[House Hearing, 111 Congress]
[From the U.S. Government Publishing Office]





                    PERSPECTIVES ON THE U.S. ECONOMY

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

                                HEARING

                               before the

                        COMMITTEE ON THE BUDGET
                        HOUSE OF REPRESENTATIVES

                     ONE HUNDRED ELEVENTH CONGRESS

                             SECOND SESSION

                               __________

              HEARING HELD IN WASHINGTON, DC, JULY 1, 2010

                               __________

                           Serial No. 111-28

                               __________

           Printed for the use of the Committee on the Budget


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                        COMMITTEE ON THE BUDGET

             JOHN M. SPRATT, Jr., South Carolina, Chairman
ALLYSON Y. SCHWARTZ, Pennsylvania    PAUL RYAN, Wisconsin,
MARCY KAPTUR, Ohio                     Ranking Minority Member
XAVIER BECERRA, California           JEB HENSARLING, Texas
LLOYD DOGGETT, Texas                 SCOTT GARRETT, New Jersey
EARL BLUMENAUER, Oregon              MARIO DIAZ-BALART, Florida
MARION BERRY, Arkansas               MICHAEL K. SIMPSON, Idaho
ALLEN BOYD, Florida                  PATRICK T. McHENRY, North Carolina
JAMES P. McGOVERN, Massachusetts     CONNIE MACK, Florida
NIKI TSONGAS, Massachusetts          JOHN CAMPBELL, California
BOB ETHERIDGE, North Carolina        JIM JORDAN, Ohio
BETTY McCOLLUM, Minnesota            DEVIN NUNES, California
JOHN A. YARMUTH, Kentucky            ROBERT B. ADERHOLT, Alabama
ROBERT E. ANDREWS, New Jersey        CYNTHIA M. LUMMIS, Wyoming
ROSA L. DeLAURO, Connecticut,        STEVE AUSTRIA, Ohio
CHET EDWARDS, Texas                  GREGG HARPER, Mississippi
ROBERT C. ``BOBBY'' SCOTT, Virginia  CHARLES K. DJOU, Hawaii
JAMES R. LANGEVIN, Rhode Island
RICK LARSEN, Washington
TIMOTHY H. BISHOP, New York
GWEN MOORE, Wisconsin
GERALD E. CONNOLLY, Virginia
KURT SCHRADER, Oregon
DENNIS MOORE, Kansas

                           Professional Staff

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











                            C O N T E N T S

                                                                   Page
Hearing held in Washington, DC, July 1, 2010.....................     1

    Hon. John M. Spratt, Jr., Chairman, Committee on the Budget..     1
        Prepared statement of....................................     3
    Hon. Paul Ryan, Ranking Minority Member, Committee on the 
      Budget.....................................................     4
    Martin Neil Baily, senior fellow, Bernard L. Schwartz chair, 
      the Brookings Institution..................................     5
        Prepared statement of....................................     8
        Response to questions submitted..........................    67
    Mark Zandi, Ph.D., chief economist, Moody's Analytics........    19
        Prepared statement of....................................    24
        Response to question submitted...........................    69
    John B. Taylor, Mary and Robert Raymond professor of 
      economics; George P. Shultz senior fellow in economics, 
      Hoover Institution, Stanford University....................    43
        Prepared statement of....................................    46
        Response to question submitted...........................    68
    Hon. Robert B. Aderholt, a Representative in Congress from 
      the State of Alabama, questions submitted and their 
      responses..................................................    67

 
                    PERSPECTIVES ON THE U.S. ECONOMY

                              ----------                              


                         THURSDAY, JULY 1, 2010

                          House of Representatives,
                                   Committee on the Budget,
                                                    Washington, DC.
    The committee met, pursuant to call, at 1:17 p.m. in room 
210, Cannon House Office Building, Hon. John Spratt [chairman 
of the committee] presiding.
    Present: Representatives Spratt, Schwartz, Kaptur, Becerra, 
Doggett, Etheridge, Scott, Connolly, Schrader, Moore, Ryan, 
Hensarling, Campbell, Lummis, and Djou.
    Chairman Spratt. We meet today to discuss the economic 
recovery and the challenges that lie ahead of us. We are joined 
by three eminent economists to help us take stock of this 
situation.
    When this Congress, the 111th, took office along with the 
Obama administration in January of 2009, the economy was 
shrinking at a 5.4 percent negative rate of growth. A year and 
a half later, the economy is in its third straight quarter of 
economic growth, growing at 5.6 percent in the fourth quarter 
of 2009 and 2.7 percent the first quarter of 2010.
    A year and a half ago, the economy was losing jobs 
massively. In January of 2009, we lost 779,000 jobs in one 
month alone. Now, after a year and a half of concentrated 
fiscal initiatives, employers added nearly one million jobs 
between January and May of this year.
    As Chairman Bernanke recently told us in his testimony 
before this committee, the Federal Reserve, quote, anticipates 
that real-growth domestic product will grow in the neighborhood 
of 3.5 percent over the course of 2010, at a somewhat faster 
pace, we hope, the next year.
    Nevertheless, the economy seldom recovers in a straight 
linear fashion. In May, the economy added 431,000 jobs on the 
strength of new Census hires, but forecasters anticipate that 
tomorrow's job report will show that while we may have added as 
many as 100,000 new private-sector jobs in June, a solid 
accomplishment, total nonfarm payrolls may still have fallen 
due to the end of many of these temporary Census jobs.
    The strength of our economy clearly lies in the private 
sector, but the action taken by this Congress and this 
administration we think have played a significant role. For 
example, it is the judgment of the Congressional Budget Office 
that the Recovery Act passed in February of 2009 has 
contributed significantly to the economic turnaround, raising 
GDP by 1.7 to 4.2 percentage points in the fourth quarter of 
2010, increasing employment by 1.2 million and 2.8 million jobs 
overall.
    Meanwhile, the Treasury Department, the Federal Reserve, 
and the FDIC have been engaged in unprecedented efforts to 
stabilize banks and the financial system by injecting 
liquidity, capital, and by securing people's savings and 
requiring banks to raise still more capital.
    In response to my question last month at the hearing on 
whether the TARP and the Recovery Act had been necessary to 
rescue the financial system and the economy, Chairman Bernanke 
replied, quote, Certainly we have averted what I think would 
have been, absent those interventions, an extraordinarily 
severe downturn, perhaps as great as the Great Depression.
    That from a person who is not known for exaggerated 
statements.
    The recession and the necessary recovery efforts have taken 
a toll on the budget in the short run. We, as Democrats, have 
been focused on the economic recovery. We have also pursued and 
sought fiscal responsibility for the long term. We want to see 
the economy and the budget recover step by step, hand in hand.
    Testifying before the President's Fiscal Commission 
yesterday, the Director of CBO, Doug Elmendorf, observed that, 
once again, there is no contradiction between providing 
additional fiscal stimulus today while the unemployment rate is 
high and many factories and offices unutilized, imposing fiscal 
restraint several years from now when output and employment 
will probably be close to the peak of potential.
    Earlier this year, we passed statutory PAYGO, requiring 
that new mandatory spending or revenue reduction be paid for. 
In addition, the President established a bipartisan commission 
now at work to make recommendations to bring down the deficit 
to a sustainable level by 2015. And, finally, we may be close 
to an agreement on an enforcement level for 2011 appropriation 
bills. These fiscally responsible policies have been undertaken 
by this administration and this Congress to good effect.
    At this time, however, our key concern is, over the short 
run, what is the economic outlook? What can we expect in the 
months ahead of us? And what is the appropriate fiscal response 
at this particular point in time?
    We have with us today three eminent economists that will 
help us sort through the progress the economy has made and look 
to the future.
    First is Dr. Martin Baily, Senior Fellow at the Brookings 
Institution and former Chairman of the CEA under President 
Clinton.
    Second is Mark Zandi, co-founder of Moody's Analytics and 
former adviser to Senator McCain as well as a number of 
Democrats.
    And, finally, we have Dr. John Taylor of Stanford 
University and the Hoover Institution, a former Under Secretary 
Treasurer for International Affairs under President Bush.
    We look forward to your testimony. We appreciate your being 
here. But before giving the floor to you, I want to turn to the 
ranking member for any statement he may care to make. Mr. Ryan.
    [The statement of Mr. Spratt follows:]

Prepared Statement of Hon. John M. Spratt, Jr., Chairman, Committee on 
                               the Budget

    We meet today to discuss the progress of the economic recovery and 
the challenges that still lie ahead of us and we are joined by three 
eminent economists who will help us take stock.
    When the 111th Congress began and the current administration took 
office, the economy was shrinking at a 5.4 percent annualized rate. One 
year and a half later, the economy is experiencing its third straight 
quarter of economic growth, including 5.6 percent growth in the fourth 
quarter of 2009 and 2.7 percent growth in the first quarter of 2010.
    A year and a half ago, the economy was hemorrhaging jobs. In 
January of 2009, we lost 779,000 jobs in one month alone. Now, after 
one and a half years of concentrated economic and fiscal initiatives, 
employers added nearly a million jobs between January and May of this 
year. And Chairman Ben Bernanke told us last month in his testimony 
that the Federal Reserve ``anticipates that real gross domestic product 
will grow in the neighborhood of 3\1/2\ percent over the course of 2010 
as a whole and at a somewhat faster pace next year.''
    As Americans and policymakers have come to know all too well, the 
economy seldom recovers in a straight, linear fashion, but instead 
tends to zigzag. In May, the economy added 431,000 jobs on the strength 
of new Census hires. However, forecasters anticipate that tomorrow's 
jobs report will show that while we may have added as many as 100,000 
new, private sector jobs in June--which would be a solid 
accomplishment--total nonfarm payrolls may still have fallen due to the 
conclusion of many of these temporary Census jobs.
    The ultimate strength of our economy clearly lies in the private 
sector, but the actions taken by this Congress and by the 
Administration have also played a significant role. For example, it is 
the judgment of the non-partisan CBO that the Recovery Act, which we 
passed in February of 2009, has contributed significantly to the 
economic turnaround, raising real GDP by 1.7 to 4.2 percentage points 
in the fourth quarter of 2010, and increasing employment by between 1.2 
million and 2.8 million jobs overall. Meanwhile, the Treasury 
Department, the Federal Reserve, and the FDIC have engaged in 
unprecedented and coordinated efforts to stabilize banks and the 
financial system by injecting liquidity, capital, securing people's 
savings, and requiring banks to raise still more capital. In response 
to my question last month at our hearing on whether TARP and the 
Recovery Act had been necessary to rescue the financial system and the 
economy, Chairman Bernanke replied ``Certainly we have averted what I 
think would have been, absent those interventions, an extraordinarily 
severe downturn, perhaps a great depression.''
    The recession and the necessary recovery efforts have taken an 
unavoidable toll on the budget in the short run. While we as Democrats 
have been focused on the economic recovery, we have also pursued fiscal 
responsibility. We want to see the economy and the budget recover step 
by step. Testifying before the President's Fiscal Commission yesterday, 
CBO Director Doug Elmendorf observed that ``There is no intrinsic 
contradiction between providing additional fiscal stimulus today, while 
the unemployment rate is high and many factories and offices are 
underused, and imposing fiscal restraint several years from now, when 
output and employment will probably be close to their potential.''
    Earlier this year we passed statutory PAYGO, requiring that new 
mandatory spending on revenue reductions be paid for. In addition, the 
President has established a bipartisan commission now at work to make 
recommendations to bring the deficit down to a sustainable level by 
2015. [[And, finally, we may be close to reaching agreement on a House 
budget plan.]] These fiscally responsible policies are in direct 
contrast to the actions of the previous administration, which inherited 
a $5.6 trillion surplus over 10 years and systematically turned it into 
large deficits, handing the current administration trillions of dollars 
of deficits for years to come.
    We will continue to pursue steps towards fiscal responsibility so 
that over the medium and long term we put the Nation on a path that 
will provide a foundation for a strong economy in the future. At the 
same time, the key concern in the short term remains the economic 
outlook. We have with us today, three eminent economists, who will help 
us sort out the progress the economy has made. First off is Dr. Martin 
Baily, a senior fellow at the Brookings Institution and former Chairman 
of the Council of Economic Advisers under President Clinton. Speaking 
second will be Dr. Mark Zandi, Chief Economist and Co-Founder of 
Moody's Analytics and a former advisor to Senator McCain as well as 
Democrats. And finally, we have Dr. John Taylor of Stanford University 
and the Hoover Institution, a former Undersecretary of Treasury for 
International Affairs under President Bush. We look forward to hearing 
your testimony on economic developments and whether you agree with the 
Federal Reserve Chairman's take on the economy or whether you see 
things differently.
    Before we hear from our witnesses, let me also turn to the ranking 
member, Mr. Ryan, for any statement he may care to make for an opening 
purpose.

    Mr. Ryan. Thank you, Mr. Chairman; and thank you to our 
three distinguished witnesses for being here with us today. I 
know some of you had to travel a great distance, and we are 
really grateful for your attendance.
    We convene this hearing under renewed concern about the 
health of our economy. Experts tell us that we are technically 
in the process of an economic recovery, but for too many 
Americans it feels more like an economic malaise. Private-
sector job growth has been lackluster. The unemployment rate is 
hovering at a 25-year high; and fear and anxiety are, once 
again, gripping our financial markets.
    Most policymakers here in Congress are asking the right 
questions, namely, how do we spark sustained growth and job 
creation? But too many are searching for answers in the 
discredited economic playbook of borrow-and-spend Keynesian 
policies. We have seen this movie before, and we know how it 
ends. Ask the Europeans. You can't take money from the private 
productive sector of our economy, funnel it through Washington, 
and expect to create wealth and sustained economic growth. 
Centralizing power in Washington, expanding government's reach 
into all sectors of our economy and more and more aspects of 
our lives does not create jobs.
    Unfortunately, I believe our policy differences center more 
on ideology, not on economics. If a debate were purely about 
economics, the administration wouldn't be doubling down on the 
renewed debt-financed government spending spree. If it was 
about economics or even pragmatism, we wouldn't be planning to 
hit the economy, struggling to recover from a deep recession, 
with a slew of new tax hikes. We wouldn't be shackling our job-
producing businesses with more regulations. But that is exactly 
what the administration and the majority in the Congress are 
doing.
    Americans want their representatives to do what works. They 
want common sense pragmatism, not blind progressivism.
    I reject the false premise that only forceful and sustained 
government intervention in the economy can secure this 
country's renewed prosperity. Adherence to this premise has 
given us a damaging policy mixture. It has sparked a government 
spending spree and borrowing binge with no end in sight. It has 
led to a centralization of power in health care, energy, 
financial services, the auto industry, and more, tightening 
Washington's grip on key sectors of our economy. It has 
fostered continued policy uncertainty about tomorrow, which 
stifles investment today. It has caused new barriers to growth 
that has rationalized the need for more tax hikes in the 
future.
    This Congress has failed to even produce a budget, and it 
has refused to consider the tough choices that deal with our 
massive debt burden, a debt burden growing exponentially larger 
with each kick of the can further down the road.
    Workers, taxpayers, and families across this country have 
been Guinea pigs in this neo-Keynesian experiment long enough. 
The results are in. Washington's economic experiment has 
failed.
    Let's try something different. Let's try something that 
works. Instead of erecting new hurdles for entrepreneurs, let's 
reduce the government-imposed barriers to grow, produce, 
create, and innovate. Let's instill a sense of certainty and 
confidence for investment in job creation. Let's reform our 
anti-competitive Tax Code, restore the promise of our bankrupt 
entitlement programs, and work to lift our crippling debt 
burden.
    We need to chart a new fiscal and economic course, 
reforming government and putting in place a plan for growth, a 
plan for prosperity.
    I hope today's hearing can help inform policymakers as to 
why the economy remains sluggish, jobs remain elusive, and the 
forecast remains bleak. I believe we can, and must, do better 
than this. I appreciate your participation in today's hearing, 
and I look forward to your testimony.
    Chairman Spratt. Gentlemen, we have framed the issues for a 
lively hearing, and we look forward to your testimony.
    Before turning to you, a couple of housekeeping details. I 
ask unanimous consent that all members be allowed to submit an 
opening statement for the record at this point.
    Hearing no objection, so ordered.
    We recognize you for such time as you need to take. Your 
statements previously filed have been made part of the record, 
so you can summarize as you see fit. Let's start with Dr. 
Baily.

