[House Hearing, 110 Congress]
[From the U.S. Government Publishing Office]


 
                  A WEAKENED ECONOMY: HOW TO RESPOND?

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

                                HEARING

                               before the

                        COMMITTEE ON THE BUDGET
                        HOUSE OF REPRESENTATIVES

                       ONE HUNDRED TENTH CONGRESS

                             SECOND SESSION

                               __________

           HEARING HELD IN WASHINGTON, DC, SEPTEMBER 9, 2008

                               __________

                           Serial No. 110-39

                               __________

           Printed for the use of the Committee on the Budget


                       Available on the Internet:
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                        COMMITTEE ON THE BUDGET

             JOHN M. SPRATT, Jr., South Carolina, Chairman
ROSA L. DeLAURO, Connecticut,        PAUL RYAN, Wisconsin,
CHET EDWARDS, Texas                    Ranking Minority Member
JIM COOPER, Tennessee                J. GRESHAM BARRETT, South Carolina
THOMAS H. ALLEN, Maine               JO BONNER, Alabama
ALLYSON Y. SCHWARTZ, Pennsylvania    SCOTT GARRETT, New Jersey
MARCY KAPTUR, Ohio                   MARIO DIAZ-BALART, Florida
XAVIER BECERRA, California           JEB HENSARLING, Texas
LLOYD DOGGETT, Texas                 DANIEL E. LUNGREN, California
EARL BLUMENAUER, Oregon              MICHAEL K. SIMPSON, Idaho
MARION BERRY, Arkansas               PATRICK T. McHENRY, North Carolina
ALLEN BOYD, Florida                  CONNIE MACK, Florida
JAMES P. McGOVERN, Massachusetts     K. MICHAEL CONAWAY, Texas
NIKI TSONGAS, Massachusetts          JOHN CAMPBELL, California
ROBERT E. ANDREWS, New Jersey        PATRICK J. TIBERI, Ohio
ROBERT C. ``BOBBY'' SCOTT, Virginia  JON C. PORTER, Nevada
BOB ETHERIDGE, North Carolina        RODNEY ALEXANDER, Louisiana
DARLENE HOOLEY, Oregon               ADRIAN SMITH, Nebraska
BRIAN BAIRD, Washington              JIM JORDAN, Ohio
DENNIS MOORE, Kansas
TIMOTHY H. BISHOP, New York
GWEN MOORE, Wisconsin

                           Professional Staff

            Thomas S. Kahn, Staff Director and Chief Counsel
                 Austin Smythe, Minority Staff Director


                            C O N T E N T S

                                                                   Page
Hearing held in Washington, DC, September 9, 2008................     1

Statement of:
    Hon. John M. Spratt, Jr., Chairman, House Committee on the 
      Budget.....................................................     1
    Hon. Paul Ryan, ranking minority member, House Committee on 
      the Budget.................................................     2
    Hon. Adrian Smith, a Representative in Congress from the 
      State of Nebraska, prepared statement of...................     3
    Lawrence H. Summers, Charles W. Eliot university professor, 
      Harvard University.........................................     4
        Prepared statement of....................................     7
    Allen Sinai, Ph.D., chief global economist, Decision 
      Economics, Inc.............................................     8
        Prepared statement of....................................    13
    David W. Kreutzer, Ph.D., senior policy analyst in energy 
      economics and climate change, Center for Data Analysis, the 
      Heritage Foundation........................................    27
        Prepared statement of....................................    29


                  A WEAKENED ECONOMY: HOW TO RESPOND?

                              ----------                              


                       TUESDAY, SEPTEMBER 9, 2008

                          House of Representatives,
                                   Committee on the Budget,
                                                    Washington, DC.
    The committee met, pursuant to call, at 2:03 p.m., in Room 
210, Cannon House Office Building, Hon. John Spratt [chairman 
of the committee] presiding.
    Present: Representatives Spratt, DeLauro, Edwards, Cooper, 
Schwartz, Kaptur, Becerra, Doggett, Blumenauer, Scott, 
Etheridge, Baird, Moore of Kansas, Bishop, Ryan, Barrett, 
Bonner, Hensarling, Conaway, Campbell, Tiberi, Porter, 
Alexander and Smith.
    Chairman Spratt. Welcome to the Budget Committee and 
today's hearing on our weakening economy and what productive 
steps we can take to avoid a full-fledged recession and pump up 
near-term growth.
    We are pleased to have a panel that includes Dr. Larry 
Summers, the former Secretary of the Treasury and currently 
Charles Eliot University Professor at Harvard; Allen Sinai, 
President and Chief Economist at Decision Economics; and, 
finally, David Kreutzer, Senior Policy Analyst at the Heritage 
Foundation.
    Today, CBS has released this update, it is like the 
consensus forecast, that shows a dim outlook on the economy and 
the budget. On Friday, we received the latest jobs data. We 
show unemployment at a 5-year high, 6.1 percent. And, over the 
weekend, concerns about the housing and financial markets 
caused the government to take radical steps to control Fannie 
Mae and Freddie Mac, the secondary market firms that buy three-
quarters of all new mortgage loans made in this country.
    Nearly 7 months ago, in response to clouds gathering on the 
economy's horizon, the Congress passed and the President signed 
a $152 billion stimulus package of tax rebates for households 
and businesses. Our personal consumption and economic growth 
appear to have picked up as a result.
    A ticker tape of economic distress signals continues to 
play out, suggesting that, helpful as it may have been, the 
stimulus may also have not been enough. The worsening in 
housing, in jobs, inflation, the prospect that net exports may 
not bail us out if the economies of our trading partners 
continues to slow down and the shoes that keep dropping in the 
financial sector keep concerning us.
    While the economic statistics give us one measure of the 
economy, we need to keep in mind that the most important 
measure is Main Street America where the measure is clear, 
Americans are hurting economically in many different ways. And 
that is why we called this hearing, to consider what else, if 
anything, the Federal Government can do and how we can balance 
short-term assistance with fiscal responsibility.
    Boosting the economy and putting the budget back on track 
are closely linked. As OMB Director Jim Nussle himself noted 
today, the hike in the deficit from 2007 to 2008 is due 
primarily to a weakening economy, and the short-term cost of 
the bipartisan stimulus bill, which we passed to keep the 
economy from getting any worse, this and increased defense 
spending explain almost all the difference.
    We would like today to get a sense from our witnesses of 
how much more of an economic storm we have to weather. What are 
the most effective steps we can take to boost the economy, to 
raise consumer confidence, and to give relief to millions of 
hard-working Americans who continue to struggle?
    Before I turn to our panel of witnesses for their 
testimony, I would like to recognize Mr. Ryan, the ranking 
member, for his opening statement. Mr. Ryan.
    Mr. Ryan. I thank the chairman. I thank you also for having 
this hearing. It is well timed and something we need to be 
focused on, given we are not going to be in session much longer 
this year.
    This is an issue that demands our urgent attention, given 
the fact that we have a joblessness rate that is going up at an 
alarming pace. And so what we are finding here is that our 
economy is continuing to shed jobs, unemployment is increasing, 
Americans are paying more for food, energy, gas prices are 
high. We are finding the housing slump may not yet have reached 
its bottom, and we have an unprecedented bailout or 
conservatorship of Fanny and Freddie. Businesses are having, as 
a consequence, a very hard time getting access to credit.
    So I think the question that we ought to be asking 
ourselves as policymakers is are we going in the right 
direction with respect to economic policy? And I would argue 
the answer is no.
    We have a confluence of bad economic policy coming onto the 
American economy and the American people. You have got spending 
out of control here in Congress. The deficit just doubled in 
one year. Now some of those factors are outside of our control. 
But the question is, what are we doing here in Congress given 
that we have the power of the purse to do something about it? 
And the answer is, more spending out of this Congress and much 
higher taxes.
    That leads me to the second bad economic policy that is 
being committed here in Congress, higher taxes. And so you have 
Congress spending out of control. You have Congress passing 
budgets promising to raise taxes. Not just raise them here, not 
just raise them there, raise taxes on almost every aspect and 
factor of our economy: raising taxes on companies, raising 
taxes on small businesses, raising taxes on entrepreneurs, 
raising taxes on families with small children. These tax 
increases are putting an economic cloud over our economy.
    And we have loose monetary policy to boot. Loose monetary 
policy, which we know will have to inevitably be followed by 
tight monetary policy.
    So when we look out on the horizon, no wonder investors 
aren't investing. No wonder the investment horizon is 
uncertain.
    Congress not able to control spending, very high taxes 
coming into the economy, and a declared credit tightening and 
interest rate hikes from the Federal Reserve. So we have the 
confluence of bad macroeconomic policy in the form of bad 
fiscal policy, tight monetary policy, and Congress not only 
passing a budget to have the largest tax increase in American 
history followed by more spending but Congress not even 
following its own budget and spending--and passing even higher 
tax increases than even its budget calls for and higher 
spending increases. This is the direction this Congress is 
heading, the Nation's fiscal policy.
    This is not the direction that the American economy should 
go. The market is sending us these signals that we ought to get 
serious about controlling spending, serious about reforming 
entitlements, serious about keeping tax rates low so we can 
foster innovation and economic growth and, I would argue, more 
sound monetary policy so we can build that foundation for 
economic growth. Unfortunately, that is not the direction we 
are headed right now.
    Hopefully, the witnesses can give us a glimpse as to maybe 
a better path to take for this Congress and I await their 
testimony. I want to thank these three distinguished gentlemen 
for joining us here today.
    Chairman Spratt. Before returning to our panel, let me do a 
couple housekeeping details.
    I want to ask unanimous consent that all Members be allowed 
to submit an opening statement for the record at this point.
    [The statement of Mr. Smith follows:]

 Prepared Statement of Hon. Adrian Smith, a Representative in Congress 
                       from the State of Nebraska

    Good afternoon. There are a number of challenges facing our 
economy, and I thank you, Chairman, for holding this hearing today.
    We must rise to address our economic challenges in a bipartisan 
fashion. Rushing to a solution, however, could prove more costly than 
our current situation. We must not hamstring our economy by increasing 
taxes to pay for more federal spending, as has been suggested.
    It is important to create policies which will strengthen our 
economy and provide long-term stability for American taxpayers, and to 
promote economic policies which will foster sustained growth. An 
important component of that policy should be to strengthen foreign 
demand for our products, by aggressively pursuing new markets and 
breaking down barriers to trade.
    In addition, we must also work to lower energy prices. For too long 
we have grown ever more dependent on unreliable foreign sources of 
energy. There has been a lot of focus on reducing our energy 
consumption, but that is only a piece of the energy puzzle. I support 
efforts to increase the supply of all forms of energy right here at 
home in order to decrease high energy prices for all Americans.
    Chairman, I look forward to continuing to work with you to achieve 
real economic growth, and I thank you for your time.

    Chairman Spratt. I also want to say generically to all 
three witnesses that your statements have been received and 
will be made part of the record, and you can summarize as you 
see fit. Since we only have three of you today to testify, I 
would urge you to take your time and amplify your views, 
because we called you here to find out your best advice as to 
what the situation is and what we can best do about it.

    STATEMENTS OF LAWRENCE SUMMERS, PH.D., CHARLES W. ELIOT 
   UNIVERSITY PROFESSOR, KENNEDY SCHOOL, HARVARD UNIVERSITY, 
FORMER SECRETARY OF THE U.S. DEPARTMENT OF THE TREASURY; ALLEN 
SINAI, PH.D., CHIEF GLOBAL ECONOMIST, STRATEGIST AND PRESIDENT, 
  DECISION ECONOMICS, INC.; AND DAVID KREUTZER, PH.D., SENIOR 
 POLICY ANALYST IN ENERGY ECONOMICS AND CLIMATE CHANGE, CENTER 
           FOR DATA ANALYSIS, THE HERITAGE FOUNDATION

    Chairman Spratt. Dr. Summers, we will begin with you. Thank 
you for coming.

              STATEMENT OF LAWRENCE SUMMERS, PH.D.

    Dr. Summers. Thank you very much, Mr. Chairman, Mr. Ranking 
Member. I appreciate very much this opportunity to testify 
before this important committee at what I believe is a key 
juncture for economic policy.
    I want to address four questions in my testimony today. 
First, the current state of the American economy; second, I 
want to make the case for further fiscal stimulus; third, I 
want to address the question of fiscal stimulus in the context 
of the necessary commitment for long-term fiscal prudence; and, 
fourth, I will address and make some suggestions regarding the 
appropriate content of a fiscal stimulus program.
    First, with respect to the economy, my judgment, which I 
think is widely shared, is that the American economy remains in 
a highly uncertain state with very significant risks to the 
downside. Weak employment statistics, contracting credit, 
diminishing confidence, likely further declines in housing 
prices and a slowing global economy all place negative 
pressures on the American economy.
    Even after the current downturn ends and growth resumes, 
the economy will be producing output significantly short of its 
potential. Losses in output relative to potential are likely to 
cost the economy $300 billion a year or more, or more than 
$4,000 for the average family over the next year or two.
    Experience suggests that, even after downturns end, 
unemployment continues to increase. Indeed, unemployment peaked 
in our last business cycle nearly 2 years after the officially 
dated end of the recession.
    All of this suggests that the balance of risks is towards a 
contraction and will be for some time, with particular concern 
surrounding the possibility of a vicious cycle in which 
declining economic performance exacerbates financial strains 
which feed back towards the economy. This judgment, that it is 
contraction rather than overheating, which is always an 
uncertain judgment, appears a more secure one today than it did 
2 months ago with the weak economic statistics of the last 2 
months and also the declines in commodity prices and increases 
in the value of the dollar. I believe, Mr. Chairman, that 
increased fiscal stimulus is the right response to this kind of 
economic downturn.
    While it would be traditionally appropriate to employ 
monetary policy as the first tool of cyclical response, as Mr. 
Ryan's comments suggested, there are a number of reasons to 
doubt the future monetary policy stimulus is a viable option at 
this point. It would be difficult to lower interest rates 
further without putting the U.S. dollar and commodity markets 
at risk. In an environment where banks and other firms are 
constrained by lack of capital, it is not clear that lowering 
policy interest rates will have a substantial effect on lending 
or borrowing. There are, in any event, long lags between 
monetary policy and changes in the performance of the economy.
    Given all that has happened in the housing and financial 
sector, many observers have been surprised that overall 
economic performance has not been even worse than it has been. 
In my judgment, this is in significant part a result of the 
stimulus to the economy provided by legislation passed last 
winter. Without this stimulus, our economic situation would 
likely be even worse.
    If new policy is going to support the economy by raising 
demand for goods and services and closing that gap, it likely 
will have to come on the fiscal side. Indeed, in a situation of 
excess capacity and a situation where interest rates are likely 
to be relatively rigid because of financial strains, the 
multiplier from fiscal policy is in the short run likely now to 
be larger than normal. There is a strong case for the prompt 
enactment of further timely, targeted and temporary fiscal 
stimulus.
    The third area I want to address is the question of fiscal 
stimulus in the context of the overall budget picture. While 
there is a strong case for new fiscal stimulus measures, which 
by definition increase the deficit in the short run, the long-
run Federal budget situation remains a matter of great concern. 
Excessive accumulation of Federal debt over the next decade 
threatens to reduce investments in slow growth, compromise 
financial stability, and increase America's vulnerability and 
reduce its influence in the world.
    It is critical to recognize that large, permanent increases 
in the Federal deficit, if enacted today, are likely to slow 
the economy by raising capital costs and undermining confidence 
as investors recognize that ultimately they will have to pay 
higher taxes to service the interest or repay the principal on 
debt incurred. Measures such as pre-committing now to large 
unpaid tax cuts or spending programs that will take effect only 
several years from now are likely to have adverse effects on 
near-term economic growth and exacerbate the current downturn. 
This effect is just the mirror image of the progress made in 
the 1990s following enactment of a credible medium-term program 
of deficit reduction.
    It follows that in enacting fiscal stimulus measures, care 
should be taken not to raise projected deficits beyond a short 
horizon of a year or, at most, two. Beyond this horizon, it is 
essential that any new spending or tax cutting be offset by 
measures that reduce projected deficits. Indeed, at least a 
portion of any new stimulus enacted over the next couple of 
years would best be matched with a longer horizon effort to 
reduce deficits so that over a 5- to 10-year horizon the 
enacted program was budget neutral.
    Finally, let me make several observations on the content of 
fiscal stimulus. Unlike the topics I have discussed so far, 
this is significantly a matter of value judgments rather than 
simply economic forecasting and analysis. Seems to me, however, 
that particularly strong arguments can be made for the 
following components:
    Support for low-income families and for those who have been 
laid off is much more likely to be spent rapidly than support 
diffused more widely throughout the economy. Possible vehicles 
here include food stamps and extensions of unemployment 
insurance.
    Second, there is a compelling case, in my judgment, for 
significant new commitments to infrastructure spending. While 
infrastructure spending is often seen as operating only with 
significant lags, I have become convinced that properly 
designed infrastructure support can make a timely difference 
for the American economy. Evidence from the Minneapolis bridge 
collapse suggests that it is possible to launch infrastructure 
programs where the vast majority of the money is spent within a 
year.
    Moreover, the combination of declining trust fund revenues 
and dramatic--more than 70 percent in the case of highways--
increases in some categories of construction costs means that 
there are a large number of projects that are currently on 
hold, slowed down or contracted and awaiting funding. Properly 
designed infrastructure projects have the virtue of being 
helpful as short-run stimulus, especially for the employment of 
workers most hard hit by the housing decline, while at the same 
time augmenting the economy's long-run productive potential.
    State and local governments are facing grave pressures 
resulting in forced cutbacks that may compromise either very 
vulnerable populations or necessary long-term investments. 
While it is true that some State and local problems are a 
consequence of imprudent tax cutting during the good times, 
there is a strong case that properly targeted assistance, 
perhaps new temporary changes in Medicaid reimbursement rules, 
could provide valuable stimulus to the economy while at the 
same time avoiding dangerous cutbacks.
    Other areas that should receive consideration include 
compensating consumers in the most affected regions for the 
effect of higher energy prices through LIHEAP, beginning a 
process of making necessary investments in energy efficiency 
and renewable energy and, where appropriate, responding to the 
adverse effects of ongoing financial turbulence.
    Mr. Chairman, I can remember only a very small number of 
moments in the last three decades when the economy has sat at a 
cusp in the way that it does today. The decisions that the 
Congress and the President make in the next several months and 
make early next year will have very substantial consequences 
for some time to come. I believe that the balance of risks 
suggests a compelling case for a significant fiscal stimulus 
program that increases the deficit in the short run but that 
over the medium to long term does not increase national 
indebtedness. Indeed, I believe such a program, by 
strengthening the American economy, may actually reduce our 
indebtedness in the long run.
    I wish you and your colleagues all the very best as you 
respond to what I think are a very serious set of challenges. 
Thank you very much.
    Chairman Spratt. Thank you, Dr. Summers.
    [The statement of Dr. Summers follows:]

Prepared Statement of Lawrence H. Summers, Charles W. Eliot University 
                     Professor, Harvard University

                              THE ECONOMY

    The American economy remains in a highly uncertain state with very 
significant risks to the downside. Weak employment statistics, 
contracting credit, diminishing confidence, likely further declines in 
housing prices, and a slowing global economy all place negative 
pressures on the US economy. While strong exports, declining commodity 
prices, and yesterday's actions to shore up the housing finance system 
are welcome developments, the preponderant probability is that we are a 
year or so away from a resumption of strong economic growth.
    Even after the downturn ends and growth resumes the economy will be 
producing output significantly short of its potential. Experience in 
the United States and abroad suggests that downturns associated with 
asset price collapses and financial sector problems such as the one we 
are now experiencing tend to be especially protracted. Moreover, 
unemployment typically continues to rise well past the business cycle 
troughs with peak levels of unemployment occurring as in the last cycle 
as much as two years after recessions end.
    As a consequence, the balance of risks in the American economy is 
now towards contraction and a vicious cycle in which declining economic 
performance exacerbates financial strains which feed back to hurt the 
economy rather than towards overheating and rising inflation. While 
this has been my reading of the balance of risks consistently over the 
last year it has been reinforced by the declines in commodity prices, 
increases in the value of the dollar, and increases in unemployment 
over the last several months.
    Losses in output relative to potential are likely to cost the 
economy $300 billion a year or more than $4000 for the average family 
of four. The economic downturn will also place pressure on the Federal 
budget, reduce productive investment in plant and equipment, and delay 
recovery in housing. Inevitably the burdens of economic slowdown are 
felt most acutely by minority groups and those struggling to rise on 
the economic ladder.

