[Senate Hearing 107-]
[From the U.S. Government Publishing Office]



                                                       S. Hrg. 107- 940


                       THE U.S. ECONOMIC OUTLOOK

=======================================================================

                                HEARING

                               before the

                              COMMITTEE ON
                   BANKING,HOUSING,AND URBAN AFFAIRS
                          UNITED STATES SENATE

                      ONE HUNDRED SEVENTH CONGRESS

                             SECOND SESSION

                                   ON

 THE CURRENT ECONOMIC OUTLOOK IN THE SHORT- AND LONG-TERM; PREDICTIONS 
    CONCERNING THE ROBUSTNESS OF THE ECONOMIC RECOVERY; EFFECTS OF 
 INCREASED UNEMPLOYMENT; CONTINUED WEAKNESS IN THE GLOBAL ECONOMY; AND 
             RECOMMENDATIONS FOR MONETARY AND FISCAL POLICY

                               __________

                             MARCH 12, 2002

                               __________

  Printed for the use of the Committee on Banking, Housing, and Urban 
                                Affairs


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            COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

                  PAUL S. SARBANES, Maryland, Chairman

CHRISTOPHER J. DODD, Connecticut     PHIL GRAMM, Texas
TIM JOHNSON, South Dakota            RICHARD C. SHELBY, Alabama
JACK REED, Rhode Island              ROBERT F. BENNETT, Utah
CHARLES E. SCHUMER, New York         WAYNE ALLARD, Colorado
EVAN BAYH, Indiana                   MICHAEL B. ENZI, Wyoming
ZELL MILLER, Georgia                 CHUCK HAGEL, Nebraska
THOMAS R. CARPER, Delaware           RICK SANTORUM, Pennsylvania
DEBBIE STABENOW, Michigan            JIM BUNNING, Kentucky
JON S. CORZINE, New Jersey           MIKE CRAPO, Idaho
DANIEL K. AKAKA, Hawaii              JOHN ENSIGN, Nevada

           Steven B. Harris, Staff Director and Chief Counsel

             Wayne A. Abernathy, Republican Staff Director

                       Aaron D. Klein, Economist

                  Martin J. Gruenberg, Senior Counsel

                Thomas Loo, Republican Senior Economist

   Joseph R. Kolinski, Chief Clerk and Computer Systems Administrator

                       George E. Whittle, Editor

                                  (ii)
?

                            C O N T E N T S

                              ----------                              

                        TUESDAY, MARCH 12, 2002

                                                                   Page

Opening statement of Chairman Sarbanes...........................     1

Opening statements, comments, or prepared statements of:
    Senator Carper...............................................     2
    Senator Bennett..............................................    20
    Senator Reed.................................................    26
    Senator Corzine..............................................    30

                               WITNESSES

Robert M. Solow, Nobel Laureate in Economics, 1987; Professor of 
  Economics, Massachusetts Institute oF Technology...............     2
    Prepared statement...........................................    39
Joseph E. Stiglitz, Nobel Laureate in Economics, 2001; Professor 
  of Economics and Finance, Columbia University..................     5
    Prepared statement...........................................    41
Alan B. Krueger, Bendheim Professorship in Economics and Public 
  Affairs; Professor of Economics, Princeton University..........    10
    Prepared statement...........................................    46
David R. Malpass, Chief Global Economist, Bear Stearns & Co., 
  Inc............................................................    14
    Prepared statement...........................................    52

                                 (iii)

 
                       THE U.S. ECONOMIC OUTLOOK

                              ----------                              


                        TUESDAY, MARCH 12, 2002

                                       U.S. Senate,
          Committee on Banking, Housing, and Urban Affairs,
                                                    Washington, DC.

    The Committee met at 10:15 a.m. in room SD-538 of the 
Dirksen Senate Office Building, Senator Paul S. Sarbanes 
(Chairman of the Committee) presiding.

         OPENING STATEMENT OF SENATOR PAUL S. SARBANES

    Chairman Sarbanes. The hearing will come to order.
    I am pleased to welcome before the Committee this morning 
this distinguished panel: Robert Solow, Professor Emeritus of 
Economics at MIT and a Nobel Laureate in Economics; Joe 
Stiglitz, Professor of Economics and Finance at Columbia, and 
recipient last year of a Nobel Prize in Economics; Alan 
Krueger, the Benheim Professor of Economic and Public Affairs 
at Princeton; and David Malpass, Chief Global Economist for 
Bear Stearns & Co., Inc.
    Actually, all of these witnesses are well-known to the 
Committee and to Washington. Professor Solow, of course, has 
testified before Congress many times. Joe Stiglitz served as 
Chairman of the Council of Economic Advisers under President 
Clinton, Chief Economist at the World Bank. Alan Krueger served 
as the Chief Economist at the Labor Department in the mid-
1990's. And David Malpass was at the Department of the Treasury 
under Presidents Reagan and Bush. He was also the Staff 
Director of the Joint Economic Committee of the Congress.
    I want to thank all the witnesses for appearing today and 
for the care and effort they took in preparing their written 
remarks. Your full statements will be included in the record.
    I was going to make a few comments about the current 
economic situation, but I think I will save that until the 
question period.
    Before yielding to Senator Carper, though, I do want to 
note with great sadness and with very deep respect the passing 
yesterday of James Tobin, really one of our Nation's preeminent 
economists, a man who I knew. I knew him well and he was a man 
of extraordinary ability and great civility, and very 
fundamental decency. He had very strong views about public 
policy, but he put them forth in a way that led to really a 
very rational and reasonable debate I think with others. And I 
think he had a profound influence on the thinking in this 
country.
    I actually was Administrative Assistant to Walter Heller 
when he was Chairman of the Council of Economic Advisers under 
President Kennedy. Jim Tobin was a Member of that Council, 
perhaps one of the most distinguished, certainly amongst the 
most distinguished that we have had.
    Senator Carper.

              COMMENTS OF SENATOR THOMAS R. CARPER

    Senator Carper. Thank you, Mr. Chairman. I had not heard of 
Dr. Tobin's passing until this moment. He was one of those 
people who could disagree with you without being disagreeable.
    Chairman Sarbanes. That is for sure.
    Senator Carper. Any number of times, I remember him sitting 
in forums in the House and the Senate like this and providing 
his guidance and counsel to those of us who were fortunate 
enough to be in the room with him.
    I just want to thank our witnesses today for joining us. I 
had a chance to welcome you individually and would do so 
collectively.
    David Malpass, who used to work for Bill Roth, my 
predecessor from Delaware, we are especially glad that you are 
here today.
    I will be slipping out in a little bit. We are taking up 
the energy bill, as we wrestle with developing a comprehensive 
energy policy for our country and we are anxious to make 
progress on that today and certainly this week starting this 
morning at 10:30 a.m.
    You are here really right after we passed an economic 
stimulus package last Thursday. Some have said that it is a day 
late and a dollar long.
    [Laughter.]
    Time will tell if we have, indeed, spent money that we did 
not have for a recession that is over. Maybe you will have some 
thoughts on that today.
    We are glad you are here and we look forward to your 
testimony. Thanks very much.
    Chairman Sarbanes. Thank you, Senator.
    Dr. Solow, we would be happy to hear from you and then we 
will go right across the panel.

                  STATEMENT OF ROBERT M. SOLOW

               NOBEL LAUREATE IN ECONOMICS, 1987

                     PROFESSOR OF ECONOMICS

             MASSACHUSETTS INSTITUTE OF TECHNOLOGY

    Dr. Solow. Thank you very much, Senator Sarbanes.
    I want to add my word about Jim Tobin, whom I worked at the 
Council when Senator Sarbanes was Walter Heller's Assistant. He 
was a role model for all of us from my generation and others, 
and a person of remarkable integrity. Someone once asked me 
whether he would be a suitable person for a very delicate and 
responsible job. My response was that whenever I find myself 
having to make a hard decision as between right or wrong, my 
universal method is to ask myself what Jim Tobin would do, and 
do exactly the same. It is too bad that you cannot be hearing 
from him today.
    I am going to just comment briefly on a couple of important 
points that were raised in the written statement that I turned 
in, without trying to read it all.
    This is, after all, a Senate Committee. We should be 
thinking about fiscal policy.
    There is a problem with fiscal policy. It takes too much 
time to make decisions. It is hard to avoid getting those 
decisions mixed up with the search for political advantage. The 
decisions that are made in fiscal policy are often not easily 
reversible if the facts change. And that creates a problem in 
using fiscal policy devices in the business cycle context in 
the short run, just as was mentioned by Senator Carper.
    The current stimulus package is an excellent example. The 
bill that finally passed last Thursday was an okay bill, though 
it could have been better and it should certainly have been 
much quicker. If it had been a term paper, I would have graded 
it a ``B,'' but I would have penalized it for being handed in 
late.
    The contrast with monetary policy is, of course, very 
strong. Monetary policy is much more flexible, at least in some 
hands, at least in the United States in some hands. It is more 
reversible when facts change, when our reading of the economic 
situation changes. And so, monetary policy is generally 
accepted to be a more suitable way to do tactical economic 
policy, short-run-oriented tactical policy. I had hoped that we 
were getting to the point where we could call more on fiscal 
policy, but the recent episode is not an optimistic indication 
on that point.
    We used to get a lot of help from what are called automatic 
stabilizers, from the built-in tendency for the Federal budget 
to move sharply toward surplus in a strong boom and to move 
just as sharply toward deficit in a sharp slump. The automatic 
stabilizers were a very important part of fiscal policy 30 
years ago, or 40 years ago. They are especially important 
because no one has to act and no one has the opportunity to 
obstruct. They happen automatically.
    The strength of the automatic stabilizers in our economy 
has been weakened over the years, not on purpose, not as a 
deliberate decision, but because the mechanisms on which those 
automatic stabilizers rest have changed. Cyclical transfer 
payments are a smaller part of our economy now than they used 
to be. State and local governments are a larger part of 
government purchases of goods and services these days than they 
used to be, and State and local governments are statutorily not 
able to conduct their own fiscal policy in a counter-cyclical 
way. The general reduction in tax rates and the diminishing 
importance of corporate profit tax revenues in the total 
budget--I am not now speaking about whether that is a good 
thing or a bad thing--only that those are the mechanisms that 
used to make the Federal budget very sensitive to economic 
conditions and make it less sensitive now. The automatic 
stabilizers are not likely to get stronger, so we are not going 
to be able to rely on them in the way that we used to.
    One possibility--this is a theoretical possibility that 
appealed to Jim Tobin and to me 40 years ago--would be for 
Congress to legislate once and for all a standard stimulus 
package which would be effective and temporary and politically 
neutral; the same package could work in reverse as a standard 
sedative package. Congress could then turn this package, and 
only this package, on and off by straight up-or-down votes when 
the situation called for it.
    You could arrange such a package at a number of levels--
weak, moderate, strong. It could be triggered by events or 
proposed by the President and then subject to an up-or-down 
vote by the Congress.
    I realize that won't happen. I know that. But it is what 
would be needed as a substitute for the automatic stabilizers 
if we are to turn fiscal policy into a tool for countering the 
business cycle.
    The next point I want to make is a very different kind. 
Think how uncertain we have been over the past few months about 
whether there was or wasn't a recession. If there was one, when 
did it begin? When will it end? Where are the next few months 
going to go? The four of us sitting here could go back and 
forth on that for days, weeks.
    That cannot be the right intellectual background for 
conducting macroeconomic policy, especially fiscal policy. 
There is simply too much noise and too much nonsense in trying 
on the basis of yesterday's data to predict next week's 
economy. Here is an idea that will be very familiar to Senator 
Sarbanes because Jim Tobin and Art Oakun and I and others were 
talking about it when he was at the Council of Economic 
Advisers.
    It would make much more sense and be much more relevant to 
look at the concept that we call potential output, potential 
GDP. It is the number we come up with when we ask: What is the 
economy's capacity to produce with reasonably full use of its 
resources? Our focus should be to compare where we are now with 
where potential GDP is. That would be a far better indicator of 
which way fiscal policy should be pushing.
    In the written statement that I have submitted to you, I 
point out that real GDP now is right about within a percent or 
so of where it was a year ago, the beginning of 2001, or 2000. 
And by the standard estimates of what has been happening to 
potential output on which the current Council of Economic 
Advisers and the Congressional Budget Office and private 
economists like myself tend to agree--by those standards, we 
have built up slack, room for expansion in the economy of about 
4 percent of GDP.
    If the economy grows at 3 percent during the four quarters 
of this year, which is what the standard forecast right now is, 
we will not cut into that gap at all. We will still in the 
first quarter of 2003 have room for expansion amounting to 4 
percent of GDP.
    By the way, many people, including on Mondays, Wednesdays, 
and Fridays met, thought that 2 years ago, when the 
unemployment rate was down to 4 percent, we were maybe a little 
too close to the risk of inflation.
    That is okay. One could make that adjustment in the kind of 
thinking that I am suggesting, and still get a much clearer 
picture of where the economy stands relative to where we should 
want it to be, and to use that as an indicator of what we 
should do.
    That is not a foolproof way of making fiscal policy or 
monetary policy or anything else. Nothing is. But the raw 
materials are there both within the Government and outside the 
Government. By going back to thinking in those terms, we would 
avoid a lot of intellectual wheel spinning.
    That is why I was content to give the stimulus package a B. 
Even having been handed in late, the stimulus package was a 
good idea; and this has nothing particular to do with there 
never having been a recession or the recession already having 
been over or being the only one-quarter recession in the 
history of mankind or that thing, but because there is room for 
the economy to expand.
    I want to say just one last sentence: As I read Alan 
Greenspan's testimony before this Committee last week, it was 
not in contradiction to what I have just been saying. Mr. 
Greenspan spent a lot of time waffling over what happened last 
week and what will happen next week. Waffling is what that kind 
of conversation calls for and he is a master of it. But the 
general picture of where the economy is relative to a 
reasonable standard we might set is certainly consistent with 
what I have been saying. I think that what we have to hope for 
from monetary policy is that we will get the same kind of 
flexibility, nondoctrinaire flexibility, in dealing with the 
next year or two that we did get to our great advantage over 
the past 4 or 5 years from the Fed.
    Thank you very much.
    Chairman Sarbanes. Good. Thank you very much.
    Dr. Stiglitz.