  STATEMENT OF MARTIN BAILY, PH.D., SENIOR FELLOW, BROOKINGS 
   INSTITUTION; MARK ZANDI, PH.D., CHIEF ECONOMIST, MOODY'S 
   ANALYTICS; AND JOHN TAYLOR, PH.D., SENIOR FELLOW, HOOVER 
                          INSTITUTION

                   STATEMENT OF MARTIN BAILY

    Mr. Baily. Thank you, Chairman Spratt, Ranking Member Ryan, 
and members of the committee. It is a great privilege to 
testify.
    I am very pleased to be part of this very distinguished 
panel. I know Mark very well and John, and I am sure we will 
have some lively disagreements, but I have a lot of respect for 
their views.
    I didn't come a long distance here, although, as I noted in 
my testimony, since the Recovery Act is digging up every street 
in Washington, it sometimes feels like a long distance just to 
get from Dupont Circle.
    There were many contributors to this crisis. I think there 
are folks, and John may be one of them, that sort of focus on a 
particular cause in this crisis, that it was the Federal 
Reserve interest rate policy. My friend Peter Wallison believes 
it was Fannie and Freddie and the GSEs that caused the problem.
    But, in my judgment, this really was, to use the cliche, a 
perfect storm. We had market failures on Wall Street, and even 
some of the Main Street banks did things that were very foolish 
in retrospect. I think there were policy failures, a lack of 
regulatory watchfulness, and also policy choices that were a 
mistake. So it is a variety of things that went wrong, and this 
really has been one of the nastiest recessions in history and 
certainly since the Great Depression.
    I think it is important to stress this multiplicity of 
causes. Because when an economy goes into this kind of 
recession and we have this kind of financial crisis, we know it 
takes a long time to get out. That is the historical record. 
And Ken Rogoff and his coauthor have documented that very 
carefully. You cannot turn around an economy that quickly and 
easily.
    I think that there should be a lot of credit given to the 
measures that were taken to overcome this crisis. It started, 
obviously, under Secretary Paulson and President Bush. 
Secretary Paulson asked for the TARP and was eventually given 
that, and that was a resource that was absolutely essential to 
turn around the financial sector. We really were on the verge 
of a huge meltdown.
    I think there were some missteps taken on the way to 
getting the financial sector back, but eventually that was 
sorted out working with Secretary Geithner and Ben Bernanke. 
And the Wall Street banks are now, if not healthy, looking much 
stronger. I think the immediate crisis, the likelihood that 
those institutions are going to fail, has been alleviated.
    We have also had a lot of, as I said, smaller banks, and 
the FDIC has played a really important role. That has been 
expensive, too. That cost is going to be borne by the banks 
themselves in terms of higher fees, but for the society it has 
been a very expensive business to restore the financial sector. 
It has taken a long time. We are still not all the way there. 
There are still a lot of banks on the watchlist, between 700 
and 800 banks still on the FDIC watchlist.
    So we have a ways to go on the financial sector, and that 
is restricting lending, and that is one of the factors that is 
slowing the recovery a little bit. But we could not have done 
this without the aggressive actions of the policymakers, 
including those of you here in Congress that somewhat 
reluctantly approved this. And the electorate doesn't like it, 
I know that, but I think it was to your credit that it was 
done.
    I think the fiscal stimulus played an important role, too. 
I am actually not one of those who think we should use fiscal 
policy all the time to try to stabilize the economy. In normal 
times, I think the Fed does a good job of keeping the economy 
on track, and that is what we should do.
    There are, of course, the automatic stabilizers are very 
important. I mean, they are very important. So that when we go 
into a downturn, tax revenues fall and things like unemployment 
insurance rise, and they help stabilize this economy. But given 
the situation we were in, which I liken in my testimony to 
being in a foxhole with the shells crashing around us, we 
really needed additional help; and the fiscal stimulus provided 
that.
    Now, one can argue about this. I don't think it is rocket 
science that if an economy is suffering because aggregate 
demand is weak, consumers aren't spending, the housing market 
is collapsing, businesses aren't investing, you need to find 
some way to keep demand going, to keep jobs, to keep people 
employed. In a full employment economy, it is a different 
story. And I would point out that when I was chairman of the 
Council of Economic Advisers, we had a balanced budget in both 
of the years that I was chair.
    So I am a believer in balanced budgets, and I am a believer 
in keeping Federal spending under control, but, in this 
situation, this was the medicine we needed, and I think it was 
delivered, and it does seem to have worked.
    Let's look at a comparison of where we were in the spring 
of 2009.
    It was just so dangerous. GDP was falling. We were losing 
700,000 jobs a month. The financial sector was on the verge of 
collapse. Now, even by late 2009, the whole economic situation 
looks so much better. We have economic growth. We are beginning 
to get job growth. It is much too slow and much too hesitant, 
but it is beginning to happen. So it is just really a night-
and-day comparison.
    Again, not to say everything is great. Everything is not 
great. Not to say we won't have stumbles along the way. As Alan 
Greenspan I think said yesterday, in a normal recovery--and 
this is maybe not quite a normal recovery--you are going to get 
periods of slower growth. You are going to get hesitations. And 
when you get something like the aftershock in Europe, that is 
particularly true. So it is not a surprise that we are getting 
some weakness now.
    You know, the month before, the numbers look good. The last 
month, the numbers have looked not so good. That is the way it 
is going to go during the course of a normal recovery.
    I think Mark is going to talk--and he is one of the best 
modelers around--of what his model shows about the effect of 
stimulus. But I think one probably needs to go even beyond 
those models. When you get really a crisis situation, then the 
TARP and the stimulus spending become much more important.
    Now, what about going forward, to which Chairman Spratt 
referred? What do we need to do going forward?
    I guess my own view is sort of hold the course steady. I am 
still optimistic that we will get something like 3 percent to 4 
percent growth this year. I don't think that is a certainty, 
but I am hopeful that we will get that.
    What has happened in Europe has given us problems here. It 
is one of the main reasons the stock market has been weak just 
lately, and there is this sort of effect. It affects our trade, 
but it also affects confidence and business confidence. Quite 
large corporations are heavily involved in Europe, so some of 
their profits, some of their investment is derived from those 
markets. So, inevitably, that is having an effect on the U.S.
    Now, in the G-20 meeting, the President, President Obama, 
said to the Europeans purportedly that they need to keep their 
stimulus going. And they said, no, they weren't going to do 
that. Was that right or not? I think they are sort of damned if 
they do and damned if they don't, if you excuse my language. It 
was a situation where their own economies really would call for 
more stimulus, that they need that, because they are not 
growing rapidly. Even Germany, let's say, which is in good 
budget position and their exports are growing, but even its 
overall economy is not growing. Certainly the others are not.
    So from that point of view, it would be a good idea to keep 
the stimulus going. But given the crisis they have on their 
financing and with the Euro, I think they probably are making a 
wise decision to not try to put in additional stimulus.
    Now, what I hope they don't do is try to contract or do 
fiscal consolidation too quickly. They do need to do fiscal 
consolidation, just as we do here in the United States, but I 
think they should do it slowly and not shoot themselves in the 
foot. If they push themselves back into another deep recession, 
it will affect not only us, but it will give them bigger 
deficits. Because, of course, declining tax revenues during a 
recession are a big reason why we have had deficits and why 
they have had deficits.
    In terms of the U.S., we are in a somewhat similar 
situation. We really have to weigh off those two forces: Can we 
afford to borrow any more or can we afford not to, so to speak, 
in order to keep the economic stimulus going? And I think those 
things are quite evenly balanced at this point. Again, I would 
probably like to see some additional stimulus, except for the 
fact that we have this constraint.
    As Larry Summers said back in the Clinton administration, 
one of the advantages of running a budget surplus is that you 
reload the fiscal canon. That means you can use fiscal policy 
without being concerned that you are borrowing too much or 
going to drive up interest rates or create a financial crisis. 
We are not in that situation now. Because we have had deficits 
for so many years, we are now somewhat vulnerable. I don't 
think we are Greece, because the U.S. is a much bigger and much 
stronger economy and our interest rates right now are very low, 
but we don't want to push the envelope there.
    So I have supported the extension of unemployment 
insurance. I think that is a good thing to do. And I think some 
additional help to the States is called for, but I would not 
institute, in my judgment, another major fiscal stimulus 
because of the borrowing constraints. If we end up, towards the 
end of this year, going back into a second dip recession, then 
I would reevaluate that depending on where financial markets 
stood.
    Thank you for the opportunity.
    [The prepared statement of Martin Baily follows:]

  Prepared Statement of Martin Neil Baily, Senior Fellow, Bernard L. 
               Schwartz Chair, the Brookings Institution

    Chairman Pratt, Ranking Member Ryan and members of the Committee, 
it is a privilege to testify to this committee on the economy.
                      key points in this testimony
    There were early signs of financial crisis even in 2006 and early 
2007, and then financial markets seized up in the summer of 2007. 
Initially, the decline in GDP and jobs was mild, but the economy fell 
like a stone in the last quarter of 2008 and the first quarter of 2009. 
The situation in the spring of 2009 was extremely dire with the risk of 
continuing deep declines and collapse of the financial sector.
    There were many contributors to this crisis, market failures, 
regulatory failures and policy failures. Regardless, given the severity 
of the recession and the financial turmoil and the global reach of both 
elements, no policies could have restored full employment quickly or 
healed the problems in the financial sector rapidly. Financial crises 
and the ensuing recessions result in prolonged losses.
    The Treasury and the Federal Reserve were slow to react to the 
financial crisis, but once its enormity became clear they moved 
aggressively to fight it. Secretary Geithner was part of the team at 
the Federal Reserve dealing with the crisis from the outset and he 
provided continuity as the Obama team took over. The TARP was essential 
to restoring the financial sector and the FDIC played a vital role in 
resolving small and medium-sized banks. The stress tests in the spring 
of 2009 were a turning point in financial recovery in large part 
because the Treasury was able to promise bank capital if the private 
sector could not provide it.
    The fiscal stimulus had to be deployed quickly and the money had to 
reach households and businesses as soon as possible. The states were 
facing large budget deficits that would trigger sharp cutbacks unless 
federal funds could provide emergency relief. The stimulus package was 
messy, but it did what it was supposed to do as evidenced by the 
recovery of growth in the fall of 2009.
    The fact that GDP growth was solid by the end of 2009 and that 
employment started to grow in 2010 is a miracle, given how bad the 
situation became.
    Despite the gains achieved, the jobs picture remains extremely 
bleak and the problems in Europe could result in a double dip recession 
here at home. Our ability to respond is weakened by the fact that there 
were federal budget deficits every year from 2002 on, and because the 
deficit ballooned in this crisis.
    The European crisis has forced some countries to curtail their 
stimulus packages and move towards fiscal consolidation. With the 
backing of the IMF, they are making a virtue of necessity and arguing 
that fiscal discipline will encourage growth even in the short run. I 
agree they should start down a well-marked path to lower deficits, but 
they should avoid acting too quickly. An aborted economic recovery will 
result in even worse budget deficits.
    The US situation is somewhat similar in that we also need to weigh 
the need for stronger demand growth against the limits on Treasury 
borrowing. The US economy is less constrained and markets are not 
flashing warnings about Treasury borrowing, given that interest rates 
are at historic lows. That could change, however, and we do not want to 
get too close to the edge of the cliff. If the economic recovery peters 
out, I would support a further fiscal stimulus, but only if accompanied 
by a clear and credible path towards lower deficits in the out years.
    Where We Were There were signs in 2006 and early 2007 that 
financial markets, particularly housing and mortgage-backed securities 
markets, were troubled. With the benefit of hindsight, we can see that 
the decline in median home prices that started in 2006, the collapse of 
25 subprime lenders in early 2007 and the collapse of two Bear Stearns 
hedge funds in July 2007 were early-warning signs of much worse trouble 
to come. The financial crisis hit front and center in August of 2007 
when wholesale lending markets seized up, making it difficult or 
impossible for some financial institutions to roll over their short 
term borrowing. Chart 1 shows the ``Ted Spread'' the difference between 
the LIBOR interest rate and the 3-month Treasury bill interest rate, an 
indication of the willingness of financial institutions to lend to each 
other. It spiked up in 2007 as the crisis hit and then went through the 
roof in 2008 in the turmoil following the collapse of Lehman.
    The financial crisis worsened through 2008 and into 2009 as both 
large and small banks failed or were propped up. Wall Street was 
reeling but so were a lot of regional and local institutions. Many FDIC 
insured banks have failed and the number of banks currently considered 
to be problem banks reached 775 by the end of the first quarter 2010. 
These banks collectively hold $431 billion of assets, so the 
difficulties facing the banking sector are not over yet.


    At first, it seemed as if the financial crisis would cause only 
modest collateral damage to the Main Street economy of jobs and 
production. Real GDP grew at 3.6 percent in the third quarter of 2007 
and 2.1 percent in the fourth quarter. Even the first half of 2008 was 
not too bad with a small decline in GDP in the first quarter and a 
modest increase in the second. By the second half of 2008, however, the 
economy went into freefall, particularly in the fourth quarter when GDP 
declined by 5.4 percent, followed by a 6.4 percent annual rate of 
decline in the first quarter of 2009. Chart 2 shows this pattern.


    Employment in this recession has been horrendous. Payroll 
employment started to decline by the end of 2007 and the freefall of 
GDP that occurred in the second half of 2008 was matched and then some 
in the labor market with monthly employment declines of around 700,000. 
As Chart 3 shows, the loss of employment in this recession dwarfs 
anything in prior recessions in the postwar period. The business 
community became very scared by the speed and depth of the recession 
and moved very aggressively to cut costs in whatever ways they could 
find. Nonfarm payroll employment declined by 8.4 million jobs between 
December 2007 and December 2010.


    The stock market directly affects households through their wealth 
holdings and affects the pension retirement accounts held by 
individuals and by companies. In addition, the stock market acts as a 
sign of confidence for everyone. If the stock market is plunging, 
families become reluctant to spend even if they do not have a 
significant stake in the market themselves. Chart 4 shows the movement 
of the S&P 500 index over the period 2001 to early 2010. After rising 
into the 1,500 to 1,600 range in 2007 it plunged over the next several 
months, dropping below 700 before recovering partially. Families that 
were counting on a comfortable retirement realized they lacked the 
necessary resources and would either have to keep working or adjust to 
a much reduced lifestyle.


