[Senate Hearing 111-736]
[From the U.S. Government Publishing Office]




                                                           S. Hrg. 111-736
 
                  A STATUS REPORT ON THE U.S. ECONOMY

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

                                HEARINGS

                               before the

                        COMMITTEE ON THE BUDGET
                          UNITED STATES SENATE

                     ONE HUNDRED ELEVENTH CONGRESS

                             SECOND SESSION

                               ----------                              


           August 3, 2010-A STATUS REPORT ON THE U.S. ECONOMY

    September 22, 2010-ASSESSING THE FEDERAL POLICY RESPONSE TO THE 
                            ECONOMIC CRISIS

    September 28, 2010-OUTLOOK FOR THE ECONOMY AND FISCAL POLICY 

                                     
                                     



                  A Status Report on the U.S. Economy
                  A Status Report on the U.S. Economy




                                                        S. Hrg. 111-736

                  A STATUS REPORT ON THE U.S. ECONOMY

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

                                HEARINGS

                               before the

                        COMMITTEE ON THE BUDGET
                          UNITED STATES SENATE

                     ONE HUNDRED ELEVENTH CONGRESS

                             SECOND SESSION

                               __________


           August 3, 2010-A STATUS REPORT ON THE U.S. ECONOMY

    September 22, 2010-ASSESSING THE FEDERAL POLICY RESPONSE TO THE 
                            ECONOMIC CRISIS

      September 28, 2010-OUTLOOK FOR THE ECONOMY AND FISCAL POLICY

                                     
                                     




           Printed for the use of the Committee on the Budget


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                        COMMITTEE ON THE BUDGET

                  KENT CONRAD, NORTH DAKOTA, CHAIRMAN

PATTY MURRAY, WASHINGTON             JUDD GREGG, NEW HAMPSHIRE
RON WYDEN, OREGON                    CHARLES E. GRASSLEY, IOWA
RUSSELL D. FEINGOLD, WISCONSIN       MICHAEL ENZI, WYOMING
BILL NELSON, FLORIDA                 JEFF SESSIONS, ALABAMA
DEBBIE STABENOW, MICHIGAN            JIM BUNNING, KENTUCKY
BENJAMIN CARDIN, MARYLAND            MIKE CRAPO, IDAHO
BERNARD SANDERS, VERMONT             JOHN ENSIGN, NEVEDA
SHELDON WHITEHOUSE, RHODE ISLAND     JOHN CORNYN, TEXAS
MARK WARNER, VIRGINIA                LINDSEY O. GRAHAM, SOUTH CAROLINA
JEFF MERKLEY, OREGON                 LAMAR ALEXANDER, TENNESSEE
MARK BEGICH, ALASKA
CARTE GOODWIN, WEST VIRGINIA


                Mary Ann Naylor, Majority Staff Director

              Cheryl Janas Reidy, Minority Staff Director

                                  (ii)


                            C O N T E N T S

                               __________

                                HEARINGS

                                                                   Page
August 3, 2010--A Status Report on the U.S. Economy..............     1
September 22, 2010--Assessing the Federal Policy Response to the 
  Economic Crisis................................................    71
September 28, 2010--Outlook for the Economy and Fiscal Policy....   165

                    STATEMENTS BY COMMITTEE MEMBERS

Chairman Conrad..............................................1, 71, 165
Ranking Member Gregg........................................12, 78, 172

                               WITNESSES

Richard Berner, Ph.D., Managing Director, Co-Head of Global 
  Economics, and Chief U.S., Economist, Morgan Stanley & Co., 
  Inc............................................................14, 19
Alan S. Blinder, Ph.D., Gordon S. Rentschler Memorial Professor 
  of Economics and Public Affairs, Founder and Co-Director, 
  Center for Economic Policy Studies, Princeton University.......81, 85
Douglas W. Elemdorf, Director, Congressional Budget Office.....173, 177
Simon Johnson, Ph.D., Senior Fellow, Peterson Institute for 
  International Economics and Ronald A. Kurtz Professor of 
  Entrepreneurship, Sloan School of Management, Massachusetts 
  Institute of Technology........................................25, 28
Joel L. Naroff, Ph.D., President and Founder, Naroff Economic 
  Advisors, Inc..................................................34, 38
John Taylor, Ph.D., Mary and Robert Raymond Professor of 
  Economics, Stanford University, George P. Shultz Senior Fellow 
  in Economics, The Hoover Institution.........................128, 131
Mark Zandi, Ph.D., Chief Economist, Moody's Analytics............91, 94

                        QUESTIONS FOR THE RECORD

Questions and Answers..........................................159, 236


                  A STATUS REPORT ON THE U.S. ECONOMY

                              ----------                              


                        TUESDAY, AUGUST 3, 2010

                                       U.S. Senate,
                                   Committee on the Budget,
                                                    Washington, DC.
    The Committee met, pursuant to notice, at 10 a.m., in room 
SD-608, Dirksen Senate Office Building, Hon. Kent Conrad, 
Chairman of the Committee, presiding.
    Present: Senators Conrad, Nelson, Sanders, Begich, Goodwin, 
Gregg, and Bunning.
    Staff present: Mary Ann Naylor, Majority Staff Director; 
and Cheri Reidy, Minority Staff Director.

              OPENING STATEMENT OF CHAIRMAN CONRAD

    Chairman Conrad. The hearing will come to order. I want to 
welcome everyone to the Senate Budget Committee. We are going 
to be doing a series of hearings on the economy. This hearing 
is focused on the status of the economy now, how are we doing, 
where are things headed. We are going to do some followup 
hearings on what action we should be taking here in Washington 
to respond to the current economic conditions. So this will be 
the first in a series. I am delighted Senator Gregg is with us 
today, and I am going to begin with an opening statement. Then 
we will go to Senator Gregg for any remarks that he might want 
to make, and then we will go to our distinguished panel of 
witnesses.
    I think all of us know that we have just gone through the 
worst recession since the Great Depression. Economic growth in 
the fourth quarter of 2008 was actually a negative 6.8 percent; 
in other words, the economy was contracting at that point by 
more than 6 percent.

[GRAPHIC] [TIFF OMITTED] T8156.136


    In the first month of 2009, we actually lost 800,000 jobs, 
and unemployment was surging. The housing market crisis rippled 
through the economy. Home building and sales plummeted. We had 
record foreclosures. We had a financial crisis that threatened 
a global economic collapse, a lending lockdown, and we saw very 
severe effects throughout the financial sector.
    Let me just say I will never forget being called to a 
meeting--I believe Senator Gregg was there as well--when the 
Secretary of the Treasury and the Chairman of the Federal 
Reserve told us that they were going to be taking over AIG the 
next morning, and they told us that if they did not, they 
believed we would face a financial collapse in a matter of 
days. So this was an extraordinary crisis.
    We have just received a report from the economists Alan 
Blinder and Mark Zandi entitled ``How We Ended the Great 
Recession.'' With respect to the Federal Government's response 
to the crisis, they say, in part, ``We find that its effects on 
real GDP, jobs, and inflation are huge and probably averted 
what could have been called a `Great Depression II.' For 
example, we estimate that without the Government's response, 
GDP in 2010 would be about 6.5 percent lower, payroll 
employment would be less by some 8.5 million jobs, and the 
Nation would now be experiencing deflation. When all is said 
and done, the financial and fiscal policies will have cost 
taxpayers a substantial sum,'' they say, ``but not nearly as 
much as most had feared and not nearly as much as if 
policymakers had not acted at all. If the comprehensive policy 
response saved the economy from another depression, as we 
estimate, they were well worth their cost.''

[GRAPHIC] [TIFF OMITTED] T8156.137


    We can now look back at the economic performance. As I 
indicated, in the first quarter of 2008, there was a negative 
6.8 percent; in the most recent quarter, the second quarter of 
2010, a positive 2.4 percent; but you can see in the fourth 
quarter of 2009, it was a positive 5 percent. So we are seeing 
the recovery decelerate. That has to be a concern to all of us.

[GRAPHIC] [TIFF OMITTED] T8156.138


    Going to the next slide, if we can, private sector jobs 
picture, as I indicated, in January of 2009 we lost over 
800,000 jobs. In the most recent month for which we have 
figures, we gained 83,000--a remarkable turnaround, but well 
below where we need to be.

[GRAPHIC] [TIFF OMITTED] T8156.139


    Let us go to the next slide, if we can. Unemployment 
remains stubbornly high at 9.5 percent. It is down from its 
peak but, nonetheless, too high.

[GRAPHIC] [TIFF OMITTED] T8156.140


    If we go to the next slide, the housing slump continues. 
You can see the peak there. In January of 2006, we had 2.3 
million housing starts on an annual basis. That was the peak. 
We are down dramatically off that peak to 549,000 in June of 
2010.

[GRAPHIC] [TIFF OMITTED] T8156.141


    The next slide is a USA Today story headlined, ``Expect 
lots of layoffs at State and local levels; Tight budgets, lack 
of Medicaid help put governments in a bind.'' All of us know 
the States, most of them have a balanced budget requirement. So 
when there is an economic slowdown, revenue decreases, they are 
compelled to cut spending--in some cases cut it dramatically.

[GRAPHIC] [TIFF OMITTED] T8156.142


    The next slide is ``Cuts in Europe stoke global fears; 
Britain and Germany plan drastic austerity measures that may 
hamper recovery in the United States.'' I also want to indicate 
in my contacts with business leaders across the country, they 
tell me that the financial crisis in Europe has had a notable 
effect on the economy here; that is, they have told me, almost 
without exception, that the recovery was going quite well until 
the European debt crisis hit, and that has slowed economic 
growth here, and it certainly has affected those countries as 
well.

[GRAPHIC] [TIFF OMITTED] T8156.143


    If we look at the deficit, we see that under the 
President's proposal the deficit will come down quite sharply 
over the next 5 years, but not sharply enough in the judgment 
of many of us. Most concerning to me are the years beyond the 
next five, where we see the deficit again rising. That cannot 
be the course for the country. That is why the fiscal 
commission has been put in place to come up with a long-term 
plan to deal with deficits and debt. But what has been outlined 
in the President's budget for the long term cannot be the 
course that we take. That would simply add too much to the 
debt, and we are going to have to face up to that, as shown in 
the next slide, because this is a longer-term by the 
Congressional Budget Office looking at 2010 and beyond, going 
out to 2054. And if we stay on the current course, we will have 
a debt that approaches 400 percent of the gross domestic 
product of the country.
    Now, let me state that again. If we stay on the current 
course, the Congressional Budget Office tells us by 2054 we 
will have a debt that will be 400 percent of the gross domestic 
product of the country. Nobody believes that is sustainable. 
Nobody believes we would not face a financial crisis well 
before 2054.

[GRAPHIC] [TIFF OMITTED] T8156.144


[GRAPHIC] [TIFF OMITTED] T8156.145


    Let me go to the final slide, which is the Chairman of the 
Federal Reserve Board saying that we need a credible plan to 
achieve long-term fiscal sustainability. Ben Bernanke, the 
Federal Reserve Chairman, on April 7th said to the Dallas 
Regional Chamber, ``A sharp near-term reduction in our fiscal 
deficit is probably neither practical nor advisable. However, 
nothing prevents us from beginning now to develop a credible 
plan for meeting our long-run fiscal challenges. Indeed, a 
credible plan that demonstrated a commitment to achieving long-
run fiscal sustainability could lead to lower interest rates 
and more rapid growth in the near term.''

[GRAPHIC] [TIFF OMITTED] T8156.146


    So that is the challenge before us. It is absolutely 
imperative that we develop a plan and implement a plan to face 
up to our long-term debt.
    With that, I want to go to our witnesses, start with Dr. 
Berner, if we just go left to right--ah, we are going to hear 
from Senator Gregg first.
    Senator Gregg. Trying to shut me off again.
    [Laughter.]
    Chairman Conrad. I would never try to shut you off. I was 
so eager--honestly, I am so eager to hear from these witnesses. 
I was going to go to them and then maybe turn to you after the 
hearing was concluded.
    [Laughter.]
    Senator Gregg. That would have been perfect timing. Perfect 
timing.
    Chairman Conrad. Senator Gregg.

               OPENING STATEMENT OF SENATOR GREGG

    Senator Gregg. First off, I appreciate the Chairman holding 
this hearing, and I especially appreciate this very exceptional 
panel that has been put together, and I look forward to hearing 
from them also.
    I also want to commend the Chairman for putting forth some 
stark numbers that are accurate, as he always does, and once 
again pointing out that the path that we are on simply is not 
sustainable as a Nation. I asked my staff was that--off the top 
of my head, I did not know the answer to this question--what 
the Greek gross debt to GDP ratio is, of course, Greece having 
basically defaulted and then been saved. And they said it was 
about 100 percent. I am not sure if that is their public debt 
or their gross debt. But, anyway, your number of 400 percent 
for gross debt is a staggering number. We know our public debt 
goes to close to 100 percent during the timeframe that you have 
discussed there.
    Let me just take a more global view of the issue. I know 
our witnesses are going to take sort of a macro view. Let me--
or a micro view. Let me take more of a macro view.
    If we look at what is happening here, we are seeing a new 
normal, as is the term used, I guess, by Mohamed El- Erian, in 
the way we work as a Nation and the way we function as a 
Nation. And I am not sure it is a good new normal because 
basically we are taking American exceptionalism, which I 
believe has always been uniquely founded on the basis of fiscal 
responsibility, individual entrepreneurship, and the capacity 
of the country to grow as a result of people taking risks and 
creating jobs, which require access to capital and access to 
credit which was reasonably available at a fair price, and we 
have contracted all of this. We are contracting it because the 
Government is growing so far. The Government has gone from 20 
percent of GDP just 2-1/2 years ago to now it is 24 percent of 
GDP; it is projected to go to 26 to 27 percent of GDP. 
Historically, it has always managed to be in the range of 19 to 
20 percent of GDP since the end of World War II.
    Even if our revenues recover to their historic levels--and 
it appears they will; in fact, under the President's budget it 
looked like they will exceed our normal levels, the normal 
level of revenues being about 18.2 percent of GDP; the 
President is projecting they will go to 20 percent within 3 
years--we cannot fill this gap. We cannot fill this gap because 
the Government has simply grown too much. And the question is: 
How do we bring the Government back down? But how do we do it 
in a way that does not stifle this recovery to the extent we 
are having recovery?
    That really becomes a very complicated two-step event for 
us as people who are the keepers of fiscal policy and for the 
keepers of monetary policy, because if we act precipitously to 
try to control the deficit, do we end up stifling the recovery? 
But if we do not act soon enough or put in place a reasonably 
acceptable plan which is perceived by the markets, both 
internationally and domestically, as legitimate to bring down 
the long-term debt, then do we aggravate the capacity to get a 
short-term recovery also? Because I happen to believe a short-
term recovery depends on the markets, and specifically the 
marketplace, Main Street believing that we are going to get our 
fiscal house in order. But in getting it in order, how do we do 
it in a way that does not also dampen this slow recovery?
    So these are the complicated policy issues we face, and I 
would be interested to hear from our witnesses as to what they 
think. What can we do in the short term on the deficit, or what 
should we do, and what must we do in the long term on the 
deficit in order to give ourselves viability as a Nation that 
we are going to be serious about the fiscal insolvency of our 
country and, therefore, our recovery?
    So I look forward to hearing from our witnesses on whatever 
they want to talk about, but hopefully on these topics. Thank 
you.
    Chairman Conrad. I thank the Senator for his very good 
opening statement. Really, I agree with the way he has framed 
it. I think he has framed it very, very well.
    Before we turn to the witnesses, I also want to welcome the 
newest member to this Committee, Senator Goodwin of West 
Virginia, who is here. We very much regret the passing of 
Senator Byrd, who was a giant in the Senate, a valuable member 
of this Committee. But we are delighted that Senator----
    Senator Gregg. Who wrote the bill that created this 
Committee.
    Chairman Conrad. Wrote the bill that created this 
Committee, and many of the rules under which we operate. We are 
delighted that Senator Goodwin has agreed to join this 
Committee. Senator Goodwin, we look forward very much to 
working with you. This Committee has a heavy responsibility, 
and based on what I have seen of your past and your conduct as 
a new Senator, you will be up to the responsibilities that this 
Committee faces. Welcome. We are glad to have you here.
    Senator Goodwin. Thank you.
    Chairman Conrad. Next we will turn to our witnesses: 
Richard Berner, the managing director and co-head of Global 
economics, chief U.S. economist at Morgan Stanley; Dr. Simon 
Johnson, a senior fellow at the Peterson Institute for 
International Economics and a professor of entrepreneurship at 
MIT's Sloan School of Management; and Dr. Joel Naroff, the 
president and founder of Naroff Economic Advisers. I hope I am 
pronouncing your name correctly, Dr. Naroff.
    Mr. Naroff. That is correct.
    Chairman Conrad. Great.
    Dr. Berner, welcome. Please proceed.

STATEMENT OF RICHARD BERNER, PH.D., MANAGING DIRECTOR, CO-HEAD 
OF GLOBAL ECONOMICS, AND CHIEF U.S., ECONOMIST, MORGAN STANLEY 
                          & CO., INC.

    Mr. Berner. Chairman Conrad, Ranking Member Gregg, and 
other members of the Committee, thank you for inviting me here 
to discuss the state of the U.S. economy and, with your 
permission, also to talk a little bit about what policymakers 
can do to improve it.
    First, a status report on the economy. As you noted, Mr. 
Chairman, we have emerged very slowly from the worst financial 
crisis since the Great Depression. But the legacy of that 
crisis is scattered across the landscape, and you noted some of 
the things that are important. I would add that one in four 
homeowners with a mortgage owes more than their house is worth. 
Lenders are still hesitant to lend to or refinance many 
borrowers. The process of cleaning up lenders' and household 
balance sheets is incomplete, so additional, steady progress is 
required to achieve a sustainable recovery.
    Likewise, headwinds from the crisis linger. GDP is still 1 
percent below its peak of 2 years ago. Federal, State, and 
local budgets are strained, as you noted. A faster pace of job 
and hours gains is required to generate needed income and also 
consumer confidence.
    This subpar recovery has left housing vacancy rates and the 
unemployment rate high, and other measures have slackened the 
economy high. So there is a ``tail risk'' that inflation could 
sink too low and turn into deflation. While I see signs of a 
bottoming in inflation at low rates, not deflation, we cannot 
take that outlook for granted.
    What about the outlook for our economy? Nonetheless, 
despite those problems, moderated but sustainable growth of 
about 3 to 3.5 percent through 2011 is likely. Now, I would 
note that is still pretty tepid for the first couple of years 
of a recovery, but four factors underpin that view.
    First, the shock from the European sovereign debt crisis 
that you noted earlier has begun to fade, and financial 
conditions over the past several weeks have improved, and that 
is essential for growth.
    Second, and more broadly, global growth, especially in the 
big emerging market countries where domestic demand is now 
strong, is still hearty. We expect global growth to be 4.7 
percent this year, 4.2 percent next year. And, for example, 
although the Chinese economy has slowed in respond to 
restraints on lending and tighter monetary policy, growth is 
still strong. We estimate it is slowing from about 10 percent 
this year to 9.5 percent next year.
    Third, the ongoing revival in job and income gains, 
although modest, will provide income gains sufficient to 
sustain 2 to 2.5 percent consumer spending growth. Now, that is 
a big step-down from the past but nonetheless sustainable. And 
we expect data this Friday to show that hours and payrolls 
improved somewhat in July.
    And, finally, infrastructure spending, the last part of the 
fiscal stimulus enacted in 2009, is now starting to gain steam.
    Five aspects of the recent data that we saw from our 
national income accounts I think support that reasoning.
    First, domestic demand accelerated in the second quarter to 
over 4 percent. That pace is not sustainable, but I think 
around 3 percent probably is, and it is likely.
    Second, we have seen the personal saving rate ramp up very 
significantly, suggesting that American consumers have rebuilt 
their saving and balance sheets by paying and writing down debt 
more than previously thought. Most important, underlying income 
growth in the revised data that we got last week is now 
stronger. So I think the consumers will spend more of that 
income in the second half of the year.
    Third, a wider trade gap was a drag on growth in the first 
half, but I see signs that it is likely to narrow as global 
growth persists and U.S. producers satisfy more global and 
domestic demand.
    Fourth, the rebound in profitability has been sharper than 
expected, and peak profit margins still lie ahead. So 
businesses now have the wherewithal to replace worn-out 
equipment, and they are spending money on those things to do 
it.
    And, finally, inflation measured by the Fed's preferred 
gauge of the core personal Consumer Price Index has run at 
about a 1.4-percent pace over the past year--still very low, 
but a couple of tenths higher than previously thought. And with 
rents now firming in apartments and elsewhere, those revisions 
reinforce our conviction that inflation is now bottoming and 
that the deflation scare will be just that--a scare. But there 
are obvious risks to any scenario, and I would mention two that 
are important to me.
    First, it remains in housing. In addition to the payback 
following expiration of the first-time homebuyer tax credit, 
the downside risks to home prices, mortgage credit 
availability, and housing demand are still present.
    Second, policy and political uncertainty. We think 
increased uncertainty around taxes and the implementation of 
health care and regulatory reform is a key reason that consumer 
confidence slipped in the last couple of months. It is not the 
only reason, but I think it is an ingredient.
    In the rest of my time, I would like to discuss some 
policies that Congress might consider to improve the outlook 
for housing and employment, two key areas that need attention, 
and thus the overall economy.
    First, housing. As I noted when I testified before this 
Committee in January 2009, mitigating foreclosures is necessary 
to stem the slide in house prices, slow credit losses, and 
reduce the pressure on household wealth. But neglect in the 
past 18 months has created two related, additional risks. The 
first is from accelerating strategic defaults, which are now 18 
percent of total defaults. These are borrowers who can pay but 
who are so far under water they choose to mail the keys back to 
their lenders. In addition, high loan-to-value ratios, 
appraisal problems, unemployment, and low credit scores block 
refinancing opportunities.
    I think the best options for relief continue to be simple, 
act quickly, and spread the pain broadly. Unfortunately, one 
program, the Home Affordable Modification Program, or HAMP, has 
fallen short.
    Two policy changes announced in March--a new ``earned 
principal forgiveness'' initiative, and the short refinance 
program through the FHA--could help. Earned principal 
forgiveness gives the borrower a strong incentive to stay 
current on modified payments by turning a portion of initial 
principal forbearance into principal forgiveness for each year 
the borrower stays current.
    These programs should be strengthened. They are not working 
because the language in the forgiveness modification rules is 
weak, and the FHA short-sale program continues to be advertised 
as being de minimis, with lenders pushing back on both.
    Another proposal to enable borrowers to refinance 
Government-guaranteed mortgages comes from my colleague David 
Greenlaw. Senator Gregg, I would note that Mr. Greenlaw hails 
from the great State of New Hampshire. The Government has 
guaranteed the principal value of the 37 million mortgages are 
backed by the agencies. There would be no credit risk for a 
mortgage originator who agreed to refinance these mortgages if 
the Government guarantee was extended to refinanced loans. I 
will not go into details. We can provide those to you. But Dave 
estimates that households would save $46 billion annually if 
half the mortgages among these 37 million were refinanced.
    What about policies to improve employment? Private nonfarm 
payrolls obviously have been flat over the past year, much less 
than we would hope. And clearly, much of that weakness is 
cyclical, related to the tepid state of the recovery.
    In our view, however, there are four structural components 
also at work. One is the cost of labor resulting from the 
escalation of benefits. The problem is that thanks to that high 
fixed costs of health and other benefits or labor costs are of 
line with other countries when adjusted for living standards. I 
say fixed because benefit costs do not vary with hours worked; 
they are paid on a per worker basis. So as employers seek to 
cut the cost of compensation in tough times, these benefit 
costs drive a growing wedge between total compensation and 
take-home pay and continue to escalate the cost. The recession 
made that wedge bigger, leaving benefits intact.
    Long-term solutions include implementation of health care 
reform to save costs and, of course, innovation to boost 
productivity and labor skills. The Affordable Care Act will 
possibly realize cost savings through Medicare, but more work 
is needed to reduce the soaring costs of health care for 
employers and employees alike.
    Short-term remedies: Perhaps a refundable payroll tax 
credit, we have one of those, but more aggressive 
implementation might be helpful.
    The second obstacle is a mismatch in skills. The problem is 
that for years employers have complained that they do not find 
the skills they need in today's work force. Long-term solutions 
include policies that keep students in school and improve 
access to education, reorientation of our higher educational 
system toward specialized and vocational training and community 
colleges, and immigration reform.
    In terms of short-term remedies, beyond unemployment 
insurance, one remedy would pair training and basic skills that 
are needed for work with income support. Two other groups 
seeking employment--newly minted college students and 
unemployed teachers perhaps--could be an ideal nucleus for a 
Job Training Corps that would empower job seekers with new 
skills.
    The third obstacle is related to housing: labor immobility. 
Negative among a Nation of homeowners leads to substantially 
lower mobility rates--one-third less, according to one study. 
Long-term solutions obviously include some of the ones I have 
outlined before. Short-term remedies beyond the ones I talked 
about would include an effort to establish a protocol for short 
sales and/or principal reduction, which should be a useful 
tool.
    And the last obstacle is the policy uncertainty factor I 
mentioned above. Obviously we need to solve our long-term 
challenges, but the uncertainty around the implementation of 
the legislation and the solutions we have adopted I think is to 
some extent weighing on business and consumer decisions to 
hire, expand, buy homes, and spend.
    I can tell you as somebody who works in financial markets 
that market participants are used to thinking that political 
gridlock is good because it keeps politicians from interfering 
with the marketplace. Well, today gridlock is more likely to be 
bad for markets, as our long-term economic problems require 
solutions with political action.
    Long-term solutions obviously require bipartisan 
leadership, and, Mr. Chairman and Ranking Member Gregg, your 
work as Commissioners on the deficit reduction commission is 
obviously critical. I know you agree that crafting a long-term 
credible plan, as you just mentioned, to restore fiscal 
sustainability will ease concerns and uncertainty about future 
tax hikes and the potential loss of our safety nets.
    In addition, reducing policy uncertainty now could be a 
tonic for growth, offering investors a chance to reassess the 
fundamentals again. For example, we assume that Congress will 
agree to a 1-year extension of all expiring tax cuts and other 
provisions. Doing so should reduce uncertainty as well as 
sustain fiscal stimulus. Obviously, the sooner such action is 
implemented, the sooner the reduction in uncertainty can be 
achieved.
    Mr. Chairman and members of the Committee, we have many 
challenges ahead. Our short-term challenge is obviously to 
enhance the odds for a more vigorous, and our long-term 
challenge to promote a sustainable fiscal policy and to reform 
our entitlement and other programs that represent claims on our 
future resources.
    Thank you for your attention and for the opportunity to 
offer advice. I would be happy to answer any questions you may 
have.
    [The prepared statement of Mr. Berner follows:]

    [GRAPHIC] [TIFF OMITTED] T8156.147
    

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    [GRAPHIC] [TIFF OMITTED] T8156.150
    

    [GRAPHIC] [TIFF OMITTED] T8156.151
    

    [GRAPHIC] [TIFF OMITTED] T8156.152
    

    Chairman Conrad. Thank you very much, Dr. Berner.
    Now we will go to Dr. Johnson, senior fellow at the 
Peterson Institute for International Economics, someone who has 
testified before this Committee before. We welcome you back. 
Dr. Johnson.