                STATEMENT OF JOSEPH E. STIGLITZ

               NOBEL LAUREATE IN ECONOMICS, 2001

               PROFESSOR OF ECONOMICS AND FINANCE

                      COLUMBIA UNIVERSITY

    Dr. Stiglitz. Thank you, Mr. Chairman.
    I want to begin by seconding what Professor Solow just 
said, that the critical issue is not the one that has been 
focused upon, but whether the recession is over or not.
    The real point is that the economy for the last year has 
been performing substantially below its potential. I think that 
there is absolutely no doubt about it. And if we go from minus 
one-half a percent to plus one-half a percent, it is still 
performing substantially below its potential. Even the most 
optimistic people do not see any change in that prospect, that 
it was very likely to perform below potential.
    The numbers that I talked about in my written statement are 
substantially more conservative than those of Professor Solow. 
I talked about a 3 percent GDP shortfall. But one should try to 
remember what that entails. In a $10 trillion economy, a 
shortfall of 3 percent is $300 billion per year. If it goes on 
for 2 years, we have lost $600 billion. That is an enormous 
wastage of resources.
    The consequence also is that there is unemployment. Alan 
will talk a little bit more about the unemployment problem. But 
even as the economy in this recession--if it is true--ends, 
long-term unemployment has remained high. And the suffering 
that that causes is significant.
    The step that was made to finally--and again, too late--
provide for extended benefits last week was an important step 
in the right direction. But it only extends for 1 year and 
there is little prospect that the long-term unemployment 
problem will be resolved in the course of a year.
    I wanted to move on and talk a little bit about the nature 
of this current economic downturn and the reason why I am not 
optimistic that there will be a robust recovery.
    In my written testimony, I talk about the number of 
negative factors. I go through each of the major categories of 
expenditure--consumption, capital expenditure, exports--and 
explain why I think that the prospects of a robust recovery are 
limited.
    I note that the one positive from a macroeconomic point of 
view is the increased expenditures in military. That does help 
sustain economic recovery. But I emphasize there that unlike 
investments in education or roads, they do not contribute to 
long-term economic growth. They are a utilization of resources 
that does not promote the long-term economic strength of our 
economy. And one needs to take that into account when one looks 
at the overall long-run picture. A lot of what I am going to be 
saying is focusing on the medium- and long-term.
    I want to move on in my discussion to address the sources 
of our current problem.
    I believe that if we are to formulate policies aimed at 
enhancing the strength of the economy in the middle- to long-
run, we must understand better the sources of our current 
downturn, of the massive under-performance of the U.S. economy.
    While every boom comes to an end, there are lessons to 
each. Earlier booms and the busts that follow taught us the 
dangers of inflation and the effects have been too hard on the 
brakes to stop it. The recession of 1991 can ultimately be 
traced back to the weaknesses in the financial sector. Those in 
turn impart to the excessive deregulation of the 1980's. I am 
not sure that we have learned the lessons of excessive 
exuberance of the late 1990's.
    In some ways, it is a familiar pattern. Deregulation in a 
sector--here telecommunications--leading to excessive 
investment in that sector, in this case, the problems 
exacerbated by breathtaking technological developments and--I 
want to emphasize this--deregulation in the financial sector.
    The Glass-Steagall Act was concerned with the problems 
raised by the conflicts of interest. It was foolhardy to think 
that such behavior would not reappear with its repeal.
    At the time I served on the Council of Economic Advisers, 
we raised strong concerns about conflicts of interest and 
problems in accounting standards and practices, particularly as 
they related to derivatives and options. Our concerns have 
proved to be on the mark. There were, of course, others who 
raised similar concerns. Arthur Levitt was right in calling 
attention to these conflicts of interest in accounting firms 
when they simultaneously provide consulting services.
    The FASB called for a changing of accounting practices to 
more accurately reflect the costs of options given to 
executives.
    I have devoted much of my academic life to the economics of 
information, and to the consequences of imperfections of 
information. The proposed revisions would have improved the 
quality of information. To be sure, some firms' economic 
prospects might have looked worse as a result, and its stock 
market price might have fallen as a result--as well it should.
    It was inevitable that a day of reckoning would come. 
Providing misleading information only delayed the day of 
reckoning. But worse, it led to a massive misallocation of 
resources, as overinflated stock prices led to the excessive 
investment which is at the root of the economic downturn.
    Some contend that it is difficult to obtain an accurate 
measure of the value of options. But this much is clear--zero, 
the implicit value assigned under current arrangements, is 
clearly wrong, and leaving it to footnotes to be sorted out by 
investors is not an adequate response, as the Enron case has 
brought home clearly.
    If we are to have a stock market in which investors are to 
have confidence, if we are to have stock markets which avoid 
the kind of massive misallocation of resources that result when 
information provided does not accurately report the true 
condition of firms, we must have accounting and regulatory 
frameworks that address these issues.
    I am convinced that leaving it to the market will not work. 
I served on an SEC commission on valuation on which Ken Lay 
also served. Many on that commission believed that leaving it 
to the market was the view of many of those, and I think we see 
perhaps why and certainly the consequences.
    As derivatives and other techniques of financial 
engineering become more common, these problems too will become 
much more pervasive. While headlines and journalistic accounts 
describe some of the inequities, those who have seen their 
pensions disappear as corporate executives have stashed away 
millions for themselves, what is also at stake is the long-run 
well-being of our economy. The problems of Enron and Global 
Crossing are part and parcel of the current downturn.
    So, I want to emphasize that, while typically, 
macroeconomics 
focuses on macroeconomics, there are important microeconomic 
foundations to the problems and, as is often the case, this is 
the case today.
    In the limited amount of time, I want to spend a few 
minutes talking about a couple of particular issues. The first 
is the tax cut.
    When we were talking about fiscal policy in the early 
1990's, 1993, 1994, the economy was facing an economic 
downturn. We focused very much on the question of what was 
called a low-cost stimulus. How to stimulate the economy using 
fiscal measures and at the same time having a minimal budgetary 
impact.
    My view is that the tax cut that was passed by Congress in 
the spring was extremely badly designed. It provided very 
little stimulus to the economy, at the cost of a substantial 
adverse effect on the overall fiscal position of the United 
States. The result is that, while short-term interest rates 
have come down significantly, long-term interest rates have 
come down very little. And many people believe it is the long-
term interest rates which are more relevant for investment.
    One of the reasons that many people do not see a strong, 
robust recovery is precisely because there has not been that 
decline in long-term interest rates. That means, looking 
forward, that there should be a certain degree of pessimism.
    As I point out in my written testimony, there are tax 
reforms that, for instance, would have done far more to promote 
investment in the short-run with far lower budgetary costs, 
like the net investment tax credit, and better income-averaging 
provisions.
    Both you and Professor Solow talked about the legacy of Jim 
Tobin. One of his legacies was the investment tax credit. And 
that was one of the sources of economic growth that began in 
the 1960's. We now know how to even improve upon that through a 
net investment tax credit. That was not the stance that was 
taken. It was really much more corporate giveaways rather than 
trying to design a tax reform that would have been good for the 
overall performance of the economy.
    I strongly side with those who believe that when one makes 
a mistake, one should recognize it. It is not just the size of 
the tax cut that was a mistake, but its design. Given the 
peculiar structure of the tax bill, with provisions that expire 
in 10 years, it is inevitable that the issues will have to be 
revisited. It is better that that be done sooner than later.
    As you all know, I have spent a lot of time in the last 4 
years involved in foreign economic policy and I want to spend a 
few moments talking about that because it is related to our 
current macroeconomic situation.
    One of the sources of strength of the U.S. economy during 
the 1990's was increased export to emerging markets. This was 
partly a result of trade opening, partly a result of the robust 
economy in those regions.
    Mismanagement of international economic policy by the IMF 
has contributed significantly to a worsening of prospects, and 
I think that will have adverse effects not only on the 
political position of the United States and how it is perceived 
around the world, but also on our economic prospects.
    It is also the case, let me emphasize, that the problems 
that we face in our exports are caused largely by the strength 
of the dollar. And the strength of the dollar, in turn, is 
caused by our macroeconomic stance.
    In the early 1980's, a large tax cut was enacted, and that 
led to a massive worsening of the fiscal situation. The trade 
deficit is simply the difference between what we invest and 
what we save. National savings--including public savings--has 
gone down from what it otherwise would have been. The trade 
deficit would have been even worse, were it not that investment 
too has gone down. But when our economy recovers, investment 
will increase, and with it, there is a good chance that the 
trade deficit will worsen.
    We should be clear--it is not protectionist policies abroad 
or unfair trade practices or just the failed macroeconomic 
policies that have caused our current trade deficit problems. 
Whether they get reflected in the steel industry, the 
automobile industry or elsewhere, it is our overall 
macroeconomic framework, including the tax cut that was passed 
last May. And I suspect that the full adverse effects of the 
tax cut on our international economic position are yet to be 
fully felt.
    You mentioned that you were going to have a vote on energy 
policy, and let me just make a few brief remarks. I think that 
this is important for the long-run economic prospects of the 
economy.
    There is a widespread agreement among economists that GDP 
does not provide a good measure of economic well-being. At the 
very least, we should take account of the degradation of the 
environment and natural resources. Bad information systems can 
lead to bad decisionmaking, as we have recently seen in the 
corporate world, and I referred to that earlier.
    Nowhere is this more true than in energy policy. Extraction 
of oil and natural gases may increase our measured GDP, but it 
does not increase our economic well-being commensurately.
    We should take account of the depletion of our resource 
base and the degradation of our environment as a result of 
carbon emissions. An energy policy which focuses on drain 
America first is not even good for our long-run national 
security, for it leaves us potentially more vulnerable in the 
future. Long-run economic growth-- correctly measured-- and 
long-run security both suggest that we should focus more on 
conservation. And basic principles of economics suggest that 
what is required is incentives. Why should we think that moral 
suasion would be more effective in this arena than it is in any 
other area of economic activity?
    I want to conclude with a few remarks about one of our 
long-term problems-- our Social Security system.
    That program has been an enormous success. We have brought 
the elderly out of poverty and we have provided a new measure 
of economic security to the aged. Transaction costs are low. 
Improvements in the design of the program over the years have 
reduced some of the unintended inequities, reduced any adverse 
effects it might have on labor supply, and increased overall 
efficiency. There is still a way to go to put it on sound 
financial grounds.
    Economics is traditionally described as the science of 
choice. The legacy of the Clinton years, a huge fiscal surplus, 
provided us with an opportunity to make some choices. We could 
have used some of these funds to put the Social Security system 
on sound financial ground. We could have fully funded that 
system. We could have decided on how to proceed in the future. 
We have largely squandered that opportunity.
    Proposals for partial privatization typically leave the 
fiscal situation of our Social Security system worse off. Any 
reform proposal which does not begin by addressing the question 
of how current unfunded liabilities are to be financed is 
irresponsible, and should be a nonstarter.
    Elsewhere, I described at greater length common myths 
concerning Social Security. One that has recently received some 
attention is the low return on Social Security accounts. We 
should be clear--Social Security funds are invested well, but 
conservatively. To the extent that capital markets work 
efficiently, then any higher returns that might be received 
would simply reflect higher risk.
    It is imprudent for those approaching retirement to invest 
all, or even most, of their assets in highly risky investments. 
If there were a decision to undertake greater risk, the public 
Social Security system could do so, again, at low-transactions 
costs.
    Just to put things into perspective, the transaction costs 
in the privatized part of the British system have been 
estimated to reduce benefits by 40 percent from what they 
otherwise would have been. This is how privatized systems work.
    Part of the reason that in partial pay-as-you-go Social 
Security systems, it appears that returns are low is that some 
of the returns are used to bear the costs of the unfunded 
liabilities. The problem of funding those unfunded liabilities 
does not go away with partial or complete privatization. It 
will have to be borne elsewhere.
    To assess the merits of any reform proposal, therefore, one 
must know how, and who, will bear those costs. To do otherwise 
is dishonest. It may put in jeopardy the long-run prospects of 
our economy, for a day of reckoning will undoubtedly come.
    Let me conclude by saying that I continue to believe that 
the basic fundamentals of the U.S. economy remain strong. But I 
have seen the fortunes of countries change quickly as a result 
of economic mismanagement. The decisions, the choices, we take 
today will affect not only economic performance during the next 
year, but also our long-run prospects.
    I believe that the tax cut that was enacted last spring was 
based on a serious miscalculation of our economic situation. It 
is a decision which, however, is reversible. If we do not 
revisit the issue, in the light of the new information which 
has come to light and the new situation which has evolved, the 
damage which could be done may itself be irreversible--or at 
least it will take a long time to undo it. Much is at stake.
    Thank you.
    Chairman Sarbanes. Thank you very much.
    Dr. Krueger.

                  STATEMENT OF ALAN B. KRUEGER

                   BENDHEIM PROFESSORSHIP IN

                  ECONOMICS AND PUBLIC AFFAIRS

          PROFESSOR OF ECONOMICS, PRINCETON UNIVERSITY

    Dr. Krueger. Thank you, Senator Sarbanes. I appreciate the 
opportunity to talk about the economy this morning.
    Let me begin by seconding Joe Stiglitz and thirding Bob 
Solow by saying it is not very productive to debate whether 
there was a recession. It is quite clear looking at the labor 
market that the labor market turned down in 2001 and March 
marked the turning point in the labor market.
    The unemployment rate reached a 30 year low of 3.9 percent 
in April 2000. It hugged pretty close to 4 percent until the 
end of 2000. March 2001, the unemployment rate stood at 4.3 
percent. Then it increased to 4.9 percent by August 2001, 
before the September 11 attacks, and reached a recent high of 
5.8 percent 2 months ago. The last 2 months, the unemployment 
rate has ticked down a bit to 5\1/2\ percent.
    I think it is a bit too premature to celebrate the recovery 
in the labor market. In terms of employment, 1.4 million jobs 
were lost in the 11 months since March 2001, and 1.8 million 
jobs were lost in the private sector. If we compare that to the 
recession in the early 1990's, 11 months after the start of the 
recession in 1990, 1\1/2\ million jobs were lost in both the 
private sector and in total.
    This downturn has not been less mild as far as job losses 
is concerned. In fact, if we compare the total job loss in the 
recession in the early 1990's, even in the period after the 
recession ended when jobs continued to drift down, total job 
loss in the private sector was 1.8 million jobs then and 1.8 
million jobs now.
    So in terms of job loss, as I said, this recession so far 
has been about as severe as the one in the early 1990's.
    This recession seems to me to have two distinct phases in 
the labor market. The first phase was quite a surprise. 
Ordinarily, in a downturn, less skilled workers and minorities 
are the hardest hit.
    In the first 4 months of this recession, from March to July 
of 2001, the unemployment rate actually increased more for 
highly skilled workers than for less skilled workers. So for 
college graduates, the unemployment rate increased from 1.9 to 
2.2 percent. For high school drop-outs, the unemployment rate 
held steady at 6.8 percent.
    I have to say that that was quite a surprise to those of us 
who watched the labor market. By past history, we expected the 
labor market to turn down more quickly for the less skilled and 
also because of welfare reform, I certainly expected that those 
last hired would have been the first fired and thought we would 
see more difficulty among the less skilled at the beginning of 
the recession.
    Well, since the summer, the typical pattern has emerged.
    From July to February, the unemployment rate has risen much 
more for the less skilled than for the highly skilled. And 
these numbers are reported more fully in my written statement. 
But the unemployment rate for high school drop-outs increased 
from 6.8 percent in July, up to 8.3 percent last month.
    I should also add, while the overall unemployment rate went 
down last month, an amount that was not statistically 
significant, the unemployment rate did increase for high school 
drop-outs last month. So the situation does not appear to have 
turned around for the less skilled.
    Meanwhile, the unemployment rate in the last 7 months 
increased for highly skilled workers, but not by as much as it 
increased for the less skilled.
    So if you look over the whole period of the downturn, the 
unemployment situation has worsened more for less educated 
workers than for more highly educated workers, as is the 
typical pattern. And we get a similar picture if we look by 
race. It looks like there were two phases.
    In the first phase, the unemployment rate increased for 
white workers and actually fell for black workers, which was 
again quite a surprise. And then in the second phase, the 
unemployment rate has been rising more for black workers than 
for white workers.
    Now the usual pattern is for unemployment to linger at a 
high level after a recovery begins. If we go back to the 
experience in the early 1990's, the unemployment rate stayed 
high and continued to rise for 15 months after the recession 
officially ended.
    There are several explanations for why jobs are slow to 
grow after economic growth resumes. One is that employers are 
simply uncertain how long the conditions will last. I think all 
of us here are uncertain what type of a recovery we are about 
to have. That naturally leads employers to be cautious in terms 
of hiring and rehiring workers.
    Another explanation is called labor hoarding. During a 
recession, firms will sometimes hold onto workers, particularly 
those who they invested a lot in their training, because it 
would be costly to rehire workers with such skills after the 
recession ends.
    Another factor is called upskilling of positions. Employers 
often will raise the standards for jobs in a recession and will 
hire highly skilled workers to do the kind of work that 
previously was done by less skilled workers, and not until 
demand increases rather smartly will they adjust the standards 
and begin to hire the less skilled workers again.
    Then, finally, I would add that recessions give firms an 
opportunity to reorganize, to rethink the way they do things 
and change the way they do things. And that often leads them to 
prefer to hire more highly skilled workers than less skilled 
workers because more highly skilled workers are more flexible. 
This also dovetails with the purchase of new equipment, 
implementing new equipment, which tends to go hand-in-hand with 
more highly skilled workers.
    So, looking forward, my guess is that the soft labor market 
situation will linger for a while. That has been the past 
practice. Also, if you look at the numbers and say, well, 
suppose the recession ended in the fourth quarter of 2001, 
which is a reasonable guess at this point. Well, then, it has 
been the case that unemployment has continued to climb for the 
less skilled workers and climbed overall since the recession 
ended because it is higher now than it was in the fourth 
quarter of 2001. But I have to confess a fair amount of 
uncertainty in this prediction that unemployment will remain 
stubbornly high, even if we are in the midst of a recovery.
    The first reason for my uncertainty is that the beginning 
of this recession was unusual. I am somewhat heartened in the 
sense that I see a familiar pattern in what has happened since 
the summer. But one does have to admit that different forces do 
seem to be at work in this recession, as Joe pointed out 
earlier.
    Another difference is that productivity growth has remained 
strong in this recession, stronger than is ordinarily the case 
in a recession. And that might imply that there has been less 
labor- 
hoarding, that firms might be leaner coming out of this 
recession than is typically the case and they might be quicker 
to expand employment.
    And that leads me to the third factor which might lead the 
labor market to recover sooner than is usually the case.
    It seems that we have gone through some fundamental changes 
in the labor market, that the way in which employees find jobs 
has changed over the last 10 or 15 years. Unfortunately, the 
data are not terrific, but it looks like the number of 
vacancies at a given unemployment rate is lower than it used to 
be, and there are several hypotheses for why that is the case. 
One explanation is that temporary help firms make the labor 
market more efficient, speedier in terms of placing workers, 
make it easier for firms to adjust to hire workers, and also 
make it easier for them to reduce their workforce. There is 
also more outsourcing. And I suspect that the web has changed 
things. A remarkably high number of people search for work by 
looking at Internet job boards and using techniques that did 
not exist even 10 years ago.
    In spite of these factors, my best guess would be that the 
labor market will remain soft, even if we are in the midst of a 
recovery.
    What I think is probably most important to bear in mind for 
policy, at least in the short run, is that, to avoid a jobless 
recovery, we should look at what kinds of options we have to 
increase employment for less skilled workers.
    The unemployment rate is much higher for less skilled 
workers. It is been growing for less skilled workers relative 
to more highly skilled workers. And if we are to reduce 
unemployment further, I think it will come mainly from reducing 
unemployment for less skilled workers.
    Now, Bob Solow mentioned that fiscal policy in this 
instance has been slow to respond. I think I certainly agree 
with that. I remain somewhat optimistic that if the recession 
was more severe, fiscal policy might have been a bit quicker. 
But fiscal policy does come with the types of problems that Bob 
mentioned.
    And that leads me also to discuss automatic stabilizers. I 
commend the Congress for extending unemployment benefits, 
although I think Bob Solow's is a softer grader than I am. I do 
not know if I would have given a ``B.'' I think more could have 
been done in this situation.
    One thing would have been to expand benefits for workers 
who seek part-time jobs. Part-time employees pay into 
unemployment insurance. Yet, in most States, they do not 
qualify for benefits.
    I think for stabilizing the economy, another more important 
point is that the automatic stabilizers built in for extended 
benefits to kick in are no longer realistic.
    The insured unemployment rate in a State must exceed 5 
percent and then some other conditions have to be met for 
extended benefits to turn on. The trigger used to be 4 percent 
in the 1980's. It increased to 5 percent. Since then, the 
insured unemployment rate relative to the overall unemployment 
rate has drifted down.
    In other words, the unemployment insurance extended 
benefits and the automatic triggers rely on the fraction of 
people who are receiving benefits, receiving unemployment 
benefits relative to the workforce rising, but the take-up rate 
for unemployment insurance has declined and because of that, it 
makes it much harder to reach the automatic triggers. Moreover, 
the national rate of unemployment appears to have declined, 
which also means that the triggers are beyond reach, even with 
the fairly substantial increase in unemployment.
    I think one fairly straightforward thing to do would be to 
lower the triggers for State benefits to turn on. That way, it 
wouldn't be necessary for Congress to deliberate in a downturn 
whether it is necessary to extend benefits. And I think that if 
extended benefits were available more quickly, it would shorten 
the length of downturns and could also save money because it 
wouldn't be necessary to extend benefits nationwide, but they 
could be targeted more to the States which are suffering the 
most.
    Some other changes in unemployment insurance which I think 
would also be important would be to improve the experience 
rating in the system. Employers are supposed to pay a higher 
tax rate if they have had a worse record laying off workers. In 
a number of States, experience rating has lapsed. There are 
very few rates. Some States, only two rates.
    In essence, what we are doing is subsidizing employers who 
lay off workers. We are subsidizing them by providing benefits 
to their workers when they lay them off and we are not charging 
the firms for those costs.
    Then I would also add that the taxable base for 
unemployment insurance in many States is quite low. The taxable 
base in the majority of States is between $7,000 and $10,000, 
which means that for higher-income people, they do not pay any 
unemployment insurance tax after their first $10,000. This 
leads to very regressive financing. And if we were to raise the 
tax caps, we would be able to lower the rates, which I think 
would have a favorable impact on employment demand.
    Let me conclude by saying that I think this is a time to 
think about how we can make Government policy respond more 
quickly in the event of a downturn. One of the most important 
automatic stabilizers we have now is the tax system, not by 
design, but just the way it works.
    Progressive taxes work as an automatic stabilizer. If 
income falls, people fall into lower tax brackets. So, I think 
it is important to bear in mind that this is one aspect of 
progressive taxation.
    I think another policy to consider at this point would be 
job training, how that connects with unemployment insurance. 
Funding sufficient job-training programs, especially for youth, 
which were cut during the Clinton Administration and the Bush 
Administration has proposed cutting even deeper.
    Last, I would just add that I think it is important that we 
think about these policies in the context of a budget that is 
sustainable and a budget that is forward-looking and helps us 
to prepare for the retirement of the baby boom generation.
    Chairman Sarbanes. Thank you very much.
    We will now turn to David Malpass, the concluding panelist.

