negative contribution to real GDP growth) in the fourth quarter of 2009
and the first quarter of 2010.
One could argue that government spending might have declined by a
larger amount without the stimulus because the stimulus package
prevented state and local government from cutting spending. More
research is needed to determine what would have happened in the
counterfactual of ``no discretionary stimulus,'' but in the meantime
these data at the least suggest that the recovery and the slowdown have
been due to changes in investment not government purchases.
conclusion
The combination of the unsustainable debt projections illustrated
in my first chart and the little if any impact of the stimulus packages
illustrated in my other charts has clear policy implications: Fiscal
policy should avoid further debt-increasing stimulus packages which do
little to stimulate employment or GDP. Fiscal policy should focus on
reducing the deficit and the growth of the debt-to-GDP ratio. Reforming
existing entitlement programs to hold their growth down and limiting
the creation of additional entitlement programs are essential.
Chairman Spratt. Thank you, sir.
Let me read you what Dr. Bernanke had to say, each one of
you, and ask you do you think it is a fair statement.
``Certainly we have averted what I think would have been,
absent those interventions, an extraordinarily severe downturn
and perhaps a Great Depression.''
Is this overstating it for dramatic effect? Is this
exaggerating the risk? And do you accept his judgment that,
absent those interventions, we would have had severe
consequences? Dr. Baily?
Mr. Baily. I would generally agree with what Ben Bernanke
said. And, by the way, I think he is one of the heroes of this.
He made mistakes before the crisis, but when he got hold of
things he did a lot of the right things, working with Congress
and the administration.
Would we have gone into a Great Depression? I think our
economy is a little bit more stable, the institutions and so on
are more stable than they were in the Great Depression. And we
do have deposit insurance. We do have unemployment insurance.
So I am not sure we would have gone 25 percent unemployment,
but basically he is right. We already did go into a very nasty
recession, and it would have been much worse without those
things.
Chairman Spratt. Dr. Zandi?
Mr. Zandi. Yes, I would have agreed with that view, that
without the policy response the recession would have devolved
into another depression; and, in all likelihood, we would still
be struggling with that.
And one other quick point. I think if we go back into
recession, which I would put the odds at still being low but
uncomfortably high and rising--if we go back into recession, we
cannot rule out that we would go back into a depression.
Chairman Spratt. Dr. Taylor.
Mr. Taylor. Yes. I disagree with that interpretation. Of
course, it is a generalization. But I have looked carefully at
many of the programs and new facilities that the Federal
Reserve has implemented, and I have tried to divide it into
things done before the panic and the fall of 2008, those during
the panic of 2008, and those since the panic of 2008.
By and large, the ones done before the panic I think were
quite harmful; and, in fact, I think you can argue they led to
the panic. The ones--some during the panic I think were
constructive. They indicated there were some markets that were
actually shut down and were helpful. The ones after the panic,
I would go back and say it seems to me they have not been very
effective.
So I believe that if you just look back through all the
interventions and if we had actually followed policies that
were followed much of the 1980s and 1990s, we wouldn't have not
only the--we wouldn't have had even the recession we had. And
so, in my view, the way to think about the policy is a better
policy could have avoided the whole mess, and I have seen no
evidence that the policy that was taken avoided another Great
Depression.
Chairman Spratt. Dr. Taylor, you have shown some graphs
which you think cast some doubt on whether or not there was a
causal connection between the Recovery Act and the performance
of the economy. To all three of you, how do we establish a
causal connection between economic policies taken and the
apparent turnaround of the economy in a rather dramatic fashion
over a period of 12 months? What is the correct way to
establish causality?
Mr. Taylor. I think timing is probably the best way to do
it, Mr. Chairman. If you look at monthly data, for example, on
orders, investment orders definitely bottomed in December of
2008, January, 2009, forward-looking order statistics. It seems
to me that represented a fact that people realized the panic
was over and it wasn't going to be as bad as they thought. That
is pretty simultaneous with the second group of measures I
mentioned that were taking place during the panic, and so that
is why I say some of those I think were helpful.
But this fiscal stimulus package, the originally $878
billion, that came after that. So I think the timing is
important.
Plus you have to really look at the data, look at the
numbers. And, as I showed you, my numbers seem to say that the
private investment, including inventory investment, by the way,
both accentuated that downturn and was part of the reason for
the rapid boom.
So I believe you can learn a lot from looking at the
numbers themselves. It is not foolproof. You need to have sort
of a model or a theory to think through what would have
happened otherwise, try to do that. But you have to look at the
numbers and look at the timing. That is what I have tried to
do.
Chairman Spratt. Dr. Zandi, Dr. Baily, how do you determine
this causality between policies taken and results achieved?
Mr. Zandi. Well, I also think timing is important, and I
think the timing is very consistent with the view that the
stimulus, the fiscal stimulus--and I am speaking of the ARRA--
jump-started the recovery.
I am speaking from memory, but Q-1 '09 the economy
contracted, as measured by real GDP, at just over a 5 percent
annualized rate. In Q-2, it contracted approximately 2 percent;
and by Q-3 we had positive growth. This is precisely when the
stimulus kicked in. We had no stimulus in Q-1 '09; we had 60,
70 billion in Q-2; and about 80, 90 billion in Q-3. And that is
precisely when we went from a very severe recession with
rapidly rising unemployment to economic growth and stable
unemployment.
So I think timing is very, very important. And the timing,
from my perspective, is very strong evidence that the stimulus
has worked well. And even using the graphs that John has
presented, I think we can explain exactly what is going on in
those charts if we look at the data a little bit more
carefully. So it is a matter of I think extensive debate, but I
think the timing is clear evidence of the stimulus' benefit.
Chairman Spratt. Dr. Baily.
Mr. Baily. John looks at model results, and obviously
models do differ. But I think a set of reasonably mainstream
models, including Mark's Moody model, Global Insights, Macro
Advisers, the main forecasting models that have been successful
in forecasting the economy, they didn't necessarily forecast
the depth of this recession but have proven their worth over
the years. They generally show that the stimulus had a
significant impact.