  STATEMENT OF SIMON JOHNSON, PH.D., SENIOR FELLOW, PETERSON 
   INSTITUTE FOR INTERNATIONAL ECONOMICS AND RONALD A. KURTZ 
  PROFESSOR OF ENTREPRENEURSHIP, SLOAN SCHOOL OF MANAGEMENT, 
             MASSACHUSETTS INSTITUTE OF TECHNOLOGY

    Mr. Johnson. Thank you very much, Senator.
    Compared to Mr. Berner, I think I am somewhat more 
pessimistic about our immediate prospects. I am also much more 
worried about policy and our ability to put in place effective 
countermeasures.
    I would have suggested we frame our discussion of the U.S. 
economy in the following rather stark terms: If you look at the 
latest numbers from the BEA and compare the first quarter of 
2006 real GDP with the latest quarter, second quarter of 2010, 
real GDP has hardly changed. So we are on track, if we are 
pessimistic about the second half of this year, to experience 
essentially a lost half decade of growth in the United States. 
And I think this should remind us all of the lessons from 
Japan. I am not in the camp of thinking that we are going to 
enter into a Japanese-type deflation. But in terms of the 
damage that has been done to balance sheets, for example, of 
homeowners, the latest data there suggests around 20 percent of 
all homeowners still have negative equity, and this percentage 
has not declined much over the last four quarters. So the 
damage remains there, and I think you see this in the latest 
consumption data that came out today. Consumption is unlikely 
to rebound quickly.
    Our corporates, of course, have stronger balance sheets in 
the United States, but my experience talking to CEOs and CFOs 
in the U.S. and also from global companies is that they want to 
be careful now, that the big shock and the massive uncertainty 
that everyone experienced over the last 2 years was very much 
about the credit system, and most corporate leaders do not want 
to rely on borrowing and do not want to extend themselves and 
hire, obviously, as much as they would have done in the past. 
So, again, I think this undermines and slows growth.
    And, of course, on top of this we have the sovereign debt 
crisis and pressure toward austerity, which is most manifest in 
Western Europe, but we see it in other countries also. The 
``withdrawal of fiscal stimulus'' is the term often used by the 
IMF now. This is prevalent around the world.
    I was just recently in China, and talking to some of the 
leading economists there, I was struck that they are the least 
bullish economists on China that I meet anywhere in the world. 
They were very much about the need for cutting back on their 
expansion programs. They were very worried about the waste of 
Government funds in infrastructure, and I can share more 
details with your staff if you are interested.
    My bottom line is that I think global growth on a fourth-
quarter-over-fourth-quarter basis--I think Mr. Berner's data 
were annual averages, but I am using Q4 over Q4. I think the 
global economy will struggle to break 4 percent this year. I 
think next year should be a little bit better. I am not calling 
at all for stagnation, but I think slow growth is going to be 
with us for a while, both globally and in the United States.
    The second point I would like to make is that while I 
completely agree with what both you, Senator Conrad, and you, 
Senator Gregg, said at the beginning about our longer-term 
fiscal issues--and, of course, the very careful and excellent 
analysis done by the Congressional Budget Office on these 
issues--I am very concerned that a major fiscal issue is 
completely missing from this discussion. This is the contingent 
liabilities created by our financial sector and the risks that, 
in my opinion and in the opinion of many, are caused by the 
continued existence of undercapitalized banks that have an 
incentive to take very big risks and that are, in the language 
that some people like, ``too big to fail.''
    And this is a problem, obviously, in the United States. It 
is not unique to the United States. We will see it in Western 
Europe. But it is a very big fiscal issue in the U.S., and you 
can see this again from the CBO's numbers. Compare the baseline 
that they put out in January of this year with the January 2008 
numbers, and look at the projected debt level, net debt as a 
percent of GDP for 2018. It is 40 percentage points of GDP 
higher now than it was in the 2008 projection, and you can 
decompose that increase in debt. You can see where the deficit 
comes from. It is mostly from the lost tax revenue due to the 
recession. There is a small part, about 17 percent, that comes 
from the discretionary fiscal stimulus, which I am sure we will 
have a discussion about. But with or without that discretionary 
stimulus, you still would have had a massive hit to the budget 
and to the debt from the lost tax revenue and, of course, the 
increased interest payments on top of the debt because the debt 
has increased. And this is assuming a low rate of interest.
    If the more difficult fiscal scenarios that you, Senator 
Conrad and Senator Gregg, were outlining in the beginning start 
to play out, we should expect an increase in long-term interest 
rates, which presumably will increase the debt even further.
    Now, we can obviously have a discussion about the extent to 
which the Dodd-Frank legislation has addressed these risks. I 
think it was a step in the right direction but did not go far 
enough. But surely we will agree, I think, in that discussion 
that these risks have not gone to zero, and the CBO's 
methodology consistently across different kinds of problems, 
whether or not they are demographic or, for example, the way 
they treat the U.S.' commitment to the International Monetary 
Fund, which is essentially a line of credit, and we actually 
spend money out of the budget only with some hopefully low 
probability. There is a budget scoring for that, and I think 
the two of you were leaders in insisting that the CBO score 
that appropriately.
    Well, we are not scoring in the budget, according to the 
CBO methodology, and I think as discussed by Congress, in any 
way a contingent liability, the damage to the Government budget 
that would arise from a future financial crisis.
    Now, we can, of course, argue about how frequently those 
crises occur, but leading people in the financial sector, 
including Mr. Dimon, the head of JPMorgan Chase, and Mr. 
Paulson, former Secretary of the Treasury and former head of 
Goldman Sachs, say these crises occur on a 3- to 7-year time 
horizon. So this is all within your short- to medium-term 
framework, Senator Conrad, and that is why I worry that many of 
Mr. Berner's ideas, which are very sensible ideas taken 
individually, if I look at them together and consider that 
alongside this danger to the budget coming from the short term, 
I am very concerned about our scope for action.
    I do completely agree, I think, with all of you that over 
the longer term we must act, and the good news there, compared 
to other countries--and I was formerly chief economist at the 
IMF, so I look at these numbers very much in a comparative 
framework, including the Greek numbers, Senator Gregg, which I 
have right here if you are interested. My point would be there 
is some good news, which is that we have plenty of capacity for 
tax reform in the United States. Our tax system is relatively 
antiquated. It could be modernized fairly easily. I have some 
proposals in here. Many of the best ideas come from Greg 
Mankiw, former head of the Council of Economic Advisers under 
President George W. Bush. I see the beginnings of a bipartisan 
consensus at the technical level on tax reform issues that 
will, I think, generate somewhat more revenue than Senator 
Gregg was anticipating if we look out beyond a decade.
    Medicare, though, remains a huge problem, and I think that 
is the most difficult issue, and I think that is much more 
about ethics and about arithmetic than it is about economics, 
because the question of how much you are willing to pay for 
people who are relatively late in life is a very difficult and 
obviously emotional question. On that I agree the conversation 
has not moved forward very much over the past 2 years.
    The good news, though, is we do not face imminent fiscal 
crisis. We have time to make those decisions. We should deal 
with them now, as you gentlemen are already doing, and we 
should also deal with this issue of the contingent liabilities 
posed by, unfortunately, a still dangerous financial sector in 
this country.
    Thank you very much.
    [The prepared statement of Mr. Johnson follows:]

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    Chairman Conrad. Thank you, Dr. Johnson.
    Now I will go to Dr. Naroff. Again, welcome to the 
Committee. Please proceed with your testimony.

  STATEMENT OF JOEL L. NAROFF, PH.D., PRESIDENT AND FOUNDER, 
                 NAROFF ECONOMIC ADVISORS, INC.

    Mr. Naroff. Thank you, Chairman Conrad, Senator Gregg, 
members of the Senate Budget Committee. Thank you for the 
opportunity to discuss my views on the status of the economy 
and to provide some ideas on the direction that fiscal policy 
should take.
    The good news is that we have had one full year of economic 
growth, and the economy did expand by about 3.2 percent, which 
is pretty impressive given the problems that we faced over this 
period of time. Consumers have started spending again, though 
instead of ``shopping 'til they drop,'' they are really 
``shopping 'til they are tired'' at this point. Business 
investment, which had collapsed during the recession, has made 
a strong comeback. Exports are solid, inventories are being 
rebuilt, and workers are being rehired. All these factors 
indicate, at least to me, that the recession is over.
    However, I am in the camp that is extremely concerned about 
growth over the next year. I believe that the economy, as Dick 
Berner said, will face a significant number of significant 
headwinds and that the damage done from the bursting of both 
the housing bubble and the near collapse of the international 
financial system cannot be cured in a relatively short period 
of time.
    While the banking industry is better, it is hardly in good 
condition. Bank failures this year are running at twice last 
year's pace. Larger institutions are concentrating on 
rebuilding capital, not adding to their loan books. Credit, 
while slowly becoming more available, is still very limited.
    Bankers like to say that they are not turning down good 
loans. They are correct. But the devil is in the definition of 
a ``good loan.'' Credit decisions require reviewing in the past 
few years of corporate financials, and since many firms had to 
deal with that kind of economy, not many had stellar results 
over that period. Therefore, good credit risks are very hard to 
find.
    Unless the expansion is stronger than I expect, credit 
standards may not ease significantly for at least another 12 to 
18 months. And given that the economy runs on credit, it is 
hard to see how growth could surge. The housing sector will 
also continue to restrain activity, possibly through 2011.
    There are too many challenges to overcome. First, it is 
``back to the future'' when it comes to mortgage credit 
standards. The days of ``no docs'' and little or nothing down 
are over, thankfully. But that means fewer people will qualify 
for mortgages.
    But maybe more important is the loss of equity many 
homeowners have suffered, and that has been discussed a lot 
here. But the point in terms of housing demand is that, without 
rebuilding that equity, a smaller number of households are 
actually going to have the ability to make downpayments on 
additional homes, and without being able to do that, they are 
not going to be able to move.
    The diminution of demand is but one factor in the dismal 
forecast for new residential construction. There is also the 
foreclosure crisis. Foreclosures are greatest in those parts of 
the country where construction has typically been strongest: 
California, Arizona, Nevada, and Florida. As long as builders 
face the competition of large numbers of relatively low-priced 
foreclosed units, new construction activity will be limited.
    The weak home construction recovery is especially worrisome 
because in previous upturns housing either led the recovery or 
within one quarter was once again growing robustly, often in 
double-digit rates. I do not expect that to happen now.
    So, where can growth come from? Normally, we look toward 
the consumer, who makes up about two-thirds of the economy. 
Indeed, except for the 2001 recession and recovery, consumers 
returned to the malls early, after the downturn ended. This 
time the upturn in consumption is being delayed.
    There are good reasons for households to be cautious and 
consumer confidence to be depressed. Two decades ago, workers 
believed that if they did well, their positions were safe. They 
defined ``job security'' as the ability to work for one firm 
possibly for their entire careers.
    But businesses learned that in a globalized economy, 
productivity and cost containment are critical to long-term 
survival, and workers are, unfortunately, largely overhead. The 
employment compact between businesses and workers was broken.
    What has replaced this relationship? Several years ago I 
argued we should redefine ``job security'' as the ability to 
walk across the street and get another job.'' In other words, 
job security is having a robust job market. People will feel 
comfortable about their economic situation when they can sell 
their labor easily and not feel they are stuck in their current 
position or with their current employer.
    This new definition has critical implications. Since labor 
is the largest expense for businesses, there must be tight 
controls over payrolls. You do that by limiting hiring and wage 
gains. In the early part of the recovery, that strategy allows 
profits to rise. The combination of modest payroll gains and 
rising earnings, though, has created a disconnect between Main 
Street and Wall Street.
    Firms will remain hesitant to hire until they believe the 
economy will expand strongly for an extended period of time. 
That creates a troubling cycle. If companies limit hiring, then 
workers, who define job security as the ability to get a new 
job, will be worried, and consumer confidence will remain low. 
And depressed workers do not usually spend lavishly.
    The cycle of sluggish spending and limited private sector 
job creation will be broken, but not until the expansion 
lengthens, becomes broader-based, and corporate balance sheets 
improve. Payrolls should continue rising as they have this 
year, but the increases are not likely to be large enough to 
rapidly reduce the unemployment rate.
    It should not be a surprise that we are having a jobless 
recovery. The reality is that the last couple of recoveries and 
most future recoveries will be defined by slow job growth. The 
perception that upturns lead to an immediate surge in jobs is 
an anachronism, popularized when we were a largely 
manufacturing economy. The massive industrial sector that 
created lots of jobs early in the recovery by rapidly ramping 
up output and hiring is history. And as we saw with the latest 
GDP report, when our economy expands, we feed the growing 
economic needs with products not only from U.S. companies but 
with good produced around the world. We should stop using the 
phrase ``jobless recovery'' because it is normal that 
recoveries begin with anemic job growth.
    With employment and income growth modest and consumers 
uncertain, it is not a great leap to expect only moderate 
consumption growth over the next year. It should be enough to 
keep the economy going, but that is about all.
    If consumers are not spending lavishly, can business 
investment remain robust? Spending for software and equipment 
soared over the past three quarters. However, that too may 
change.
    From the summer of 2008 through the spring of 2009, firms 
dramatically reduced capital spending. More recently, 
businesses have started making up for the failure to invest in 
capital required to remain competitive and on depreciation. But 
that activity is just infilling delayed investments. Once that 
process is completed, firms will invest only when they believe 
their returns warrant the costs.
    Currently, it is hard to rationalize major new purchases of 
software, equipment, or structures if the economy is not 
expected to grow solidly. Uncertainty about tax policy is not 
helping either. As a consequence, investment could be limited 
to replacement and competitive factors. All this argues for 
decent but not spectacular gains in capital spending.
    Similarly, the inventory rebuilding that added greatly to 
GDP growth is likely over. In 2009, firms reduced inventories 
at a breathtaking but excessive pace. This year, they have been 
refilling their empty warehouses. Once more reasonable levels 
are reached, firms will need only to replace depleted stocks 
rather than refill emptied shelves.
    Can exports save the day? Yes, there have been strong gains 
in exports, and that should continue. However, as the recovery 
continues, imports will also grow faster. And I expect the 
trade deficit to widen further, and that will restrain growth.
    So let me summarize. We are facing a lack of credit, a 
stuck-in-the-mud housing market, an uncertain and cautious 
consumer, a wary business community that has already largely 
restocked empty warehouses, infilled depleted work forces, and 
replaced depreciated equipment and software, as well as a 
widening trade gap. And I have not even talked about the State 
and local governments that are cutting back dramatically.
    Without changes in fiscal or monetary policy, my forecast 
next year for growth is in the 2- to 2.5-percent range. This 
may appear to be modest, but we should not compare the pace 
with the past two decades when strong growth was closer to 3.75 
percent. Over the past 20 years, the economy was hyped by the 
1990's tech bubble and the 2000's housing bubble. Massive and 
excessive amounts of resources flowed to those sectors, 
creating outsized growth rates. Without another bubble, more 
moderate growth is likely, so do not evaluate this recovery on 
the basis of two artificial bubble-hyped expansions. Instead, 
look at what is now possible and, that is, a slow but steady 
recovery.
    It is in this context of a badly weakened, slowly 
recovering economy that the structure of fiscal policy must be 
determined. While monetary policy is always evaluated on the 
basis of where we are in the business cycle, fiscal policy 
seems to be viewed in a vacuum. Fiscal policies are often 
proposed as if the impacts are the same regardless of the 
condition of businesses, households, or even the Federal budget 
deficit.
    I believe that policies intended to grow the economy should 
always be evaluated on the basis of whether they makes sense in 
the context of the current economic circumstances and where we 
are in the business cycle. Tax cuts should not be implemented--
or should be implemented and retained only to the extent that 
they produce new growth and set the stage for further economic 
activity. Spending increases should be implemented only if they 
can quickly and efficiently increase domestic demand.
    We are moving from an economy that lacked demand to one 
where demand is growing slowly. We need to take that to the 
next level where businesses expand sharply, that implies 
phasing in the schedule of policies that meet the changing 
economic conditions.
    Thank you for your time.
    [The prepared statement of Mr. Naroff follows:]