                      THE CASE FOR FISCAL STIMULUS

    There are a number of reasons why monetary policy is unlikely to 
provide stimulus going forwards: (i) It would be difficult to lower 
interest rates further without putting the US dollar and commodity 
markets at risk. (ii) In an environment where banks and other firms are 
constrained by lack of capital, it is not clear that lowering interest 
rates will have a substantial effect on lending and borrowing. (iii) 
There are long lags between monetary policy changes and changes in the 
performance of the economy. As the recent takeover of Fannie Mae and 
Freddie Mac illustrates, financial authorities will face important 
challenges simply maintaining adequate liquidity in financial markets 
in the coming months.
    Given all that has happened in the housing and financial sector, 
many observers have been surprised that overall economic performance 
has not been worse. This is in significant part a result of the 
stimulus to the economy provided by legislation passed last winter. 
Without that stimulus which is wearing out now, our economic situation 
would likely be even worse.
    If new policy action is going to support the economy by raising the 
demand for goods and services, it likely will have to come on the 
fiscal side. Indeed, in a situation of excess capacity and a situation 
where interest rates are likely to be relatively rigid because of 
financial strains, the multiplier from fiscal policy is in the short 
run likely to be larger than normal. There is a strong case for the 
prompt enactment of further timely, targeted and temporary fiscal 
stimulus * * *

                         FISCAL RESPONSIBILITY

    While there is a strong case for new fiscal stimulus measures which 
by definition increase the deficit in the short run, the long term 
Federal budget situation remains a matter of great concern. Excessive 
accumulation of Federal debt over the next decade threatens to reduce 
investment and slow growth, compromise financial stability, increase 
America's vulnerability and reduce its influence in the world. It is 
critical to recognize that large permanent increases in Federal 
deficits are likely to slow the economy by raising capital costs and by 
undermining confidence as investors recognize that ultimately they will 
have to pay higher taxes to service the interest or repay the principal 
on debt incurred. These concerns are exacerbated by our very low level 
of national saving, by the likely budget costs of supporting the 
financial sector and by the imminent beginning of the retirement of the 
baby boom generation.
    Measures such as pre-committing now to large new unpaid tax cuts or 
spending programs that will only take effect several years from now are 
likely to have adverse effects on near term economic growth and 
exacerbate the current downturn. This is just the mirror image of the 
success the economy had in the mid 1990s following enactment of a 
credible medium term program of deficit reduction.
    It follows that in enacting fiscal stimulus measures care should be 
taken not to raise projected deficits beyond a short horizon of a year 
or at most two. Beyond this horizon it is essential that any new 
spending or tax cutting be offset by measures that reduce projected 
deficits. Ideally, at least a portion of any new stimulus enacted over 
the next couple of years would be matched by actions with a longer 
horizon to reduce deficits so that over a five or ten year horizon the 
enacted program was budget neutral.

                      THE COMPOSITION OF STIMULUS

    In many ways the composition of a fiscal stimulus program is a 
decision that goes to value rather than economic judgments. It seems to 
me however that particularly strong arguments can be made for the 
following components:
    Support for low income families and for those who have been laid 
off is much more likely to be spent rapidly than support diffused more 
widely throughout the economy. Possible vehicles here include food 
stamps and extensions of unemployment insurance.
    There is a compelling case for significant new commitment to 
infrastructure spending. While infrastructure spending is often seen as 
operating only with significant lags, I have become convinced that 
properly designed infrastructure support can make a timely difference 
for the economy. Evidence from the Minneapolis bridge collapse suggests 
that it is possible to launch infrastructure programs where the vast 
majority of the money is spent within a year. Moreover, the combination 
of declining trust fund revenues, and dramatic (more than 70 percent) 
increases in some categories of construction costs mean that there are 
a large number of projects that are currently on hold, slowed down, or 
contracted and awaiting funding. Properly designed infrastructure 
projects have the virtue of being helpful as short run stimulus, 
especially for the employment of the workers most hard hit by the 
housing decline, while at the same time augmenting the economy's 
productive potential in the long run.
    State and local governments are facing grave budget pressures 
resulting in forced cutbacks that in many cases compromise either very 
vulnerable populations, or necessary long term investments. While it is 
true that some state and local problems are consequences of imprudent 
tax cutting during the good times, there is a strong case that properly 
targeted assistance perhaps through temporary changes in Medicaid 
reimbursement rules could provide valuable stimulus to the economy 
while at the same time avoiding dangerous cutbacks.
    Other areas that should receive consideration include compensating 
consumers in the most affected regions for the effects of higher energy 
prices through LIHEAP, beginning a process of making necessary 
investments in energy efficiency and renewable energy and where 
appropriate, responding to the adverse impacts of the ongoing financial 
turbulence.

    Chairman Spratt. Now Dr. Sinai, Allen Sinai.

                STATEMENT OF ALLEN SINAI, PH.D.

    Dr. Sinai. Thank you, Mr. Chairman. I am happy to be here 
testifying on the difficult set of problems confronting the 
U.S. economy now and in the future.
    The four sections to my remarks: First, a backdrop sketch 
of problems confronting the U.S. and global economies. They are 
intertwined. Closer look at the U.S. situation, and then some 
of the policy challenges and some general perspectives. Not 
much detail on policies.
    In summary, the U.S. economy is in some sort of a 
recession. Technically, I think it is in recession and will be 
declared to be that way. And it feels like a recession for most 
Americans. It does appear to be getting worse. It does appear 
to be spreading. At the moment, it is focused on the American 
consumer more than anything else.
    The global economy is moving toward recession. More and 
more countries are dropping into recession or near recession, 
and that later on will impact on what is a very strong part of 
the U.S. economy now. Exports, our exports will soften.
    Almost all countries around the world are seeing at the 
same time high or rising inflation. In fact, startlingly high 
in the last 6 or 8 months the number of countries, particularly 
the emerging world, which creates its own set of problems for 
policy. That is, the United States, besides having to deal with 
a weak and weakening economy, we think a prolonged situation of 
essentially stagnation.
    We also have to deal with inflation. It is a kind of 
stagflation. It is not the stagflation of the 1970s and 1980s, 
but it really is that. And the information and data, as one 
looks around the world, shows stagflation to have emerged 
around the world as well.
    Energy and oil prices and food prices are part of that, and 
that complicates policy even more because it is going to be 
impossible to deal with any one problem with only one kind of 
policy without taking account of other policies that deal with 
other problems and how they all interact. It is hard enough to 
deal with one policy and to use it effectively and at the right 
time to deal with a particular economic problem, let alone the 
multitude of problems that require an ammunition approach of 
many policies, all of which have byproducts and side effects in 
interacting with one another. I think if we come to thinking 
about it like that here in Washington and elsewhere, that will 
be very new in macroeconomic policy thinking.
    The prospect of stagflation in the United States and a weak 
economy and sticking high inflation creates a tough problem for 
policy short or long run. It is near impossible for the Federal 
Reserve to sort that one out, given the dual mandate; and 
fiscal policy is made much more difficult in that kind of 
situation as well.
    To add to the list of problems, we have a financial crisis 
in the United States. Our financial system is not functioning 
in anywhere near its normal state. The financial institutions 
are contracting, consolidating, deleveraging. Some are failing. 
More will fail. And we just witnessed an extraordinary 
intervention in the private sector economy by our government 
with regard to the changing of the way in which the GSEs will 
operate. That is meant to be transitory, but the policy problem 
in the future will be to figure out how we handle and support, 
structured mortgage finance and housing in the U.S. without the 
government running the function forever, which I don't think 
any of us want.
    The policy guidance comments I might offer would be, one, 
monetary policy can't do much more than it has done. The 
Federal funds rate is very low. Some think it is too low. Some 
in the Federal Reserve think it is too low in real terms.
    The central bank has opened its window to all the primary 
dealers and is making liquidity amply available. It is the 
financial system itself that is not pumping that liquidity out. 
It is absorbing liquidity much as the Japanese institutions did 
in prior years not because of the risk-averse situation and 
because borrowers from the demand side don't want to borrow as 
much. So that means fiscal policy will come to the forefront. I 
think in this kind of situation, monetary policy is relatively 
helpless from here on in.
    And fiscal policy, in terms of certain kinds of necessary 
support that we have always done as a country, the support for 
extended unemployment benefits, for food stamp enhancement and 
extension for the poor and, in some situations, help for States 
and localities, I think that is all that most economists could 
come to a consensus about. And our society can handle quite 
easily the overall costs of such actions in the short term, 
would not be that great.
    But I think the economy is going to need further fiscal 
stimulus both for the short and long run, and the kinds of tax 
and spending measures that are discussed and debated is where 
there will be considerable controversy.
    At the same time, we have to maintain long-run budget 
discipline. I would extend the notion of PAYGO to a multi-year 
notion. If we tried to apply PAYGO to every fiscal measure of 
stimulus in a time when the economy needed stimulus, we would 
never get the stimulus that the economy needed; and so we have 
to open up the horizon for PAYGO and think of it, somewhat 
dangerous, as balance the budget over a multi-year period. The 
danger is of course, if we open up that door and don't stick to 
a PAYGO discipline, then we may never get the fiscal discipline 
that we need.
    The alternative, though, is that by its very nature fiscal 
stimulus is going to be used to stimulate the economy. It 
almost necessitates some initial taking of an increased deficit 
to do that.
    We will need to keep separate I think what we do cyclically 
and what we do for measures to deal with longer-run issues 
confronting the economy, such as health care, such as energy 
and energy independence, such as the long-run budget deficits 
at the heart of which are runaway costs and rising 
beneficiaries in the older segment of America which drive 
Medicare and Medicaid costs sky high.
    Dealing with that problem, which is at the heart of the--I 
think many scholars would say the long-run structural budget 
deficits--is different from dealing with how to get consumers 
spending more money if the spending growth of consumption is 
far below potential and is dragging the economy down as well as 
having other effects, negative ones on business, tax receipts 
for State, local governments, negative effects on other 
countries, and then other countries' exports diminishing, whose 
economies then, if they diminish, will hurt the U.S. economy.
    The details of these more general comments that I made can 
be found in the material that I have submitted. I just want to 
highlight a few of these general comments in some of the 
specific information. First, about the United States and its 
position, the reason for the current delays, the financial 
crisis that exists and the difficulty for the U.S. economy to 
mount any kind of sustained or sustainable recovery on its own 
in any reasonable length of time, and then some of the 
policies, short and longer run, that would be more specific to 
our country.
    We are judging the U.S. economy to be in recession now. We 
are not making that judgment based on real GDP, which on the 
latest numbers were revised up to a 3.3 percent annual rate in 
the second quarter. Some of that increase in real GDP came from 
increases in retail sales and consumption, which came from 
temporary tax rebates. The help is welcomed, but those tax 
rebates are now essentially over. We won't get that help 
anymore. That is a problem with temporary stimulus and 
temporary tax policy. You do not get permanent help; and if 
nothing else comes along to lift the economy up after, in this 
case the tax rebates have expired, then we are back where we 
were at the start, with an economy which now looks like it is 
going to go down in real GDP terms perhaps in the fourth and 
first quarters. To us, that would be an extension of a 
recession that already exists, the widening of it and not the 
beginning of a new recession.
    On the monthly indicators, key ones that describe the U.S. 
economy, it is very clear that we do have some sort of 
recession. And it is these monthly indicators, at least as 
much, perhaps more so, than real GDP that calls the tune in 
terms of describing what is really going on in the U.S. 
economy. Whether it is nonfarm payroll, industrial production, 
personal income, less transfers adjusted for inflation, real 
business sales, all of those monthly indicators are below their 
previous peaks which occurred in the fourth quarter and in the 
case of nonfarm payroll in December.
    It is only real GDP that tells a different story and sings 
a different song. I tell our business clients, our financial 
clients, for decisions in reality, forget real GDP. At certain 
times it will totally mislead you as to what is going on. I can 
tell you, none of our clients in the financial world or in the 
business world rely on real GDP to make their bottom-line 
decisions; and I think it is dangerous down here in Washington 
for you to rely on that as well.
    So I want to underscore, recession, mild so far in the U.S. 
It is getting worse. The global economy is sinking. That will 
impact on us in the future. And we have as part of the 
recession not just a housing bust, not just the bursting of an 
asset price bubble in residential real estate, very unique 
events and very negative, but more than anything at the moment 
we are watching consumer spending growth about 2 percentage 
points less than historical trend. And although positive in 
producing a positive, real GDP, if you are in business or you 
are a country that exports to the American consumer and 
consumer spending on average is running 2 percentage points 
lower than what its historical trend has been, your business is 
bad.
    Consumer spending is 71.5 percent of real GDP. If it is 
positive, real GDP is going to be positive. But if it is 
growing at 1.5 percent per annum now, and that is about the 
average rate over the last five quarters, and its historical 
trend is 3.5 percent per annum, that 2 percentage points 
difference is really a big deal and that tells the character of 
the economy. And if the unemployment rate, which is now 6.1 
percent and in March, 2007, it was 4.4 percent, that is a 1.7 
percentage point increase, even though we haven't lost as many 
jobs as we typically do during a so-called recession, guess 
what, that is a recession, and it is getting worse.
    The financial crisis that is upon us, very unusual in our 
history, involving many more financial institutions and 
commercial banks because of the growth of so many nonbank 
financial intermediaries over the past 5, 10, 15 years and the 
use of capital market-centric lending and asset-based and 
balance sheet financing for so much of what went on in the U.S. 
and world economies. That part of our system essentially is 
imploding, contracting. It was triggered by the housing 
downturn, the unwinding of the housing boom into a bust. I 
think it is fair to describe it as a bust. It is classic.
    And the unprecedented declines in residential real estate 
prices. Basically, asset price deflation. So that all of the 
paper securities and debt and businesses geared to residential 
real estate are going through a major downturn. Deflation and 
the financial balance sheets of financial institutions heavily 
levered and involved in this are all contracting. And we have 
seen an explosion of write-downs in subprime mortgages, a need 
for restructuring and recapitalization, attempts to 
recapitalize through the market, sell stock, all the things 
that the financial institutions have to do in order to squeeze 
down to meet and fit a much smaller financial world in the 
future.
    In addition, part of the bubble in this set of activities 
certainly came from what was a benign, to put it mildly, 
regulatory and unsupervisory environment which allowed and 
permitted a large range of old and new financial institutions 
to invent products, to sell them off, to originate and 
distribute, to not bear the risk of using the borrowed money 
that they used to invent these products, and then really the 
oldest game in the world, using other people's money to take 
that and carry that to an extraordinary extent.
    We are going through an unwinding of that now. None of us 
knows how big that will be, how long that will be. But I can 
say it is far from over at this point.
    And it is one of the reasons why the temporary tax rebates, 
which did help for a couple of quarters, didn't do the trick 
because other parts of the economy that had been hoped for to 
come on stream to help out, like a viable, strong financial 
system, did not deliver. But there is no reason why it should 
have delivered, because the unwinding of the huge boom in debt, 
credit and finance is going to take a long time. I think we are 
only partway through, and we have a long way to go in terms of 
the failures that we are going to see in financial institutions 
before all of this ends. That is an impediment to a quick and 
sustainable recovery in the U.S. economy.
    The malaise of the consumer may be another impediment, but 
it has been decades since the American consumer has hunkered 
down, spent less, borrowed less, saved more. We now are 
observing five quarters of subpar growth in consumer spending. 
That is very rare. Consumer spending could be negative in real 
terms in the third quarter. The third quarter of this year will 
be the sixth quarter. That is about as long as any period of 
time we have had with weak, anemic subpar consumer spending.
    We judge all of the fundamentals around the consumer, 
ranging from job and income to household wealth, to the 
financial position of households, to the inability to get money 
out by tapping the equity in their homes, to a credit crunch, 
credit tightness, to the sentiment of the consumers. All the 
fundamentals are negative, and our thought is we are going to 
see something we haven't seen in decades, consumer spending 
weakness that will last a long, long time.
    And then third on the impediment list of course are the 
high prices of oil and energy. Yes, they have come down. But 
they are still quite high. Crude oil was $19 a barrel back in 
November of 2001. We have been turning up for a long time.
    So what is the response to this kind of fairly grim 
outlook, a stagflation situation of some sort, and the 
impediments, the three that I have mentioned?
    I think a second fiscal stimulus is worth getting going 
even though you have only days left before you recess because 
of how long it takes to get fiscal stimulus going and in 
process in Washington and the lags before a fiscal stimulus can 
impact on the economy.
    The one--a suggestion I would make is that you need to 
think a little bit about the longer-run fiscal stimulus that 
you wish to apply in devising short-run fiscal stimulus, and I 
would just throw out the following suggestion: Cut taxes, 
income tax rates for middle- and lower-income families. Do it 
permanently, that is, beyond the tax rates that now exist under 
the existing legislation, and finance that by doing something I 
think we are going to do anyway, longer run, which is to return 
tax rates on the upper-income families toward the rates that 
prevailed in the Clinton years. Use some other tax increases to 
finance the middle- and lower-income family tax cuts and get 
what we are going to do anyway I think in the longer run going, 
and get some stimulus into the thinking of middle- and lower-
income families where consumption, in our judgment, is a major 
source of weakness in the U.S. economy.
    The tax cuts----
    Chairman Spratt. Dr. Sinai, could you sort of wrap up? We 
have got a vote on the floor is the reason I am asking.
    Dr. Sinai. Of the other tax cuts in the Bush 
administration, I think you will need to take a look at that 
and see in the face of a difficult economy what you want to do 
with those. And capital gains taxes at a 15 percent rate and 
dividend taxes on qualifying dividends, 15 percent rate I 
would--there is nothing wrong with keeping that.
    And the other two big issues to start to work on: energy, 
energy independence. There is a whole set of tax policies that 
can be used to deal with that. Some of them are very painful. 
And of course the other one is dealing with the financial 
system crisis and what the rules of our financial system will 
be in the future once we get through with the current problems.
    [The statement of Dr. Sinai follows:]

   Prepared Statement of Allen Sinai, Ph.D., Chief Global Economist,
                        Decision Economics, Inc.

    After approximately six years of economic expansion in the U.S. 
characterized by booms in housing and mortgage finance, credit and 
debt, financial services and financial markets generally; strong 
economic growth or booms in a number of non-U.S. countries; relatively 
low inflation globally until six-to-nine months ago; and improving jobs 
and falling unemployment rates, the U.S. and Global economies now are 
in the midst of very difficult economic and financial stresses that 
pose great challenges to economic policy.
    What are they? For the U.S., there is a witch's brew of problems 
and issues, ranging from recession and inflation to disarray and 
turmoil in the financial system and financial markets; to high and 
rising energy costs and the increasingly unacceptable long-time U.S. 
dependence on fossil fuels; rising federal government deficits and 
increasing U.S. Government debt relative to GDP; although improving, 
continuing imbalances in foreign trade and on current account; the 
inefficient provision of health care and reining in of its high 
inflation and rising costs; the financing of Social Security and 
retirement saving; a need to rebuild savings to rebalance imbalances in 
the financial positions of financial institutions, households and 
government; and the rebuilding of U.S. infrastructure to help increase 
productivity and public welfare.
    In addition, the unwinding of what was an incredible housing, 
mortgage finance, debt, derivatives, structured investment product, 
credit and debt boom has led to financial turmoil and financial 
instability in the U.S. financial system and financial markets--
characterized by a housing boom that has bust, a bursting housing asset 
price bubble, credit crunch, and unprecedented contractions in the 
balance sheets of numerous bank and nonbank financial intermediaries--
posing yet another difficult policy challenge.
    Financial instability, a portion of what might be called the 
financial business cycle, always has been integral to real economy 
downturns; indeed, especially the most severe and long-lasting ones. 
Crunches and financial instability typically present at the upper 
turning point of the U.S. business cycle, integrated in the structure 
and processes of the U.S. macroeconomic system.
    In the global economy, U.S. economic weakness and financial 
instability are impacting other countries through diminished export 
growth. Higher oil, energy, food and derivative prices, many set in 
world commodities markets but exogenous to individual countries, are 
providing a negative economic and inflation shock, much as in the 1970s 
and early 1980s. While endogenously determined by aggregate global 
demands and supplies, crude oil and food prices present themselves as 
exogenous to oil-consuming countries, essentially much of the global 
economy.
    Currently, an increasing number of countries are experiencing 
incipient recession, recession-like conditions, or appear headed for 
them. Financial turmoil in the U.S. and elsewhere is preventing the 
normal economic responses to the lower interest rates and increased 
liquidity provided by the Federal Reserve and other central banks, and 
is being overshadowed by risk-averse financial institutions who are 
absorbing liquidity but not lending nor investing much. Previously, 
strong-growing economies are slowing. Boom economy countries are 
settling-down to lower growth. As measured by DE, some 55% to 60% of 
the global economy probably is in, or about to enter, some sort of 
recession. A global recession-of-sorts perhaps is becoming a reality!
    Presently, as shown in Table 1, 11 countries are forecasted to be 
in or very near recession, 8 countries headed for recession, 14 that 
were solidly-growing now weakening and 7 countries previously booming, 
now slowing. 7 countries still seem strong or stable.