John mentions Robert Barro's model. Well, Bob Barro is a
wonderful economist, but he very firmly believes, starting from
the beginning, that fiscal policy won't do anything to
stabilize the economy. That has been one of his viewpoints for
years and years. And he believes that if you cut taxes now, for
example, people won't change their spending because they will
anticipate taxes are going to rise later. I think that is a
little bit fanciful.
So I think some of these models are more plausible than
others, and I think the more sensible models show the effect.
In terms of government purchases, well, I would agree with
John in the following sense: Government purchases were not by
any means the biggest driver of this recovery. I think the fact
that they continued to go forward even though we were going
into this downturn was helpful. So the fact that they did not
fall dramatically, and particularly the State and local
spending didn't fall dramatically, was a positive item. But
quite a bit of the stimulus was not directed toward government
spending. It was directed towards tax cuts or benefit increases
of some kind and went into people's pockets. And, again, it is
just the underlying logic.
I am sympathetic to the view, in a full-employment economy,
if the government increases its spending, probably someone else
in the private sector is going to cut back their spending if
you are going to maintain overall balance. But during a
recession when you have got a huge shortage of demand, when
employment is falling, when GDP is falling, you don't get that
offset. It is just a net addition to jobs and income.
Chairman Spratt. Thank you.
And let me turn now to Mr. Ryan for any questions, because
it looks like we have a vote coming up.
Mr. Ryan. I will try to keep mine briefer than normal.
We have John Taylor here. You are from California. You are
not here that often. So I want to go into monetary policy just
for a minute, if I could, since we don't have the opportunity
to have this kind of conversation; and, these days, that
monetary policy matters a great deal.
You wrote a great book sort of indicting the Fed funds
rate, the loose money in 2003 to 2005, getting us off the
Taylor rule, off the great moderation. Give us a sense of where
you see monetary policy now, how this unwinds, and what is your
read of your rule?
Some people say we ought to have a negative fed funds rate.
What is your take on where rates ought to be now? And what is
the unwinding going to look like, in your opinion, and when
will the timing of it occur? And interest on reserves. I am
very concerned about that tool, on how, when it is deployed to
fight an eventual inflation problem--obviously, not one right
now--will that basically precipitate another credit crunch?
Mr. Taylor. Thank you very much.
I think there is no question in my view--and I think more
and more people are looking at this--that the very low rates in
2003, 2004, 2005 did accentuate the housing boom and ultimately
the bust. There are different ways to look at it. If you look
at other countries, that seems to be a major factor as well. Of
course, there is still debate about it.
When you look at the current level of the Federal funds
rate, of course, we are in a much different situation now. We
are just coming out of a deep recession. The inflation rate is
lower. There is not inflationary pressure. So the low interest
rate that is there now seems to me about right.
I don't think that if you use a Taylor rule, at least as I
originally defined it, you see negative rates. I think that
some people change the rule and they do other things. So I
think it is about right, right now. And what that suggests is
that if we are unfortunate and inflation starts to pick up
sooner than we think, or even if we are fortunate and the
economy starts to move faster than as markets indicated, then
the Federal Reserve will have to raise rates if they are going
to prevent a future inflation or actually prevent another
downturn later in typical boom-bust style.
With respect to the unwinding of the huge balance sheet,
over $1 trillion of reserve balances which largely is due to
the purchases of mortgage-backed securities, I am concerned
that that could occur too rapidly or too slowly. It is one of
the uncertainties that is out there about how this is going to
be unwound. I would prefer that the Federal Reserve reduces
that balance sheet rather than try to pay interest on reserves
or try to actually go out and do some actions itself with
respect to its own securities. I think that would be a much
quicker way to get back to what was working.
Because, after all, it seems to me, if you follow my logic,
what we were doing before monetary policy got off track worked
very well. We had this long great moderation, expansion in the
1980s, expansion in the 1990s, two minor recessions during that
period. So as soon as we can get back to that policy, I think
the better off we will be. And we don't do that by trying to do
new things like interest on reserves, using that as a way to
manage the Federal funds rate, but rather use just money, the
supply and demand for money, to get to the funds rate that we
need.
Mr. Ryan. Multiplier effects.
I have read Bernstein/Romer, read some of Mark's work. You
did a piece with two German economists. I can't recall their
names. I read it a while ago. Bob Barro, we have heard his
stuff. Why are the multiplier rates lower, in your view, than
what, say, Bernstein/Romer claims?
Mr. Taylor. Well, the models used by Bernstein/Romer, which
by the way they didn't indicate which models they were,
unfortunately. But as far as we can tell, there was one type of
model used at the Federal Reserve and one private-sector model.
As far as I know, those models don't have expectations built in
very well. They don't model the financial market's expectations
of the impact of future interest rates or inflation. And, in
fact, there are many models that have been developed in the
last 20, 30 years, the kind of models that we teach our
graduate students. Almost all the universities do take account
of expectations. So people will see, for example, that if there
is a stimulus package, that means their taxes are going to
increase to some extent in the future.
Mr. Ryan. It is a Neo-Keynesian model----
Mr. Taylor. It is called new Keynesian. It has the word
Keynesian in it. Absolutely. It has very many of the rigidities
and things like that that are typical Keynesian models. They
are good models, but they do have this crowding out that can
come pretty quickly even when the economy is at reduced levels
of operation.
Mr. Ryan. I will cut my thing short.
Dr. Baily, you had a really interesting op-ed today in the
Journal on multinationals. When it comes to tax policy,
obviously, they are very elastic and sensitive to it. Is
repealing deferral, trimming back on the tax, the foreign tax
credit, is that helpful? Is that a good idea for fiscal policy
with respect to multinationals going forward?
Mr. Baily. I don't want to give you a direct answer to that
question. What I would----
Mr. Ryan. Most economists don't.
Mr. Baily. Well, give me a break here. I think it is
appropriate to take a good, hard look at how we tax
corporations. We don't collect a lot of revenue from
corporations and so----
Mr. Ryan. Relative to?
Mr. Baily. Relative to the tax rate. We have a high
marginal tax rate of 40 percent, but we don't collect a lot of
revenue. So I don't think the corporate tax is very efficient.