                            where we are now
    The good news is as follows:
     After its frightening freefall in late 2008 and early 
2009, the economy slowed its rate of decline in the second quarter of 
2009 and resumed growth in the third quarter, averaging a solid 3.6 
percent through the first quarter of 2010. A mainstream forecaster 
suggests growth of 3-4 percent for the next year or two. This is a 
remarkable turnaround with the pattern also shown in Chart 2.
     The labor market has stabilized, with unemployment having 
peaked at 10.1 percent in October 2009 and now declining slowly to 9.7 
percent in May. Payroll employment is rising, at a rate of about 
200,000 a month for total payroll \1\ and about 100,000 for private 
nonfarm employment for 2010 through May.
---------------------------------------------------------------------------
    \1\ Total payroll employment received a temporary boost from Census 
hiring that will not persist.
---------------------------------------------------------------------------
     The stock market has partially recovered from its swoon 
and is up substantially since March of 2009. Arguably, the high that it 
reached at its peak was above its sustainable level and it is now at an 
appropriate level in relation to earnings. I do not try to forecast 
stock price movements, but if the economy continues to recover, there 
is upside potential in the market.
     According to the S&P Case-Shiller home price index for 
April, the large drop in home prices has ameliorated with the index up 
modestly over the prior year.
    The bad news is also evident:
     The unemployment rate is close to 10 percent while full 
employment is thought to be around 5 percent. This means that American 
output and incomes are about 10 percent below their potential.\2\
---------------------------------------------------------------------------
    \2\ Based on a standard ``Okun's Law'' calculation that each 
percentage point decline in unemployment is associated with 2 
percentage points of GDP relative to its trend or potential.
---------------------------------------------------------------------------
     If employment growth continues at the rate of 200,000 a 
month it will take around seven years to get back to full 
employment.\3\
---------------------------------------------------------------------------
    \3\ Calculation made by Ezra Greenberg of McKinsey & Company.
---------------------------------------------------------------------------
     Household wealth, including financial assets and housing 
wealth, is $11.7 trillion below its peak as of the end of 2009 and this 
decline has erased all of the wealth gains accumulated since the early 
1990s.\4\
---------------------------------------------------------------------------
    \4\ Calculations by the McKinsey Global Institute based on Federal 
Reserve Data.
---------------------------------------------------------------------------
     The federal budget deficit was over $1.4 trillion in 2009 
and is forecast to be over a trillion dollars a year through 2019 
unless there are major policy changes.
     Growth at 3-4 percent is below the usual level achieved in 
an economic recovery from a deep recession and there is a danger of a 
second dip recession.
    Without in any way discounting the economic challenge that remains, 
I will make the case in this testimony that the big policy measures 
taken to turn the economy around have worked extraordinarily well, 
indeed much better than could have been expected. Around the Ides of 
March of 2009 the economic situation was truly frightening. Workers had 
been laid off at a rate of 700,000 a month for several months, GDP was 
plummeting, the housing market was collapsing, and the stock market was 
hitting lows not seen for 15 years. At that time, I would have reacted 
with disbelief to anyone who had predicted that by the fall of 2009 
there would be solid economic growth; that the stock market would have 
rebounded; and that employment would start growing by 2010. The natural 
resilience of the American economy has, of course, helped this ongoing 
recovery, but it would not have been possible without the massive 
policy interventions undertaken by Congress and two Administrations. 
There were plenty of mistakes made in the period leading up to the 
crisis, some of them very serious. And mistakes were made in dealing 
with the crisis, some of them also serious. But the simple fact is that 
in the end the treatment worked and the economy is recovering.
    I read op-eds and hear commentary to the effect: Hey, it has been 
18 months since Obama took office, so how come the economy has not 
recovered? He should quit blaming Bush for his problems. Such 
statements make no sense in terms of economic logic and represent 
political posturing. There were many causes of this crisis and plenty 
of blame to go around. Yes, the policies of the Bush Administration 
bear responsibility because they were based on the belief that 
financial markets did not need to be regulated. Federal housing 
policies pushed by both political parties, but especially by Democrats, 
contributed to the problem by encouraging over borrowing and too much 
home building. But, regardless of the causes of the crisis, this was a 
terrible global meltdown and recession and could not possibly have been 
reversed quickly. Former McCain advisor and Harvard economist Kenneth 
Rogoff has shown in his empirical studies with Carmen Reinhardt that 
economies always take a long time to recover from financial crises. 
Aftershocks of the global crisis, like the sovereign debt crisis in 
Europe, have slowed the pace of U.S. recovery and could threaten a 
double dip despite the progress to date. There are limits to the power 
of policymakers to affect economic outcomes. The policies that were 
followed have done what was expected of them; actually, they have 
worked much better than could have been expected--except for the fact 
that private employment gains are still very slow indeed.
             policies used to restore the financial sector
    The financial crisis was threatening to pull the U.S. and global 
economies into recession or even depression when the Bush 
Administration and Secretary Paulson asked for a fund of $700 billion--
the TARP--to stabilize the financial sector. The Emergency Economic 
Stabilization Act, signed in October 2008, authorized the Department of 
Treasury to spend up to this amount to purchase or insure troubled 
assets, but with broad discretionary authority. The Treasury's stated 
diagnosis of the financial crisis was that distressed mortgage-related 
assets had become impossible to trade and value because of the 
breakdown of normal market relationships. The TARP was to be used to 
facilitate the return of private valuation of these assets, including 
the use of reverse auctions. Treasury was willing to buy distressed 
mortgage-related assets on the open market in order to get this process 
started. As the crisis unfolded, it became clear that financial markets 
were too troubled and many of the assets were so bad that they simply 
had to be written down in the books of banks and other financial 
institutions. The proposed reverse auctions never got off the ground.
    Consequently, the TARP's manner of intervention had to change. 
Under the Capital Purchase Program (CPP), one component of the TARP, 
money was used to stabilize and reinforce the core capital reserves of 
banks, primarily through the purchase of preferred shares. In October 
2008, immediately after Congress created the program, the CPP bought 
$125 billion of preferred shares from nine of the nation's largest 
banks. Hundreds of other banks applied and were accepted into the 
program in the following weeks. Ultimately, the TARP would purchase 
$205 billion in preferred shares from 707 financial institutions. It is 
important to note that the TARP was not simply used as a transfer to 
failing institutions. Even healthy banks were forced to accept money in 
an attempt to mask government opinions about which banks were healthier 
than others.
    Beyond the CPP, more extraordinary intervention was provided for 
critical and interconnected institutions. AIG received $40 billion from 
the purchase of preferred shares, money that was used, in part, to 
restructure two Federal Reserve credit lines that totaled $123 billion. 
The TARP also extended AIG a $30 billion preferred line of credit. 
Citigroup and Bank of America each received an additional $20 billion 
capital infusion on top of the $25 billion committed to each bank from 
the CPP.
    Another problem is that ``runs on banks'' began to occur. 
Historically, a bank run occurred when retail depositors feared that 
their money in deposit accounts was not safe and they rushed to 
withdraw it before the bank went under. During the Great Depression, 
deposit insurance and the FDIC were created, and these policy changes 
have virtually eliminated the problem of retail bank runs in the United 
States. However, FDIC bank guarantees do not cover non-bank financial 
institutions, such as investment banks, which comprise the so-called 
shadow banking system. These institutions have grown increasingly 
important during the last decade, and in the lead up to the financial 
crisis they were engaged in a massive game of borrowing short and 
lending long. Given the lack of insurance as well as the generally 
opaque nature of their operations, brokers trading in derivatives and 
other securities were vulnerable to runs as their clients rushed to 
withdraw the funds they had deposited with them or avoided entering 
into new derivative or repo contracts. Bear Stearns went under as a 
result of this, followed by Lehman and then AIG.\5\ It turned out that 
money market mutual funds were holding large amounts of repo contracts 
as part of their asset portfolios and as they feared losses on these 
contracts, they, too, pulled them out of troubled companies like Lehman 
and faced losses. One such fund threatened to impose losses on retail 
depositors that had accounts with them (break the buck) and this caused 
a run on money market mutual funds.
---------------------------------------------------------------------------
    \5\ AIG, of course was an insurance company not a broker dealer but 
it had developed a huge book of Credit Default Swaps through its 
operations in London.
---------------------------------------------------------------------------
    The Federal Reserve acted forcefully to contain the spreading 
damage, providing guarantees for depositors in money market funds 
(deposit insurance for these non-bank depositors) and guaranteeing 
interbank lending in order to stop the payments system worldwide from 
freezing up. Even with these measures there were disruptions as global 
trade plunged when importers and exporters were unable to obtain 
funding.
    One of the biggest turning points of the financial crisis was the 
Supervisory Capital Assessment Program (SCAP), informally known as the 
``bank stress tests.'' This was a comprehensive, simultaneous 
assessment of the capital held by the banking groups of the 19 largest 
U.S. bank holding companies which collectively accounted for two-thirds 
of all deposits. Conducted by the Federal Reserve and bank supervisors, 
the effort was meant to determine if these groups had sufficient 
capital to withstand two macroeconomic scenarios, one with baseline 
conditions and the other a more pessimistic take on the economy in 
which the jobless rate would climb to 10.3 percent. The results were to 
be made public so the skeletons were going to be brought out of the 
closet.
    Taken overall, the stress tests revealed that the banking industry 
was not as troubled as many had feared. Among the 19 surveyed, 9 were 
deemed to have sufficient capital already. The other 10 were told to 
raise a combined $75 billion in equity. The day after results were 
published, Wells Fargo and Morgan Stanley raised $7.5 billion and $8 
billion, respectively. Goldman Sachs had raised $5 billion before the 
results were even released (though the report said they did not need 
any). Of the 19 banking groups that underwent stress tests, all but one 
were able to raise sufficient capital from issuing stock, selling 
business units, and strong earnings. GMAC, the troubled lending arm of 
General Motors, was said to need $11.5 billion, the most of any banking 
group as a percentage of assets--much of this money would come from the 
TARP in two subsequent rounds of funding. In the worst case scenario, 
the stress test report predicted losses by the 19 banks could total 
$600 billion. Nevertheless, the stock market reacted positively after 
the results were announced, with the S&P 500 climbing 2.4 percent that 
Friday. Soon afterwards, the strongest banks were able to begin 
repayment of their TARP funds.
    The TARP and SCAP programs worked. The vast majority of banks 
receiving the TARP funding remained open,\6\ and the large banks 
returned this funding more quickly than could have been expected from 
their problems, becoming much more stable and earning profits. As well 
as the capital injections, the low interest rate environment allowed 
them to make profits on the lending they made and their trading 
businesses were also profitable.
---------------------------------------------------------------------------
    \6\ Three banks that received TARP money have failed: Midwest Bank 
and Trust Company, Pacific Coast National Bank, and United Commercial 
Bank. A fourth, CIT Group Inc., filed for bankruptcy. The expected loss 
from these 4 institutions is $2.7 billion, $2.3 billion from CIT Group 
Inc. alone.
---------------------------------------------------------------------------
    Various other programs, unrelated to toxic assets, were housed in 
the TARP, given its broad mandate and the difficulty of earning new 
allocations from Congress. Hence the TARP was involved with the auto 
industry, mortgage modification, and providing capital to institutions 
that serve underrepresented communities.\7\ The automotive industry--
including GM, Chrysler, and two of their financing arms\8\--has 
collectively received $64 billion, which is now held as a mixture of 
debt, equity, and preferred shares. The jury is still out on the 
sustainability of GM and Chrysler, but so far so good. They are both 
making a comeback and their survival prevented what would have been 
even more massive job losses.
---------------------------------------------------------------------------
    \7\ Through the Community Development Capital Initiative.
    \8\ GMAC and Chrysler Financial.
---------------------------------------------------------------------------
    Wall Street has taken the bulk of the criticism in this crisis, but 
actually the financial system more broadly contributed to the crisis 
and many smaller and regional banks remain troubled. Many of the bad 
mortgage loans were originated by state regulated non-bank institutions 
and many insured small banks have been troubled. The TARP funds were 
used to help smaller institutions as well as larger ones but 
nevertheless several hundred FDIC banks have been placed into 
receivership and, as noted earlier, 775 are currently problem banks. 
The chart below shows FDIC bank failures over time.


    The FDIC has been faced with enormous challenges in this crisis 
and, under the leadership of Sheila Bair, has shown skill in resolving 
failing institutions. Not everything has gone right, and the FDIC 
programs have been pretty expensive (the costs will be borne by member 
banks in the form of higher deposit insurance premiums not directly by 
taxpayers). The FDIC programs to reduce foreclosures and keep people in 
houses have not been very successful--although no plan has proven good 
at that. Despite these issues, our economy is much, much better off 
today for having the FDIC on the watch and ready to deal with failing 
banks. It is hard to think how bad the situation would have become 
without the FDIC to step in and resolve failing banks.
    Costs of the TARP: According to a March 2010 CBO report, the CPP 
part of the TARP should earn $2 billion in profit. Net income from 
investments in Citigroup and Bank of America will total $5 billion. 
That said, total returns will still be negative, largely because of 
anticipated losses from the automotive industry ($34 billion), AIG ($36 
billion), and a home loan modification program ($22 billion). The total 
cost of the TARP program should be roughly $100 billion net, much 
smaller than February 2009 forecasts of more than $500 billion. At less 
than 1 percent of GDP, that cost is well below historical averages of 
13 percent of GDP, according to IMF numbers. As Ben Bernanke, chairman 
of the Federal Reserve, said, ``This is a pretty good return on 
investment.''
    In summary, the policies to restore the financial sector are 
working. The recovery of the sector is not complete but the period of 
extreme anxiety is over and banks are positioned to lend more as 
recovery takes hold. This was done with costs that are large but not 
disproportionate to the problems being faced.
               fiscal policy used to combat the recession
    At the end of the Clinton Administration, the federal budget was in 
substantial surplus and one of the many advantages of this was that we 
had ``reloaded the fiscal cannon,'' in the words of then Treasury 
Secretary Lawrence Summers. This meant that in the event of a serious 
recession in the future, expansionary fiscal policy could be used to 
mitigate the unemployment and lost output that would result. The Bush 
Administration decided that the surpluses should be used to finance 
very large tax cuts and the result has been chronic federal budget 
deficits from 2001 through the present. I was not opposed to tax cuts 
as a way of returning families' incomes back to them and easing the tax 
burden, but the size of the cuts was excessive. It is irresponsible for 
the United States to run chronic deficits and become reliant on foreign 
capital inflows to finance our domestic investment. Moreover, it meant 
that we entered the crisis in 2007 in a vulnerable fiscal condition. 
The fiscal cannon was short on powder.
    Recessions always cause deficits because tax revenues fall, and the 
severe recession of the past three years is no exception. Much of the 
deficit of $1.4 trillion in 2009 was the result of the loss of tax 
revenue that followed the economic decline. The chart below shows that 
federal revenues declined $515 billion or 31 percent from their peak to 
the trough.
    Some expenditures rise automatically in recessions, notably 
unemployment insurance benefits, and these also add to deficits. It is 
important to note that these ``automatic stabilizers'' are vital to the 
maintenance of economic stability. Without any action by Congress, tax 
revenues fall and some types of spending rise, cushioning households 
and businesses from the downturn. Historically, these stabilizers have 
formed the frontline defense against more severe recessions and it is 
important that their effect not be offset by ill-timed actions to 
reduce the deficit--Herbert Hoover economics. As in other things in 
life, timing is everything. Chronic deficits are bad, in fact the 
budget should be balanced or even a little in surplus on average. But 
at times of recession deficits are a necessary evil.
    In an effort to hold off the recession, the Bush Administration had 
proposed and Congress had passed a stimulus package in 2007, mostly 
consisting of temporary tax cuts. I supported this policy, but it 
clearly did not solve a problem that was much bigger than we knew. 
During the transition, President Obama and his team proposed a much 
larger stimulus package of $787 billion, which was enacted in early 
2009 and the chart below shows a breakdown of this spending by 
creditloan.com on the basis of who got the money and what was it used 
for.