                                                                   TABLE 1.--POLICY CHALLENGES: U.S. AND GLOBAL ``RECESSION?''
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                       Countries In-or-Close to           Countries Headed for            Solid Growth Weakening           Boom Countries Slowing         Countries Still Strong or
                            ``Recession''                    ``Recession''          ------------------------------------------------------------------              Stable
                  ------------------------------------------------------------------                                                                  ---------------------------------   Total
                                          Pct. of                          Pct. of          Country         Pct. of          Country         Pct. of                          Pct. of
                          Country         Total\1\         Country         Total\1\                         Total\1\                         Total\1\         Country         Total\1\
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
1.                 U.S.................      25.6   Spain...............       2.6   Brazil..............       2.2   China...............       5.8   Russia..............       2.2   ........
2.                 Japan...............       8.6   Australia...........       2.5   South Korea.........       1.8   India...............       2.0   Indonesia...........       0.8   ........
3.                 Germany.............       6.1   Mexico..............       1.7   Switzerland.........       1.7   Argentina...........       0.5   Austria.............       0.7   ........
4.                 U.K.................       5.0   Netherlands.........       1.4   Belgium.............       0.8   Hong Kong...........       0.4   Poland..............       0.7   ........
5.                 France..............       4.6   Sweden..............       0.8   Turkey..............       0.8   Venezuela...........       0.4   Israel..............       0.3   ........
6.                 Italy...............       3.8   Taiwan..............       0.7   Greece..............       0.7   Columbia............       0.1   Egypt...............       0.2   ........
7.                 Canada..............       2.5   Portugal............       0.4   Norway..............       0.6   Peru................       0.1   Jordan..............      0.03   ........
8.                 Denmark.............       0.5   Hungary.............       0.2   South Africa........       0.5   ....................  .........  ....................  .........  ........
9.                 Ireland.............       0.5   ....................  .........  Finland.............       0.4   ....................  .........  ....................  .........  ........
10.                New Zealand.........       0.5   ....................  .........  Thailand............       0.4   ....................  .........  ....................  .........  ........
11.                Singapore...........       0.3   ....................  .........  Chile...............       0.3   ....................  .........  ....................  .........  ........
12.                ....................  .........  ....................  .........  Czech Republic......       0.3   ....................  .........  ....................  .........  ........
13.                ....................  .........  ....................  .........  Malaysia............       0.3   ....................  .........  ....................  .........  ........
14.                ....................  .........  ....................  .........  Philippines.........       0.3   ....................  .........  ....................  .........  ........
15.                Total(s)............      58.0   ....................      10.3   ....................      11.1   9.3.................  .........  4.93................  (\2\)92.9
                                                                                                                                                                                    3
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
\1\ 2007 end-of-year data, with conversion to nominal GDP in dollars; percent of global total.
\2\ Rounding and omitted countries approximately 7% of the global total.

Source: Decision Economics, Inc. (DE).

    Less jobs growth and rising unemployment are already occurring in a 
significant number of countries; where not, probably to-come. In the 
U.S., the bulk of the reductions in the workforce and biggest part of 
rising unemployment probably are still on the horizon for well into 
2009.
    The countries in or near recession account for about 58% of the 
global economy, as measured by Decision Economics, Inc. (DE). The seven 
countries counted as headed toward recession represent 10.3% of total 
world output. The 21 countries where economic growth is slowing from 
the previous pace represent about 20.4% of the global economy. And, of 
the remaining countries forecasted and analyzed, seven of them are 
still growing nicely or not slowing, representing 4.93% of global 
output.\1\
---------------------------------------------------------------------------
    \1\ Decision Economics, Inc. (DE) forecasts and analyzes some 47 
countries in the global economy, which account for approximately 93% of 
total global output. The rankings of these countries in the global 
economy are obtained by converting local currencies to nominal dollars 
using country exchange rates. Thus, the calculations relating to 
expansion and recession and for the rankings of the economies involved 
may differ from others, such as the IMF. For example, a U.S. recession 
is defined by standard NBER criteria, which includes growth in real GDP 
but more importantly relies on a wide range of readings, relative to 
previous peaks, for a number of monthly economic indicators. A global 
recession on the DE figures is less than 2% real GDP growth and is 
based on a diffusion index approach to growth versus historical 
potential rates of growth. Monthly economic indicators also are used 
for individual countries, although in many nowhere near as reliable as 
is the U.S. monthly indicator information.
---------------------------------------------------------------------------
    Why this slippage globally?
    The U.S. is at the epicenter of the downmove in economic activity 
that is rippling-through much of the world, with now a ``hunkering-
down'' by the American consumer to far below historical trend growth 
spreading-out to reduce the export growth of numerous countries, 
although less exposed to a U.S. downturn than previously, still 
exposed, particularly to the demands for their exports from U.S. 
consumers and businesses. With intra-global regional trade more 
pronounced than ever before within Asia, the Eurozone and Emerging 
Europe, the Americas and the Middle East, those countries whose exports 
to the United States are weakening are also seeing trade flows and 
trade-related businesses with each other weaken.
    The financial turmoil and financial instability in the U.S. also 
are significant, operating to impact other countries indirectly through 
depressed housing activity, declining housing prices, and the negatives 
surrounding aggregate consumption and business spending. But the U.S. 
financial turmoil also is directly a factor, negatively impacting on 
global equity markets and taking away support for global economic 
activity by U.S.-based companies who are cutting-back and some damaged 
globally-based financial institutions whose balance sheets are 
contracting.
    A future risk to the U.S. lies in a current area of strength, 
exports, and to the companies whose businesses have become increasingly 
tied to revenues and earnings generation from outside the U.S.. 
Currently, U.S. exports are over 13% of real GDP, more than four times 
the now depressed real residential construction, so that as the global 
economy weakens, with lags U.S. exports will themselves weaken and then 
through export multipliers negatively affect the economy.
    At the same time and over the past six-to-nine months, inflation 
almost everywhere has surged higher, in part a consequence of large 
rises in crude oil prices, in energy prices, and in food inflation. The 
high and rising inflation that has occurred is squeezing domestic 
purchasing power in many countries, particularly for consumption, so 
that along with worsening trade is creating recession or recession-like 
conditions.
    Over 40 countries are showing high, or rising, inflation rates--
some double-digit, some mid- to high single-digits, or high low single-
digit--that have exceeded, or some exceeding, the limits set by central 
banks. In many countries, wage inflation is on the rise as well, 
threatening to pass into higher prices through rising unit labor costs 
then back perhaps into wages again, then prices, etc., although at the 
current time not the United States.
    Table 2 indicates the ranges of inflation and countries assessed to 
be in each range; also whether price inflation has been Accelerating 
(A), is Stable (S), or Decelerating (D).\2\
---------------------------------------------------------------------------
    \2\ The overall CPI was used for these assessments. ``Core'' 
inflation, generally CPI inflation Ex-Food and Energy, also was 
examined and is on the rise in numerous countries, including the United 
States. But, for most, readings on core CPI, originally meant mainly as 
a classificatory measure, present the lowest possible readings on 
inflation when energy and food prices are rising and even when they are 
not. If the increases are exogenous or transitory, then taking-out food 
and energy prices can make policy sense. If not, then policymakers that 
use it run the risk of thinking that inflation might be low, arguably 
the situation that has existed before in the United States. Crude oil 
and energy prices have been rising, on average, for years, hardly a 
transitory phenomenon; volatile yes, transitory no. The very low 
interest rate regime chosen by the Federal Reserve in the early and 
middle part of this decade reflected a core inflation focus, 
undoubtedly contributing to the boom in housing, credit and debt, and 
indirectly the excesses that grew up around these areas of activity.
---------------------------------------------------------------------------
    Inflation has moved up quite sharply in a large number of 
countries, particularly over the past six-to-nine months. Of the 47 
economies analyzed and forecasted by Decision Economics, Inc. (DE), the 
inflation indicated has been high or rising in 41 of the countries, in 
part from the same forces that have been driving U.S. inflation 
higher--rising oil, energy and food prices--but also from the demand-
pull of strongly-growing economies and increased costs of production. 
Inflation targets or the desired ranges of central banks are being 
exceeded in more than half the countries where applied.
    Central banks can be hamstrung when there is both recession and too 
high inflation, or ``stagflation,'' not sure which to deal with, the 
``stag'' or the ``flation.'' The combination of a weak or weakening 
economy, high or rising inflation, and rising unemployment presents an 
extremely negative backdrop for the U.S. economy. The circumstances 
being seen now have few parallels--perhaps the downturns of 1973-75, 
1979-80, and the early 1980s.
    But none of these downturns had some of the other challenges now 
confronting the U.S.--1) contraction and crisis in the financial system 
with a degree of risk-averse behavior and deleveraging not seen since 
the 1930s or in

                                               TABLE 2.--POLICY CHALLENGES: U.S. AND GLOBAL--``INFLATION''
--------------------------------------------------------------------------------------------------------------------------------------------------------
                    Countries with Double-Digit      Countries with Inflation (6% to   Countries with Inflation (3% to   Countries with Still Low (Below
                     Inflation (10% to 35%)\1\                  9.9%)\1\                          5.9%)\1\                        3%) Inflation
                ----------------------------------------------------------------------------------------------------------------------------------------
                                      Accelerating                                                        Accelerating                      Accelerating
                                       (A), Stable                                                         (A), Stable                       (A), Stable
                       Country           (S), or          Country          Pct. of          Country          (S), or          Country          (S), or
                                      Decelerating                         Total\1\                       Decelerating                      Decelerating
                                           (D)                                                                 (D)                               (D)
--------------------------------------------------------------------------------------------------------------------------------------------------------
1.               Venezuela..........            A   Chile..............           A   Taiwan............            A   Japan.............            A
2.               Egypt..............            A   Thailand...........           A   South Korea.......            A   ..................  ............
3.               Jordan.............            A   Malaysia...........           A   Peru..............            A   ..................  ............
4.               Russia.............            S   Columbia...........           A   U.S...............            A   ..................  ............
5.               South Africa.......            A   Czech Repub........           S   Mexico............            A   ..................  ............
6.               Turkey.............            A   Hungary............           S   Belgium...........            D   ..................  ............
7.               India..............            A   Singapore..........           D   Spain.............            A   ..................  ............
8.               Philippines........            A   China..............           D   Greece............            S   ..................  ............
9.               Indonesia..........            A   Hong Kong..........           S   Israel............            D   ..................  ............
10.              Argentina..........            A   Brazil.............           A   Poland............            A   ..................  ............
11.              ...................  ............  ...................  ...........  New Zealand.......            A   ..................  ............
12.              ...................  ............  ...................  ...........  U.K...............            A   ..................  ............
13.              ...................  ............  ...................  ...........  Ireland...........            D   ..................  ............
14.              ...................  ............  ...................  ...........  Sweden............            A   ..................  ............
15.              ...................  ............  ...................  ...........  Finland...........            S   ..................  ............
16.              ...................  ............  ...................  ...........  Norway............            A   ..................  ............
17.              ...................  ............  ...................  ...........  Australia.........            A   ..................  ............
18.              ...................  ............  ...................  ...........  Italy.............            S   ..................  ............
19.              ...................  ............  ...................  ...........  Denmark...........            A   ..................  ............
20.              ...................  ............  ...................  ...........  Austria...........            S   ..................  ............
21.              ...................  ............  ...................  ...........  France............            A   ..................  ............
22.              ...................  ............  ...................  ...........  Canada............            A   ..................  ............
23.              ...................  ............  ...................  ...........  Germany...........            S   ..................  ............
24.              ...................  ............  ...................  ...........  Netherlands.......            A   ..................  ............
25.              ...................  ............  ...................  ...........  Switzerland.......            A   ..................  ............
26.              ...................  ............  ...................  ...........  Portugal..........            D   ..................  ............
--------------------------------------------------------------------------------------------------------------------------------------------------------
\1\ Latest, Year-over-Year; CPI Overall.

Source: Decision Economics, Inc. (DE).

    Japan during the 1990s; 2) increasingly fragile U.S. government 
finance, with increasing burdens thrust on the Federal Reserve and U.S. 
Treasury of weak asset collateral and risks to the full faith and 
credit of U.S. sovereign debt from failing financial institutions; 3) 
the unknown effects of a huge deleveraging, contractions in asset-based 
lending, investments, and financial intermediary balance sheets a large 
number of financial intermediaries responsible for the greatest amounts 
of funding to the U.S. economy ever; and 4) a global inflation 
reflecting increased costs-of-production in non-U.S. economies, 
especially developing, that for a long time provided considerable 
deflation and disinflation. Cost-push sources of rising inflation from 
this source are numerous.
    The collapse of the U.S. commercial banking system and in credit 
during the 1930s now is widely, and correctly, seen as a major reason 
for the Great Depression. But the large number of nonbank financial 
institutions that have been involved in asset and balance sheet-
leveraged financing now dwarfs the commercial banking system in size 
and amounts, having operated through capital markets to fund much of 
the economic expansion, now contracting and presenting unknown 
potential downside consequences.\3\
---------------------------------------------------------------------------
    \3\ See Tobias Adrian and Hyun Song Shin, ``Financial 
Intermediaries, Financial Stability and Monetary Policy,'' presented at 
the Federal Reserve of Kansas City Symposium, Maintaining Stability in 
a Changing Financial System, August 22, 2008, Jackson, Wyoming. The 
authors present evidence on the growth in asset-backed lending and 
capital markets-centric nature of lending and investing by financial 
intermediaries rather than the deposit-based lending and investments of 
commercial banks that previously characterized the financial system. 
Left out of the authors' calculations are the asset-based and balance 
sheet-levered activities of the now very large number of bank-like 
financial intermediaries such as Private Equity, Venture Capital, Hedge 
Funds and Sovereign Wealth Funds that have been so important in the 
intermediation of funds from all sources everywhere, and in energizing 
economic activity in the U.S. and around-the-world.
---------------------------------------------------------------------------
      U.S. ECONOMY PROSPECT: RECESSION AND IMPEDIMENTS TO RECOVERY

    The state of the U.S. economy is a recession or recession-like 
conditions; if recession so far ``shallow,'' but spreading and 
intensifying, complicated by the high and rising inflation that has 
mainly stemmed from increased oil, energy and food prices, and 
increased costs of production, domestic and global.
    This recession episode is unlikely to be short, instead ``Shallow 
and Long'' or ``Deep and Long.'' The shortest U.S. economic downturns 
previously were six months in 1980 and in 1991 and 2001 eight months 
each. The longest were in 1973-75 and 1981-82, each sixteen months, 
when crude oil and energy prices were rising sharply.
    The current episode appears most similar to the late '70s or early 
'80s, with an unusually negative combination of elements; some new, 
some old: 1) a severe housing downturn (``Bust ''); 2) a bursting 
housing asset price bubble (biggest declines in home prices since the 
Great Depression); 3) a credit crunch within and outside the financial 
system (Financial Crisis); 4) contractions in the assets and balance 
sheets of commercial banks and now large number of nonbank financial 
intermediaries such as Investment Bank/Broker Dealers, Private Equity, 
Venture Capital, Hedge Funds, and off-balance sheet subsidiaries of 
Commercial Banks (Financial Crisis); 5) a potentially considerable 
``Failure Fallout'' of failed banks and other financial institutions, 
with consolidation and absorptions (Financial Crisis); and 6) the rises 
in oil and energy prices that have adversely affected economic activity 
and inflation in all oil-consuming nations. Major oil-producing 
countries are net beneficiaries.
    The downturn and its extent and severity cannot be seen in 
quarterly real GDP, a measure many look to as the main summary 
statistic for the U.S. economy, e.g., the most recent upwardly revised 
3.3% annualized rate of growth in GDP for the second quarter. Temporary 
tax rebates helped raise consumption, although in real terms only 1.7%, 
annualized, raising real GDP but probably only temporarily, along with 
strong growth in exports off a strong global economy and previously 
weaker dollar, and very strong real federal government spending.
    But this quarterly summary statistic can be misleading and is not 
the only one used to technically define a recession.\4\ Other important 
monthly measures--personal income less transfers adjusted for 
inflation, real business sales, nonfarm payroll employment and 
industrial production--show peaks back in October 2007, December 2007 
and January 2008, and currently stand below them. Though the declines 
from the peaks have been relatively small so far, the expected course 
for the economy suggests that its recessionary thrust will deepen and 
be prolonged at least until mid-2009, likely taking a turn for the 
worse in the third and fourth quarters and first quarter of 2009.
---------------------------------------------------------------------------
    \4\ The National Bureau of Economic Research (NBER) defines a 
recession as ``a significant decline in activity spread across the 
economy, lasting more than a few months, normally visible in real GDP, 
real income, employment, industrial production, and wholesale-retail 
sales,'' in The NBER's Business-Cycle Dating Procedure, Business Cycle 
Dating Committee, National Bureau of Economic Research, June 18, 2003.
    The Committee maintains a monthly chronology and refers to a 
variety of monthly economic indicators to choose months of peaks and 
troughs. Particular emphasis is placed on Personal Income less 
Transfers, in real terms, and Employment, measured by nonfarm payrolls. 
In addition, the Committee refers to two indicators with coverage 
primarily of manufacturing and goods. These are Industrial Production 
and Manufacturing and Wholesale-Retail Sales, adjusted for price 
changes. Real GDP is viewed as the single best measure of aggregate 
economic activity but is available only quarterly and with lags; also 
often is revised. Considerable weight is placed on this Bureau of 
Economic Analysis (BEA) measure. The NBER definition thus encompasses a 
wide range of economic data, mostly monthly, not quarterly, economic 
time-series, and not just, or mainly, real GDP. In particular, two 
consecutive quarters of negative growth in real GDP is not the 
definition of a recession; nor does it make technical sense that it be 
so.
---------------------------------------------------------------------------
    The expectation is for a transitory lift in real GDP during the 
second and third quarters from the temporary tax rebates and their 
positive effects on consumption spending, then after the rebates 
further retrenchment by consumers with no particular stimulus coming 
from any source that can be currently seen (essentially flat real GDP 
or declines in the 0.5% to 1% range).
    Ripple effects into U.S. business sales and profits from the 
consumer retrenchment; cutbacks in production, spending and employment; 
weakness in state and local government spending from declines in tax 
receipts; depressed commercial real estate activity; and continuing 
financial system disarray suggest a long period of economic weakness 
accompanied by a decline of inflation but not necessarily to acceptable 
levels. Weak U.S. consumption, averaging only 1.6% per annum over the 
last five quarters against an historical trend rate of growth of 3-1/2% 
per annum, can be a depressant on the export growth of numerous non-
U.S. countries, in turn feeding back negatively later on the currently 
booming U.S. export economy.
    The U.S. prospect looking forward is thus stagnant economic growth 
and sticky-high inflation--a generic ``Stagflation'' with a weak, or 
recessionary, economy and high inflation moving somewhat lower for 
awhile but not enough to represent a significant downtrend. The 
unemployment rate is expected to rise unevenly to a range of 6-1/2% to 
7% by mid- or late-2009.
    There are numerous impediments to quick and sustained recovery for 
the United States.
    1) Crude oil and energy price inflation are negatively affecting 
oil-consuming economies--reducing economic growth and raising 
inflation. Most of the global economy falls into this category with 
particular exposure to rising oil and energy prices in the developed 
Asian world including Japan and South Korea, emerging Asian countries 
except to some extent China and India, much of the Eurozone, the U.S. 
to a significant degree, some other industrialized nations, and the 
majority of Emerging Europe. The oil producers of the world economy are 
in relatively good shape, although not all of them, e.g., Venezuela and 
perhaps Norway. In Latin America, Brazil and Argentina are relatively 
immune to higher oil and energy prices. Brazil is now a producer. So is 
Russia, a leading oil and gas producer, the second largest for crude 
oil, many oil-producing countries in the Middle East, Australia and New 
Zealand. But the Brazil, Argentina, Australia and New Zealand economies 
still are weakening from higher inflation and other sources. Economic 
weakness in non-U.S. countries can later negatively affect U.S. 
exports.
    2) The bust in U.S. housing and crunch in mortgage credit, not just 
for Subprime and Alt-A loans, but generally throughout mortgage 
finance, as well as the inability of consumers to draw on home equity 
for various purposes, continues as a major drag on the economy. The end 
may be in sight here as housing sales and starts appear to be 
bottoming-out; although not, however, for falling home prices. For 
awhile, the best that can be expected in house prices is less 
deceleration.
    3) The U.S. financial system, beset by a housing bust after an 
incredible boom, now is dealing with its own kind of ``bust,'' an 
unwinding of the huge residential real estate asset price, credit and 
derivative financial products booms and in the businesses of the 
financial institutions associated with derivative securities, 
structured investment products, and financial business development in a 
benign regulatory environment. Excesses in leveraged balance sheet 
expansion, unprecedented in scope for the numbers of financial firms 
involved and the amounts, suggest an uncertain timeline for the 
adjustment on the recapitalization necessary at many bank and nonbank 
financial intermediaries. This is particularly so at commercial banks, 
investment bank/broker dealers, private equity, venture capital and 
financial firms performing similar functions, collectively now the 
primary credit and financial intermediary channel for the economy. 
Tight credit in commercial real estate, for the consumer in various 
dimensions of borrowing, and increasingly for nonfinancial businesses 
is a result, as well as a drying-up of new IPOs and private equity 
financing.
    Writing down values from eroding or hard-to-estimate asset prices, 
raising and shoring up capital, cutting expenses, and tight credit are 
characteristics of the unwinding, the likes of which in a necessary 
deleveraging probably have not heretofore been seen. How long this 
process lasts and the time it takes to repair and rebuild the U.S. 
financial system are extremely important for determining the length and 
depth of the U.S. downturn--and extremely difficult to know at this 
time. Extreme risk aversion by financial institutions and in the 
economy at-large are preventing the massive injections of liquidity by 
the Federal Reserve from lifting economic activity.
    4) An overhang of debt and credit for households, businesses and 
even states and localities, and the necessary adjustments given a 
recession and declining asset values are other impediments to a 
sustained and sustainable pickup in economic activity.
    Aggressive and widespread debt-financed expansion has left 
households, businesses, financial institutions and governments with 
excessive debt and credit relative to secure collateral, vulnerable to 
an extended period of subpar economic activity, and in need of 
restoring balance sheet stability through less spending, less 
borrowing, less lending, and more savings.
    5) The biggest impediment may well be the American consumer, 
usually ebullient and boomy in expenditures and borrowing, as indicated 
by the historical trend rate of growth for aggregate consumption, 
adjusted for inflation, of 3-1/2% per year over the past 45 years. 
Given that trend rate of growth, even a reduction to a positive 1%-or-
2%, although not necessarily bringing about a decline in real GDP, 
would be a major depressant. Inflation-adjusted consumption is now near 
71-1/2% of real GDP. Significantly less growth in consumption could 
alter the business cycle in a fundamental way.
    Here is where the downward momentum of the U.S. business cycle is 
currently focused. All the fundamental determinants of aggregate 
consumer spending appear negative--1) growth in real disposable income, 
depressed by an increasingly weakening jobs market, low growth in 
nominal and real wages, and high price inflation; 2) huge reductions in 
real household net worth on declines in real estate and stock prices, 
somewhere between $3 trillion and $4 trillion over the past year and at 
a DE-estimated six cents of consumption, with lags, on a dollar of 
``permanently'' lower real net worth, representing nearly two 
percentage points of lost economic growth this year; 3) consumer 
confidence depressed to levels previously seen only in the deepest part 
of recessions; 4) the inability to tap and use housing equity for 
spending and investing, reversed now because of foreclosures, 
delinquencies, and negative home equity; 5) on DE measures the most 
deteriorated household financial conditions since the early '80s; and 
6) tight and tightening mortgage finance and consumer credit.
    Consumption spending has grown significantly below trend for five 
consecutive quarters now, averaging only 1.6% growth, at an annual 
rate, and may even turn negative in the third quarter. This is despite 
a $108 billion injection of temporary tax rebates over April-to-July, 
or $432 billion, at an annual rate. This weakness in consumer spending 
is striking given the historical propensity for a much higher rate of 
spending and few periods in history where the consumer has spent weakly 
for any length of time.
    How long this consumer weakness lasts and whether the consumer 
stays ``hunkered-down'' are keys to the timing and degree of any 
economic recovery.
    6) Finally, financial markets themselves, particularly an equity 
bear market, present impediments to a sustained pickup. Declining stock 
prices negatively affect consumer sentiment and household wealth, thus 
consumer spending. A bear equity market presents an impediment to 
raising funds for new enterprise and for corporate balance sheets. 
Declining stock prices raise the aftertax weighted average cost-of-
capital, increasing the cost of new projects. This reduces the 
transactions and IPOs that can support economic activity.
    Stock prices go down on expectations of a weaker economy; lower 
stock prices act to weaken the economy; a weaker economy reduces 
earnings growth; stock valuations decline; the economy weakens, etc.; 
that is, a negative feedback loop occurs. Once the economy downturn 
bottoms out and declines in earnings growth begin to reverse; in the 
presence of low, or falling, interest rates the stock market can start 
to gain and the negative feedback loop be broken. The U.S. is not near 
this point at the current time.
    A long period of adjustment is thus suggested, very likely 
prolonged economic weakness or recession-like conditions--the ``stag'' 
part of stagflation--with sticky-high inflation rates overall and for 
the ``core'' (ex-food and energy), the ``flation'' side of stagflation.