I think we do need to make sure--and maybe this goes in your
direction--that the way we treat our corporations is in line
with the way other countries do so that we don't give them a
competitive disadvantage. So I agree with you there.
I would mention, by the way, if we are talking about taxes,
one of the things we do is give a very strong preference for
borrowing in our society, both at the personal level and at the
corporate level.
Mr. Ryan. That is the negative in your view.
Mr. Baily. So maybe we could do a deal with the
corporations. We will cut their corporate tax rate but maybe
they pay a little more tax on interest and level that playing
field a little bit.
Mr. Ryan. Should we go to a territorial system? Most of the
rest of the world is. Do you think worldwide, hamstring us, we
ought to go territorial?
Mr. Baily. I think it is certainly worth looking at. I am
not a tax expert at that level, I am afraid, but I think it is
something that can be considered, yes.
Mr. Ryan. Do the rest of you agree that our bias in favor
of debt is a distortion that ought to be remedied? What is--you
can just give a quick answer.
Mr. Zandi. Yes.
Mr. Baily. Yes.
Mr. Taylor. I do.
Mr. Ryan. Thank you.
I want to give other people time. Thank you very much.
Chairman Spratt. At this particular point in time I
recognize Mr. Becerra.
Mr. Becerra. Thank you, Mr. Chairman; and thank you,
gentlemen, for your testimony. And recognizing our time is
short, let me go to Dr. Zandi and ask a quick question.
Dr. Zandi, when you were an economic adviser for then-
Presidential candidate John McCain, Senator McCain, in his
Presidential campaign, you and others who were advising him
economically, did you foresee at that point back in 2007, 2008,
the depths and the grip of this economic--great recession, I
guess you would call it at this stage, that we are now trying
to escape?
Mr. Zandi. No, I can't say that I did, no.
Mr. Becerra. And could you have foreseen the economic
consequences that we now find ourselves in as we try to escape
the grips of this great recession?
Mr. Zandi. I am less surprised at how difficult it is for
the recovery to get going, because this was a very, very severe
shock with enormous implications. So it is not surprising to me
that this is a weak recovery.
Mr. Becerra. And there are always the Scrooges and the
folks who say America has got the glass half empty these days,
the pessimists that won't accept some good news. And while we
are still in the midst of this great recession, the fact is
over the last 5 to 6 months we have created about 1 million new
jobs in this country. Compare that to the last month that
George Bush was in office, where in that 1 month of January,
2009, we lost close to 800,000 jobs, big turnaround.
Obviously, we have a long way to go. And you mentioned, as
the chairman in his remarks mentioned, that Chairman Bernanke
has mentioned, that we need to continue to make sure we can
climb out of this dark hole and that if we act too quickly to
squeeze ourselves out of this fiscal deficit that we face this
year and this national debt that we are facing that we might
actually squeeze out the economic recovery.
And yesterday, in testimony before the President's fiscal
commission, I believe Mr. Elmendorf, Doug Elmendorf of the
Congressional Budget Office, said something about the same as
what you just said. He essentially said--again, speaking your
economic language--``There is no intrinsic contradiction
between providing additional fiscal stimulus today while the
unemployment rate is high and many factories and offices are
underused and imposing fiscal restraint several years from now
when output and employment will probably be close to their
potential.''
Is what Mr. Elmendorf said consistent with what you were
saying?
Mr. Zandi. Exactly. I wish I could say it as nicely as he
just said it.
Mr. Becerra. I think I prefer the way you said it. It is
more like plain English.
Mr. Zandi. I think that is entirely correct, yes.
Mr. Becerra. Dr. Baily, quick question for you as well.
You mentioned in your testimony that we had to be very
careful how we go about trying to get ourselves out of this
black hole, but my sense was that you also believe that fiscal
stimulus, where we try to help that recovery accelerate, is
essential, although we have to be careful that it is modest
enough to give us a chance to make sure that we can do the
fiscally responsible thing with our budgets into the future.
Mr. Baily. I think it would be helpful. I think, as Mark
said, a lot of people are living off unemployment insurance,
and I think it would be helpful to give them some consumption--
some income so they can keep consuming.
And on the States and localities that are in just terrible
budget situation--now, you know, obviously, we want our States
and localities to be disciplined over the long run, but I think
right now none of them foresaw this any more than the rest of
us did, and it is a good thing to help them.
Mr. Becerra. Don't cut off the swimmer's ability to swim
out of the pond before it is too late and drown.
Mr. Baily. Exactly. Now, you do have to send, I think, the
right signal that you really are thinking substantively, and I
applaud the commission and I hope that it is effective and I
hope its recommendations result in changes in policy, but we do
need to signal both ourselves and the rest of the world that we
are going to do something about these huge deficits.
Mr. Becerra. Thank you.
And, Dr. Taylor, before I run out of time, first, can you
convey back to Stanford our best wishes, tell them that we gave
you some Stanford weather here in Washington, D.C., today. It
is nice to know we have got someone from our alma mater here
with us.
I would love if you--and, unfortunately, my time is getting
ready to expire, Mr. Chairman, but perhaps I can ask the doctor
that he might give me his comments about the situation in
Ireland, which my sense is tried to apply the brakes on any
kind of stimulus and, in fact, went the other way, more along
the lines that I think you talked about and that is to try to
be fiscally responsible with our budget, and my understanding
is things are pretty bad.
I am going to real quickly just mention that Ireland's
downturn has been sharper than if the government had spent more
to keep people working. Lacking stimulus money, the Irish
economy shrank 7.1 percent last year and remains in recession.
Joblessness in the country is above 13 percent. The ranks of
their long-term unemployed have more than doubled, and the
budget went from surpluses just a few years ago in 2006 and
2007 to a staggering deficit of 14.3 percent of gross domestic
product last year, and it continues to deteriorate.
I would be interested to hear your comments. I don't have
time, but if you can go ahead and give me some comments on how
you see the situation in Ireland I would very much appreciate
that.
Mr. Taylor. Just very quickly now?
Mr. Becerra. Well, I know I am out of time, but go right
ahead.
Mr. Taylor. I think when you look at Ireland you have to
recognize where they were coming into this. It is like
Portugal. It is like Greece. High debt levels mainly because of
an over-stimulus and so they are partly reacting to something
that was so excessive.