    As you can see from the left side of the chart, the largest portion 
of the stimulus went to governments--federal agencies, state and local 
governments. As you know, states and localities are almost all in 
terrible trouble financially and are making cuts in spending. In the 
long run it is a good thing that our state and local governments are 
forced to operate with balanced budget constraints. But in a recession 
like the one we are going through, cuts in such spending contribute to 
the recession. In my judgment, it was a good choice to support states 
and localities. The spending on infrastructure and energy efficiency 
was a mixed bag and not part of a coherent national strategy to deal 
with energy or infrastructure problems. Understandably, perhaps, it was 
decided to act quickly and avoid political or implementation delays as 
far as possible. Judging by the District of Columbia, the 
infrastructure spending is being used to dig up every road on my 
commute home, but this does create jobs and hopefully is to good effect 
in the longer run.
    Nearly $300 billion or 38 percent of the total went to individuals, 
and that may be a surprise to some. This money was received either in 
the form of lower taxes or in higher support payments but, either way, 
it was money in the pockets of American families that could be used to 
help them through the crisis and add to their consumption. About 17 
percent of the total was used for businesses, not an especially large 
number.
    Overall, the stimulus package was messy, and some of the spending 
was wasteful. But the context must be kept in mind. A sizeable stimulus 
had to be passed quickly to protect against an even deeper recession 
and there were 535 cooks stirring the pot. The stimulus package did add 
to aggregate demand and reduced the size of the recession.
    Predictions about the Effectiveness of the Stimulus. President 
Obama asked his economic team--specifically Christina Romer, now CEA 
Chair, and Jared Bernstein, of the Vice President's staff--to prepare 
an estimate of the impact of his proposed stimulus package. They 
predicted that the package would generate 3.3 to 4.1 million additional 
jobs in 2010 and add 3.7 percent to GDP growth, compared to the 
counterfactual of no stimulus. Their forecasts have been criticized 
because employment was terrible in 2009 and GDP fell sharply in the 
first half of that year, but that is a misunderstanding of what they 
did. They looked at the incremental effect of the policy, relative to 
the no-policy alternative. I note also that their forecasts about the 
impact of the stimulus on GDP look reasonable in light of the second 
half of 2009 and early 2010.
    A financial crisis and recession like the one we are in represents 
a discontinuity in our economic path. Econometricians are very skilled 
at sorting out the historical patterns of economic data and using them 
to say what is the most likely future given past experience. This 
crisis is not anything like any recent history and has produced very 
severe economic stresses. The employment declines in the United States 
in this recession have been much larger than would have been predicted 
given the path of GDP and much larger than in European countries with 
similar GDP declines. The stimulus package did not preserve as many 
jobs as Romer and Bernstein had hoped, but that is because the old 
employment patterns broke down, which is not something they could have 
predicted. Productivity also soared in 2009, a very unusual occurrence 
in a deep recession.\9\
---------------------------------------------------------------------------
    \9\ GDP is measured with considerable uncertainty, especially data 
from recent quarters. There is an alternative way of getting at the 
same concept through total income, Gross Domestic Income or GDI. Based 
on the income side of the National Accounts, the recession has been 
much deeper than is implied by the GDP data. One explanation of the 
huge loss of jobs is that the fall in income and output have been 
understated by the available GDP statistics.
---------------------------------------------------------------------------
    I do not support frequent use of active fiscal policy to respond to 
the business cycle ups and downs, but in 2008 and 2009 we were stuck in 
a foxhole with the shells landing all around and it was a good time to 
call for reinforcements. The stimulus package provided that much-needed 
help.
                  today's growth and deficit challenge
    In the recent G-20 meetings reportedly there was tension between 
the United States and Europe over continued fiscal stimulus. 
Understandably, President Obama is worried about the sluggish global 
recovery and wants to sustain fiscal stimulus. European countries argue 
that the fiscal crisis is too severe to allow continued stimulus and 
there must be a clear path to fiscal consolidation. The IMF officials 
at the meeting supported this view. The argument is that these 
countries do not have the freedom to pursue expansionary fiscal 
policies. The debt and deficit problems in Greece and the dangers in 
Spain, Portugal, Italy, Ireland and the UK are enough to reduce the 
range of policy choices.
    Standard economic policy analysis indicates that increases in 
government spending or cuts in taxes will stimulate aggregate demand 
and hence economic growth in times of recession. I applied this logic 
to the U.S. stimulus package in claiming that it helped sustain demand 
during the downturn. Another example is China, which introduced a large 
stimulus package when the global downturn hit to offset the decline in 
their exports. This program has been judged successful and economic 
growth in China has been sustained. Does this economic logic break down 
when there is a threat of sovereign debt default and a fear of the 
financial turmoil that would result from this? Some policymakers in 
Europe even argue that fiscal consolidation will provide such great 
reassurance to markets and will so increase business and consumer 
confidence that the overall effect will be expansionary.
    I am not willing to stand the usual economic logic completely on 
its head. Fiscal consolidation in Europe will have a direct effect in 
taking money out of people's pockets and cutting jobs and this will 
reduce demand and economic growth as a first-round effect. 
Nevertheless, I am sympathetic to a more moderate version of the 
European argument because the fears of renewed financial turmoil are 
real and potentially damaging to economic recovery and this must 
condition policy decisions. My advice to Europe would be to move as 
slowly as they can towards fiscal consolidation. If they act too 
quickly, they will shoot themselves in the foot and end up with a 
deeper recession and even bigger deficits. But they do have to be 
mindful of the limits they face on sovereign borrowing. They should 
take moderate but meaningful steps towards smaller budget deficits now 
and put in place policies that will continue progress towards budget 
balance as their economies recover from recession. Keep in mind also 
that European economies generally have much more extensive safety nets 
than does the United States. These social programs have created 
problems for them in terms of incentives, but they do have the 
advantage of providing strong automatic stabilizers to the economy 
because consumption is protected in downturns.
    To what extent is the United States in the same position? The chart 
below shows a private forecast of likely federal deficits in the United 
States in the absence of any major policies to change the picture. This 
is a very scary picture. A trillion dollars a year is a lot of money to 
be borrowing. The U.S. Treasury does have some advantages, however, 
relative to Europe because of the size of our economy and the depth of 
the financial markets. And even though the projected deficits look 
large, the prospects for U.S. growth are pretty good and there are ways 
the deficit could be reduced if we only chose to follow them. Today, 
the yield on 10-year Treasuries is under three percent, so the market 
is saying that there is no problem so far in the ability of the 
Treasury to borrow, indeed these rates are among the lowest in history.
    Treasury rates are low now because lending to the US government 
looks good relative to global alternatives but market views could 
change over the next few years and perhaps even sooner. If Treasury 
interest rates rise significantly, this will crowd out private 
investment or even trigger another crisis if the dollar were to drop 
precipitously. No one knows if or when the U.S. Treasury might have its 
Greece moment. Surely, this will not happen over the next year or two, 
but quite possibly it could happen over the next five years. And it 
would be foolish to push the envelope and let a disaster happen.


    Given the reality of huge deficits, I do not support major fiscal 
expansion measures right now that would increase the deficit. I did 
support a continued extension of unemployment benefits and modest 
additional help to the states, measures that would not have 
significantly worsened the deficit. If the U.S. economy were to slip 
back into second dip recession later this year or next year, then my 
view would change and I would consider it necessary to provide another 
fiscal stimulus to the economy despite the risks to Treasury funding. 
Ideally, the Administration and Congress would agree soon on meaningful 
policies to reduce the budget deficit in out years (for example, a 
measure that put federal health care spending on a balanced-budget 
basis over a multiyear period). This would create confidence in global 
markets and would allow for further stimulus this year or next, if that 
were to prove necessary, but it would not take purchasing power out of 
the economy today.
                              conclusions
    You do not expect the bear to dance well; it is a miracle if it 
dances at all. The policies that restored the financial sector and 
helped turn around this very deep recession were not pretty but they 
were the right policies and they helped save the U.S. economy and 
indeed the global economy. The high unemployment, fluctuating stock 
market, struggling housing market and sluggish recovery that 
unfortunately are still with us are making the Administration and many 
other policymakers unpopular. It is too bad that the electorate does 
not give credit for the turnaround that has happened. It should.

    Chairman Spratt. Thank you.
    Dr. Zandi

                    STATEMENT OF MARK ZANDI

    Mr. Zandi. Thank you, Chairman Spratt, Congressman Ryan, 
and the rest of the committee, for the opportunity to be here 
today.
    These are my own views and not those of the Moody's 
Corporation. I will make four points in my remarks.
    Point number one. The recession, the great recession has 
given way to an economic recovery, and it is largely due to the 
policy response.
    The recession ended almost precisely a year ago. GDP growth 
over the past year has been approximately 3 percent year over 
year, and we have begun to see job growth since the beginning 
of 2010. Subtracting from the Census hiring, the temporary 
Census hiring and the loss of the Census jobs that are coming, 
we have seen average monthly private-sector job growth of about 
100,000 since the beginning of the year, and that is what I 
would expect to see for the month of June when we get that data 
point on Friday, which is an important point. The unemployment 
rate has stabilized as a result, obviously very high, close to 
10 percent, but it has stabilized at that level since this time 
last year.
    The recovery is broadening out. It began in manufacturing. 
It is now evident in distribution and transportation. We are 
seeing growth in various technology industries, some 
professional services, a bit in retailing. I would anticipate 
leisure, hospitality, financial services starting to hire more 
aggressively as we make our way through the year.
    The recovery is also broadening out across the country. If 
you look at the Nation's almost 400 metropolitan areas, two-
thirds of them, roughly speaking, are now in a recovery. Just 
for context, if you go back to the depth of the recession in 
late 2008, early 2009, only 10 percent of the Nation's 
metropolitan areas were expanding. So that is a significant 
improvement.
    The policy response has been key to this turnaround. I 
think we all can take exception to any individual aspect of the 
response. Some folks don't like the bank bailout, others the 
auto bailout, the housing tax credit, cash for clunkers. There 
were many, numerous policy efforts. Each of us probably didn't 
like some aspect of the response.
    But the totality of the response I think was unprecedented 
and aggressive and ultimately very successful. I don't think we 
would be experiencing a recovery at this point without those 
efforts; and that includes everything from what the Federal 
Reserve has done in providing liquidity to the financial system 
and shoring up the banking system, to what the FDIC has done 
with respect to insurance limits and guaranteeing bank debt 
temporarily, to what the Treasury has done with respect to the 
bank's stress testing process, to--as importantly or more 
importantly--what Congress has done with respect to all the 
elements of the TARP and fiscal stimulus.
    In my view, the fiscal stimulus was absolutely vital to 
jump-starting this economy. It is no accident that this 
recovery began at precisely the same time that the stimulus was 
providing its maximum economic benefit to the economy. So, 
point number one, we are now in recovery, and it is because of 
the policy effort.
    Point number two, the recovery is still fragile. The 
economic expansion is not in full swing. We are not off and 
running yet. There are a number of reasons for concern. Let me 
list a few.
    First, going back to the job market. Most of the 
improvement in the job market is related to an end of 
businesses laying off workers. We are not seeing any 
appreciable pickup in hiring. Some modest pickup in the last 
couple 3 months, but it is very modest.
    I think there are a couple impediments to hiring. One is a 
lack of credit, particularly to small businesses.
    Here is a statistic that is important: Establishments that 
employ fewer than 100 employees--let's call it a small 
business--employ half of all the workers in our country, and 
they accounted for nearly two-thirds of the net job creation in 
the last economic expansion. If small business isn't hiring and 
if they are not hiring because of credit, we have got a 
problem. So that is an impediment.
    The other issue is confidence. It was only a year ago that 
many businesses were suffering near-death experiences, and I 
think it is difficult to--as a businessperson and being a small 
business owner myself, I can attest to the fact that you don't 
forget something like that quickly.
    I also think policy uncertainty is an issue. I do think we 
are having very significant policy debates that are very 
important. We need to have them. But it is important to 
recognize that when you are having them it does create angst 
among the business community. And that is everything from 
health care reform to financial regulatory reform to energy 
policy to immigration policy.
    And I would have to say, just based on my experience just 
talking to business people in my work, they are very nervous 
about tax policy, that the tax rates are going up at the 
beginning of next year if there aren't changes, and that needs 
to be nailed down quickly, I think. That would make a big 
difference.
    A second issue with respect to the recovery is what is 
going on in State and local government. That is a problem. 
State and local governments have very large budget holes. Those 
budget holes are smaller today than they were this time last 
year, but last year's budget hole was filled largely with the 
stimulus money. So that forestalled the most Draconian budget-
cutting job loss and tax increase.
    It didn't forestall those budget cuts. There were very 
significant cuts. In fact, State and local government 
employment is down 190,000 jobs from where it was 1 year ago. 
That is significant. But the job cutting was modest. It was not 
an overwhelming economic problem. If State and local 
governments do not get more help, they will have no choice but 
to significantly cut payrolls, cut other programs, which means 
a loss of private-sector jobs, and raise taxes at just the 
wrong time when the economic recovery is fragile. So reason 
number two for concern is what is going on at State and local 
governments.
    Third, the foreclosure crisis is ongoing. It is not over. 
There are 4.3 million first-mortgage loans that are in default 
or headed in that direction, 90 days and over delinquent. For 
context, there are 49 million first-mortgage loans outstanding. 
That is a lot of loans. Those loans have been piling up in the 
foreclosure process because of the various loan mitigation 
efforts. Servicers, mortgage servicers are now figuring them 
out. They will begin to start pushing these loans that don't 
qualify for a modification through the foreclosure process to a 
sale, either short sale or foreclosure sale.
    That will begin hitting the housing market this summer and 
fall. House prices are going to continue to decline. Nothing 
really works well in our economy if house prices are falling. 
It is still the largest asset in most people's balance sheet, 
and financial institutions aren't going to extend credit if 
house prices are falling.
    Going back to small business. Small businesspeople put up 
their homes as collateral for loans. Banks aren't going to make 
a loan if they are unsure of the value of the home underlying 
that loan.
    So point number two, broadly, is that the recovery is still 
very fragile. We are not off and running yet. We still have 
work to do.
    This goes to point number three, and that is I think it 
would be premature for policymakers to exit out of their 
support for the economy too quickly. For the Federal Reserve, 
that means not raising interest rates. But the Federal Reserve 
shows no inclination to do that at any time in the near future. 
With unemployment where it is and unlikely to move lower any 
time soon, I don't anticipate that.
    Unfortunately, the Federal Reserve can't do much more than 
what it is doing. It could restart credit-easing efforts to try 
to bring down long-term interest rates, but long-term interest 
rates are already at record lows and it is not having much of 
an impact on housing demand and other activities. So I don't 
think that that would be of measurable help.
    So this puts more pressure on you, as fiscal policymakers. 
And I think it is important--in fact, I would say it is vital--
that you continue to provide some additional temporary stimulus 
to the economy, and I would recommend three things.
    First, I would extend emergency unemployment insurance 
benefits. Two to three hundred thousand folks are running off 
those rolls every week; 1.3 million are already off the rolls 
because those benefits have not been extended. This is going to 
hurt personal income and consumer spending very quickly, 
because these folks get the money and they spend it.
    Moreover, it is very difficult to gauge how this is going 
to affect consumer confidence, which, as we can see, is 
incredibly fragile. So I think it is vital to extend UI.
    Second, I would provide more help to State and local 
government. They have a budget hole, by my reckoning, that is 
close to $100 billion. I think it would be appropriate to fill 
about a third of that budget hole. That means they still have 
to go through very significant cutting and restructuring, but 
it would reduce the impact that would have on our job market in 
the next few months and on the broader economy in the next few 
months.
    And, third, I would expand out the ability of the Small 
Business Administration to make more credit available to small 
business. That was shown to be a very effective part of the 
fiscal stimulus. That should be renewed and expanded. That is a 
good mechanism for getting cash out to small businesses 
quickly.
    So, point number three, I think it is very important for 
policymakers, fiscal policymakers, for you to remain aggressive 
until the coast is, in fact, clear, until the unemployment rate 
is definitively moving lower.
    Finally, point number four goes to our fiscal situation, 
which is indeed very serious. And, as such, I think it is 
entirely appropriate--in fact, it is desirable--that this 
additional stimulus that I have recommended is paid for not 
this year, not in 2011, but when the economy is off and running 
and the unemployment rate is moving south, let's say 2012, 
2013, 2014. So I think it should be paid for.
    Now, having said that, I don't think paying for it should 
be a precondition for this stimulus that I have recommended, 
that it is too important to the economy in the near term to get 
done. So I would suggest that it is okay, fine, to run a larger 
budget deficit than otherwise would be the case in the near 
term to make sure that we do jump-start this economy and we get 
going here.
    Finally, let me say this. I do think once the economy is on 
a sound footing it is critically important that you do pivot as 
quickly as possible and address the long-term fiscal situation. 
I think without those efforts our long-term economic prospects 
will be significantly diminished.
    Thank you.
    [The prepared statement of Mark Zandi follows:]
    
    
    