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    Chairman Conrad. Thank you, Dr. Naroff.
    Let me just go right to it, if I could. Obviously, there is 
a debate going on here about what is the correct fiscal policy 
to pursue now. I think the three of you have outlined in 
significant detail the economic conditions we confront now. The 
question for us is: What do we do about it? And the debate, to 
boil it down simply, is on the one hand there is a camp that 
says you should provide more stimulus to the economy. The very 
distinguished economist Paul Krugman says you have got to 
provide more stimulus. He recommends that we provide more aid 
directly to the States through FMAP and other provisions, 
perhaps do more in terms of infrastructure.
    On the other side are those who say, look, we have got 
record deficits and debt now; you have got to take immediate 
steps to reduce deficits and debt now, so no further stimulus.
    Dr. Berner, what would your recommendation be to us in 
terms of what course to pursue?
    Mr. Berner. Well, Senator, thanks for the question. As I 
indicated earlier, I think we have a number of specific 
problems, and I think that we ought to address our policies 
more specifically to address those problems. And one of the 
biggest problems that I think all of us have talked about here 
today involves housing and housing finance and the state of 
balance sheets, the negative equity position in which many 
mortgage borrowers find themselves. So cleaning those problems 
up, mitigating those problems, really does involve fiscal 
policy. And, in effect, we are using fiscal policy currently to 
do that. So the losses incurred on agency-backed mortgages from 
Fannie and Freddie, the taxpayer, you and I are paying for that 
as those losses occur.
    The problem with that strategy is simply letting the 
foreclosures occur, letting the defaults occur, including the 
strategic defaults that I mentioned earlier, is that slow 
motion process really inhibits growth, it creates uncertainty, 
it prolongs the adjustment in housing and, by extension, in 
consumer balance sheets and, therefore, has a big impact on 
consumer spending and threatens further downside risks to home 
prices.
    Chairman Conrad. So if I can say, from your testimony, you 
would be for more aggressive intervention to prevent 
foreclosures and to try to close this gap between some 20 
percent the people are upside down in their mortgages.
    Mr. Berner. Well, Senator, some foreclosures are not 
preventable, but the point here is that we want to try to 
mitigate those which are preventable, and we want to give an 
opportunity, as I indicated, with some ideas to allow 
homeowners to refinance where the only barrier is the refi 
process, where we have already got the responsibility and the 
liability on the Federal balance sheet for those mortgages that 
might default since they are backed with the full faith and 
credit of the Federal Government to allow them to reap the 
benefits of lower mortgage rates today, and they are not so 
doing; and, in addition, to accelerate the process of bringing 
borrowers and lenders together through proposals like the 
earned principal reduction or forgiveness program so that 
lenders have a performing asset which is not now performing, 
and the borrower can stay in their home with a reduced payment 
with some expectation that they will share--maybe not gather 
completely--in any stability or upside from future home price 
appreciation. And I think that is the problem, that is why we 
have strategic defaults, because people do not have that 
expectation and they will not share in that future price 
appreciation if, in fact, it materializes. The policies that we 
are pursuing today practically guarantee that that appreciation 
is way, way off in the future. The policies that I am 
recommending would mitigate that, speed up the process, and 
reduce the imbalances in housing.
    The other things that I talked about also do involve fiscal 
policy. So, for example, if we were to start a job training 
corps, as I recommended, to bring together people who had 
skills with those who lack them, that is going to cost some 
money. But instead of giving people pure transfers, 
unemployment insurance, which is certainly needed in many 
cases, it puts money in the hands of people and gives them 
activities which are productive, which increase training, and 
which offer a lot more dignity to those activities.
    So those are some of my suggestions.
    Chairman Conrad. Dr. Johnson, what would your advice be to 
us on what we do now?
    Mr. Johnson. Senator, obviously the risk that we face in 
terms of how the financial markets see our Government debt is 
whether there is a better alternative out there. We have 
benefited greatly from the fact that while we are not in 
particularly good shape, the rest of the world is struggling--
certainly those parts of the world that issue large amounts of 
government debt. But I think it is dangerous to assume this is 
going to continue indefinitely or even continue necessarily 
into next year. The Europeans are getting their act together. I 
do not expect high growth there, but they may well be offering 
debt at the euro level, for example, by this time next year 
that could be regarded as relatively appealing. And if we see 
that sort of opportunity out there, I think you will see shifts 
in international portfolios. I think some of the foreign 
holders of our debt--as you know, about half of our debt 
outstanding is now held by foreigners one way or another. They 
could shift away from the U.S., and we would have an increase 
in interest rates.
    The best way to get ahead of this, in answering your 
question, is to undertake now measures that credibly reduce the 
deficit 10 or 15 years down the road, which would be, for 
example, tax reform or some form of Medicare reform, if you can 
deal with that. That should lower interest rates. You are 
reducing the risk on our debt, and that would create what the 
IMF likes to call fiscal space that you could choose either to 
pay down debt or not run up a larger deficit, or you could put 
that into shorter-term stimulus programs.
    But I am afraid where we are today, while I am sympathetic 
to many of the constructive ideas that we have heard today and 
we are hearing elsewhere that would be trying to stimulate the 
economy, I would caution against doing it without a medium-term 
fiscal consolidation framework. That would never be what the 
IMF advises. Obviously, the IMF does not provide advice to the 
U.S. in this kind of context. But I think that is a sound 
principle that the U.S. uses when it talks to other countries 
and the IMF uses when it talks to other countries, and we 
should use it for ourselves.
    Chairman Conrad. So the debt commission that Senator Gregg 
and I serve on, the success of that commission in your mind 
takes on even more importance given the current economic 
condition?
    Mr. Johnson. Absolutely. I think that the deficit 
commission and related--any other initiatives along those lines 
is the key to being able to provide shorter-term stimulus in 
creating scope for whatever kinds of measures you think would 
be suitable for the economy over a shorter timeframe. If you do 
not address the medium-term fiscal framework, then all of these 
additional measures are substantial risks, in my mind.
    Chairman Conrad. Dr. Naroff?
    Mr. Naroff. I look at the idea of fiscal policy in terms of 
a continuum rather than a specific set of policies. And, you 
know, if we go back to early 2009, you probably could have cut 
taxes to households and businesses all you want, but the return 
to those tax cuts would have been minimal because businesses 
and households were looking to survive rather than spend in any 
shape, form, or manner. That is the idea of where the fiscal 
stimulus made sense at that particular point.
    We are no longer at the point where businesses are not 
spending or households are not spending, so the extent of the 
fiscal stimulus I think has to be withdrawn, and that 
withdrawal needs to continue, which is already underway. And, 
therefore, we need to be transitioning from a situation where 
we are strictly looking at the demand side to I think we are at 
a phase at this point where we are looking to sustain some of 
the demand that is out there, but not nearly as heavily as we 
had.
    I think the key lesson that we did learn from the Great 
Depression from the 1930's is that you cannot have a failed 
recovery. That is what extended those downturns. And I think 
that is, you know, the concept behind a lot of the arguments, 
we need significant amounts of stimulus at this point. I do not 
think we need significant amounts of spending at this point, 
but I think we have to move more toward the combination of 
sustaining elements of those spending, but only those that 
translate into demand immediately and then move toward the tax 
side of the policy, the supply side of the fiscal policy, which 
looks to generate some initial demand but starts the process of 
laying the foundation for stronger growth.
    I do not believe that we are going to be seeing a whole lot 
of activity through the interest sensitivity of businesses if 
we lower interest rates. I do not think that--well, I look at 
the levels of interest rates right now, and I find it hard to 
believe that we are going to go a whole lot lower than we are 
at this particular point. And, you know, businesses will be 
looking at, you know, what the conditions are to make those 
investments and the return on them, not just the costs. And I 
think what Simon is really saying, and where I agree, is that 
what you need to set up is the intermediate-term and long-term 
stability so businesses can begin the process of making those 
investments. But I think, you know, the rest of this year, 
those investments are going to be very, very cautious 
regardless of what the fiscal stimulus will be, whether it is 
tax cuts or low interest rates. And it is only as we move 
through really the first half of next year and maybe even into 
the second half of next year that we will get to the economic 
portion of the cycle where tax cuts can become most effective 
on the business side. So I view it as a continuum in that 
respect.
    Chairman Conrad. All right. Senator Gregg.
    Senator Gregg. Picking up on those comments and those of 
Dr. Simon, essentially what you are saying is that the 
uncertainty issue and to a significant extent the short-term 
stimulus issue will be addressed significantly if we put in 
place policies which address the long-term debt issue so that 
people have confidence in the outyears as to where the country 
is going on the issue of debt. Is that true? Is that a true 
summation of what you were saying?
    Mr. Johnson. Yes, Senator, that is exactly what I am 
saying.
    Senator Gregg. Can I ask a question, again following up on 
that? You all talked about this issue of consumption as being a 
big driver, and that has always been--our Nation has always 
been a consumer society. But I see this recession as 
substantively different than any other that we have been in for 
a lot of reasons, but primarily because the baby-boom 
generation, which is the defining economic engine of the 
1960's, 1970's, 1980's, and 1990's--it was such a huge 
generation, so productive, driving so much of the wealth of the 
country--was right on the cusp of retiring when this recession 
hit. And a large percentage of the baby-boom generation 
retirement savings was in contributory savings as versus 
defined benefit plans. That shift had occurred throughout the 
1980's and 1990's.
    And so what happened here was that you had this huge 
generation, 70 million people, the population going from 35 
million to 70 million people, which suddenly found that all the 
money that they had saved for the purposes of retirement was 
significantly decreased in value, all their assets, by this 
recession. And now they are seeing some recovery of it, 
depending on how they were invested, but I think there is a 
fundamental mind-set shift in our Nation in this generation, 
which goes from consumption to savings to try to deal with the 
retirement they are into or about to start. But you are not 
going to see the consumerism that dominated our culture when 
this generation was so huge and was so productive and had an 
income. And, thus, you are going to see much less driving of 
the economy from the consumer side as this generation tries to 
adjust to the reality of retiring with less savings than they 
thought they had. Is that true? And if it is true, what are the 
implications of it?
    Mr. Berner. Senator Gregg, if I could answer that, I 
totally agree with you. I think that we are in a period now 
where--it is what I call a new age of thrift, responding to the 
loss of wealth that consumers have experienced, not only as you 
describe but obviously also in their houses and pension plans. 
And I think there is enormous uncertainty about the promises 
that have been made to consumers by governments, both at the 
State and Federal level, and at the local level. So all those 
things I think are coming to bear at the same time, and so we 
should not expect to see a consumer who is spending as before. 
I think the new normal, if you will, for consumer spending is 
going to be the 2 to 2.5 percent kinds of growth rates that I 
have described.
    We should look, therefore, in my view, to other parts of 
our economy, you know, to provide growth, and I think for the 
first time since the mid-1980's, we are likely to see global 
growth as a source of stimulus for U.S. growth, and we should 
rely on that. So that means we want to keep our markets open; 
we do not want to adopt protectionist measures. We want to 
encourage the kind of global rebalancing that is needed to 
reduce the size of our external deficits, to reduce our 
dependence on global investors to hold our debt, and at the 
same time encourage the growth of other economies who will 
provide markets for our companies to export to and will provide 
income for people to save and to rebuild their balance sheets.
    That is not an unsustainable environment. In fact, I think 
that is a more sustainable environment than the one we had 
left, where saving rates were declining, both national and 
personal, and where we can rebuild the foundation for a 
stronger and more sustainable recovery. But I think, 
nonetheless, there are things that we need to do short run and 
there are things that we need to do long run. I just want to 
express my complete agreement with the idea that we need to 
have a credible plan to address our long-term fiscal 
challenges. That will reduce uncertainty. The way we do that is 
also important. Whether we do that through higher taxes or 
reducing spending growth is extremely important, and we have to 
get our arms around the promises that we made for the future 
that we are going to have difficulty in keeping by cutting the 
growth of those programs.
    Senator Gregg. Thank you. My time is running out, and I did 
want to get in another question. But I have heard this argument 
before that basically our society is going to have to look to 
trade and that the trade is going to be with the rising 
nations, the BRIC countries, for example. And I understand the 
logic of it, but I am not sure I accept that it is going to 
happen as being the driver that maintains our type of economy. 
Maybe it will be; maybe it will not. I think energy policy 
probably plays even a bigger role in that issue.
    But let me ask you, Dr. Johnson, about this issue of 
scoring the contingent liability in the financial system 
correctly. It is almost a catch-22 because we are telling the 
banks and the financial systems they have to significantly 
increase their capital. And then we are hearing from the 
markets that there is no credit available because the banks are 
significantly increasing their capital. And if we went to an 
even more aggressive process of saying we must score the 
contingent liability out there and, therefore, we must actually 
see even higher capital levels, I presume you are assuming the 
way you mute this issue is by raising capital levels. You are 
going to even contract credit more.
    I mean, don't we have a catch-22 situation from the 
standpoint of fiscal policy here?
    Mr. Johnson. It is a great question, Senator. I do not 
think we do. There is a wonderful new authoritative paper on 
the effects of raising capital requirements by Professor Jeremy 
Stein of Harvard and Professor Anil Kashyap of Chicago 
University, which I commend and I will send to your staff. I do 
not think the effects----
    Senator Gregg. You can send it by e-mail.
    Mr. Johnson. OK. I do not think the effects are at all as 
portrayed by the banking community and as widely feared even by 
the U.S. Treasury. I think that what is going to come out of 
the Basel agreements, though, unfortunately, is very little by 
way of immediate raising of capital standards. And the quality 
of capital, which is more of an issue in Europe than here, but 
it is also an issue here, is going to be relatively low. So 
this is the ability of the financial sector to absorb losses.
    Given just as a political regulatory outcome I do not 
expect a lot of additional capital to be in the system, I think 
we should score the liability that this creates relative to the 
risks that it poses. That is your standard procedure for all--
--
    Senator Gregg. Well, we do not score a lot of things around 
here for real.
    Mr. Johnson. Well, this is 40 percent of GDP, so it is a 
pretty big one, which I think not scoring that one would be----
    Senator Gregg. So is Medicare's contingent liability. But 
just quickly, you do not subscribe to the view that if you put 
more and more pressure on the need to increase capital, which 
is, I accept, necessary in order to make the system sounder 
over the long run, that you are going to end up with 
contractions in credit.
    Mr. Johnson. The point made by Professors Stein and Kashyap 
is it depends on how you raise capital requirements. So if you 
look at the way in which it was done after the stress tests, 
for example, last year--you know, we can have plenty of 
reservations about the stress tests in general. But requiring 
banks to raise a certain dollar amount of capital is the right 
way to do this, and these would be phased-in requirements. You 
do not want to tell people you must change your ratio of 
capital to assets tomorrow, because then you will certainly get 
a big credit contraction.
    There are ways to adjust capital requirements. There are 
ways to make banking safer. Banking becomes less sexy, becomes 
less of a high-octane, high-risk, high-return activity. That is 
for sure. And some bankers like that and some bankers do not 
like that. But it changes the nature of banking and changes 
what a bank is as a financial asset. It does not necessarily 
cause a big credit contraction. That is what the experts say.
    Chairman Conrad. Senator Goodwin.
    Senator Goodwin. Thank you, Mr. Chairman, and I would like 
to thank you and Senator Gregg for your warm welcome. It is 
certainly my immense honor to follow in Senator Byrd's 
footsteps in serving on this Committee. And as I have said 
repeatedly over the past few weeks, although no one can replace 
Senator Byrd, what I hope to do is emulate his work ethic and 
his commitment to this Committee, the Senate, and the State of 
West Virginia. So thank you very much.
    Dr. Naroff, I have a bit of a tangential question for you. 
You alluded to some of the challenges facing our State and 
local governments in passing in your testimony, and I wanted to 
talk a little bit about the impact of the huge unfunded 
liabilities that so many of our State and local governments are 
facing.
    Now, I know in my limited experience in the State of West 
Virginia we were looking at billions of dollars in unfunded 
actuarial accrued liabilities in various pension retirement 
systems and other post-employment benefits. The State has 
strived aggressively and made courageous efforts to tackle that 
debt and amortize those liabilities over a period of years. But 
as you would expect, these decisions came at the expense of 
other spending priorities, priorities which were undoubtedly 
much more politically popular and needed in their own right.
    So my question for you is: What is the impact of these 
enormous unfunded liabilities that so many of our States and 
local governments are facing on future economic growth? And 
what sort of pressure does it place on the Federal Government's 
efforts to tackle these issues?
    Mr. Naroff. Well, that is really the thing that I think 
every State and local community is trying to get their arms 
around at this particular point, and there is no simple and 
quick resolution to that problem. I think that is the first 
thing to keep in mind.
    The unfunded liabilities in pensions, which States are 
simply not paying their shares to in order to have the 
temporary balancing of the budgets--and that is continuing and 
will likely continue--is going to mean that all of those, 
whether they were political or necessary, programs are going to 
have to be reviewed. So sometimes--and I think this is the 
time, you know, crises, if they are handled correctly, will 
create some fairly significant short-term pain, and I think 
that that is going to continue to be the case in State and 
local governments. But that is a pain that should have been 
felt over the last 5 to 10 years as these liabilities were 
building, but the unwillingness to recognize them continued.
    So my view is that at least in terms of Federal fiscal 
policy, I think the States need to come to grips with their 
spending patterns and their decisions and, to a very large 
extent, to the extent that they have to make the cuts that are 
necessary, at this point they need to get their fiscal houses 
in order.
    To the extent that there are some temporary cyclical issues 
that they might be eased through, then there may be a role for 
Federal policy. But for the most part, I think it is really 
time for the State and local governments to start recognizing 
that the costs that they have imposed upon themselves are just 
not sustainable anymore. And while I do not argue with some of 
the fiscal stimulus funds having gone to the States, because it 
was a sudden shock that you could not plan for, now they have 
had a couple of years to start dealing with that. And while you 
cannot address 10 or 20 years of fiscal irresponsibility 
overnight, I think they need to be forced to address those; 
otherwise, it never will end.
    Mr. Johnson. Could I just add and emphasize the importance 
of education in this entire adjustment process. I think what we 
are seeing at the State and local level is big cuts in 
education. If you think about the nature of our economy going 
forward and what we have seen over the past 20 years, the 
difficulties that people have if they do not get a college 
education, do not have at least 1 year of college education, 
how hard it is to participate in the modern economy, how hard 
it is to have wage growth.
    You know, Senator Gregg's idea that we move away from 
consumerism, we have other motors of growth, I think we all 
would support that. But increasing wage inequality, people with 
only high school educations or failing to complete high school, 
not being able to participate and get a decent job in a more 
globalized economy, for example, with the lack of skills that 
Mr. Berner has been emphasizing is just getting worse, because 
long-term unemployment causes all our human capital to go down. 
I think this is going to really come through as a huge weakness 
for our growth potential. But what can you do about it when you 
do not have space at the Federal level because of the longer-
term fiscal issues? That is the question. Unless you deal with 
the long-term fiscal issues, you cannot create the space to 
deal with these pressing issues such as education.
    Senator Goodwin. Thank you, Mr. Chairman.
    Chairman Conrad. Thank you, Senator Goodwin.
    Senator Bunning.
    Senator Bunning. Thank you, Mr. Chairman. Thank you for 
showing up, panel. A lot of brains sitting at one table.
    I would like to give you a quote from a former Federal 
Reserve Chairman who, in my opinion--my opinion--caused three 
major recessions in this United States with his monetary 
policy. On ``Meet the Press,'' he said that the U.S. is 
experiencing ``a pause in a modest recovery that feels like a 
quasi recession.''
    Do you agree with that characterization? What policies 
would you recommend to change that situation? What is the worst 
thing the Federal Government could do in this situation? 
Realizing that we have 15.5 million either full-time or part-
time unemployed people, 8 million of which were unemployed in 
the year 2009. So are we going to have any jobs to get them 
back to work? Are we going to be able to raise our economic 
level so that we can create those jobs?
    I would like anybody's opinion of that statement.
    Mr. Naroff. Well, let me start the discussion. I do not 
necessarily think it is a pause. I think that given the 
headwinds, given the damage done by the blow-up of the housing 
market and the near collapse of the financial sector, the idea 
that we could get anything more than a modest, you know, slow-
growth recovery I think was unrealistic. It was hopeful. The 5-
percent growth we got at the end of 2009 was largely just 
making up for excessive inventory cuts and investment cuts that 
were done at the peak of what we could call the panic in the 
first half of 2009. Except for that, I think this 2-, 2.5-
percent growth forecast, which I have and I think the others 
are not far off of, is likely to be sustained. So I do not see 
it as a deceleration necessarily in growth or a pause in growth 
as much as that is the reality of what we are facing given the 
damage done to the economy.
    Senator Bunning. Anybody else on this statement of Dr. 
Greenspan?
    Mr. Johnson. I agree. I do not think it supports--I think 
it is slow growth. It is a disappointing recovery. It is 
probably one of the slowest recoveries we have had since World 
War II. You need to deal with the long-term----
    Senator Bunning. Let me give you--Dr. Johnson, you are a 
member of CBO's panel of economic advisers. I am sure that you 
are aware CBO has predicted that economic growth will actually 
fall by 1.4 percent if the 2001 and 2003 tax relief is allowed 
to expire. Why does CBO predict that it would slow down our 
economy? I am looking to get it going faster, and by removing 
the tax cuts of 2001 and 2003, it is CBO--I want CBO to be 
realized as the independent scorekeeper here. You have 
predicted that a 1.4-percent decrease would occur.
    Mr. Johnson. Senator, I am on the panel of economic 
advisers. I am not responsible for the----
    Senator Bunning. I did not say you were, but maybe you can 
explain that.
    Mr. Johnson. Yes, sure. It is a sensible proposition that 
if the tax cuts expire completely, that will have an effect of 
slowing down the economy. By the way, if you are worried about 
stimulus, you should look at alternative ways of stimulating 
the economy. It is not clear that if you----
    Senator Bunning. I have looked at them.
    Mr. Johnson. And I for one expect and would support 
partially continuing some of the tax cuts. I think that would 
be a----
    Senator Bunning. Kentucky has got a $2 billion shortfall--
$2 billion out of an $18 billion budget over a 2-year period, 
and they are coming to the Federal Government for $240 million 
extra--are you kidding me?--so their budget can be balanced. 
What if all 50 States did the same thing?
    Mr. Johnson. Well, Senator, we are obviously in a very 
difficult place from a fiscal point of view. I am not 
advocating unconditional massive transfers at the State level. 
My point is if you had an agreement on the longer-term budget, 
then that would create fiscal space that you could choose 
whether----
    Senator Bunning. I agree 100 percent.
    Mr. Johnson [continuing]. Or additional spending. But that 
is the problem. If you do not deal with the long-term issues, 
you have got a potential credibility issue, and the financial 
markets, much as they may like you now and let you borrow 2-
year treasury notes that are at record lows, that will not 
continue indefinitely if they do not----
    Senator Bunning. Not if we have economic recovery, it will 
not. You obviously know that zero to one-quarter of 1 percent 
is what the Federal Government is borrowing short-term money at 
right now. Zero to one-quarter of 1 percent. What will happen 
if we do get some kind of economic recovery? Won't our 
borrowing go up some?
    Mr. Johnson. Yes, and I would also emphasize, compared to 
other countries, we have a lot of relatively short-term 
borrowing. The average maturity on our debt is 4.4 years. So, 
yes, these are very real risks, Senator. I am not playing them 
down at all. I am emphasizing they all push in the same 
direction, which is you need a longer-term fiscal consolidation 
framework. Without that, we are really asking for trouble.
    Mr. Naroff. And I also believe that when you look at the 
2001 and 2003 tax cuts, you should look at that in the context 
in which those tax cuts were actually implemented. It was a 
totally different economy, a totally different situation as far 
as budget----
    Senator Bunning. I do not disagree with that at all.
    Mr. Naroff. And some of those tax cuts made total sense at 
that time. Under the current set of circumstances, they simply 
may not create any new economic activity. And that is my point 
about evaluating each of those cuts individually to see whether 
they make sense in either sustaining them or allowing them to 
sunset in the context of where we are today.
    Senator Bunning. I have one more question. I just want to 
get it in before my time is up.
    We have heard time and time again that consumer spending is 
weak because consumers save rather than spend any additional 
income. You all said the same thing. Is this not a result of 
cheap money over the last decade where we have achieved a 
negative real savings rate and the average American is already 
vastly overextended? How can we expect consumer spending to 
have increased when the debt levels are so high?
    Mr. Berner. Well, Senator, that is in part why, you know, 
some of the remedies that we are talking about here involve 
helping consumers reduce those debt levels in a responsible 
way. And if we afford them the opportunity to----
    Senator Bunning. Are you talking about forgiving their 
debt?
    Mr. Berner. Well, in some cases, Senator, you know, when 
you are in very deep difficulty, either there will be 
forgiveness or there will be a default. So those are the 
choices.
    Senator Bunning. Are those the 18 percent that send their 
keys in?
    Mr. Berner. Those are the 18 percent that send their keys 
in, plus the ones who are foreclosed upon because----
    Senator Bunning. Well, sure, because the bank has to 
inherit that decreased value.
    Mr. Berner. So the choice we face is whether to let that 
process continue at the pace that it has gone and to have 
housing markets that continue to suffer, or whether we can 
choose policies that may speed up the process where the burden 
of the cost of that is shared between borrower and lender and 
taxpayer in a sensible way so that the situation we face now 
can be mitigated.
    Obviously, if we were to choose to rewind the tape and we 
were to choose to do things differently, we would have. But 
given that where we are involves these----
    Senator Bunning. I wish we could rewind the tape.
    [Laughter.]
    Mr. Berner. We all do, Senator.
    Given where we are, we have a set of not-so-good choices 
from which to pick, and that is where we are.
    Mr. Johnson. I agree with you, Senator, I think, on your 
overall assessment of the Federal Reserve's policy the way it 
led us here, including what Mr. Greenspan did, and the fact we 
are prone to repeat this because we have the same structure----
    Senator Bunning. Well, I understand that, and my complaint 
to Chairman Bernanke is the hesitant way in which the Fed has 
proceeded with the debt level that we have. And his balance 
sheet is now $2.8 trillion. I mean, I have a hard time getting 
my hand around $2.8 trillion on the balance sheet of the 
Federal Reserve. And what he does is he goes out and buys 
treasuries to sustain the treasury market, and that is how he 
fills up his balance sheet. So it is a very dangerous policy.
    Thank you.
    Chairman Conrad. Thank you.
    Senator Begich? And let me just say to all members, I have 
been very liberal today with everybody.
    Senator Bunning. Thank you.
    Chairman Conrad. No, Senator Bunning, I did not treat you 
any differently than anybody else.
    Senator Gregg. Progressive.
    Chairman Conrad. We have gone over with everybody but 
Senator Goodwin. We appreciate very much your discipline. So I 
am going to treat everybody else the same way to--you are going 
to be able to go over by a couple of minutes, at least.
    Senator Begich?
    Senator Begich. Mr. Chairman, thank you very much. Thank 
you for that comment. I leaned over to Senator Goodwin, and I 
said, ``You get credit points because you left time on the 
clock, which we will all consume.''
    Thank you all for being here. First, let me give you a 
little context. I represent the State of Alaska. I have been in 
the small business world since the age of 16, and my wife owns 
and operates four small businesses. We have built these 
businesses from scratch, so we understand what real life is 
about. It is great to hear all the theory and the discussion, 
but we have lived it, we have experienced it, and we have seen 
it in both good times and bad times. So I wanted to give you a 
little context there so as my questions come out, you will 
understand where I am kind of trying to drive to. And also it 
seems we have a short-term memory on the 1980 recession when, 
if you were a small business person and you wanted any money 
out of the market, you were paying 19 points on prime plus, 
depending on what customer rate you were. People forget that. 
You talk about seizing up capital, that was an unbelievable 
time. Banks still wanted to loan you the money because it was a 
good return, but businesses were not anxious to touch it 
because of the rates and it was all short term.
    In Alaska in the 1980's, we saw half a dozen, up to maybe I 
think eight banks, disappear overnight literally. We saw 
probably 20,000 people leave our State in less than 6 months. 
So we have seen what can happen. We saw in Anchorage, the 
largest city in the State, its assessed valuation almost cut in 
half because of real estate. Sad to say I have been in the real 
estate business also for all this time, so I have seen it come 
and go.
    This recession, we did not lose anybody. No banks failed. 
We had the highest unemployment in probably two decades, but 
now 3 months have gone by, and we have ratcheted down I think 
by almost six-tenths of a point, going the right direction.
    We have had housing pricing now moving up about 14 percent, 
which is very positive. Still, our new starts are very low, and 
I think that is what is experienced around the country. We 
learned something from the 1980 crash: diversification, focus 
on job growth, and quick stimulation to get money into the 
economy but look long term.
    So here is my first question. Do any of you agree with this 
statement: that the first thing we need to have is certainty in 
our debt, our tax policies, and spending? And when I say 
certainty, not just for the next election cycle but long term. 
Does anyone disagree with that?
    [No response.]
    Senator Begich. OK. Silence is approval. That is how I 
operate.
    The second question is: In order to move the economy 
forward, do any of you disagree that the combination of your 
ideas, some short term and long term, is what is necessary, not 
one or the other? Does anyone disagree with that?
    [No response.]
    Senator Begich. OK. Now I am going to throw some ideas out. 
I want to see your response, and I am going to thank the 
Ranking Member, Senator Gregg, and Senator Wyden who have 
proposed a piece of legislation on tax policy, because I also 
heard--and correct me if I am wrong here--different levels of 
what those tax cuts should be or should not be implemented. I 
did not hear anyone said all of them 100 percent. What I heard 
was variations.
    So why not, instead of battle over that, which will be a 
bunch of special interest debate and discussion of which tax 
cut gets who, which one will benefit, what is the level, why 
not just reform the system? And the Gregg-Wyden piece of 
legislation on tax reform is dramatic, and I do not know if any 
of you have looked at it. But it seems like that sends a 
message to the business world we are bringing some down into 
the middle class, that we are protecting them, and 
simplification, which brings confidence level back into the 
consumer. And to me the biggest number I am interested in, 
unemployment is, you know, watching--it is consumer confidence. 
If people are not confident, they are not spending one dime. 
They are not investing.
    So give me first your thought on the Gregg-Wyden bill. Then 
I have another one, which is the Mark Udall bill, which is on 
credit unions who are capped on what they can invest or use to 
put out into the marketplace, right now 12.5 percent of their 
capital for small business loans. This would raise it to 25 
percent, without putting one Federal dollar into it, just 
taking their capital and putting it out into small businesses.
    So, first, Gregg-Wyden, anyone want to comment on that tax 
policy?
    Mr. Berner. Senator, why don't I start? Gregg-Wyden would 
greatly simplify the Tax Code, which is something we all would 
like to see. It would add certainty to tax policy. And it would 
take away a lot of the special preferences that are built into 
the Tax Code. You know, all those things economists will tell 
you are good things.
    Senator Begich. And the business rate that is--correct me, 
Senator Gregg. I think it is 24 percent, if I remember that 
number right.
    Senator Gregg. That is correct.
    Senator Begich. That gives competitive edge to one of the 
questions you all said was our ability to compete worldwide.
    Mr. Berner. Right, and that would more or less level the 
playing field with respect to other countries. It would broaden 
the tax base, which is extremely important in thinking about 
how we want to deal with our fiscal problems going forward. And 
so by taking away some of those preferences, it is going to 
hurt some people, but it would broaden the tax base, collect 
more revenue, give us a more stable tax system. All those 
things are to be desired.
    Moreover, when you think about how we got to where we are 
in housing, for example, it was not just easy credit. That was 
certainly a contributor. It was not lax underwriting standards. 
That obviously was a contributor. But tax policy had a role to 
play in it as well, and we have endorsed that in the past as a 
society. Maybe it is time to rethink that so that we can 
rebalance our economy and have more resources for other things 
like education, like productivity-enhancing investment. Clearly 
we do not need more housing in terms of the stock of housing 
right now.
    Senator Begich. That is true. Inventories are high.
    Mr. Berner. Right. And so as we think about the role that 
tax policy can play in all that, you know, I commend you to 
advance that argument in the Congress and your leadership in 
doing it.
    Senator Begich. Anyone else want to comment?
    Mr. Johnson. I do.
    Senator Begich. Then I will come back on the Udall one just 
quickly, but go ahead.
    Mr. Johnson. I must admit I have not studied this bill. I 
will remedy that this afternoon.
    Senator Gregg. I will e-mail it to you.
    Mr. Johnson. Thank you. I think, as I said before, now is 
the moment for tax reform for exactly these reasons, and the 
advantage is because we have such an antiquated, painful 
system, it is going to be pretty compelling to many people that 
this is a good idea.
    I would hope that we have on the table versions of the 
value-added tax proposed by Greg Mankiw, for example, which I 
think are very sensible and middle of the road. We need to look 
at all the tax breaks hid in spending programs, including the 
mortgage interest tax deduction, as Mr. Berner said.
    Carbon pricing has to be on the agenda. Looking out 20 
years, that is your horizon for this budget, your budget 
thinking, and you can decide what to do with the revenue. You 
can use that to reduce other parts of your taxation if that is 
your priority. But this is an important issue going forward for 
energy.
    And the financial activities tax, which is a form of value-
added tax for the financial sector, as proposed by the IMF, 
again is an idea that will not come quickly, but will come over 
the next 20 years. It will come through the G-20, for example, 
and we should be including that in a 20-year tax reform 
planning horizon.
    Mr. Naroff. I cannot argue with that at all. I am now a 
small business myself, and----
    Senator Begich. That is good and bad. You will be working 
20 hours a day.
    Mr. Naroff. My accountant loves me and I do not like the 
accountant, for obvious reasons.
    You know, this is not a tax system that anybody would ever 
sit down and want to create from day one. And, you know, 
either--the problem we face in the issue of what do you do 
about taxes, what do you about the 2001 or the 2003? Do you do 
them all?
    Senator Begich. Right.
    Mr. Naroff. It is the simple fact that we start with the 
current system, and if you start with the current system, you 
have to move from that current system in evaluating any changes 
that you make. And under those circumstances there are always 
winners and losers. And that is what I think creates, you know, 
the havoc in any tax policymaking at this point.
    Massive reform, if it is at all done, would get around all 
of those individual decisionmakings. I do not think it is a 
good thing to simply say, well, we will keep all the 2001 and 
2003 so we do not get into the discussion on it, because there 
is a lot of those taxes that will have limited or no impact on 
the economy and, you know, in the context of the budget deficit 
just be a loss of additional revenues.
    So by restructuring it to a large extent, you get away from 
these crazy debates that are always going on, and that would be 
wonderful.
    Senator Begich. Well, thank you very much. I would ask you 
about the Mark Udall bill, but I do not want to take up any 
more time, Mr. Chairman. But I appreciate the comments because 
I am in this--kind of growing into this camp that, you know, 
spending our time messing with these old cuts and trying to 
figure out what is right, what is the right number, who is in, 
who is out, when really that will not change the confidence 
level in the consumer. And part of this equation is that 
consumers have to feel--and I say consumer and business. Both 
are the same in this context. And it seems to me it is time to 
just rejigger it and have the community feel like maybe we have 
done something long term here that brings certainty to the 
business world, but also to the consumer, the middle class, who 
will determine spending habits or not.
    And so I appreciate all of your comments, and I will leave 
it at that, Mr. Chairman. Thank you very much.
    Senator Gregg. Mr. Chairman, I would just like to 
congratulate the Senator from Alaska for his insightful, 
thoughtful, substantive line of questioning. But, more 
importantly, I look forward to passing him the torch of this 
effort on tax reform, which is critical.
    Senator Begich. Thank you, Mr. Ranking Member. Thank you.
    Chairman Conrad. Senator Nelson.
    Senator Nelson. You all testified that you do not think 
that the tax cuts in the stimulus bill had much effect. Tell us 
whether you think the spending in the stimulus bill had as an 
effect.
    Mr. Naroff. Well, I am not sure I completely agree with the 
Blinder/Zandi totals there. But, you know, I look at it in the 
context of, you know, the strategy that they took, that if we 
did not have it, what would the economy look like, which is one 
way of looking at it. Clearly, the other alternative is if you 
took the same amount of money and you spent it in different 
ways, whether through different tax cuts or different 
spendings, you would also have a different outcome.
    But since all we had was that set of policies, I think it 
is hard to disagree that there was a significant impact, I 
think nothing close to what we had hoped when you spent the 
kinds of money that we spent, and a lot of that is still being 
spent, and I think that needs to be kept in mind.
    I think some of the concepts in terms of infrastructure 
spending made sense because I think most of us would agree that 
if Government is going to spend money, you want to spend 
something that provides long-term returns to the economy, and 
nothing does that better than infrastructure. But there is a 
lot of other spending that just simply transition the economy 
from 2000 into 2008 to where we are right now, but I think you 
have to say that it has a moderate effect and really kept us 
out of a significantly longer and deeper recession.
    Senator Nelson. Do the rest of you agree?
    Mr. Berner. You know, you get different bang for the buck 
out of different kinds of spending, Senator, and unfortunately, 
I think a lot of the spending that was done in haste and in an 
effort to help the economy get out of the recession, to help 
State and local governments who were hit with the shock of the 
downturn, you know, probably was not as productive as it could 
have been.
    I agree about the infrastructure spending piece. We need 
enormous infrastructure repair. We need a program of 
infrastructure repair in this economy that goes beyond short-
term stimulus. And providing aid to State and local governments 
in the form of FMAP or other assistance was a short-term 
measure that probably avoided some job cuts. But there are 
other, more efficient ways to deploy Federal resources in terms 
of thinking about fiscal stimulus. I have identified some of 
them.
    Mr. Johnson. Senator, I testified to this Committee in the 
run-up to the discussion of the fiscal stimulus, and I said at 
that time I am not a proponent of discretionary fiscal 
stimulus. But this is an unusual time, and I think the sense 
that we all had in that discussion was that something was 
needed to bolster confidence in the U.S. economy.
    I think as I look at Table 2 in the Blinder and Zandi 
paper, I think that the money was spread in some sensible ways. 
Of course, infrastructure spending was pretty small, actually, 
in terms of the spend-out. I think it was a good mix. I think 
it was a one-off. I do not think you can go back and do this 
sort of thing again. It was a very unusual problem. Hopefully 
we will never see it again in our lifetimes. I worry that we 
will. I worry that we have not fixed the financial sector and 
will have to go back to a point where we have to throw money at 
a problem in a sense to prevent it from becoming much worse. 
And, roughly speaking, it works in the short term, but it 
stores up lots of issues for the future, including the debt, 
including the financial sector.
    Senator Nelson. Mr. Chairman?
    Chairman Conrad. Yes, sir--
    Senator Nelson. Do you remember when we tried to get a lot 
more infrastructure spending?
    Chairman Conrad. Yes, sir. That is what the Ranking Member 
and I were just saying. We tried to get $200 billion.
    Senator Nelson. Let me ask you--these two esteemed 
gentlemen right here, the Chairman and the Ranking Member are 
on this Deficit Reduction Commission, which I hope and pray is 
going to be successful, but since they have a threshold that 
they have to get 14 votes of 18 on the Commission, there is a 
lot of skepticism that they are going to be able to get that on 
whatever the package is that they come up with.
    So if that skepticism bears out to be true--which I hope it 
does not, and I am prepared to vote yes on their package, and I 
have not even seen it yet because I think, as you all have 
testified, we have got to do something about the deficit. But 
if it fails, what happens? What do we do?
    Mr. Berner. Senator, I am not sure that we have room for 
failure because, as Simon and Joel have talked about--and I 
have would echo their concerns--ultimately global investors who 
hold 55 percent of debt held by the public are going to 
register their vote in financial markets, and they will look at 
our inability to deal with our long-term fiscal problems, and 
they will look at the lack of credibility in our willingness to 
deal with those problems. And that will raise the cost of 
borrowing not only for the Federal Government long term, but 
also for businesses and households here as well.
    Moreover, the debt service that will grow over time will 
take increasing resources out of our economy that we can use 
for other productive means. And so that is the longer-term cost 
of not addressing our fiscal problem.
    Senator Nelson. And creates an uncertainty and lack of 
confidence----
    Mr. Berner. Correct.
    Senator Nelson [continuing]. In the U.S. Government's 
ability to manage its financial affairs.
    Dr. Johnson?
    Mr. Johnson. To go back to Senator Gregg's point about 
Greece at the very beginning, according to the IMF's numbers, 
Greece's general government gross debt--this is the numbers 
which have the best comparable measures--was in 2010 133 
percent of GDP; the United States by the same measure is close 
to 93 percent of GDP. So I think this is the answer--what 
happens if it does not work? You have some time. But you do not 
have a lot of time; however long it takes you to get from 90 to 
133 would be a rough measure.
    Obviously on net debt terms, it is not quite as bad, not 
quite as dramatic, but you know what the trajectory is. The 
pressure will make us change sooner or later. We should do it 
now. We do not want to be forced, like the Greeks are being 
forced or the Spanish are being forced, to do things in a 
precipitant manner. That is really bad for productivity and 
really bad for small business, bad for everybody. Do it now 
when we still have plenty of time. That is the right approach.
    Mr. Naroff. If you want to know what it is going to look 
like, look at most of the States. They have hit that point 
right now, and, you know, they are scrambling exactly in the 
way that you commented in order to deal with the expenses that 
have basically overwhelmed them, and that is what we will have 
to be doing.
    You know, to some extent that may force coming to grips--I 
know Dick has, you know, harped on this several times, on the 
longer-term programs for retirees, medical costs and so on that 
we have put into the entitlement programs. Crisis may be the 
only thing to cause us to deal with them, but we should not 
wait--we should not have to wait until a crisis to deal with 
them, because they are not- -you know, when we reach that 
point, it will be, you know, fairly significant on the kinds of 
cuts that have to be implemented.
    Senator Nelson. And speaking of the States, we are going to 
vote on something today or tomorrow because the States have not 
provided the revenues in their States in order to fund their 
fair share of Medicaid or education. And so, of course, they 
come to us then in times like this and that want us to bail out 
those accounts and, of course, the more that we do that at the 
Federal level, the more we add to the national debt. It is a 
vicious cycle.
    Mr. Naroff. Well, it is worse than a vicious cycle in that 
it is creating the incentives not to deal with the problem, and 
that is what you do not want to do.
    Senator Nelson. That is exactly right.
    Thank you, Mr. Chairman.
    Chairman Conrad. Thank you.
    Senator Sanders.
    Senator Sanders. Thanks very much, Mr. Chairman. This is a 
great discussion, and if I did not have an appointment at 12 
o'clock, I would prolong it.
    I wanted to maybe inject an aspect to this discussion which 
I have not heard yet. We keep talking about the economy in 
general, but you know what? This is--or we are talking about 
taxes in general. But the reality of life in the real world is 
somewhat different.
    For example, during the Bush years, median family income 
for the average American went down by $2,200. Seven million 
people lost their health insurance. Eight million people 
dropped out of the middle class and went into poverty. So while 
the middle class is shrinking and poverty is increasing, in 
this general abstract world that you are talking about, not 
everybody has been hurting, because during the Bush years, 
among other things, the people on top did very, very well. I 
think the top 400 wealthiest people in this country saw a 
doubling of their income. We now have a situation where the top 
1 percent earn more income than the bottom 50 percent, and in 
terms of wealth, we have the most unequal distribution of 
wealth in the industrialized world. The top 1 percent own more 
wealth than the bottom 90 percent. So we are not talking--and 
we talk about tax reform. Does anybody in their right mind 
think that you are going to have equitable tax reform here in 
Washington where we are going to be descended on by all kinds 
of lobbyists representing the wealthiest people and loopholes 
are going to be put in and it is not going to happen? The rich 
and wealthy and large corporations have enormous influence over 
this institution. As a result of the Supreme Court decision in 
Citizens United, they are going to get more of their friends to 
be here representing--that is the real world. Sorry to, you 
know, bring forth some reality here.
    So now what we are talking about is we all acknowledge the 
economy is in terrible shape. We know that. And we all 
acknowledge that we have a very large national debt, $13 
trillion, an unsustainable situation, a $1.3 trillion deficit. 
But I would hope we can hear some discussion that as we move 
forward, we do not see pain brought all about. Why should 
working-class people who have already experienced pain be asked 
to experience more pain? Should we really raise the Social 
Security age to 70 for those people? Should we do, as I gather 
some want to do this week, cut back on food stamps when we have 
millions of families who are struggling to provide food for 
their kids?
    Let me suggest to you, as someone who believes the deficit 
is a serious problem, but also thinks that we have got to 
create jobs that our economy desperately needs. The American 
Society of Civil Engineers tells us that we have a $2.2 
trillion need for investment in infrastructure in the next 5 
years alone. I am a former mayor. Let me tell you something. 
The infrastructure does not get better--right?--unless you 
invest in it. Why are we not investing in it and putting people 
to work doing that?
    On the other hand, I do understand you cannot spend, spend, 
spend. You have got a deficit problem. Let me give you some 
situations here that I think we can address.
    About $100 billion a year--and the Chairman of this 
Committee has made this point many, many times--in taxes are 
avoided by large corporations and the wealthy by going to tax 
havens in the Cayman Islands. How many corporations existed in 
that one building, Mr. Chairman?
    Chairman Conrad. Eighteen thousand.
    Senator Sanders. A little bit crowded. A little bit 
crowded. It was hard to do their work with 18,000 corporations 
in one building. Now, it would seem to me if you can get----
    Chairman Conrad. It was five stories.
    Senator Sanders. Oh, OK. Then that is no problem.
    [Laughter.]
    Senator Sanders. But it would seem to me if--and the 
estimate, I think, Mr. Chairman, was something like $100 
billion avoided in taxes. So why aren't we beginning in a 
serious way to talk about that? In 2005 one in four large 
corporations paid no taxes at all. This year--ExxonMobil last 
year had a bad year. They only made $19 billion in taxes--$19 
Billion in profits. You know how much they paid in taxes this 
year? Zero. They got a $156 million refund from the IRS. That 
is the tax system that the IRS and big money has helped create.
    So my question to you is: Shouldn't we be focusing on 
creating jobs in infrastructure, stopping the absurdity of 
importing $350 billion a year of foreign oil, move toward 
energy independence, and at the same time go forward with 
deficit reduction in a fair and progressive way which does not 
hurt middle-class and working-class families? Dr. Johnson, why 
don't you start it? And I would like to hear from the others.
    Mr. Johnson. Thank you, Senator. Yes, of course, we can put 
more money into infrastructure, and I supported the Committee 
in that discussion over a year ago. It is not that easy given 
the way that our spending is set up. But that certainly is a 
sensible proposition.
    And in terms of tax reform, I think what is particularly 
interesting and intriguing about the value-added tax is that 
some of this idea is coming from people to the right of the 
political spectrum, like Professor Mankiw, as well as some 
people on the left, and how progress or regressive your VAT 
system is, we can see from the experience of other countries. 
It depends on how you design it, what exactly you are taxing, 
what are you zero-rating.
    It is a relatively hard tax to avoid. It is a tax that 
focuses on consumption rather than on income, which has 
sensible effects on incentives. And I am somewhat encourage 
that people are moving at the technical level in the direction 
of thinking hard about those kinds of proposals. Obviously, it 
is a political decision how regressive it will be, and I am 
rather on your side in thinking that the vested interests, once 
they get their hands on it, will distort it.
    I do think in all of the issues that you raise, one thing 
that we must not avoid is Medicare. So Medicare is, if you look 
out at the 30-year, 40-year horizon, that is a huge issue. And 
do we address Medicare, for example, by basing it on lifetime 
earnings, your access to Medicare?
    Senator Sanders. But Medicare is part of our health care 
system, and as you well know, we end up spending almost twice 
as much per capita on health care as any other major country on 
Earth, and our outcomes in some cases are not as good. So I do 
not think it is just a question of Medicare. It is a question 
of a health care system geared toward profit in which people 
are making all kinds of money out of it and not necessarily 
providing quality care.
    Mr. Johnson. Well, that is a very good point, Senator, and 
I am sure you are right, the health care system as a whole 
needs to be addressed. Unfortunately, it is the case if you put 
all the European Union health spending projections on a 
comparable basis to what the CBO uses--the IMF has done this, 
but it is not that widely known--their numbers are just as bad 
as ours in terms of containing future health care spending.
    So all the systems across the industrialized world have a 
very similar problem, which is the demographics and----
    Senator Sanders. Aging population.
    Mr. Johnson. The aging population and the increasing cost 
of medical technologies. And so the question is: To what extent 
do you give people access to those technologies later in life?
    Senator Sanders. But here we are getting back to the basic 
point. That is a reality. It is going to be a reality in 
Europe, a reality in the United States. People are getting 
older. Health care becomes more expensive. We want the most 
cost-effective best system we can. But I do not think in the 
midst of all of this--the point that I am making is we have got 
a whole lot of problems. Some of my good friends will end up 
concluding that the way you solve these problems is punishing 
working-class people, low-income people, middle-class people. 
That will ultimately be their solution.
    I think when you have a society which is moving in many 
ways toward oligarchy--I thought I heard laughter.
    Senator Gregg. I was asking who those good friends would 
be.
    Senator Sanders. Well, some of them sitting right in this 
room, some of them who think it is funny when we talk about 
oligarchy when the richest 1 percent own more wealth than the 
bottom 90 percent, and we see that trend growing even wider. 
That is what I would call oligarchy.
    But be that as it may, I think the key debate--and I think 
Senator Conrad earlier--I was watching on TV--you know, raises 
the issue. We have got a huge debt. We have got to deal with 
it. We have got a huge financial crisis. We have got to deal 
with it. How do you deal with it?
    Well, I would suggest that, everything being equal, unless 
we rally the American people, working-class, low-income, 
middle-class people, it will be dealt with. It will be dealt 
with by making the poorest people poorer. It will be dealt with 
by seeing the middle class decline even more. It will be dealt 
with by seeing the gap between the very rich and everybody else 
grow wider. I think we can do better.
    Dr. Berner, do you have thoughts?
    Mr. Berner. Sure, Senator, I think we can do better, and it 
is clear that the income inequality problem that you are 
talking about has been growing for a long, long time. It is 
clear that part of the source of that problem has to do with 
educational opportunities and other factors. And it is clear 
that Federal policy as well as policies at other levels of 
Government can do things to deal with that. But some of those 
things involve allocating resources away from some areas and 
into others, away from, as I think Simon indicated, more 
broadly health care so that we do get better outcomes at lower 
cost, so that we have more resources left over for education 
and infrastructure investment, both of which will provide jobs 
and human capital.
    Senator Sanders. Right.
    Mr. Berner. That is the kind of economy I think we want in 
the future, and, you know, what is required is your leadership.
    Senator Sanders. OK. Thanks very much.
    Dr. Naroff?
    Mr. Naroff. The problem we face right now--and I do not 
disagree with you in the least. You know, when people would say 
to me, well, you know, X percent of the top income are paying Y 
percent of the taxes, doesn't that show that the tax system is 
fair or is taxing heavily, and my comment is it can be done 
through either the structure of taxes or the structure of 
income, how it is distributed. And you have to know the reasons 
for the change and the move. And that is obviously the 
important factor.
    But the reality where we are right now is that we have no 
longer any wiggle room. Ten years ago, if the deficit went up a 
couple hundred billion dollars, it was not going to create 
major long-term crises as far as the economy is concerned. All 
our ratios were in good shape. We do not have that luxury right 
now. And what that tells me is that getting out of this slow-
growth environment and balancing--and moving to a lower level 
of a budget deficit is going to require some groups to pay 
more. It is the politicians that decide which groups to pay 
more.
    Senator Sanders. Well, or maybe the campaign contributors 
play a role.
    Mr. Naroff. Well, whatever. But the point is, you know, in 
the current set of circumstances, you know, who are the people 
that are not spending? And part of the problem is what I find 
most interesting is that when I give--I give lots of talks over 
the course of a year to business people and average groups, and 
I ask them how many think that the recession is still going on, 
and most of them still raise their hands. And most of these are 
middle to upper-middle class. A lot of them are business 
people, small business people, and they feel that. They do not 
feel that they are seeing what is going on. They are not 
getting the benefits of it.
    Senator Sanders. Right.
    Mr. Naroff. And, consequently, they are not spending as a 
result of that. So something that provides them with the 
impression and the reality that the economy is moving in their 
direction, to the extent that improves confidence, is going to 
improve spending and get us out of the----
    Senator Sanders. Right. Well, thank you all very much. Mr. 
Chairman, thank you for your indulgence.
    Chairman Conrad. Yes, thank you for your excellent 
questioning.
    I would like to go to this panel on a separate question, 
and that is, how we got into this mess, because I have my own 
view, and I am going to try it out on each of you. I would be 
interested in your reaction.
    You know, as I look back, it strikes me that we had a 
series of bubbles formed. We did not just have a housing 
bubble. We had an energy bubble, we had a commodity bubble, and 
the evidence is all around us. Housing, we all know what 
happened to housing prices. On energy, oil went to more than 
$100 a barrel. On commodities, wheat went to more than $20 a 
bushel. So that is evidence of bubbles forming in lots of 
different places in the economy.
    Well, how did we get so many bubbles forming 
simultaneously? As I look back, it seems to me you had an 
overly loose fiscal policy, the responsibility of Congress and 
the President; massive budget deficits in the good times. On 
the monetary policy side, you had an overly loose monetary 
policy after 9/11. We had unusually low interest rates for an 
extended period of time and substantial expansion of the money 
supply. And on top of it all, a policy of deregulation, so 
nobody was watching and nobody was enforcing laws that did 
exist and some of the laws were inefficient and insufficient to 
deal with the problems of, for example, an AIG.
    So when you have an overly loose monetary policy and an 
overly loose fiscal policy at the same time--which is very 
unusual in economic history, as I have studied it. Usually you 
have one or the other. It is unusual to have them both 
simultaneously. That provides the seed bed for bubbles to form. 
And so we got multiple bubbles. Ultimately bubbles burst, and 
there is enormous economic wreckage.
    I would just like to hear your observations on that view of 
economic history. Dr. Berner?
    Mr. Berner. Sure. Senator Conrad, I think that you are 
pretty much on target, and I would start with the regulation 
piece of it. We had inappropriate regulation in the financial 
services industry and financial markets. We now recognize that 
in hindsight. We are trying to deal with that.
    What we failed to understand was that, you know, the more 
we want our markets in other respects to be open and free and 
to allow for failure since the failure impinges on the 
financial system and on lenders, that requires more not less 
regulation, appropriate regulation of the financial system. It 
includes the appropriate capital and liquidity requirements. It 
includes the appropriate regulations ruling underwriting 
standards and all the rest of it.
    So as I was listening to you talk, I thought to myself, 
well, the dimension of monetary policy that was too loose was 
in the regulatory front, which allowed the credit bubble to 
form an excessive growth in credit. And the legacy of that 
bubble, if you will, is still with us because unless we defease 
or write off that debt against which the value of real estate 
and other things has gone down, then we are going to be stuck 
in a low-growth economy where we have misallocations of 
resources.
    So the misallocation of resources is also the legacy of 
that that we are dealing with, and, you know, we are going to 
have to deal with that. That is why I tried to----
    Chairman Conrad. Well, when you say misallocation of 
resources, what I understand you to mean by that, too much 
money into housing?
    Mr. Berner. Too much money into housing, both because of 
the things that you mentioned on a macro sense, but also 
because of the incentives built into the Tax Code that 
encouraged that. And I would point, for example, to the 1997 
act which changed the capital gains treatment of housing. That 
is something that most people have overlooked, but I think it 
encouraged churning in housing an added to the subsidies that 
we have for residential real estate.
    Chairman Conrad. Very generous treatment of capital gains.
    Mr. Berner. Very generous treatment. Now there are not any 
capital gains, so maybe we do not have to worry about that for 
a while. But the fact of the matter is that was the stance of 
policy, and so all those things, as you mentioned, came 
together, and that is why it is so appealing to think about 
using this moment not only to fix our long- term fiscal future 
to make it sustainable, but to address some of the things in 
the Tax Code through tax reform that would take away those 
incentives.
    If I could just take one more minute, Senator Gregg alluded 
to energy policy earlier, and I think that that is an extremely 
important aspect of what we are talking about here. For years 
and years, we have resisted the idea that we should have higher 
prices for energy, prices that reflected what they were in 
other parts of the world. And so we have subsidized, if you 
will, relative to other economies the cost of energy, and we 
have insisted on having low-cost energy. And as a result, we 
import a lot of our energy, and so that has added to our 
external imbalances and our dependence on overseas sources of 
energy.
    We have the power to correct that through appropriate 
policies, and so a focus on energy policy and the tax treatment 
of energy is something that we can deal with. And it means that 
some people will pay more, and we have to deal with that. But 
that is an important ingredient in thinking about where we are 
going in the productive use of those resources.
    Chairman Conrad. All right. Dr. Johnson?
    Mr. Johnson. So I also agree, Senator, with the broad 
outlines of what you put forward, but I would suggest putting 
it in a somewhat longer framework and actually talking about 
the repeated cycles or what the Bank of England now calls 
``doom loop,'' that we seem to be going through repeatedly. We 
had a big expansion in global credit in the 1970's, the debt 
crisis in 1982. Big expansion in loans to U.S. commercial real 
estate in the 1980's, the savings and loans crisis. Another 
emerging market crisis in the 1990's, 1997-98, and then we have 
a crisis based on U.S. housing.
    Now, all the specific pieces that pushed us toward a bubble 
in housing are absolutely there, and I would agree with that. 
But this is not a housing-specific problem. This is a global 
financial sector issue. And monetary policy and fiscal policy 
get sucked in there. Well, fiscal policy probably should be 
pushing hard the other way, but it is not, for reasons you well 
understand. Monetary policy, though, as Senator Bunning alluded 
to, gets pulled into the cycle where you have a financial crash 
and there is the Greenspan put. You cut interest rates in order 
to reflate the economy, and nobody wants high unemployment, and 
it is very costly. So then you go out and you do it again.
    Unfortunately, regulation over a 30-year period, as these 
cycles have continued, actually deteriorated in the United 
States and in some other key countries, particularly in Europe.
    I think the Dodd-Frank legislation pushes us back some 
distance, but not far enough, in my view, and there is too much 
reliance on these international negotiations through the Basel 
Committee on capital standards, which we have already 
discussed. Those, in my assessment from many sources, are not 
going to deliver much by way of substantial change in the 
incentives here.
    So that means we are going to run another version of the 
cycle. It will not be housing. It will be our banks. They will 
be at the center one way or another. It will be global 
probably, perhaps involving emerging markets. There will be big 
capital flows around. Again, fiscal policy should be leaning 
the other way and preparing for the worst. But, again, as we 
have been discussing, it is very hard even to agree that if we 
manage in a rosy, smooth-sailing kind of future, we cannot even 
agree on how to sort out the budget over a 15-year time 
horizon.
    Chairman Conrad. Dr. Naroff.
    Mr. Naroff. I think what you said is what economists say is 
a necessary but not sufficient condition for all the bubbles 
that were out there. It is a start. There is unquestionably--
you had to have a lot of--all of what you said to create the 
bubbles. And it was not even limited to tax policy. It was not 
limited to regulation. If we just look at the tech bubble, 
which was largely a private sector bubble where there were 
massive amounts of private sector capital that got 
misallocated. And what concerns me is that it is really, I 
think, the structure and the functioning of the financial 
system whereby almost anything can be securitized and almost 
anybody can invest in almost anything at this particular point.
    So while capital flows to the greatest return, it tends to 
flow to the greatest short-term return in a given period of 
time rather than the greatest long-term return. And I think 
that that is the implication that we have gotten from the 
bubbles that are formed here, that we are looking--you know, 
capital is flowing not in a long-term direction. We are looking 
for the shortest-term gains. It is the idea that, you know, 
universities can invest in energy futures as part of their 
endowments as a way to make money. You know, is this really a 
long-term investment that makes a whole lot of sense for a 
university to make in their endowments? But they do it because 
there is a rate of return there that they can take advantage 
of.
    So, you know, while you can talk about all the things you 
have, I am not sure you get around it unless you deal with the 
way that the financial sector itself allows capital flow, and I 
am not sure how you do that without interfering with a lot of 
the good parts of the relatively free flow of capital that is 
out there.
    Mr. Berner. Could I answer that? Maybe it is because of 
where I sit that----
    Mr. Naroff. I was going to say Dick may disagree with my 
commission here, but go ahead.
    Mr. Berner. No, I do not disagree because obviously there 
is a balance. You know, the euphoria of creating credit and 
more leverage obviously creates economic activity, and it feels 
great while it is happening, but the point is there is a 
balance. And there is no handbook that gives us the exact 
number for that balance, but in financial institutions, you 
know, an appropriate level of capital that mitigates risk and 
that enables people to earn returns, that is where we can find 
that balance. In the financial system as a whole, we can find 
that balance. So does it make sense, just to pick housing again 
as an example, to lend money the way what we did? Obviously 
not.
    If you look to the north and you look at the Canadian 
financial system, you see that they have a requirement where 
nobody gets a mortgage loan with less than 20 percent down. You 
can put up more than that if you would like, but, you know, 
while 20 percent is arbitrary, it is sensible. And so, you 
know, common sense I think tells you where the regulations 
ought to be without being too precise about them and to limit 
the amount of leverage. No leverage is not good because it 
stifles growth. Too much leverage has left us with the kind 
of----
    Chairman Conrad. Hangover.
    Mr. Berner [continuing]. Problems that we have. And while I 
did not come from New Hampshire, I grew up in New England, so 
that is where my values come from.
    Chairman Conrad. I grew up in North Dakota. I was raised by 
my grandparents. My grandfather said, ``If you cannot put 20 
percent down on a house, you have no business buying it.''
    Mr. Berner. There you go.
    Chairman Conrad. Senator Gregg.
    Senator Gregg. That was my amendment in Committee and it 
lost.
    Chairman Conrad. I supported it.
    Senator Gregg. I wish you had been there, Doctor.
    I just have one last question here. Dr. Johnson, you have 
on a couple of occasions, maybe three, mentioned Medicare as 
being one of the key elements of our long-term issues, and I 
think you alluded to the issue of how we deal with the 
technology and the expense of the last 6 months of life, for 
lack of a better term, which the Chairman has mentioned on 
numerous occasions.
    Do you have any specific proposals in the Medicare area 
that could be useful to the financial commission that were not 
incorporated in the original bill, the health care bill?
    Mr. Johnson. No, unfortunately. I think this is a tough--
and I have spent time talking to leading health policy experts. 
I will share the names with your staff. There are obviously 
some indications, both within the VA system and within the 
private sector, Kaiser Permanente, for example, of health 
organizations that have really managed to get a grip on health 
care costs without severely or perhaps significantly 
compromising quality of care. But these experiments have proved 
very hard to replicate, and I think we do not actually 
understand how Kaiser Permanente, for example, in some 
instances has been so successful in cost control and not been 
able to replicate that within their own organization in other 
cities.
    This is a very tough problem, and I am not saying there are 
at all easy solutions here. I wish that I had a magic bullet 
for you, but I do not.
    Mr. Berner. Actually, Senator, if I can interrupt there, 
there is, as you probably saw yesterday, the report from CMS 
that outlined the potential savings in Medicare that might come 
out of some of the changes that have been already proposed. But 
it seems to me, as important as Medicare is, I would point to 
the bigger problem of Medicaid, because Medicaid is the example 
of how our fiscal federalism is really broken. The States 
always come on the downturn to the Federal Government for 
assistance because the Medicaid rolls expand and because their 
revenues go down, and then you are asked to give them more 
assistance. So that system does not have permanence, it does 
not have stability over the longer term. If you think about 
Medicaid as a program, that is one that needs desperate 
attention.
    More broadly, if you look in--Simon and I are both on CBO's 
commission, as I think Senator Bunning mentioned, advisory 
panel. If you look at in the CBO budget options book, you will 
see one big option that stands out, and I am sure you know what 
I am going to talk about, and that is, the tax treatment of 
health care benefits. And if we address that tax treatment in 
the broader context of our tax system and in the broader 
context of looking at health care, as difficult as I know that 
is, that is going to be something that both helps our deficit 
problem and changes the incentives for health care.
    Senator Gregg. Well, you are actually talking to the choir 
on that point.
    Mr. Berner. I understand that.
    Senator Gregg. I appreciate your time. You have been an 
excellent panel. Thank you.
    Chairman Conrad. Thank you very, very much, Dr. Berner, Dr. 
Johnson, Dr. Naroff. We very much appreciate the time and 
effort that you have extended and the assistance you have 
provided this Committee and this Senate. Thank you very much.
    The Committee will stand adjourned.
    [Whereupon, at 12:08 p.m., the Committee was adjourned.]