             WEAK OR WEAKENING ECONOMIES AND HIGH INFLATION

    The pattern of economic growth and inflation that is showing in the 
U.S. and globally is one of stagflation. The ``Stagflation Footprint'' 
appears in Table 3, with recent patterns and expectations of growth and 
inflation shown for several key countries and global regions. 2008:2 
already is essentially known, in particular virtually all of actual 
inflation. Second quarter results on real GDP still are not available 
for a number of countries.
    Weak economic growth and high or rising inflation represents two 
parameters that can define Stagflation. Others are jobs and the 
unemployment rate and the presence of pass-through from initial 
exogenous, or endogenous, sources of inflation such as energy 
inflation, wages, and nonlabor costs. The long-term presence of rising 
crude oil prices and lately food prices also are markers of 
Stagflation, certainly present in other historical episodes that have 
been so characterized. Crude oil prices, on average, have been rising 
since $19/barrel for light crude in November 2001 and particularly so 
over the past year where the increases do not appear to be solely 
endogenous. Exactly why crude oil prices have recently risen so far, so 
fast, is a puzzle. But, the effects on global inflation and on the 
inflation rates of a large number of countries are clear in the data.
    In many countries, wage inflation also is accelerating. This is 
particularly true in the emerging or developing world, where booms have 
occurred and unemployment rates moved to very low levels. Costs-of-
production are rising sharply in these countries. And, given the global 
nature of production and consumption, as well as the ability 
technologically to produce, distribute, and ship almost anywhere, the 
price and wage inflation of the emerging world must be regarded as a 
potential source of inflation everywhere.
    For many countries individually, the rises of inflation appear as 
exogenous, rather than endogenously driven through the demand-pull of a 
strong economy; for example, crude oil and food prices. Cost-push to 
individual countries has come from rising oil, energy, food and 
commodity prices and generally as part of global demands and supplies, 
but in many countries now appears to be part of the inflationary 
process.
    Table 3 shows a rather pervasive pattern of slowing real economic 
growth and rising inflation in the U.S., several key countries, and the 
major global regions of the world economy.
    Inflation appears to have picked up significantly in the U.S. and 
elsewhere sometime in the fourth quarter of 2007, a little earlier in 
the U.K., the U.S. and Eurozone, a little later in Japan. Pronounced 
global regional economic weakness is more recent and has intensified in 
the last six months.
    The rising inflation over the past six-to-nine months and its 
pervasiveness are striking (Tables 3, 2, and 4 below), with the number 
of countries showing quite high inflation, year-over-year, 6%-or-more, 
at 20, and 26 countries exhibiting year-over-year inflation between 3% 
and 5.9%. Only one country has a running inflation rate less than 3%, 
Japan. Table 3 also demonstrates that the more sharply rising inflation 
is recent and, except for the U.S., much slower growth very recent.

                              TABLE 3.--GLOBAL AND GLOBAL REGIONAL ``STAGFLATION?''
----------------------------------------------------------------------------------------------------------------
                                                 2008:3F    2008:2F    2008:1A    2007:4A    2007:3A    2007:2A
----------------------------------------------------------------------------------------------------------------
Global:
    Real GDP Growth (Pct. Chg. Year Ago)......       2.3        3.0        3.5        3.7        3.9        3.7
    CPI Inflation (Pct. Year Ago).............       5.0        4.7        4.2        3.8        2.8        2.7
U.S.:
    Real GDP Growth (Pct. Chg. Year Ago)......       1.2        2.2        2.5        2.3        2.8        1.8
    CPI Inflation (Pct. Year Ago).............       4.8        4.3        4.2        4.0        2.4        2.6
U.K.:
    Real GDP Growth (Pct. Chg. Year Ago)......       1.0        1.4        2.3        2.8        3.1        3.3
    CPI Inflation (Pct. Year Ago).............       4.3        3.4        2.4        2.1        1.8        2.6
Japan:
    Real GDP Growth (Pct. Chg. Year Ago)......       0.6        1.0        1.2        1.4        1.8        1.8
    CPI Inflation (Pct. Year Ago).............       2.2        1.4        1.0        0.5      -0.1       -0.1
EU:
    Real GDP Growth (Pct. Chg. Year Ago)......       1.0        1.5        2.1        2.2        2.6        2.6
    CPI Inflation (Pct. Year Ago).............       4.2        3.6        3.2        2.8        1.9        2.0
Eurozone:
    Real GDP Growth (Pct. Chg. Year Ago)......       0.8        1.5        2.1        2.2        2.6        2.6
    CPI Inflation (Pct. Year Ago).............       3.9        3.6        3.4        2.9        1.9        1.9
G-7:
    Real GDP Growth (Pct. Chg. Year Ago)......       0.7        1.9        2.1        2.0        2.5        2.0
    CPI Inflation (Pct. Year Ago).............       4.0        3.4        3.1        2.9        1.8        2.0
OECD:
    Real GDP Growth (Pct. Chg. Year Ago)......       1.3        2.0        2.4        2.5        2.8        2.4
    CPI Inflation (Pct. Year Ago).............       4.4        3.7        3.3        3.1        2.0        2.2
Latin America:
    Real GDP Growth (Pct. Chg. Year Ago)......       4.7        5.1        5.3        5.7        5.4        5.1
    CPI Inflation (Pct. Year Ago).............       8.4        7.5        6.4        5.7        5.3        5.1
EMG-Asia and Developing Countries (Ex-Japan):
    Real GDP Growth (Pct. Chg. Year Ago)......       7.6        8.2        9.4        9.9       10.1       10.7
    CPI Inflation (Pct. Year Ago).............       8.5        7.9        7.2        6.0        5.8        4.2
EMG-Europe:
    Real GDP Growth (Pct. Chg. Year Ago)......       7.5        6.9        5.7        4.4        4.5        4.8
    CPI Inflation (Pct. Year Ago).............       8.5        7.7        7.0        6.2        5.1        6.4
----------------------------------------------------------------------------------------------------------------
F = Forecast.
A = Actual.

    The classic ``Stagflation Footprint'' presents itself as a 
recession or stagnation that could be prolonged; stubbornly high, or 
rising, inflation, overall and in the ``core;'' pass-through to prices 
of higher cost inflation through wages, unit labor costs, lower 
productivity growth and/or nonlabor costs; and rising unemployment. 
Exogenous price, wage, or productivity shocks also can be present, from 
economic or geopolitical sources, or both. Permissive or accommodative 
monetary policy has been yet another characteristic. Rising expected 
inflation, if possible to measure, presumably also should be present.
    The policy choices, fiscal and monetary, going forward are 
difficult, for the U.S. and elsewhere in the global economy.
    If only recession, the policy choices will be simple--easier 
monetary policy, perhaps aggressively so, and fiscal stimulus. But high 
and rising inflation in the U.S. and many other countries prevent this 
and present yet another challenge--how to reduce the inflation. If only 
inflation, the policy choices would be easy--for monetary policy higher 
interest rates and tighter credit, and/or fiscal restraint. The latter 
is notably difficult to implement in any country, however, at any time.
    For monetary policy, the simultaneous appearance of recession and 
inflation presents difficult assessments and choices--whether for a 
central bank such as the Federal Reserve and perhaps the Bank of Japan 
(BOJ) that operate under a ``dual mandate'' of maximizing sustainable 
economic growth and price stability, or central banks focused on price 
stability with a ``soft'' inflation target such as the European Central 
Bank (ECB) and Bank of England (BOE), or by law an explicit ``hard'' 
inflation target, e.g., the Bank of Canada (BOC) and Reserve Bank of 
New Zealand. Which challenge to deal with, recession or inflation, and 
in what sequence are major questions.

             WHY U.S. ``STAGFLATION'' AND WILL IT PERSIST?

    Charts (1) and (2) indicate that several defining parameters of 
stagflation are present for the United States--a weakening or declining 
economy, perhaps a recession, at least on a number of monthly economic 
indicators, rising inflation, sharply so since 2007:3, and a rising 
unemployment rate. Sharply higher crude oil, energy, and food prices 
since mid-2007 after years of increases, on average, for crude oil and 
energy prices and rising expected inflation, on average for some 
measures, also are defining characteristics.



    Even ``core'' inflation and the unemployment rate have been rising 
together, yet another stagflation sign. Real GDP growth is estimated to 
have been only 1-1/4% to 1-1/2% over the past year and core inflation, 
has measured by the PCE Deflator, currently stands at its cyclical 
high, 2.4%. Core CPI inflation is 2.5%, year-over-year. The 
unemployment rate, at 6.1%, compares with 4.7% a year ago and the low 
of 4.4% in March 2007.
    Why a U.S. stagflation?
    One reason is the pronounced cyclical downturn in housing, 
unprecedented declines in residential real estate prices, resulting 
financial turmoil and instability, and negative effects on consumption 
through deteriorating consumer confidence, reductions in household real 
wealth, declines in jobs, and less growth of real incomes. Deteriorated 
household financial conditions and the failure fallout of delinquencies 
and bankruptcies are other reasons for weak consumer spending. The need 
to rebalance imbalances in household balance sheets and existence of 
tight credit conditions suggest a lengthy process of adjustment for 
consumers.
    Second is the squeeze on consumer purchasing power, also in many 
other countries, brought about by sharply higher oil, energy and food 
prices, which adds to inflation but reduces real incomes, real wealth, 
and real consumption.
    A third reason is sharply higher crude oil, gasoline, heating, 
energy and food prices, which have added to overall inflation and 
spilled over into costs-of-production, in turn passed on into prices in 
order to maintain business profit margins.
    Fourth is the aggressive easing of the Federal Reserve because of 
the U.S. financial crisis and potential risks to the financial system 
and the economy. Federal Reserve monetary policy has been easier than 
otherwise, has helped keep the dollar lower, and affected the expected 
inflation of U.S. consumers, global financial market participants, and 
businesses. Exactly how expected inflation enters actual inflation is 
unclear, but its rise has been correlated with rising actual 
inflation.\5\ Inflation will be higher than otherwise when a central 
bank follows an easy monetary policy.
---------------------------------------------------------------------------
    \5\ Expected inflation is a right-hand-side variable in most forms 
of the expectations-augmented Phillips Curve inflation paradigm that 
lies at the heart of current mainstream macroeconomic analysis. But, 
how these expectations are formed and affect price inflation, by how 
much, and over what timespan remains murky. A rise of expected 
inflation should increase actual inflation, according to this 
framework. But, the mechanisms by which this occurs have not been 
clearly spelled-out.
---------------------------------------------------------------------------
    Fifth is the American consumer, likely to stay cautious in spending 
and borrowing given so many negative fundamentals. Consumption spending 
drives the U.S. economy; if weak, the economy must largely remain weak.
    Sixth, much of the business cycle downturn looks still to-come. As 
yet, business capital spending has held up. Exports are booming. With 
business sales and earnings growth declining, indeed for the latter 
falling in levels, additional cutbacks in production, employment, 
capital spending, and new business ventures can be expected.
    Seventh, as the global economy contracts, U.S. exports likely will 
weaken, softening what has been a significant strength.
    Finally, neither monetary nor fiscal policy is being set for 
lasting stimulus. Too high inflation prevents the Federal Reserve from 
easing any more; instead, its next move on interest rates probably is 
up and, at some point, the huge liquidity and backstop financing that 
has been put-into-place will have to be withdrawn.
    Why will U.S. Stagflation persist?
    A stagnant economy, at the least low and subpar real economic 
growth, likely will continue given relatively weak consumption and 
continuing restraint stemming from the necessary adjustments in the 
U.S. financial system and private sector.
    But what about inflation? With lags, shouldn't a subpar economy, 
rising unemployment, and lower oil and commodities prices take down 
inflation?
    Certainly, for a time this seems likely later this year and next, 
if only arithmetically, on a year-ago basis when the much higher 
inflation rates that have already appeared will provide downward base 
drift for price inflation in the U.S. and elsewhere.
    But, how much deceleration of inflation is the question. And, 
whether pass-through of higher prices into wages and then through costs 
back to higher prices will occur is another. So far, U.S. laborers are 
accepting losses of jobs and a squeeze on real incomes in return for 
job security. However, this may not necessarily persist, even with a 
much higher unemployment rate. And, the global nature now of the 
inflation process and its structure suggest that other costs, for 
import goods, nonlabor, and energy-derived could prevent increased 
economy slack from taking down price inflation to acceptable levels.
    Thus, a reasonable expectation is that the U.S. economy will grow 
slowly, on average, if at all, with sticky-high inflation, although 
lower than currently, with both persisting for quite some time.

        THE ROLE OF ECONOMIC POLICY IN THE CURRENT CIRCUMSTANCES

    For U.S. policymakers, much effort has been expended to cushion the 
economic downturn and to prevent financial system disarray from taking 
the economy down further.
    With a difficult near- and intermediate-term cyclical situation in 
prospect, it is tempting for policymakers to look for quick solutions, 
using short-run and temporary measures. However, the current U.S. 
cyclical downturn and perhaps to emerge in the world-at-large reflects 
deeper, long-run problems that require longer-run policy actions for 
relief.
    So far, the measures taken by the Federal Reserve and other central 
banks and on fiscal stimulus have not resulted in much improvement, 
although certainly preventing even worse results from occurring. This 
may be because of lags in the effects of policy. Or, it may be that the 
excesses of the U.S. situation and adjustments necessary to correct 
them are so large, and require so much time, that short-run temporary 
measures will not prove curative nor provide anything other than 
temporary relief.
    Such is probably the likelihood for the ``temporary'' tax rebates 
tried in the United States. The rationale made sense, to bridge a 
possible downturn with help for the consumer until low interest rates 
and increased liquidity could lift up the financial system and the 
economy. Some of what was intended has happened. But now with the 
rebates essentially done, all things considered, the motion and process 
of the current business cycle is likely to work against any further 
lift. There is too much to go yet in the U.S. and global business cycle 
downturns and in the contraction of the financial system and in credit 
to allow easier monetary policy to produce the hoped-for significant 
upward response in economic activity. The contraction in credit and 
retrenchment of the financial system are likely to make the lags in 
monetary policy much longer-than-average, perhaps as long as in some 
other long episodes, at near 24 months or about two years. The collapse 
in housing activity will abate and come to an end over the next year, 
but housing probably will not show a significant upturn. Two years 
would take the U.S. economy into 2010.
    For the consumer, beset by the most negative set of economic 
fundamentals in several decades, the outlook is problematical. The 
excesses and imbalances of the household sector need to be worked off 
to prepare for the next upturn. How long consumption stays subpar is a 
key.
    Thus, the prospects for help from policy are daunting. The tax 
rebates have lifted consumer spending, but given the fundamentals 
surrounding consumption probably only temporarily so. As the end of the 
effects from the tax rebates approaches, there appears to be nothing 
fundamental, nor exogenous in source, that can lift the growth of 
consumer spending to any major degree.