                 STATEMENT OF DAVID R. MALPASS

                     CHIEF GLOBAL ECONOMIST

                    BEAR STEARNS & CO., INC.

    Mr. Malpass. Mr. Chairman, I want to thank the Committee 
for the opportunity to make a statement today. My written 
statement covers the economic outlook and gives some thought on 
U.S. monetary and fiscal policy. It also includes a final 
section dealing with some foreign economic policy issues.
    I am going to use some of the graphs from the written 
statement, if you have one to look at while I go through.
    I am the Chief Global Economist at Bear Stearns. So part of 
my comments for the Committee today also relate directly to the 
financial markets.
    One of the global economic features of the 1990's was the 
sharp increase in the U.S. share of world GDP. Part of this is 
a tribute to our economic system, but another part reflects the 
relatively poor economic performance in Japan and many 
developing countries. As we count our many blessings and work 
to make our own economy better for all, I think it is in our 
interest to also spend considerable time and attention working 
on an appropriate U.S. international economic policy.
    The first graph in my statement shows the nominal world 
growth rate in the 1990's. And what we can see is that in the 
first part of the 1990's, world nominal dollar growth was 
strong. Then in the latter half of the 1990's, it tailed off. 
Part of this is the strong dollar, but part of it also is the 
weakness of economies, particularly abroad.
    As we think about the economic outlook, I expect a broad-
based U.S. recovery in 2002, with support from consumption, 
inventories, Government purchases, and second-half strength in 
business investment. The U.S. economy's natural tendency is to 
grow. The latest improvement in the outlook over the last 
couple of weeks is justified, in my view, by the solid U.S. 
strengths--strong productivity growth and relatively full 
employment.
    And I will go into that in a moment.
    In recent months, Americans have shown their optimism and 
their patience when confronted with adversity, traits that I 
think auger well for the recovery.
    After some recessions, growth accelerates to high levels 
early in the recovery due to pent-up demand. I do not expect 
that pattern in this recovery. The second graph in the 
statement shows the consumption rate in this period versus the 
average recession. And what we see is that you can barely see 
that there was a recession if you just look at the consumption 
growth this time around. It did not dip the way it normally 
does in a recession.
    In many ways, the economy is reacting as if it is enjoying 
relatively full employment. For perspective, we have today a 
5.5 percent unemployment rate. At the end of the 1991 
recession, in March, the unemployment rate was 6.8 percent. We 
are well below that. So in many ways, the economy and the 
consumption growth are responding to an unemployment rate that 
by longer-term historical standards, is relatively full 
employment.
    Of course, I would like to see the unemployment rate 
substantially lower. Given the strong productivity growth, it 
is clear in my mind that the U.S. economy can again be able to 
enjoy a sub-5 percent unemployment rate without it being 
inflationary.
    I am going to skip the housing section here and turn to 
corporate profits.
    Even though the recession seems to be over, there are still 
intense pressures in the economy. I think they reflect the 
aftermath of a deflation caused by dollar strength in the late 
1990's. We should in this environment see a piece-by-piece 
recovery unfolding in the economy, meaning that some 
industries, companies, and employee groups have absorbed most 
of the shock, while others are still in its grip.
    In my view, the intensity of the corporate adjustment is 
pushing the economy quickly through the deflation process, that 
brings it closer to completion. This ability to digest mistakes 
and move forward is one of the hallmarks of the American system 
of business and labor flexibility and is a key factor in our 
strong, long-term growth rate.
    The graph labelled Behavior of Profits in Recession shows 
that in an average profits recession, corporate earnings 
decline. In this profits recession, they have declined much 
more deeply than in an average profit recession.
    So this brings me to some cautions, not in the statement.
    As we look at why those corporate earnings have gone down 
as much as they have this time around, one of the reasons is 
that nominal growth rate is weak. Economists typically deal in 
real growth rates and that is appropriate for many times. But 
as we move into a very low inflation environment--in fact, 
recall that the GDP deflator in the fourth quarter was minus 
three-tenths of a percent of GDP. And nominal growth rate was 
lower than the real growth rate. So as we look at the nominal 
growth rate in this recession, it has been deeper, the slow-
down has been deeper than in many previous recessions.
    Another caution for us right now is that part of the 
strength in real GDP is related to the weather and also to the 
increased security costs that we have had after September 11, 
and the Government spending that went along with them.
    So these will all tend to be short-term or not long-term 
growth-creating factors for the economy. Those are some 
cautions looking forward.
    I want to now turn to monetary policy, I offered a few 
thoughts in my prepared statement.
    As the U.S. recovery broadens, U.S. monetary policy will be 
faced with the question: Is growth itself inflationary? And if 
not, does it require monetary policy response?
    The graph shows that over the 1990's, the range of the 
short-term interest rates of the U.S. has been relatively wide 
as the Fed tries to respond to these growth swings.
    My view is that inflation and deflation are more related to 
changes in the value of money--let's call it the strength of 
the dollar--than to economic growth. When a currency loses 
value, it puts upward pressure on prices. Likewise, when a 
currency rises in value, it puts downward pressure on prices. 
Since the dollar is very strong right now, as judged by several 
factors, and the graph shows the trade-weighted value of the 
dollar reaching a very high level in most recent years, I think 
there is more likely to be downward pressure on prices than 
upward pressure.
    So even with a recovery, it looks as if CPI inflation will 
fall substantially in coming months and be low, relatively low, 
for the foreseeable future. This makes an argument against a 
rapid increase in interest rates and bond yields. As a policy 
matter, I would like to see a more explicit recognition of the 
connection between the value of the currency and the inflation 
or deflation rate that is expected. I think it is important for 
us to achieve stability in the value of the dollar as a step 
toward price stability.
    In addition, I wanted to offer some thoughts on fiscal 
policy. It is obviously a very complicated subject, both from 
an economic and a political perspective. These are, therefore, 
very general thoughts.
    It looks like the budget may now actually be in surplus or 
close to it in fiscal 1902, and also in fiscal 1903. This is 
the result of several positive factors. They include--a 
shallower-than-expected recession, the remarkable change in the 
interest rate policy in 2001, strong U.S. productivity growth, 
and also Congress unusually well-timed tax cut in 2001.
    The Federal budget reflects tremendous growth in spending 
and even faster growth in Federal receipts. The graph in the 
text shows nominal spending and nominal revenues and you can 
see us trading back and forth between surplus and deficit.
    Note that this graph is using CBO's February 1902 
forecasts, the ones that they made last month, and I imagine if 
they reestimated the budget today, there would be a much 
smaller deficit showing, if any, for the fiscal year 1902 
budget.
    The budget outlook is very sensitive to growth assumptions. 
No one is very good at forecasting growth rates in either the 
near-term or long-term. I am skeptical of the process of trying 
to calculate potential GDP or using it as a rule or a guidepost 
for monetary policy because of this difficulty in actually 
projecting short- or long-term growth rates.
    The bar graph in my statement shows the size of the miss by 
both CBO and OMB in the 1990's versus the actual growth rate. 
Year after year they systematically, under-estimated both the 
potential and the actual growth rates for the U.S. economy.
    I should note that in the 1980's it would show the flip 
side. There was a systematic over-estimate of the growth rate 
by both agencies during that period of time. I think it makes 
it difficult to use this kind of projection as a guidepost for 
monetary policy.
    If economic growth is as solid as I expect, then the 
glidepath for the pay-down of the national debt will be rapid 
and would not be, in my view, good economic policy. In effect, 
our current policy is to levy a stiff level of taxation on 
workers and the profitable portion of the private sector in 
order to pay off relatively low-cost Federal debt. The effect 
is to improve the Federal Government's balance sheet while 
putting pressure on the public's balance sheet.
    Given the economic recovery, then, Congress will probably 
revisit the 1990's debate about what to do with the fiscal 
surplus. In my view, tax cuts would help maximize the growth 
rate and gains in median incomes. In addition, I think a fiscal 
surplus, if it emerges, should also provide an opportunity for 
an improvement in the 
Social Security system.
    Finally, I wanted to offer some thoughts on international 
economic policy.
    The U.S. economic recovery is good news for foreign 
economies. It will probably spark a recovery in Europe and may 
even help Japan break out of its deflation spiral. Some 
developing countries will be able to participate in the global 
expansion, helping them raise their living standards.
    However, I am worried about the polarization of the world 
economy, meaning the wide gap between the U.S. growth rate and 
growth rates abroad. With each new burst of U.S. growth in the 
1990's, it became increasingly apparent that the United States 
was producing and consuming an increasingly large share of 
world output. It reached roughly 35 percent and it is climbing. 
In my view, it is important that developing countries grow 
faster and begin to narrow the gap in global living standards, 
but very few are.
    Over the years, I have advocated a rethinking of our 
international economic policy and the international financial 
institutions. I favor a vision of economic development based on 
stable currencies, lower tax rates, trade liberalization, and a 
firm belief that people at the bottom of the economic ladder 
should be able to move up. I do not think these principles are 
applied frequently enough in our international economic policy. 
My worry is that world growth may remain substantially below 
its potential, with the shortfall coming disproportionately 
from the poor.
    In conclusion, Mr. Chairman, the likely U.S. economic 
recovery is very welcome, particularly given the war on 
terrorism and the turmoil in international affairs. The 
recovery provides a real opportunity for thoughtful economic 
debate. My statement noted the importance of monetary policy 
decisions relating to growth and inflation; fiscal policy 
decisions in the event of renewed surpluses; and the 
opportunity for constructive change in our international 
economic policy.
    Thank you.
    Chairman Sarbanes. Well, thank you very much.
    There is a vote going on and I have to recess the hearing 
briefly to go and vote. I think some other Members will also be 
joining us. So, we will resume in short order. The Committee 
stands in recess.
    [Recess.]
    Chairman Sarbanes. The hearing will come to order.
    I want to ask a couple of almost preliminary questions. 
First of all, the figure for the economic output in the fourth 
quarter originally came in at two-tenths of 1 percent. That was 
subsequently revised to 1.4 percent. And we had a big change in 
the productivity figure, too. Revised from an increase of 3.5 
to 5.2 percent.
    I have had an interest in these economic statistics 
infrastructure of the Federal Government. My own view is that 
we do not invest enough in it. We are talking about really 
small amounts of dollars. But we could substantially improve 
the infrastructure. I do not know if this is a good example of 
it or not. I guess that is the question I am leading into. But 
we start thinking about policy decisions off of one set of 
figures and then later we learn that the really accurate set of 
figures is something substantially different.
    How much of a problem do you see this as being and how much 
attention should we give to it? That wasn't the purpose of 
today's hearings, but I would like to elicit some response on 
that.
    Dr. Solow. It is a problem. Here we are talking about 
policy and the information on which our discussions and your 
decisions are based, is changing under our feet as we talk. 
Part of that could, I think, be helped by investing a little 
more in the data collection process that underlies the national 
accounts. Not all of it, however, can be helped that way.
    For instance, part of the reason for the problem is that we 
rush the process. We want those summary numbers as soon as 
possible, or sooner. The quarter is barely over before we ask 
the Department of Commerce to produce the figures.
    We need, I think, to realize early in the game, that the 
first numbers are going to be revised and can be revised 
substantially. But there is a lag in the collection of some 
numbers that could be shortened by spending, as you say, 
trivial sums of money by the standards of the Federal budget.
    Dr. Stiglitz. Let me make a couple of comments.
    First, I agree with what Bob says that part of the problem 
is the fact that there are always going to be revisions. The 
first numbers are going to come in are going to be different 
from what next will be the case. At the same time, I think we 
have to recognize that the point that you made, the investment 
in this area is inadequate and that we could do better. When we 
get the revised numbers, they could be reliable. We could do 
better samples.
    So, I think there is enormous room for improvement.
    You focused on numbers of GDP and productivity. The flip 
side of that is the CPI, the cost of living, the inflation. It 
is very clear that productivity, when we revise upward 
productivity numbers, that revises downward the inflation and 
that means that the staffs at the Fed should be more 
conservative, and less concerned about inflation.
    I always found it very interesting during the debates about 
revising the CPI in the context of Social Security, that while 
Greenspan often talked about the implications that it had for 
the CPI, and for Social Security, there was less attention for 
the implications for monetary management. There were obvious 
implications, that we needed to be far less concerned about 
inflation than he and many of the other members of the board, 
Federal Reserve Board, seemed to be. And so, I think that this 
is very important.
    A third point I want to make very briefly, which is I think 
the institutional framework for statistical collection should 
be changed. I think it would be desirable to think about 
establishing an independent statistical agency.
    Chairman Sarbanes. Like Canada?
    Dr. Stiglitz. Like Canada. Inevitably, the conflicts of 
interest between an operating agency and a data collection 
agency can be very great and lack separation.
    At the international level, the problems are even greater. 
I think that the numbers that are reported for growth, for 
instance, for many countries by the IMF are simply made-up 
numbers to make their programs work and have nothing to do with 
scientific, economic-based forecasting, and that is not well 
known. I think that moving the statistical responsibilities out 
of the IMF would be a very important move in the right 
direction.
    Chairman Sarbanes. Alan.
    Dr. Krueger. Let me mention, I started the survey center at 
Princeton, so these are issues that I have thought about quite 
a bit.
    I would add that the private sector, as well as the 
Government, relies very heavily on the statistics that are 
coming out of the Bureau of Labor Statistics and the Census 
Bureau and the BEA and so on. And if you add up the costs of 
making mistakes for all those who are involved in using these 
data for decisions, it is enormous compared to the amount we 
are investing in collecting the data.
    So, I have a couple of suggestions. I think there are some 
problems that could be solved by investing more to collect more 
information. And one of the problems is the economy has become 
harder to measure. The economy has become more diverse. 
Manufacturing now is a much smaller share. We are investing 
more in collecting the data, but the economy is getting harder 
to measure at the same time. So it is kind of a race where we 
are left standing in place.
    One suggestion I have is that we should be more aware of 
the magnitudes of the revisions.
    For example, in my written testimony, I pointed out that 
the employment growth last month was 66,000, according to the 
payroll survey. The typical revision from the first report to 
the third revision, which is 2 months later, is on the order of 
magnitude of around 50,000 jobs, plus or minus.
    So when you think about these movements, you have to 
recognize that you need a wide confidence band around them. 
There are some numbers where you need a wider band than others. 
I think it would be helpful if the numbers were reported more 
frequently with those bands and if we think about those bands 
when we think about using the numbers.
    But there are some critical areas where I think we just do 
not measure or we stopped measuring what is going on. One area 
has to do with vacancies. Bob Solow and I co-edited a book 
together. There is a lot of discussion on the relationship 
between vacancies and the unemployment rate. We are forced to 
rely on help-wanted ads as a measure of vacancies. There are 
big changes in newspaper costs and in the way help-wanted ads 
are placed and so on.
    The BLS has just revised or just started again a new survey 
on vacancies. But I think that that was a critical gap, and 
there are other areas where we are just not measuring enough.
    Chairman Sarbanes. David.
    Mr. Malpass. We maybe should have lower expectations of 
what we are really getting out of the data, because it is so 
complicated to actually measure what is going on in the 
economy.
    Chairman Greenspan, in his testimony last week, mentioned 
again what he calls conceptual capital. In part, it is the 
human capital element of what is going into GDP. It is becoming 
more and more important. It is very hard to measure what that 
actually is, how productive it can be. So, I think we have to 
have some limits on what we can really expect from the data.
    We probably all have individual statistics that we dislike 
the most. I will layout one domestic and one international that 
I think are misleading.
    Personal savings is a statistic that we see every month. It 
gives us the impression that Americans are terrible at saving. 
That statistic produced by the Government is heavily biased. It 
keeps track of all the expenditures that people make, but 
doesn't keep track of all the income or cash flow savings.
    For example, when someone refinances their home, say they 
save $200 a month in their payment and spend $100 of that. The 
Government keeps track of the spending. If they then put $100 
extra every month into savings, we would think of it as their 
savings rate going up. But the Government's going to conclude 
that their savings rate actually went down by the $100 of 
spending. They do not record it properly.
    We have the impression of a terrible performance by the 
American saver and it actually wasn't nearly as bad as that 
statistic.
    On the international front, people focus on foreign direct 
investment as the solution for foreign economies. But what we 
find is that the data often comes from corporate reporting to a 
government that they want to please. The government comes to 
corporations and says, how much did you invest in our economy 
this year? And the corporation, of course, has an incentive to 
say a large number. It radically overstates the actual 
attractiveness. This is particularly true in some developing 
countries.
    I agreed with what Joe Stiglitz said on the IMF producing a 
lot of data that really is just way off and is known to be off. 
That is part of their job, I guess.
    Chairman Sarbanes. Thank you.
    Well, I have a number of questions, but my time has 
expired. I yield to Senator Bennett. I will come back.