If you want to look at examples that are I think more
helpful to the current situation, look at Poland. Poland is the
only country in the entire European Union that didn't even have
a recession. They didn't have a recession because they followed
I think a sensible policy.
Mr. Becerra. But we did have a recession here, and while
Poland may be a good example, Poland didn't have a recession.
We are in the depths of a great recession.
Mr. Taylor. They didn't have a recession because they
followed these good policies. We had a recession I think in
part----
Mr. Becerra. But our problem is we probably didn't follow
those good policies because President Obama inherited an
economy that was in the depths of a great recession. So while
it may not be exactly like Ireland and it may not be exactly
like Poland, I am interested in understanding, because my sense
is for those who say we shouldn't do economic stimulus are
speaking much the way the Irish were speaking about how they
would get out of their great recession, and as far as I can
tell, they are still in theirs, and they are trying to fiscally
constrain it.
Mr. Taylor. What I am suggesting is that we don't have more
stimulus at this point. The idea you can trade off in stimulus
now, catch up later, I think that is a fine-tuning approach
that has failed many times in the past.
What I think is most important if we get on with the
business now of consolidation, it doesn't have to be Draconian.
The point has to be laid out clearly in an orderly way. I think
that could bolster confidence, indicate that the United States
Government is moving ahead on the thing that the American
people are concerned about, and I think that would help the
economy much more than another stimulus.
Mr. Becerra. Appreciate that. And if you have any comments
on Ireland, I would love to hear them.
Mr. Zandi. Can I make one quick point on that?
If you look at every European country that is going through
fiscal austerity right now, their bond spreads have actually
widened out. One interpretation of that, and I think it is a
reasonable one, is that investors are nervous that the
austerity is undermining their economy and therefore their
ability to execute on these austerity plans. So I think that is
increasingly good evidence that if you don't get out of a weak
economy you are never going to be able to address your long-
term fiscal problems.
Mr. Becerra. To that point, I think the article I was
reading from pointed out that the spread between Ireland's
bond--what it pays for bonds and Germany pays for bonds is
about 3 percent.
Mr. Zandi. Right, it has widened out.
Mr. Becerra. It is tough for them to get any money unless
they pay a whole bunch for it.
I appreciate that very much, gentlemen. Thank you for your
testimony.
Chairman Spratt. Mr. Scott.
Mr. Scott. Thank you, Mr. Chairman.
We have been lectured by the other side about fiscal
responsibility, and I think if can we just get that first chart
up, this chart, the red is Republican administrations, blue is
Democratic administrations. And you can see that we dug
ourselves out of a ditch in 1993 and put us into a surplus
situation, such a surplus that it was not allowed to continue.
We were headed toward paying off the national debt held by the
public by 2008.
Chairman Greenspan, when he testified in 2001, was talking
about, in answer to questions, what would happen to the bond
market when there are no government bonds, what would happen
with interest rates. President Clinton had to veto Republican
budgets all through that to make sure that that blue line
wasn't changed. If you wanted to know what would happen if he
had not vetoed those bills, you can see President Bush signed
those budgets and you see where we ended up in the ditch.
The next chart, we see that the incredible thing is,
notwithstanding the fact that during the Bush administration
they overspent the budget about $1 trillion a year, they
produced the worst job growth since the--goes back to the Great
Depression.
Now, the attack on the Democrats is we have a big deficit,
but we also know that we have--we need to make sure that the
complaint is precise. The complaint is that we have a big
deficit that is there because of the policies put into effect
by the Bush administration and the Democratic administration
has not dismantled the Bush policies quickly enough. That is
the chart. Now, the fact is we made a deliberate choice not to
build the deficit until we got the job situation fixed.
And the other chart, we see where we were when--the red is
the end of the Bush administration. We can see the blue,
digging ourselves out of the ditch and beginning to create
jobs.
Dr. Zandi, if we had had serious deficit reduction during
the first year and a half of the Obama administration, what
effect would that have had on jobs? And serious deficit
reduction would mean, of course, increased taxes or reduced
spending.
Mr. Zandi. Of course, that would be very counterproductive
and be consistent with no policy response and the idea that we
would still be in a downturn.
Mr. Scott. In addition to the counterproductive effect of
cutting spending and increasing taxes in the middle of a
recession, what drag effect has there been because of cuts at
the State level? How much have States cut their spending,
thereby reducing jobs, that we have had to try to offset?
Mr. Zandi. If you look at it in the context of State and
local government spending as a contribution to GDP growth, in
an average year since World War II, State and local governments
add about a quarter percentage point to GDP growth every year.
Over the past year, they have subtracted from GDP growth by
approximately 20-basis points, 2 percentage points. And if they
don't get any additional aid from the Federal Government, then
over the coming year--of course, I have to do a number of
assumptions--but that will be a negative contribution of
somewhere around 35, 40 basis points, .4 percentage points. So
that is a swing from normal times of at least half a percentage
point.
Mr. Scott. Now, in terms of budget cuts, have the States
not cut their budgets about $500 billion already?
Mr. Zandi. I don't know the exact number, but they have
clearly gone through some very significant budget cuts.
Mr. Scott. On the order of magnitude about $500 billion?
Mr. Zandi. I think if you total it all the way back, in the
hundreds of billions sounds about right to me.
Mr. Scott. And localities have been doing the same thing?
Mr. Zandi. Yes, and I am including both State and local
governments in those hundreds of billion of dollars, yes.
Mr. Scott. Say again?
Mr. Zandi. The several hundred billion dollars would be
both State and local together.
Mr. Scott. Okay. And so the first several hundred billion
dollars of stimulus, all that did was to catch the people that
had been laid off by the localities?
Mr. Zandi. Exactly. If you take a look over the past year,
the budget hole was about $150 billion for State and local
together, and that is almost precisely what State and local
governments got as part of the stimulus package.
Mr. Scott. Dr. Baily, did you want to comment on the drag
that States have caused and the necessity of the Federal
Government to actually increase spending which has a
detrimental effect on the budget? As soon as we get the jobs
back, we will do the responsible thing and get the budget under
control. Because that first chart showed we know how to do it,
and we will do it, but we just can't do it in the middle of a
recession. Did you want to make a comment?