 WHAT THEN, FOR FUTURE POLICY? SHORT-RUN HELP IN THE CONTEXT OF A LONG-
                       RUN REBUILDING OF AMERICA

    In difficult economic times, it is essentially irresistible and 
almost politically impossible not to try and use policy for improving 
short-run economic performance, particularly when jobs and the economy 
are at stake and in an episode like the current one where the U.S. 
financial system is contracting so much. This is especially true in a 
Presidential election year, regardless of the party in power.
    But, history teaches how difficult it is in the short-run to devise 
appropriate and properly-timed macroeconomic policies, even in the best 
of circumstances. The ``rush-to-help'' should be disciplined by 
consideration of the nature of the problems and in the context of the 
longer-term.
    Also, it is important to coordinate policies in- and over-time, 
both for multiple fiscal actions that might be taken and their 
interactions and effects, and how current policy actions can dovetail 
with longer-term policies to achieve national objectives. This is 
similarly so for monetary policy and its interaction with fiscal 
policy. Macroeconomic policy effectiveness, in this sense, would be 
enhanced in a cost-efficient way if there were more coordinated 
planning and policy actions than the piecemeal, separate, approach that 
is normally the case.
    Temporary tax reductions and hurry-up programs of government 
spending do not have a good history of success in U.S. economic policy. 
Both monetary and fiscal policies, though well-intentioned, often have 
erred and been mistimed. It is very difficult to design optimal 
policies for the short-run that can also work to achieve long-run 
economic objectives such as maximum growth and price stability, 
especially in those circumstances when the two objectives are in 
conflict or where there is a negative tradeoff between them.
    The United States has perhaps the longest list of economic problems 
and backlog of societal issues in decades. Years of not facing up to 
big, long-run issues like energy conservation, energy independence from 
oil and oil derivative products, rising structural federal budget 
deficits, reforming and restructuring the tax system, social security 
and health care, and now the stabilizing of the economy and inflation 
have left staggering policy challenges for the future. Added to the 
list, given the current financial crisis, is maintaining financial 
stability along with updating and changing the regulatory and 
supervisory framework for the U.S. and global financial systems.
    One possible approach is to design short-run stimulus in the 
context of longer-run objectives--that is, measures or stimulus now as 
a step or downpayment on longer-run policies to achieve long-run 
objectives.
    Of the many longer-run economic issues the country ultimately has 
to face, there are at least eight worth noting that are highlighted and 
dovetailed with the immediacy of the current situation. The comments 
here represent only a few of the possibilities on taxes, the role of 
the federal government, and for Congress.
    These are:
     The Economy and Jobs. The U.S. economy is suffering 
cyclically and is at risk secularly, with supportive fiscal and 
monetary policies necessary in the short-run and for the long-run. 
Monetary policy has done about all it can safely do under the current 
circumstances. For fiscal policy, if a Pay-Go framework is applied, tax 
reductions for middle and lower income families financed by increased 
taxes on the highest income families and by reduced growth in 
government spending would serve to support consumption and the 
household balance sheet in a permanent way if the tax reductions were 
themselves permanent. There are other ways to accomplish this and to do 
so within a context of longer-run multi-year federal budget balance. 
The consumer is the policy lever here given the current situation and 
prospect.
     Energy Independence and Energy Conservation. Measures to 
reduce the demand for oil, gasoline and other energy derivatives as 
well as policies to stimulate supply and to develop alternative energy 
sources, both for crude oil and the refining of gasoline, are indicated 
with a ``Call to Mission'' sense of national urgency. Had the U.S. 
tackled the ``Energy Problem'' 30 years ago, the inflation part of 
today's stagflation might not be present. The dependence on crude oil 
by so many countries is a major source of the current economic malaise 
facing many of them and of too high inflation.
    For the U.S., lower crude oil and derivative energy prices would go 
a long way toward freeing-up discretionary income for spending, 
reducing business costs-of-production, and make much easier the task of 
the Federal Reserve in stimulating and sustaining maximum economic 
growth. Because of the connection between the ``Energy Problem'' and 
the ``Stagflation Problem,'' the leverage of a big visionary program 
with tangible actions to reduce demands and increase the supplies of 
oil and energy would be very high.
    Here, a Bipartisan Task Force charged with developing a National 
Energy Program is called for, with a charge and sense of urgency and 
call for response and, if necessary, sacrifice by the America people 
from our national leaders--that is, Washington!
     The Infrastructure of America--loosely defined as capital 
infrastructure as well as education infrastructure--needs much 
attention. Programs to increase infrastructure spending at the federal 
or state and local government level in-line with a longer-run program 
to Rebuild America's Infrastructure would be appropriate. Such programs 
need to be carefully planned and executed, however. There is stimulus 
to the economy and jobs in the short-run from infrastructure spending 
but it can be fleeting, misdirected, and wasteful. Planned and well-
targeted infrastructure spending can enhance long-run productivity.
     The U.S. Financial System. Measures taken so far by the 
U.S. Treasury and Federal Reserve to deal with a financial crisis 
probably serve only as a stopgap and raise the risk of underwriting 
future inflation. Constructive proposals on regulation and supervision 
in a New Financial World have been put forth in the U.S. and abroad, 
but little more than the measures already taken seem possible over the 
near-term. The regulatory side needs reform and a careful 
restructuring. Although there is a role for the federal government, 
especially since there have been market failures, care should be taken 
so that the federal government does not depart far from its principal 
public sector functions and inject itself too much into the private 
economy and financial markets along with whatever private financial 
institutions are doing to self-correct and consolidate.
     Rebuilding Housing and Restructuring Mortgage Finance. 
Policy measures to enhance the demand and supply of housing, cushion 
the fallout of the current housing crisis, and enhance the support 
functions for mortgage finance were included in the Frank-Dodd bill 
passed by Congress. Although a step in the right direction, the 
measures in it can only deal with a small part of the imbalances in the 
supplies-and-demands for mortgages and of housing, where price erosion 
of residential real estate is at the heart of the financial distress. 
Measures to directly affect the demand and supply of housing involving 
the federal government are worth examining--including something like 
the Reconstruction Finance Corporation used in the early 1990s when the 
savings-and-loan industry collapsed. So is trying to determine the 
appropriate private sector financial institutions and intermediaries to 
support mortgage finance and housing. The governance structure of the 
current GSEs, their future role, that of others, the provision of 
mortgage finance to housing needs to be reexamined especially in light 
of the recent emergency actions taken by the U.S. Treasury and new GSE 
regulatory agency.
     The U.S. Health Care System has to be Rebuilt and 
Reformed, with health care inflation and the aging population major 
sources of federal government budget deficits and growing U.S. 
indebtedness in future years. More than any other factor, rising 
numbers of health system beneficiaries, the rising costs of health 
care, and a chaotic system of providing medical care services is a 
major drain on future government financing. How to handle the societal, 
economic, financial, and inflationary problems created by health care 
needs to be figured-out.
    A Bipartisan Commission on this great national problem, charged 
with getting results and taking actions, is one way to proceed. Here, 
as in so many of the economic and societal issues faced by the nation, 
strong leadership is needed--if not the federal government then some 
sort of public-private partnership to deal with the problems.
     Household Savings and the Household Balance Sheet. Here, a 
rebalancing and rebuilding of currently fragile household financial 
conditions is necessary. Years of dissaving, wealth created principally 
by rising prices of residential real estate, and heavy use of credit 
and debt have left many households in considerable financial distress. 
The household sector financial imbalances engendered by heavy spending, 
borrowing, and use of new, innovative ways to finance and tap equity in 
homes have left the financial condition of households in the most 
deteriorated state since the early 1980s. With a stagnant or slow-
growing economy and rising unemployment, household financial fragility 
is made worse. Tax policy can play a role by providing savings 
incentives and through stimulus to the economy to support equity and 
real estate markets, the biggest base of household net worth.
     The U.S. as a Debtor Nation. Debt has been a way-of-life 
in the U.S. no matter who the borrower or lender. Now, the U.S. finds 
itself a large net debtor, relatively poor compared with much of the 
rest-of-the-world, and where currently asset collateral values are 
eroding. This makes the burden of debt much higher. There appears to be 
more debt accumulation relative to assets than less and the exposure 
varies across individual families, businesses, and government. The 
evolving nature of the U.S. recession, growing global economic 
weakness, continuing tight credit, and the need to retrench on debt and 
credit make the prospect for adequate future economic growth appear 
hard-to-reach. The accumulation of debt can become a burden relative to 
assets and to income, with debt payments, across all sectors, private 
and public, too onerous. The exposure of households on debt and squeeze 
on financial conditions facing households is considerable. Similarly 
so, for the federal government and international fronts.
    Rebuilding America means Rebuilding and Reforming the Financial 
System, Rebuilding Infrastructure, Reforming and Restructuring the Tax 
System, Building an Energy Program that achieves Energy Independence, 
Rebuilding and Reforming Health Care, Restoring and Maintaining 
Financial Stability, and most importantly Rebuilding the Economy and 
Jobs to make sure that enough jobs are created at low enough inflation 
to sustain, and maintain, full employment.

    Chairman Spratt. Mr. Kreutzer, we have a vote on the floor. 
There is 12 minutes remaining. And is it Dr. Kreutzer?
    Dr. Kreutzer. Yes.
    Chairman Spratt. Let's start with you. You can take 5 
minutes and then we will go vote and come back.

               STATEMENT OF DAVID KREUTZER, PH.D.

    Dr. Kreutzer. That is fine with me.
    Mr. Chairman, I want to thank you and the other members of 
the House Committee on the Budget for this opportunity to 
address you concerning responses to a weakened economy.
    Energy is critical to the operation of our economy and the 
maintenance and improvement of our standard of living. 
Restricting access to energy, as higher prices do, hurts the 
economy, drives down income and, of course, drives up prices of 
other goods.
    For the past several years, I have seen a dramatic increase 
in the price of petroleum and petroleum products. The price of 
petroleum doubled in the last year, although it has eased in 
the last two months. The resulting increases in gasoline, 
diesel fuel and heating oil prices not only directly impact 
household budgets, they reduce jobs and income as well.
    Just using the example of gasoline, the cost to the average 
household of a $1 per gallon increase in the price of gasoline 
reduces what they can spend on everything else by $1,100 per 
year. But the damage to the economy doesn't stop there just 
with household budgets. Producers must adapt to higher fuel 
costs as well. They can't pass their higher fuel costs on 
entirely to consumers. So they must cut production and, 
therefore, employment. In turn, these conditions put downward 
pressure on wages and salaries.
    The effect of higher petroleum prices in the U.S. is a 
weaker economy. The cause of higher petroleum prices is changes 
in supply and demand. In the past decade, worldwide demand for 
petroleum has grown faster than supply and has virtually erased 
spare capacity worldwide. When there was spare capacity on the 
order of 3 to 5 million barrels a day, which wasn't too long 
ago, the demand of a new car owner in the developing world 
could be met with additional lifting. In essence, the price of 
petroleum in this environment reflected the cost of getting the 
oil from the deepest well.
    With little or no spare capacity, as we have now, when a 
new car driver emerges in the developing world, price now has 
to go up high enough to get some other driver in some other 
part of the world out of their car. And that is a much higher 
price increase. In this situation, slight changes in demand can 
lead to large changes in price--and we have seen that. 
Similarly, slight changes in supply can also lead to large 
changes in price.
    An obvious way to counter the high cost of petroleum is to 
produce more of it ourselves. This will reduce energy 
expenditures, reduce the balance of trade deficit, and expand 
economic activity.
    The impact of increased production on world petroleum 
prices depends on the market conditions into which the 
additional petroleum is supplied. In a July 2, 2008 letter, Guy 
Caruso, Administrator of the Energy Information Administration, 
estimated for each additional million barrels of oil per day we 
produce we would drop the price of petroleum by $20 per barrel.
    Now this is consistent with research showing what 
economists call a short-run elasticity of demand by .05. And 
what that means is that, in the short run, a 1 percent change 
in supply or demand will lead to a 20 percent change in price.
    What then would be the impact of increasing domestic 
petroleum production?
    The Center for Data Analysis at the Heritage Foundation 
analyzed the economic effects of increasing domestic petroleum 
production by 1 and 2 million barrels a day. Increasing 
domestic production by 1 million barrels per day will reduce 
imported petroleum costs by $123 billion per year, generate an 
additional $7.7 billion in economic activity, cost an 
additional $25.6 billion as we produce the oil ourselves, 
leading to a net gain to our economy of $105 billion per year. 
In addition, the impact on unemployment will be an increase of 
128,000 jobs.
    Applying the same analysis to a 2 million barrel per day 
increase in domestic production yields net gains to the economy 
of 270,000 jobs and $164 billion per year.
    We have untapped resources. The Arctic National Wildlife 
Refuge and the Outer Continental Shelf are estimated to contain 
30 billion barrels of petroleum. The 10 billion barrels that 
are estimated to be in the Arctic National Wildlife Refuge are 
enough to fuel all the vehicles for 7.4 million households for 
50 years. I would note that only two States, California and 
Texas, have more than 7.4 million households.
    While bringing an additional 1 to 2 million barrels per day 
of petroleum out of these reserves is not a trivial enterprise, 
it should be noted that a single platform in the Gulf of 
Mexico, Thunder Horse, is slated to produce one-quarter of a 
million barrels per day within the next year. I recommend that 
Congress proceed expeditiously to open up the Outer Continental 
Shelf and the Arctic National Wildlife Refuge to safe, clean, 
modern drilling so we can get critically needed petroleum 
without jeopardizing the environment.
    Chairman Spratt. Thank you very much.
    [The statement of Dr. Kreutzer follows:]

 Prepared Statement of David W. Kreutzer, Ph.D., Senior Policy Analyst 
 in Energy Economics and Climate Change, Center for Data Analysis, the 
                          Heritage Foundation

    My name is David Kreutzer. I am Senior Policy Analyst in Energy 
Economics and Climate Change at The Heritage Foundation. The views I 
express in this testimony are my own, and should not be construed as 
representing any official position of The Heritage Foundation.
    Mr. Chairman, I want to thank you and the other members of the 
House Committee on the Budget for this opportunity to address you 
concerning responses to a weakened economy.
    Energy is critical to the operation of our economy and the 
maintenance and improvement of our standard of living. Restricting 
access to energy, as higher prices do, hurts the economy, drives income 
down and, of course, drives up prices of other goods.

                     PETROLEUM PRICES HURT ECONOMY

    The past several years have seen a dramatic increase in the price 
of petroleum and petroleum products. The price of petroleum doubled in 
the past year, though it has eased in the past two months. The 
resulting increases in gasoline, diesel fuel and heating oil prices not 
only directly impact household budgets; they reduce jobs and income as 
well.
    For example, the EPA estimates that the typical light vehicle 
travels 12,000 miles per year and averages about 20 miles per gallon. 1 
Doing the division indicates that the typical vehicle uses about 600 
gallons per year. Further, the Department of Transportation data show 
that the average household owns nearly two cars. 2 Therefore, the cost 
to the average household of a one-dollar-per-gallon price increase is 
about $1,100 per year. But, the damage to the economy doesn't stop 
there.
    Higher petroleum prices squeeze the production side of the economy 
from both the demand and costs directions. Consumers' demand for output 
drops as they divert expenditures from other items to gasoline and 
heating oil. In addition, petroleum products are inputs to both the 
production and distribution of many goods and services.
    Faced with these higher costs, producers try to raise their prices. 
But the lower demand prevents the prices from rising enough to 
completely offset cost increases. This leads to production cuts and, 
therefore, to lower employment. In turn, these conditions put downward 
pressure on wages and salaries.
    The effect of high petroleum prices in the US is a weaker economy; 
the cause of the high petroleum prices is a change in supply and 
demand. In the past decade world-wide demand for petroleum has grown 
faster than supply and has virtually erased spare capacity. Over five 
million barrels per day as recently as 2002, spare capacity has dropped 
below two million barrels per day in the past couple of years. When 
supply is pushed up against its capacity constraints, as it is now, 
additional demand in one part of the world can be met only with demand 
reductions elsewhere.
    When there was spare capacity on the order of three to five million 
barrels per day, the demand of a new car owner in the developing world 
could be met with additional lifting. In essence, price in this 
environment reflects the cost of getting oil from the deepest well. 
With no spare capacity, fuel for a new driver can be provided only when 
the price rises high enough to force drivers elsewhere out of their 
cars. In this situation, slight changes in demand can lead to large 
changes in price. Similarly, slight changes in supply can also lead to 
large changes in price.

                     WHAT IF PETROLEUM OUTPUT ROSE?

    Among other things, the Center for Data Analysis at the Heritage 
Foundation has the capability to analyze broad, economy-wide impacts of 
changes in energy prices. This past spring we analyzed the impacts of 
higher energy costs that might result from policies to restrict carbon 
dioxide emissions. This summer we analyzed the impacts of higher 
gasoline prices on employment, income and household budgets.
    Last week the Center analyzed the economic effects of increasing 
domestic petroleum production by one million barrels per day and two 
million barrels per day. Because the United States consumes 20 million 
barrels per day of petroleum and petroleum products, these increases 
correspond to five percent and ten percent changes on the mix of 
domestically produced versus imported petroleum. In other words, the 
additional domestic production would reduce imports from their current 
level of 65 percent to 60 percent and then 55 percent.
    Increasing domestic production of petroleum will affect the economy 
two ways. First, it will reduce the amount we spend on imported oil. 
Second, it will lower the price of petroleum. The two effects work 
together to reduce energy expenditures; to reduce the balance of trade 
deficit; and to expand economic activity.
    The impact of increased production on world petroleum prices 
depends on the market conditions into which the additional oil is 
supplied. In a letter dated ``July 2, 2008'' to Representative Jack 
Kingston, Guy Caruso, Administrator of the Energy Information 
Administration, estimated each additional million barrels of oil would 
lower world price by $20 per barrel.3
    This price impact is consistent with recent research showing a 
short-run elasticity of about 0.05.4 Adjusting consumption of gasoline, 
heating oil and other petroleum products is difficult for consumers to 
do in the short-run. As a consequence, a one percent increase in price 
reduces consumption by only 0.05 percent. So, a one percent change in 
supply requires a 20 percent change in price to bring markets back into 
balance. It is understood that the price impact would be smaller over 
time once the world economy fully adjusts to the increased production.
    We are comfortable using this elasticity since it seems probable 
that world petroleum markets, which are not currently in long-run 
equilibrium, will continue to see strong demand growth, especially over 
the long-run.56 Nevertheless, we note that should the world petroleum 
market ease significantly by the time this increased production comes 
on line, the price and economic impacts will be less pronounced. Of 
course, this reduced impact would occur in a world that already had 
significantly lower petroleum prices.

                             THE ESTIMATES

    Increasing domestic production by one million barrels per day will 
reduce imported petroleum costs by $123 billion; generate an additional 
$7.7 billion in economic activity; and cost $25.6 billion in additional 
oil production costs. The net gain to the economy will be $105 billion. 
The impact on employment will be an increase of 128,000 jobs.
    Applying the same analysis to a two million barrel per day increase 
in domestic petroleum production yields net economic gains to the 
economy of 270,000 jobs and $164 billion.

                           UNTAPPED RESOURCES

    The Artic National Wildlife Refuge and the Outer Continental Shelf 
are estimated to contain 30 billion barrels of petroleum. The 10 
billion barrels estimated to be in ANWR are enough to fuel all the 
vehicles for 7.4 million households for 50 years.
    While bringing an additional one to two million barrels per day of 
petroleum out of these resources is not a trivial enterprise, it should 
be noted that a single platform in the Gulf of Mexico is slated produce 
one-quarter of a million barrels per day within the next year.
    I recommend that Congress proceed expeditiously to open up the 
Outer Continental Shelf and the Artic National Wildlife Refuge to safe, 
clean modern drilling so that we can get critically needed petroleum 
without jeopardizing the environment.