    Chairman Spratt. Thank you, Dr. Zandi.
    Dr. Taylor

                    STATEMENT OF JOHN TAYLOR

    Mr. Taylor. Thank you, Mr. Chairman, Ranking Member Ryan 
for inviting me to testify. I appreciate the opportunity.
    I think the economic recovery has slowed significantly, if 
you look at the numbers carefully. Just, for example, in the 
fourth quarter of last year we had growth at 5.6 percent. That 
has slowed by more than half, to 2.7 in the first quarter of 
this year and probably around 3 percent the rest of the year. 
So it is what economists think of as a U-shaped recovery, not 
the V-shaped, and some are even worrying about a double dipper 
or W-shaped recovery.
    In my view, the problem here is largely a great deal of 
uncertainty about what is happening with economic policy. I 
think there is also uncertainty about how some obvious 
inconsistencies in policy are going to be resolved. There is 
uncertainty about tax increases, there is uncertainty about 
regulatory reform, there is uncertainty about how the Fed will 
unwind its operations, and perhaps the biggest uncertainty now 
is what is going to happen with the rapidly growing debt.
    In this respect, I think that CBO's release yesterday of 
their annual long-term budget outlook is quite of concern. I 
had some charts in my testimony which try to illustrate this.
    If you have a chance to look on page 1, there is a chart 
which I put together from the data reported in the CBO long-
term outlook. It reports debt as a share of GDP in the United 
States. We used to think that the gigantic increase in World 
War II was about as much as we would ever have. If you look at 
this chart, it looks like a small blip compared to where we are 
going, according to CBO, if we don't do something about it. 947 
percent of GDP. It is just astronomical. Obviously, the United 
States of America will not be the United States of America if 
we let this happen. So resolving this inconsistency I think is 
one of the biggest drags on the economy at this point.
    On the other hand, if we address it, address it in a 
sensible way, I believe we can start to restore confidence, 
start to grow more robustly again, and ultimately get that 
unemployment rate declining back.
    So what is holding us back? What is holding us back from 
just moving ahead right away? I think the main factor is people 
are worried about removing stimulus, so to speak. And my 
distinguished colleagues on this panel have already referred to 
that. In my view, there shouldn't be much worry from either 
ending or even removing some of the so-called fiscal stimulus, 
and my written testimony tries to describe why.
    I basically, respectfully, but also strongly, disagree with 
the view that the stimulus has been a big factor in the 
recovery. And there are various ways to think about this. I 
think one is to try to realize that those who argue--those 
economists who argue that it was a big factor are using models 
about which there is not a large degree of agreement. I try to 
illustrate this on some charts on page 3 of my testimony, if 
you would look at those.
    I took some charts which were originally published in the 
New York Times which purport to show that the stimulus was 
effective, and they look at three different models. Actually, 
one of the models is from Mark Zandi's group. And you can see, 
if you just glance at the black line, that is sort of what has 
happened or what is forecast to happen, and the gray line is 
what the models say what would have happened without the 
stimulus, and the three models in the left which were in the 
New York Times show a big effect.
    The problem is, those aren't the only models around. To 
illustrate this, I took another model, actually, one that me 
and my colleagues at Stanford have looked at quite a bit. It is 
a model developed by the European Central Bank. It is also a 
quite common kind of model that academics use in their own 
research, and you can see there is very little effect. In fact, 
to make the point completely, if you take the view of the 
modeling of Professor Robert Barro at Harvard, there is 
actually no effect of the stimulus, using exactly the same 
reasoning that people who use models of this kind.
    So the bottom line here is I view the right model as 
something where there is very little impact of the stimulus. 
But at least you have to recognize there is a tremendous amount 
of disagreement.
    I think in terms of understanding what has happened, it is 
important to go beyond models, quite frankly. Models have their 
problems, I can speak to that as an economic modeler, and look 
at actually what happened. So the other charts in my testimony 
try to look at what actually happened, and page 4 is one 
example.
    We have actually had a couple stimulus packages in this 
downturn. One was back in 2008 and the other in 2009. And if 
you look at my chart, you can see that part of those packages 
were to send checks to people, rebate checks or advance tax 
cuts. And, in both cases, in 2008 and 2009, you can see from 
the red line personal income rose substantially. But if you 
look at the lower line and see what people spent, look at their 
consumption--remember, these were supposed to jump-start 
consumption--you see very little impact whatsoever. So I think 
if you look at the data, look what actually happened, stop 
simulating models and look at what actually happened, you see 
very little impact of this part of the stimulus packages.
    But, of course, the stimulus packages have more than just 
sending cash to people. They actually have to do with changing 
government purchases. As Martin indicated, you can see some of 
this when you drive around Washington. But let's look at really 
what happened in terms of government purchases. So if you look 
at page 5 of my testimony, I think it is a pretty simple 
illustration of this great recession, the recovery, the 
weakening of the recovery, and what are the factors.
    So the chart at the very top is a picture of real GDP 
growth. And you can see the blue line, it comes down, goes 
about down to pass minus 6, and you have this recovery up to 
5.6, and then the slowdown, as I mentioned in my introduction. 
You can find out how much of that growth is due to different 
parts of GDP, investment, consumption, government purchases, 
net exports. So I did that.
    And you can see, if you look at the contribution of 
investment, private investment, the private economy, it almost 
tells the whole story: a huge decline in investment in the 
panic, a huge increase in investment after the panic, a 
slowdown in investment now. So it is the private sector that is 
driving this.
    And to actually illustrate this further, look at the chart 
at the bottom of page 5, and you can see that, through these 
ups and downs in the economy, changes in government purchases 
have played almost no role whatsoever. Now, this doesn't prove 
anything, but it certainly convinces me that one should be wary 
about claims that this fiscal stimulus did very much. In fact, 
my view is that it has done remarkably little.
    So where does this lead me? It seems to me the conclusion 
is that we should focus on this problem of the debt and the 
deficit, address the consolidation issues now. Don't delay. 
Because concerns about either ending or not continuing with 
stimulus packages, get started now, orderly way. It doesn't 
have to be Draconian. But I think that as soon as people 
realize that this is what you are trying to do confidence will 
be restored and you can see the recovery picking up again.
    Thank you very much.
    [The prepared statement of John Taylor follows:]

Prepared Statement of John B. Taylor, Mary and Robert Raymond Professor 
   of Economics; George P. Shultz Senior Fellow in Economics, Hoover 
                    Institution, Stanford University

    Thank you, Chairman Spratt, Ranking Member Ryan, and other members 
of the House Committee on the Budget for inviting me to testify on 
``Perspectives on the U.S. Economy.''
    The recovery of the U.S. economy has slowed significantly since the 
start of this year. After rebounding to 5.6 percent in the fourth 
quarter of last year, real GDP growth slipped to 2.7 percent in the 
first quarter and is expected to remain in the 3 percent range for the 
rest of the year. In the lingo of economics it is a U-shaped recovery 
rather than a V-shaped recovery and some economists are now predicting 
a double dip, or a W-shaped recovery. As a result of the slower 
economic growth unemployment remains high and is expected to decline 
slowly.
             uncertainty and fiscal policy inconsistencies
    In my view the weakness in the recovery is mainly due to 
uncertainty about economic policy and concerns about how large policy 
inconsistencies will be resolved in the future. The long term budget 
outlook released yesterday by the Congressional Budget Office (CBO) is 
a timely reminder of these inconsistencies as this alarming chart of 
past and future federal debt illustrates.


    The chart shows the federal debt as a share of GDP going back to 
the beginning of the United States and continuing into the future 
assuming that fiscal policy is not changed as defined by the CBO's 
alternative scenario. You can see the increase in the debt ratio during 
World War II, which fortunately was reversed in the years after the 
war. The CBO's projection through the next decade shows a similar 
increase in federal debt as a share of GDP as in World War II. The 
projections for future decades then explode. According to the CBO, the 
debt reaches an unbelievable 947 percent of GDP by 2084 which dwarfs 
the peak debt incurred during World War II. So something has to give, 
and people are beginning to wonder what.
    The near term increase in the debt is due to the recession, the 
stimulus packages, and other recent expansions in government spending 
growth. The longer term increase is due to the inability to rein in 
spending on entitlement programs. Thus it is not only the fiscal 
response to the crisis that has caused debt problems for the United 
States. But the response to the crisis has distracted us from efforts 
to address the problems. Adding to the uncertainty is that many tax 
provisions are scheduled to expire in just 6 months, and without 
legislative action, there will be substantial tax increases on all 
Americans. There is also a looming change in financial market 
regulations which add uncertainty to a financial system still 
recovering from the crisis.
    A clear and credible path of fiscal consolidation is clearly needed 
and would do much to remove uncertainty about future policy and thereby 
build confidence. The reason why such a plan is not being articulated 
and carried out now is an apparent concern that such a consolidation 
would remove needed stimulus from the economy. In my view, the fiscal 
stimulus packages did not stimulate very much if at all and ending them 
would not have such negative consequences. But the debate is a serious 
one and for this reason I want to devote the rest of my testimony to 
explaining why I disagree with those that claim the stimulus has 
worked.
    evidence from the models: no consensus that the stimulus had a 
                           significant impact
    Unfortunately most attempts to answer the question ``What was the 
impact of the fiscal stimulus?'' are still based on economic models in 
which the answer is built-in, and was built-in well before the stimulus 
package was enacted. Frequently the same economic models that said, a 
year and half ago, that the impact would be large are now used to show 
that the impact is in fact large. In other words these assessments are 
not based on the actual experience with the stimulus. I think this has 
confused public discourse.
    An example is an article in the New York Times (11/21/2009) with 
the headline ``New Consensus Sees Stimulus Package as a Worthy Step,'' 
which states that ``accumulation of hard data and real-life experience 
has allowed more dispassionate analysts to reach a consensus that the 
stimulus package, messy as it is, is working. The legislation, a 
variety of economists say, is helping an economy in free fall a year 
ago to grow again and shed fewer jobs than it otherwise would.''
    As evidence the article includes simulation results from three 
models, which are reproduced in the three charts on the left below. 
Each of the three graphs on the left corresponds to a model maintained 
by the group shown above the graph. All three graphs show that without 
the stimulus the recovery would be considerably weaker. The difference 
between the black line and the gray line is their estimated impact of 
the stimulus. But this difference was built-in to these models before 
the stimulus, and in this sense there are no new hard data or 
experiences here.
    In fact other economic models predicted that the stimulus would not 
be very effective, and, using the same approach those now say that it 
has not been very effective. To illustrate this I show two other graphs 
on the right-hand side of the chart which did not appear in the New 
York Times article. The first one is based a model estimated by Frank 
Smets, Director of Research at the European Central Bank, and his 
colleague Raf Wouters. The difference between the black and the gray 
lines is what is predicted by that model. Note that the impact is very 
small. The second additional graph on the right is based on the 
research of Professor Robert Barro of Harvard University who reported 
in an article in the Wall Street Journal ``when I attempted to estimate 
directly the multiplier associated with peacetime government purchases, 
I got a number insignificantly different from zero.'' So according to 
that research, the difference between the black and the gray line 
should be about zero, which is what that graph shows. So there is no 
consensus among models or theories that the stimulus had a significant 
impact.


    Other evidence from models comes from an International Monetary 
Fund study which reports estimates of government spending impacts which 
are much smaller than those previously reported by the Administration. 
The IMF uses a very large complex model called the Global Integrated 
Monetary and Fiscal (GIMF) Model. It shows that a one percent increase 
in government purchases (as a share of GDP) increases GDP by a maximum 
of 0.7 percent and then fades out rapidly. This means that government 
spending crowds out other components of GDP (investment, consumption, 
net exports) immediately and by a large amount. The IMF estimate is 
much less than the impact reported in a paper released last year by 
Christina Romer of the Council of Economic Advisers and Jared Bernstein 
of the Vice President's Office.
    John Cogan, Volker Wieland, Tobias Cwik and I raised questions 
about the Romer-Bernstein estimates soon after they were released in 
January 2009 because the estimates seemed to be much different from 
comparable estimates based on more modern models. In fact, we found the 
economic impacts to be much smaller. Since then many technical papers 
have been written on this subject and in my view the consensus is that 
the impacts are much smaller than originally reported by Romer and 
Bernstein.
evidence from the facts: the stimulus did not have a significant impact
    Now let me go beyond the models and look at the direct impacts 
using data. Consider first the 2008 discretionary countercyclical 
fiscal stimulus--the Economic Stimulus Act of 2008--in which checks 
were sent to people on a one-time basis and aggregate disposable 
personal income jumped dramatically though temporarily. The objective 
of the stimulus was to jump-start consumption demand and thereby jump-
start the economy. However, aggregate personal consumption expenditures 
did not increase by much at all around the time of the stimulus 
payments. For the discretionary fiscal stimulus which was passed in 
February 2009--the American Recovery and Reinvestment Act of 2009--
checks were also sent; they were smaller and more drawn out than the 
2008 stimulus, but the impact was about the same: no noticeable effect 
on consumption. Both cases are illustrated in the chart below. This is 
what basic economics--in particular the permanent income theory and the 
life cycle theory of consumption--would predict from such temporary 
lump-sum payments.
    In addition, my analysis of the government spending part of the 
stimulus suggests that it had little to do with the turnaround in 
economic activity. Indeed the swings in economic growth from positive 
to negative during the recession and again to positive during the 
recovery (including the slowdown to 2.7 percent growth rate of real GDP 
in the first quarter) provides evidence that changes in government 
spending had at best a very small contribution to the recovery. Most of 
the recovery has been due to investment--including inventory 
investment, which was positive in the first quarter after declining for 
all of last year--and has little to do with discretionary stimulus 
packages. The two charts show the percentage contribution of investment 
and government purchases to real GDP.



    The charts clearly indicate that the changes in real GDP growth 
have been mostly due to changes in investment and little to changes in 
government purchases. In fact, government purchases were a drag (a 
negative contribution to real GDP growth) in the fourth quarter of 2009 
and the first quarter of 2010.
    One could argue that government spending might have declined by a 
larger amount without the stimulus because the stimulus package 
prevented state and local government from cutting spending. More 
research is needed to determine what would have happened in the 
counterfactual of ``no discretionary stimulus,'' but in the meantime 
these data at the least suggest that the recovery and the slowdown have 
been due to changes in investment not government purchases.
                               conclusion
    The combination of the unsustainable debt projections illustrated 
in my first chart and the little if any impact of the stimulus packages 
illustrated in my other charts has clear policy implications: Fiscal 
policy should avoid further debt-increasing stimulus packages which do 
little to stimulate employment or GDP. Fiscal policy should focus on 
reducing the deficit and the growth of the debt-to-GDP ratio. Reforming 
existing entitlement programs to hold their growth down and limiting 
the creation of additional entitlement programs are essential.