Mr. Baily. I think I agree with pretty much everything you
said, and certainly I think it goes to the earlier discussion.
When you see the stimulus and say, well, it didn't prevent the
recession from happening, that is in part because States and
localities were cutting so much employment that you were really
just filling in the hole they were creating. So I think I agree
with you very much on that.
Going forward, I think dealing with the deficit is going to
be tougher than it was during the Clinton years. It was plenty
tough then, but we did get very strong economic growth, and we
had not yet reached the sort of some of the pressures that come
from the baby boom generation retiring. So I think it is going
to be a tougher challenge down the road as we deal with the
deficit. But on the points you made and that Mark made I agree
with you completely.
Mr. Scott. Well, people suggested that the Clinton
administration was lucky because of the economic growth, but it
is kind of paraphrasing that sports analogy, the more fiscally
responsible we were, the luckier we got.
Mr. Baily. I think we were lucky, but I also think that the
administration did the right things, and, you know, it was
Congress as well as the administration. But I think Clinton--
the general Clinton-Rubin policy was to try to allow markets to
work but to get the budget back on track and to regulate
responsibly, and I think those policies worked extraordinarily
well.
Mr. Scott. So we made our luck because we were fiscally
responsible and we had that loaded cannon every time
something----
Mr. Baily. Exactly.
Mr. Scott. We had a surplus that was sufficient to pay off
the national debt. If this recession had occurred back in the
Clinton years, we could have had the stimulus out of the
surplus without having to borrow the money.
Mr. Baily. Exactly.
Chairman Spratt. Thank you, Mr. Scott.
Mr. Etheridge.
Mr. Etheridge. Thank you, Mr. Chairman.
Let me thank these gentlemen this afternoon for being here.
Early on, I was a small businessman long before I got into
this business and understand something about balancing your
books and keeping your books right. But, at the same time,
there are times when you are required to make an investment,
and I think you have to be prudent in how you make that
investment if you want to grow. And if you are a businessperson
and you continue to cut, you can't get there, but you have got
to have prudent investments.
Dr. Zandi, let me ask you a question, because the economic
recovery, many are saying, is still fragile. I think you have
said that. All three of you have indicated that one way or
another.
Do you agree with the Federal Reserve Chairman Bernanke, as
the chairman said earlier, when he testified at our last
hearing that the danger of scaling back too soon may be far
greater than some of the other things we could do if we want to
keep this economy from really sliding into some more problems?
Mr. Zandi. Yes, I would agree with that. I think the odds
are that if fiscal policymakers did nothing else that the
economy would still probably get through this period without
going back into recession.
But, having said that, I think the odds are uncomfortably
high that I am wrong and that we would go back. And more
importantly than that, if we do go back into recession, there
is no good policy response. The Federal Reserve cannot respond
effectively, and you won't be able to effectively respond
because at that point the deficit will be ballooning out.
So, given that, I think it is prudent risk management to
err on the side of doing too much rather than too little over
the next 6 to 12 months.
Mr. Etheridge. Let me ask one additional question along
that line. Because we have been struggling here, as you well
know, for several months on Federal medical assistance
percentages going to the States. We have talked with our
Governor, and I think something like 34 Governors have included
it in their budgets, and in North Carolina that is about half a
billion dollars. It is a substantial amount. If it doesn't
flow, then they will be cutting education and a host of other
things.
And many States are really suffering from unemployment. My
home State is higher than the national averages----
Can you speak for just a moment about the importance of
this kind of aid, how this blends with the other--you touched
on it some--and if it continues to decline, what effect it will
have on the overall deficit in the short term as well as in the
long term as we are trying to dig out of this hole?
Mr. Zandi. Well, I think that the need for helping--the
Federal Government to help State and local governments through
this mess next fiscal year is very important for the reasons we
have discussed. The most efficient way I think to do that is to
help them with the Medicaid program, the costs related to FMAP;
and if the Federal Government is able to provide help for FMAP
say for the second half of fiscal year 2011, that would free up
resources that will allow them to forestall more serious job
cuts, program cuts, and tax increases. They will have to do it
anyway, because their budget hole is that large and there is no
way the Federal Government is going to help them to the degree
to forestall it. It will be significant but at least it will
forestall the most Draconian cutting.
Mr. Etheridge. Let me ask one additional question or maybe
two if we can get them in in time.
Congress passed--I introduced a piece of legislation and
the administration worked on it, we got it through--called the
HIRE Act to create credit for people hiring people who are
unemployed. Is it too early to know if this is really working?
I have talked with some people in the last few days. One
company has already hired 50 people. Now, whether or not they
would have hired them or not, I don't know, but they are going
to get the tax credit. So that is an advantage. I would be
interested in your thought on that.
Mr. Zandi. I think it is too early to evaluate that program
based on macroeconomic data. I think right now it is mostly
anecdotal.
I do think as you approach the deadline, which I believe is
November, December, I think you will start to see--in the next
few months, we should see a little bit more take-up. But, you
know, so far, the macroeconomic data is not sufficient to be
able to evaluate it.
Mr. Etheridge. Dr. Taylor, let me ask you one question.
Because you didn't talk about the recession or how deep it was.
What you talked about was panic. I would be interested in your
definition of panic.
Mr. Taylor. I was referring to the period mainly in the
fall of 2008 when the financial markets froze up, equity prices
fell by 30 percent in 2 or 3 weeks, and that really went around
the world, actually, equity prices. It was a major hit to the
world economy in that particular period. So that is what I mean
by the panic. The crisis is sort of a longer period beginning--
--
Mr. Etheridge. Right. During that panic period, as it was
descending, we lost about $17 trillion in value of retirement
income, housing, et cetera, 8 million jobs, and all these
things were a part of that panic piece----
Mr. Taylor. Part of the panic. And I think without that
panic we obviously were going into a recession anyway, but that
is really what made this the great recession. That panic was
really a terrible shock. And I think, in my looking at the
numbers, people realized were stabilizing by December of 2008,
and if you look at the monthly data, you see investment
beginning to recover by January. So that panic was very
important, and so in my analysis of this whole great recession,
that is why I focused on it.