      ASSESSING THE FEDERAL POLICY RESPONSE TO THE ECONOMIC CRISIS

                     WEDNESDAY, SEPTEMBER 22, 2010


                                       U.S. Senate,
                                   Committee on the Budget,
                                                    Washington, DC.

    The Committee met, pursuant to notice, at 10:09 a.m. in 
room SD-608, Dirksen Senate Office Building, Hon. Kent Conrad, 
Chairman of the Committee, presiding.
    Present: Senators Conrad.
    [presiding], Nelson, Stabenow, Begich, Gregg, and Sessions.
    Index: Senators Conrad, Nelson, Stabenow, Begich, Gregg, 
and Sessions.

OPENING STATEMENT OF HON. KENT CONRAD, U.S. SENATOR FROM NORTH 
                             DAKOTA

    The Chairman. First of all, I want to apologize. I was just 
on a lengthy call with the Vice President on other matters, and 
it was something that had to be dealt with because he is about 
to get on a plane. So I apologize.
    But I want to welcome everyone to the Budget Committee. 
Today's hearing will focus on the Federal Government's response 
to the economic crisis. We will examine the effectiveness of 
the Federal response and what lessons have been learned.
    Our witnesses are Dr. Alan Blinder, professor of economics 
and public affairs at Princeton and the founder and co-director 
of the Center for Economic Policy Studies. Welcome, Dr. 
Blinder.
    Dr. Mark Zandi, the chief economist at Moody's Analytics, a 
good friend. Welcome. Good to have you here. Dr. Zandi has been 
to North Dakota at my invitation.
    Dr. John Taylor, is a professor of economics at Stanford 
and a senior fellow in economics at the Hoover Institution. We 
are delighted that you are here as well, sir. I am a proud 
graduate of Stanford myself.
    This is a really distinguished panel. I don't think we 
could have done better in terms of having a diversity of views, 
and we welcome you all and your testimony.
    I would like to begin by highlighting the two challenges 
confronting our Nation--the near-term economic weakness and the 
longer-term budget crunch and the need to get to focusing like 
a laser on our long-term debt. In considering the near-term 
challenge, it is important to remember the crisis we faced just 
2 years ago. By mid to late 2008, we were in the midst of the 
worst recession since the Great Depression.

[GRAPHIC] [TIFF OMITTED] T8156.166


    The economy contracted 6.8 percent in the fourth quarter of 
2008. Unemployment was surging, with 800,000 private sector 
jobs lost in January of 2009 alone. A housing market crisis was 
rippling through the economy, with home building and home sales 
plummeting and record foreclosures. Much of that still remains 
with us. And we faced a financial market crisis that threatened 
to set off a global economic collapse. Credit markets and 
lending were largely frozen.
    We have come a long way since then. The Federal response to 
the crisis, I believe, has successfully pulled the economy back 
from the brink, and this year, we have begun to see a return to 
economic and job growth, although much weaker than I think all 
of us would like to see.
    The key elements of the Federal response included actions 
by the Federal Reserve. Efforts to stabilize the financial 
sector started with the Bush administration and continued in 
the Obama administration, and then we had last year's economic 
recovery package as well.
    Two of our witnesses, Dr. Blinder and Dr. Zandi, have 
completed a study that measures the impact of that Federal 
response. To quote their report, they say, ``We find that its 
effects on real GDP, jobs, and inflation are huge and probably 
averted what would have been called Great Depression 2.0. When 
all is said and done, the financial and fiscal policies will 
have cost taxpayers a substantial sum, but not nearly as much 
as most had feared and not nearly as much as if policymakers 
had not acted at all. If the comprehensive policy responses 
saved the economy from another depression, as we estimate, they 
were well worth their cost.''

[GRAPHIC] [TIFF OMITTED] T8156.167


    The next slide compares the economic growth we have 
actually experienced recently with an estimate of the economic 
growth we would have experienced without the Federal response. 
I would note that the estimates of economic growth without the 
Federal response have been updated by Budget Committee staff to 
reflect revisions in the actual economic growth that were 
released after Dr. Blinder and Dr. Zandi submitted their 
report.

[GRAPHIC] [TIFF OMITTED] T8156.168


    As you can see depicted in the yellow bars, actual economic 
growth in the fourth quarter of 2008 was a negative 6.8 
percent. By the last quarter of 2009, economic growth had 
improved to a positive 5 percent. Growth has continued but has 
slowed, falling to 1.6 percent in the second quarter.
    In contrast, as you can see in the red bars, without the 
Federal response, the economy would have contracted far more 
sharply, as much as 10.1 percent in the first quarter of 2009, 
and we would never have returned to positive economic growth 
during this time period.
    The next slide shows the job picture following a similar 
trajectory. The green line on this chart depicts the actual 
number of jobs in our economy. We can see that in the first two 
quarters of 2010 the number of jobs has begun to increase 
again.

[GRAPHIC] [TIFF OMITTED] T8156.169


    The red line shows Dr. Blinder and Dr. Zandi's estimate of 
the number of jobs we would have had without the Federal 
response. According to their findings, we would have had 8.1 
million fewer jobs in the second quarter of 2010 if we had not 
had the Federal response.
    We see a similar picture in the unemployment rate. The 
green line on this chart shows the actual unemployment rate on 
a quarterly basis now hovering about 9.7 percent, still far too 
high. We have got to do more to create jobs, bring this rate 
down. But according to Dr. Blinder and Dr. Zandi, if we had not 
had the Federal response, the unemployment rate would now be 15 
percent and would continue rising to 16.2 percent by the fourth 
quarter of 2010.

[GRAPHIC] [TIFF OMITTED] T8156.170


    So, clearly, the Federal response to the economic crisis 
has had and continues to have a significant positive effect, 
but we are clearly not out of the woods yet. The economy 
remains unsteady and faces strong head winds. That is why in 
the near term, probably in the next 18 to 24 months, I believe 
we need to focus on providing additional liquidity to boost 
demand. We can't afford to repeat the mistake of the mid 
1930's, when recovery measures were curtailed too quickly and 
the depression was prolonged.
    Now let me be clear. That does not mean that we should be 
ignoring the looming budget crisis. Because the debt is the 
long-term threat, it must be confronted and it must be dealt 
with. The impacts on Federalspending from the retirement of the 
baby boom generation, rising healthcare costs, and our outdated 
and inefficient and noncompetitive tax system all need to be 
addressed. We need to face up to exploding deficits and debt.
    According to CBO, Federal debt could rise to almost 400 
percent of GDP by 2054. Of course, that would be 40 years from 
now. Nevertheless, that is a completely unsustainable course.

[GRAPHIC] [TIFF OMITTED] T8156.171


    What we should be doing now is putting in place deficit 
reduction policies that will kick in after the economy has more 
fully recovered, but very soon. And by establishing and 
enacting those policies now, we will reassure financial markets 
that the United States is confronting its long-term fiscal 
imbalances.
    This is what Federal Chairman Bernanke said earlier this 
year about the need for a credible plan to address the long-
term fiscal imbalance, and I quote, ``A sharp near-term 
reduction in our fiscal deficit is probably neither practical, 
nor advisable. However, nothing prevents us from beginning now 
to develop a credible plan for meeting our long-term fiscal 
challenges. Indeed, a credible plan that demonstrated a 
commitment to achieving long-term fiscal sustainability could 
lead to lower interest rates and more rapid growth in the near 
term.''

[GRAPHIC] [TIFF OMITTED] T8156.172


    I completely agree. That is why the work of the President's 
fiscal commission is important. As a member of that commission, 
I can attest to the serious work that is being done there. 
Senator Gregg, of course, serves on that commission as well.
    I remain hopeful that we will come up with a serious and 
credible plan to face up to our long-term deficits and debt. 
The steps that must be taken will not be easy, but they will 
pay significant dividends for this country.
    I turn to Senator Gregg now for his opening comments. And 
again, I want to apologize for starting this hearing late. I 
don't think in the time I have been chairman that has ever 
happened. But I apologize to Senator Gregg and my colleagues 
and the witnesses as well.

 STATEMENT OF HON. JUDD GREGG, U.S. SENATOR FROM NEW HAMPSHIRE

    Senator Gregg. Thank you, Mr. Chairman.
    We certainly understand that you had other issues which had 
to be addressed.
    Let me associate myself, of course, with the second half of 
your comments, as I have on many occasions, and your concern 
about the long-term deficit and debt of this country. And it 
is, as you have described, critical that we address this.
    On the first half, though, I have to kindly disagree. You 
have attempted to put lipstick on a pig. The fact is that the 
Federal response in this area has been woeful, misdirected, 
and, unfortunately, has probably aggravated the problem, in my 
opinion, rather than assisted the issue.
    I had an economics professor when I was at Columbia, who 
tolerated my appearing in his class on occasion, named Raymond 
J. Saulnier. I also had the good fortune to have a fellow named 
Arthur Burns as an economics professor. And Raymond J. Saulnier 
had this wonderful saying. He said sometimes you have got to 
evaluate problems by looking at what is intuitively obvious and 
reaching a conclusion.
    And what is intuitively obvious here is that the stimulus 
package was misdirected. It was a massive expansion in deficit 
and debt, which has energized some economic activity, but which 
basically ended up being walking around money for a group of 
appropriators here in the Senate. And I am an appropriator. So 
I say that with some generosity.
    But the fact is that the money was spent out over too much 
time, and it was not focused on capital formation. It was not 
focused on immediate return in the economy. And so, to the 
extent a stimulus should have occurred, it was a misdirected 
stimulus, in my opinion.
    And you can look at whatever models you want, but the fact 
is that the unemployment rate has not come down. It has gone 
up. And the unemployment rate does not appear to be coming down 
in the future at any significant rate or at least consistent 
with most recoveries.
    And why is that? Well, I believe it goes to the second part 
of your hypothesis, which is that the American people, and 
especially the folks on Main Street who create the jobs in this 
country, are looking at our Government and saying it isn't part 
of the solution. It is the problem. It is the concern for them.
    I have traveled throughout my State. I know you have in 
North Dakota. Every small business person I talk to is just 
worried to death about their coming costs in healthcare, just 
worried to death about it.
    You know, I was talking to a guy just a couple of weeks 
ago--last week, actually--last weekend, and he had a business 
that generates $2 million to $3 million a year. He is worried 
that he is going to have to pay $400,000 to $500,000 in new 
healthcare costs. He doesn't know where he is going to get the 
money. But he knows he is not going to expand until he figures 
it out.
    On top of that, you have got the financial regulatory bill 
which passed, which is forcing a contraction in credit across 
this country because it was misdirected in the way it addressed 
the fundamental underlying issue, which is real estate and how 
we deal with real estate. Instead of setting up a responsible 
approach toward down payments, it basically created a massive 
regulatory over-structure, which is going to cause contraction 
in the short term as the credit markets try to adjust to it.
    You couple that with the tax policy, which is--the Senator 
from North Dakota has correctly disagreed with--the idea that 
we should raise taxes in this economy is not a good idea. And 
yet that appears to be the thing that we may end up doing 
because that is the policy of the presidency, and that is 
causing people to have uncertainties about their future, their 
economic future.
    And then you throw on top of that this whole debt issue and 
the fact that most Americans look at this and they apply this 
test of intuitive--what is intuitively obvious, and they say it 
is intuitively obvious that we can't support our debt or our 
deficits, and there doesn't appear to be a plan to straighten 
it out. And so, they are worried. They are worried about the 
future of this country. They are afraid we are going to pass on 
a less prosperous nation than they have lived in and a less 
secure nation as a result of it.
    So my view is that in order to get the employment issue 
under control, we have to get the long-term problems that this 
Government is creating for the markets under control and for 
the guy or woman on Main Street who wants to create a job under 
control. We have to allow that person to be willing to go out 
and expand their business and take a risk without fearing that 
the Government is going to make it economically unfeasible for 
them to succeed either because of the costs which are being put 
on through regulatory burden or healthcare cost or because of 
the fear of taxes or because of the burden of the Government 
simply running up a debt it can't afford and knowing that that 
price is going to have to be paid by the productive sector of 
the economy.
    And that is intuitively obvious through inspection, and 
that is what we need to address.
    Senator Nelson. Mr. Chairman?
    The Chairman. Senator Nelson?
    Senator Nelson. I have to leave to go to a meeting, and I 
will be back. But in light of what both you and the ranking 
member have said, what is extremely important right now is the 
two of you and your deliberations in this deficit reduction 
commission. Can you give us a brief progress report of how that 
is going? And do we really have any hope when we come back in a 
lame-duck session that we can pass a package that will 
seriously address the deficit?
    The Chairman. I would just say quickly in response to the 
Senator's inquiry, the commission is working in a very serious, 
deliberative way. You know, I don't think anyone knows at this 
point if 14 of the 18 of us can agree on a plan because that is 
a requirement. If 14 of 18 of us can agree, that plan will come 
to a vote before the end of the year in the Senate and the 
House.
    I am hopeful, but we have not gotten to the point of 
considering options. We don't have a plan. So it is impossible 
to say at this point whether there would be agreement on a 
plan.
    But I am encouraged by the seriousness of the membership of 
this commission--six from the Senate, equally divided 
Republican and Democrat; six from the House, evenly divided 
Republican and Democrat; six appointed by the President, four 
Democrats, two Republicans. I think the membership of the 
commission really recognizes the seriousness of the 
responsibility that has been given to them.
    Senator Gregg?
    Senator Gregg. I would second the Senator's statement. 
There is a seriousness of purpose amongst all the 
commissioners. And I think we all appreciate the fact that it 
is critical that we put forward a product that is substantive 
and that the American people and the world markets will look at 
as a step in the direction of fiscal responsibility.
    But we are at 10,000 feet, and when you get down on the 
ground and put the details together, that is where the problems 
are, as the Senator from Florida certainly knows. But there is 
a real effort to try to do that.
    The Chairman. I thank the Senator for his inquiry. I thank 
Senator Gregg for his response.
    Let us go to the witnesses, and we will start with Dr. 
Blinder.