    Chairman Spratt. Thank you, sir.
    Let me read you what Dr. Bernanke had to say, each one of 
you, and ask you do you think it is a fair statement.
    ``Certainly we have averted what I think would have been, 
absent those interventions, an extraordinarily severe downturn 
and perhaps a Great Depression.''
    Is this overstating it for dramatic effect? Is this 
exaggerating the risk? And do you accept his judgment that, 
absent those interventions, we would have had severe 
consequences? Dr. Baily?
    Mr. Baily. I would generally agree with what Ben Bernanke 
said. And, by the way, I think he is one of the heroes of this. 
He made mistakes before the crisis, but when he got hold of 
things he did a lot of the right things, working with Congress 
and the administration.
    Would we have gone into a Great Depression? I think our 
economy is a little bit more stable, the institutions and so on 
are more stable than they were in the Great Depression. And we 
do have deposit insurance. We do have unemployment insurance. 
So I am not sure we would have gone 25 percent unemployment, 
but basically he is right. We already did go into a very nasty 
recession, and it would have been much worse without those 
things.
    Chairman Spratt. Dr. Zandi?
    Mr. Zandi. Yes, I would have agreed with that view, that 
without the policy response the recession would have devolved 
into another depression; and, in all likelihood, we would still 
be struggling with that.
    And one other quick point. I think if we go back into 
recession, which I would put the odds at still being low but 
uncomfortably high and rising--if we go back into recession, we 
cannot rule out that we would go back into a depression.
    Chairman Spratt. Dr. Taylor.
    Mr. Taylor. Yes. I disagree with that interpretation. Of 
course, it is a generalization. But I have looked carefully at 
many of the programs and new facilities that the Federal 
Reserve has implemented, and I have tried to divide it into 
things done before the panic and the fall of 2008, those during 
the panic of 2008, and those since the panic of 2008.
    By and large, the ones done before the panic I think were 
quite harmful; and, in fact, I think you can argue they led to 
the panic. The ones--some during the panic I think were 
constructive. They indicated there were some markets that were 
actually shut down and were helpful. The ones after the panic, 
I would go back and say it seems to me they have not been very 
effective.
    So I believe that if you just look back through all the 
interventions and if we had actually followed policies that 
were followed much of the 1980s and 1990s, we wouldn't have not 
only the--we wouldn't have had even the recession we had. And 
so, in my view, the way to think about the policy is a better 
policy could have avoided the whole mess, and I have seen no 
evidence that the policy that was taken avoided another Great 
Depression.
    Chairman Spratt. Dr. Taylor, you have shown some graphs 
which you think cast some doubt on whether or not there was a 
causal connection between the Recovery Act and the performance 
of the economy. To all three of you, how do we establish a 
causal connection between economic policies taken and the 
apparent turnaround of the economy in a rather dramatic fashion 
over a period of 12 months? What is the correct way to 
establish causality?
    Mr. Taylor. I think timing is probably the best way to do 
it, Mr. Chairman. If you look at monthly data, for example, on 
orders, investment orders definitely bottomed in December of 
2008, January, 2009, forward-looking order statistics. It seems 
to me that represented a fact that people realized the panic 
was over and it wasn't going to be as bad as they thought. That 
is pretty simultaneous with the second group of measures I 
mentioned that were taking place during the panic, and so that 
is why I say some of those I think were helpful.
    But this fiscal stimulus package, the originally $878 
billion, that came after that. So I think the timing is 
important.
    Plus you have to really look at the data, look at the 
numbers. And, as I showed you, my numbers seem to say that the 
private investment, including inventory investment, by the way, 
both accentuated that downturn and was part of the reason for 
the rapid boom.
    So I believe you can learn a lot from looking at the 
numbers themselves. It is not foolproof. You need to have sort 
of a model or a theory to think through what would have 
happened otherwise, try to do that. But you have to look at the 
numbers and look at the timing. That is what I have tried to 
do.
    Chairman Spratt. Dr. Zandi, Dr. Baily, how do you determine 
this causality between policies taken and results achieved?
    Mr. Zandi. Well, I also think timing is important, and I 
think the timing is very consistent with the view that the 
stimulus, the fiscal stimulus--and I am speaking of the ARRA--
jump-started the recovery.
    I am speaking from memory, but Q-1 '09 the economy 
contracted, as measured by real GDP, at just over a 5 percent 
annualized rate. In Q-2, it contracted approximately 2 percent; 
and by Q-3 we had positive growth. This is precisely when the 
stimulus kicked in. We had no stimulus in Q-1 '09; we had 60, 
70 billion in Q-2; and about 80, 90 billion in Q-3. And that is 
precisely when we went from a very severe recession with 
rapidly rising unemployment to economic growth and stable 
unemployment.
    So I think timing is very, very important. And the timing, 
from my perspective, is very strong evidence that the stimulus 
has worked well. And even using the graphs that John has 
presented, I think we can explain exactly what is going on in 
those charts if we look at the data a little bit more 
carefully. So it is a matter of I think extensive debate, but I 
think the timing is clear evidence of the stimulus' benefit.
    Chairman Spratt. Dr. Baily.
    Mr. Baily. John looks at model results, and obviously 
models do differ. But I think a set of reasonably mainstream 
models, including Mark's Moody model, Global Insights, Macro 
Advisers, the main forecasting models that have been successful 
in forecasting the economy, they didn't necessarily forecast 
the depth of this recession but have proven their worth over 
the years. They generally show that the stimulus had a 
significant impact.
    John mentions Robert Barro's model. Well, Bob Barro is a 
wonderful economist, but he very firmly believes, starting from 
the beginning, that fiscal policy won't do anything to 
stabilize the economy. That has been one of his viewpoints for 
years and years. And he believes that if you cut taxes now, for 
example, people won't change their spending because they will 
anticipate taxes are going to rise later. I think that is a 
little bit fanciful.
    So I think some of these models are more plausible than 
others, and I think the more sensible models show the effect.
    In terms of government purchases, well, I would agree with 
John in the following sense: Government purchases were not by 
any means the biggest driver of this recovery. I think the fact 
that they continued to go forward even though we were going 
into this downturn was helpful. So the fact that they did not 
fall dramatically, and particularly the State and local 
spending didn't fall dramatically, was a positive item. But 
quite a bit of the stimulus was not directed toward government 
spending. It was directed towards tax cuts or benefit increases 
of some kind and went into people's pockets. And, again, it is 
just the underlying logic.
    I am sympathetic to the view, in a full-employment economy, 
if the government increases its spending, probably someone else 
in the private sector is going to cut back their spending if 
you are going to maintain overall balance. But during a 
recession when you have got a huge shortage of demand, when 
employment is falling, when GDP is falling, you don't get that 
offset. It is just a net addition to jobs and income.
    Chairman Spratt. Thank you.
    And let me turn now to Mr. Ryan for any questions, because 
it looks like we have a vote coming up.
    Mr. Ryan. I will try to keep mine briefer than normal.
    We have John Taylor here. You are from California. You are 
not here that often. So I want to go into monetary policy just 
for a minute, if I could, since we don't have the opportunity 
to have this kind of conversation; and, these days, that 
monetary policy matters a great deal.
    You wrote a great book sort of indicting the Fed funds 
rate, the loose money in 2003 to 2005, getting us off the 
Taylor rule, off the great moderation. Give us a sense of where 
you see monetary policy now, how this unwinds, and what is your 
read of your rule?
    Some people say we ought to have a negative fed funds rate. 
What is your take on where rates ought to be now? And what is 
the unwinding going to look like, in your opinion, and when 
will the timing of it occur? And interest on reserves. I am 
very concerned about that tool, on how, when it is deployed to 
fight an eventual inflation problem--obviously, not one right 
now--will that basically precipitate another credit crunch?
    Mr. Taylor. Thank you very much.
    I think there is no question in my view--and I think more 
and more people are looking at this--that the very low rates in 
2003, 2004, 2005 did accentuate the housing boom and ultimately 
the bust. There are different ways to look at it. If you look 
at other countries, that seems to be a major factor as well. Of 
course, there is still debate about it.
    When you look at the current level of the Federal funds 
rate, of course, we are in a much different situation now. We 
are just coming out of a deep recession. The inflation rate is 
lower. There is not inflationary pressure. So the low interest 
rate that is there now seems to me about right.
    I don't think that if you use a Taylor rule, at least as I 
originally defined it, you see negative rates. I think that 
some people change the rule and they do other things. So I 
think it is about right, right now. And what that suggests is 
that if we are unfortunate and inflation starts to pick up 
sooner than we think, or even if we are fortunate and the 
economy starts to move faster than as markets indicated, then 
the Federal Reserve will have to raise rates if they are going 
to prevent a future inflation or actually prevent another 
downturn later in typical boom-bust style.
    With respect to the unwinding of the huge balance sheet, 
over $1 trillion of reserve balances which largely is due to 
the purchases of mortgage-backed securities, I am concerned 
that that could occur too rapidly or too slowly. It is one of 
the uncertainties that is out there about how this is going to 
be unwound. I would prefer that the Federal Reserve reduces 
that balance sheet rather than try to pay interest on reserves 
or try to actually go out and do some actions itself with 
respect to its own securities. I think that would be a much 
quicker way to get back to what was working.
    Because, after all, it seems to me, if you follow my logic, 
what we were doing before monetary policy got off track worked 
very well. We had this long great moderation, expansion in the 
1980s, expansion in the 1990s, two minor recessions during that 
period. So as soon as we can get back to that policy, I think 
the better off we will be. And we don't do that by trying to do 
new things like interest on reserves, using that as a way to 
manage the Federal funds rate, but rather use just money, the 
supply and demand for money, to get to the funds rate that we 
need.
    Mr. Ryan. Multiplier effects.
    I have read Bernstein/Romer, read some of Mark's work. You 
did a piece with two German economists. I can't recall their 
names. I read it a while ago. Bob Barro, we have heard his 
stuff. Why are the multiplier rates lower, in your view, than 
what, say, Bernstein/Romer claims?
    Mr. Taylor. Well, the models used by Bernstein/Romer, which 
by the way they didn't indicate which models they were, 
unfortunately. But as far as we can tell, there was one type of 
model used at the Federal Reserve and one private-sector model. 
As far as I know, those models don't have expectations built in 
very well. They don't model the financial market's expectations 
of the impact of future interest rates or inflation. And, in 
fact, there are many models that have been developed in the 
last 20, 30 years, the kind of models that we teach our 
graduate students. Almost all the universities do take account 
of expectations. So people will see, for example, that if there 
is a stimulus package, that means their taxes are going to 
increase to some extent in the future.
    Mr. Ryan. It is a Neo-Keynesian model----
    Mr. Taylor. It is called new Keynesian. It has the word 
Keynesian in it. Absolutely. It has very many of the rigidities 
and things like that that are typical Keynesian models. They 
are good models, but they do have this crowding out that can 
come pretty quickly even when the economy is at reduced levels 
of operation.
    Mr. Ryan. I will cut my thing short.
    Dr. Baily, you had a really interesting op-ed today in the 
Journal on multinationals. When it comes to tax policy, 
obviously, they are very elastic and sensitive to it. Is 
repealing deferral, trimming back on the tax, the foreign tax 
credit, is that helpful? Is that a good idea for fiscal policy 
with respect to multinationals going forward?
    Mr. Baily. I don't want to give you a direct answer to that 
question. What I would----
    Mr. Ryan. Most economists don't.
    Mr. Baily. Well, give me a break here. I think it is 
appropriate to take a good, hard look at how we tax 
corporations. We don't collect a lot of revenue from 
corporations and so----
    Mr. Ryan. Relative to?
    Mr. Baily. Relative to the tax rate. We have a high 
marginal tax rate of 40 percent, but we don't collect a lot of 
revenue. So I don't think the corporate tax is very efficient. 
I think we do need to make sure--and maybe this goes in your 
direction--that the way we treat our corporations is in line 
with the way other countries do so that we don't give them a 
competitive disadvantage. So I agree with you there.
    I would mention, by the way, if we are talking about taxes, 
one of the things we do is give a very strong preference for 
borrowing in our society, both at the personal level and at the 
corporate level.
    Mr. Ryan. That is the negative in your view.
    Mr. Baily. So maybe we could do a deal with the 
corporations. We will cut their corporate tax rate but maybe 
they pay a little more tax on interest and level that playing 
field a little bit.
    Mr. Ryan. Should we go to a territorial system? Most of the 
rest of the world is. Do you think worldwide, hamstring us, we 
ought to go territorial?
    Mr. Baily. I think it is certainly worth looking at. I am 
not a tax expert at that level, I am afraid, but I think it is 
something that can be considered, yes.
    Mr. Ryan. Do the rest of you agree that our bias in favor 
of debt is a distortion that ought to be remedied? What is--you 
can just give a quick answer.
    Mr. Zandi. Yes.
    Mr. Baily. Yes.
    Mr. Taylor. I do.
    Mr. Ryan. Thank you.
    I want to give other people time. Thank you very much.
    Chairman Spratt. At this particular point in time I 
recognize Mr. Becerra.
    Mr. Becerra. Thank you, Mr. Chairman; and thank you, 
gentlemen, for your testimony. And recognizing our time is 
short, let me go to Dr. Zandi and ask a quick question.
    Dr. Zandi, when you were an economic adviser for then-
Presidential candidate John McCain, Senator McCain, in his 
Presidential campaign, you and others who were advising him 
economically, did you foresee at that point back in 2007, 2008, 
the depths and the grip of this economic--great recession, I 
guess you would call it at this stage, that we are now trying 
to escape?
    Mr. Zandi. No, I can't say that I did, no.
    Mr. Becerra. And could you have foreseen the economic 
consequences that we now find ourselves in as we try to escape 
the grips of this great recession?
    Mr. Zandi. I am less surprised at how difficult it is for 
the recovery to get going, because this was a very, very severe 
shock with enormous implications. So it is not surprising to me 
that this is a weak recovery.
    Mr. Becerra. And there are always the Scrooges and the 
folks who say America has got the glass half empty these days, 
the pessimists that won't accept some good news. And while we 
are still in the midst of this great recession, the fact is 
over the last 5 to 6 months we have created about 1 million new 
jobs in this country. Compare that to the last month that 
George Bush was in office, where in that 1 month of January, 
2009, we lost close to 800,000 jobs, big turnaround.
    Obviously, we have a long way to go. And you mentioned, as 
the chairman in his remarks mentioned, that Chairman Bernanke 
has mentioned, that we need to continue to make sure we can 
climb out of this dark hole and that if we act too quickly to 
squeeze ourselves out of this fiscal deficit that we face this 
year and this national debt that we are facing that we might 
actually squeeze out the economic recovery.
    And yesterday, in testimony before the President's fiscal 
commission, I believe Mr. Elmendorf, Doug Elmendorf of the 
Congressional Budget Office, said something about the same as 
what you just said. He essentially said--again, speaking your 
economic language--``There is no intrinsic contradiction 
between providing additional fiscal stimulus today while the 
unemployment rate is high and many factories and offices are 
underused and imposing fiscal restraint several years from now 
when output and employment will probably be close to their 
potential.''
    Is what Mr. Elmendorf said consistent with what you were 
saying?
    Mr. Zandi. Exactly. I wish I could say it as nicely as he 
just said it.
    Mr. Becerra. I think I prefer the way you said it. It is 
more like plain English.
    Mr. Zandi. I think that is entirely correct, yes.
    Mr. Becerra. Dr. Baily, quick question for you as well.
    You mentioned in your testimony that we had to be very 
careful how we go about trying to get ourselves out of this 
black hole, but my sense was that you also believe that fiscal 
stimulus, where we try to help that recovery accelerate, is 
essential, although we have to be careful that it is modest 
enough to give us a chance to make sure that we can do the 
fiscally responsible thing with our budgets into the future.
    Mr. Baily. I think it would be helpful. I think, as Mark 
said, a lot of people are living off unemployment insurance, 
and I think it would be helpful to give them some consumption--
some income so they can keep consuming.
    And on the States and localities that are in just terrible 
budget situation--now, you know, obviously, we want our States 
and localities to be disciplined over the long run, but I think 
right now none of them foresaw this any more than the rest of 
us did, and it is a good thing to help them.
    Mr. Becerra. Don't cut off the swimmer's ability to swim 
out of the pond before it is too late and drown.
    Mr. Baily. Exactly. Now, you do have to send, I think, the 
right signal that you really are thinking substantively, and I 
applaud the commission and I hope that it is effective and I 
hope its recommendations result in changes in policy, but we do 
need to signal both ourselves and the rest of the world that we 
are going to do something about these huge deficits.
    Mr. Becerra. Thank you.
    And, Dr. Taylor, before I run out of time, first, can you 
convey back to Stanford our best wishes, tell them that we gave 
you some Stanford weather here in Washington, D.C., today. It 
is nice to know we have got someone from our alma mater here 
with us.
    I would love if you--and, unfortunately, my time is getting 
ready to expire, Mr. Chairman, but perhaps I can ask the doctor 
that he might give me his comments about the situation in 
Ireland, which my sense is tried to apply the brakes on any 
kind of stimulus and, in fact, went the other way, more along 
the lines that I think you talked about and that is to try to 
be fiscally responsible with our budget, and my understanding 
is things are pretty bad.
    I am going to real quickly just mention that Ireland's 
downturn has been sharper than if the government had spent more 
to keep people working. Lacking stimulus money, the Irish 
economy shrank 7.1 percent last year and remains in recession. 
Joblessness in the country is above 13 percent. The ranks of 
their long-term unemployed have more than doubled, and the 
budget went from surpluses just a few years ago in 2006 and 
2007 to a staggering deficit of 14.3 percent of gross domestic 
product last year, and it continues to deteriorate.
    I would be interested to hear your comments. I don't have 
time, but if you can go ahead and give me some comments on how 
you see the situation in Ireland I would very much appreciate 
that.
    Mr. Taylor. Just very quickly now?
    Mr. Becerra. Well, I know I am out of time, but go right 
ahead.
    Mr. Taylor. I think when you look at Ireland you have to 
recognize where they were coming into this. It is like 
Portugal. It is like Greece. High debt levels mainly because of 
an over-stimulus and so they are partly reacting to something 
that was so excessive.
    If you want to look at examples that are I think more 
helpful to the current situation, look at Poland. Poland is the 
only country in the entire European Union that didn't even have 
a recession. They didn't have a recession because they followed 
I think a sensible policy.
    Mr. Becerra. But we did have a recession here, and while 
Poland may be a good example, Poland didn't have a recession. 
We are in the depths of a great recession.
    Mr. Taylor. They didn't have a recession because they 
followed these good policies. We had a recession I think in 
part----
    Mr. Becerra. But our problem is we probably didn't follow 
those good policies because President Obama inherited an 
economy that was in the depths of a great recession. So while 
it may not be exactly like Ireland and it may not be exactly 
like Poland, I am interested in understanding, because my sense 
is for those who say we shouldn't do economic stimulus are 
speaking much the way the Irish were speaking about how they 
would get out of their great recession, and as far as I can 
tell, they are still in theirs, and they are trying to fiscally 
constrain it.
    Mr. Taylor. What I am suggesting is that we don't have more 
stimulus at this point. The idea you can trade off in stimulus 
now, catch up later, I think that is a fine-tuning approach 
that has failed many times in the past.
    What I think is most important if we get on with the 
business now of consolidation, it doesn't have to be Draconian. 
The point has to be laid out clearly in an orderly way. I think 
that could bolster confidence, indicate that the United States 
Government is moving ahead on the thing that the American 
people are concerned about, and I think that would help the 
economy much more than another stimulus.
    Mr. Becerra. Appreciate that. And if you have any comments 
on Ireland, I would love to hear them.
    Mr. Zandi. Can I make one quick point on that?
    If you look at every European country that is going through 
fiscal austerity right now, their bond spreads have actually 
widened out. One interpretation of that, and I think it is a 
reasonable one, is that investors are nervous that the 
austerity is undermining their economy and therefore their 
ability to execute on these austerity plans. So I think that is 
increasingly good evidence that if you don't get out of a weak 
economy you are never going to be able to address your long-
term fiscal problems.
    Mr. Becerra. To that point, I think the article I was 
reading from pointed out that the spread between Ireland's 
bond--what it pays for bonds and Germany pays for bonds is 
about 3 percent.
    Mr. Zandi. Right, it has widened out.
    Mr. Becerra. It is tough for them to get any money unless 
they pay a whole bunch for it.
    I appreciate that very much, gentlemen. Thank you for your 
testimony.
    Chairman Spratt. Mr. Scott.
    Mr. Scott. Thank you, Mr. Chairman.
    We have been lectured by the other side about fiscal 
responsibility, and I think if can we just get that first chart 
up, this chart, the red is Republican administrations, blue is 
Democratic administrations. And you can see that we dug 
ourselves out of a ditch in 1993 and put us into a surplus 
situation, such a surplus that it was not allowed to continue. 
We were headed toward paying off the national debt held by the 
public by 2008.