             STATEMENT OF SENATOR ROBERT F. BENNETT

    Senator Bennett. Thank you, Mr. Chairman. I appreciate your 
holding this hearing.
    I look around the room for the hordes of visitors and 
observers and they are not here, which is too bad because I 
think the economy really is the starting place of virtually 
everything else.
    One of the cliches that I repeat often and often again, and 
like most cliches, it happens to be true--money does not come 
from the budget.
    We here in Congress forget that. We think we can pass a 
budget that creates a surplus or pass a budget that creates a 
deficit. We are always surprised. Nobody's prediction of what 
the fiscal year is going to produce is ever right or even close 
to right, except the one that is issued with only 1 month left 
in the fiscal year, and that is usually pretty close. But at 
the beginning of the fiscal year, we are always either overly 
optimistic or overly pessimistic.
    Money comes from the economy. If the economy is doing 
extremely well, then we get surpluses that we did not predict. 
If the economy turns south, why, we get deficits that we did 
not predict. And too many people blame the predictors and do 
not realize that you are dealing with so many variables.
    The example I like to use is a little like the weather 
forecaster. There are some who say, well, the weather 
forecaster is never right, so he cannot be any kind of a 
scientist. Actually, he can be a very good scientist. He is 
just dealing with so many variables that you have to cut him a 
little slack.
    Economists get snorted at because their forecasts are never 
any good. Actually, I think you are scientific and you do 
pretty well.
    With that having been said, let me raise an issue that came 
out of my exchange with Chairman Greenspan, when he was before 
us last week, that has to do with the role of capital gains and 
the amount of income that came from capital gains.
    I made the observation to Chairman Greenspan that tax rates 
are at historic highs. They have never been higher as a 
percentage of GDP than they are now. He said, yes, that is 
true, except that we have had a tremendous amount of tax 
revenue coming from people cashing in on capital gains, and we 
have had some tax revenue on people cashing in on stock 
options. If you go below those to the income that comes from 
what one might consider more normal kinds of tax sources, the 
situation doesn't look quite so great.
    Nonetheless, in macro terms, the tax burden on the economy 
is very high and the question is raised whether or not the 
economy over time can sustain a tax burden that is in excess of 
20 percent of GDP, which we have not had. Does that produce 
some kind of a drag that will bring the economy down? And if it 
does bring the growth rate of the economy down--nothing's going 
to bring the U.S. economy down. We are not going to be 
Argentina. We are not even going to be Japan. But if our growth 
rate slows, then we are back into deficits rather than 
surpluses, however much we politicians would like to think we 
can control whether we are in deficits or surpluses.
    If our growth rate slows, we are back into deficits rather 
than surpluses. We have other kinds of problems. I would like 
you to address that question of the overall 20 percent-plus tax 
burden that we have had. Then, if you would, in that, let's 
talk about capital gains because I view the capital gains tax 
as a tariff on money as it moves from one purpose to another.
    And just to put it into simple terms that I can understand, 
I know an entrepreneurial type who is willing to invest his 
money in relatively high-risk activities because he has learned 
that they produce high returns, and he has enough experience to 
pick, he believes, the right kind of high-risk activities.
    When he is successful, and one such investment becomes much 
larger than it was when he got into it, he is loathe to unload 
it because if he takes his money out of investment A in an 
effort to put it into investment B, there is a tariff on the 
movement of the money, from A to B, in the form of the capital 
gains tax.
    Now there is a widow who is most anxious to buy A because 
it is now a mature investment that is producing a stable and 
reliable 7 percent per year income, and she thinks that is just 
nifty.
    He is very anxious to get out of A and into B because, for 
him, a mature investment that produces only 7 percent a year is 
a real drag. But the capital gains tax stands as a tariff 
barrier to prevent him from moving his money from A to B. And 
as we have lowered that tariff barrier, we have seen more and 
more money move from A to B, and in the process, produced the 
capital gains tax revenue that Chairman Greenspan was talking 
about.
    So, I would appreciate your comment on those two issues.
    Dr. Solow. I guess I will start. I am the oldest one here 
by a wide margin.
    [Laughter.]
    Senator Bennett. As I am on this side.
    [Laughter.]
    Dr. Solow. I do not think that it makes sense to imagine 
that there is some natural upper limit to the ratio of Federal 
revenues to national income or GDP that we surpass temporarily 
or for a longer time at great peril, or that if we fall short 
of it, something else happens.
    Much more depends on the nature of the taxes we levy, and 
the uses of the revenue that we collect, than on any simple 
statistic like the fraction of the national income that goes in 
taxes.
    It is very important I think to focus on an obvious case: 
The need for national defense. If the safety of the country, 
the security of the country, requires expenditures that are 
naturally directed through the Federal Government, we will make 
those expenditures and we will tax for them if taxing is the 
rational way to finance them, and we will borrow for them if by 
any chance, borrowing is the rational method to finance them.
    One problem with the illustration that Senator Bennett 
mentions is that it under-estimates the ability of the 
financial engineer to convert one form of income into another. 
In our tax system, we favor capital gains as against other 
forms of income, and as a result, there is a thriving industry 
of converting large salaries into asset transactions which 
appear as capital gains----
    Senator Bennett. If I could interrupt you. I have always 
heard the argument that, gee, you lower the capital gains tax 
and everybody will transfer their income into capital gains. I 
have never been able to do it. I have tried, and I have never 
heard of anybody being able to do it.
    Dr. Solow. You do not hire a fancy enough tax lawyer and 
accountant. If, instead of being a poor but honest Senator, you 
were a rich movie star, or a rock star, I assure you that 
clever people would cluster around you who are anxious to do 
just that, for a mere tiny fraction of what they are going to 
save you.
    Senator Bennett. Yes, I know. And very often, they end up 
putting you into something that has wonderful upside protection 
and turns out not to be--like a percentage of your movie when 
you would have been better off by taking it in salary. There is 
always risk connected with the transaction.
    Dr. Solow. Of course, there is always risk connected with 
any asset transaction. I am merely saying that you cannot 
simply look at the gross numbers without asking what incentives 
for the private economy, as well as for public servants, are 
created by different forms of taxation.
    Alan Greenspan was right that, if you look at the numbers, 
when we passed through a period in which large asset gains are 
being realized and therefore, taxed, even if they are taxed at 
low rates, that will increase measured revenues. And they are 
not just measured revenues, they are real revenues of the 
Federal Government.
    The lesson I would draw is that we should try, in thinking 
about public finance, to pay attention, more attention than we 
actually do, to the incentive effects of every tax increase, 
tax decrease, tax change, that we make, incentives that bear on 
businesses, bear on individuals, and to a certain extent, bear 
on the Government itself.
    Senator Bennett. Dr. Stiglitz.
    Dr. Stiglitz. Let me try to amplify a couple of points.
    I agree with Bob that there are no magic numbers percent. 
It really depends in part on what you are doing with the money. 
For instance, we have done studies that show that the returns 
to investments in R&D by the Government have enormous returns, 
and we have not been investing enough in that area. So, my view 
is that if we spent more money on that kind of research, that 
would be a high-yield return that would help the economy grow.
    We were talking about investments in statistical 
infrastructure. If the private sector is getting bad 
statistics, making bad decisions as a result, and spending more 
public money, that can yield very high returns.
    The first point is what is the money going for? And we 
could obviously waste money. I am not going to tell you how to 
do that as well. But if we spend it well, it can yield high 
returns.
    Second point, the design of the tax structure can make a 
great deal of difference. We can design tax structures that 
give strong incentives to people who are creative. We can give 
strong incentives to people who are engaged in tax shelters 
that are basically not creating value. And so, much of the 
concern about the debate of tax reform has been the design of 
tax structures that enhance productivity versus those who are 
advocating tax structures that help the rich or help, unrelated 
to their activities with respect to enhancing economic 
productivity.
    So, I view a very strong part of the burden of the tax 
system as having to do with the design. Again, we can have bad 
design and good design and right now, I think we have been 
moving in the wrong direction.
    Third, with respect to capital gains itself, a relatively 
small fraction of the capital gains comes from the picture of 
the innovative activity that you have in mind. Most of capital 
gains comes from real estate speculation.
    I do not want to downgrade the importance of real estate as 
an important sector of the economy, but I think most of us 
think of, what is the strength of the new economy, the strength 
of the U.S. economy over the last decade? It has been 
innovation. It has been a whole set of activities like that and 
not building the kinds of empty office building that led to the 
real estate crash in 1988, 1989, or in the 1990's.
    Most of the capital gains goes to the real estate sector, 
not to innovation. I am more sympathetic with special treatment 
for capital gains for innovation sectors than I am to real 
estate, but other people do not believe in that kind of 
differentiation.
    I think it does make sense.
    The final point I want to make is to reemphasize the point 
Bob made that the kind of financial engineering that one saw in 
Enron has been well known and can be used for--if you have 
special tax treatment of capital gains, can be used to avoid 
taxes.
    I wrote a paper a number of years ago detailing how that 
could be done and how you could actually basically get rid of 
most of your capital gains.
    Chairman Sarbanes. It is probably in the Enron files.
    [Laughter.]
    Dr. Stiglitz. Over the years, the tax authorities have 
tried to circumscribe one or the other of these kinds of 
devices and it explains a lot of the complexity of our tax 
code. And that complexity is part of the downside cost of our 
tax system.
    Unfortunately, a lot of the creativity of our economy is 
going not into producing new products, but trying to circumvent 
the tax laws and finding out loopholes, on accounting and in 
this area. I think it is a mistake to try to provide them even 
more incentives to do that. And afterwards, if you want to find 
some advice on how to use our current tax system to avoid 
taxes, we can arrange for that.
    Senator Bennett. I am not talking about using the current 
tax system to avoid taxes. I understand that perfectly.
    I do object to the canard that I hear over and over again 
that people will simply change their form of compensation to 
take advantage of the lower capital gains tax rate. And I hear 
that in the debate often.
    Michael Jordan doesn't take shares in the Wizards. Michael 
Jordan takes cash. And if you say, we are going to give you 
shares in the Wizards so that you can get capital gains 
advantage when the price of the Wizards goes up and his knee 
goes out, he wishes he did not take shares in the Wizards.
    You cannot transfer income from normal income, ordinary 
income, or earned income. To use the tax phrase, you cannot 
transfer from earned income to capital gains income without 
risk. It is not something that you just need a good accountant 
to do. Risk is always there and you are compensated for the 
risk. As Enron demonstrated, stocks go down just as much as 
they go up, and options become worthless just as often as they 
become valuable.
    I was hired as the CEO of a company and was compensated in 
options. And I did such a wonderful job in the company that the 
options never ever exercised because the stock price never got 
as high as it was on the day I was hired.
    Dr. Stiglitz. Can I just say, much of the paper that I 
wrote was how you manipulate within the capital sector itself, 
borrowing money, moving within that, and avoiding. But it is 
also the case that there has been a lot of discussion, and I 
think some evidence, that firms--one of the reasons they use 
stock options is for the favorable treatment.
    What a number of corporations are doing as the stock goes 
down of resetting the strike price, so implicitly, they are 
sharing the risk. They are absorbing the risk.
    And if you look at the studies that have looked at overall 
compensation, what you see is that many executives do not bear 
the risk that you would appear to see that they would bear from 
the stock options because when things do not work out as well, 
there are other ways of giving them money, either through 
resetting the strike price or through other forms of 
compensation.
    Chairman Sarbanes. Does anyone else want to add anything 
before we move on?
    Mr. Malpass. I have a few points, if I may, Mr. Chairman.
    Chairman Sarbanes. Yes. Go right ahead.
    Mr. Malpass. In very rough terms, Federal revenues are $2 
trillion per year and State and local governments add another 
roughly trillion dollars. So there is a lot of tax revenues.
    Chairman Sarbanes. Rates or revenues?
    Mr. Malpass. CBO, in its recent report, goes through some 
scenarios. Over the life of the budget, the 10 year life of the 
budget, even with last year's tax rate cut, they expect 
revenues from personal income taxes to rise from 12.8 percent 
of GDP now to 13.6 percent of GDP. And if we have a good 
economy, they will rise to 15.5 percent of GDP.
    So even apart from the capital gains issue, we have the 
personal income tax as a burdensome tax. Also, the Social 
Security tax is a very burdensome tax on labor itself. It puts 
a wedge between the employer and what the employee really 
receives.
    Now, as far as capital gains taxes, we should note that 
each time the rate is cut, the proceeds from capital gains are 
way above the projections.
    We have a systematic bias in the way capital gains are 
perceived in the Government computer models. They don't fully 
account for, the fact that, when the rate is cut, there is more 
activity and more economic growth or simply transactions, and 
the total capital gains receipts get a good bump.
    One of the debates last year that was very confusing to me 
was the assertion that if the capital gains tax rate had been 
cut, the stock market would fall.
    I believe that economists would by and large agree that if 
you cut the tax on an exit from a given investment position, it 
adds to the value of that position.
    I think it is demonstrable and almost a certainty that if 
you had a lower capital gains tax rate, you would see a big 
positive impact on the value of capital assets--stocks, bonds, 
and real estate. So that was a confusing debate to me on the 
sidelines last year.
    A final point is the distribution of tax receipts from 
capital gains taxes, the issue of who actually pays capital 
gains. What I am struck by is that the rich actually can avoid 
much of the capital gains tax by selectively taking gains. Also 
through the estate tax system and through the charitable 
contributions system.
    I was just at a dinner the night before last with a big 
group of universities that receive a lot of charitable 
contributions. One of the sizable tasks that they have is 
taking care of rich people as they donate their appreciated 
property into the university before their death.
    The rich person avoids capital gains taxation and gets 
higher current income from the charitable contribution. The 
whole process is driven by the heavy taxation of capital gains.
    On the other side of it, the small business owner really 
doesn't have those mechanisms in order to avoid or work around 
the capital gains tax.
    I think that the distribution of capital gains taxation 
falls very heavily on the middle class and entrepreneur, 
precisely the people that you would really rather leave the 
proceeds with.
    Chairman Sarbanes. Now as I understood Chairman Greenspan's 
response to this question that Senator Bennett put at the 
hearing last week, he made the observation that the capital 
gains tax revenues are factored into the numerator. But there 
is not an item that is factored into the denominator.
    Therefore, the percentage of tax revenues compared with the 
gross product will, by virtue of that, be higher. And if you 
are getting more capital gains, the figure will look higher 
because you do not put any comparable item into the 
denominator. You get, in a sense, an overstated figure when you 
are trying to make these comparisons or something that 
certainly should be taken into account.
    Of course, the point is that we have had a lot of capital 
gains in recent years with all of what has been going on in the 
market and that that had an impact on these percentages.
    He was, I thought, very careful to try to make that point 
in the response.
    Senator Reed.

                 COMMENTS OF SENATOR JACK REED

    Senator Reed. Thank you, Mr. Chairman. Thank you, 
gentlemen, for your testimony and your presence here today.
    Dr. Stiglitz, you seem to have an urge to say something, 
and I do not want to deny that.
    [Laughter.]
    Dr. Solow. It is always the case, Senator.
    [Laughter.]
    Chairman Sarbanes. What else is new?
    [Laughter.]
    Dr. Stiglitz. Very briefly, let me just say that the Social 
Security tax, since the contributions that people make under 
the Social Security system are reflected in the benefits and 
move basically commensurate with the benefits, doesn't have the 
distortionary 
effect of other kinds of taxes. It is really like an 
investment. So viewing it that way I think is fundamentally 
misguided.
    Second, it is the case that cutting capital gains taxes 
leads in the short run to increases in revenues because people 
worry that this is a temporary benefit and they want to take 
advantage while there is a sale going on.
    The econometrics, the statistical evidence shows that over 
the long run, cutting the capital gains tax is like cutting any 
other tax--it leads in the long run to lower revenue and a 
worsening of the fiscal position of the United States.
    I will stop at those two points. I have concerns about the 
other points, too, but let stop there.
    Senator Reed. Thank you, Dr. Stiglitz.
    It seems to me that the proponents of tax cuts, and this in 
some respects seems to be the Administration's Swiss army knife 
for economic policy--it can do everything--base some of their 
judgments on a bet that productivity will increase at very 
prodigious rates for the indefinite future.
    I wonder if Dr. Solow and everyone, if you might comment on 
your views on productivity increases.
    Dr. Solow. Yes, I would be glad to. I should begin by 
saying that these quarter-to-quarter numbers that are reported 
are intrinsicly unreliable and volatile. Productivity has a 
numerator and a denominator. They can both change 
unpredictably. They can both change dramatically, and 
particularly when a denominator changes. It can change the 
value of the fraction very much. Quarter-to-quarter numbers are 
not an indicator of very much at all.
    Over the longer run, in the quarter-century after the end 
of the Second World War, we had very rapid productivity 
increase, reflected directly in the rise in the standard of 
living of the country.
    For mysterious reasons, for reasons which are not fully 
understood by anyone, the following 25 years, from about 1970 
to about 1995, had extraordinarily low productivity increase. 
We thought, at first, that productivity was growing 1 percent a 
year. It turns out to be nearer a percent and a half a year 
after the data are revised.
    Beginning in 1995, we had very rapid productivity increase 
again, and much of that is undoubtedly information technology 
related. A lot of it is related to other things, including 
organization innovations by businesses, and still other things.
    It is very hard to extract from numbers like that what part 
is business-cycle-related--there is a normal pattern of 
productivity change in the business cycle--and what part is 
durable. What we really need to know is what is durable over 
the next 5 or 10 years.
    I have put some time into studying that question in detail 
industry by industry, in fact, and so have many other people. I 
think a consensus is emerging that we probably have a durable 
benefit from accelerated technological change in the United 
States, especially in telecommunications and information 
technology, but that the period from 1995 to 2000 exaggerates 
considerably what we can hope for over the longer run.
    The longer run forecasts, naturally uncertain, that make 
most sense to me are those that suggest that we can look ahead 
at something like 2 percent a year annual productivity 
increase, taking the private economy, the private business 
economy as a whole.
    Two percent a year ain't hay. A number that rises at 2 
percent a year doubles in about 35 years. So doubling the 
productivity of American workers in the course of a little over 
a generation is not a negligible thing. This is nothing like 
the 3, 3\1/2\, 4 percent increases that we saw during that 5 
year period, which almost certainly cannot be repeated 
regularly.
    The 2 percent a year is a little less than we got between 
1950 and 1975, which were very good years for productivity. It 
is more easily explicable why we did so well in those years 
than why we did so poorly in the 25 years.
    Senator Reed. Thank you.
    Dr. Stiglitz.
    Dr. Stiglitz. Just to add one thing. I agree with 
everything that he said. One point is that there has been a lot 
of research, a lot of thinking over the last 20 years of how 
you make decisions under uncertainty. These numbers are 
inherently uncertain. One of the principles is you do not spend 
money before you have it. And you revise policies as new 
information comes in.
    So if you made a decision to spend a certain amount of 
money when you thought you had a surplus of $5 trillion, or 
whatever the number is, when it was a mistake to have spent as 
much as was spent, given the uncertainty. But when you have new 
information that comes in and that says it is much less than 
you thought, it calls for revising the policy decisions that 
were made under that framework.
    Senator Reed. Thank you, Dr. Stiglitz.
    Dr. Krueger.
    Dr. Krueger. I agree completely with what Joe and Bob said.
    One point I would add is that one of the things that helps 
productivity growth and it has helped historically has been 
increases in education, increases in the human capital of the 
workforce. In the post-World War II period, we had very rapid 
increases in college attendance and high school graduation and 
so on. That source seems to have slowed down considerably.
    So that is one of the reasons why I think it is very hard 
to predict going forward. The technological changes that Bob 
pointed to I think probably are durable, although the probably 
should be underscored, not the durable, in that sentence.
    I also think there is a tremendous amount of uncertainty, 
even looking over the next 5 years, for what the productivity 
growth numbers will be. That is why the budget projections are 
so variable and often so far off. And given that reality, I 
think what Joe said is absolutely right, that one wants to 
adjust when one gets new information about what productivity 
growth looks like.
    Senator Reed. Mr. Malpass.
    Mr. Malpass. Senator Reed, very briefly, in my opening 
statement I went through the policy implications of this 
question. I think it is, indeed, worthy of a lot of thoughtful 
discussion. Could the productivity growth be as high as we have 
been recently witnessing? If it is anywhere close to that, as 
Dr. Solow says, even if it is 2 percent, that compounds 
rapidly.
    From the monetary policy standpoint, it means that we may 
have a period where the inflationary impact of a given growth 
rate is a lot less than what we are used to. That means that 
the potential growth of the economy, or the possible growth of 
the economy, is higher than what we have thought in the past.
    From the fiscal policy standpoint, it means that we may 
have surpluses rather than deficits. As I laid out in my 
statement, it is worthwhile for Congress to begin thinking 
about what we would do if we really had a sizable surplus, to 
begin thinking about the glidepath.
    Chairman Greenspan laid out a year or two ago the idea that 
if we run surpluses, if we have the higher productivity growth 
that we think we do, then the glidepath in the pay-down of the 
national debt will be uncomfortably rapid. He went through that 
in a rather detailed way.
    Senator Reed. But that was at the point that we had a 
projected surplus of several trillion dollars, which is much 
less now. It is not a glidepath. It is a cliff, I think.
    Dr. Stiglitz. Can I make one more remark which is a point 
that I had in my written testimony having to do with the short-
run?
    Whenever you have a recession, a down-turn, even a 
shortfall below potential, one of the impacts is that profits 
go down, and as his testimony pointed out, they have come down 
considerably in this economic down-turn. And when profits go 
down, firms cut back on their R&D. The cut-back in long-term 
R&D is even more in the short-term. Long-term R&D being focused 
on real productivity increases rather than just making sure 
that you can compete with the competitor.
    I have been at some recent meetings with people who have 
been involved very strongly in the high-tech area. They say 
that there has been dramatic cut-backs in R&D in their firms 
and in their 
industry in the last year, last year and a half. And that 
portends very strongly for a slowing down of the pace of 
productivity over the medium-term, at least in that particular 
sector.
    Senator Reed. Well, you can correct me. My sense is that 
productivity is not at the levels that we saw in the late 
1990's, at 2 percent. That, as a result, GDP will not grow as 
fast as it tended to grow. With the declining GDP and even a 
constant obligation by the Federal and State and local 
governments to spend money, the likelihood will be in deficit, 
not surplus. Is that your judgment?
    Dr. Solow. It is not clear that we will be in deficit 
rather than surplus. But any surplus we generate will be much 
smaller than the very optimistic numbers that we had before.
    You are quite right that with roughly 2 percent 
productivity growth and roughly 1 percent employment increase 
over the long run, the long-term growth rate for real GDP is 
likely to be of the order of magnitude of 3 percent, 3.1 
percent, thereabouts. That is the number that I come up with. 
That is the number given in the Economic Report that the 
President issued a month ago. There is a fairly good consensus 
on that.
    That is not, I think, going to generate large surpluses, 
nor is it going to give us much protection against inflation. 
Incomes tend to rise along with productivity. What was so 
fortunate about the period from 1995 to 2000 was that there was 
an unexpected splurge in productivity, and as a result, an 
awful lot of it was fed into cost reduction rather than into 
increases in earnings and other nonprofit forms of income.
    I do not think that is likely to happen again. This works 
the other way, too. The double-digit inflation of the early 
1970's that scared us so much came in part from the fact that 
wages and other incomes were rising as if productivity were to 
continue to go up as fast as it did in the years after 1950. It 
did not, and prices went up instead.
    Dr. Stiglitz. Let me just make one more point, which is 
that the numbers that are often cited include the Social 
Security system. We should be putting away money for those 
obligations we have.
    In addition, we have the long-term problem of Medicare. 
There are estimates of what is going to be happening to health 
care costs, that it will go up to 17 percent of GDP. And that 
is typically not fully accounted in the forecast.
    So there is a real risk on that side, as well as on the GDP 
side that we have not really taken into account. I think it is 
irresponsible to spend the money before we have it and before 
we know what these expenditures are going to be.
    Senator Reed. Thank you very much. My time is expired.
    Thank you, Mr. Chairman.
    Chairman Sarbanes. Senator Corzine.