Mr. Etheridge. I am not an economist. I just have enough
training in 101 to know that the markets are doing some of the
same things all over again, I have noticed over the last
several days, and people are getting nervous all over again.
Thank you, Mr. Chairman. I yield back.
Chairman Spratt. Thank you, Mr. Etheridge.
Mr. Ryan has further questions, and Mr. Hensarling I
believe is on his way. Mr. Ryan.
Mr. Ryan. I am just curious. I would like to ask each of
you. Sovereign debt is now becoming a new kind of toxic asset,
I suppose. Give us your take on the risk of contagion washing
up on our shores with respect to Europe. Do you think the
European bailout program, whatever you want to call that, is
going to work and what is the risk of default among the PIGS,
Greece? And if a default does occur, what do you think happens
to our bond market?
Dr. Baily and going over, why don't we just do that?
Mr. Baily. It is very hard to see Greece getting out of its
mess without some of kind of restructuring, which means to say
a partial default on those bonds. If you look at--I think John
mentioned in his testimony there are some fundamental
structural problems in the euro, that some of the countries are
just not competitive. Germany got its costs under control and
became competitive, and Greece and some of the other countries
did not. And so that puts you in a bind. Because if you are
going to repay that debt, basically you have got to transfer
money to the other countries in Europe. The only way to
transfer the money is to make the money by exporting, and if
you are not competitive exporting, you are really locked up.
So I think they are going to have to restructure. I think
there is a threat that the euro could unravel, although I think
it is very unlikely. I don't think Greece and Spain and
Portugal would leave the euro, because they would see their own
interest rates rise so much that they don't want to.
A country that in a sense might be thinking about it is
Germany, because they are, in a sense, carrying the weight of
the other countries. But then again I don't think Germany will
because Europe is a big export market, and so I think it will
hold together, but it is proving to be fairly costly.
Your question was, will this wash up on our shores? Well,
it has washed up on our shores. Every time there was sort of a
new story about problems in Europe our stock market lost a
couple hundred points and that foments some of the concerns and
panics here, and it is amazing how these financial crises do
spread around the world. I mean, some of it is also
interdependent in trade but also a lot of the same companies
operate, a lot of the banks operate across borders.
You would sort of think, well, Greece is such a tiny
country and it is only a fraction of California, never mind the
United States, but it does seem to create an unsettled feeling
in the markets that could affect us.
I think the blessing in disguise for Greece is that it
maybe has given all of us a lesson in that we can't just borrow
and borrow and borrow forever, that at some point we are going
to have to deal with deficits. As I say, not necessarily today
but down the road we have to do that.
Mr. Zandi. My sense is that the European policymakers will
contain the crisis, that what they have done so far is really
quite impressive and they still have room to maneuver. The
trillion dollar package from the EU IMF is equal to all of the
sovereign debt of Greece, Portugal, Spain, Ireland that will
mature over the next 5 years. So I don't think there is any
real possibility of a default anytime in that period of time.
And the ECB, European Central Bank, is engaged in purchases
of sovereign debt. Mostly, it appears they are buying Greek and
Portuguese debt. They can expand that out.
Mr. Ryan. How do they sterilize? They claim to be
sterilizing. They are not easing. How do they do that?
Mr. Zandi. They are issuing securities into the marketplace
to drain the liquidity. So they are buying the bonds that is
providing liquidity and they are issuing other securities.
Mr. Ryan. And the market is working for that?
Mr. Zandi. So far, so good. The ECB target rate is still 1
percent, and they have been able to target that pretty well,
but they could decide if things start to weaken to not
sterilize, right? They have room to maneuver there, too, and
the European economy is roughly the same size as the U.S.
economy, the Federal Reserve about $300 billion worth of
Treasury bonds, when they were credit easing, put it in the
same kind of ballpark, they could buy up $300 billion.
Now, so far, the impact on our economy has been meaningful,
but it is modest. There is positive and there is negative. The
negative, obviously, is the equity market.
The bond market has been a positive, right? Long-term
interest rates have come in. The 10-year Treasury yield is
below 3 percent. There is a flight to quality. People still
believe, and rightfully so, that we are the AAA credit on the
planet. We have the strongest economy. We have a large economy.
We have managed our affairs extraordinarily well over
centuries. So I think they trust us and I think with good
reason. So I think we are the beneficiaries and we have
latitude in the near term to continue to borrow to help finance
and support our economy.
Mr. Taylor. I do think Greece will have to restructure
their debt. I think it can be done in a pretty orderly way, so
I wouldn't call it default or something that would shock the
markets. Their foreign bonds are all denominated in euros. That
is a fairly straightforward operation. Some of the debt is
issued under Greek law, some under English law. So it is pretty
simple to do.
I think it would have been much better if they did it
earlier because then we wouldn't have had to have this huge
bailout package which creates its own worries down the road
because other countries may get into the same situation.
I think the ECB's intervention is quite worrisome from the
perspective of monetary policy. They are actually buying
distressed debt. Central banks are supposed to be insuring the
money supply and interest rates, keeping things stable. So this
is taking them into a really new phase. They didn't want to do
it. I think they want to get out of it as fast as they can.
I think I agree with Mark, and I put it this way. Contagion
can be through markets but it can also be through policy. So
often bad policy is contagious. It spreads across countries. It
seems to me that what we might be finding here is the reaction
in Europe to Greece is spreading. At that G-20 meeting where
the United States was told a few things, I think is beneficial
for us as well because that feels like a contagion of some
better policies.
Mr. Ryan. Thank you.
I see we have got somebody back.
Chairman Spratt. I recognize Mr. Hensarling.
Mr. Hensarling. Thank you, Mr. Chairman. I am glad that you
have reconvened us. I wish it would be to take up a budget, but
we haven't lost hope yet. Maybe that day will occur sometime
this year.
I see that at least two of the three of our panelists have
been published in the Wall Street Journal today. I am not sure
what to accord this honor to. And, Dr. Zandi, I haven't read
one of your op-eds recently, but I did read your book, and it
was helpful.
Mr. Zandi. Thank you.