    Chairman Greenspan, when he testified in 2001, was talking 
about, in answer to questions, what would happen to the bond 
market when there are no government bonds, what would happen 
with interest rates. President Clinton had to veto Republican 
budgets all through that to make sure that that blue line 
wasn't changed. If you wanted to know what would happen if he 
had not vetoed those bills, you can see President Bush signed 
those budgets and you see where we ended up in the ditch.
    The next chart, we see that the incredible thing is, 
notwithstanding the fact that during the Bush administration 
they overspent the budget about $1 trillion a year, they 
produced the worst job growth since the--goes back to the Great 
Depression.


    Now, the attack on the Democrats is we have a big deficit, 
but we also know that we have--we need to make sure that the 
complaint is precise. The complaint is that we have a big 
deficit that is there because of the policies put into effect 
by the Bush administration and the Democratic administration 
has not dismantled the Bush policies quickly enough. That is 
the chart. Now, the fact is we made a deliberate choice not to 
build the deficit until we got the job situation fixed.
    And the other chart, we see where we were when--the red is 
the end of the Bush administration. We can see the blue, 
digging ourselves out of the ditch and beginning to create 
jobs.


    Dr. Zandi, if we had had serious deficit reduction during 
the first year and a half of the Obama administration, what 
effect would that have had on jobs? And serious deficit 
reduction would mean, of course, increased taxes or reduced 
spending.
    Mr. Zandi. Of course, that would be very counterproductive 
and be consistent with no policy response and the idea that we 
would still be in a downturn.
    Mr. Scott. In addition to the counterproductive effect of 
cutting spending and increasing taxes in the middle of a 
recession, what drag effect has there been because of cuts at 
the State level? How much have States cut their spending, 
thereby reducing jobs, that we have had to try to offset?
    Mr. Zandi. If you look at it in the context of State and 
local government spending as a contribution to GDP growth, in 
an average year since World War II, State and local governments 
add about a quarter percentage point to GDP growth every year. 
Over the past year, they have subtracted from GDP growth by 
approximately 20-basis points, 2 percentage points. And if they 
don't get any additional aid from the Federal Government, then 
over the coming year--of course, I have to do a number of 
assumptions--but that will be a negative contribution of 
somewhere around 35, 40 basis points, .4 percentage points. So 
that is a swing from normal times of at least half a percentage 
point.
    Mr. Scott. Now, in terms of budget cuts, have the States 
not cut their budgets about $500 billion already?
    Mr. Zandi. I don't know the exact number, but they have 
clearly gone through some very significant budget cuts.
    Mr. Scott. On the order of magnitude about $500 billion?
    Mr. Zandi. I think if you total it all the way back, in the 
hundreds of billions sounds about right to me.
    Mr. Scott. And localities have been doing the same thing?
    Mr. Zandi. Yes, and I am including both State and local 
governments in those hundreds of billion of dollars, yes.
    Mr. Scott. Say again?
    Mr. Zandi. The several hundred billion dollars would be 
both State and local together.
    Mr. Scott. Okay. And so the first several hundred billion 
dollars of stimulus, all that did was to catch the people that 
had been laid off by the localities?
    Mr. Zandi. Exactly. If you take a look over the past year, 
the budget hole was about $150 billion for State and local 
together, and that is almost precisely what State and local 
governments got as part of the stimulus package.
    Mr. Scott. Dr. Baily, did you want to comment on the drag 
that States have caused and the necessity of the Federal 
Government to actually increase spending which has a 
detrimental effect on the budget? As soon as we get the jobs 
back, we will do the responsible thing and get the budget under 
control. Because that first chart showed we know how to do it, 
and we will do it, but we just can't do it in the middle of a 
recession. Did you want to make a comment?
    Mr. Baily. I think I agree with pretty much everything you 
said, and certainly I think it goes to the earlier discussion. 
When you see the stimulus and say, well, it didn't prevent the 
recession from happening, that is in part because States and 
localities were cutting so much employment that you were really 
just filling in the hole they were creating. So I think I agree 
with you very much on that.
    Going forward, I think dealing with the deficit is going to 
be tougher than it was during the Clinton years. It was plenty 
tough then, but we did get very strong economic growth, and we 
had not yet reached the sort of some of the pressures that come 
from the baby boom generation retiring. So I think it is going 
to be a tougher challenge down the road as we deal with the 
deficit. But on the points you made and that Mark made I agree 
with you completely.
    Mr. Scott. Well, people suggested that the Clinton 
administration was lucky because of the economic growth, but it 
is kind of paraphrasing that sports analogy, the more fiscally 
responsible we were, the luckier we got.
    Mr. Baily. I think we were lucky, but I also think that the 
administration did the right things, and, you know, it was 
Congress as well as the administration. But I think Clinton--
the general Clinton-Rubin policy was to try to allow markets to 
work but to get the budget back on track and to regulate 
responsibly, and I think those policies worked extraordinarily 
well.
    Mr. Scott. So we made our luck because we were fiscally 
responsible and we had that loaded cannon every time 
something----
    Mr. Baily. Exactly.
    Mr. Scott. We had a surplus that was sufficient to pay off 
the national debt. If this recession had occurred back in the 
Clinton years, we could have had the stimulus out of the 
surplus without having to borrow the money.
    Mr. Baily. Exactly.
    Chairman Spratt. Thank you, Mr. Scott.
    Mr. Etheridge.
    Mr. Etheridge. Thank you, Mr. Chairman.
    Let me thank these gentlemen this afternoon for being here.
    Early on, I was a small businessman long before I got into 
this business and understand something about balancing your 
books and keeping your books right. But, at the same time, 
there are times when you are required to make an investment, 
and I think you have to be prudent in how you make that 
investment if you want to grow. And if you are a businessperson 
and you continue to cut, you can't get there, but you have got 
to have prudent investments.
    Dr. Zandi, let me ask you a question, because the economic 
recovery, many are saying, is still fragile. I think you have 
said that. All three of you have indicated that one way or 
another.
    Do you agree with the Federal Reserve Chairman Bernanke, as 
the chairman said earlier, when he testified at our last 
hearing that the danger of scaling back too soon may be far 
greater than some of the other things we could do if we want to 
keep this economy from really sliding into some more problems?
    Mr. Zandi. Yes, I would agree with that. I think the odds 
are that if fiscal policymakers did nothing else that the 
economy would still probably get through this period without 
going back into recession.
    But, having said that, I think the odds are uncomfortably 
high that I am wrong and that we would go back. And more 
importantly than that, if we do go back into recession, there 
is no good policy response. The Federal Reserve cannot respond 
effectively, and you won't be able to effectively respond 
because at that point the deficit will be ballooning out.
    So, given that, I think it is prudent risk management to 
err on the side of doing too much rather than too little over 
the next 6 to 12 months.
    Mr. Etheridge. Let me ask one additional question along 
that line. Because we have been struggling here, as you well 
know, for several months on Federal medical assistance 
percentages going to the States. We have talked with our 
Governor, and I think something like 34 Governors have included 
it in their budgets, and in North Carolina that is about half a 
billion dollars. It is a substantial amount. If it doesn't 
flow, then they will be cutting education and a host of other 
things.
    And many States are really suffering from unemployment. My 
home State is higher than the national averages----
    Can you speak for just a moment about the importance of 
this kind of aid, how this blends with the other--you touched 
on it some--and if it continues to decline, what effect it will 
have on the overall deficit in the short term as well as in the 
long term as we are trying to dig out of this hole?
    Mr. Zandi. Well, I think that the need for helping--the 
Federal Government to help State and local governments through 
this mess next fiscal year is very important for the reasons we 
have discussed. The most efficient way I think to do that is to 
help them with the Medicaid program, the costs related to FMAP; 
and if the Federal Government is able to provide help for FMAP 
say for the second half of fiscal year 2011, that would free up 
resources that will allow them to forestall more serious job 
cuts, program cuts, and tax increases. They will have to do it 
anyway, because their budget hole is that large and there is no 
way the Federal Government is going to help them to the degree 
to forestall it. It will be significant but at least it will 
forestall the most Draconian cutting.
    Mr. Etheridge. Let me ask one additional question or maybe 
two if we can get them in in time.
    Congress passed--I introduced a piece of legislation and 
the administration worked on it, we got it through--called the 
HIRE Act to create credit for people hiring people who are 
unemployed. Is it too early to know if this is really working?
    I have talked with some people in the last few days. One 
company has already hired 50 people. Now, whether or not they 
would have hired them or not, I don't know, but they are going 
to get the tax credit. So that is an advantage. I would be 
interested in your thought on that.
    Mr. Zandi. I think it is too early to evaluate that program 
based on macroeconomic data. I think right now it is mostly 
anecdotal.
    I do think as you approach the deadline, which I believe is 
November, December, I think you will start to see--in the next 
few months, we should see a little bit more take-up. But, you 
know, so far, the macroeconomic data is not sufficient to be 
able to evaluate it.
    Mr. Etheridge. Dr. Taylor, let me ask you one question. 
Because you didn't talk about the recession or how deep it was. 
What you talked about was panic. I would be interested in your 
definition of panic.
    Mr. Taylor. I was referring to the period mainly in the 
fall of 2008 when the financial markets froze up, equity prices 
fell by 30 percent in 2 or 3 weeks, and that really went around 
the world, actually, equity prices. It was a major hit to the 
world economy in that particular period. So that is what I mean 
by the panic. The crisis is sort of a longer period beginning--
--
    Mr. Etheridge. Right. During that panic period, as it was 
descending, we lost about $17 trillion in value of retirement 
income, housing, et cetera, 8 million jobs, and all these 
things were a part of that panic piece----
    Mr. Taylor. Part of the panic. And I think without that 
panic we obviously were going into a recession anyway, but that 
is really what made this the great recession. That panic was 
really a terrible shock. And I think, in my looking at the 
numbers, people realized were stabilizing by December of 2008, 
and if you look at the monthly data, you see investment 
beginning to recover by January. So that panic was very 
important, and so in my analysis of this whole great recession, 
that is why I focused on it.
    Mr. Etheridge. I am not an economist. I just have enough 
training in 101 to know that the markets are doing some of the 
same things all over again, I have noticed over the last 
several days, and people are getting nervous all over again.
    Thank you, Mr. Chairman. I yield back.
    Chairman Spratt. Thank you, Mr. Etheridge.
    Mr. Ryan has further questions, and Mr. Hensarling I 
believe is on his way. Mr. Ryan.
    Mr. Ryan. I am just curious. I would like to ask each of 
you. Sovereign debt is now becoming a new kind of toxic asset, 
I suppose. Give us your take on the risk of contagion washing 
up on our shores with respect to Europe. Do you think the 
European bailout program, whatever you want to call that, is 
going to work and what is the risk of default among the PIGS, 
Greece? And if a default does occur, what do you think happens 
to our bond market?
    Dr. Baily and going over, why don't we just do that?
    Mr. Baily. It is very hard to see Greece getting out of its 
mess without some of kind of restructuring, which means to say 
a partial default on those bonds. If you look at--I think John 
mentioned in his testimony there are some fundamental 
structural problems in the euro, that some of the countries are 
just not competitive. Germany got its costs under control and 
became competitive, and Greece and some of the other countries 
did not. And so that puts you in a bind. Because if you are 
going to repay that debt, basically you have got to transfer 
money to the other countries in Europe. The only way to 
transfer the money is to make the money by exporting, and if 
you are not competitive exporting, you are really locked up.
    So I think they are going to have to restructure. I think 
there is a threat that the euro could unravel, although I think 
it is very unlikely. I don't think Greece and Spain and 
Portugal would leave the euro, because they would see their own 
interest rates rise so much that they don't want to.
    A country that in a sense might be thinking about it is 
Germany, because they are, in a sense, carrying the weight of 
the other countries. But then again I don't think Germany will 
because Europe is a big export market, and so I think it will 
hold together, but it is proving to be fairly costly.
    Your question was, will this wash up on our shores? Well, 
it has washed up on our shores. Every time there was sort of a 
new story about problems in Europe our stock market lost a 
couple hundred points and that foments some of the concerns and 
panics here, and it is amazing how these financial crises do 
spread around the world. I mean, some of it is also 
interdependent in trade but also a lot of the same companies 
operate, a lot of the banks operate across borders.
    You would sort of think, well, Greece is such a tiny 
country and it is only a fraction of California, never mind the 
United States, but it does seem to create an unsettled feeling 
in the markets that could affect us.
    I think the blessing in disguise for Greece is that it 
maybe has given all of us a lesson in that we can't just borrow 
and borrow and borrow forever, that at some point we are going 
to have to deal with deficits. As I say, not necessarily today 
but down the road we have to do that.
    Mr. Zandi. My sense is that the European policymakers will 
contain the crisis, that what they have done so far is really 
quite impressive and they still have room to maneuver. The 
trillion dollar package from the EU IMF is equal to all of the 
sovereign debt of Greece, Portugal, Spain, Ireland that will 
mature over the next 5 years. So I don't think there is any 
real possibility of a default anytime in that period of time.
    And the ECB, European Central Bank, is engaged in purchases 
of sovereign debt. Mostly, it appears they are buying Greek and 
Portuguese debt. They can expand that out.
    Mr. Ryan. How do they sterilize? They claim to be 
sterilizing. They are not easing. How do they do that?
    Mr. Zandi. They are issuing securities into the marketplace 
to drain the liquidity. So they are buying the bonds that is 
providing liquidity and they are issuing other securities.
    Mr. Ryan. And the market is working for that?
    Mr. Zandi. So far, so good. The ECB target rate is still 1 
percent, and they have been able to target that pretty well, 
but they could decide if things start to weaken to not 
sterilize, right? They have room to maneuver there, too, and 
the European economy is roughly the same size as the U.S. 
economy, the Federal Reserve about $300 billion worth of 
Treasury bonds, when they were credit easing, put it in the 
same kind of ballpark, they could buy up $300 billion.
    Now, so far, the impact on our economy has been meaningful, 
but it is modest. There is positive and there is negative. The 
negative, obviously, is the equity market.
    The bond market has been a positive, right? Long-term 
interest rates have come in. The 10-year Treasury yield is 
below 3 percent. There is a flight to quality. People still 
believe, and rightfully so, that we are the AAA credit on the 
planet. We have the strongest economy. We have a large economy. 
We have managed our affairs extraordinarily well over 
centuries. So I think they trust us and I think with good 
reason. So I think we are the beneficiaries and we have 
latitude in the near term to continue to borrow to help finance 
and support our economy.
    Mr. Taylor. I do think Greece will have to restructure 
their debt. I think it can be done in a pretty orderly way, so 
I wouldn't call it default or something that would shock the 
markets. Their foreign bonds are all denominated in euros. That 
is a fairly straightforward operation. Some of the debt is 
issued under Greek law, some under English law. So it is pretty 
simple to do.
    I think it would have been much better if they did it 
earlier because then we wouldn't have had to have this huge 
bailout package which creates its own worries down the road 
because other countries may get into the same situation.
    I think the ECB's intervention is quite worrisome from the 
perspective of monetary policy. They are actually buying 
distressed debt. Central banks are supposed to be insuring the 
money supply and interest rates, keeping things stable. So this 
is taking them into a really new phase. They didn't want to do 
it. I think they want to get out of it as fast as they can.
    I think I agree with Mark, and I put it this way. Contagion 
can be through markets but it can also be through policy. So 
often bad policy is contagious. It spreads across countries. It 
seems to me that what we might be finding here is the reaction 
in Europe to Greece is spreading. At that G-20 meeting where 
the United States was told a few things, I think is beneficial 
for us as well because that feels like a contagion of some 
better policies.
    Mr. Ryan. Thank you.
    I see we have got somebody back.
    Chairman Spratt. I recognize Mr. Hensarling.
    Mr. Hensarling. Thank you, Mr. Chairman. I am glad that you 
have reconvened us. I wish it would be to take up a budget, but 
we haven't lost hope yet. Maybe that day will occur sometime 
this year.
    I see that at least two of the three of our panelists have 
been published in the Wall Street Journal today. I am not sure 
what to accord this honor to. And, Dr. Zandi, I haven't read 
one of your op-eds recently, but I did read your book, and it 
was helpful.
    Mr. Zandi. Thank you.
    Mr. Hensarling. It was helpful. I appreciate that.
    Mr. Zandi. I am going to start working harder.
    Mr. Hensarling. Apparently, you need to work a little 
harder here.
    Dr. Taylor, before I ask you about your editorial, I am 
actually going to ask you if you had read one by Dr. Meltzer 
that appeared in the Wall Street Journal yesterday on why 
Obamanomics has failed. He seems to take up a theme that you 
have about a kind of seed of uncertainty that had been sowed 
due to major policy initiatives. He states in his editorial 
piece, ``Second, the administration and Congress have through 
their deeds and work heightened uncertainty about the economic 
future. High uncertainty is the enemy of investment and 
growth.''
    I assume that you agree with that; and, if so, could you go 
into greater detail in what you base your thesis on that 
uncertainty is part of what is keeping back our economic 
growth?
    Mr. Taylor. Sure, and I do agree with Allan Meltzer in that 
piece. The uncertainty is due to several factors. It is just 
the depth that I mentioned is coming in a way we have never 
seen it before. Look, in our history this is well beyond, many 
times, what we have seen before. So that, if you like, new 
situation creates uncertainty. People don't know how it is 
going to get resolved.
    There is an inconsistency. You can't have all that debt 
created and have the inflation forecast the things that people 
are predicting. So there is an inconsistency that has to be 
resolved, and people don't know how it is going to be resolved. 
That is an inherent uncertainty.
    I think also you referred to my piece in the Journal today. 
That highlights another form of uncertainty, a massive change 
in how our financial institutions will be regulated, their 
relationship with government, a very complicated set of changes 
which people don't know exactly how it is going to work. It is 
a very complex bill.
    Mr. Hensarling. Including one of the authors of the 
legislation, Senator Dodd. You may have read his quote in the 
newspaper.
    Mr. Taylor. I missed that.
    But I think if you just go down the line you see this great 
uncertainty, plus globally you see situations like the 
sovereign debt that Congressman Ryan was referring to. We 
haven't seen that for a long time. I think that is affecting 
our markets. I say there is a lot of evidence for this. It is 
hard to measure. I don't want to say we have great models and 
theories of it, but I have never seen it like this before. It 
is very concerning to me.
    Mr. Hensarling. The chairman, the ranking member, and 
myself all serve on the President's Fiscal Responsibility 
Commission. We had a session yesterday and heard from Dr. 
Elmendorf. There still appears to be a continuing debate within 
the Commission on whether or not it is possible to both lay out 
a plan of fiscal sustainability for the long term while we 
debate government stimulus in the short term. I myself have 
strong opinions that the stimulus has failed, and I think it is 
a bad policy.
    But, setting that aside--and I know that Chairman 
Bernanke's name has been invoked here. I believe he has said 
something along the lines of how important it would be to job 
growth today to lay out a plan of fiscal sustainability. And so 
do you have an opinion whether these are competing goals, 
complementary goals? Can Congress or this Commission, in 
specific, walk and chew gum at the same time?
    Mr. Taylor. I guess I would say it would be tremendously 
valuable for confidence if a plan could be laid out, a credible 
plan, to keep the debt from exploding, which is where it is 
going right now, to keep it at a low level, to try to get it 
down.
    There is not really an inconsistency. I think I would 
prefer if that path began right now with the budget you are 
starting to deliberate with, but even if that is up a little 
bit, then you can lay out the plan. So there is no--there is so 
much advantage--I used to do simulations of models that showed 
that you can get fiscal stimulus from having a good plan laid 
out for consolidation in the future. It builds confidence. It 
affects interest rates in a healthy way. So I think it would be 
beneficial to the economy, plus it would have the added 
advantage of showing that government is really doing something 
that is hard to do.
    Mr. Hensarling. In the absence of other members, if the 
chairman might indulge me one more question--I didn't hear the 
word ``no''--in your piece, Dr. Taylor, you mentioned that I 
believe by far the most significant error of omission in this 
bill--referring to the financial regulatory markets bill--is 
the failure to reform Fannie Mae and Freddie Mac, the 
government-sponsored enterprises. Can you elaborate on just how 
significant an omission this is? And by lack of reform, to what 
extent does that contribute to the uncertainty that in turn 
contributes to our high unemployment rate?
    Mr. Taylor. Well, it is an omission because if you would 
like the reform bill to address the financial crisis and, 
therefore, deal with it, that was one of the big factors in the 
financial crisis, the encouragement by Fannie and Freddie to 
buy risky mortgages, which accentuated the housing boom. So in 
terms of addressing the financial crisis, it was essential to 
have that in there.
    Also, by not having it in there, if the bill actually goes 
through without that, it will be very hard to get it later. 
Because, as you know, comprehensive reform has the advantage of 
balancing off different interests, and so that balancing is now 
going to be much harder to do if Fannie and Freddie want to 
build a future.
    With respect to the uncertainty, yes, the housing market 
isn't moving along as much as you think. I think Mark Zandi's 
referred to that. I think there is uncertainty about what the 
Fed has done, what Fannie and Freddie are going to do in the 
future. So some clarification of that would be I think very 
valuable for the same reasons I mentioned.
    Mr. Hensarling. Thank you.
    Thank you, Mr. Chairman.
    Chairman Spratt. Gentlemen, thank you very much for your 
testimony today. We have got several votes coming up on the 
floor. We could continue this fruitful conversation for the 
rest of the afternoon, but thank you for coming. Thanks for 
your clarity and forbearance and your answers. We very much 
appreciate it, and we will be calling upon you in the future, I 
am sure. Thank you again.
    The hearing stands adjourned.
    [Questions submitted by Mr. Aderholt and their responses 
follow:]