    Chairman Spratt. Now we have 6 minutes to make this vote. 
We have a vote right behind it, and we will be back as quickly 
as we possibly can. We appreciate your forbearance.
    [Recess.]
    Chairman Spratt. I call the hearing back to order, and we 
will begin with questions.
    Dr. Kreutzer, first of all, were you finished with your 
statement?
    Dr. Kreutzer. I was finished. Yes, sir.
    Chairman Spratt. Thank you, sir.
    Beginning with questions of the panel, Dr. Summers, there 
has been analysis of the effects of the first rebate or 
stimulus program that indicate that only a small fraction of 
the rebate was actually spent. Martin Feldstein, among others, 
even though he was one of the original adherents, now wonders 
whether or not the stimulus, particularly the rebates, had 
their intended effect. What is your view of that?
    Dr. Summers. I think it is difficult to judge, Mr. 
Chairman, because it is difficult to construct a 
counterfactual. On the one hand, there is evidence that the 
savings rate rose when the rebates were given. On the other 
hand, consumers were buffeted with a lot of bad news at the 
same moment that happened. So you don't know what would have 
happened to spending if the rebates had not come.
    There is other more micro-evidence the scholars at the 
Chicago Federal Reserve Bank have developed looking at 
individual consumers that suggests some potency to the rebates.
    My judgment is that they had a constructive impact. I think 
we are in better shape than we would have if they had not been 
enacted. I do, as my recommendations suggest, believe that a 
subsequent stimulus probably should contain a number of 
significant measures on the expenditures side where the 
propensity to spend is likely to be greater than it is in 
association with the rebates.
    I would highlight, Mr. Chairman, because it is a point that 
is often I think overlooked in these discussions, that if one 
provides rebates and if those rebates are not spent, by 
definition, they are saved. And from an overall macro point of 
view, if the increase in the Federal deficit is matched by an 
increase in private saving, you don't have adverse impacts on 
interest rates. And so there is at least the offsetting 
consideration with respect to rebates that--or tax cuts--that 
if they are not spent, they are saved. And in some sense, 
therefore, what one is concerned about as the negative side of 
this in terms of increased debt also materializes less.
    On balance, some of them were spent, some of them were 
saved. We are better off having done it than we would have been 
if we hadn't; and we would be better off doing further 
stimulus, though not all on the tax side. Some in areas where 
we know it will all be spent.
    Chairman Spratt. But in your testimony you do not recommend 
a second round with rebates included.
    Dr. Summers. I didn't. And I did refer to increasing the 
LIHEAP program, which has some of the same--which has some of 
the same character. I don't--I could go either--I could go 
either way on that.
    I think the suggestion that Dr. Sinai made that if, as has 
been much discussed in the last year, there was going to be 
sustained middle-class tax relief, one way of turning that into 
fiscal stimulus would be to phase it in in a way where the tax 
cuts took effect prior to the pay-fors; and that would be an 
alternative way of achieving the objective of near-term fiscal 
stimulus.
    But, on balance, Mr. Chairman, I would prefer rebates to 
inaction. But I would assign a higher priority to support for 
those with low incomes, to infrastructure spending and to 
relief for State and local governments. But I wouldn't have 
trouble with rebates as an element of the package.
    Chairman Spratt. Would you subscribe to the argument that 
some of the cost of the rebates, stimulus plan was in effect 
recouped in terms of a lower deficit because the impact on 
the--because of the alleviating impact on the economy?
    Dr. Summers. I think that was the argument I was rather 
clumsily attempting to--rather clumsily attempting to 
articulate a moment ago when I suggested that, to the extent 
that the rebates are saved, any adverse deficit impact of them 
is naturally offset by the increased household saving. So I 
think one can't have it both ways in criticizing the rebates. 
That is, to the extent that they are ineffective, they are also 
not depleting of the Nation's supply of savings. Insofar as 
they are only depleting of the Nation's supply of savings 
insofar as they are effective in stimulating consumption.
    Chairman Spratt. Finally, you said from the first time you 
expressed concern about this I believe in the Financial Times 
that the stimulus program should be targeted, timely and 
temporary. In terms of targeting, what would you target in our 
infrastructure?
    Dr. Summers. I would target things where it is likely to be 
spent. And I think that infrastructure seems to me to be a high 
priority. I have become persuaded that it is possible to move a 
fair amount of infrastructure funding relatively quickly. And I 
think in the long-run context, there is a strong case for 
increased infrastructure spending.
    State and local governments, the easiest funds to move 
quickly are reversing what are otherwise cutbacks, and there is 
so much cutting back at the State and local government that I 
can believe that, properly targeted, that would be availing. 
And then I think there is also a case for targeting those with 
low incomes and those with incomes that have declined.
    Chairman Spratt. In terms of being timely, if we don't get 
something adopted, say, in September before we adjourn and come 
back for a lame duck session in late November, or don't come 
back at all and don't really reconvene until January, have we 
missed the boat?
    Dr. Summers. In the unfortunate event that something 
doesn't happen in the next several months, we will have a 
chance to revisit that question in January. My best guess is 
that while it would be better to do fiscal stimulus now, it 
will still be necessary in January. I hope I am wrong. And I 
think it is possible that I will have a different view come 
January. But my fear is, frankly, that the case will look that 
much more compelling in January because we will have gone 
through a weak economic period.
    Chairman Spratt. Thank you very much.
    Mr. Ryan.
    Mr. Ryan. Thank you.
    Let me start with you, Dr. Summers. You and I had a few 
conversations back in 1999, 2000, when you were Treasury 
Secretary, along with your Under Secretary, I think his name is 
Gary Gensler, about Fannie Mae and Freddie Mac. And at that 
time you warned us of the moral hazard contained within the 
construction of these GSEs. You urged Congress to take action 
to restrain their activities. The Bush administration, 
subsequent to your tenure, echoed your same concerns, and yet 
Congress in both parties didn't do anything about that. So you 
were right. And I want you to get the credit you deserve for 
having been right at the time 10 years ago in more or less 
foretelling the fate that occurred.
    Now that it has happened, now what we see happened 2 days 
ago, what is your recommendation for once the dust settles, we 
wind down these portfolios, what should these things look like 
in the future? Should they be totally privatized? Should they 
be sort of nationalized, broken up into bite-size regional 
things like regional Ginnie Maes? What do you think the 
structure of these entities ought to be once the current 
turmoil has passed?
    Dr. Summers. I hesitate to make a--thank you for your kind 
words, Congressman. I hesitate to make a definitive 
recommendation without a lot more study and without a lot of 
consideration, without a lot of study of what happens in the 
housing finance markets over the next year or two. I would just 
make these comments, though.
    First, I think the future of these institutions has to be 
thought of in the context of our whole mortgage finance system 
in this country, and that system has shown itself to be much 
more severely flawed than most people recognized even a few 
years ago. You pointed to the flaws in GSEs. Certainly if one 
looks at what has happened in the subprime market area and the 
jumbo market area, in those areas where responsibility has been 
purely private, we have also observed substantial amounts of 
predatory, unsound lending. We have also observed substantial 
amounts of cascading financial failure. So I think it would be 
a mistake not to recognize that the experience of the last 
months hardly bears out the case for a kind of fundamentalist 
laissez faire, free-market approach.
    My sense is that what the authorities will have to do is--
Congress, the President, the new administration--will have to 
do is recognize that the model where the same company is 
supposed to be working for both the public interest and its 
shareholders and is relieved of normal regulatory burdens 
because it is supposed to be working for the public interest 
and with the knowledge that there is an implicit but not an 
explicit guarantee, these fuzzy-line arrangements that we have 
had have shown themselves to be deeply suspect, and I think we 
will have to move beyond them.
    I suspect that what will be necessary is a clearer division 
of labor than the one we have now between explicitly public 
institutions that will take on certain explicit public 
responsibilities and private institutions that cannot rely on a 
general government financial backstop, or, to the extent that 
some government guarantee authority is appropriate, pay an 
explicit fee in return for that government backstop, just as 
banks pay an explicit fee to the FDIC. And I suspect there will 
be an active debate as to just how those divisions between 
public and private responsibility should be drawn.
    It seems to me, for example, that there is a much stronger 
case for the government to be involved in the guarantee of 
mortgages than it is for the government to be involved in 
providing credit support for the direct purchase of mortgage-
backed securities. It seems to me there is a clearer case for 
the government's role with respect to low- and middle-income 
families than with respect to higher-income families.
    I also think that there will be a need for a careful 
examination if there are to be such entities as to what number 
of such entities is appropriate.
    One of the several critiques that we also had occasion to 
discuss a decade ago was that when you had a situation of 
duopoly in the conforming mortgage market, whatever benefits 
were being provided were not likely to be hugely passed on to 
consumers. And so to the extent that there are government 
benefits, I would hope there would be more scope for 
competition in taking advantage of those benefits as they are 
passed on to consumers.
    What I think is absolutely clear is that we need to move 
past the ``heads I win, tails the public loses'' model in which 
we have operated. And this is not a feature of just the U.S. 
experience. I remember, and it is, frankly, part of what 
stimulated my concern about this issue as we studied the 
lessons of the Asian financial crisis, realizing that no small 
part of the Asian financial crisis resulted from a combination 
of high leverage, government guarantee or quasi-government 
guarantee and close political connection, and all three of 
those elements are here.
    I don't want to conclude, though, without saying that there 
have, I think, over the last years been a variety of breakdowns 
in the regulation of the financial system, the letting of new 
mortgages in all kinds of unsound ways, and the judgment, 
frankly, that these institutions were well capitalized after 
that was a reasonable reading of the facts. And I think that 
contributed to bringing us to the point we have reached.
    Mr. Ryan. Thanks.
    Dr. Sinai, let us talk quickly about inflation and tax 
policy. You are kind of warning us of a specter of a new sort 
of 21st century version of stagflation; not quite 1970s 
version, but a new type version. If you can give us kind of a 
little bit more of exactly what you mean when you say that. Are 
we going to see the kind of inflation we are seeing overseas in 
emerging markets coming to our shores? If so, what should we 
do? What should the Federal Reserve do if you were the Chair?
    And also, second, in January you reported that the 2001-
2003 tax relief laws played a significant role in boosting the 
economy. Do you believe that the uncertainty of the extension 
of those tax laws--and you inferred a little bit to this in 
your testimony--do you believe that the closer we get to the 
end of the decade where we are going to have a snapback of tax 
rates, and we have a dramatic decrease in the after rate of 
return on capital is putting sort of a cloud over the economy? 
Is the uncertainty premium increasing in the employment 
investment? Are investors beginning to inhibit the way they 
make investments because they are uncertain about the after 
rate of return on capital given these large tax rate increases 
that may or may not occur, whether it is marginal tax rate 
increases or capital taxes like gift dividends and capital 
gains?
    Dr. Sinai. Thank you for the questions. Stagflation, that 
is weakening economies, rising unemployment, high or rising 
inflation, I think it is a fact of life now. It is here and 
now. And I will just refer you to the testimony, table 3, I 
think, in that. And in the United States it is a little more 
controversial because a lot of people don't think we are 
already in a recession. But the unemployment rate has gone up, 
overall inflation in the CPI is 5.6 percent year over year, 
core inflation excluding energy----
    Mr. Ryan. So are we in stagflation right now?
    Dr. Sinai. I think we absolutely have it in this country 
right now. Now, that makes the policy choices of, say, the 
Federal Reserve extremely difficult because--and we see it in 
divided, legitimately divided, views in the Federal Reserve. If 
you worry about recession, financial instability, the effect of 
financial instability to create more recession, then you want 
to have easy monetary policy, but you can't do that because you 
have high inflation.
    Mr. Ryan. Are we at that point where the Fed is out of 
bullets, and we are not in a price of money problem, but a 
solvency, a money solvency problem now, and the Federal Reserve 
needs to go back and shore up the value? Where are we?
    Dr. Sinai. I think the Federal Reserve is conflicted enough 
that they can't help us out anymore in terms of any more 
actions in the financial side of the economy. The solution and 
the eventual evolving getting out of our financial crisis, I 
think, will be more private-sector oriented and private-sector 
developed than otherwise. So they are out of bullets in that 
sense, in my view.
    You asked about the tax cuts, and we did find that the tax 
cuts lower marginal tax rates across the board for low- and 
higher-income families, as well as the tax reductions for 
capital gains taxes and dividends had a very positive--all by 
itself had a very positive effect in lifting the U.S. economy 
indirectly, the world economy, over the years from 2000, the 
early part of this decade, to about 2006. They have faded in 
their impact now. So I would not favor, especially given the 
prospect for the economy that I have described, tax--the ending 
of the expiration of all of the tax reductions.
    Mr. Ryan. Raising the rates.
    Dr. Sinai. In effect, in your words, raising the taxes.
    There was one exception, which I noted in my testimony. 
Because the consumer side of it is the weak part, and we know 
that middle- and lower-income families spend more out of an 
extra dollar of income than do higher-income families, I favor 
permanent tax reductions that can come in the form of ending 
the AMT, not just doing a patch every year for middle- and 
lower-income families and leaving them in for the families that 
they were originally intended for, which were highly affluent 
families. Some, I would say, could pay the higher tax rate or 
the minimum tax rate implied by the AMT. But if we want to 
stimulate consumption, then I think we need to reduce marginal 
income tax rates for middle- and lower-income families. And 
middle income to me is much larger than $50,000 or $60,000. If 
you look at the tax data, and you combine a family of two 
young--two professionals with two or three children, you are 
talking about $200,000--to $300,000 of income. So in the modern 
U.S. economy, the notion I have of the middle-income families 
is at higher income levels than we used to think.
    But if we have to finance it, if we have to finance it, and 
I think we do for reasons of the long-run budget 
responsibility, we have to get the funds from somewhere. And so 
I think it is easier, if we want to generate more spending, to 
let the tax rates go up for higher-income families. But I would 
not say that for capital gains and the dividend tax exclusion, 
because in my work I find that those tax rate reductions help a 
lot in the funding and the flow of savings that goes into the 
economy to support new business private-equity transactions. 
But on income tax rates I have a definite view that we need to 
finance that by raising taxes, and that is the only place that 
I would suggest we raise taxes in the future, given the economy 
we have now.
    Mr. Ryan. Well, in the interest of time, I could follow up 
for quite a while on that, but I want to----
    Dr. Sinai. Just one more thing. The uncertainty of whatever 
the tax decision is going to be definitely is a negative for 
the stock market. It probably will get resolved after the 
election when we know who wins, and it might even get resolved 
before, because the candidates aren't that different in terms 
of some aspects of tax policy as they relate to investments in 
the stock market. But there is always that uncertainty that 
lingers until you are done with an election, and almost every 
election year can be a negative for markets. It is a negative 
now.
    Mr. Ryan. I will say there is a difference between these 
two candidates on tax rates on capital, but I don't want to get 
into it.
    Dr. Kreutzer, just quickly, we are talking about inflation. 
Energy is obviously a major component of inflation right now. 
We are also talking about jobs, four-tenths of an increase in 
the joblessness rate from the last measurement. And you have 
done some modeling on this.
    To what factor are energy prices a contributor toward our 
measurement of inflation, number one? Number two, how many 
jobs--will you repeat this--how many jobs would we create in 
this country if we actually opened up domestic energy 
production and exploration? And number three, what would the 
revenue estimates be to the Federal Government?
    You hear all these ideas about money for tax policy, money 
for spending, but we don't have money. We have a Federal 
deficit that just doubled this one year over the next. How much 
revenues would we receive over, say, a 5- or 10-year horizon 
through the royalties and leases and the income the Federal 
Government gets if we opened up all of these areas to oil and 
gas exploration?
    Dr. Kreutzer. Doggone it, I don't have an answer to that 
question. We didn't model that. We looked at the change I 
mentioned. Actually I don't have the whole number on the trade 
deficit. That would be the obvious one. If you are importing 
1.4 million barrels fewer at $115 or $90 or whatever it is 
dollars per barrel, that is a huge savings there. That could 
have an impact on the value of the dollar if you changed the 
supply and demand.
    The jobs number I gave was 128,000 jobs for a 1-million-
barrel-per-year increase in domestic production, and in my 
written testimony I mentioned that this would be the case if we 
have as tight a market as we have now. And the International 
Energy Agency is projecting that spare capacity will grow a 
little bit in the next couple of years, but then get very tight 
again. And so when you have that situation where somebody in 
China buys a car they never had before, you have got to kick 
somebody else out of a car, and that takes a really high price, 
and that is why we use this short-running elasticity over a 
period of time that you might not otherwise use it. So the 2 
million barrels per day, we are talking about 270,000 jobs; 1 
million barrels per day, 128,000.
    Mr. Ryan. In the price reduction--so you are saying you can 
achieve a two-for, sort of You can achieve addressing one of 
the root causes of inflation, high fuel prices, and joblessness 
in this country through greater domestic energy production. 
What is the price?
    Dr. Kreutzer. The price elasticity is .05, which is a 
number that should not mean anything to anybody here, but it 
tells us that a 1 percent change in supply or demand will 
change the price by 20 percent. And so that is 1 million 
barrels per day on the world market would change it by about 
$20 per barrel starting at $100 per barrel. That analysis was 
done last winter, though the letter was written in July.
    Mr. Ryan. So a significant change?
    Dr. Kreutzer. It is a significant change. Even--I was 
talking during the break. Even if you want to use the long-run 
elasticity, and I think there are reasons for not using that, 
you would still get tens of thousands of jobs and tens of 
billions of dollars. That would be on the low end. And I think 
it is more likely to be the hundreds of thousands of jobs, 
hundreds of billions of dollars.
    Mr. Ryan. Thank you.
    Chairman Spratt. Mr. Edwards.
    Mr. Edwards. Thank you Mr. Chairman.
    Dr. Summers, Mr. Ryan, my colleague, gave you credit, 
deservedly so, for being right back in 1999 and 2000 predicting 
some potential housing market problems if we didn't better 
regulate Fannie Mae and Freddie Mac. I personally think you 
were right in having in place the Clinton administration fiscal 
policies that about the time you left, I believe, created the 
largest surpluses in American history, which, since the Bush 
administration tax policy has been put in place, has been 
turned into the largest deficits in American history. I think 
the time you left as Treasury Secretary, there were predictions 
about paying off the entire national debt, which at that time I 
think was $4 trillion or $5 trillion by the end of this 
administration. Instead we are going to have over a $9 
trillion, perhaps a $10 trillion, national debt. So I think you 
have been right on a lot of economic policies.
    Let me ask you your views about the short-term impact of 
domestic drilling on today's economy. What are your views on 
that issue?
    Dr. Summers. You know, I have been following political and 
economic debates here for 15 or 20 years now, and on most of 
these questions, like the questions of tax policy that you 
referred to or the questions of the GSEs, I have my views, and 
they are reasonably strong views. But I understand the logic 
and the rationale through which other people can have different 
views, though they wouldn't precisely be mine.
    I would have to say that the recent political debate over 
drilling is one that I find very hard to understand. As I 
understand it, the demand for oil, the price of oil, is set by 
demand and supply. I am aware of no serious observer anywhere 
who believes that any of this, any of the policies that are 
under discussion, will have any impact on that supply for at 
least 5 years and any substantial impact for more than 10 
years. So I understand that the political appointee who heads 
the energy agency has judged these issues to have a negligible 
impact on energy prices going out for a matter of several 
decades.
    Now, I don't know precisely what the right configuration 
is. As I understand the debate, and again I am just an 
economist, I am not engaged in the political struggle right 
now, there are, I think, two positions that are held. There are 
some who favor seeing this issue entirely through the prism of 
drilling and who focus on drilling as the central policy. And I 
don't think that there is any case that is going to do anything 
for gasoline prices or home heating oil prices during the term 
of the next President. And there are others who recognize that 
it may be appropriate to have a compromise to do some 
exploration around those issues, but favor doing it in the 
context of a wide-ranging program that emphasizes energy 
efficiency, emphasizes renewables. And I guess it seems to me 
that it is pretty clear that the second approach is much 
larger--much more likely to have the kind of impacts that we 
favor.
    So the kinds of statistics that were presented, you know, 
economists distinguish between a short-run elasticity and a 
long-run elasticity, and to use a whole model based on a short-
run elasticity to describe an event that is going take 5 to 10 
years to happen just doesn't seem to me to be a reasonable 
basis for doing these kinds of analyses.
    Mr. Edwards. Thank you for that answer. In fact, let me put 
into the record a statement that agrees with that. The 
projections in the OCS access case indicate that access to the 
Pacific, Atlantic and eastern gulf regions would not, would 
not, have a significant impact on domestic crude oil and 
natural gas production or prices before 2030. That is not my 
statement, that is the statement of the Bush administration's 
Energy Information Agency in its report presented in 2007.
    Thank you, Mr. Chairman.
    Chairman Spratt. Mr. Porter.
    Mr. Porter. Thank you, Mr. Chairman. I appreciate our 
guests being here today.
    I just wanted to point out some things that are happening 
in my community in the State of Nevada. As you know, we are a 
tourist destination, one of the top in the world, and we are 
very proud of that, from entertainment to shopping and gaming. 
We have seen a huge impact on our visitor volume and our, of 
course, return on investment.
    In regards to the cost of energy, United Airlines has 
determined they are going to cut 150 cities out of their 
routes. U.S. Air is cutting flights into our community to a 
point where they tell us they can't even start up their 
airplanes to break even because of the cost of energy. We have 
families in Nevada that are hurting. And I know you have heard 
the arguments probably time and time again today, but I just 
wanted to give you my firsthand experience.
    In Nevada, not only is it about the cost of energy, cost of 
gas going to and from work, and the impact on families and 
kids, but we have some of our major properties that are cutting 
back on their projects. The Boyd Group has cut back a $4 
billion construction project, and part of it is already above 
ground, so there is a skeleton there of a facility. MGM Grand 
has cut back on one of its major projects.
    So I certainly appreciate your expertise, and I am sorry I 
wasn't here for all of your testimony, but I have read the 
background. But whether it is 30 years out or 5 years out or 1 
year out, we need to restore confidence to our country that we 
are doing something. And what I hear right now from my 
constituents is that, yeah, it may take a year or 2 or 5, but 
if Republicans and Democrats sit on the steps of the Capitol 
and say, we are going to work on this, and we are going to do 
renewable, and we are going to conserve, it would add some 
confidence.
    And I, of course, look back through the years at 
opportunities prior Congresses had and decisions were made. I 
can't tell you why they were made. But 10 years ago ANWR had an 
opportunity, and it was vetoed. My point is from an economic 
standpoint the number one thing right now impacting Nevada 
families is the cost of energy and the lack of ability of this 
Congress to take steps.
    Now, let us take it a step further. I used to be mayor of a 
small community in Nevada. We had our own public utility. So I 
had a chance to meet with utilities in Nevada and those across 
the country, and what I hear from the small and large utilities 
separate from the cost at the pump is that there is not a 
comprehensive energy plan for them to invest in energy for the 
future, whether it is nuclear, or whether it is natural gas, or 
whether it is coal, so they are having to buy less product to 
provide for lower cost of energy into our homes.
    So my point is we are here today, and we are talking about 
a weakening economy and how to respond. We certainly can have 
differences of opinion. But I am sharing with you firsthand 
families that are struggling because of the cost of gas, and 
they haven't gotten their power bills yet. And look out, with 
energy up 10, 20 and 30 percent. So I would appreciate, as, 
again, you are the experts, I think you need to add to your 
research firsthand what is happening with our families.
    And again, I don't really have a question; I just want to 
say thank you for being here, and I want to let you know that 
there are families that need help, and they need it now, or at 
least they need the confidence that we are going to take some 
steps. And it is really all of those different energy sources 
working together. So thank you.
    Mr. Chairman, thank you.
    Chairman Spratt. Dr. Sinai.
    Dr. Sinai. On this topic, please look at page 25 of my 
testimony. It is energy independence and energy conservation. 
It really is an economist with a cry-out for leadership coming 
from Washington, a call to arms, call to mission.
    There are lots of pieces that go into dealing with energy 
independence, renewables, carbon, all of the problems you are 
discussing. And my suggestion is a bipartisan commission and 
whoever is the leader of this country to put it number one, 
because it is a huge lever on what I described as stagflation. 
That is the high oil and energy prices hurts growth, raises 
inflation, complicates the Federal Reserve's already difficult 
problems, makes it very hard to devise normal fiscal policies 
that will help it out, and those costs get sometimes stuck in 
the inflation system, and we are with them for long times, as 
we were in the 1970s and 1980s.
    Now, as a citizen, I believe that if we had come to grips 
with it in the way we should have some several decades ago, and 
I do look myself to Washington for leadership--I make 
contributions, Washington is the leader on this, our executives 
are--that is where it has to come from. And the country will 
respond, the country will respond.
    Mr. Porter. As we did in the 1970s?
    Dr. Sinai. Well, the country will respond. This time the 
country will respond.
    Mr. Porter. Thank you. I appreciate your comments very 
much.
    Chairman Spratt. Dr. Summers.
    Dr. Summers. Congressman, I have a trip scheduled to Nevada 
in a week or two, so I look forward to the chance to learn it. 
And I, in planning that trip, came to appreciate what you have 
said about airline schedules which have changed, so I certainly 
share your concerns.
    It seems to me there are sort of two crucial policy aspects 
where I would have hoped that people would be able to come 
together. One is on the question of tax policy, where insofar 
as there is tax relief to be provided, it seems to me there is 
a very compelling case towards focusing that tax relief on the 
families that are bearing the burdens that you describe through 
some kind of across-the-board credit of a kind that has been 
discussed in the Presidential campaign. And I think that is a 
very constructive step. It seems to me that it is a much less 
constructive step to focus tax relief on the companies that are 
the beneficiaries of all of this. Because of much higher oil 
prices, they are receiving much, much larger profits than they 
ever would have expected. And so I think there is some crucial 
questions of tax priority that come out of this.
    And then the second piece is it seems to me that what 
everyone is in favor of is finding some kind of bipartisan 
approach. My understanding is that those who are less 
enthusiastic about the oil exploration aspects that were 
emphasized in the testimony here are prepared to accept a 
certain amount of that as part of an overall program that also 
emphasizes energy efficiency, and that also emphasizes 
renewables, and that also emphasizes making sure that families 
are protected.
    So I would hope that the political debate could leave what 
seems to me to be the very sterile territory of drill or not 
drill and move to a much broader focus on what I think are the 
two imperatives here: helping the families that are in trouble 
in the very near term, and in a balanced and across-the-board 
way addressing all the different aspects of energy policy.
    You know, an issue like the kind of automobile fleet that 
we have and its fuel efficiency and whether there is support in 
developing a better automobile fleet will have a much larger 
impact on the demand for oil if you use models like the ones we 
have heard described in the next several years than anything 
about ANWR or the Outer Continental Shelf. So I would reject 
some kind of religious opposition about ANWR and the Outer 
Continental Shelf, but to somehow elevate that to being the 
single totem of discussion on energy policy just seems to me to 
be selling the country short.
    Mr. Porter. I think one of the problems is that--and I am 
getting into politics and not policy--but on the Republican 
side what I hear Republicans asking for as they vote, and to 
include all of those things that you are talking about. And I 
think that will send a message to the country that we want to 
work together, Democrats and Republicans. I think my colleagues 
across the aisle have some great ideas, and I think we have 
some great ideas, and I think we can find a solution to this.
    There are economic challenges to the country, lots of them. 
This is one thing that Congress can control. And if nothing 
else, working together will send a message to the world, and I 
believe that we can do it. I think that we are agreeing. We 
need to include all of the above, and I think we can do that. 
Thank you.
    Chairman Spratt. Let's move on. Ms. Schwartz.
    Ms. Schwartz. Thank you, Mr. Chairman.
    And I appreciate the last two questions, because this is 
where I wanted to go on this also to have a greater discussion 
about energy. And I think what we might all agree that we want 
to have all the options on the table.
    There has been, as was pointed out, very serious discussion 
that somehow domestic drilling is the answer. And I did want to 
just follow up on Dr. Kreutzer's testimony. And you referred in 
both your written and oral testimony to a letter that EIA 
Administrator Caruso sent to a colleague of ours, Congressman 
Kingston, and you said that Mr. Caruso estimated--and you said 
this orally again--that 1 million barrels of oil will lower the 
world price of oil by $20 per barrel. You made a clear 
statement of that. You did make note that that was a part of a 
letter, and so you referred to the letter, and we got a hold of 
the letter, which was written on July 2nd.
    And I just say that neither your written nor your oral 
testimony really gives a full explanation of the context of 
that short-term assessment. And I think that one of the things 
we do have to be clear with the American people, because they 
are struggling on energy prices, and they would like to see the 
price at the pump go down as quickly as possible, to not 
mislead them into thinking that either drilling is the single 
answer or a silver bullet, or that, in fact, it is going to 
happen in the short run. And your language in your oral 
testimony in particular suggested that this could happen 
immediately.
    And so I really want to ask you very specifically, and I 
would like a really short answer on this, Mr. Caruso actually 
says that the estimate requires an unanticipated new productive 
capacity of 1 million barrels of oil a day, and in addition 
that this--an addition of this size would typically take years 
of planning and development activity. That is what his letter 
says. So my question to you is, immediate--and this was 
suggested by Dr. Summers--is immediate, in your mind, 5 years, 
10 years? It is certainly not--most Americans think of 
immediate like next week. What do you suggest is actually 
immediate, in your mind? Five or ten years or a number of years 
would be a good answer.
    Dr. Kreutzer. That is not going to answer the question.
    Ms. Schwartz. Well, I have a follow-up question, so start 
with that.
    Dr. Kreutzer. In my written testimony I also pointed out 
there were other sources that gave the .05 short-run 
elasticity. And the reason it is not legitimate to use a long-
run elasticity is because it depends on how the market adjusts 
over that 5- or 10-year period. Where will we be in 5 or 10 
years? If, anticipating this additional development, we have 
spare capacity of 3 to 5 million barrels a day, as I said, the 
markets will have eased, we will get a much smaller response.
    The International Energy Agency doesn't see that. Neither 
do I. I have talked to other energy experts. They say the 
critical thing is the spare capacity. Are we going to be--in 5 
years when we get this additional, or 10 years when we get 
additional oil on the market, are we going have the tight 
situation we have now that when one more person in China buys a 
car, somebody in the U.S. or in Europe has to get out of the 
car? If so, we get that $20-per-million-barrel price response.
    Ms. Schwartz. So you are saying it is about 5 to 10 years. 
I appreciate that. But you are also being honest about that.
    I think that we have to understand, and I think many of us 
would agree, that drilling and, in fact, increased production, 
U.S. production, could be helpful. But certainly if you are 
looking at drilling, it is going to take some time. That 
doesn't mean we shouldn't start doing it. It just means that 
let us be realistic about what we can do.
    But let me also, just following up on that, you say that it 
depends what the market does. And so even if we were to put our 
own U.S. capacity--increase our U.S. capacity, which certainly 
we want some more energy independence, but if we specifically 
just relate it only to oil, what is to say that the other oil-
producing nations won't actually reduce their production in 
order to keep the supply down in order to keep the demand and 
the price up? In fact, President Bush did ask the Saudis and 
said, wouldn't you please just increase your production? We 
could use it, and we would like to see more supply so our costs 
go down. And do you know what? They didn't do it. So what is to 
say that they won't actually say, you know, we are not crazy 
about the U.S. market increasing production; we are going 
reduce our production, and we are going to see increased costs 
for consumers, businesses and families.
    Dr. Kreutzer. Because at $110, $120, $115 a barrel, they 
are maxed out. That is what I was saying. The Saudis, no matter 
who begs them, no matter what happens, no matter what type of 
expectations, they are pumping at the limit. All of OPEC is 
pumping at the limit.
    Ms. Schwartz. Right. I am suggesting the opposite: that 
they will stop pumping in order to----
    Dr. Kreutzer. Right. That would happen if we have prices 
down to $60, $70, $80 a barrel, which I mentioned in my 
testimony.
    Ms. Schwartz. That Americans might like.
    Dr. Kreutzer. Of course they would. And if we are in that 
situation, then indeed we are not going to get that $20-per-
million-barrel increase. I said that explicitly in my 
testimony. I was told we had 5 minutes to talk. I am sorry I 
shortened mine to exactly 5 minutes. That is what I was 
prepared to say. I mentioned other things in my written 
testimony.
    Ms. Schwartz. Well, I appreciate that. And I think that for 
the record we should include the entire letter that was written 
to Congressman Kingston, because it does explain that, in fact, 
you took some of the language out of context.*
---------------------------------------------------------------------------
    *As of March 13, 2009, the correspondence referenced has not been 
received by the committee.
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    Ms. Schwartz. And I appreciate your saying that given the 
length of your testimony, you could only say so much.