Mr. Hensarling. It was helpful. I appreciate that.
Mr. Zandi. I am going to start working harder.
Mr. Hensarling. Apparently, you need to work a little
harder here.
Dr. Taylor, before I ask you about your editorial, I am
actually going to ask you if you had read one by Dr. Meltzer
that appeared in the Wall Street Journal yesterday on why
Obamanomics has failed. He seems to take up a theme that you
have about a kind of seed of uncertainty that had been sowed
due to major policy initiatives. He states in his editorial
piece, ``Second, the administration and Congress have through
their deeds and work heightened uncertainty about the economic
future. High uncertainty is the enemy of investment and
growth.''
I assume that you agree with that; and, if so, could you go
into greater detail in what you base your thesis on that
uncertainty is part of what is keeping back our economic
growth?
Mr. Taylor. Sure, and I do agree with Allan Meltzer in that
piece. The uncertainty is due to several factors. It is just
the depth that I mentioned is coming in a way we have never
seen it before. Look, in our history this is well beyond, many
times, what we have seen before. So that, if you like, new
situation creates uncertainty. People don't know how it is
going to get resolved.
There is an inconsistency. You can't have all that debt
created and have the inflation forecast the things that people
are predicting. So there is an inconsistency that has to be
resolved, and people don't know how it is going to be resolved.
That is an inherent uncertainty.
I think also you referred to my piece in the Journal today.
That highlights another form of uncertainty, a massive change
in how our financial institutions will be regulated, their
relationship with government, a very complicated set of changes
which people don't know exactly how it is going to work. It is
a very complex bill.
Mr. Hensarling. Including one of the authors of the
legislation, Senator Dodd. You may have read his quote in the
newspaper.
Mr. Taylor. I missed that.
But I think if you just go down the line you see this great
uncertainty, plus globally you see situations like the
sovereign debt that Congressman Ryan was referring to. We
haven't seen that for a long time. I think that is affecting
our markets. I say there is a lot of evidence for this. It is
hard to measure. I don't want to say we have great models and
theories of it, but I have never seen it like this before. It
is very concerning to me.
Mr. Hensarling. The chairman, the ranking member, and
myself all serve on the President's Fiscal Responsibility
Commission. We had a session yesterday and heard from Dr.
Elmendorf. There still appears to be a continuing debate within
the Commission on whether or not it is possible to both lay out
a plan of fiscal sustainability for the long term while we
debate government stimulus in the short term. I myself have
strong opinions that the stimulus has failed, and I think it is
a bad policy.
But, setting that aside--and I know that Chairman
Bernanke's name has been invoked here. I believe he has said
something along the lines of how important it would be to job
growth today to lay out a plan of fiscal sustainability. And so
do you have an opinion whether these are competing goals,
complementary goals? Can Congress or this Commission, in
specific, walk and chew gum at the same time?
Mr. Taylor. I guess I would say it would be tremendously
valuable for confidence if a plan could be laid out, a credible
plan, to keep the debt from exploding, which is where it is
going right now, to keep it at a low level, to try to get it
down.
There is not really an inconsistency. I think I would
prefer if that path began right now with the budget you are
starting to deliberate with, but even if that is up a little
bit, then you can lay out the plan. So there is no--there is so
much advantage--I used to do simulations of models that showed
that you can get fiscal stimulus from having a good plan laid
out for consolidation in the future. It builds confidence. It
affects interest rates in a healthy way. So I think it would be
beneficial to the economy, plus it would have the added
advantage of showing that government is really doing something
that is hard to do.
Mr. Hensarling. In the absence of other members, if the
chairman might indulge me one more question--I didn't hear the
word ``no''--in your piece, Dr. Taylor, you mentioned that I
believe by far the most significant error of omission in this
bill--referring to the financial regulatory markets bill--is
the failure to reform Fannie Mae and Freddie Mac, the
government-sponsored enterprises. Can you elaborate on just how
significant an omission this is? And by lack of reform, to what
extent does that contribute to the uncertainty that in turn
contributes to our high unemployment rate?
Mr. Taylor. Well, it is an omission because if you would
like the reform bill to address the financial crisis and,
therefore, deal with it, that was one of the big factors in the
financial crisis, the encouragement by Fannie and Freddie to
buy risky mortgages, which accentuated the housing boom. So in
terms of addressing the financial crisis, it was essential to
have that in there.
Also, by not having it in there, if the bill actually goes
through without that, it will be very hard to get it later.
Because, as you know, comprehensive reform has the advantage of
balancing off different interests, and so that balancing is now
going to be much harder to do if Fannie and Freddie want to
build a future.
With respect to the uncertainty, yes, the housing market
isn't moving along as much as you think. I think Mark Zandi's
referred to that. I think there is uncertainty about what the
Fed has done, what Fannie and Freddie are going to do in the
future. So some clarification of that would be I think very
valuable for the same reasons I mentioned.
Mr. Hensarling. Thank you.
Thank you, Mr. Chairman.
Chairman Spratt. Gentlemen, thank you very much for your
testimony today. We have got several votes coming up on the
floor. We could continue this fruitful conversation for the
rest of the afternoon, but thank you for coming. Thanks for
your clarity and forbearance and your answers. We very much
appreciate it, and we will be calling upon you in the future, I
am sure. Thank you again.
The hearing stands adjourned.
[Questions submitted by Mr. Aderholt and their responses
follow:]
Questions Submitted to Witnesses by Hon. Robert B. Aderholt, a
Representative in Congress From the State of Alabama
dr. baily
1. In your testimony, you state that the financial crisis was
caused by a ``perfect storm'' of problems, one of which was regulator
errors. Today, I hear from many community bankers in my district that
overzealous regulators are hurting their ability to loan money to their
customers. Do you believe such knee-jerk reactions as over-regulating
may hurt the recovery more than it will help?
As discussed in my testimony, poor decisions by regulators did
contribute to the financial crisis. Regulators and credit rating
agencies were caught up in the same spirit of excessive risk taking
that was endemic amongst financial institutions and ordinary market
participants alike. In addition, government regulators failed to
adequately oversee Fannie Mae and Freddie Mac, whose behavior did
contribute to the development of a housing bubble, an important--but
not singular--cause of the crisis.