               COMMENTS OF SENATOR JON S. CORZINE

    Senator Corzine. Thank you, Mr. Chairman. I apologize to 
the witnesses for attending another hearing first. This is a 
remarkable panel and I intend to read all of your testimony.
    Let me ask a question that relates to something that seems 
to come up on the floor in our debates fairly frequently with 
regard to tax policy. And that is the permanent repeat of the 
estate tax, which seems to get tacked onto every piece of 
legislation that gets presented to us that has any economic 
bearing. Would you all give some of your perspectives on its 
impact into the economy long-run capital formation? I hope this 
question has not been asked, Mr. Chairman.
    I would start with Mr. Malpass and then work the other way, 
or vice-versa.
    Mr. Malpass. You put me on the spot first.
    [Laughter.]
    The one observation I would make on the estate tax is that 
it places huge costs on the economy. I think it is very hard to 
quantify those costs or be aware of how large they are.
    I do not really want to go farther into exactly how it 
should be revised. But we should recognize the gigantic number 
of workers within the economy and systems within the economy 
that are devoted to dealing with the estate tax, from lawyers 
to accountants to the university systems, which have staffs and 
whole processes involved in helping people deal with the estate 
tax system.
    We should be aware of those costs and also aware of the 
distortions that are brought on by the system that we have 
right now.
    Dr. Krueger. My own view is that the estate tax is largely 
an issue of equity. Different people will have different views 
about what constitutes equitable taxation.
    I think one issue that David raised which is important is 
the loopholes. What seems to upset people is having to spend 
money on lawyers to avoid the estate tax. I think they would 
probably be happier to give that money to the Government than 
to their attorneys. My own sense is that part of the outrage 
over the estate tax in the public has to do with the loopholes 
which they consider to be unfair.
    I do think in terms of the economic impacts, there would be 
impacts in terms of charitable giving. I think from the 
standpoint of universities, for example, they will get fewer 
donations with the 
repeal of the estate tax.
    Dr. Stiglitz. Let me make a couple of points.
    First, I think one has to think about the repeal of the 
estate tax in a broader context. In particular, in the context 
of the issue of the step-up of basis of capital gains tax, 
step-up basis for payment of the capital gains taxes. The step-
up of basis, I believe that, as our previous discuss, we said 
that there should be a capital gains tax and that without that, 
there can be enormous tax evasion or avoidance--tax avoidance, 
I am sorry. And that without fully dealing with the problems of 
step-up of basis, repealing of estate tax is bad tax policy, 
both from efficiency and equity points of view.
    The second point, a lot of the criticisms that have been 
raised against estate taxes have focused on small businesses, 
farms, and all those people who have to sell their property in 
order to pay the tax. I think there is a legitimate concern 
about that. But that could have been dealt with in a variety of 
ways other than the repeal.
    For instance, giving people an extended period of repay, 
increasing the exemption level maybe to $5 million, but not the 
complete repeal. I think that was going far beyond what was 
necessary to deal with those problems.
    I think there is very little evidence that the repeal will 
increase the efficiency. The core issue is the one that Alan 
pointed out, the issue of equity and what kind of society that 
we want to have.
    There are going to be significant impacts on charitable 
giving. I think the evidence on that is fairly clear. One of 
the strengths of the American society and the American economy 
is based on the nonprofit sector. And I think that in some 
sense could be some of the most serious adverse effects of the 
repeal.
    I do not think it is a bad thing that people are encouraged 
to give money to nonprofit organizations. But I have to admit 
that I have some self-interest in that particular perspective 
because I have been one of the beneficiaries of the nonprofit 
sector.
    Mr. Malpass. But the cost of that in the efficiency, or I 
wanted to ask your point on efficiency. Why don't we have to go 
through that, in the efficiency of extraction within the tax 
system?
    Dr. Stiglitz. I think the net cost of that is negligible 
compared to what happens more broadly in trying to evade a 
whole variety of taxes or to take advantage of special capital 
gains provisions, real estate provisions, and so forth. I think 
this is really second-order effect.
    Dr. Solow. I think everything has been said here. I will 
take 30 second and emphasize a couple of points. There have 
been studies of the incentive effects on business entrepreneurs 
of the existence of the estate tax. And generally, they come up 
with very small numbers.
    The key technical matter is constructive realization of 
capital gains at death. Under the present system, without the 
estate tax, there are large capital gains that escape taxation 
forever. And that cannot be appropriate as long as we are 
taxing capital gains elsewhere in the system.
    This is primarily a matter of equity. There is no danger 
that well-off parents will be unable to create advantages for 
their children by educating them properly and endowing them one 
way or the other.
    To return some portion of an estate at death to society or 
in anticipation of death to charitable organizations does not 
seem to me to be a bad thing at all. It seems to be a good 
thing.
    The evidence is that, well, here we are, the most 
entrepreneurial society in the world. You would think that we 
had been stifling entrepreneurship for generations by having 
this tax. In fact, Route 128 and similar centers are crawling 
with businesses like that, somehow. People with the creativity 
to create enterprises will do it.
    Chairman Sarbanes. We will go around again, but let's move 
more quickly. We have four panelists and it takes a lot of time 
to get an answer. I am just going to ask a couple of questions 
and----
    Dr. Solow. Five, counting Joe.
    [Laughter.]
    Chairman Sarbanes. Maybe if I can get a yes or no or a 
short answer.
    What is your view of the argument that the projections out 
that we would shift from a strong surplus position either to a 
weak surplus in the budget or even a deficit, because of the 
extensive tax cuts that were made, has had an impact in keeping 
up long-term interest rates? And that therefore, some of the 
stimulus that could have come to the economy by lower long-term 
rates was lost because we did this extensive tax cut and then 
people looked out into the future and they saw this.
    So that was one way that the tax cut fed back into the 
current situation and, in effect, detracted from moving the 
economy forward. What is your view of that argument?
    Dr. Solow. You wanted a yes or no answer. My answer is, 
yes, that has to be the case. Something in the capital markets 
has been lifting up expectation of interest rates in the future 
and it is at least in part the expected supply-demand balance 
for funds in the future. And that cannot help but be affected 
by the fiscal policy of the Government.
    Dr. Stiglitz. I agree. I have actually written that. One 
other factor is the uncertainty that all of us have been 
talking about gets reflected in the risk premium that is 
reflected in turn in the medium- to long-term interest rates.
    And so, it is not just the average numbers we are talking 
about. It is the uncertainty by this commitment, seeming 
commitment we have made to a tax cut when we are not sure if we 
can afford it.
    Dr. Krueger. I tend to share those views.
    Mr. Malpass. You asked four economists, so that often means 
six opinions. I will give you a different opinion.
    It is pretty clear from the evidence that the fiscal 
deficit doesn't have much impact on bond yields. We have the 
experience from the 1980's. It is discussed in detail in my 
statement with a graph showing the bond yields versus the size 
of the fiscal deficit. As the expectations of the fiscal 
deficit and the actual fiscal deficit grew, bond yields 
actually came down heavily in the 1980's.
    We have had the experience of last week. As it became clear 
that the U.S. fiscal deficit was going to be much smaller than 
people expected, or perhaps a surplus, yet bond yields are 
going up. The rise in yields is reflecting the expected growth 
of the economy, the inflation outlook, and I also think the 
currency outlook. Those are the dominant variables in a bond 
yield.
    Chairman Sarbanes. Now what about the argument that doing 
this extensive tax cut provided a stimulus to address the 
shortfall that we were experiencing here?
    I take it this really goes to the question of whether, 
somehow, you can borrow frontwards or move frontwards tax cuts 
projected out into the future in order to provide a stimulus 
now. Does it work that way, or can it work that way?
    Dr. Solow. I do not think it had or did. The Economic 
Growth and Tax Relief Reconciliation Act of 2001 was not passed 
in anticipation of a recession and it is not mainly an 
antirecessionary act.
    I am sure that the early stages of that tax reduction did 
have the usual effect in supporting the demand for goods and 
services in the economy.
    Chairman Sarbanes. You mean the early stages, what happened 
in the current or the next fiscal year.
    Dr. Solow. In the current fiscal year. But the notion that 
tax reductions scheduled for 5 or 6 years from now, or 4 or 5 
years from now, can have a major effect on the current 
consumption expenditures of the population seems to me to be 
far-fetched.
    Chairman Sarbanes. Does anyone disagree with that?
    Dr. Stiglitz. No. The only other factor is the point made 
earlier that the anticipation of the worsening fiscal position 
has had a negative effect through interest rates.
    Dr. Krueger. I was going to make the point also that rate 
cuts in the future should cause people to delay their labor 
supply today.
    To the extent that there is some substitution in the way 
people work, it would work in the opposite direction, the 
future cuts. The rebates might have had some effect, I suspect. 
When the history of this period is written, it will probably be 
a small impact. But the future cuts, I suspect, were probably 
having no effect or a small negative effect.
    Mr. Malpass. People spend from their lifetime income 
expectations, the after-tax expectations of how much money they 
are going to have over their lifetime. So if the Government 
changes its view of how much taxes it is going to extract from 
people, that certainly has an effect on people's confidence 
about their near-term outlook.
    If they see that their long-term after-tax income is going 
to be more, then that gives them confidence in what they are 
doing. I really think that it has to be the opposite of the 
points of view that we have just heard.
    Dr. Solow. Even a believer in something like the permanent 
income theory of consumption, like me, for instance, 
understands that permanent income is discounted like other 
incomes and increments to anticipated permanent income 5 years 
down the line will not generate very large amounts of 
consumptions. I am perfectly at home and comfortable with that 
way of looking at consumption. But it cannot have any 
substantial quantitative impact, I think.
    Dr. Stiglitz. The work that I did in connection with the 
Nobel Prize emphasized the importance of credit rationing. And 
it is one of the reasons why you cannot borrow against income 
that you are going to get in 5 years. The evidence in this 
particular episode is very strong that it has not had any 
effect.
    Chairman Sarbanes. Senator Bennett.
    Senator Bennett. Thank you.
    I have to return to the estate tax for just a minute.
    I agree with you, Dr. Stiglitz, that the stepped-up basis 
is a stupid idea. And it came because it was an attempt to 
ameliorate the impact of the death tax, which I think is 
another stupid idea. The problem with the death tax is that 
death is not a voluntary decision. It should not be an economic 
event. When I decide to sell a stock, I decide to sell a stock 
based on my analysis of my needs, the stock market, where 
things are. I make a rational decision, taking into account all 
factors. When my father dies, there is no such options. He dies 
because of uneconomic circumstances.
    If his entire estate is cash, that is one thing. If his 
estate is a business, his death may occur at the worst possible 
economic moment for the survival of that business. But the 
Government pays no attention to that, assumes that it is cash, 
and demands payment within 9 months.
    And so, in an effort to get around the arbitrariness of 
death, we get all of the battalion of lawyers, tax accountants, 
and others that you have talked about.
    I have lived through a number of deaths. The most 
spectacular one from an economic point of view was Howard 
Hughes'. I was working for Howard Hughes when he died, and I 
watched the gyrations that everybody went through in an effort 
to preserve his assets, not necessarily for his heirs because 
none of his heirs expected to receive any of his assets. We 
spent a frantic amount of time trying to find a signed copy of 
the will that left everything to charity, which was Mr. Hughes' 
intention.
    Mr. Hughes, being Mr. Hughes, never bothered to sign the 
will. And so, it did end up going to his relatives, none of 
whom expected a dime on his death.
    I watched the gyrations that people went through to write 
down for assessment purposes the value of his assets, in many 
instances, to preserve those assets because they represented 
businesses that were not at that point in their lives where 
they could afford to liquidate into cash.
    So, I would much prefer a circumstance that says, death is 
not a taxable event.
    If Howard Hughes paid $10 for an asset, on his death, that 
basis stays unchanged. There is no step-up in basis. When the 
asset gets sold, no matter who sells it, it then produces a 
capital gain that is taxed at the existing capital gain tax 
rate, whether it is 20 percent or 28 percent or 25 percent or 
15 percent, wherever it might be. And that means the people who 
own the asset can make an intelligent economic decision that 
the time has come to sell it and pay the tax, instead of an 
involuntary decision that says, uh oh, Mr. Hughes died 10 years 
before we expected him to. This business is not in shape to 
liquidate. But the Government said to come up with the money, 
as if it were cash.
    Now comment on the economic impact of saying, okay, death 
is not going to be considered a taxable event. Therefore, there 
will be no stepped-up basis, and whoever gets the asset by 
virtue of somebody's death is facing a capital gains tax on the 
original basis, just as the individual would have faced it if 
he had survived.
    That, by the way, is exactly what would happen if the asset 
were given to a corporation at the very beginning when the 
corporation decides to sell it, and the corporation can live 
for 150 years before it decides to sell it. It pays the capital 
gains on the original basis.
    Chairman Sarbanes. I am going to have to excuse myself 
because of another engagement for which I am now quite far 
behind. Senator Corzine will take over and conclude the 
hearing. But I did not want to leave without thanking the panel 
for your contribution. We really very much appreciate it. And I 
have looked through the statements and obviously, a good deal 
of work went into these statements as well.
    This has been a fascinating session. It could go on 
indefinitely. And I apologize to Senator Bennett.
    Thank you all very much.
    Dr. Solow. Since I am closer to this taxable event than any 
of my colleagues----
    [Laughter.]
    --I will take the first crack at it. If it is good public 
policy that unrealized gains on capital assets should escape 
taxation for time periods measured in generations, in five, 
six, seven, eight generations, then I might agree with the 
direction of Senator Bennett's comments. I do agree with him to 
the extent that I think it is a little odd that death should be 
such an important taxable event.
    I would think that a reasonable way of dealing with that, 
to say that, at the very least, death is a transaction or the 
passing on of assets at death is a transaction. And there is 
something very peculiar about different treatment of someone 
who sells an asset 10 minutes before he or she dies and someone 
who forgets to do that and holds the assets for 10 minutes 
more.
    It would be my choice in view of the equity considerations 
and the kind of society that I at least like to think of us as 
having, I could be happy if the transfer of an asset at death, 
which is, after all, from one person to another person, were 
treated as a transaction and what in the modern vocabulary is 
stepping up the basis, or what I learned to call constructive 
realization of capital gains took place. Then assets would be 
treated as if death constituted a sale to heirs. By the way, 
not all of those heirs have to be members of the family. They 
can be others.
    Senator Bennett. But it is an involuntary transaction.
    Dr. Solow. No, it is not an involuntary transaction. That 
transaction could have taken place earlier, had anyone wanted 
to make it, and might have taken place if the tax laws were 
different. And not to sell something is as much a voluntary 
action as to sell it.
    Dr. Stiglitz. Let me just make a couple of points.
    First, I think that smart businesses tend to buy insurance 
that can pay the capital gains taxes--the estate taxes. So, we 
have a vibrant insurance industry, so the issue for most 
individuals can be covered.
    Senator Bennett. You are assuming that the cost of 
insurance is a minor issue to the business. There is a cost.
    Dr. Stiglitz. There is a cost.
    Senator Bennett. There is no cost-free way out of this.
    Dr. Stiglitz. But you have to understand, it is also the 
case that in a competitive market, with the tax preferences 
associated with the insurance industry, on average, it is not 
really a cost.
    I really do think that the stepped-up basis is very 
distortionary. It is also the case, though, that not forcing a 
constructive realization in one form or another leads to this 
problem that is well documented, called the locked-in effect, 
that it discourages the turnover of assets. And it is very 
important to address that issue.
    I think that there are a number of ways in which one can 
try to facilitate, help people who are facing the kinds of 
situations that you describe.
    I think that, for instance, under current law, they can, I 
believe, have, if they are small businesses, extend the 
payments over a number of years. I could imagine extending that 
more generally with an interest charge that reflects the cost 
of the deferred receipt of the Government. I do not think that 
is unreasonable.
    Finally, in the end, I do think that, as I look at it from 
the point of view of the efficiency effects, not talking about 
the equity. I would make a trade-off in which I would have a 
step-up of basis, constructive realization and a somewhat 
lowering of the estate tax from what it was, but clearly not 
the elimination of the estate tax.
    Senator Bennett. We could debate this, but my time is gone.
    Just one last thing. Dr. Solow, if Howard Hughes had 
decided to put his initial stock in a corporation rather than 
in his own name, it would have stayed in that corporation for 
generation after generation after generation and you wouldn't 
object to that because it wasn't an individual. And the people 
who ran the corporation would decide when to dispose of those 
assets and they wouldn't have had the cost of any insurance 
firm to do it. They would make intelligent business decisions 
on the disposition of the assets and they would pay the capital 
gains tax when it came. You are treating individuals different 
than corporations.
    Dr. Solow. I would regard that as a loophole and if I were 
a legislator, I would consider closing that loophole.
    Senator Corzine. Okay. Let me change subjects here.
    Mr. Malpass, being an old washed-up bond trader, I thought 
you picked the timeframes for increases in debt associated with 
the rise in interest rates at a rather interesting time. You 
picked the 1980's and you apparently were picking 1982 or 1983, 
when we were at the peak of interest rates and debts had 
continued to go on.
    If you had just turned the clock back 6 years, I think we 
were at very low rates, roughly where we are now, 5\1/2\, 6 
percent on long-term rates. And the expectations of growing 
deficits took us to 13 or 14 percent, if my memory serves me 
correctly, about 1982 or 1983, and a clear sense at least of 
when I was sitting at the desk buying and selling bonds, that 
supply had something to do with the level of anticipated 
interest rates.
    I think that those levels stayed very high throughout the 
1980's. There were some dips as people thought we were going 
into recessions or had different problems. But I do not see 
that correlation that you pointed out.
    Then I wonder about the analysis even under the 
circumstances that we see a little stronger economy. No one is 
revising down dramatically the kinds of changes in borrowing 
arrangements that we are going to have over the next decade and 
certainly not as they look out beyond the ending of this tax 
cut and the demands that we are going to have with regard to 
Social Security and Medicare and Medicaid.
    I actually draw almost the opposite conclusion with regard 
to my own personal experience of looking at the correlation of 
anticipated debt financing relative to interest rates. It is 
not a one-to-one correlation. But I would have a hard time 
explaining what happened in the late 1970's and in the early 
1980's with regard to the expansion of debt.
    I do not know whether you want to comment.
    Mr. Malpass. Well, there was a huge change in the value of 
the dollar in the 1970's. I think what was going on in the 
1970's was a mis-estimate by the bond market of the amount of 
inflation that was coming out. And so, the yields stayed low. I 
imagine that people lost a lot of money being long bonds in the 
1970's because there ensued a very high inflation rate, not 
because of the fiscal deficit, but because of the change in the 
value of the dollar and the inflation that came out of it.
    As I look at the graph of the 1980's, it looks to me that 
as the fiscal deficit went bigger and bigger and bigger, you 
had a steady decline in the 10 year bond yield falling from 10 
percent in 1981 all the way down to 7 percent by the late 
1980's. And then we have the reverse process, of course, in the 
1990's, as we moved toward fiscal surplus. We actually ended up 
with an 8 percent interest rate in 10 year bond yields in the 
year 2000. Even as we had moved into a solid fiscal surplus, 
the bond yields were actually going up. I think that was 
related to the growth rate that we had going at that time.
    Dr. Stiglitz. Can I say something?
    Senator Corzine. It certainly did not stay there very long, 
though. It came crashing back down to lower levels when people 
thought they were going to be sustainable pay-downs in debt.
    Mr. Malpass. It is hard to find the fiscal correlation. We 
were moving into a recession and we moved toward rate cuts by 
the Federal Reserve.
    Senator Corzine. Dr. Stiglitz.
    Dr. Stiglitz. The general point that I think you raised is 
that interest rates reflect demand and supply for bonds. That 
is basic economics. That demand and supply are affected by a 
number of variables. In economics, we call it multivariant 
analysis. We do regressions. Looking at one variable is likely 
to be misleading.
    The appropriate question is, given everything else, what is 
the impact of increased deficits? And viewed that way, I think 
it is unambiguously the case that increased deficits mean that 
the Government is going to have to borrow more. Reduced 
surpluses means that the Government is not buying back as many 
bonds as it otherwise would, the same basic story.
    When that happens, the interest rates, those will be 
reflected in the interest rates relative to what would have 
happened in the absence of that action? Lots of other things 
are going on in the world. We cannot control them all. But that 
clearly is the dominant factor.
    Senator Corzine. There are studies out that show those 
correlations, I take it.
    Dr. Stiglitz. Yes.
    Senator Corzine. We probably should cite those for the 
record at some point and try to get them in because I think 
this is one of those debates. It is like the estate tax that we 
have on a daily basis around here.
    It would be great to have some objective evidence.
    I appreciate it. This is the first time I got to chair a 
hearing and I will close it.
    Thank you.
    Dr. Stiglitz. Thank you.
    Dr. Solow. Thank you.
    Mr. Malpass. Thank you, Mr. Chairman.
    Dr. Krueger. Thank you.
    Senator Corzine. This hearing is adjourned.
    [Whereupon, at 12:55 p.m., the hearing was concluded.]
    [Prepared statements supplied for the record follow:]
                 PREPARED STATEMENT OF ROBERT M. SOLOW
                   Nobel Laureate in Economics, 1987
     Professor of Economics, Massachusetts Institute of Technology
                             March 12, 2002
    I want to thank the Committee for the opportunity to testify today 
on the economic outlook. This initial statement will be short and 
pointed, because I believe that a lively discussion will get us closer 
to where you want to go.
    The current economic situation is a living example of the reason 
why most economists think of monetary policy as the tool of choice for 
short-run economic stabilization purposes. We have been told by the 
National Bureau of Economic Research that a recession began exactly a 
year ago. The Council of Economic Advisers, in its Annual Report, seems 
to think that the recession began on September 12. But then, to 
everyone's surprise, including mine, the first revision of data for the 
fourth quarter of 2001 showed that real aggregate output actually rose 
nontrivially, and gained back everything it had lost in the third 
quarter. The preliminary tea leaves suggest that the current quarter 
will show a further gain in real GDP, probably faster than the quarter 
before.
    So with maybe only one down quarter, was it worth calling this a 
recession? Perhaps more to the point: Is that really the right question 
to ask? I think the answer is No, and focusing on that questions leads 
to unnecessary confusion. There are some good reasons to fear that the 
current upswing will be weak, at least for a while. Corporate profits 
and business fixed investment are still falling. Unemployment will 
continue to rise for a while. Much of the strength in the fourth 
quarter came from consumption spending, but more than half of that was 
on automobiles, and thus very likely borrowed from later quarters, 
enticed by temporary incentives. Europe and Japan have been stagnant or 
worse, and do not seem to be turning around as rapidly as the United 
States. They will not be good markets for American producers; on the 
contrary, they will be trying very hard to sell in the United States. 
All in all, I was going to conclude that only God knows how the next 
few quarters will turn out; but it may be that God has not yet decided.
    In this kind of environment, it is hard to know what to do now. The 
Federal Reserve doesn't know any better than you or we do. The 
fundamental difference is that the Fed can act quickly and then, if it 
soon changes its mind, it can reverse itself quickly. It would be 
helpful if fiscal policy could be mobilized in tandem with monetary 
policy, but you can not reverse yourself.
    This lack of maneuverability in fiscal policy explains why the so-
called ``automatic stabilizers'' are so valuable; they do adapt to 
events, without requiring you, or anyone, to take action. But they have 
been allowed to get weaker, for various special reasons. They are not 
likely to be revitalized. Maybe it would be useful if you could enact a 
``standard stimulus package'' (which, worked in the other direction, 
could serve as a standard cooling-off package). It could be triggered 
automatically by events--at one of several levels-- or even proposed by 
the President, and subject to a straight up-or-down vote. I realize 
that no such thing is likely to happen; maybe you have a better idea.
    There should be a more appropriate basis for making stabilization 
decisions than wondering if there is or is not a recession, and when it 
will end. In fact, I think it would still be a good idea to pass a 
stimulus package in spite of the current lack of clarity about which 
way the economy is headed. I will explain why, briefly, because that 
may help untangle fiscal policy from the inevitable uncertainties of 
forecasting that Congress is too ponderous to deal with, unlike the 
Fed.
    Real GDP in the fourth quarter of 2001 was only about 1 percent 
higher than it was in the second quarter of 2000 when the clearly 
visible slowdown began. Two years ago the unemployment rate was about 4 
percent, compared with 5.8 percent now. Capacity utilization in 
industry was then measured at 83 - 84 percent, compared with 74 -75 
percent now. Suppose that early 2000 was a desirable state of the 
national economy. (Some thought it was a little too prosperous for 
peace of mind about inflation; but that requires only a small change in 
what I am about to say.)
    We have to presume that the economy's aggregative productive 
potential has been increasing fairly smoothly since then, because that 
is how it usually behaves. The Council of Economic Advisers estimates 
that the rate of increase of productive potential is a hair over 3 
percent a year. In that case, full utilization of our economy's 
potential this spring would entail a real GDP about 6 percent higher 
than current output. By this time next year, even if the economy grows 
by 3 percent this year (which is slightly faster than the Council's 
forecast in the Economic Report ), there will still be a 6 percent gap 
of unused economic potential. The gap will be larger if the economy 
grows more slowly, and smaller in the opposite case.
    That gap cannot be safely closed in a single year. The Fed would 
certainly fear that an upswing fast enough to do that is fast enough to 
exceed the inflation-safe speed limit, and would choke it off. But it 
would certainly be safe to grow fast enough to close some of that gap. 
That is why I think there is still room for a modest stimulus package, 
if you are capable of enacting a sensible one. By sensible I mean 
effective, temporary, and free of partisan sacred cows. The House bill 
started off as a ghastly mockery. And it has gotten better, just not 
enough better to be acceptable. Accelerated depreciation is not the 
best way to promote capital spending, and it fails the test of being 
temporary.
    I mention all this for a broader reason. All this talk about 
whether there is or is not a recession, when did it begin and when will 
it end, leads to confusion because nobody knows. Anyway, it 
concentrates on the wrong thing. The CEA can make approximate 
calculations of economic potential; in effect it already does so. The 
Congressional Budget Office does something similar. Focusing on that 
would force debate on the right issue, which is where we stand relative 
to potential, and would provide a better guide to policy.
    I should say that I am one of those who thinks the Economic Growth 
and Tax Reduction Reconciliation Act of 2001 was a big mistake. Part of 
the ``surplus'' it gave away has already evaporated, as we knew it 
would as soon as the economy weakened. And we have converted the rest 
mostly into future consumption instead of the future saving and 
investment that the country urgently needs as it looks ahead to an 
aging population. You should resist any suggestion that stimulus should 
take the form of advancing the date at which an ill-advised decision 
comes into effect.
    Like most observers, I think that monetary policy has done very 
well in coping with the past five quarters. Long-term interest rates 
have not fallen very much. Nevertheless, if the Fed had behaved more 
traditionally the housing sector would not have held up as well as it 
has, the auto industry would have had a harder time providing those 
successful incentives, and business investment might have fallen even 
faster.
    Some people complain that the Fed stuck with its contractionary 
stance a bit too long in 2000. Maybe it did; hindsight is usually 20-
20. But perfection is the wrong benchmark against which to judge Alan 
Greenspan and the Federal Open Market Committee. They are not 
omniscient; I have already said that they are, like the rest of us, 
uncertain about what will happen next month. What distinguishes the Fed 
is the flexibility with which it handled the boom of the late 1990's. 
If you want to see how well they have performed, take a look at the 
record of the much more doctrinaire central banks of Japan, the U.K., 
and Europe.
    What we have a right to hope for is that the Fed will exercise the 
same kind of informed flexibility in the course of the coming upswing, 
whatever shape it takes. If the recovery is indeed anemic, then the gap 
between current and potential output, which is already ample, will be 
widening; there will be no need to move short-term interest rates 
higher. Anecdote is piling up that lenders are being extra-cautious, as 
a reaction to the Enron swindle. Suspicion falls especially on smaller, 
less well-known companies without much of a track record, and they find 
it hard to get 
credit. Other things equal, this state of affairs should incline the 
Fed toward maintaining liquidity and credit ease. (It is this kind of 
circumstance that makes me suspicious of even a reasonable formula like 
the so-called Taylor rule: Why should the central bank ignore this kind 
of market fact?) But if the economy picks up enough speed, the margin 
of slack will narrow. In that case, we have to expect the Fed to begin 
positioning itself for the inevitable palaver about soft and hard 
landings, and interest rates will rise pretty quickly. Having a 
flexible monetary policy means learning to live with a certain number 
of tentative and even reversible steps. Right now I imagine wait-and-
see is the right attitude.
    All of the above was written before I saw Alan Greenspan's 
statement to this Committee last week. It contained no surprises, 
unless you count his strengthened conviction that the third quarter of 
last year would be the only down quarter. At this late date, I would 
not count it as a surprise.
    There is only one point I would like to call to your attention. Mr. 
Greenspan agrees that the upswing now launched is likely to be 
``subdued,'' and he gives the standard reasons for suspecting a slow 
increase. He waffles a bit, but a little of waffle is justifiable. He 
reports that the FOMC forecast is for real output to increase by 2.5 to 
3 percent during the four quarters of 2002. That forecast is 6 weeks 
old, and thus possibly already out of date. Anyway this pace is just a 
bit slower than the estimate I quoted from the Economic Report that 
potential output is growing at about 3.1 percent a year. The last 
decimal place in such estimates is not to be taken as doctrine, of 
course. The underlying point is that in this scheme of things, the gap 
between actual and potential output will not narrow during the rest of 
this year. That is what matters, not just whether the movement is up or 
down. The 
implication is that a somewhat faster path for the economy would be 
desirable; a 
slower path definitely would not.