    But I think the point of all of this is that we should be 
really clear with Americans that we are not going to mislead 
them into thinking they are going to see a change of price at 
the pump. And I think, as suggested by Mr. Porter earlier, that 
there is not any single solution; that while we might increase 
drilling, to suggest that drilling alone is going to change the 
cost at the pump is really simply not correct.
    Dr. Kreutzer. No, it is correct. Changing supply will 
change the price at the pump. The question is how much. And I 
tried to be clear on that in how long it takes.
    Now, so what you are saying is it is a good idea if it 
happens now, but it will be a bad idea if it doesn't happen for 
a long time. It doesn't cost the government anything. We can 
open up ANWR. All the problems that we hear from the other two 
witnesses are we would like to do this, but then we would have 
to raise taxes here; we would like to do that, but it is going 
to cost us. This doesn't take anything. This is a no-brainer. 
Even Paris Hilton was in favor of it. That was the no-brainer 
part.
    But anyhow, the Alaska pipeline was built in 2 years. The 
investment in Detroit depends on what is going to happen to gas 
prices 4 or 5 years from now. Are we going to expand? So there 
are all sorts of things that can happen in the short term.
    Ms. Schwartz. Let me just say, there are a number of things 
long term, you would also grant. There is a limited capacity of 
fossil fuel, certainly of oil, even on the Outer Continental 
Shelf, and that what we need to do even if we do expand the 
opportunities for drilling for the oil industry, we have to be 
clear with the American people that we don't want to be in the 
same place certainly a month from now, but not a year from now, 
not 5 years, not 10 years from now unless we do things that we 
also know we can do very fairly quickly, which is to increase 
production of biofuels that produces, we know, about--almost 
immediately about 140,000 jobs; that we have to improve 
automobile efficiency; and we have to have more alternatives 
and options for Americans. And all of that together will 
actually create a reduction in the cost of energy, and that is 
what we ought to be looking at.
    So the suggestion--and because you only talked about 
drilling, I want to make it absolutely clear that this is not a 
short-term solution. Even though you used the term ``short 
term,'' it is a long-term part potentially of what needs to be 
a much broader comprehensive energy policy. That is very 
different than what we are doing right now.
    And I yield back.
    Chairman Spratt. Mr. Doggett.
    Mr. Doggett. Thank you, Mr. Chairman. And I appreciate the 
testimony of each of our witnesses.
    I have some questions for Secretary Summers, but before 
asking them, let me just say that in response to some of the 
comments that my colleagues have made that the Bush 
administration has presided over the largest fiscal 
deterioration in this country in its history, and has proceeded 
on the notion that if we just let government be permissive 
enough to our corporate misconduct, and if we just let it be 
irresponsible enough with regard to providing the revenues to 
fund essential public services, that everything would work out 
okay. And as a result of that ideology, what we have is a 
disaster that has threatened the world economy, that has caused 
tremendous pain to many people who are losing their homes, and 
it has caused tremendous pain across the world to our economy, 
and now taxpayers are having to pick up much of the expense. 
And while I applaud the efforts of Chairman Bernanke and 
Secretary Paulson, much of what is being done now is an attempt 
to put in place a regulatory structure to take care of damage 
that has already occurred. So maybe it will prevent some of 
this damage in the future, but the regulatory structure and the 
regulations and the laws that were already in place were not 
effectively used to avoid the tremendous amount of abuse that 
led to the problems that we have right now.
    As for the discussion that my colleague from Pennsylvania 
was just engaging in, and that my colleague from Texas spoke to 
earlier, this is just the latest election-year gimmick. When 
you are so desperate having created so much damage to our 
economy, you have got to come up with some gimmick like drill 
everywhere yesterday. The energy policy we have is the natural 
result of the Bush policy on energy, Vice President Cheney's 
secret energy task force, combined with President Bush's 
holding hands with the Saudis, and it shouldn't be any surprise 
that we are in the predicament we are in now.
    The question is how to get out of it, and drilling has to 
be part of it in a comprehensive energy policy. But to make it 
the exclusive gimmick for the election is a serious mistake. 
And it is much more important to move away from the addiction 
to oil, just as the President said, but failed to support any 
policies to help us avoid that addiction.
    Mr. Ryan. Will the gentleman yield?
    Mr. Doggett. After my time is used with the Secretary, I 
will be glad to.
    Mr. Secretary, your testimony with reference to how we get 
out of this mess, whether it is now if we can get enough 
bipartisan support for it or it is in January, is not 
dissimilar from the testimony that you gave us about the first 
stimulus, and which I must say almost every single economist 
seemed to share your view that if you want the maximum 
stimulative effect, you try to get the dollars as quickly and 
efficiently to the people that have been left desperate enough 
by these Bush economic policies in the form of food stamps; 
extended unemployment compensation; perhaps, given the 
disastrous energy policy, the LIHEAP that you talk about today, 
the people that will literally be in the cold this winter 
because of those policies if we don't have adequate assistance 
for heating, the same problems my folks in Texas will face in 
the summer. Those are going to be the kind of stimulative 
policies that will give us the most stimulation and do it the 
quickest; is that not right?
    Dr. Summers. As far as the----
    Mr. Doggett. As far as short-term stimulus.
    Dr. Summers. In terms of the analytical judgments that 
targeting spending to those who have low incomes or incomes 
that have sharply declined or being burdened by new 
expenditures or to government purposes where money can be 
expended quickly will have the greatest fiscal impact, I would 
agree completely with that judgment.
    Mr. Doggett. And your testimony also is--and we have PAYGO 
not just over 5 months, but 5 years, as was the testimony 
earlier in the year--that if we provide that short-term 
stimulus, there is a way to do it and pay for it over a longer 
range of time so that you don't aggravate our long-term 
national debt problems.
    Dr. Summers. I believe that would be best. The choices 
involved in paying for it are more painful than the choices 
involved in providing it.
    Mr. Doggett. They always are.
    Dr. Summers. But that is certainly what I believe would 
have the best impact. And just to reiterate a point that I made 
in my testimony, I believe that to commit now to actions that 
would substantially increase the budget deficit in 2011, 2012 
out through the remainder of the decade, such as proposals to 
extend the tax cut permanently, I believe those would not just 
be dangerous in the future because of the debt, but would also, 
because of their impact on interest rates and confidence today, 
inhibit the process of economic recovery.
    So I believe that such proposals would be quite 
counterproductive from the point of view of stimulus and would 
emphasize that if you look at any discussion of confidence, 
enormous emphasis is placed on the question of government 
indebtedness and the closely related question of the country's 
international indebtedness. And so to pursue policies that 
compromise that objective by several trillion dollars, as some 
suggest, would, I think, have the likely consequence--you can't 
quantify how much, but would have the likely consequence of 
inhibiting the process of recovery.
    Mr. Doggett. Thank you very much.
    Chairman Spratt. Mr. Etheridge.
    Mr. Etheridge. Thank you, Mr. Chairman. Let me thank you 
for holding this hearing and for our panelists for being here 
today. And being with us this extended period of time, we 
really appreciate it.
    Let me, as interested as I am, and as important as it is 
dealing with the energy piece, and now let me come back to 
another piece to get it in. If I have a chance, I will come 
back to the energy and the long-term piece. But last week I 
held, as I do quarterly in my district--I had a meeting with 
our bankers, with our small-business people and others and 
talked about some issues. Mr. Secretary, I am going to start 
with you on this one because you would have had some background 
in this. You didn't create it, but maybe you can give me some 
understanding, because what I heard from the bankers, as well 
as from the business people, was as follows.
    Number one, from the bankers, liquidity is a real problem 
in the banking community right now, as it was with them moving 
money, as you know, from bank to bank. And then they are 
reaching out to the business community and saying to home 
builders, to any business person who has some money, who has a 
line of credit, especially if that line of credit is tied to 
real estate or something else, by the way, we have just cut it 
in half, or we are drawing it in because it may not be 
affecting this economic market, but because of the size of the 
reach of this institution, I have got problems in another part 
of the country.
    So my question, I think, is this: How can we--or how can we 
encourage at some level--because if this keeps happening, it 
becomes a self-fulfilling prophecy because we have all these 
housing units out here that are unsold--get your financing for. 
So I would be interested in your thinking. Originally, 
remember, in the previous stimulus and we put together a 
package, and we said for the first time, homebuyers, we are 
going give you an incentive to buy. We didn't have the rest of 
the inventory stock that is now really pulling the market down 
in the whole communities. They had raised the issue of finding 
a way to move this inventory, in some way to get the market so 
these folks can get back to work and get liquidity in the 
market.
    Dr. Summers. I would address that in three ways, 
Congressman. I thought what you said from your community 
bankers track very well my impressions studying the economic 
statistics. I think there are three important aspects. First, 
if we provide the right kind of fiscal stimulus, it will 
stimulate spending, that will stimulate traffic in the 
restaurants, that will stimulate buying in the stores, that 
will make all those institutions more creditworthy that will 
feed back to help the banks. Helping the banks will enable them 
to provide more credit to others.
    So you don't fill a flat tire through where the leak is, 
and in the same way, whatever the source of our economic 
problem, I believe fiscal stimulus that supports the real 
economy will have an important impact.
    Second, I think while I regret very much that they were 
necessary, the set of actions undertaken over the last weekend, 
if they are pursued aggressively, have the potential to make a 
real contribution to the housing situation. If one looks at 
mortgage rates today, it appears that mortgage rates in the 2 
days since those plans were enacted have declined by as much as 
3- or 4/10 of a percentage point. That is not a trivial move in 
terms of what it means for the cost of carrying a house or what 
a given family can afford.
    Third, I think it is an open question for financial 
policymakers whether we are going to need to engage in further 
involvement in supporting the financial housing system. The 
legislation that the Congress passed in July that Congressman 
Frank was very involved with, directed at providing mortgage 
relief and reducing foreclosures, frankly I wish it hadn't 
taken the Fannie Mae emergency to serve as an engine for 
passing that legislation. It was another case of better late 
than never, but it was late. And I am not sure whether further 
programs of that kind may well prove necessary. Ultimately we 
are going have a significant number of financial institutions 
in quite serious trouble, and it may well be that we are going 
to need a more comprehensive approach to supporting those 
financial institutions and to supporting the financial system 
than we have had to date. I don't think it is quite time yet, 
but I would hope that the responsible authorities are 
extensively involved in contingency planning.
    Mr. Etheridge. One follow-up as we look at the right type 
of stimulus time line in getting it in place.
    Dr. Summers. Sooner is better than later. It would be 
better if you passed it before you went out in September. If 
you didn't pass it in September, it would be better if you 
passed it during a lame-duck session. And if you didn't pass it 
during the lame-duck session, most likely it would be better if 
you passed it very quickly after you came back.
    You know, none of us know. It is possible that the economy 
will recover more rapidly than we expected, and you will not 
have succeeded in passing a stimulus, and we will come back in 
January and it won't look necessary. I don't preclude that 
possibility. It is not what I would expect.
    Mr. Etheridge. Thank you, Mr. Chairman. I yield back.
    Chairman Spratt. Thank you.
    Ms. Kaptur.
    Ms. Kaptur. Thank you, Mr. Chairman.
    I wanted to ask Dr. Summers, what do you think of this idea 
on infrastructure? If we take the 18-cent gas tax and we were 
to issue $200 billion worth of bonds guaranteed by the 
repayment of those over a period of time with that 18-cent gas 
tax, how do you think the markets would react to that?
    Dr. Summers. I think that, frankly, Congresswoman Kaptur, 
while we have a lot of economic problems, I think the Federal 
Government's debt really is relied on as safe and trustworthy. 
So if the government issued an extra $200 billion of bonds, I 
don't think it would make much difference whether they were in 
some sense secured by future gasoline tax revenues or they were 
not secured by future gasoline tax revenues.
    I tend to be an enthusiast of larger fiscal stimulus, but I 
think I would be surprised if we could invest quickly $200 
billion in infrastructure in an effective way. Over the next 
decade we are going to have to invest considerably more than 
that. But I don't think the primary problem is with the 
financial engineering and how you issue the debt. I think the 
challenge is identifying the right projects, avoiding bridges, 
if I might, bridges to nowhere, while meeting the most crucial 
needs.
    Ms. Kaptur. If the gentleman would kindly yield. In my 
district we got the projects on the shelf. We need water 
systems, we need sewer systems, we need street systems. It 
isn't very complicated what we need. And those projects are 
ready to go, and, I would venture to say, all over the country. 
But I appreciate your opinion on that.
    Dr. Summers. By the way, in my testimony I emphasized 
exactly that point, that there was a large volume of projects 
that were on hold, being slow-walked, or contracted, but not 
quite ready to go.
    Ms. Kaptur. Thank you very much. I know I don't have very 
much time. Thank you, Doctor.
    I wanted to ask anyone on the panel if they could give me a 
benchmark year. At what point in, let us say, the last 15 years 
did the sale of mortgage-backed securities to international--
into the international marketplace accelerate as opposed to 
being sold predominantly in our own market? And if you could 
pinpoint a year or approximate period. And where--can you 
pinpoint where and which institutions in our country provided 
the impetus for this activity? And can you name three or four 
firms that were most aggressive in designing these instruments?
    Dr. Sinai. I will check the data for you, Congresswoman, 
but my sense is 2003 approximately, the investment banking/
broker-dealer community, and then other nonbank financial 
intermediaries as well. And it all kind of took off like a 
topsy.
    But I really want to hesitate to guess at any individual 
firms. I just don't think that would be quite appropriate. But 
the phenomenon which your questions really get to really came 
because of the housing boom and what turned out to be the 
housing bubble. It is like bees flocking to honey. In the 
financial community everybody flocks to it, those businesses 
around it, and then it exploded. And they sold it to lots of 
financial institutions.
    Ms. Kaptur. And I am very interested in the progress, 
because the largest fine in American history imposed by the 
FDIC was on a bank from Illinois called Superior Bank, a $450 
million fine, the largest ever. Now, they were involved in 
subprime loans for autos back in the late 1980s, early 1990s, 
and then they accelerated into the housing market. There had to 
be some leaders out there in the marketplace. I am very 
interested. This wasn't just spontaneous combustion.
    Dr. Sinai. It is really collective movement toward what 
appeared to be attractive businesses. I don't think there was 
anything illegal or unethical.
    Ms. Kaptur. But there had to be certain leaders, and I 
would be interested if anyone could provide that for the 
record.
    I wanted to ask Dr. Summers as the former Secretary of 
Treasury, can you estimate how much money has been expended to 
date by the Fed to bail out private brokerages and Wall Street 
banks, not including the current proposal for Fannie Mae and 
Freddie, which I guess is about at least $200 billion minimum?
    Dr. Summers. Well, I think it is $200 billion maximum. In 
fact, the Fed has, in effect, taken over $30 billion of assets 
on a basis where JPMorgan will bear the first billion dollars 
of losses. The ultimate cost would be $29 billion if all of 
that money was lost, but there is no reason to expect any 
outcome like that. Depending on what happens, if there is sort 
of middling performance, the cost won't have been anything to 
the Fed. If the assets recover well, the government will 
actually turn a profit. If the assets perform poorly, the 
government will take a loss. But I think most experts would say 
even in relatively negative scenarios, the loss would be a 
small fraction of the $30 billion. The Fed is also, as you 
know, engaged in lending operations to a range of financial 
institutions.
    There are some risks associated with those operations, 
although they are--the Fed is careful to take collateral and 
require adjustments to collateral as market conditions warrant. 
So I think it is difficult to make an estimate of what the cost 
to taxpayers is, and based on what has happened so far, it is 
not certain that there will be any positive cost to taxpayers.
    Ms. Kaptur. Well, you know, Mr. Chairman, I just wanted to 
place on the record, as this committee knows, we are over $10 
trillion in debt. The ceiling on the mortgage mess is $2.4 
trillion. Now, maybe it won't be that bad. So we are adding to 
an already essentially bankrupt situation in terms of revenue 
inflows, and that means we are borrowing from someplace to fund 
all this. And the American taxpayer becomes the insurance 
corporation for Wall Street.
    I did not vote for the elimination of Glass-Steagall. Some 
people supported that. And now the chickens are coming home to 
roost. And I have to say that I don't like the fact that the 
American people are now going to be looked upon as the cash cow 
for three generations hence to try to fund the mess that some 
very powerful individuals and companies in this society have 
placed our society at this precipice.
    So I just wanted to place that on the record. And I thank 
you, gentlemen, for your testimony. And I vehemently oppose the 
taxpayers of this country becoming the glue to hold Wall Street 
together. And I oppose the elimination of Glass-Steagall today, 
as much today as I did in the late 1990s when others gladly 
supported it.
    Dr. Summers. Congresswoman, I think we can all agree that 
the function of tax dollars is not to bail out speculators. I 
would just caution on the subject of Glass-Steagall that what 
Glass-Steagall was directed at primarily was codifying a set of 
regulatory arrangements that had already taken place that 
allowed combinations between investment banks and commercial 
banks. To date there have been no taxpayer costs for the 
institutions where commercial banking and investment banking 
have been combined. Where investment banking stood alone, as in 
Bear Stearns, is where the problems came. And indeed, many 
observers have suggested that central to that problem was that 
if Bear Stearns had been willing to accept capital from a 
commercial bank at an earlier point, the need for the taxpayer 
bailout might have been attenuated.
    So one can have different opinions as to the merits or 
demerits of Glass-Steagall reform and of the regulatory changes 
that preceded Glass-Steagall reform, but I think it is almost 
impossible to make the case that the unfortunate events that we 
have seen recently can be traced back at--certainly those at 
Bear Stearns can be traced back to Glass-Steagall.
    Ms. Kaptur. I think the legitimate question can be raised, 
sir, going back to that change, what is a bank? And the 
blurring of the line between banking and commerce is a very 
serious blurring. And right now we are in a situation, however 
it was caused, that the American people become the insurance 
company for these very large institutions.
    So I know my time has expired, Mr. Chairman. I thank you 
very much.
    Dr. Sinai. Just one comment for the Congresswoman, because 
what you say reflects the feelings of my contacts, lots and 
lots of Americans. It is almost a sense of outrage at what has 
happened. My sense is that--and I am not really blaming anyone 
here. The players in each sphere play by the rules. There are 
rules in Washington. There are rules on Wall Street. There are 
rules set by Washington for Wall Street. I think Washington 
didn't keep up with the players in, quote/unquote, Wall Street, 
and a lot of the things that happened should not have happened.
    That is history. You are going to get another opportunity 
to reset the rules of the game for those private-sector agents 
that in some sense have misbehaved. But we will have to see if 
they get convicted, if any go to jail on any of the particular 
kinds of things that have happened.
    I encourage you to enthusiastically get involved in 
resetting the rules, because all over the world now we are 
examining the new set of rules for the U.S. and global 
financial system in light of what has happened, and that will 
be your chance to get into that debate. And it is absolutely 
essential----
    Ms. Kaptur. Well, sir, you are looking prospectively. I am 
also looking retrospectively. And I want to lock a lot of 
people up, and I want a lot of fines placed on those who put 
the American people in this position. And I don't just buy 
looking forward. I want to go back with that hook and get those 
people that put us--and a lot of them walked away with millions 
and millions and millions of dollars, and we are acting like 
they didn't exist. History didn't just start in 2003.
    Thank you very much.
    Chairman Spratt. Ms. Kaptur, would you take the gavel? Be 
careful with it. And the Ranking Member has a couple of 
questions he would like to put before the hearing is over. And 
I have some constituents.
    Let me say to all our witnesses before leaving, you have 
been forthcoming and forbearing, and we very much appreciate 
it. We have gained a great deal from today's hearing, and we 
appreciate your participation. Thank you very much indeed.
    Mr. Ryan. Thank you for yielding, Chairman. I will be 
fairly brief. I won't take a full 5 minutes here. I simply want 
to follow up and finish up with what I think is a little bit of 
a mischaracterization of some of the views on this side of the 
aisle.
    Number one, the legislation we are trying to get to the 
floor is not just drill, drill, drill. It is drill and do all 
of the above. That is why it is called the ``all of the above'' 
Energy Act. Conservation, research, renewables, solar, wind, 
biomass, nuclear, all of it. Get out on the supply side right 
away.
    Another point is--and I don't want to directly refute Ms. 
Schwartz. I wanted to, but she is not here to defend herself, 
so I won't go down that path. Only to say I think we have to 
look at how the markets worked, the law of supply and demand, 
and how the futures markets worked. And in the opening 
statements, just because of the vote, each of our first two 
witnesses had plenty of time to go through their full 
testimony. And, Dr. Kreutzer, you only got 5 minutes. 
Therefore, you had to kind of truncate your remarks. So I am 
concerned that some of your testimony was taken out of context 
in a narrow viewpoint. So I wanted to give you an opportunity 
to fully expand on your points and your remarks, given the fact 
that you just haven't had that opportunity as some of the other 
witnesses did.
    Dr. Kreutzer. Okay. Yeah. I will say that I truncated my 
statement because I was told we had 5 minutes.
    Mr. Ryan. That is because we had a vote.
    Dr. Kreutzer. I am new at this.
    I was not trying to mislead anybody, and I think in my 
written testimony I didn't. There is no intent. If I did, I 
apologize.
    Start at the bottom of page 2. ``It is understood that the 
price impact would be smaller over time once the world economy 
fully adjusts to the increased production. We are comfortable 
using this elasticity''--that was the discussion I have had 
with Dr. Summers and with Congresswoman Schwartz--``since it 
seems probable that world petroleum markets, which are not 
currently in long-run equilibrium, will continue to see strong 
demand growth, especially over the long run. Nonetheless, we 
note that should the world petroleum market ease significantly 
by the time this increased production comes on line, the price 
and economic impacts will be less pronounced.''
    Okay. I would go on and say that we are having an argument 
over whether it is a really, really, really good idea or just a 
really, really good idea. Okay. That is, would creating 40,000 
jobs and adding $25 billion to the economy be a bad idea 
because it is not 128,000 jobs and $105 billion? No. What if it 
takes 10 years? It is still a good idea. That is the point I am 
trying to make. I am not presenting this as the answer to all 
energy problems or answer to all economic problems. We have 
something very simple. It doesn't cost the Federal Government 
anything. You have to release in the budget some money to allow 
the exploration and the geologic testing. That is pretty 
trivial. Okay. Beyond that it doesn't cost anything. You don't 
have to raise any taxes. You don't have to take money from 
somebody else. The drilling technology now is very safe. We are 
not going to be killing wildlife. Okay.
    So that is why I said it seems to be a no-brainer. It is 
not the answer to all problems. It will have an impact on 
price. Though the market may ease, what we will have then will 
be the $70-, $80-dollar-a-barrel petroleum. We should all be 
happy that we have that. The International Energy 
Administration is saying we are still going to have that very 
tight spare capacity. So I am taking that, and that is what we 
have seen. We were surprised by China. The markets are 
responding where we let them. The number of drill rigs 
operating in North America is more than any time since 1985. 
They built seven drill ships between 2001 and 2007. They are 
building 15 this year and 25 next year.
    But we are not letting markets do all they can. That is all 
I am asking. Let them go where we have resources. We know we 
have them, 30 billion, 20 billion, maybe much more than that. 
Who knows? Let us find out. There is no cost there. That is my 
only point. It will help the economy.
    Mr. Ryan. So is it not axiomatic that with China and India 
going through their version of the industrial revolution, 
surging demand increasing worldwide, would it not be better for 
our economy, for our national security that we get our supply 
here rather than depend on such foreign sources? Now that we 
have got new drilling technologies, now that we have new 
discovered reserves in the gulf, now that we can get the shale 
oil, the oil out of shale, which we couldn't 15 years ago, and 
there is something like 2 trillion barrels in the West, aren't 
these good ideas that just passing the authorization of this, 
showing this new future supply coming on line in the economy at 
some point time in the future, would not that just new supply 
coming in the future reduce the price in the futures market in 
a short period of time?
    Dr. Kreutzer. It could if there were excess capacity. There 
is plenty of theory that says that the Saudis and the other 
OPEC members can say, we can sell the petroleum now, or we can 
sell it next year, or we can sell it in 20 years. If there is 
going to be a lot of extra supply in 20 years, hmm, then the 
present value of that petroleum is not so high, we ought to 
sell it now. That is the argument.
    Right now they don't have the capacity, but the Saudis can 
expand their capacity much more rapidly than we can with the 
Outer Continental Shelf. So you might have a link. We say, hey, 
we are going to the Outer Continental Shelf, 5 years, 10 years, 
15 years, 20, 30. Thirty is--I think is just an exaggeration. 
That is not believable then. That number has been quoted 
earlier. That number is in print. So seeing that that is coming 
on line in 20 years, their reserves that they are going to have 
then won't be worth as much. They can expand now much more 
rapidly. There is oil in Saudi Arabia and the Middle East that 
they can expand in the next couple of years.
    One more point. Even if it doesn't change the price at all, 
that is $45 billion a year less petroleum that we have to 
import for each million barrels that we produce domestically. 
Forty-five billion dollars.
    Mr. Ryan. So from a trade deficit standpoint, from a U.S. 
jobs standpoint, all the better?
    Dr. Kreutzer. Yes.
    Mr. Ryan. Dr. Summers,let me ask you something. I want to 
make sure I understand what you said a minute ago about the tax 
changes that are coming to effect. At the end of 2010, the 
beginning of 2011, marginal income tax rates are going up 
across the board. Tax rates on capital gains dividends are 
going up, so higher tax rates on income, higher tax rates on 
capital. Are you saying that in order to maximize economic 
growth, it is necessary, right and good that those tax 
increases occur?
    Dr. Summers. With respect to dividends and capital gains 
cuts, I would favor raising the capital gains rate back to the 
Clinton era--the 20 percent capital gains rate. And I think if 
the dividend rate was at 20 percent, you would still have lower 
capital costs, lower capital taxes than we had through the 
spectacular market boom of the 1990s.
    With respect to the increase in rates, I believe that the 
extra confidence that would come from a lower deficit, that 
would come as a consequence of making clear that those upper 
income rates would be repealed, that the confidence that would 
come from greater fiscal responsibility would have benefits 
that would far exceed any possible costs associated with the 
increase in tax rates, and would simply cite the rather 
dramatic difference in the quality of economic performance 
during the 1990s and in recent years as evidence calling into 
question the reviews of those who somehow think that the 
difference between 35 percent marginal tax rates and 39 percent 
marginal tax rates on work incentives is very large. We can in 
a sense run this--run this as an experiment, and I think we 
have seen the answer quite clearly in terms of rates of growth. 
And, of course, if you look to what I believe should be the 
touchstone for economic policy, which is what happens to 
middle-income families, then if you look at median family 
income, or if you look at real wages, the difference between 
the performance and the pre-tax-cut regime and the post-tax-cut 
regime is really very, very dramatic.
    Mr. Ryan. So the premise of that requires that that--the 
revenues--the additional revenues supposedly raised through 
that be applied to deficit for your projection to materialize, 
correct? Meaning this extra tax revenue goes to the deficit, 
and therefore it is good.
    The problem we are having here in Congress is every new tax 
revenue coming in goes to spending. The sunset of those tax 
cuts, those revenues coming in are not being applied to the 
deficit. They are already being called for in new spending in 
the current baselines in the budget resolution that has passed.
    So I would simply say, let us control spending, work on the 
deficit that way, lock in a more credible spending-control 
budget and regime, and keep tax rates low. That way we can have 
our cake and eat it, too. We can have low tax rates on income, 
low tax rates on capital, better income incentives at the 
margin, and a credible Congress actually cutting spending and 
reducing the deficit. You know, that way we can satisfy both 
philosophies, both agendas, and actually achieve the results we 
are all trying to achieve, which is better and higher economic 
growth.
    Dr. Summers. I would say a couple things, Congressman. 
First, as one who takes some pride in his time in government 
service, I think the record in containing the growth of 
spending, whether you look at what actually happened to 
spending or you look at the President's budget proposals, was 
rather more favorable between 1993 and 2001 than it has been in 
the last 8 years.
    Second, I know that it is common to assert that extra tax 
revenues always get spent, and that if you cut taxes, that will 
lead to cuts in spending. But in a sense we have had a very 
strong test of that proposition. We cut taxes by several 
trillion dollars on a 10-year basis in 2001. We were told by 
the advocates of those tax cuts that it wouldn't exacerbate the 
budget situation. And somehow $3 trillion of tax cuts were 
associated with, depending on how you choose the interval, $6 
trillion of deficit deformation. In contrast, in the early 
1990s, when tax revenues were increased, we were told that that 
wouldn't lead to deficit reduction, but, in fact, for 16 half 
years in a row, CBO was revising its budget forecasts to show 
larger surpluses.
    So, yes, these are matters of theory, and you can make 
different arguments, but I would argue that the empirical 
evidence is actually relatively clear.
    By the way, if you go back and you look at family incomes 
during the 1980s, I think you will also find that that wasn't 
as favorable a period as during the 1990s.
    Mr. Ryan. Okay. I could go back and forth for a good hour 
with you on this. Let us not forget the 1997 budget agreement, 
which the Clinton administration used to control spending and 
cut taxes, which I would argue gave us better economic growth, 
a better budget projection, which was more behind these 
projected surpluses. Remember, these surpluses materialized to 
the tune of, I think, about $600 billion. You used that to buy 
back bonds. But after 9/11, the dot-com bubble and the 
recession, those projected surpluses never materialized.
    We can go on and on and on about this, but the one fact 
remains: Unless Congress gets a handle on controlling spending, 
this whole point is moot. I would just yield on that point. I 
know, Dr. Sinai, you want to get a quick point in.
    Dr. Sinai. I have to come down on the side of reductions in 
the growth of Federal spending in keeping tax rates low for 
those who will stimulate the economy most on the spending side 
given our current context. The rub is in the spending, and that 
is really up to Congress and how one wants to use Federal 
Government spending.
    I happen to think there is room to use it now for some 
well-planned infrastructure projects over the long term. PAYGO 
gives you a way to offset tax cuts over a period of time with 
legislated-in-advance reductions in spending. Odds are Congress 
won't agree on the latter. And although you and I are in 
agreement philosophically, and I think actually Larry and I are 
very close philosophically in the wording of how he responded 
to the question, we are talking about practical problems on the 
spending side, and that, again, is a question of leadership to 
me, not from economists but from the people in Washington.
    Mr. Ryan. We can come up with as many gimmicks as we want 
to. There is no substitute for the Congress actually having the 
discipline to control spending.
    Thank you. I yield.
    Ms. Kaptur [presiding]. I thank the gentleman and would 
like to state for the record that if one looks back to the last 
decade, in 1998, that was the year in which the United States 
began to import over half of the petroleum that it used. That 
was when the scale began to really tip in the wrong direction. 
And this year, after this administration's two terms, we are 
importing an additional billion barrels of oil into this 
economy, and now we are over two-thirds to three-quarters 
coming from foreign sources.
    And I am not one of the Members of Congress who believes 
there is a free market in the oil industry. It is amazing that 
companies can earn $40 billion; one company, $40 billion a 
year, the largest profits of any company in U.S. history, maybe 
in world history, just one of those oil companies.
    So we have a market that is very, very unusual, and they 
literally have us captive. The situation we are facing now is 
how do we, as a country, delink ourselves from this hostage 
situation in which we are held? I would like to believe that 
what Congress does can help, but as I look back over several 
years of service, I think some of the most creative actions are 
being taken at the local level where communities are saying, we 
have to become energy independent in our own regions. And we 
are seeing a lot of activity in rural America. We are looking 
at rural cooperatives. We are looking at new biofuels. We are 
looking at even county governments beginning to look at solar 
fields and geothermal and green roofs and cryogenic hydrogen, a 
whole host of--and wind farms going up across this country.
    I think the American people are beginning to understand 
that Washington in many ways is paralyzed and perhaps captive 
of the very interests that are holding us hostage. I would like 
to believe that it is otherwise, but it seems whether it is the 
1990s or the 2000s, the numbers just keep getting worse. I am 
very dismayed by that. I have done everything within my power 
to try to change it. But I am hoping that the republican nature 
of our government where we share power with States, with 
localities, with regions, will produce a different America, and 
that those of us at the national level who are trying to change 
this equation will--will aspire to the highest of our ideals, 
and that is that not all answers exist here in Washington, and 
that when Washington fails the country--and we are failing, we 
are failing this Nation by keeping us hostage--that the 
American people will find their way forward, and that there 
will just be enough incentives that we might be able to provide 
that will ripen these local efforts.
    As far as I am concerned, Minnesota has been the ``lone 
star'' State in leading us forward. I think the new farm bill 
is a real--is a real plus, and I don't think that history will 
record this generation as doing America any favors. I think 
that we could do a whole lot better. And I resent being held 
hostage by any group of interests that hold the American people 
by the carotid artery and by the aorta and don't allow us to 
really be free. I consider our energy dependence our chief 
strategic vulnerability.
    I wanted to ask unanimous consent that Members who did not 
have the opportunity to ask questions of the witnesses be given 
7 days to submit questions for the record.
    [Questions submitted by Mr. Barrett follow:*]