   STATEMENT OF ALAN S. BLINDER, PH.D., GORDON S. RENTSCHLER 
MEMORIAL PROFESSOR OF ECONOMICS AND PUBLIC AFFAIRS, FOUNDER AND 
  CO-DIRECTOR, CENTER FOR ECONOMIC POLICY STUDIES, PRINCETON 
                           UNIVERSITY

    Dr. Blinder. Mr. Chairman, Ranking Member Gregg, members of 
the committee, I would like to thank you for holding this 
hearing. I am going to confine my opening remarks to the 
historic subject of the hearing, the stated subject of the 
hearing--assessing the effects of the policies that were done 
in the past.
    I am sure we will come to the longer-run budget shortly, 
and I would like to compliment both of you for trying to do the 
right thing on this. The problem, of course, as you perceive, 
is that nobody quite agrees what the right thing to do is--
other than that the deficit should be a lot smaller than it is. 
And I, of course, agree with that, too.
    Roughly 2 months ago, Mark Zandi and I published a paper, 
which you kindly cited several times, showing, among other 
things, the quite large estimated effects of the panoply of 
anti-recession and anti-financial-market-crisis policies that 
were promulgated and/or enacted in 2008-2009. Now, Mark is 
right here, and he will speak for himself. But in my view, the 
two of us wrote this paper for a quite simple reason, and it is 
this. That the public, and especially the political, debate 
over the policy responses seemed to us long on rhetoric, short 
on analytics, and, in many important ways, discordant with the 
facts.
    In particular, both TARP and the Recovery Act were being 
branded as failures or worse, while we viewed them as 
successes, although not without flaws. In a politically charged 
atmosphere nearly devoid of quantitative appraisals--notable 
exceptions being some of the work of John Taylor, who is right 
here to speak about it--prejudice and assertion seemed in 
danger of being accepted as fact and reasoning. So it looked 
like there was a void to be filled.
    The estimates that we produced have been subject both to 
unwarranted praise by those who liked them and unwarranted 
criticism by those who didn't. Many of these attacks have 
actually been methodological in nature. So even though this is 
not really the right forum for a technical disquisition--and I 
won't give one--I do want to say a few things about the 
methodology that we used.
    Mark and I used a large-scale econometric model of the 
United States economy to estimate the effects of a long list of 
fiscal and financial policies. These models are complicated 
beasts, but for present purposes, there are only two important 
aspects.
    One, they are statistical representations of the economy 
based on past history. That is what we have to go on. Two, at 
bedrock, they are complicated algebraic renderings of the 
simple textbook models that you probably learned in Economics 
101, and certainly that I teach in Economics 101, though vastly 
more complicated in the details. A number of the criticisms 
derive directly from these two points.
    Models of the sort that the two of us used are called 
``structural model'' because they posit a structure of 
equations that allegedly describe the economy, and then they 
use real historical data to fill those equations with numbers. 
So they are not just conceptual frames, but they are actually 
numerical. By the nature of their construction, these estimated 
structural equations have to be tied closely to the data. If 
the models didn't fit past experience tolerably well, the 
equations wouldn't be there.
    Nonetheless, such models have been criticized on a variety 
of grounds, including that economists don't know the true 
structure and that they don't handle expectations about the 
future very well. And our work inherited those generic 
criticisms, which do have some validity.
    But when I think about this, I ask: What is the 
alternative? Some economists champion the use of purely 
statistical techniques that allegedly impose no structure at 
all but simply let the data speak for themselves. That might be 
a sensible approach when you are studying repetitive events 
that have happened many, many times in the past, but not when 
you are studying phenomenon that have never happened before, 
which we were.
    It is true that models based on history might be poorly 
equipped to deal with events that are outside the range of 
previous experience. Statisticians call this ``out of sample.'' 
The sensible version of this criticism warns against placing 
too much confidence in out of sample results, and we agree with 
that. But what, other than displaying appropriate modesty, is 
one to do about it?
    The silly version of this criticism would ignore the 
discipline imposed by the data, which are the facts, and simply 
assert the answers based on a priori reasoning. That approach 
allows either ideology or technical fascination to triumph over 
admittedly fallible science.
    Modern economic theory and econometrics offer a variety of 
alternatives to the brand of Keynesian economics that is 
embodied in the Moody's model that we used and in other models 
of that style. Some academics reject the Keynesian approach 
entirely for reasons that need not detain us here, though I 
think we will probably hear some of them in Professor Taylor's 
testimony. And that attitude has spawned several criticisms of 
our work as ``old-fashioned.''
    Now, I must say that as I approach my 65th birthday, I feel 
compelled to say that old ideas are not necessarily bad ideas. 
The question should not be whether it is old-fashioned or 
newfangled, but whether it is close to a description of reality 
or far. As examples, I have noted in the testimony that both 
the Declaration of Independence and Adam Smith's invisible hand 
date from 1776. I count them both as very good ideas, but very 
old-fashioned.
    Everyone agrees that all statistical models are fallible. 
So it is incorrect to say, as some of our supporters have, that 
Mark and I have ``proven'' or ``demonstrated'' that these 
policies had large effects. No, that is not right. We just 
estimated the effects to be large with a statistical 
representation of the U.S. economy. Other such representations 
would give different estimates, as thoughtful critics such as 
John Taylor have pointed out.
    One last methodological point. Some critics have argued 
that the counterfactual that we used in our thought experiment, 
which was what would have happened with no policy responses at 
all--just laissez-faire--is either unrealistic or 
uninteresting, a kind of a straw man. We disagree with that 
criticism.
    In fact, every single policy initiative on that lengthy 
list of Table 1 in our paper had opponents who argued 
strenuously against it. In fact, one of them is sitting right 
here two seats to my left pretty much, and you will hear from 
John Taylor shortly.
    That brings me to current policy, very briefly. The 
recovery looks to be sputtering right now. Recent data may 
prove to be nothing more than one of those pauses that happen 
now and then during recoveries. I hope so, but I fear they may 
indicate something worse.
    I want to be clear. I am less worried about the feared 
double-dip recession, which doesn't look likely, than I am 
about the prospect that GDP growth will continue to undershoot 
capacity growth, widening the GDP gap instead of narrowing it, 
and that does look realistic, unfortunately.
    My conclusion is that monetary and fiscal policy should be 
spurring growth right now. Given the parlous state of the 
budget, it seems natural to rely on monetary policy, and we 
heard from the Federal Open Market Committee yesterday that 
they are certainly thinking in that direction. But if the Fed 
can't or won't do much more to spur growth, then I think 
Congress should.
    Now I realize that this committee is properly concerned 
about the budget deficit, as it should be. You all know that we 
are now on an unsustainable long-run fiscal path. But the 
deficit does not pose a short-run problem. The Treasury is now 
borrowing huge sums of money at extremely low interest rates, 
and it can borrow more. Today, I believe the jobs deficit is 
more urgent than the budget deficit.
    That said, the days of what I like to call the ``Field of 
Dreams'' strategy are over. The ``Field of Dreams'' strategy is 
build a bigger GDP, and the jobs will come. And that is the way 
we usually think about fiscal policy.
    Unfortunately, the ``Field of Dreams'' strategy has two 
serious drawbacks in the present situation. The first is 
obvious. It is working very slowly because firms are extremely 
reluctant to hire, for whatever reasons. Second, it is 
expensive, costing in the neighborhood of $100,000 of either 
government spending or tax cutting for every job that is saved 
or created. We need to do this job cheaper, given the state of 
the budget.
    To me, those two considerations point toward two policies, 
and I will finish by mentioning them. One is a substantial 
broadening of what Congress did earlier this year with the HIRE 
Act, a temporary tax credit for new jobs. The other is also 
temporary: public employment centered on relatively low wage 
workers.
    Simple calculations suggest that either of those options or 
both can create jobs with a price tag in the $30,000 to $40,000 
per job range, not $100,000 per job. And given where we are and 
where we have been, that seems like a pretty good deal to me.
    Thank you all for listening.
    [The prepared statement of Dr. Blinder follows:]

    [GRAPHIC] [TIFF OMITTED] T8156.038
    

    [GRAPHIC] [TIFF OMITTED] T8156.039
    

    [GRAPHIC] [TIFF OMITTED] T8156.040
    

    [GRAPHIC] [TIFF OMITTED] T8156.041
    

    [GRAPHIC] [TIFF OMITTED] T8156.042
    

    [GRAPHIC] [TIFF OMITTED] T8156.043
    

    The Chairman. Thank you.
    Dr. Zandi, welcome.

   STATEMENT OF MARK ZANDI, PH.D., CHIEF ECONOMIST, MOODY'S 
                           ANALYTICS

    Dr. Zandi. Thank you, Senator Conrad, Senator Gregg, and 
the rest of the committee, for the opportunity to speak today. 
My remarks are my own and not those of the Moody's Corporation.
    I am going to make three points in my time. Point No. 1, I 
believe that the policy response to the economic crisis was 
very successful. I think the merits of any individual aspect of 
the policy response--and of course, there were many--are 
debatable. If I were king for the day, I probably would have 
designed it differently myself. But the totality of the 
response was very impressive. And without that response, I 
think it is fair to say we would have suffered a 1930's-style 
Great Depression, and that is borne out in the results that 
Alan and I came together on in our study.
    Broadly speaking, the policy response had two objectives. 
The first objective was to stabilize the financial system, and 
the second was to jumpstart an economic recovery.
    In terms of stabilizing the financial system, let me focus 
on three particular aspects of the response, and I am going to 
illustrate it in the context of the spread between--the 
interest rate spread between 3-month LIBOR, which is the 
interest rate that banks charge each other for borrowing and 
lending to each other, and Treasury bill yields. This is the 
so-called TED spread. It is a very good measure, perhaps the 
best measure of the angst in the financial system, the banking 
system. And you can see prior to the beginning of the crisis 
back in early 1907, it was running around 20, 25 basis points, 
which is where we are today.
    And you can see the increase that occurred as the financial 
crisis gained steam. And then in the wake of the Lehman 
failure, the Fannie and Freddie takeover, it gapped out, 
peaking in October, early October at just under 500 basis 
points, 5 percentage points.
    Three key policy responses stemmed this financial panic and 
stabilized the system. A first was the Capital Purchase 
Program, which was the bank bailout, which was funded by TARP. 
The peak was $250 billion. That has been a slam-dunk success. 
Taxpayers are making money on the deal. The banking system is 
intact. Banks are lending to each other and beginning to lend 
to businesses and consumers.
    Without that capital from the Capital Purchase Program, 
which again was funded by TARP, the banking system would have 
collapsed, and the result would have been devastating.
    The second policy step I would like to point to is the 
FDIC's Temporary Liquidity Guarantee Fund, and you will note 
that on the precise day that that fund was implemented--October 
13th--that is the precise day that this TED spread hit its 
apex. This program was guaranteeing bank debt issuance. This 
addressed the liquidity problem in the banking system. Banks 
could issue debt. The liquidity problem faded very rapidly. The 
banking system found its bearings.
    And then the third policy step that I would like to point 
to would be the bank stress tests that were conducted in the 
spring of 1909, the results of which were publicly announced on 
May 7th. And you can see that they were very successful and put 
an end to the financial crisis, and you will note that the TED 
spread is now back to where it was prior to the crisis. The 
financial system has stabilized. I don't think there was any 
possible way that could have happened without the policy 
response.
    With regard to fiscal stimulus, in my view, it is no 
coincidence that the recession ended, the great recession ended 
precisely when the stimulus was providing its maximum economic 
benefit. The NBER, the National Bureau of Economic Research, 
told us earlier this week the recession ended in June of 2009. 
That is the precise month in which the stimulus spend-out was 
at its maximum, when the temporary tax cuts and spending 
increases were at their maximum, that precise month. It is no 
coincidence of the timing of this. The turnaround in the 
economy occurred exactly when the stimulus was providing its 
maximum benefit.
    Now, of course, the stimulus has many different moving 
parts. Some have worked better than others. I just want to 
mention one other, and that is the Cash for Clunkers. That was 
very successful. It ended a freefall in that very key industry, 
and it is very clear in this slide. You can see here this shows 
industrial production in the motor vehicle industry. That is 
the orange line, left-hand scale. And employment in the motor 
vehicle industry. That is the green line, right-hand scale.
    You can see the complete freefall in production that 
occurred during the recession. The precise bottom in production 
in jobs in the motor vehicle industry was August of 2009. That 
was the precise month in which Cash for Clunkers was in full 
swing. It is no coincidence. Cash for Clunkers worked. It is a 
very good example of a good program--very cheap, $3 billion--
that was very effective, and many of the other aspects of the 
stimulus were as well. So, in my view, point No. 1, the policy 
response was incredibly successful.
    Point No. 2, the recovery is intact. It is now over a year 
old, but it is very fragile. Growth has slowed. GDP growth, 
which has been 3 percent over the past year, is now tracking 
about half that--1.5 percent in Q3. That is still growth, but 
it is insufficient to forestall a further increase in 
unemployment. Unemployment will rise. The unemployment rate is 
9.6 percent. I expect it to drift back closer to double digits 
by year's end or early next.
    It should be no surprise that the recovery is a fragile 
recovery. Very well respected research has shown that in 
previous examples where countries have gone through financial 
crises like the one we have experienced, recoveries are 
difficult. They are not easy, largely because of the 
deleveraging that has to occur in the economy. People have to 
reduce their debt loads. Businesses and consumers have to 
deleverage, and in that process, it is a significant weight on 
economic growth.
    Moreover, it is not surprising that the benefit of the 
fiscal stimulus is fading. That is by design. The stimulus had 
its maximum impact back last summer or late last year, early 
this. The stimulus spend-out is now going back to zero unless 
Congress does more, and thus, you are going to see economic 
growth slow. So it should be no surprise.
    The slowdown has been more than I would have anticipated. 
In my view, that is largely the result of the European debt 
crisis, which undermined confidence at a critical juncture. We 
created 400,000 private sector jobs in April and May of this 
year. The European debt crisis hit in May and June. The stock 
market fell 15 percent. It knocked the wind out of business 
confidence, and hiring has stalled out. So that was something 
that no one expected. And it didn't derail the recovery, but it 
certainly has sidetracked the economic recovery.
    Finally, point No. 3, if one believes that the policy 
response was effective, and moreover, if one believes that the 
recovery is still too fragile, point No. 3 is that policymakers 
must remain aggressive. They should not exit out. At the very 
least, they should not exit out of their policy support for the 
economy until the recovery has engaged in a self-sustaining 
economic expansion. And my definition of that is a steadily 
consistently falling unemployment rate. Until that happens, I 
think it would be imprudent for policymakers to pull back.
    Let me quickly name, articulate three things that I would 
do in the very immediate term. First is decide what we are 
going to do about the expiring tax cuts. That uncertainty, I 
agree with the Senator, the policy uncertainty is a problem. 
The tax cuts, the uncertainty with regard to the tax cuts is a 
problem. We have got to nail that down.
    I would not raise anyone's taxes in 2011. The recovery is 
just too fragile. 2012, 1913, I don't think--when the economy 
is on sound ground, I think it is reasonable to allow the tax 
rates in upper-income households to rise. I think we need to 
address our long- term fiscal problems, and that has got to be 
at least part of that solution.
    Second, one easy thing that could be done is to require 
Fannie Mae and Freddie Mac to be more aggressive in 
facilitating mortgage refinancing. One of the ways the Federal 
Reserve is trying to help support the economy is to keep 
mortgage rates at record lows. The key link between those low 
rates and the economy, the most direct, fast key link is 
refinancing. That is disturbingly low, given the low rates. 
This can be easily facilitated. I would be happy to go into how 
that could be done if you care to go down that path.
    And then, finally, the third thing I would do, I would 
endorse a proposal that Alan gave. If we get into early next 
year and the recovery is not engaging and we are still 
struggling, I would advocate a payroll tax holiday targeted at 
companies that hire and add to their payrolls. The HIRE Act was 
insufficient. It was too small. It was too restrictive. It is 
not working. It could be quite effective if we did it in a 
better way, and I think that would be very important for our 
recovery next year.
    Thank you.
    [The prepared statement of Dr. Zandi follows:]

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    The Chairman. Thank you very much.
    Dr. Taylor?

   STATEMENT OF JOHN TAYLOR, PH.D., MARY AND ROBERT RAYMOND 
 PROFESSOR OF ECONOMICS, STANFORD UNIVERSITY, GEORGE P. SHULTZ 
       SENIOR FELLOW IN ECONOMICS, THE HOOVER INSTITUTION

    Dr. Taylor. Thank you, Mr. Chairman, Senator Gregg, for 
inviting me and other members of the panel.
    I want to first start out by reminding everybody of the 
obvious. It has been 3 years, more than 3 years since this 
crisis began in August of 2007, and the economy is still 
operating way below its potential. We have got an unemployment 
rate of 9.6 percent and a growth rate of 1.6 percent.
    What I have tried to do, and I will testify about this 
briefly, is to look at the impact of the policy responses to 
the crisis. But just on the face of it, it seems like they 
haven't done very good. But we have got to go beyond that and 
look at the details, look at the facts.
    For the last 3 years, we have been working on this at 
Stanford University, at the Hoover Institution, trying to look 
at all aspects of these policies. And I have listed on three 
pages of my testimony, which I would like to refer to, a 
summary of that research. It is empirical. It is fact based. It 
is looking at the details of as many programs as we can 
possibly do. And based on that, I come to some conclusions, 
which I am prepared to defend.
    First, if you look at the fiscal policy response to the 
crisis, it has been mainly in the form of what I would call 
discretionary short-term stimulus packages. In my view, these 
packages did not stimulate the economy much, if at all. And I 
based my conclusion on empirical research, looking at the 
specific actions taken.
    So, for example, some part of the stimulus package was to 
send checks to people or to temporarily reduce their 
withholding. When you look at these changes, you don't see any 
impact on consumption in the aggregate. In other words, the 
purpose of these changes was to jumpstart consumption and 
thereby jumpstart the economy.
    You can look at the timing. You can look at the increases 
in the income associated with this, and you see almost no 
changes in consumption at those times. So, again, if you look 
at the details, you don't see the impact of these policies.
    Another big part of the stimulus packages was to increase 
Government purchases. We have the various kinds of models that 
might predict that those increase in Government purchases would 
stimulate demand and stimulate the economy. Well, here, I also 
find very little impact on the recovery. And if I could ask you 
to look at page 3 of my testimony, I have a couple of charts, 
which I think illustrate this quite well, and if I just could 
dwell on these for a minute or so?
    The chart at the top shows real GDP growth. That is the 
blue line. Real GDP growth, and you can see how it plummeted in 
the recession and how it has recovered to some extent, but it 
is slowing down again now. You can also look at how much 
Government purchases has contributed to those changes in 
growth, and you can look at other parts of spending that has 
contributed.
    The top part of the graph shows the contribution of 
investment--business fixed investment, inventory investment--to 
those changes in real GDP. They are part of real GDP. So the 
Commerce Department tabulates these data, and you look at them 
very clearly, and what you can see is the recovery, to the 
extent we have had one, has been due to investment.
    If you look at the bottom part of the chart, you can also 
see how much of the contribution to this up-and-down, down-and-
up in the economy has been due to purchases, both at the 
Federal level--non-defense Federal purchases are indicated--and 
also at the State and local level. And you see almost no impact 
of these changes. So, to me, this is what I mean by looking at 
the facts, looking at the numbers, and there is very little 
impact.
    Now you might ask, how could an $862 billion package have 
so little impact on Government purchases? Well, the truth is, 
much of this package has not been in Government purchases. 
Believe it or not, in the six quarters since the package has 
been in place the total amount of Federal purchases for 
infrastructure projects has been $2.4 billion. That is 0.3 
percent of the total package.
    Now more of it could have been at the State and local 
level. After all, the package did send grants and aid in 
capital grants to the States. But if you look at this, you see 
very little connection between the grants being spent and the 
infrastructure that is actually being constructed. It is very 
hard to trace any difference, and my statistical work shows 
very little connection. So I think that is why you see that 
this just really has not worked.
    Now you can also use models, and Professor Blinder and 
Professor Zandi have looked at models. The problem with 
models--and I have been a modeler for almost my whole career--
is that you get different models, and they disagree. So the 
work that has been used by Blinder and Zandi uses a particular 
model--Mr. Zandi's model, I believe. But if you look at other 
models, you get different results.
    In January of last year, when the administration put out a 
study to show that the stimulus package would work, my 
colleagues and I did a study showing with another model, a 
model we favored, that it wouldn't have much impact, maybe a 
quarter of the amount or a fifth of the amount.
    And so, you could look at models--the IMF has a model. They 
have very small impacts. So the models differ, and that is why 
I think it is so important to go beyond the models--models are 
useful--but go beyond the models and look at the data 
themselves.
    Now, of course, the other big part of the Federal response 
was monetary policy, and I have looked at this extensively. I 
don't have time to look at the details, but I think it is 
useful to divide the crisis, which again began in August of 
2007, into three periods. The first period I will call the pre-
panic. That occurred from August 2007 until the panic in the 
fall of 2008.
    Then you had the panic, and that was when the stock market 
plummeted. The interest rate spreads that Mark Zandi showed you 
rose tremendously. That is the panic. And then you had the 
post-panic period, which I think really begins in November of 
2008.
    So if you look at the policies in these three periods, I 
look at the pre-panic period. I see the impact of the monetary 
policy actions as not being very constructive. The Fed used its 
balance sheet to bail out some firms and not other firms. It 
established some programs which drew attention away from 
counterparty risk in the banking sector and I think ultimately 
was part of the reason we had this panic in the first place, 
the confusion over those ad hoc bailouts.
    Then you had the ending of the panic, which I believe was 
finally when the TARP was clarified what the TARP was used for. 
There was tremendous uncertainty in the first 3 weeks after the 
TARP was proposed. That was the panic period. As soon as it was 
indicated that the money would be used for equity injections, 
the panic stopped, and we saw mass improvements.
    I think some of the Federal Reserve's actions during the 
panic period were helpful in stemming the panic. But if you 
think that they may have caused the panic in the first place, 
you might not applaud so much.
    And then, finally, in the post-panic period, these are the 
large-scale purchases of assets by the Fed, the mortgages. My 
estimates, my statistical work on this shows that they did not 
have very much effect on reducing mortgage spreads, and those 
are based on looking specifically at the risk premiums in the 
mortgage market.
    So it seems to me that you look at these details, these 
packages did not do very much good. In fact, now with the 
legacy of the debt, the legacy of the uncertainty in the 
economy that they have caused, I think very well they could be 
causing harm and holding back the recovery.
    There were other policies that could have worked better. In 
fact, in testimony before this committee almost 2 years ago, 
November 2008, I recommended a set of policies. First of all, 
there would have been a commitment not to raise taxes for the 
foreseeable future. I hope that can still be a policy.
    Second, it would have been to make President Obama's 
middle-class tax cut permanent. It was a temporary tax cut. Why 
would you do that? It doesn't affect the economy much at all. 
Should have made it permanent. That is what I recommended.
    Should have had a Government spending policy that was 
dedicated to moving up the spending that was already on the 
books in a responsible way that laid out then a policy to get 
the budget deficit down in the long run. Not wait until now or 
not to wait until the commission has finished. It would have 
been far much better.
    But instead, rather than being predictable, the policy I 
think created uncertainty. Rather than being permanent, we had 
these temporary changes, and that is why we don't have a 
lasting recovery.
    So I think the good news is that we can change things. We 
can go back to the kind of principles that we know have worked 
in the past and get away from these temporary targeted types of 
policies, which are really leading to uncertainty and, I 
believe, holding the economy back.
    Thank you very much.
    [The prepared statement of Dr. Taylor follows:]