                               ----------
                PREPARED STATEMENT OF JOSEPH E. STIGLITZ
                   Nobel Laureate in Economics, 2001
        Professor of Economics and Finance, Columbia University
                             March 12, 2002

    It is a pleasure to appear before you to provide my assessment of 
the outlook for U.S. economic growth and employment and the appropriate 
public policies to promote those objectives. I will divide my remarks 
into seven sections. In the first, I will discuss the overall prospects 
for the short and medium term. In the remaining sections, I shall 
address specific policy concerns.

The Overall Prospects
    While economists always look into the future with cloudy crystal 
balls, they are particularly cloudy when it comes to forecasting 
turning points. The question that is repeatedly asked is, is the 
recession over? I think, however, that that is the wrong question. 
There is little doubt that for the past year, the economy has been 
performing substantially below its potential. The potential growth rate 
of the economy clearly improved through the 1990's, and even if the 
robust growth of the late 1990's could not be sustained, there is a 
widespread consensus that the economy has a potential for growth of 
between 3 to 4 percent. Taking the mid-point in that range of 3.5 
percent, even a positive growth of .5 percent would represent a 
shortfall of $300 billion in our 10 trillion economy--an enormous 
wastage of resources, even if we were to ignore the tribulations 
imposed on those forced into unemployment. Moreover, we should remember 
that America's unemployment insurance program is one of the poorest in 
the advanced industrial countries. It is unconscionable that benefits 
be terminated after 26 weeks. The argument that providing extended 
benefits would attenuate search incentives is nonsense: The problem is 
a lack of jobs, not the lack of job seeking. I shall return to this 
later.
    While a great deal of pleasure is being taken in the fact that the 
rate of job destruction has been reduced, our economy needs to create a 
couple hundred thousand jobs a month to just break even, to ensure that 
employment keeps pace with the growing labor force. It is not a mark of 
success if the unemployment rate comes down because workers have become 
discouraged from working, so the number of job seekers is reduced.
    Broadly, there are three types of recessions--those associated with 
inventory cycles, overinvestment in capital and housing, and financial 
crises. The current downturn is a combination of the first two. Some of 
the downturn was associated with a decrease in the stock of 
inventories. There were reasons to believe that with the New Economy, 
inventory cycles would be attenuated and become less important as a 
source of economic volatility, as better control mechanisms kept 
inventories better in control, as production methods (just in time 
production) reduced the required size of inventories, and as the 
overall size of manufacturing in the economy declined. As the economy 
nears the end of the period of inventory retrenchment, this source of 
negative drag on the growth of the economy will be eliminated. This, by 
itself, would suffice to bring an end to the recession; but it will not 
be enough to restore the economy to robust growth.
    The overinvestment in certain key sectors of the economy has left 
an overhang, which will take some time to redress fully. The good news 
is that some of these areas are those in which technological advances 
have been proceeding at a rapid pace, so that much of the old IT 
equipment will become obsolete relatively quickly, before the equipment 
wears out, and this will help restore demand for new IT.
    There are a number of other negative forces which suggest that the 
economy will continue to operate substantially below its potential, and 
which represent a substantial risk for a strong recovery.

Consumer Spending
    Robust consumer spending has sustained the economy. The U.S. 
savings rate remains dismally low, which is not good for the long-run 
prospects for growth. Part of the explanation for the sustained 
spending is the mortgage refinancing which 
resulted from the lowering of interest rates, part from the special 
deals that automobile dealers were offering. Given that consumption has 
not fallen in the way that it does in a typical downturn, it is 
unlikely that an increase in consumption will provide a strong impetus 
for growth in the short run. Moreover, there are several reasons to 
believe that the forces which have sustained consumption could weaken. 
(i) Mortgage rates may well rise; as it is, they have fallen far less 
than the short-term interest rates have fallen, partly for reasons that 
I will discuss later. (ii) Similarly, it is not obvious that the 
special deals on automobiles will continue. (iii) The heavy 
indebtedness of the consumer may impose an important dampener on 
spending, one which will become especially important if interest rates 
rise. As it is, by some estimates, consumers are spending 14 percent of 
their income on debt service. (iv) If the unemployment rate is not soon 
brought down significantly, fears of job security may increase, and 
given the poor unemployment insurance system, workers may be induced to 
save as a precautionary measure. (v) One of the primary reasons for the 
low savings rate is that through the nineties, households saw their 
wealth increase through capital gains, even without putting aside money 
out of disposable income. But with stock prices down or increasing 
slowly, it will gradually dawn on consumers that their wealth is less 
than it once was, or than they thought. The switch to defined 
contribution pension systems may exacerbate the resulting instability. 
Today, individuals must bear the risk of stock market fluctuations.