  Questions Submitted by Hon. J. Gresham Barrett, a Representative in 
               Congress From the State of South Carolina

    1. Considering the federal government's new role in Fannie and 
Freddie, what incentives face Congress that would lead to policies that 
spur growth in the short term at a long term cost?
---------------------------------------------------------------------------
    *As of March 13, 2009, responses to the questions submitted have 
not been received by the committee.
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    2. What are the international macroeconomic effects of this 
takeover in terms of our trade balance, flows of capital from 
international firms, and strength of the dollar?
    3. What type of effect does the addition of Fannie and Freddie's 
debt have on the federal balance sheet?
    a. How will this additional debt affect expected economic growth 
given the already growing national debt?
    4. How important is energy independence to the long-term health of 
the economy?

    Ms. Kaptur. And I also wanted to ask a question of any of 
the witnesses. In Dr. Summers' testimony, Dr. Summers, you say 
that losses in output relative to potential are likely to cost 
the economy $300 billion a year, or more than $4,000 for the 
average family of four. So you talk about the real cost to the 
average family of what is happening in the economy. Could I ask 
any of you or Dr. Summers to comment, with a trillion-dollar 
trade deficit now bearing down on this country, with more 
imports coming in here than exports going out, what share of 
lost output can we attribute to the displacement of U.S. 
productivity here at home, U.S. production here at home, in 
manufacturing and agriculture and related wealth-producing 
activities that used to occur here?
    Dr. Sinai.
    Dr. Summers. Congresswoman, if you will excuse me, I have 
another commitment, so I will have to leave.
    Ms. Kaptur. You don't wish to comment on that, Dr. Summers?
    Dr. Summers. I will make a very brief comment. There is no 
question that over the long term we are going to have to reduce 
our trade deficit and our consequent dependence on foreign 
capital. As we do that, there are likely to be significant 
benefits in employment, and those significant benefits of 
employment, of course, will be focused on parts of the country 
that have lagged, parts of the country that have lagged behind 
to our very significant benefits. Certainly the trade deficit 
at its roots, which go to many different aspects of our 
economic performance, is, as you have often highlighted in the 
past, a crucial issue.
    Ms. Kaptur. Thank you. Thank you very much.
    Dr. Sinai, we are almost finished here.
    Dr. Sinai. Thank you.
    I was going to say we are moving in the right direction at 
the moment on our trade balance and on current account 
deficits, so it isn't quite as dire as it was. And I think a 
trillion dollars is a little high on that deficit. So you 
want----
    Ms. Kaptur. Well, three-quarters of a trillion to $1 
trillion.
    Dr. Sinai. So 25 percent margin of error. I am an 
economist, not a statistician. I will accept that.
    Ms. Kaptur. Seven hundred billion dollars is pretty 
significant.
    Dr. Sinai. If whatever we do in our concern about the 
deficit, international account and our dependence on foreign 
capital leads us down a protectionist path, that would be very 
counterproductive. That is the only comment I have on that. It 
is definitely a huge problem. We are a big debtor almost 
everywhere, particularly on the government side. That is going 
to get much, much worse.
    I think on trade in the current account deficit and our 
indebtedness there, that actually is probably going to keep on 
improving. And we are losing fewer jobs at the moment overseas. 
Nevertheless it is a big problem. But if the answer turns out 
to be any kind of protectionism, fair trade, which is sometimes 
hand-to-hand combat with our trading partners who are not 
playing the game in a free-trade way, and where we are, I go 
back to Mickey Cantor and the tough approach. Fair trade is 
more for me than free trade, depending on who you are dealing 
with. But protectionism is definitely the wrong way to go.
    Ms. Kaptur. We need to have all markets open.
    Dr. Sinai. And fear. And fear. So the playing rules are the 
same for the participants.
    Ms. Kaptur. Thank you, Doctor, very much.
    Dr. Kreutzer, do you have any final words?
    Dr. Kreutzer. No, thank you.
    Ms. Kaptur. I want to thank you, thank all the witnesses 
for your attendance today, all of the membership. The committee 
is now adjourned.
    [New York Times article submitted by Ms. Schwartz follows:]
    
    
    
    
    
    
    [Whereupon, at 5:05 p.m., the committee was adjourned.]

                                  
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