However, the mistakes made by regulators were often a result of a
systematic decline in the premium placed on risk following 25 years of
strong performance in the financial sector and the belief that the
business cycle had effectively vanished. All sorts of investors and
financial institutions learned that financial risks were profitable and
became less risk averse. Regulators remained more risk averse than the
financial system writ large, but in times of excessive risk taking,
regulators that are more conservative than the average investor are
unlikely to provide adequate oversight. As a result, bubbles were
allowed to pervade the financial system, in housing and other sectors.
The number of bank failures continues to remain high, with 118 in
2010 alone (through August 20), most of which are small banks. In
addition, 775 banks continue to be classified as problem banks by the
FDIC. These banks continue to have bad assets on their balance sheets
and regulators can and should play an important role in ensuring that
community banks are brought back to health responsibly, without
returning to excessively risky lending standards that characterized the
period immediately preceding the crisis.
During the boom years regulators erred in the direction of not
being strict enough and in not requiring more stringent lending
standards. However, the pendulum may have swung back too far in the
other direction as banks are discouraged from making loans even when
the prospects for repayment are good, if rather risky. It is important
that we find the right balance of protecting depositors and taxpayers
while encouraging economic growth.
2. In the question and answers with Congressman Becerra, you noted
that ``the right signal does have to be sent'' to the world that the
United States is serious in its commitment to put our fiscal house in
order. Is the House of Representatives failing to pass a budget for the
first time in 35 years the signal we want to send to the world
regarding our fiscal stability? Do you see any negative consequences
resulting from the failure of passing a budget for fiscal year 2011?
The failure to pass a budget is a problem and does not send the
right signal to the world that the United States government can manage
its fiscal affairs. I will not comment on who is to blame for the lack
of agreement on the budget. In order to balance the federal budget over
the next ten years it will be necessary to both increase revenues and
curb spending. I hope that Republicans and Democrats will recognize
this and work together to restore our fiscal integrity.
3. The Constitution does not give spending authority to a
Presidentially-appointed Commission; it gives it to elected officials
who comprise the House of Representatives and who must face the voters
every two years to be re-elected. Isn't the refusal to pass a budget a
direct refusal to do the job House Members are elected to do?
It is my understanding that the Commission will make
recommendations and then Congress will act on those suggestions, while
of course retaining its constitutional powers. Unfortunately the budget
process has become mired in politics, a politics that is not grounded
in reality. Any political leader that suggests raising taxes is
vilified. Any political leader who suggests serious efforts to curb
federal health spending or proposes measures to balance the long term
Social Security budget is also subject to attack. Until Congress
overcomes this poisonous atmosphere it will be difficult to achieve
budget agreements. The Presidential Commission is a brave effort to cut
through the politics and I hope that its recommendations can form the
basis for a more constructive bipartisan dialog aimed at solving the
terrible fiscal crisis we face.
dr. taylor
1. As you know, the House of Representatives recently passed the
conference committee version of the Financial Reform Bill.
Unfortunately, this bill does little to reform government sponsored
enterprises (GSEs) such as Fannie Mae and Freddie Mac. Does failing to
address GSE reform in the financial reform bill leave the economy and
financial sector exposed to another possible meltdown?
Failing to reform Fannie Mae and Freddie Mac leaves the economy and
the financial sector in a more risky situation. Fannie Mae and Freddie
Mac now sit with an estimated several hundred dollar cost to taxpayers
and no path to resolution. Effectively their obligations add to the
federal debt which is already starting to reach unsustainable levels.
These agencies were encouraged to expand and buy securities many of
which were backed by mortgages that were very risky. Five years ago
legislation, such as the Federal Housing Enterprise Regulatory Reform
Act of 2005, was proposed to control these excesses, but it was not
passed into law. These actions of these agencies should be added to the
list of government interventions that were part of the problem leading
to the financial crisis. Without reform the same series of events could
occur again.
Unfortunately, neither the conference committee report nor the
final Dodd-Frank financial legislation dealt with Fannie Mae and
Freddie Mac, so reform is still needed. Doing so outside of that
broader reform effort will be very difficult, but it is essential to
get started.
dr. zandi
1. You noted that Congress must pivot to the ``long-term fiscal
situation once the recovery is complete''. What policies would create a
``long-term fiscal situation'' that is conducive to economic growth and
leaves future generations of Americans with a fiscally secure country?
Do you prefer cutting spending or tax increases?
To ensure the nation's long-term fiscal sustainability,
policymakers should work to reduce the nation's cyclically adjusted
federal budget deficit to GDP ratio to no more than 3% by fiscal year
2021. The current cyclical adjusted deficit to GDP ratio is almost 6%.
To accomplish this objective will require both federal government
spending cuts and tax increases. I would prefer that the majority of
the required deficit reduction be done through spending cuts; something
close to \2/3\ spending cuts and \1/3\ tax increases would be a
reasonable goal. Based on an assessment of previous fiscal austerity
efforts here in the U.S. and overseas suggests that government spending
cuts rather than tax increases results in better longer-term economic
performance.
With regard to spending restraint, a good first step would be
address the current short-falls in the nation's Social Security system.
This is a well-defined problem that if addressed could result in
significant deficit reduction. With regard to tax increases, a good
first step would be to cap the amount of tax deductions to some percent
of taxpayers' total tax liability. This too would contribute
significantly to deficit reduction. Taken together and fully
implemented by FY 2014, these actions would go a long way to obtaining
the goal of a 3% cyclically adjusted deficit to GDP ratio by 2021.
It is likely that policymakers will eventually need to do even more
to address our longer-term fiscal problems as the large baby-boomer
generation retires and uses the entitlement programs more intensively.
To do this, growth in the costs of the Medicare and Medicaid programs
will likely have to addressed. Comprehensive tax reform will also be
necessary given that the nation's current tax system is complex,
opaque, unfair, and is an impediment to strong long-term economic
growth.
Returning the nation to fiscal sustainability will not be easy, but
it is very doable, and of course we have no choice but to do it.
[Whereupon, at 2:48 p.m., the committee was adjourned.]