Capital Spending
    Long-term interest rates have not come down anywhere near as much 
as short-term interest rates. One of the reasons for this may be the 
increasing uncertainty about the country's long-term fiscal position, 
caused in part by the large tax cut, where we seemed to be spending 
money before we got it. In addition, there is continuing worry about 
problems of valuation in the corporate sector. I served on the SEC 
Commission on Valuation, which focused on the difficulties of valuation 
in the new economy. While there was general recognition that old 
accounting principles might be ill-suited for providing accurate 
pictures of the economic prospects of firms, many on the Commission 
believed that the market should be relied upon. Enron and Global 
Crossing confirmed the suspicions of the skeptics, and today, many if 
not most investors feel high levels of uncertainty about the numbers 
that many corporations are reporting. This may dampen stock market 
prices, at least for a while.

Exports
    The strong dollar and the weak international situation suggests 
prospects for 
exports remain diminished.

Technology
    A source of some concern is that the economic downturn has led many 
firms to decrease significantly their investments in R&D. And 
investments in long-term 
research--the kind that is likely to result in productivity increases 
down the line--has been particularly hard hit, in ways that are hard to 
assess from the numbers alone. This is likely to be one of the 
lingering costs of not having responded to the economic downturn 
earlier, with stronger measures. (I do not include the House or 
Administration so-called stimulus package among the stronger measures 
that would have made a big difference.)
    The one positive (from a macroeconomic perspective) is the 
increased military 
expenditure; but such expenditures detract from resources that could be 
used to increase long-term productivity, and hence to not contribute to 
the long-term strength of the U.S. economy.
    It will be noted that I have not listed the tax cut as a major 
positive factor. Its net impact on the economy is in fact ambiguous. It 
was not designed to stimulate the economy, and its regressive features 
and other elements of its design suggest that the bang for the buck is 
likely to be quite low. On the other hand, the quickly diminishing 
surplus (and, in some years, the emerging deficit) that resulted lead 
to upward pressures on interest rates. The Fed only controls the short-
term interest rates. What firms care about far more is the longer-term 
interest rates that they have to face, and the tax cut has changed the 
yield structure adversely, and in ways which are quite dramatic: There 
has been an almost 4 percent reduction in short-term interest rates, 
with less than a 25 basis reduction in some long-term interest rates. 
And while this weakens the prospects for a robust short-term recovery, 
its implications for the longer term are even more bleak.

Tax Cut
    This brings me naturally to the subject of the tax cut. The tax cut 
was not only ill-designed for stimulating the economy in the short run; 
it was also badly designed for promoting long-term economic growth. (I 
put aside for the moment broader concerns about equity.) There are tax 
reforms, for instance, that would have done far more to promote 
investment in the short run with far lower budgetary costs, like the 
net investment tax credit and better income averaging provisions. I 
strongly side with those who believe that when one makes a mistake, one 
should recognize it. It is not just the size of the tax cut that was a 
mistake, but its design. Given the peculiar structure of the tax bill--
with provisions which expire in 10 years--it is inevitable that the 
issues will have to be revisited. It is better that that be done sooner 
rather than later.

Foreign Economic Policy
    One of the sources of strength of the U.S. economy during the 
1990's was increased exports to emerging markets. This was partly a 
result of trade opening, partly a result of the robust economy in those 
regions. Mismanagement of international economic policy by the IMF has 
contributed significantly to a worsening of prospects. Much of Latin 
America today faces stagnation, recession, or depression. As people in 
these countries look at the performance of their economies over the so-
called reform decade, they see growth rates that are half those that 
prevailed in the much criticized pre-reform period (the so-called 
import substitution era), though, to be sure, better than during the 
lost decade of the 1980's. There is a growing disillusionment with the 
IMF, and with the United States, which is seen as responsible for its 
policies. While there was consensus in the United States that in the 
face of an economic downturn, there should be a fiscal stimulus--the 
debate was only over how to design the most effective stimulus--the IMF 
was seen as pushing for contractionary policies. The question is being 
asked everywhere, why? The asymmetries associated with trade 
liberalization of the past have increasingly come to be a source of 
resentment, and recent actions in steel have only heightened a 
perception of hypocrisy. The European initiative of unilaterally 
eliminating trade barriers for the poorest countries (``Everything but 
arms'') is one of the few positive developments, but the United States, 
by failing to take corresponding actions, is increasingly losing 
standing. Unless the United States does something, both to ensure that 
the IMF pursues policies which are more in accord with the economic 
well-being of the developing countries, and especially the poor in 
those countries, and to ensure that there are movements toward a more 
balanced trade agenda, it is hard to see a renewal of the kind of 
growth in exports to these countries that has played such an important 
role in our own country's growth in the future. (There are even more 
important consequences for global economic and political stability.)
    We won World War II, but we also won the Peace that followed. The 
Marshall Plan was not only magnanimous, but it also won lasting allies 
in the struggle for peace and democracy. We stand on the threshold of 
winning the War against terrorism, but will we win the Peace? Though 
the link between terrorism and poverty is complicated, this much is 
clear: Unemployment and poverty, especially among young males, provide 
fertile feeding grounds. The United States has neither provided aid nor 
trade; among the major more advanced developed countries, it is the 
stingiest in providing assistance to the less developed. The contention 
that aid does not work is simply wrong, and those who assert this must 
neither have looked at the evidence nor gone into the field. I have 
seen aid work: Small irrigation projects that double or triple the 
incomes of desperately poor, education projects that have brought 
literacy and meaning to those who otherwise would not have had it, 
health projects eradicate river blindness and other diseases that have 
plagued some of the poorest countries of the world. Statistical studies 
at the World Bank have shown that aid, when appropriately directly, has 
significant effects in increasing growth and reducing poverty. To be 
sure, not every dollar of aid is well spent, but the same thing could 
be said for any other category of expenditures, whether in the public 
or the private sector. The Monterey meeting in Mexico on finance for 
development is an occasion on which we could make a commitment both to 
increased assistance and to explore innovative ways of helping the 
developing countries more. It is our moral duty; it is also in our 
self-interest.
    The continuing large trade deficit of the United States represents 
a potential source of instability, not only for the United States, but 
also for the world. If an objective outsider were to conduct the kind 
of review of the U.S. economy that is regularly conducted for other 
countries around the world, the grades would be mixed: The abysmally 
low savings rate, the high trade deficit, the worsening fiscal 
situation. The problems are all related, and the prospects are that 
some could even get worse in the short run. The reason that we have a 
large trade deficit, as I noted, in part is due to the strong dollar. 
As in the early 1980's, a large tax cut has led to a massive worsening 
of the fiscal situation. The trade deficit is simply the difference 
between what we invest and what we save. National savings (including 
public savings) has gone down from what it otherwise would have been. 
The trade deficit would have been even worse, were it not that 
investment too has gone down. But when our economy recovers, investment 
will increase, and with it there is a good chance that the trade 
deficit will worsen. We should be clear: It is not protectionist 
policies abroad or unfair trade practices that have caused our 
problems, whether they get reflected in the steel industry, the 
automobile industry, or elsewhere; it is our overall macroeconomic 
framework I suspect the full adverse affects of the tax cut are yet to 
be felt.

Addressing the Sources of Our Current Problem
    If we are to formulate policies aimed at enhancing the strength of 
the economy in the middle to long run, we must understand better the 
sources of our current downturn, of the massive underperformance of the 
U.S. economy. While every boom comes to an end, there are lessons to 
each. Earlier booms and the busts that followed taught us the dangers 
of inflation, and of the Fed stepping too hard on the brakes to stop 
inflation. We have learned the dangers of excessive inflation; and 
inflation was not the cause of the current downturn. The recession of 
1991 can 
ultimately be traced back to weaknesses in the financial sector, those 
in turn in part to the excessive deregulation of the 1980's. I am not 
sure that we have learned those lessons, or the lessons of the 
excessive exuberance of the late 1990's.
    In some ways, it is a familiar pattern: Deregulation in a sector 
(here telecommunications) leading to excessive investment in that 
sector--in this case the problems exacerbated by breathtaking 
technological developments and deregulation in the financial sector. 
The Glass-Steagall Act was concerned with the problems raised by 
conflicts of interest. It was foolhardy to think that such behavior 
would not reappear with its repeal.
    At the time I served on the Council of Economic Advisers, we raised 
strong concerns about conflicts of interest and problems in accounting 
standards and practices, particularly as they related to derivatives 
and options. Our concerns have proved to be on the mark. There were 
others who raised similar concerns. Arthur Levitt, of course, was right 
in calling attention to the conflicts of interest in the accounting 
firms, when they simultaneously provide consulting services. FASB 
called for a changing of accounting practices to more accurately 
reflect the costs of options given to executives. And I strongly 
agreed. The Secretary of the Treasury and the Secretary of Commerce, 
however, violated basic principles of good governance, which call for 
the independence of FASB, and intervened to squash the proposed 
revisions. They succeeded.
    I have devoted much of my academic life to the economics of 
information, and to the consequences of imperfections of information. 
The proposed revisions would have improved the quality of information. 
To be sure, some firms' economic prospects might have looked worse as a 
result, and its stock market price might have fallen as a result--as 
well it should. It was inevitable that a day of reckoning would come. 
Providing misleading information only delayed the day of reckoning, but 
worse, it led to a misallocation of resources, as overinflated stock 
prices led to the excessive investment which is at the root of the 
economic downturn.
    Some contend that it is difficult to obtain an accurate measure of 
the value of the options. But this much is clear: Zero, the implicit 
value assigned under current arrangements, is clearly wrong. And 
leaving it to footnotes, to be sorted out by investors, is not an 
adequate response, as the Enron case has brought home so clearly. At 
the Council of Economic Advisers, we devised a formula that represented 
a far more accurate lower bound estimate of the value of the options 
than zero. Moreover, many firms use formulae for their own purposes, in 
valuing stock options (charging them against particular divisions of 
the firm). However, Treasury, in its opposition to the FASB concerns, 
was singularly uninterested in these alternatives. I leave it to others 
to hypothesize why that might have been the case.
    If we are to have a stock market in which investors are to have 
confidence, if we are to have stock markets which avoids the kind of 
massive misallocation of 
resources that result when information provided does not accurately 
report the true condition of firms, we must have accounting and 
regulatory frameworks that address these issues. As derivatives and 
other techniques of financial engineering become more common, these 
problems too will become more pervasive. While headlines and 
journalistic accounts describe some of the inequities--those who have 
seen their pensions disappear as corporate executives have stashed away 
millions for themselves--what is also at stake is the long run well-
being of our economy. The problems of Enron and Global Crossing are 
part and parcel of the current downturn.

Energy Policy
    There is a widespread agreement among economists that GDP does not 
provide a good measure of economic well-being. We should, at the very 
least, take account of the degradation of the environment and natural 
resources. Bad information systems can lead to bad decisionmaking (as 
we have seen recently in the corporate world.) Nowhere is this more 
true than in energy policy. Extraction of oil and natural gases may 
increase our measured GDP, but it does not increase our economic well-
being commensurately. We should take account of the depletion of our 
resource basis, and the degradation of our environment as a result of 
carbon emissions. An energy policy which focuses on ``drain America 
first'' is not even good for long-run national security, for it leaves 
us potentially more vulnerable in the future. Long run economic growth 
(correctly measured) and long-run political strength both suggest that 
we should focus more on conservation. And basic principles of economics 
suggest that what is required is incentives, carrots and sticks. Why 
should we think that moral suasion would be more effective in this 
arena than it is in any other area of economic activity?

Social Security
    I want to conclude with a few remarks about one of our long-term 
problems, our Social Security program. Our Social Security program has 
been an enormous success. We have brought the elderly out of poverty, 
and we have provided a new measure of economic security to the aged. 
Transactions costs are low. Improvements in the design of the program 
over the years have reduced some of the unintended inequities, reduced 
any adverse effects it might have on labor supply, and increased 
overall efficiency. There is still a way to go to put it on sound 
financial grounds.
    Economics is traditionally described as the science of choice. The 
legacy of the Clinton years, a huge fiscal surplus, provided us with an 
opportunity to make some choices. We could have used some of these 
funds to put the Social Security system on sound financial grounds. We 
could have fully funded the system, and we could have then decided on 
how to proceed in the future. We have largely squandered that 
opportunity. Proposals for partial privatization typically leave the 
fiscal situation of our Social Security worse off. They do not provide 
additional funds to fill in the 
gap; some proposals simple force current and future beneficiaries to 
take a cut in 
benefits. Any reform proposal which does not begin by addressing the 
question of how current unfunded liabilities are to be financed is 
irresponsible, and should be a nonstarter.
    Elsewhere, with Peter Orszag, I have described at greater length 10 
myths concerning Social Security that have been widely circulated. One 
that has recently received considerable attention is the low return on 
Social Security accounts. We should be clear: Social Security funds are 
invested well, but conservatively. To the extent that capital markets 
work efficiently, then any higher returns that might be received would 
simply reflect the higher risk. It is imprudent for those approaching 
retirement to invest all, or even most, of their assets in high-risk 
investments. If there were a decision to undertake greater risk, the 
public Social Security system could do so, again at low transaction 
costs. (The transaction costs in the privatized part of the British 
system have been estimated to reduce benefits by 40 percent from what 
they otherwise would have been!)
    Part of the reason that in partial pay-as-you go Social Security 
systems, it appears that returns are low is that some of the returns 
are used to bear the costs of the unfunded liabilities. The problem of 
funding those unfunded liabilities does not go away with partial or 
complete privatization. It will have to be borne elsewhere. To assess 
the merits of any reform proposal, therefore, one must know how, and 
who, will bear these costs. To do otherwise is dishonest. It may put in 
jeopardy the long-run prospects of our economy, for a day of reckoning 
will come.
Concluding Remarks
    I continue to believe that the basic fundamentals of the U.S. 
economy remain strong. But I have seen the fortunes of countries change 
quickly, as a result of economic mismanagement. The decisions, the 
choices, we make today will affect not only economic performance during 
the next year, but also our long-run prospects. I believe that the tax 
cut that was enacted last spring was based on a serious miscalculation 
of our economic situation. It is a decision which, however, is 
reversible. If we do not revisit the issue, in the light of the new 
information which has come to light and the new situation which has 
evolved, the damage which could be done may itself be irreversible--or 
at least it will take a long time to undo. It will take political 
courage. Much is at stake.

                 PREPARED STATEMENT OF ALAN B. KRUEGER
         Bendheim Professorship in Economics and Public Affairs
              Professor of Economics, Princeton University
                             March 12, 2002

    Good morning, Mr. Chairman and distinguished Members of the Senate 
Banking, Housing, and Urban Affairs Committee. My name is Alan Krueger 
and I hold the Bendheim Professorship in Economics and Public Affairs 
at Princeton University. I appreciate the opportunity to share my views 
on recent economic developments, particularly as they relate to the 
labor market.

The Labor Market Situation and Short-Term Outlook
    Although some debate the exact meaning of the subjective definition 
commonly used to define a recession, there is little doubt that the 
labor market started to turn down in the beginning of 2001, and that 
March 2001--the official beginning of the recession according to the 
National Bureau of Economic Research--marked a turning point. After 
reaching a 30 year low of 3.9 percent in April 2000, the unemployment 
rate fluctuated in a narrow range between 3.9 and 4.1 percent for the 
remainder of 2000, amid signs that economic growth was weakening.\1\ 
The unemployment rate increased from 4.3 percent in March 2001 to 4.9 
percent in August 2001, and reached a recent peak of 5.8 percent in 
December 2001. The rate fell to 5.6 percent in January and fell again 
in February to 5.5 percent.
---------------------------------------------------------------------------
    \1\ All reported estimates are seasonally adjusted, unless stated 
otherwise.
---------------------------------------------------------------------------
    Because, other things being equal, the unemployment rate increases 
when the 
discouraged workers decide to actively search for work, economists 
often prefer to 
examine employment growth from the establishment survey, and the 
employment-to-population rate from the household survey, in addition to 
the unemployment rate. These data tell a similar story. The employment-
to-population rate reached an all-time high of 64.8 percent in April 
2000, stood at 64.3 percent in March 2001, and fell to 63.4 percent as 
of August 2001. The employment rate continued to fall to 62.6 percent 
in January 2002, and increased to 63.0 percent in the latest employment 
report, which pertains to February 2002. Unlike the unemployment rate, 
the employment rate fell in January 2002, suggesting that the 
improvement in the un- 
employment rate that month resulted from labor force withdrawal rather 
than an 
increased rate of job finding. In February, the small decline in the 
unemployment rate and the rise in the employment rate both pointed in 
the same direction.
    Total payroll employment peaked at 132.7 million jobs in March 
2001, and was down to 132.4 million in August 2001. It fell to 131.2 
million in January 2002, and increased by 66,000 in February, an amount 
that is close to the average monthly absolute revision to the series. 
(The January and February figures are preliminary and subject to future 
revisions.) In the 11 months since March 2001, the month the recession 
began, total employment has fallen by 1.4 million jobs. Private sector 
employment is down by 1.8 million jobs in this period. By comparison, 
11 months after the 1991 recession began, private sector employment was 
down 1.5 million jobs, and total employment was also down 1.5 million 
jobs. So, looking over a comparable 
interval, job destruction was somewhat greater in the private sector in 
the latest 
recession than in the previous one. Employment continued to drift 
downward after the recovery began in March 1991, and reached bottom in 
February 1992, with private sector employment down a total of 1.8 
million jobs from the peak and total employment down 1.6 million from 
the peak.
    The latest GDP news suggests that the economy began to turn around 
late in 2001 and that the recession likely has ended. I think it will 
take more months of data before one can reach the conclusion that the 
labor market has reached bottom and is on the upswing, however. I also 
suspect that employment growth will remain sluggish for a time to come, 
especially for the less skilled. Employment and unemployment tend to be 
lagging indicators when the economy begins to improve. This point was 
made by Alan Greenspan in his prepared testimony before the House 
Committee on Financial Services on February 27. ``Even if the economy 
is on the road to recovery,'' he said, ``the unemployment rate, in 
typical cyclical fashion, may resume its increase for a time.''
    Historically, the lingering effects of high unemployment in the 
first stages of a recovery tend to be concentrated among the less 
skilled and minorities. This seems to be the case despite the fact that 
recessions are becoming more egalitarian in terms of who they affect.
    Such a pattern was clearly evident in the early 1990's. When the 
recession officially ended in March 1991, the unemployment rate was 6.8 
percent. The rate continued to rise for another 15 months, however, and 
did not settle below 6.8 percent again until the end of 1993. Moreover, 
the unemployment rate rose from 12.3 to 13.5 percent for high school 
dropouts in the year after the recession ended, while for college 
graduates it held steady at 2.9 percent. The ``jobless recovery'' 
mainly involved the less skilled.
    The current recession started out in a very unusual fashion. As the 
following table makes clear, from March to July of 2001, unemployment 
rose more for college graduates and those with some college education 
than it did for high school dropouts. Since July, however, unemployment 
has increased more for high school dropouts and high school graduates 
than for more highly educated workers, as is the usual pattern in a 
downturn. It is also worth noting that the unemployment rate ticked up 
for those with a high school degree or less last month, despite falling 
overall.