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    The Chairman. Thank you, Dr. Taylor, for your thoughtful 
comments.
    You know, this is very healthy. This is the kind of debate 
we need. I wish this kind of debate, this kind of discussion 
were more prevalent more broadly in our society at this point.
    You know, I don't know why it is that we seem to get off on 
tangential, insignificant issues. This is what the American 
people deserve to hear, this kind of discussion at this level. 
So I thank the three of you for contributing in a serious way 
to a discussion.
    The first thing I would like is to give each of you a 
chance to respond to anything that you heard from others 
testifying here that you--something you heard that you feel 
should be responded to. Dr. Blinder, anything that you heard 
here from Dr. Zandi or Dr. Taylor that you would want to take 
issue with or respond to?
    Dr. Blinder. Just a couple of things. I am sorry. Very 
briefly, a couple of things that Dr. Taylor mentioned, starting 
with the last.
    He is quite correct that when it comes to income taxes, 
though not to many other kinds of taxes, if you make the cut 
temporary, you dull its effect. But I don't think you eliminate 
its effect. I think there is lots and lots of evidence that 
cash income matters. But you do reduce the effects.
    The problem, however, is where you sort of started the 
hearing, that we are in a simply horrendous long-run fiscal 
position and unable to afford permanent tax reductions anymore. 
I don't think we could afford the ones we did in 2001, 1902, 
1903. But we certainly can't afford more, given the state of 
the economy, and that is what leads you to temporary.
    And under that heading, it is sensible to come up with 
ideas where temporariness may either not undermine or possibly 
even enhance the effectiveness of a tax cut. For example, the 
liberalization of depreciation, if done on a temporary basis, 
probably has stronger effects than it does if it is done 
permanently.
    Following that point, the argument is often made that well, 
you are just pulling spending forward, so you will create a 
dearth of spending later. That is true, but it is not an 
argument against the policy. Recessions are not going to last 
forever.
    Anti-recession policy is, in large measure, about pulling 
spending forward to fill in holes that we have on the belief, 
supported by lots and lots of evidence, that economies do 
recover on their own and are going to need support in the 
future, although they need it longer in really deep recessions, 
such as the one we are having.
    That is germane, for example, to tax Cash for Clunkers 
program that Mark Zandi was speaking about. Yes, it pulled 
spending forward and caused there to be less automobile 
spending after the Cash for Clunkers program expired. That is 
what it was supposed to do.
    Now, I think Congress made it much too short. I don't think 
it made a lot of sense to pull spending 3 months forward. We 
needed to pull it a year forward or something like that. But 
nonetheless, the principle was correct.
    The Chairman. Dr. Zandi?
    Dr. Zandi. I would like to focus on an area of agreement 
that I have with Dr. Taylor, and that is with regard to the 
need for consistent and clear policy. And I think the need for 
this is vividly illustrated in what Dr. Taylor labeled the pre-
panic period. I do think it is fair to say that the lack of 
consistency with respect to how policymakers treated financial 
institutions during that period is what caused the financial 
crisis to devolve into a panic, beginning with Bear Stearns, 
extending to Fannie Mae and Freddie Mac, to Lehman Brothers, 
and then some of the other subsequent failures.
    Each institution was treated very differently, and it 
created a great deal of uncertainty in the minds of creditors, 
who ultimately provide the liquidity to the financial system 
that makes it all work. So they just ran for the door.
    So it was that lack of consistency and clarity that I think 
precipitated the panic and the mess that we got ourselves into. 
We would have had a financial crisis regardless and a recession 
regardless, but we got a panic and a great recession because of 
those missteps. So I would agree with that, and I think that is 
important to try and guide policy going forward. I think it is 
now very key for policymakers to try to provide clarity and 
consistency, that the uncertainty is a real problem.
    I am not arguing that we shouldn't have had these big 
debates in healthcare reform and financial regulatory reform. 
How could we go through a financial crisis and not have 
regulatory reform? You may disagree with the reform we got, but 
we had to go through it. It is just part of the process, and I 
think, in my view, ultimately, it will be therapeutic.
    But at this point, I think it is very, very important that 
policy work much more judiciously so that everyone knows what 
the rules of the game are. Because, otherwise, businesses 
aren't going to start deploying that cash, and we are not going 
to get the job creation that we need.
    The Chairman. Dr. Taylor?
    Dr. Taylor. One of the problems with the temporary policies 
that Professor Blinder is referring to, in addition to the fact 
that they don't stimulate consumption very much, is that they 
don't get the economy growing. It is not true that you want to 
have policies that just push some money out there and then take 
it away. That is not--we want a strong, growing economy, a 
sustainable growth.
    So, for example, keeping the tax rates from rising now. 
That is something that affects incentives, that affects longer-
term growth, businesses can plan for the next 2, 3, 4 years. 
And so, I think the permanency has to do with predictability, 
and it is very important to stress.
    I would just say one other thing in terms of permanent 
leaving, say, the tax rates where they are for the foreseeable 
future. I think it is important to note that we have had a 
massive increase in Government spending recently.
    Just some statistics--last week, I had an op-ed in the Wall 
Street Journal, along with George Shultz and Michael Boskin, 
John Cogan and Allan Meltzer, kind of outlining a strategy for 
the future. But we noted that Government purchases as a share 
of GDP were 18.2 percent in 2000. They are now 24 percent. And 
as you know from the chart, CBO is projecting they are going up 
to 30, 40, 50, and who knows what.
    So 18.2 percent in the year 2000. They are now 24 percent 
of GDP, and they are going up. I think there is a lot of room 
here on the spending side, and that is really the problem with 
our deficit. It isn't the taxes.
    Thank you.
    The Chairman. Senator Gregg?
    Senator Gregg. Thank you, Senator Conrad.
    Gee, so much has been said here that is thoughtful and 
extraordinarily informative, but also very, hopefully, listened 
to. This is an exceptional panel of talented people--Princeton, 
Stanford. I know that Dr. Zandi would want to affiliate himself 
with Dartmouth because it doesn't appear to be identified with 
anybody.
    [Laughter.]
    The Chairman. You will have your chance, Dr. Zandi.
    Senator Gregg. One message I think I am hearing, and 
disagree with me if I am wrong, is that to the extent temporary 
is done in this type of an atmosphere where we are facing a 
long-term debt crisis of inordinate proportions, it should have 
been coupled with long-term action that corrected the long-term 
debt crisis, as well as addressed a temporary solution. Is 
there a consensus that that was what we should have done?
    Dr. Zandi. In an ideal world, yes.
    Dr. Taylor. Yes.
    Dr. Blinder. Yes, but, and it is the ideal world. Having 
participated in the frenzy of redoing the Federal budget, a 
thorough-going deficit reduction program at the beginning of 
the Clinton administration, I think to have asked the Obama 
team, in addition to all the short-run things they were doing, 
to also remake the Federal budget in 6 weeks would have been 
asking a lot.
    Senator Gregg. Yes, but that is when they had the 
opportunity and we probably had the Congress, which was ready 
to act, hopefully, because it was a new Congress----
    Dr. Blinder. I agree with that in principle completely.
    Senator Gregg. And as a very practical matter, an economic 
recovery is--I think a lot of people have been talking about 
uncertainty--would have been significantly increased and would 
be significantly increased if we could give some certainty to 
the American people and to the international community that we 
were actually going to address our long-term financial 
problems. Is that not true?
    [Witnesses nodding.]
    Senator Gregg. I will take the nods as yes. Which we 
aren't. I mean, it is a simple statement, but we haven't done 
it.
    The Chairman. Can I just give them a chance to answer your 
question because the nods will never be captured on the record.
    Senator Gregg. OK. Please, to what extent is getting some 
long-term action--getting some action on our long-term fiscal 
instability critical to a stronger, healthier economy that 
produces jobs? If you could just give us your one-sentence 
thoughts on that?
    Dr. Zandi. I think that would be critical. I think if we 
could do that, that would lay the foundation for much stronger 
economic growth and much stronger growth in our living 
standards for a long time to come. That would be a vital thing 
that we could do.
    Dr. Taylor. I agree. It would have to be credible, of 
course, not just a matter of laying out a plan. An especially, 
I think, bad approach would be to say we will start in 2 years. 
You have got to start when you make the plan. I think that 
would be very helpful in terms of creating certainty.
    Dr. Blinder. Well, I think--I do agree that it is important 
for the long run. The tricky aspect of this comes exactly where 
John Taylor just finished off, which is what do you do about 
the short run?
    The economy is not in a position where it can take a fiscal 
contraction right now, whether that means higher taxes or lower 
spending. So the key difficulty facing the Congress now, I 
think, is to legislate or in other ways lock in future deficit 
reduction. This is a hard thing to do, as you all know. Again, 
in an ideal world, that is exactly what you would do. You would 
commit the Government to do substantial fiscal contraction, 
starting a few years from now. But since you don't do it now, 
that is hard to make credible, quite hard.
    Senator Gregg. Dr. Taylor, you made one statement that sort 
of startled me because I didn't realize this number was so out 
of whack. You said that in the first six quarters of the 
stimulus, only $2.4 billion has gone into infrastructure, of 
the $861 billion, which is actually $1.1 billion when you throw 
the interest rate cost on top of it. Is that correct?
    Dr. Taylor. Yes, that is the Federal--at the Federal level, 
and that is data produced by the Bureau of Economic Analysis. I 
can give you the tables for that.
    Senator Gregg. No, I just wanted to confirm that number. If 
the stimulus had been--let us take a threshold assumption here, 
which a lot of my colleagues and maybe myself wouldn't even go 
to. But if the stimulus was going to be done, shouldn't it have 
really pushed the money out the door on infrastructure 
improvement for long-term benefit and for immediate activity?
    Dr. Taylor. Absolutely. I think there were lots of projects 
that had passed cost-benefit tests that were useful. Probably 
some of them were process already. They could have been brought 
forward so you actually get the people with the jobs at the 
start. And for many reasons, this has been delayed. I think 
sometimes this is the way Government works. It is hard to----
    Senator Gregg. Well, you are absolutely right. That is the 
way Government works. When this stimulus was put together, so 
much of it basically became, as I said earlier, walking around 
money for appropriators. You had your program that you had been 
trying to fund for years. You hadn't been able to find the 
money. Suddenly, you funded it, and the funding may be spent 2 
or 3 years from now.
    Well-intentioned programs, but I don't think they really 
encouraged economic activity, and I don't think they went--
another corollary issue which infrastructure does, which is it 
makes us a more competition nation of capital investment.
    Dr. Zandi. Senator, can I make a quick point about that?
    Senator Gregg. Sure.
    Dr. Zandi. The total amount of infrastructure spending 
appropriated in the all of the stimulus back to the Bush tax 
rebates, if you total up all the stimulus, all the money 
appropriated, it is $1.1 trillion. That is the total amount of 
stimulus. Of that, $38 billion was infrastructure spending. So 
it was always a very, very small piece of the pie.
    Senator Gregg. That was a problem. My point is that was why 
the stimulus----
    Dr. Zandi. And even under the best of circumstances, it is 
hard to see how you get that out quickly if you want to make 
sure that you are doing good projects.
    Senator Gregg. Well, there are a lot of bridges that need 
to be fixed in New Hampshire. We had a highway director when I 
was Governor who said about the bridges ``drive fast and don't 
look back.'' So----
    [Laughter.]
    Senator Gregg. He was a good director. He just shouldn't 
have been quoted so often.
    Just on aside here, I was interested in your chart which 
showed the effects of TARP and your argument that the TARP was 
a slam dunk. It has obviously become a pejorative because I 
think it has been misrepresented as to what it actually it did, 
and terminology has picked up its own purposes as versus being 
tied to what actually it did.
    But, really, the bringing down the LIBOR rates was purely 
an exercise of intervention by the Treasury through TARP, by 
the FDIC, and by Federal Reserve action, wasn't it?
    Dr. Zandi. Yes. Those actions were key to restoring 
financial stability, which was represented in the narrowing of 
that spread.
    Senator Gregg. They weren't tied to the stimulus 
initiative, however?
    Dr. Zandi. No. That is a separate policy response.
    Senator Gregg. Right. I mean, the two policies get wrapped 
up together.
    Dr. Zandi. Yes. Yes, I am sorry. Yes.
    Senator Gregg. One was trying to address a crisis where we 
were at a cliff. We were going over the cliff, or we were on a 
bridge that was about to fall in, and we decided to fix the 
bridge. The other addressed the issue of economic activity----
    Dr. Zandi. But I should say in the work that Alan and I did 
and the results that were presented, they represented the 
impact of both aspects of that response, the stimulus as well 
as----
    Senator Gregg. Right. I noticed you had a whole lot of 
things in there, and I was just trying to separate out the 
parts that I happen to think actually worked right----
    Dr. Zandi. OK.
    Senator Gregg [continuing]. Which was the TARP part and the 
financial intervention by the Fed and the FDIC to stabilize the 
financial markets as versus the stimulus package, which I found 
to be less than--well, I think the comment, which was made by 
you, Dr. Taylor, which is, in the long run, it may end up being 
a negative because it is going to add to the debt in a way that 
basically gets us very little for it.
    My time is up, but I thank you for the panel. Yes, did you 
want to make a comment?
    Dr. Taylor. On the issue about the end of the panic, the 
panic, as measured by the TED spread, my paper has--my 
testimony has the spread between LIBOR and the Federal funds 
rate at I think a slightly better measure, but it is very 
similar.
    The worst part of the panic was the period from the 
announcement of the TARP until the TARP was clarified how it 
was going to be used. There was a tremendous uncertainty. ``How 
are we going to buy these toxic assets?'' is the way it was 
frequently put. And that really stopped as soon as there was 
some clarification.
    You might not like the clarification. But on October 13th, 
a meeting of the Treasury, it was made clear that these were 
for equity injections, and then things improved. That is how I 
think of this. So, in some sense, the cause of these spreads 
was the action. And fortunately, people reacted and fixed the 
problem before it was finished.
    Senator Gregg. And just as a point of editorial comment, it 
was lucky that we drafted the TARP in the way that gave the 
Treasury Secretary that flexibility because he could never have 
bought the toxic assets as it turned out and gotten the bang 
for the buck that he got by buying equity.
    The Chairman. Let me just make three kind of parenthetical 
observations. One, when the President was elected, but before 
he took office, I wrote him a letter urging that when we do 
stimulus, we simultaneously make a commitment to long-term 
deficit reduction so that we signal the markets and we signal 
people that we recognize the increase in deficits and debt have 
got to be dealt with and that the debt is a serious overhanging 
threat.
    Second, as we went through the question of recovery 
package, I fought for $200 billion of infrastructure rather 
than $38 billion. We lost that fight. I still believe we would 
have been much better off, for the reasons the Senator gave. 
And you know, we will never know.
    But I think if you look at the Recovery Act package, the 
parts of that package that are the weakest are the exact ones 
Senator Gregg is referencing that were basically appropriators 
taking money for programs they had long wanted to fund, 
regardless of bang for the buck. And a lot of it was stuff that 
wasn't particularly strong on a bang for the buck evaluation.
    Senator Stabenow?
    Senator Stabenow. Well, thank you very much, Mr. Chairman.
    And I first start by agreeing with the chairman that this 
is a very important, thoughtful discussion, and there are 
differences in approaches that are legitimate and I think are 
very important to talk about.
    I also want to stress, as we look at long term, one of the 
frustrating parts of being around here for a while, coming in 
2001, in this committee. At that time, we were talking about 
the largest surpluses in history of the country. And being in 
the House when we balanced the budget, I thought we were 
dealing with that. And we did balance the budget, and we did 
put in place the largest surpluses in the history of the 
country and debated that--what do we do with that?
    Unfortunately, I believe the wrong structure was put in 
place. And as my mother would say, proof is in the pudding. We 
are now in the largest deficit in the history of the country. 
If we had listened to our chairman at the time in looking at 
the possibility on what do we do with the surpluses, he had--
our current chairman had recommended a third for strategic tax 
cuts to grow the economy, a third for strategic investments and 
innovation in education and so on, and a third to pre-pay down 
the liability of Social Security.
    Looking back on that now, as before, I think that would 
have been a pretty good plan to put us on a solid footing. But 
we are where we are. And so, now we have a hole, and we have to 
once again dig out of a very, very big hole.
    I also want to agree with the ranking member and the 
chairman on infrastructure spending. We tried to do that. As 
the chairman indicated, he was advocating for much more. In all 
honesty, Mr. Chairman, I think it is important to say we didn't 
get the bipartisan support, or we would have done it.
    Because I remember school construction and water and sewer 
and roads. We are at a point in our country where we need to 
give the country a facelift. You know, all of us baby boomers 
may feel the same. So we tried, and we will try again to be 
able to do that.
    When we look at this--and I have a couple of specific 
questions for you. Very much appreciate your comments. But I do 
want to make two other points. We have to deal with long-term 
debt. In my judgment, we will never be able to deal with that 
with more than 15 million people out of work, which is why we 
started with jobs.
    You have to start with jobs so that people are 
contributing, buying things, paying their taxes, or we will 
never get out of debt if people aren't working. And so, I 
believe jobs in the short run and moving forward has to be a 
huge part of that.
    And with all respect to colleagues who feel differently, we 
have had a set of tax strategies in place for 10 years, and the 
argument about extending the top rates, I guess my question is 
where are the jobs? People in Michigan have lost 1 million 
jobs. If that had worked as an incentive, I would have been 
very happy--very, very happy. And, but we didn't see the jobs 
from that strategy.
    So that brings us to now, and I want to thank you. I have a 
big smile on my face about Cash for Clunkers. I appreciate the 
comments on that. The coming together on timing was more luck, 
but strategically really was the right program at the right 
time. And I agree with you that I wish we could have made it 
longer. But I am appreciative of your comments about the fact 
that this did come at the right time.
    It got people into showrooms. It gave them an opportunity 
to put some money in their pocket on the demand side and go 
look at vehicles. And they cleared out showrooms, and we put 
second shifts on in plants. So caring about demand is 
important, not just supply.
    Question on manufacturing. A lot of what we did in the 
Recovery Act was focus on manufacturing for the first time in a 
long time. The 30 percent advanced manufacturing tax credit for 
new equipment and vehicles, for clean energy, the battery 
dollars, which have created many, many new opportunities for us 
in Michigan, are going to take us from 2 percent of the world's 
advanced battery manufacturing to 40 percent of the world's 
battery manufacturing in the next 5 years.
    I wonder if you might speak about building on those kind of 
things. We have seen manufacturing numbers going up, not as 
fast as I would like, but certainly going in the right 
direction. And what role do you think manufacturing will play 
in recovery? What more should we be doing?
    I am wondering, Dr. Blinder, if you would like to? And then 
Dr. Zandi and Dr. Taylor.
    Dr. Blinder. Sure. Manufacturing is pretty much--through 
housing is another contestant--the most cyclical aspect of the 
economy. So when we have a slump, manufacturing gets hit worse. 
Usually when we have a recovery, manufacturing is going to go 
up faster than GDP. I think that is happening now.
    Second, however, and I hate to say this to the Senator from 
Michigan, but there has been for 50 years about now, and it 
will continue, a secular decline in the share of employment 
that is in manufacturing.
    Senator Stabenow. Right.
    Dr. Blinder. And we should not expect that to change. What 
is in that manufacturing bucket has changed dramatically over 
50 years, and I want to come back to that in my third point. 
But I think we have to accept it as more or less a fact of life 
that the share of employment in manufacturing is on a secular 
decline.
    It has to do with consumer taste. It has to do with 
productivity. It has to do with a lot of things. The only point 
I want to make is that it is happening in every single advanced 
country in the world. We are just ahead of the pack. France, 
Britain, Germany--they are all following us with a lag. Theirs 
are declining also, and we are just ahead of them.
    Third, however, there are some things we can do, and this 
has to do with what is inside the bucket. Ironically, I think 
one of the best things we could do to spur more manufacturing 
in the U.S., and this bears on the long-run deficit also, is to 
enact now a carbon tax or some variant on that that would start 
at essentially zero and rise on a predictable schedule, that 
would get American businesses focused on the kind of innovation 
which leads to production that they are capable of, if they 
have the incentive.
    If people knew that fossil fuels were going to be vastly 
more expensive 10 years from now than they are now, American 
business would get to work right away in developing energy-
saving technologies. We have seen this in the past. We have 
seen what American industry is capable of in terms of 
innovativeness.
    And I don't believe any of these doomsday scenarios that we 
have lost the edge or anything like that. But you need to give 
than the incentives, and I think, ironically, even though it is 
a tax increase for the future and not for the present, I think 
that is one of the best things that we could do to spur 
manufacturing activity in the U.S.
    Senator Stabenow. Thank you.
    Dr. Zandi. I rarely disagree with Alan. In fact, I can't 
even remember the last time I disagreed, but with regard to the 
prospects for the Nation's manufacturing base, I take a very 
different perspective. My view is that if you are a 
manufacturer and you survived what we have been through, you 
are mettle tested. You have a market niche. You are very cost 
competitive. Your prospects are incredibly bright.
    And I think manufacturing has to be key, a key source of 
growth in our economy going forward. It is key to good, solid, 
high-paying jobs in parts of the country that we have got, for 
goodness sakes, a lot of unemployed workers that can't move 
because they are under water on their homes. So we need 
manufacturing to come back, and I think we are poised for very 
good, solid growth.
    A different kind of manufacturing than we have done in the 
past--aircraft, aerospace, electronics, battery technology, 
machine tools, sophisticated instrumentation, construction 
equipment. I mean, we do a lot of things very well, and we are 
going to do them very competitively going forward.
    Now there are a few things that could help. In the very 
near term, I think the President's proposal for accelerated 
depreciation benefits in 2011, that is a darned good idea. For 
2011, that is going to juice up investment spending. It doesn't 
cost taxpayers very much because of the way the tax liabilities 
are distributed, and we are going to get a real boost to 
business investment, which helps long-run productivity growth 
and a growth in our living standards. And for goodness sakes, 
that is key to manufacturing. So I would be very supportive of 
that.
    Second, another important policy effort where you have less 
control but we have some influence, it is very important for 
the Chinese to continue to allow their currency to revalue. 
They are on a path. My sense is they go 3, 5 percent on the 
currency, let it revalue every year.
    Hopefully, 5, 6 years down the road they are fairly valued 
against the U.S. currency. Then U.S. manufacturers are going to 
be in a much better place competitively. But we need to 
continue to convince and educate the Chinese that this is the 
appropriate policy response not only for us and the global 
economy, but for their own economy it makes perfect sense.
    And finally, third, fitting right in with infrastructure, 
you know, infrastructure I think is the best way to get 
persistent unemployment rates down, and it can be self 
financed. We have got lots of private capital. I get calls from 
hedge funds every day saying can we figure out a way--we want 
to invest in the Nation's infrastructure. We want to partner 
with Government. If Government can give us some catastrophic 
backstop, then we are in. And we are going to provide capital, 
and we can do this. And it is going to create jobs in those 
communities that are trapped right now.
    And that is--when you build infrastructure, you are driving 
manufacturing activity, right? So I think that would be a very 
effective way of promoting long-term growth maybe. My view is 
manufacturing, as Alan has said, for the last--sorry, I am on a 
soapbox for a second, but I will get off--last 25 or 50 years, 
but I think its prospects for the next quarter century are very 
bright.
    Senator Stabenow. Thank you.
    I know we are out of time. I didn't know if Mr. Taylor 
wanted to comment or not. But, Mr. Chairman, I know I am out of 
time. So thank you.
    The Chairman. We will go to Senator Sessions.
    Senator Sessions. Thank you, Mr. Chairman.
    I do have to go to the floor. So I just have a few minutes. 
I will cut it short.
    One of the things you discussed was instability arising now 
from uncertainty about tax rates, which could be fixed, should 
be fixed, and there is no reason that instability stays out 
there. But the President apparently is not willing to step up 
and make that plain statement.
    In addition, we have the announcement that Larry Summers is 
leaving, following Christina Romer and Peter Orszag, the key 
team. And if this was a change because we have a new plan for 
the economy, perhaps that could be a positive. But in fact, it 
leaves us only with more uncertainty. It is not a healthy thing 
that is occurring.
    And Dr. Blinder and Dr. Zandi, you talk about 
infrastructure, and Senator Conrad said he fought for more 
infrastructure in the bill. That was one of my biggest 
criticisms of it. It was sold as an infrastructure bill. The 
President and the Democratic leadership said this was for roads 
and bridges, we are going to fix our crumbling infrastructure, 
and only 3 percent or so of that money went to that.
    And it didn't create jobs, unfortunately. I want to ask 
about that. But one thing about infrastructure. You have got 
the bridge. You have got the road that helps make the economy a 
little more productive at least, maybe for generations to come.
    During the debate about the stimulus package, I remember 
reading on the floor from a Wall Street Journal article by Gary 
Becker, the Nobel Prize Laureate, and Kevin Murphy, and they 
posed the question, ``How much will the stimulus package moving 
in Congress really stimulate the economy?'' Now that was a good 
question to ask. And their conclusion was not much.
    And it appears that they were proven correct. He says, 
quote--and this was in February 10, 2009. ``In fact, much of 
the proposed spending would be in sectors and on programs where 
the Government would mainly have to draw resources away from 
other uses.'' He notes that, ``Our conclusion is that the 
stimulus to short-term GDP will not be zero.''
    For heaven sakes, it couldn't be zero with that much money 
getting spent. ``And will be positive, but the stimulus is 
likely to be modest in magnitude. Some economists have assumed 
that every $1 billion spent by the Government through the 
stimulus package would raise short-term GDP by $1.5 billion, or 
in economics jargon, a multiplier of 1.5. That seems too 
optimistic, given the nature of the spending programs being 
proposed. We believe a multiplier well below 1 seems much more 
likely.''
    Mr. Taylor, do you think that Professor Becker and Murphy 
were correct in their prediction?
    Dr. Taylor. Basically, yes. My empirical research, 
simulations of models, finds that for this particular package, 
multiplier was less than 1--0.7, sort of a round number we 
found, to some extent. But in addition, those multipliers, so 
to speak, refer to purchases of infrastructure or goods and 
services. And, in fact, as you have pointed out, that has been 
very small. So, on top of the fact that the multiplier is 
smaller than some people argued, the thing that is being 
multiplied was quite small.
    So, for those two reasons, I think that the conclusion of 
Becker and Murphy is basically correct. It certainly coincides 
with what I have been finding.
    Senator Sessions. Well, one of the concerns I had, in 
retrospect, over what happened in the early Bush years and Alan 
Greenspan's leadership, was that we had surpluses, and they 
seemed to think that we could carry more debt. And even some 
were saying deficits don't matter. Do you remember that, 
Senator Conrad? I remember Alan Greenspan saying, ``Well, I 
felt that we could carry some more debt.''
    But they didn't understand the politics of it, the 
economists. Once we lost the high ground of defending balanced 
budgets, it just roared out of control. The spending took over 
in ways that now jeopardize us.
    Dr. Taylor, would you say that with regard to Professor 
Blinder's comment that we can't stand fiscal restraint right 
now that that does have some cost, in terms of creating more 
debt. Also, does it not create instability and concern in the 
financial markets when they don't see Congress commencing any 
fiscal restraint, and can we continue to just put off the day 
that we start showing restraint?
    Dr. Taylor. I believe that it would be best to start right 
away, start when you announce the program. It doesn't have to 
be draconian, although quite frankly, if you look at my 
numbers, 18.2 percent of GDP in 1980, 24 percent now. It looks 
like we have capabilities of doing something.
    But I think that, basically, it is important to start at 
the same time, not to put it off for a couple of years. Again, 
it doesn't have to be draconian. It can basically start making 
progress now, and that is where the credibility will come from. 
It is so easy to promise we are going to do something next year 
or the following year. It is hard to get started now, and that 
is where the credibility will come from.
    So I strongly view that that is a positive for the economy. 
The reduction of uncertainty, the demonstration that our 
Government is dealing with these problems I think would be very 
beneficial and would help us get out of this really unfortunate 
situation of high unemployment and very low growth.
    Senator Sessions. Well, as one constituent told me in 
Evergreen, ``As my granddaddy said, you can't borrow your way 
out of debt.'' And I believe the old verities, if applied with 
minimal ``masters of the universe'' influence with the 
marketplace--no disrespect intended--by the people who think we 
can do this and we can do that, and we can stimulate this and 
we can reduce that, and allow the strength of the American 
economy to surge would be the best approach for us. And we need 
some firmer leadership than we have had, in my opinion.
    The Chairman. Thank you, Senator Sessions.
    Senator Begich?
    Senator Begich. Thank you, Mr. Chairman.
    Let me first ask a very simple question. Hopefully, a 
simple answer.
    Compared to January 1909 to where we are today, is the 
economy better off?
    Dr. Blinder. Vastly.
    Dr. Zandi. Measurably better.
    Dr. Taylor. January 1909, the unemployment rate was lower--
--
    Senator Begich. That is not what I asked you. I don't want 
to get into the unemployment rate. I want to ask you the 
general, overall question. Is the economy better today than it 
was in 1909? It is a very simple question. It is a yes or a no.
    Dr. Taylor. Well, I think--the dimensions I am looking at, 
we are in worse shape. The unemployment rate is higher. Our 
growth rate is better. It is 1.6, rather then I guess it was 
about minus 6 at that point. That is definitely an improvement.
    But it is very disappointing, Senator. I mean, this is 3 
years--the crisis really started in August 2007. So in terms of 
what is better and what is worse, I think it is not in a good 
shape, and we need to think about fixing it.
    Senator Begich. So I want to make sure I got your 
commentary. I am not disagreeing that there is more work to be 
done. That is a question over here. In 1909 to where we are 
today, are you telling me the economy is worse off?
    That is the--it is not a complicated question.
    Dr. Taylor. Growth is higher, which is good.
    Senator Begich. Now see----
    Dr. Taylor. Unemployment is higher, which is bad.
    Senator Begich. OK. I am not going to get an answer from 
you. I can tell that because--now maybe I am missing something. 
Now, and I know I have these discussions in budget, and I 
appreciate, Mr. Chairman, your graciousness to allow me on this 
committee in kind of midstream. But I will be very blunt with 
you, all three of you.
    First off, I agree with I think there is a lot of issues 
that Senator Gregg and I agree on. The ranking member, Senator 
Sessions, and I are cosponsors of some budget bills, some 
deficit control bills. But I am one of the few in this whole 
U.S. Senate that is a small business person, that has had to go 
scrape capital together, that actually had to go talk to a bank 
and understand what it is like. Had to fill out a 1099, to 
actually decide what is going to get an employee to work for me 
and how to grow the customer.
    I appreciate your comment on the HIRE Act. For a small 
business person, that doesn't incentivize me to hire someone. 
There is only one thing that incentivizes me is my business 
increasing. And I will be very blunt with you, people who--and 
I hear this, and it is the political jawboning that goes on in 
this place. They always try and figure out what side they need 
to be on.
    The economy is better. The amount of cash that corporations 
have today than they had before is greater. Their stock prices 
are better today than they were in 1909. When people get their 
third quarter retirement, 401(k), education statements, which 
they will get in a few weeks, it is like the best direct mail 
program ever because they are going to see that their 
portfolios are better than they were in 1909.
    Now what I hear a lot, and I will say also on the recovery, 
I also like the way creation of history happens around here. I 
was in those negotiations in February on that stimulus bill, 
and all due respect to my colleagues on the other side, if I 
now know all these people who wanted infrastructure because I 
am a guy--I am a mayor, a former mayor. We build stuff. That is 
what we love to do. Because when we build stuff, it changes the 
economy immediately.
    Now that there is all this new support for infrastructure, 
that stimulus bill should have had $800 billion for 
infrastructure. But that is not the case because the other side 
had all this about tax cuts and all this other stuff, and that 
amount of infrastructure dollars shrunk and shrunk. But it is 
interesting to find out today that so many people supported it, 
I just missed them back last February. Because that is just a 
fact, I agree. I think everyone agrees infrastructure 
investment is a great way to stimulate an economy.
    My problem is of how we distributed it. I am a believer 
that you have got to put it out on the local end. You want it 
to hit the streets to people who actually can get the jobs 
done. I am biased. I am a former mayor. Mayors know how to do 
it. School boards how to do it.
    So I just--you know, when I hear some of this jawboning 
that goes on in these committee meetings and some of the re-
creation of history, it is amazing to me. If this was the case, 
we would have had 100 votes for an infrastructure bill at $800 
billion.
    And I know the Democrats worked very hard on it. I sat in a 
meeting about education construction dollars, and what we heard 
from the other side is, well, we have never really done that. 
We don't do that.
    My view was a double. If we put money in a school budget 
for school construction, first off, it gets distributed down at 
a local level, which means actually you would build something. 
Second, you would offset the property taxes that are usually 
paying for those, and therefore, you will have another 
opportunity to hit homeowners in a positive way.
    Also, a property tax makes a difference. If you can lower 
property taxes, it makes more properties more financeable 
because that is a piece of the equation for a mortgage. It 
seems so simple, but this place is not a simple place, as we 
all learn.
    But I will just say again that the record to me is so 
clear. Are we a fragile economy? Yes, we are. Is there more 
work to be done? We can debate that. How that will occur is the 
work that we are all here to try to do. And in my view, I just 
sit here patiently listening, and I just get frustrated when I 
see history re-created based on the needs of a political cycle 
rather than what is right for this country.
    The second thing is--and I know these two words. If you ask 
any pollster, they say don't mention ``TARP.'' Don't mention 
``stimulus.'' But the fact is, and I don't think anyone would 
disagree, TARP, in its own way, painfully worked. I didn't like 
it. I campaigned against it.
    But when we look back and see the repayment schedules that 
has occurred and the infusion that occurred to create certainty 
to the financial institutions, it was a huge plus. It may not 
have been the amount of dollars. But I think you mentioned 
earlier about once they knew kind of what was going on, 
certainty is the name of the game in business--certainty. Not a 
few dollars on the table to build something, but certainty.
    If they knew there was a long-term infrastructure plan, 
they would know certainty. They knew there was a tax policy, 
not one that is going to be extended for a year or 6 months 
or--people don't plan multibillion dollar businesses on a thing 
Congress does for 6 months. That is the most ridiculous 
thinking I have ever seen. It is based on certainty. And so, I 
got on a little rant because I got a little frustrated when I 
hear people re-create history and then repackage it in a way 
that makes it sound so bad.
    I will tell you I have never seen more panic sitting in a 
political office in January 1909 when I came here and was sworn 
in. More panic in members that have been around here for ages 
because this economy was over the cliff and hanging on by just 
a thread. So I feel like we have moved a little bit further.
    Now saying that, I have got two quick questions. I am sorry 
I went on a rant. I just get a little frustrated when people 
want to re-create things for political purposes. Two things. Do 
you believe my statement that I made on businesses want 
certainty to determine the long- term investments they make?
    And this should be simple. I try to keep my questions 
simple. I know, as economists, you want to give long answers, 
and I recognize that. But can you answer that? And then it 
leads to the next question.
    Dr. Blinder. Can I just make a----
    [Laughter.]
    Dr. Blinder. This is going to sound slightly pedagogical. 
There is no such thing as certainty in business. You have been 
in business. I am in a business myself.
    Senator Begich. That is fair. That is a fair statement.
    Dr. Blinder. But I think what you mean is reduction of 
uncertainty.
    Senator Begich. Yes.
    Dr. Blinder. Especially the uncertainty about the rules of 
the game, and absolutely.
    Senator Begich. Yes. That is a better way to phrase it. 
Yes. That is the question then.
    Dr. Zandi. You should know I am not just an egghead. I 
started my own company----
    Senator Begich. So you know what it is like.
    Dr. Zandi [continuing]. In 1990, me and my brother. And we 
sold it 15 years later. So I know exactly what you are talking 
about. And yes, you need to know what the rules of the game 
are. Until you do--and it is down to the crossed T and the 
dotted I. Until you do, you are not going to make a big 
investment decision or a hiring decision.
    Dr. Taylor. I agree 100 percent. Certainty is important, 
and predictability of policy----
    Senator Begich. Microphone? Dr. Taylor?
    Dr. Taylor. I agree 100 percent. Certainty is a great 
benefit to businesses, and I think that the greater policy can 
be predictable, the more certain the environment will be for 
businesses.
    Senator Begich. Excellent. Let me, if I, Mr. Chairman, 
could just ask one quick question, and then I will stop. And I 
appreciate----
    The Chairman. No, go ahead.
    Senator Begich. I thank you for the additional time here.
    Thank you for all agreeing on that.
    Now, and I have pitched this before in this committee, you 
know, we are going to contemplate this tax policy, and I could 
argue that some people think there is no leadership on this 
issue. I don't know. I have heard the President talk about 98 
percent of the people getting a tax reduction. Some are 
fighting over the last 2 percent. I mean, in politics, if you 
get 98 percent on anything, that is a pretty good deal.
    But leaving that aside, I am a believer that, again, 
certainty is the name of the game. I have saddled up to the 
Wyden-Gregg tax policy legislation, which takes corporate rates 
down to a flat of 24 percent, taking it from the second highest 
in the world down to about midstream, compressing the six 
individual rates down to three--35, 25, 15. It gets rid of a 
lot of loopholes, simplifies it, deals with capital gains, 
reinvestment, really focused on small business and how to make 
sure those dollars.
    I recognize we have to debate the Bush tax cuts because 
that is what is in front of us, but isn't it wiser for us to 
really think about a longer-term reform? There has not been 
really tax reform for so long that the uncertainty in business 
is they just don't know what we are doing. Are we going to have 
an energy tax credit? Are we going to have a capital gains 
reduction? Are we going to have what?
    Isn't that the better approach if we are serious about 
reviving the economy, just have some rules of the game, at 
least on tax policy? I am putting infrastructure aside because 
that is a different ballgame. Who wants to respond to that?
    Dr. Taylor. Very briefly, your points about the corporate 
rate and a need for tax reform are very well taken. I think in 
this environment, though, Senator, for certainty, which is 
really what you are emphasizing, just the certainty that the 
tax system will not change for a while, just leave it alone for 
a while, that will create certainty. We know what the tax rates 
are. Leave them where they are.
    I think in this situation where the very credit worthiness 
of the United States is going to be at stake, maybe postpone 
these important things and just create stability right now. 
That is what I would argue for.
    Dr. Blinder. I am actually quite sympathetic to that. I 
have been a longtime advocate--forever, as far as I can 
remember--of tax reform and especially tax simplification. But 
I must say, given all the tumult of recent years, I am pretty 
sympathetic to what John just said, that we sort of can't do 
everything at once. You can't throw everything into the hopper 
at once.
    For example, doing something about the long-run budget 
deficit may right now be more important than tax reform. That 
is something I never thought I would hear myself saying, but I 
think there is validity to that right now.
    Dr. Zandi. I would just say I would think to address our 
long-term fiscal problems we are going to need tax reform. I 
don't know how we are going to be able to do it in a credible 
way unless that reform includes spending restraint and some 
substantive changes to the tax code.
    And I think part of that would be consistent with what you 
are saying. I do think it would be prudent to lower the 
corporate tax rate. I do think that that would be an 
appropriate way to move. Of course, you have to put that into 
the context of the long-term fiscal situation.
    Senator Begich. Correct. Let me end there.
    Mr. Chairman, thank you for letting me extend further than 
I should have, but I thought it was some interesting dialog.
    The Chairman. That was very good.
    Senator Begich. Thank you very much, Mr. Chairman.
    The Chairman. That was very good. I am glad that you did 
it.
    Let me just say with respect to answering your question on 
whether or not we are better off now than 2009, I don't think 
there is any question. Just on the facts, the economy 
contracted about 5 percent in the first quarter of 1909. We 
have positive economic right now, although not as strong as we 
would like. But it is positive 1.6 percent.
    On the employment front, in January 1909, we were losing 
800,000 private sector jobs a month. Now we are in positive 
territory. Jobs are being created, again, though not at the 
rate we would like.
    Look to the markets. Look where the stock market was in 
January of 2009. Look where it is today. It has dramatically 
improved.
    Now, what hasn't improved is our long-term fiscal outlook, 
and that does require our attention. I personally am in the 
camp of Dr. Blinder. I would not do something draconian in 
terms of fiscal discipline at this moment.
    I would put in place the plan that brings us to a debt that 
would be lower as a share of our economy than the debt we have 
now because I think we are at a very--a tipping point, if you 
will, at a debt, gross debt of 90 percent of GDP. If we look at 
economic history, that has been a tipping point. We had 
testimony to that effect before the fiscal commission.
    And clearly, it is going to take attention on both the 
spending and the revenue side. On the spending side, spending 
is the highest it has been as a share of GDP in 60 years. 
Revenue is the lowest it has been as a share of GDP in 60 
years.
    So I think it is going to take a response on both sides, 
and I personally believe tax reform, fundamental tax reform has 
got to be part of it. I think Gregg-Wyden is a very good 
beginning. I can tell you it is getting a great deal of 
attention on the commission. No decisions have been made, but I 
think it is a very thoughtful beginning.
    And you know, we have got a tax system that was designed 
when we didn't have to worry about the competitive position of 
the United States. We were so dominant when this tax system was 
constructed we simply did not have to worry about the 
competitive position of the United States. We do now. And we 
have got to write a tax system that helps us compete as 
effectively as we can as a country.
    It would be very foolish not to take this opportunity to 
work on that but without changing the tax code in the next 
several years, but put in place the reforms that I think most 
of us know really are needed.
    With that, I want to thank this panel. Senator Gregg said 
to me as he left, ``Boy, that is an all-star panel.'' And it 
is. These are three of America's very best. And we owe a deep 
debt of gratitude to not only testimony here today, but much 
more than that--a career of contributing to the dialog in this 
country on very complex issues.
    Three of America's very best--Alan Blinder, Dr. Mark Zandi, 
and Dr. Taylor. Thank you so much for being here. We appreciate 
it.
    [Whereupon, at 11:48 a.m., the hearing was adjourned.]
    QUESTIONS FOR THE RECORD