    Questions Submitted to Witnesses by Hon. Robert B. Aderholt, a 
          Representative in Congress From the State of Alabama

                               dr. baily
    1. In your testimony, you state that the financial crisis was 
caused by a ``perfect storm'' of problems, one of which was regulator 
errors. Today, I hear from many community bankers in my district that 
overzealous regulators are hurting their ability to loan money to their 
customers. Do you believe such knee-jerk reactions as over-regulating 
may hurt the recovery more than it will help?

    As discussed in my testimony, poor decisions by regulators did 
contribute to the financial crisis. Regulators and credit rating 
agencies were caught up in the same spirit of excessive risk taking 
that was endemic amongst financial institutions and ordinary market 
participants alike. In addition, government regulators failed to 
adequately oversee Fannie Mae and Freddie Mac, whose behavior did 
contribute to the development of a housing bubble, an important--but 
not singular--cause of the crisis.
    However, the mistakes made by regulators were often a result of a 
systematic decline in the premium placed on risk following 25 years of 
strong performance in the financial sector and the belief that the 
business cycle had effectively vanished. All sorts of investors and 
financial institutions learned that financial risks were profitable and 
became less risk averse. Regulators remained more risk averse than the 
financial system writ large, but in times of excessive risk taking, 
regulators that are more conservative than the average investor are 
unlikely to provide adequate oversight. As a result, bubbles were 
allowed to pervade the financial system, in housing and other sectors.
    The number of bank failures continues to remain high, with 118 in 
2010 alone (through August 20), most of which are small banks. In 
addition, 775 banks continue to be classified as problem banks by the 
FDIC. These banks continue to have bad assets on their balance sheets 
and regulators can and should play an important role in ensuring that 
community banks are brought back to health responsibly, without 
returning to excessively risky lending standards that characterized the 
period immediately preceding the crisis.
    During the boom years regulators erred in the direction of not 
being strict enough and in not requiring more stringent lending 
standards. However, the pendulum may have swung back too far in the 
other direction as banks are discouraged from making loans even when 
the prospects for repayment are good, if rather risky. It is important 
that we find the right balance of protecting depositors and taxpayers 
while encouraging economic growth.

    2. In the question and answers with Congressman Becerra, you noted 
that ``the right signal does have to be sent'' to the world that the 
United States is serious in its commitment to put our fiscal house in 
order. Is the House of Representatives failing to pass a budget for the 
first time in 35 years the signal we want to send to the world 
regarding our fiscal stability? Do you see any negative consequences 
resulting from the failure of passing a budget for fiscal year 2011?

    The failure to pass a budget is a problem and does not send the 
right signal to the world that the United States government can manage 
its fiscal affairs. I will not comment on who is to blame for the lack 
of agreement on the budget. In order to balance the federal budget over 
the next ten years it will be necessary to both increase revenues and 
curb spending. I hope that Republicans and Democrats will recognize 
this and work together to restore our fiscal integrity.

    3. The Constitution does not give spending authority to a 
Presidentially-appointed Commission; it gives it to elected officials 
who comprise the House of Representatives and who must face the voters 
every two years to be re-elected. Isn't the refusal to pass a budget a 
direct refusal to do the job House Members are elected to do?

    It is my understanding that the Commission will make 
recommendations and then Congress will act on those suggestions, while 
of course retaining its constitutional powers. Unfortunately the budget 
process has become mired in politics, a politics that is not grounded 
in reality. Any political leader that suggests raising taxes is 
vilified. Any political leader who suggests serious efforts to curb 
federal health spending or proposes measures to balance the long term 
Social Security budget is also subject to attack. Until Congress 
overcomes this poisonous atmosphere it will be difficult to achieve 
budget agreements. The Presidential Commission is a brave effort to cut 
through the politics and I hope that its recommendations can form the 
basis for a more constructive bipartisan dialog aimed at solving the 
terrible fiscal crisis we face.
                               dr. taylor
    1. As you know, the House of Representatives recently passed the 
conference committee version of the Financial Reform Bill. 
Unfortunately, this bill does little to reform government sponsored 
enterprises (GSEs) such as Fannie Mae and Freddie Mac. Does failing to 
address GSE reform in the financial reform bill leave the economy and 
financial sector exposed to another possible meltdown?

    Failing to reform Fannie Mae and Freddie Mac leaves the economy and 
the financial sector in a more risky situation. Fannie Mae and Freddie 
Mac now sit with an estimated several hundred dollar cost to taxpayers 
and no path to resolution. Effectively their obligations add to the 
federal debt which is already starting to reach unsustainable levels.
    These agencies were encouraged to expand and buy securities many of 
which were backed by mortgages that were very risky. Five years ago 
legislation, such as the Federal Housing Enterprise Regulatory Reform 
Act of 2005, was proposed to control these excesses, but it was not 
passed into law. These actions of these agencies should be added to the 
list of government interventions that were part of the problem leading 
to the financial crisis. Without reform the same series of events could 
occur again.
    Unfortunately, neither the conference committee report nor the 
final Dodd-Frank financial legislation dealt with Fannie Mae and 
Freddie Mac, so reform is still needed. Doing so outside of that 
broader reform effort will be very difficult, but it is essential to 
get started.
                               dr. zandi
    1. You noted that Congress must pivot to the ``long-term fiscal 
situation once the recovery is complete''. What policies would create a 
``long-term fiscal situation'' that is conducive to economic growth and 
leaves future generations of Americans with a fiscally secure country? 
Do you prefer cutting spending or tax increases?

    To ensure the nation's long-term fiscal sustainability, 
policymakers should work to reduce the nation's cyclically adjusted 
federal budget deficit to GDP ratio to no more than 3% by fiscal year 
2021. The current cyclical adjusted deficit to GDP ratio is almost 6%.
    To accomplish this objective will require both federal government 
spending cuts and tax increases. I would prefer that the majority of 
the required deficit reduction be done through spending cuts; something 
close to \2/3\ spending cuts and \1/3\ tax increases would be a 
reasonable goal. Based on an assessment of previous fiscal austerity 
efforts here in the U.S. and overseas suggests that government spending 
cuts rather than tax increases results in better longer-term economic 
performance.
    With regard to spending restraint, a good first step would be 
address the current short-falls in the nation's Social Security system. 
This is a well-defined problem that if addressed could result in 
significant deficit reduction. With regard to tax increases, a good 
first step would be to cap the amount of tax deductions to some percent 
of taxpayers' total tax liability. This too would contribute 
significantly to deficit reduction. Taken together and fully 
implemented by FY 2014, these actions would go a long way to obtaining 
the goal of a 3% cyclically adjusted deficit to GDP ratio by 2021.
    It is likely that policymakers will eventually need to do even more 
to address our longer-term fiscal problems as the large baby-boomer 
generation retires and uses the entitlement programs more intensively. 
To do this, growth in the costs of the Medicare and Medicaid programs 
will likely have to addressed. Comprehensive tax reform will also be 
necessary given that the nation's current tax system is complex, 
opaque, unfair, and is an impediment to strong long-term economic 
growth.
    Returning the nation to fiscal sustainability will not be easy, but 
it is very doable, and of course we have no choice but to do it.

    [Whereupon, at 2:48 p.m., the committee was adjourned.]

                                  
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