                           Table 1: Seasonally Adjusted Unemployment Rate by Education
                                                Age 25 and Older
----------------------------------------------------------------------------------------------------------------
                            Education                               March 2001       July 2001     February 2002
----------------------------------------------------------------------------------------------------------------
Less than High School...........................................    6.8 percent     6.8 percent     8.3 percent
High School.....................................................    3.8 percent     4.1 percent     5.3 percent
Some College....................................................    2.7 percent     3.1 percent     4.1 percent
BA or higher....................................................    1.9 percent     2.2 percent     2.9 percent
----------------------------------------------------------------------------------------------------------------
Source: Bureau of Labor Statistics.

    A similar picture holds by race. From March to July of 2001 the 
unemployment rate increased from 3.7 to 4.1 percent for whites, and, 
uncharacteristically, fell from 8.4 to 8.1 percent for blacks. From 
July 2001 to February 2002, however, the rate increased from 8.1 to 9.6 
percent for blacks, and increased more moderately, from 4.1 to 4.9 
percent, for whites. The unemployment rate for Hispanics was also 
uncharacteristically stable in the beginning of the recession (standing 
at 6.2 percent in March and July), and then increased sharply to 8.1 
percent by January 2002, before quixotically falling by a percentage 
point in February.
    The broad nature of the first phase of the latest recession came as 
a surprise, but is consistent with the more-than-usual egalitarian tilt 
to the early 1990's recession, and probably resulted from the plunge in 
capital investment that apparently precipitated the downturn, the 
implosion of many dot-coms, and the fact that the cyclically sensitive 
manufacturing sector is much more skill intensive than it was 20 or 30 
years ago. In any event, it is likely that the egalitarian phase is 
over.
    There are many theoretical reasons to suspect that job growth would 
be slow at the beginning of the recovery.
    First, at the beginning of a recovery employers are not sure if 
improved conditions will persist, so they expand work hours rather than 
hire new employees.
    Second, many employers also ``hoard'' skilled workers (for example, 
particularly those with specific training) during a recession because 
if they let them go it would be costly to hire and train replacements 
when conditions improve. Neither of these reasons, however, accounts 
for why job growth is particularly sluggish for the less skilled when 
the economy begins to turnaround, which seems to regularly occur. In 
fact, because of labor hoarding of skilled workers one might expect 
that employers are relatively ``overstaffed'' with skilled workers when 
the recession ends, and would therefore be less likely to hire skilled 
workers.
    Third, as Melvin Reder suggested in a 1955 article, in a downturn 
many employers raise skill requirements for a given job, rather than 
cut pay.\2\ ``Upskilling'' of positions is common in a recession and 
probably at the beginning of a recovery as well. Consequently, the less 
skilled find their job options even more limited until demand picks up 
smartly, while skilled workers take positions further down the job 
ladder.
---------------------------------------------------------------------------
    \2\ See Melvin W. Reder, ``A Theory of Occupational Wage 
Differentials,'' American Economic Review 45(5), 1955, pp. 833-52.
---------------------------------------------------------------------------
    Finally, Lawrence Katz of Harvard suggests another reason: ``Think 
of a recession as a time when firms reorganize.'' Reorganization tends 
to increase demand for skilled workers, who are more flexible, over 
less skilled workers. Furthermore, when companies introduce new 
technology as part of a reorganization they tend to hire skilled 
workers to operate the equipment and release unskilled workers whose 
jobs are made redundant.
    To some extent, the lingering pattern of unemployment, especially 
among the less skilled, after growth resumes is probably inadvertently 
reinforced by interest rate cuts by the Federal Reserve. With a lag, 
rate cuts stimulate demand for new capital and consumer durables. But 
this is a two-edge sword for workers. On the one hand, a general rise 
in economic activity increases the demand for all factors of 
production, including workers. On the other hand, because machinery is 
cheaper than it used to be, in many industries companies replace some 
workers with machines, or hire fewer workers than they otherwise would 
have, because the machines can do the work at lower cost.
    Also notice that capital--especially high-tech equipment--and 
skilled labor are generally considered complementary inputs in 
production, while capital and unskilled workers are substitutes.\3\ In 
other words, high skilled workers are hired to operate and service the 
new machines, while less skilled workers are let go because the 
machines can do their work.
---------------------------------------------------------------------------
    \3\ For a survey of evidence on capital-skill complementarity, see 
Daniel Hamermesh, Labor 
Demand, Princeton University Press, 1996. For evidence on high-tech 
equipment and skill up- 
grading see David Autor, Lawrence Katz, and Alan Krueger, ``Computing 
Inequality: Have 
Computers Changed the Labor Market?'' Quarterly Journal of Economics, 
113(4), November 1998, pages 1169 -1213.
---------------------------------------------------------------------------
    This leads me to the conclusion that the best way to avoid another 
``jobless recovery'' is by stimulating demand for less skilled workers 
and by raising the skills of the unemployed. I think the interest rate 
cuts and the recently passed accelerated depreciation allowance will 
stimulate demand for more highly skilled workers. In looking forward, I 
would recommend policies that would increase employment of less skilled 
labor, such as job training.
    Another important aspect of the labor market concerns wages. Table 
2 (at the end of this testimony) reports real hourly wages by decile of 
the wage distribution each year since 1973 based on Current Population 
Survey Data.\4\ As is well-known, real wages fell considerably for 
lower paid workers from 1979 to the mid-1990's. (This table uses the 
BLS's new research series CPI to deflate wages, so the decline in real 
wages in the 1980's was not as great as it is with the conventional CPI 
deflator.) Real wage growth was very strong after 1996, however. 
Notably, most of the ground that was lost for those at the bottom in 
the 1979-95 period was regained in the last 5 years. The weakest wage 
growth in the last decade was for those in the middle of the 
distribution, a phenomenon that I previously called ``the sagging 
middle.''
---------------------------------------------------------------------------
    \4\ These data were kindly provided by Jared Bernstein.
---------------------------------------------------------------------------
    Most research finds that real wages have moved slightly 
procyclically since 1970, although I agree with Katharine Abraham and 
John Haltiwanger that ``the cyclicality of real wages is not likely to 
be stable over time.'' \5\ The exceptionally low unemployment in the 
late 1990's, combined with two minimum wage increases, spurred the 
impressive wage growth in the second half of the 1990's, especially for 
the least paid workers.\6\ In the latest downturn, nominal wage growth 
slowed down, but inflation slowed even more, so real wages continued to 
grow.\7\ This factor has probably bolstered consumer spending, which 
was surprisingly robust during the downturn.
---------------------------------------------------------------------------
    \5\ Abraham, Katherine and John Haltiwanger. 1995. ``Real Wages and 
the Business Cycle.'' Journal of Economic Literature 33, no. 3, pp. 
1215-64.
    \6\ See, e.g., Lawrence Katz and Alan Krueger, ``The High-Pressure 
U.S. Labor Market of the 1990's,'' Brookings Papers on Economic 
Activity. 1999:1, pp. 1-87.
    \7\ See Jared Bernstein, ``What Drove Low Wages Up in the 1990's?'' 
Mimeo., Economic Policy Institute, 2002.
---------------------------------------------------------------------------
    A rising tide continues to lift all boats, and the late 1990's 
provides ample evidence that strong economic growth greatly helps all 
segments of society. But the 
effect of a rising tide on employment does not appear to occur 
immediately. In the early 1990's, weak employment growth lingered long 
after the national economic tide began to rise. Moreover, research 
suggests that a given change in economic conditions has a more gradual 
effect on labor demand in a recovery than in a recession.\8\ As Edward 
F. McKelvey, a Senior Economist at Goldman Sachs observed after the 
latest unemployment report, ``It would be premature to say that there 
is going to be heavy net hiring soon.''
---------------------------------------------------------------------------
    \8\ See James R. Hines, Hilary Hoynes, and Alan B. Krueger. 
``Another Look at Whether a Rising Tide Lifts All Boats,'' The Roaring 
Nineties: Can Full Employment Be Sustained, edited by Alan B. Krueger 
and Robert Solow, New York: Russell Sage and Century Fund, 2001.
---------------------------------------------------------------------------

Unemployment Insurance
    Because I expect unemployment to linger at relatively high levels 
in the beginning of the recovery, I think it is important and 
appropriate that last week both Houses of Congress passed, and the 
President signed, a bill to extend unemployment insurance (UI) benefits 
for an additional 13 weeks.
    But I think recent history highlights the importance of making 
additional reforms to make unemployment insurance a more efficient and 
more effective automatic stabilizer. First, the automatic triggers that 
temporarily turn on extended benefits without Congressional action 
should be set at more realistic levels. The State triggers are 
connected to the insured unemployment rate; that is, the fraction of 
covered workers who receive benefits. The insured unemployment rate 
must exceed 5 percent for extended benefits to be provided, and must be 
120 percent above the rate in the corresponding period in each of the 
prior 2 calendar years. Because insured unemployment has drifted down 
relative to the BLS's total unemployment rate, and because the natural 
rate of unemployment has declined, it is very unlikely that a State 
will automatically trigger extended benefits. In practice, the 
automatic triggers have become beyond reach, and we rely on Congress to 
vote for extended benefits during a downturn.
    It should not be necessary for Congress to have to agree to ad hoc 
extended UI benefits when it is clear that the economy has deteriorated 
in a specific region. Realistic automatic triggers would be much more 
expedient and more efficient. Funds would be saved if extended benefits 
were more closely targeted to specific States experiencing severe 
economic distress, rather than applied nationwide. Furthermore, if 
extended benefits turned on more quickly in contracting areas, 
consumption would be smoothed and the downturn would be less severe.
    Second, the financing of UI could do more to stabilize the economy 
and discourage layoffs. To pay for benefits, the UI system builds up 
reserves during prosperous times and draws them down during slack 
times. A common measure of the health of trust funds is the reserve 
ratio: The ratio of accumulated trust fund balances to annual payroll. 
A higher reserve ratio provides more protection in an economic 
downturn.
    Unfortunately, the UI reserve fund in several States--most notably, 
New York and Texas--were quite low even before September 11.\9\ Phillip 
B. Levine, an economist at Wellesley College, calculates that to remain 
solvent through a severe recession, like the one experienced in the 
early 1980's, unemployment insurance funds would require a reserve 
ratio of at least 1.25 percent.\10\ Using this standard, 16 States were 
at risk of insolvency in a severe recession based on their reserve 
funds as of the first quarter of 2001. In New York the reserve ratio 
was 0.28 percent and in Texas it was 0.22 percent.
---------------------------------------------------------------------------
    \9\ See Alan B. Krueger, Economic Scene; ``Now is the time to 
reform unemployment insurance--before it is really needed.'' The New 
York Times, January 4, 2001, p. B2.
    \10\ Phillip B. Levine, ``Cyclical Welfare Costs in the Post-Reform 
Era: Will There Be Enough Money?'' Mimeo., Wellesley College, December 
28, 2000.
---------------------------------------------------------------------------
    This predicament arose because many States did not build up their 
funds during the 1990's, and because experience rating--that is, the 
extent to which a business's payments increase with its past record of 
laying off workers--is poorly implemented. If the funds become 
insolvent, they will borrow from the Federal Government at close to 
market rates, and probably tighten eligibility standards to stem the 
shortfall. I would recommend considering that the States be required to 
implement real experience rating and maintain ample fund balances 
within 3 years (for example, after the economy improves sufficiently). 
This would shore up the long-run financing of the State programs. In 
addition, a study by Phillip B. Levine and David Card of U.C. Berkeley 
estimates that the unemployment rate would decline by six-tenths of a 
percentage point if industries were fully experience rated--that is, if 
employers in an industry were required to pay the full additional costs 
of unemployment benefits for layoffs in that industry.\11\
---------------------------------------------------------------------------
    \11\ David Card and Phillip B. Levine, ``Unemployment Insurance 
Taxes and the Cyclical and Seasonal Properties of Unemployment,'' 
Journal of Public Economics, vol. 53, February 1994.
---------------------------------------------------------------------------
    The Federal Government sets minimum standards for State 
unemployment insurance programs and has a history of encouraging 
experience rating. This is a unique aspect of the American system of 
UI, and may in part help to account for the 
relatively low unemployment in the United States compared to other 
economically 
advanced countries. Better experience rating could be accomplished by 
increasing the 5.4 percent maximum tax rate on high-layoff employers, 
and by requiring the States to have at least 10 different rates. Some 
States currently only have two rates: 0 or 5.4 percent. In addition, I 
would recommend that the per employee taxable earnings cap--which range 
from $7,000 to $10,000 in most States--be raised, which would allow 
better experience rating at lower tax rates and make the financing of 
the program less regressive. Raising the caps and lowering the rates 
would also increase demand for less skilled workers. Improved 
experience rating would discourage employers from laying off workers, 
and help to internalize the externalities layoffs impose on society.
    Third, unemployed workers who are otherwise eligible for UI but are 
searching for a part-time job (that is, because of family obligations) 
are ineligible for benefits in most States. These workers pay into the 
system, but they are prevented from receiving benefits. States could be 
required to expand eligibility. Workers who would be made eligible for 
UI benefits as a result of this reform would be primarily single-
parent, female, and low-income workers.
    I realize that Congress is likely to be reluctant to make 
additional changes to UI having just voted to expand benefit payments, 
but perhaps a commission could be established to study longer-term 
issues in UI, including the automatic triggers, 
financing, and eligibility requirements of the State programs.

Conclusion
    Since the summer of 2001 the downturn has looked more like a 
typical downturn, with the labor market softening more for the less 
skilled and minorities than for highly educated, white workers. 
Recessions typically last longer and are more severe for the less 
skilled and minorities. Job growth early in a recovery is typically 
weaker for these groups as well. My guess is that the typical pattern 
will continue in the near future, but I have to confess a great deal of 
uncertainty as the recession initially was unusual in terms of the 
breadth of groups of workers affected. Additionally, the temporary help 
sector is much larger than it was in the early 1990's, and it is 
possible that employment adjustment over the business cycles will be 
quicker because the option of hiring from temporary help firms enhances 
labor market flexibility.\12\ If this is the case, employment growth on 
the upswing may not lag economic growth as much as it has in the past. 
Nevertheless, it is probably more likely than not that higher 
unemployment will linger for less skilled and minority workers in the 
beginning of the recovery--and such a process has already begun if the 
recession ended in the fourth quarter of 2001.
---------------------------------------------------------------------------
    \12\ See, e.g., Lawrence Katz and Alan Krueger, ``The High-Pressure 
U.S. Labor Market of the 1990's. Brookings Papers on Economic Activity. 
1999:1, pp.1-87.
---------------------------------------------------------------------------
    To have a balanced recovery I would argue that policy has to be 
balanced as well. Fiscal and monetary policies are in place to lower 
the costs of capital and stimulate growth. Because of the phenomenon of 
capital-skill complementarity, this will likely increase demand for 
employment of skilled workers and reduce demand for employment of less 
skilled workers in the future. Policies are also in place (that is, 
extended UI benefits) to maintain consumption. To the extent that 
further policy initiatives are sought to stimulate job growth, I would 
expect that policies geared to stimulate demand for hiring less skilled 
workers would be most effective. Such policies could include job 
training, the Targeted Jobs Tax Credit, and a temporary reduction of 
payroll taxes. But I think it is also important to recognize that there 
will be pressures on the Federal budget as the baby boom cohort retires 
because of Medicare and Social Security commitments, so policies to 
address short-run cyclical adjustments should be careful not to weaken 
the long-run budget outlook.

                          Table 2: Real Hourly Wages by Decile of the Wage Distribution
                                             (2000 Dollars)--DECILE:
----------------------------------------------------------------------------------------------------------------
              Year                  1        2        3        4        5        6        7        8        9
----------------------------------------------------------------------------------------------------------------
1973...........................    $6.03    $7.28    $8.65   $10.06   $11.53   $13.23   $15.36   $17.57   $22.07
1974...........................     5.96     7.15     8.49     9.83    11.26    12.96    15.02    17.31    21.84
1975...........................     5.80     7.09     8.38     9.72    11.27    13.13    14.86    17.31    21.86
1976...........................     6.25     7.26     8.44     9.76    11.34    13.20    15.13    17.59    22.11
1977...........................     6.18     7.16     8.36     9.72    11.40    13.09    15.19    17.95    22.02
1978...........................     6.27     7.40     8.62    10.05    11.77    13.50    15.59    18.42    23.09
1979...........................     6.55     7.47     8.77    10.32    11.68    13.53    16.00    18.65    22.90
1980...........................     6.19     7.32     8.59     9.97    11.55    13.43    15.59    18.47    22.62
1981...........................     6.29     7.17     8.54     9.76    11.26    13.31    15.52    18.30    22.66
1982...........................     6.06     7.06     8.44     9.82    11.44    13.35    15.72    18.52    22.93
1983...........................     5.87     6.93     8.27     9.69    11.38    13.27    15.89    18.41    23.29
1984...........................     5.74     6.97     8.22     9.67    11.45    13.31    15.78    18.78    23.64
1985...........................     5.65     7.04     8.28     9.70    11.56    13.47    15.69    18.92    23.44
1986...........................     5.64     7.21     8.52    10.05    11.78    13.83    16.19    19.13    24.17
1987...........................     5.62     7.15     8.55    10.12    11.78    14.01    16.13    19.17    24.62
1988...........................     5.63     7.10     8.50    10.12    11.71    13.92    16.22    19.35    24.81
1989...........................     5.62     6.99     8.38    10.02    11.64    13.60    16.18    19.35    24.44
1990...........................     5.70     7.06     8.47     9.98    11.63    13.48    15.99    19.24    24.55
1991...........................     5.81     7.12     8.49     9.93    11.69    13.52    15.92    19.11    24.69
1992...........................     5.79     7.05     8.43     9.85    11.78    13.45    15.93    19.24    24.33
1993...........................     5.76     7.03     8.42     9.89    11.68    13.67    16.09    19.41    24.70
1994...........................     5.70     6.96     8.27     9.70    11.47    13.51    16.05    19.54    25.12
1995...........................     5.68     6.95     8.30     9.77    11.37    13.46    16.04    19.42    25.09
1996...........................     5.65     7.00     8.38     9.78    11.31    13.36    16.09    19.45    25.16
1997...........................     5.84     7.21     8.50     9.90    11.58    13.58    16.14    19.66    25.57
1998...........................     6.16     7.44     8.71    10.36    11.91    14.00    16.65    20.07    26.31
1999...........................     6.25     7.60     9.01    10.44    12.27    14.40    17.01    20.60    26.92
2000...........................     6.31     7.77     9.08    10.51    12.26    14.51    17.19    20.91    27.50
2001...........................     6.51     7.85     9.36    10.73    12.52    14.65    17.46    21.14    28.25
----------------------------------------------------------------------------------------------------------------
Source: Economic Policy Institute analysis of CPS data.
Note: Hourly wages were deflated by the BLS Research Series CPI deflator.



















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