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    Answers from Dr. Mark Zandi

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               OUTLOOK FOR THE ECONOMY AND FISCAL POLICY

                              ----------                              


                      TUESDAY, SEPTEMBER 28, 2010

                                       U.S. Senate,
                                   Committee on the Budget,
                                                    Washington, DC.
    The Committee met, pursuant to notice, at 10:01 a.m., in 
room SD-608, Dirksen Senate Office Building, Hon. Kent Conrad, 
Chairman of the Committee, presiding.
    Present: Senators Conrad, Wyden, Nelson, Whitehouse, 
Warner, Gregg, Bunning, and Ensign.
    Staff present: Mary Ann Naylor, Majority Staff Director; 
and Cheri Reidy, Minority Staff Director.

              OPENING STATEMENT OF CHAIRMAN CONRAD

    Chairman Conrad. The hearing will come to order. I want to 
thank my colleagues and thank our witness for being here. 
Today's hearing will focus on the outlook for the economy and 
fiscal policy. Our witness today is CBO Director Doug 
Elmendorf.
    Director Elmendorf, welcome back. We look forward to your 
testimony.
    I would note that this is our third hearing on the economy 
in the last 2 months. We have heard from six outstanding 
economists so far. Director Elmendorf will make it seven.
    Let me begin by providing an overview of our fiscal and 
budget outlook. I think it is critically important to remember 
the economic crisis we faced just a short time ago. By late 
2008, we were in the midst of the worst recession since the 
Great Depression. The economy shrunk at a rate of 6.8 percent 
in the fourth quarter of 2008. Unemployment was surging, with 
800,000 private sector jobs lost in January of 2009 alone. A 
housing crisis was rippling through the economy, with home 
building and home sales plummeting and record foreclosures. And 
we faced a financial market crisis that threatened to set off a 
global economic collapse.

[GRAPHIC] [TIFF OMITTED] T8156.173


    I will never forget being called to an emergency meeting in 
the Leader's office in the fall of 2008. I arrived at about 6 
o'clock. There were the leaders of Congress, Republicans and 
Democrats, Senate and the House, the Chairman of the Federal 
Reserve, the Secretary of the Treasury in the previous 
administration, and they told us they were taking over AIG the 
next morning. They believed that if they did not, there would 
be a financial collapse.
    Those were very, very serious days. And the Federal 
response to the crisis I believe has successfully pulled the 
economy back from the brink. And this year we have begun to see 
a return to economic and job growth, although both are weaker 
than we would hope.
    Two of our witnesses from last week's hearing, Dr. Blinder 
and Dr. Zandi, completed a study that measures the impact of 
the Federal response to the crisis. I would like to highlight 
their findings and then ask Dr. Elmendorf to comment in his 
testimony on whether CBO has found a similar impact and result.
    Dr. Blinder and Dr. Zandi's report said, in part, and I 
quote, ``We find that the Federal response effects on real GDP, 
jobs, and inflation are huge and probably averted what could 
have been called Great Depression II. When all is said and 
done, the financial and fiscal policies will have cost 
taxpayers a substantial sum, but not nearly as much as most had 
feared and not nearly as much as if policymakers had not acted 
at all. If the comprehensive policy responses saved the economy 
from another depression, as we estimate, they were well worth 
their cost.''

[GRAPHIC] [TIFF OMITTED] T8156.174


    This chart compares the jobs we have actually had in our 
economy recently with an estimate of the jobs we would have had 
without the Federal response. It shows that we would have had 
8.1 million fewer jobs in the second quarter of 2010 if we had 
not had the Federal response.

[GRAPHIC] [TIFF OMITTED] T8156.175


    Let me go to the next chart. You see a similar picture with 
the unemployment rate. The actual unemployment rate on a 
quarterly basis is now hovering at about 9.7 percent. That is 
still far too high, and we must do more to create jobs and 
bring this rate down. But if we had not had the Federal 
response, the unemployment rate would now be 15 percent--again, 
this is according to the analysis by Dr. Blinder and Dr. 
Zandi--and would continue rising to 16.2 percent by the fourth 
quarter of 2010. So, clearly, the Federal response to the 
economic crisis has had and continues to have a significant 
positive impact on the economy.

[GRAPHIC] [TIFF OMITTED] T8156.176


    But, clearly, we are not out of the woods. The economy 
remains unsteady and faces strong head winds. That is why in 
the near term I believe we need to focus on providing 
additional liquidity to boost demand and promote job creation. 
We cannot afford to repeat the mistake of the mid-1930's when 
recovery measures were pulled back too quickly, and the Great 
Depression was prolonged.
    At my request, CBO has previously provided Congress with 
the ranking of the bang for the buck we get from various 
Federal policies designed to spur economic growth. This chart 
depicts some of the policy options ranked by CBO.

[GRAPHIC] [TIFF OMITTED] T8156.177


    On the upper end of the scale, it shows that policies like 
extending unemployment insurance and providing payroll tax 
relief for firms hiring unemployed workers give you a higher 
impact on GDP for each dollar spent. Also at my request, CBO 
has now done further refinements of these rankings to help 
Congress as it considers options going forward. I look forward 
to hearing from Director Elmendorf about CBO's latest findings 
in this area.
    In addition to the near-term economic challenge, we must 
also confront the looming long-term budget crisis. The 
retirement of the baby-boom generation, rising health care 
costs, and our outdated and inefficient tax system are 
projected to explode deficits and debt in the years ahead. I 
might say if we extend all the tax cuts permanently, that would 
have a profound effect on increasing deficits and debt as well.
    According to CBO, Federal debt could rise to 400 percent of 
gross domestic product by 2054. That is 44 years from now. That 
is a completely unsustainable course. What we should be doing 
now is putting in place deficit reduction policies that will 
kick in after the economy has more fully recovered. By 
establishing and enacting these policies now, we will reassure 
the financial markets the United States is confronting its 
long-term fiscal imbalances.

[GRAPHIC] [TIFF OMITTED] T8156.178


    Let me just conclude by what Chairman Bernanke has said 
earlier this year about the need for a credible plan to address 
our long-term fiscal challenges. He said, and I quote, ``A 
sharp near-term reduction in our fiscal deficit is probably 
neither practical nor advisable. However, nothing prevents us 
from beginning now to develop a credible plan for meeting our 
long-term fiscal challenges. Indeed, a credible plan that 
demonstrated a commitment to achieve long-run fiscal 
sustainability could lead to lower interest rates and more 
rapid growth in the near term.''

[GRAPHIC] [TIFF OMITTED] T8156.179


    I believe that. That is why I believe the work of the 
President's Fiscal Commission is so important. As members of 
that Commission, Senator Gregg and I can attest to the hard 
work being done by the Commission. I remain hopeful that we 
will come up with a bipartisan plan that puts the Nation back 
on track.
    With that, I would turn to Senator Gregg for his 
observations, and then we will go to the witness for his 
testimony.

               OPENING STATEMENT OF SENATOR GREGG

    Senator Gregg. Thank you, Mr. Chairman, and I look forward 
to hearing from the Director on his view of where the economy 
is going. I would like to associate myself with the second half 
of your presentation, which is that I do not believe economic 
recovery will occur until we make it clear to the markets and 
to the American people that we are going to be serious about 
dealing with the debt of this country and the rising deficits 
and their impact on the markets, their impact on confidence.
    I believe the American people have pretty much lost their 
confidence in their Government. They are seeing a Government 
which has grossly overexpanded, which has exploded in its size 
from 20 percent of GDP when this administration came into 
office and now to 24 percent of GDP, headed up to 26, 27 
percent of GDP; a Government which has exploded not only in 
size of its spending but also in size of regulatory activity, 
to the point where it is very hard for small businesses to be 
able to do business because they are weighed down by this 
massive expansion in regulatory activity, especially from the 
health care bill, creating huge uncertainties in the future of 
small companies or small businesses as to whether or not it 
should expand.
    That is coupled with the fact that we passed laws which 
have significantly retarded the availability of credit by being 
a misdirected effort to try to correct the very serious 
problems with our banking system, the financial reform being a 
specific act of transgression here in that it is a bill which 
has caused credit to contract and will cause credit to continue 
to contract, without doing anything substantial, at least 
significant in the area of addressing the underlying problems 
which drove the credit contraction, which were the real estate 
bubble and the excessive and inappropriate lending that was 
occurring in the marketplace. Instead of addressing those 
issues, it created, again, layers and layers of new regulatory 
activity, hundreds literally of new regulatory agency 
initiatives, including a brand-new agency called the Consumer 
Protection Agency, which is going to be headed up by an ad hoc 
individual who is not even going to appear before the Congress 
for confirmation. What a transgression of the constitutional 
process that is since this person will probably be one of the 
most powerful people in Washington with a stream of funding 
which has no, absolutely no accountability to the Congress 
because it comes from the Federal Reserve and, therefore, is 
not subject to annual appropriations, and a Director who it 
appears will also have no accountability to Congress because 
the Director will not even come to the Congress to be confirmed 
as the law requires. And that agency, I predict, will be an 
agency not for the purposes of protecting consumer credit, but 
for the purposes of pursuing a political agenda of social 
justice as defined by the leader of that agency.
    So the American small business person is being inundated 
with a Government of excess spending, excess regulation, excess 
concern about the capacity to know what is going to happen in 
the future in the area of credit, and that is why the economy 
is not moving forward.
    So if we want to get the economy moving forward, we should 
begin by putting in place financial systems in the Federal 
Government which will control the deficit and debt in the out-
years and give people confidence that we will get that under 
control.
    And we should begin the process of an orderly 
reorganization of our health care system that will make it 
function rather than become more bureaucratic. And we should 
take a look at our credit markets and see how we can make them 
function more efficiently and effectively in a responsible way, 
all of which we have not done.
    So I would say that if we want to--you know, there is that 
old ``Pogo'' saying, the cartoon ``Pogo'': ``We have met the 
enemy and he is us.'' Well, the enemy of economic expansion in 
this country is the Federal Government, especially the way it 
has been pursuing policies for the last 2 years. And we need to 
change, and I look forward to Director Elmendorf's thoughts.
    Chairman Conrad. Welcome back, Director Elmendorf, and 
please proceed with your testimony, and then we will go to 
questions.

  STATEMENT OF DOUGLAS W. ELMENDORF, DIRECTOR, CONGRESSIONAL 
                         BUDGET OFFICE

    Mr. Elmendorf. Thank you, Chairman Conrad, Senator Gregg, 
and members of the Committee. I appreciate the opportunity to 
discuss the economic outlook and CBO's analysis of the 
potential impact on the economy of various fiscal policy 
actions. My comments will summarize our lengthy written 
statement.
    Although the recession ended officially more than a year 
ago, the economy has not bounced back quickly. Employment now 
stands roughly 10 million below the level it would have reached 
if the recession had not occurred. Measured unemployment would 
be even higher today had there not been a considerable fall-off 
in the rate of participation in the labor force as the lack of 
available jobs caused some people to stop looking for one.
    CBO expects, as do most private forecasters, that the 
economic recovery will proceed at a modest pace during the next 
few years. International experience shows that recoveries from 
recessions that began with financial crises tend to be slower 
than average. Following such a crisis, it takes time for equity 
in other asset markets to recover, for households to replenish 
their resources and boost their spending, for financial 
institutions to restore their capital bases, and for businesses 
to regain the confidence needed to invest in plant and 
equipment. Weak demand for goods and services resulting from 
these and other factors is the primary constraint on the 
recovery.
    Under current laws governing Federal spending and revenues, 
CBO expects the unemployment rate to remain above 8 percent 
until 2012 and above 6 percent until 2014. And we released an 
issue brief in April that reviewed the evidence on the effects 
on people of losing jobs during recessions.
    Policymakers cannot reverse all of the effects of the 
housing and credit boom, the subsequent bust and financial 
crisis, and the severe recession. However, in CBO's judgment, 
there are both monetary and fiscal policy actions that, if 
applied at a sufficient scale, would increase output and 
employment during the next few years. But there would be a 
price to pay. Those fiscal policy options would increase 
Federal debt, which is already larger relative to the size of 
the economy than it has been in more than 50 years and is 
headed higher.
    If taxes were cut permanently or Government spending 
increased permanently, and no other changes were made to fiscal 
policy, the Federal budget would be on an unsustainable path 
and the economy would suffer. Even if tax cuts or spending 
increases were temporary, the additional debt accumulated 
during that temporary period would weigh on the economy over 
time.
    But 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.
    If policymakers wanted to achieve both short-term stimulus 
and medium- and long-term sustainability, a combination of 
policies would be required: changes in taxes and spending that 
would widen the deficit now but reduce it relative to baseline 
projections after a few years.
    To assist policymakers in their decisions, CBO has 
quantified the effects of some alternative fiscal policy 
actions. In a report last January to which the Chairman 
referred, we analyzed a diverse set of temporary policies and 
reported their 2-year effects on the economy per dollar of 
budgetary cost--what you might call the ``bang for the buck.'' 
The overall effects of those policies would depend also on the 
scale at which they were implemented. Making a significant 
difference in an economy with an annual output of nearly $15 
trillion would involve a considerable budgetary cost.
    This figure summarizes CBO's key findings. A temporary 
increase in aid to the unemployed would have the largest effect 
on the economy per dollar of budgetary cost. A temporary 
reduction in payroll taxes paid by employers would also have a 
large bang for the buck as it would both increase demand for 
goods and services and provide a direct incentive for 
additional hiring.
    Temporary expensing of business investment and providing 
aid to states would have smaller effects. And yet smaller 
effects would arise from a temporary increase in infrastructure 
investment or a temporary across-the-board reduction in income 
taxes.
    In that January study, we explained that those temporary 
policy actions would lead to the accumulation of additional 
Government debt that would reduce incomes beyond the next few 
years unless other policies were adopted that had offsetting 
effects. However, we did not quantify those future reductions 
in income at that time.
    At the request of the Chairman, we have now estimated the 
short-term and longer-term effects of extending the 2001 and 
2003 tax cuts, extending higher exemption amounts for the AMT, 
and reinstating the estate tax as it stood in 2009 adjusted for 
inflation.
    The methodology for our analysis was quite similar to the 
methodology that we follow in analyzing the President's budget 
each spring. We used several different models and made 
different assumptions about people's behavior. The models used 
to estimate the effects on the economy in 2011 and 2012 focused 
on the policy's impact on the demand for goods and services 
because we think that economic growth in the near term will be 
restrained by a shortfall in demand.
    In contrast, the models used to estimate effects on the 
economy in 2020 and beyond focused on the policy's impact on 
the supply of labor and capital because we think that economic 
growth over that longer horizon will be restrained by supply 
factors.
    As shown on the left side of this figure, we examined four 
alternative approaches to extending those tax cuts, and working 
my way down in order: a full, permanent extension that would 
extend all of the provisions permanently; a partial permanent 
extension that would extend permanently all of the provisions 
except those applying only to high-income taxpayers; a full 
extension through 2012 that would extend all provisions but 
only through 2012; and a partial extension through 2012 that 
would extend through 2012 all provisions except those applying 
only to high-income taxpayers.
    As CBO has reported before, permanently or temporarily 
extending all or part of the expiring income tax cuts would 
boost output and employment in the next few years relative to 
what would occur under current law where those tax cuts expire. 
That would occur because, all else being equal, lower tax 
payments increase demand for goods and services, and thereby 
boost economic activity. A permanent extension, whether full or 
partial, would provide a larger boost to income and employment 
in the next 2 years than would a temporary extension. And a 
full extension would provide a larger boost than with a 
corresponding partial extension. However, the effects of 
extending those tax cuts on the economy in the longer term 
would be very different from their effects during the next 2 
years.
    The long-term effects would be the net result of two 
competing forces. On the one hand, lower tax revenues increase 
budget deficits, all else being equal, and thereby Government 
borrowing, which reduces economic growth by crowding out 
investment.
    Chairman Conrad. Excuse me, just on that point. Do you have 
a slide that shows the longer term?
    Mr. Elmendorf. Yes. I was going to make the point and then 
show you the results, but those are the longer-term results. 
What you cannot see in the picture is the netting of these two 
forces. So, on the one hand, there is the effect of increasing 
Government borrowing which crowds out investment and reduces 
economic growth. On the other hand, lower tax rates boost 
people's work effort and saving, which increases economic 
activity and income. And the net effect of these policy 
changes--or the overall effect is the netting of these two 
different forces.
    For some of the options, our estimates of the net effects 
of the forces based on different models and assumptions span a 
broad range. This figure, however, shows the averages of the 
estimates across different models and assumptions for 2020. It 
indicates that all four of the options for extending the tax 
cuts would probably reduce national income in 2020 relative to 
what would occur under current law where those tax cuts expire. 
Beyond 2020, the reductions in national income from all of the 
alternative tax extensions become larger, especially for the 
permanent extensions.
    Moreover, a permanent extension of the tax cuts combined 
with the budgetary pressures posed by the aging of the 
population and rising costs for health care would put Federal 
debt on an unsustainable path. Specifically, a permanent 
extension that was not accompanied by future increases in other 
taxes or reductions in Federal spending would roughly double 
the projected budget deficit in 2020 from about $700 billion to 
about $1.4 trillion.
    A permanent extension except for certain provisions that 
would apply only to high-income taxpayers would increase the 
budget deficit by roughly three-quarters to four-fifths as 
much. Similarly, and also shown in the picture, permanent large 
increases in spending--for example, increases in discretionary 
appropriations in step with GDP rather than with inflation, as 
assumed in our baseline--that were not accompanied by 
reductions in other spending or tax increases would also put 
Federal debt on an unsustainable path.
    If policymakers adopted either of those policies shown, 
putting Federal debt back on a sustainable path would require 
future increases in taxes or reductions in spending that would 
amount to a large share of the budget.
    Thank you.
    [The prepared statement of Mr. Elmendorf follows:]

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    Chairman Conrad. Thank you very much.
    Let me go first to the question of ``bang for the buck.'' 
In terms of economic policies we might enact now to strengthen 
an economy that is too weak, your analysis shows that the 
largest effect would arise from a temporary increase in aid to 
the unemployed. The next largest effect would be a temporary 
reduction in employers' payroll taxes. Smaller but still 
significant effects would come from other policies such as 
temporary reduction in the employees' payroll taxes, additional 
one-time Social Security payments, additional temporary 
refundable tax credits for lower- and middle-income countries 
households. And going down the line, other things that would 
have an effect but would be still smaller would be a temporary 
increase in investment in infrastructure. And the final option 
you looked at was tax reduction, a 1-year deferral of the 
increase in income taxes that you also found would have a 
positive effect, although it would be the least bang for the 
buck of the options analyzed. Is that correct?
    Mr. Elmendorf. Yes, that is right, Mr. Chairman. Let me 
just make two quick points. One is that this analysis we did in 
January assumed that these policies would be enacted in early 
2010. Of course, that is not possible at this point. We have 
not updated all of these estimates. One that would look 
somewhat different--actually, if this picture could go back up 
there on my screen, that would be helpful, whoever is 
controlling that.
    Chairman Conrad. Is that the slide you wanted?
    Mr. Elmendorf. Yes, that is the slide I had in mind.
    If we updated the numbers now, they would change a little 
bit. The basic pattern would not be different. But it is true 
that the effect of extending the tax cuts would look a little 
stronger because this extension was one that actually began in 
2011--in other words, 1 year into the 2-year window we were 
focusing on at the time--and that diminished its effect a 
little bit. But if we updated all these numbers, the options of 
extending the tax cuts would still have lower bang for the buck 
than almost all of the options on this list.
    The other thing I just want to add, Mr. Chairman, is that 
it is important to recognize this is the effect per dollar of 
budgetary impact. As I mentioned in my remarks, if one wants to 
have an effect of a certain size on the economy, it also 
matters the scale at which these things are done. Some of these 
options can naturally be done at a larger scale than others, 
and that is a consideration for you and your colleagues as 
well.
    Chairman Conrad. So let us go to the question of the tax 
cuts because that is one of the key issues Congress will 
confront when we return. As I analyze the results of your work, 
it is that although they are pretty modest with respect to bang 
for the buck, extension of the tax cuts would be positive in 
the short term, 2011 and 2012, but actually be negative in the 
long term; that is, permanent extension of the tax cuts, all of 
them, would actually be the most negative in terms of its 
effect on economic growth in the long term. Is that correct?
    Mr. Elmendorf. As you know, we have not looked at all of 
these options over the longer term, but of the tax options that 
we studied, the four different ways of extending the expiring 
tax provisions, the permanent extensions would have the largest 
negative effect on national income over the longer run--the 
largest boost in the short run, as you said, but the largest 
negative effect in the long run. And that would occur because 
the extra Government borrowing from the significantly larger 
deficits would drag down income more than the extra work effort 
or saving that would be generated by the lower tax rates.
    Chairman Conrad. So the effect of tax cuts, which many of 
us associate as being positive with respect to economic growth, 
your conclusion is in the short term additional tax cuts, 
extending the tax cuts, the expiring provisions, would be 
positive, although the least positive of the policies that you 
have looked at in terms of effect on the economy, would give us 
the least bang for the buck, but longer term the tax cuts are 
actually harmful to economic growth because they are deficit 
financed. Is that correct?
    Mr. Elmendorf. Yes, that is correct, Mr. Chairman.
    Chairman Conrad. So that really creates a conundrum because 
we have two things that kind of work against each other here. 
On the one hand, we have got a series of policies that have 
been rated in terms of bang for the buck. Extending the tax 
cuts is among the weakest in terms of helping boost economic 
growth, although it is positive. So extending tax cuts would 
have a mildly positive effect short term, but it would have a 
negative effect long term because they are deficit financed, 
just as additional spending would help us short term but be 
negative long term.
    Mr. Elmendorf. Yes, that is right. The effects are really 
rather symmetric in that way. We have written this on a number 
of occasions, that the sorts of policies that lead to short-
term boosts, higher Government or lower taxes, if not 
accompanied by other offsetting changes over time, if just 
allowed to increase deficits and debt over time, will have 
negative effects in the medium and long run.
    Chairman Conrad. Let me just say for many people it is 
counterintuitive that tax cuts could somehow hurt future 
economic growth. How is that? Why is it that in your analysis 
tax cuts could be actually harmful to long-term economic 
growth?
    Mr. Elmendorf. I think the natural intuition is people 
thinking about their own situations and thinking, correctly, 
that if their tax rates were lower, that would give them an 
incentive to work more, to save more, to invest more. And that 
is right as far as it goes. The problem is that if those tax 
cuts are not accompanied by other changes in the Government 
budget and are simply funded through borrowing, that that 
borrowing crowds out other private investment in productive 
capital in the sorts of equipment--the computers, the 
machinery, the buildings--that are the source of long- term 
economic growth. And that connection is less visible, and I 
think this is less apparent in most people's intuition. But it 
is no less important for being not so visible, for being more 
indirect.
    Chairman Conrad. Well, I think that is incredibly important 
testimony that you are giving us here today. I hope people are 
listening because what I hear you saying is, short term, 
anything we do to provide stimulus, whether it is increased 
spending or additional tax cuts, will give you a short-term 
boost; but either of them, additional spending over what is 
projected or additional tax cuts, will actually hurt longer-
term economic growth because the impact of the deficits and 
debt will serve like a weight around the neck of the economic 
engine of this country.
    Well, I thank you very much for that testimony. I hope 
people are paying attention.
    Senator Gregg. Picking up on that point, because there is 
another side to the coin if you use your logic, it would be, 
would it not be true that spending would all have the exact 
same effect of crowding out economic activity if it were 
borrowed to spend, if you had to borrow to spend?
    Mr. Elmendorf. Yes, that is exactly right. As I said, it is 
symmetric.
    Senator Gregg. And I do not know that you have done this 
analysis, but which generates more economic activity, the 
spending or the tax cuts?
    Mr. Elmendorf. So if you--so actually, I did not have time 
to show it, but there is a table in the report, which I think I 
have here. It is a rather complicated table. You can read along 
if you want, but I will try to make the points more directly.
    If one looks out--the right-hand column is where we modeled 
the effects over time both in 2020 and beyond that, and what we 
have done here is we have modeled not just the effects of the 
initial cut in taxes, but also the policies that we needed 
later to put fiscal policy back on a sustainable path. It is 
actually required for this model. And you can see in the far 
right columns the changes that we assume for later to put 
policy back on a sustainable path, either decreases in 
government spending or increases in tax rates.
    In the middle columns, it was a later dencrease in 
government spending. And, in fact, as you are suggesting 
Senator Gregg, the increases in tax rates have a much more 
negative effect on the economy over the longer term than if the 
budget is returned to sustainability through a reduction in 
government spending.
    Senator Gregg. That is very important testimony.
    Let me ask you another question. Your projections going 
forward, the size of government spending as a percent of GDP 
goes from what to what, starting, say, 2 years ago and working 
forward 10 years?
    Mr. Elmendorf. So in our latest baseline projections, 
government spending would be about 24 percent of GDP in 2020 
compared with an average in the past 40 years that I think is 
closer to 20 or 21 percent of GDP. So much higher than we have 
experienced before in this country.
    Senator Gregg. That being the case, is it not reasonable to 
presume that spending is the problem that is driving the debt?
    Mr. Elmendorf. Umm----
    Senator Gregg. Primarily. I mean, accepting your argument 
that if you raise taxes, you know, we have a present tax law 
and you raise taxes, yes, you are going to get more revenues. 
But if I understood what you said, four-fifths of the tax 
increase or the tax revenues that are lost are not high-end 
people paying taxes. They are middle- income people paying 
taxes, correct?
    Mr. Elmendorf. So let me clarify that. Extending the top 
brackets is about a fifth or a quarter of the cost of extending 
all of it.
    Senator Gregg. So----
    Mr. Elmendorf. The trick is that the people below--the 
tricky part is the people who are--the lower tax brackets 
affect the high-income people, as well.
    Senator Gregg. If there is consensus--I did not mean to 
interrupt. If there is consensus in the Congress and the 
President is calling for an extension of middle-class tax cuts 
and the only thing that the President is calling for is the 
increase in the taxes of high-income individuals or people or 
small businesses earning more than $250,000, if that is the 
case, then your numbers are still 75 to 80 percent off, right? 
I mean, your revenues.
    Mr. Elmendorf. Yes, exactly. Extending all the tax cuts 
except for those affecting higher-income people has three-
quarters or four-fifths, roughly, of the positive effects and 
the negative effects of extending all of the tax cuts.
    And I want to say to your question about the problem, I do 
not want to use the word ``problem'' because it is a choice of 
people how big the government should be. But relative to 
historical experience, the thing which is different going 
forward is the high share of spending, due as we have written, 
as you know, to population aging, changes in health system and 
other aspects of the government budget.
    Senator Gregg. Well, I think that is an important point 
that we need to keep in mind, that dealing with reality as it 
is coming at us, the government is going to go from 20 percent 
of GDP to 24 percent of GDP. That spending is the driver, in 
large part, of the gap that is causing the deficit and the debt 
which is going to bankrupt the country. That is how I phrase 
it.
    Mr. Elmendorf. Yes.
    Senator Gregg. Thank you. And this debate over taxes is 
really, in my opinion, a bit of a straw dog debate, because as 
you have pointed out, 75 to 80 percent of the revenues that 
will not be received because we are not going to raise taxes, 
everybody agrees are not going to be received because everybody 
agrees those taxes are not going to be raised. So it really 
is--this whole tax debate, in my opinion, is really not what we 
should be focusing. We should be focusing on the growth of this 
government from 20 percent to 24 percent and how do we get that 
back under control. How do we get that into a manageable 
number, considering our revenue base.
    I think that summarizes my points, come to think of it, and 
I thank you for your testimony. I also want to thank you for 
your professionalism, your staff's professionalism. You folks 
get a lot of pressure from a lot of different people, including 
myself, and you are always very professional and you always 
give us a straight answer as you see it and that is the way it 
should be. You are the fair umpire around here and we 
appreciate it. Thank you.
    Mr. Elmendorf. Senator Gregg, thank you very much, and let 
me just say on behalf of all of us at CBO, we very much have 
appreciated your support for many years for the work that we 
do.
    Chairman Conrad. Thank you, and Senator Wyden.
    Senator Wyden. Thank you, Mr. Chairman, and Director 
Elmendorf, I share Senator Gregg's view about your 
professionalism. We thank you.
    And I want to take this tax discussion in a bit of a 
different direction, because right now, there is a comparison 
underway between the tax policies of George W. Bush and the 
proposals that have been offered by President Obama. And I am 
of the view that that tax debate misses the point because both 
of those approaches, George W. Bush and now what has been 
offered by President Obama, in my view, involve tinkering with 
a badly flawed, discredited tax system.
    And to me, the much more relevant comparison--I want to 
walk you through the numbers and just get your reaction--are 
the numbers that you have when Ronald Reagan got together with 
a big group of Democrats and reformed the tax system, and 
compare those and what we saw in our country for job growth and 
economic growth, payroll growth, to what we saw during the 
years of George W. Bush in 2001 to 2008 and get your reaction.
    Now, here are the numbers. When Ronald Reagan and Democrats 
worked together, 16 million new jobs were created. There was a 
17.6 percent expansion in payrolls. That is when Democrats and 
Republicans worked together to create a tax system that was 
more pro-growth and more of an engine for job creation. By 
comparison, from 2001 to 2008, when there was just partisanship 
in the tax area, three million jobs were created. There was 
only a 2.3 percent expansion in payrolls.
    Now, you have to look at the entire challenge for the 
American economy, and tax policies are not the only thing 
behind economic growth and job creation. But are not those 
numbers relevant with respect to this question of job growth 
that you saw? With tax reform, the Democrats and Republicans 
worked together. You certainly saw more positive numbers, 
numbers that were pro-growth, pro-job creation, than you saw in 
the years of 2001 to 2008.
    Mr. Elmendorf. So as you mentioned, Senator, there are a 
lot of forces affecting the economy in addition to tax policy 
and it is difficult to isolate the effects of tax policy. But I 
think you raise a very important point about the nature of the 
tax system matters just as much, if not more, than the level of 
revenue collected, and we mention that a number of places in 
the written testimony, that the experiments we conduct would 
have different results if the tax code were constructed in 
different ways, if the nature of the tax changes over time were 
different.
    In particular, what is very important for the incentive 
effects are the marginal tax rates, and there are ways to raise 
revenue or lower revenue that involve changing marginal tax 
rates, but there are also ways that involve changing the base, 
the amount of income that is subject to tax at the corporate or 
individual level, and those are very important decisions for 
you and your colleagues----
    Senator Wyden. Would you agree that the fundamental model 
of 1986, which is what Senator Gregg and I have picked up on in 
our bipartisan legislation, that that model of radically 
simplifying the code--we have a one-page 1040 Form, 29 lines 
long--broadening the base and lowering rates, lowering rates 
for both individuals and businesses, would you agree that that 
model is more economically efficient than just going out and 
extending this vast array of loophole-ridden tax breaks that 
constitute the code today?
    Mr. Elmendorf. So I cannot speak to the details of your 
specific proposal, which I am sorry, we have not studied 
carefully, but I think there would be widespread agreement 
among analysts that a tax system with a broader base and lower 
tax rates would be a much more efficient way to raise revenue 
and thus a better way to strengthen the economy while raising 
revenue.
    Senator Wyden. Why would one think that the tax policies 
that produced anemic job growth and declining real income for 
the middle class--those were the policies between 2001 and 
2008--why would one think that just reenacting them would 
create substantially more jobs and substantially more income in 
the pockets of middle class folks? I mean, we have what 
occurred. Now someone is talking about redoing it. People like 
Senator Gregg and I are saying, no. Why not go with a model we 
know worked when Democrats and Republicans get together. And my 
question is, why would you re-up for something that showed such 
anemic economic growth, job creation, payrolls between that 
2001 and 2008 period?
    Mr. Elmendorf. So as you know, Senator, I am not in a 
position to re-up or not re-up any policy, but----
    Senator Wyden. I am just talking about the analysis.
    Mr. Elmendorf. In our analysis, the only distinction I 
would make is between the short-run effects and longer-run 
effects. In the short-run, the principal effect of tax changes 
on the economy is likely to be through the additional income 
that households would receive. But over time, in the medium-run 
and long-run, the most important effect of tax policy is likely 
to be not just the changes in total revenue, but also the 
changes in incentives, and our modeling reflects that. And I 
think the points that you were making about the proposal that 
you put forward are focused principally on the medium- and 
longer-run effects of tax policy and economic growth.
    Senator Wyden. Let me ask you about the international 
economic challenge and the tax law as it relates again to job 
creation. When you talk to American businesses, they say they 
have to have this array of breaks for going overseas, because 
the United States has a high, comparatively, tax rate to other 
countries with respect to the business rate. So along came 
these various breaks, deferral and others, the American people 
do not understand.
    What Senator Gregg and I did is, in effect, go to American 
business and say, how much would you have to reduce these 
American rates in order to junk a lot of the stuff that you 
have overseas? So we came in with a rate of about 24 percent, 
significantly lowering the corporate rate. But it is paid for. 
Every single dime of it is paid for in our tax reform bill, 
because we, in effect, take away those overseas breaks to use 
it to strengthen American manufacturing.
    Would not that, again, just apart from our bill, and in 
theory, would not that particular change make it more 
attractive to grow businesses and generate job growth in the 
United States?
    Mr. Elmendorf. Yes, Senator. I think most analysts would 
agree that broadening the corporate tax base and lowering the 
tax rate would be a more efficient way to raise that revenue.
    Senator Wyden. Thank you, Mr. Chairman. My time is up. I 
would also ask, Mr. Chairman, to put into the record several 
studies that have been very supportive of the bipartisan tax 
reform bill, particularly that done by the Manufacturing 
Alliance, the Brookings Association, and the Heritage 
Foundation. They would just be short summaries, if we could put 
that in.
    Chairman Conrad. Yes, without objection. I also want to 
commend you and Senator Gregg for coming up with really a very 
thoughtful tax reform proposal.
    Let me just say, just quickly, if I could, Senator Ensign, 
it is very clear we are going to have to cut spending as a 
share of the economy. It is also clear to me we cannot afford 
to make permanent all of the tax cuts that are currently in the 
code, which kind of jumps out at you that what we need is tax 
reform. The tax code is now 7,500 pages long, and it was never 
designed with competitiveness in mind. The world has changed 
since that tax code was written. And if we do not write a new 
tax code that relates to the reality we confront today, that we 
are in a fully competitive global environment, and we write a 
tax code with that in mind, I think we are making a profound 
mistake. Just to double-down on this current tax code is just a 
huge mistake.
    Senator Ensign, I thank you for your courtesy.
    Senator Ensign. Thank you, Mr. Chairman. I want to 
associate myself with the remarks that Senator Wyden just 
talked about. There is no question that some of the economic 
effects of our tax code are just complying with the tax code. 
It is a huge burden on individuals as well as businesses in 
complying with our tax code. Just look at the estate tax, death 
tax, whatever you want to talk about. There are many 
complexities of trying to avoid taxes, the huge costs. 
Businesses make investments based on the tax code instead of 
what necessarily makes good economic sense, and so there is no 
question. I believe very strongly that the best thing that we 
could do is what you just talked about, Mr. Elmendorf, and that 
is broadening the base and lowering the tax rates. I think that 
it is absolutely the best way to go.
    I do want to pick up on something that you said a little 
while ago. You said that if we lower tax rates, in one of your 
charts, over the next couple of years, it will increase GDP. Is 
the opposite true? If we raise taxes over the next couple of 
years--if we raise--in other words, if we let the tax rates 
that are on the books currently expire, will GDP go down?
    Mr. Elmendorf. Well, so our economic baseline, as you know, 
has to be conditioned on current law. So our economic forecast 
assumes that those tax cuts expire, and relative to that, an 
extension--so it is relative to that that we have done our 
estimates. Relative to that, an extension of the tax cuts 
would, in fact, boost GDP and would boost employment. 
Conversely, if one pictured starting from that point, then 
having the tax cuts expire would lower GDP. I just want to be 
clear that that effect is essentially in our economic 
forecast----
    Senator Ensign. Right, but it does make sense that raising 
taxes will decrease the GDP? In other words, if taxes go up, 
there is no question that GDP will go down versus keeping those 
tax rates where they are today.
    Mr. Elmendorf. Yes. Over the next few years, that is the 
short-term effects----
    Senator Ensign. Yes. I think that is important. And I 
also--I think some of the analysis that you have done as far as 
the long-term is very, very important, and like you said, it is 
not just the tax cuts, the spending, both of those things. I 
agree with you. I think if we are going to do these tax cuts, 
we should actually be looking at ways to cut spending, because 
it is not just the short-term economy that we need to think 
about here. We need to be responsible in the long-term, and 
while ideally doing what Senator Wyden is talking about, to me, 
that would be the best way to do it, and if we could lower the 
rates low enough and do that, paying for it through lowering 
spending, in the long run, we are going to be better off as an 
economy, as a country. Obviously, those are tough choices to 
make along the way, but the responsible thing to me, because 
the biggest threat to long-term economic output is the debt, is 
it not?
    Mr. Elmendorf. Yes, I think that is right, Senator. I think 
the challenge on the spending side is that the revenue lost 
from extending the tax cuts is a very large number, as we have 
reported, based on estimates from the staff of the Joint 
Committee on Taxation. And the full extension would reduce 
revenue by nearly $4 trillion over the next 10 years.
    Senator Ensign. What percentage of revenues is that, over 
10 years?
    Mr. Elmendorf. That, I do not know offhand. I think we do 
report in our--so I guess we report in this testimony that a 
full extension would reduce tax revenue by about 2 percent of 
GNP in 2020 against a base that is around 20 percent or so of 
GNP----
    Senator Ensign. I am talking about as far as----
    Mr. Elmendorf [continuing]. I think it is about a 10-
percent reduction in revenues. About a 10-percent reduction in 
revenues.
    Senator Ensign. A 10 percent reduction in revenues over 
that period of time. Have you looked at what States and cities 
are doing as far as cutting their budgets?
    Mr. Elmendorf. We follow it a little bit, not as closely as 
we follow the Federal Government.
    Senator Ensign. Do we think there is 10 percent waste in 
the Federal Government?
    Mr. Elmendorf. Well, I think the problem turns out to be 
that one person's view of what is the waste differs from the 
other person's view of what is the waste.
    Senator Ensign. OK. Let us take it this way. Every family, 
every business, local government, State governments across 
America right now are cutting their budgets and they are 
basically wringing out the waste. You talk to every business in 
America and that is what they have done over the last 2 years, 
and this is the private sector, and they had a lot of fat. The 
private sector did. Local governments had a lot of fat. State 
governments had a lot of fat, and they are wringing that out.
    The one place where we have not wrung out and cut the fat 
is at the Federal level. If we can sit here and honestly say 
that we do not think there is at least 10 percent waste in the 
Federal Government, then that is a completely preposterous 
statement to think that we do not have at least 10 percent 
waste in this government.
    And so all I am saying is that $4 trillion is a big number. 
It sounds like a big number. Except when you look at it, it is 
10 percent. And if we do not think that we can take 10 percent 
and get this government more efficient by 10 percent by cutting 
out inefficient programs and streamlining programs, eliminating 
duplication, eliminating waste, I think that if this Congress 
cannot find 10 percent waste, then they should throw this 
Congress out. That is all I am saying. And that is why I think 
that the 10-percent number is really, really important.
    Mr. Elmendorf. So, Senator, it is up to you and your 
colleagues. It is not our place to say what parts of the 
government should be bigger or smaller in what ways. But I do 
want to just emphasize the magnitude of the problem here. So 
the left set of bars show revenues and then spending under 
current law and the right set show them with the tax cuts 
extended and the AMT indexed, kind of the full extension 
through 2020 we have been talking about.
    So on the right-hand set of bars, that red box is the size 
of the deficit. You can see that that amount is larger than all 
of the spending on Social Security in 2020. It is, I think, a 
little smaller than all of the Federal spending on Medicare and 
Medicaid and health insurance subsidies. It is much larger than 
all spending on defense. It is much larger, you can see, than 
the box right next to it, which is all spending apart from 
those handful of the largest programs.
    Senator Ensign. And a big part of that, a big part of the 
reason for those deficits is because in that year, that $1.4 
trillion deficit, at that point, how much of that is interest 
on the debt?
    Mr. Elmendorf. Well, so interest is large, and you can----
    Senator Ensign. It is over $900 billion, is that not 
correct?
    Mr. Elmendorf. Exactly. With those tax cuts extended, that 
is a fair estimate.
    Senator Ensign. That is because we are adding to it every 
year right now with such huge numbers. And what Senator Gregg 
talked about, about spending being the largest part of the 
problem, that is why at the Federal level we need to get 
spending under control. That is why we are at a critical point, 
because this is unsustainable. The numbers you are putting up 
here, it is unsustainable. This country is going to become 
Greece, except we do not have the European Union to bail us 
out. If we have these kind of debt and deficit numbers going 
into the future, it is unsustainable, and that is why this 
Congress needs to heed the warning that we have to get our 
spending habits under control. It is critical for the future of 
this country.
    Thank you, Mr. Chairman.
    Chairman Conrad. Senator Warner?
    Senator Warner. Thank you, Mr. Chairman, and thank you, 
Director Elmendorf, for your comments. I concur with my 
colleague from Nevada on streamlining, as somebody who was a 
Governor who did some of that.
    But I also think the notion, and I think your testimony 
reflects this, that the problem is of such a magnitude that if 
we are only going to do it on one side of the balance sheet, 
this challenge is going to require us to recognize sufficient 
revenues to meet core functions of the government. Cutting the 
revenue side constantly and saying we are going to simply find 
all of the spending through waste and fraud is a tired and true 
political axiom that has never proven to be the case.
    But at the same time, those who say we can simply tax on 
the top end and continue to spend at the rate, I think it is 
going to take both sides. I would have preferred, frankly, the 
statutory approach that the Chairman and the Ranking Member had 
on a fiscal commission. Unfortunately, many of our colleagues 
on the other side of the aisle would not join us on that 
statutory approach that would have forced our feet to the Fire. 
I am hopeful that the Presidential Commission, and I hope that 
all the members will keep their powder dry to let this 
Presidential Commission work its way through, and I hope it 
comes up with very bold and challenging courses that challenges 
the orthodoxies of both political parties to make hard choices, 
because the notion that we are going to do it on simply the 
spending side or simply the revenue side, is false.
    Let me turn my questions back to your first chart, sir, 
where you looked at things that could have effect on 
unemployment in the next couple of years. We seem to be having 
a binary discussion here, either extend the so-called Bush tax 
cuts for everyone, or some on my side, extend them for the 98 
percent and let them expire for the top end, and a lot of 
debate about the value of that top-end 2 percent, $700 billion 
over 10 years in terms of lost revenue, approximately, I think 
since it is an accelerating number, more in the $70 billion 
over the two-year period. I know some have said, let us simply 
extend for the top 2 years [sic].
    The question I would have, is if we say that taking that 
money out of the economy on the short-term basis may have some 
negative effects, and then the only choice becomes, let us just 
leave it with the top income earners, some of which may spend, 
but many of whom will, evidence will show, would simply save 
those dollars and deposit them, which would not have the kind 
of short-term effect we might need to get employment restarted 
and the recovery continued.
    You have looked at payroll tax. You have looked at full and 
partial expensing of investment costs. What I am asking is, if 
we said what we could do for a 2-year period, $70 billion of 
targeted short-term tax cuts that might have the most bang for 
the buck, are those the two that you have analyzed, and are 
there others?
    I would argue that at the macro level, we in government 
have used most of our bullets. We have used monetary policy and 
lowered interest rates to historic lows. And while perhaps not 
as efficiently as many, including myself, would have liked, we 
have used stimulus. The one good piece of news in our economy 
that does not get as much attention is that during this 
recession, large-scale enterprises have dramatically retooled 
and their balance sheets are healthier than ever. The balance 
sheets of American corporate 1000 companies today are healthier 
than they were pre-recession, north of $2 trillion sitting in 
cash on those balance sheets. Now, we can argue regulatory 
uncertainty, policy uncertainty. I will grant that is one of 
the issues.
    But if you, and I am asking you to speculate here, had $70 
billion of short-term targeted tax cuts that would expire in 2 
years to try to get that $2 trillion off that corporate balance 
sheets, into the economy, reinvested as the economic engine, 
private sector engine that would jump-start it, would you 
choose either employers' payroll tax reduction, the immediate 
expensing, or are there other tax reduction tools on a short-
term basis we could use to get that $2 trillion reactivated 
into the economy?
    Mr. Elmendorf. So, Senator, there may well be some other 
policies. We cast a fairly wide net in January, but I am sure 
we did not catch everything. Among the policies that we 
studied, as this chart shows, reducing employers' payroll taxes 
or allowing full or partial expensing of investment costs would 
have much more bang for the buck, much more positive impact on 
the economy per dollar of budgetary cost than would a broad 
extension of the expiring tax cuts.
    Senator Warner. And your assumption was that those would 
be, whether it is the payroll taxes or the immediate deducting, 
short-term, targeted, and during----
    Mr. Elmendorf. We studied simply temporary policies----
    Senator Warner. Temporary, year, 2-year, what have you?
    Mr. Elmendorf. Yes.
    Senator Warner. There are a host of other things, R&D tax 
credit, other issues out there. Did you go through the whole 
analysis? The business community has laid forward a series of 
other options, or----
    Mr. Elmendorf. So we have not looked as carefully at 
extending the research and experimentation tax credit. It is 
tricky. Because that tax credit has been extended many times 
before----
    Senator Warner. Right.
    Mr. Elmendorf [continuing]. Many businesses probably expect 
it to be extended. That probably means that if it were extended 
now and that uncertainty were resolved, that would have a 
little positive effect. But if you and your colleagues were 
going to enact an extension anyway, than it is not as 
incremental as----
    Senator Warner. Of course, if it was at 14 and the 
President has proposed raising it to 17, many OECD countries 
are at 20, and I am not----
    Mr. Elmendorf. So we looked a little bit at that. A small 
increase in the rate would matter a little bit. It probably 
would not----
    Senator Warner. And I do not want to just lay on that, but 
what I would ask--the Chairman has left, but I guess what I 
would love to see your office do some analysis is recognizing 
that if you take the dollar of 1 year or 2 year of that top 2 
percent. Could those funds be better put to use, recognizing 
that perhaps taking those dollars out of the economy right now 
might not make that much sense, but where are we going to get 
our best bang for the buck? You are saying at this point your 
analysis says----
    Mr. Elmendorf. The policy----
    Senator Warner [continuing]. Payroll taxes or immediate 
expensing are the best bang----
    Mr. Elmendorf. Right.
    Senator Warner [continuing]. And you have----
    Mr. Elmendorf. Would be significantly more bang for the 
buck than extending all of the tax cuts. And within this bottom 
bar, extending all of the tax cuts, the extending the tax cuts 
in the higher brackets is actually the less effective piece of 
that because those people would be likely to spend a smaller 
share than people receiving the bulk of the rest of the tax 
cuts.
    Senator Warner. My time is about expired, but I would love 
to have your office go back and maybe scrub those a little bit 
more, and if you could give us with some more specificity bang 
for the dollar invested in terms of these targeted tax cuts, 
and I would ask you, as well, to look at some of the other 
menus of suggestions that the business community has laid out, 
because, again, my point is we have $2 trillion. That is the 
last bullet that we have not used. Getting those resources back 
invested in our economy, would be a great value.
    Thank you, Mr. Chairman.
    Mr. Elmendorf. Thank you, Senator.
    Senator Nelson [presiding]. Senator Bunning?
    Senator Bunning. Thank you, Mr. Chairman.
    Dr. Elmendorf, thank you for coming. My question is one of 
kind of comparisons. Over the last two to 3 years, we have 
stimulated or spent or printed about $4.5 trillion if you count 
what the Federal Reserve has put in and taken out and put in, 
taken out, over the past two to 3 years, besides the money that 
the Congress has allocated either through TARP or through the 
stimulus program. So it is about $4 trillion, give or take.
    The unemployment rate as of January 2009 was 7.7 percent. 
In August of this year, the unemployment rate was 9.6 percent. 
It has been in excess of 9 percent for over 16 consecutive 
months. With the stimulus that we used, can you estimate or 
have you the ability to estimate--I am not sure you do--when we 
are going to see 7.7 percent or pre- recession 5 percent 
unemployment rate? Can you give me an idea?
    Mr. Elmendorf. Well, so we do make projections, and you 
understand the uncertainty that----
    Senator Bunning. I understand the uncertainty because I 
have been here for 12 years and have looked at all the 
projections.
    Mr. Elmendorf. So our current projection, the projection we 
published in August is that under current law, the unemployment 
rate would fall back to the 7.7 percent you have in mind, I 
think in 2012 at some point.
    Senator Bunning. Twenty-twelve?
    Mr. Elmendorf. Twenty-twelve.
    Senator Bunning. Are you telling me that the 15 million 
part-time or totally unemployed people will be back to work?
    Mr. Elmendorf. Well, there is a lot of churning, of course, 
in the labor force, so many people who are without work today 
will find jobs, but others will lose jobs, so on balance, we 
think the unemployment rate, as we say in the testimony, will 
remain above 8 percent until 2012 and remain above 6 percent 
until 2014.
    There is a significant and growing literature on the 
effects of--on the longer-term effects of financial crisis, and 
in addition to the severe recessions that often follow 
immediately, that literature shows very clearly that economic 
growth can be weak for many years to come.
    And the question about the 5-percent unemployment rate that 
you raised, we do project the unemployment rate going back down 
to 5 percent, but there are reasons other people are more 
concerned that that may not happen, or may not happen for quite 
a long time, because of tremendous dislocations in the 
financial system and the economy and the longer-term effects of 
that.
    Senator Bunning. Well, use a personal family unemployed. I 
have a grandson who is unemployed. He has been unemployed now 
for 8 months. His job is never going to come back. Delta 
Airlines used to have 400 flights out of the Greater Cincinnati 
Airport. They are at one-third the number of flights now, not 
to ever return to the 400-plus that they had at one time. So 
his job is never going to come back. He is going to have to be 
reeducated into some other type of position.
    Tell me this, and I have seen all your wonderful charts on 
the employment, the tax, the changes or the non-changes in the 
tax code, the expiration of the tax at the end of this year. 
Have we ever been successful in raising taxes to help our 
economy in a recession?
    Mr. Elmendorf. Not that I am aware of, Senator. Raising 
taxes in a recession will tend to slow economic growth, and 
that is, as we have explained in our report, part of why we 
have such a slow growth rate projected for 2011 under current 
law.
    Senator Bunning. And how do you get out from under that?
    Mr. Elmendorf. Well, so in the short run, tax cuts or 
government spending increases provide a boost. The challenge, 
as you understand----
    Senator Bunning. Is the balance.
    Mr. Elmendorf [continuing]. Is what happens beyond that, 
and over the medium- term and long-term, unless those actions 
are undone, offset in some way by other actions, then there is 
a medium-term and long-term drag on the economy.
    Senator Bunning. We talked about debt and other things, and 
we did not talk about interagency debt. Right now, to pay our 
Social Security benefits, the Federal Government has borrowed 
right at a trillion dollars from the Social Security Trust 
Fund, right at. We have written IOUs. They are kept in 
Parkersburg, West Virginia, and there is nothing to back it 
except the IOU, which means that the Federal Government has to 
make good on those IOUs----
    Mr. Elmendorf. Yes.
    Senator Bunning [continuing]. And they do not have anything 
to do except to print the money, or----
    Mr. Elmendorf. Raise taxes or----
    Senator Bunning [continuing]. Raise taxes or raise----
    Mr. Elmendorf [continuing]. When the IOUs come due.
    Senator Bunning. Yes, any way you can pay off that trillion 
dollars. So my question--this is a little off the wall, and it 
is the last question I will do--according to the Social 
Security and Medicare Board of Trustees' most recent report, 
Social Security is projected to begin permanently facing 
deficits in 2015--permanently--and Medicare will become 
insolvent in 2029. However, if this was not bad enough, the 
report indicates that Social Security will begin operating with 
a cash-flow deficit this very year.
    Should we not be concerned about the impact this, paired 
with the large budget deficits that this administration has 
projected, will have on my 40 grandchildren and future 
generations?
    Mr. Elmendorf. Senator, yes. I think the concern, the 
effects of mounting debt, will be felt particularly by future 
generations.
    Senator Bunning. Is that not just kind of a transferring of 
what we cannot pay for and what our excesses are presently to 
my children and grandchildren? Is that not kind of a wealth 
transfer or a debt transfer?
    Mr. Elmendorf. The issue about how large the Federal debt 
is is importantly a distributional issue across generations.
    Senator Bunning. Thank you very much for your answers.
    Mr. Elmendorf. Thank you, Senator.
    Senator Nelson. Dr. Elmendorf, would you explain the 
phenomenon of the fact that the U.S. Government is borrowing 
more and more money, albeit the Federal Reserve is trying to 
hold down the rates, and why those rates projected well into 
the future, interest rates, are staying so low?
    Mr. Elmendorf. So I think most analysts believe that 
interest rates are low because although the Federal Government 
is borrowing a tremendous, unprecedented amount, private 
borrowers are borrowing much less than they generally borrow, 
and interest rates will reflect the overall balance between the 
demand and supply of credit. So one can think about the decline 
in private borrowing as reflecting and reinforcing the slow 
private spending. The Federal Government has stepped in, partly 
through automatic stabilizers and partly through deliberate 
actions, to try to boost spending and is boosting its borrowing 
as part of that, and it is the balance of those forces with a 
supply of funds, some coming in from overseas and some from 
domestic saving, that leads to the level of interest rates.
    In our forecast, interest rates rise a good deal over the 
coming decade as the economy recovers and private credit 
demands go up. And meanwhile, Federal borrowing would be very 
high, and the combination of that demand, we think will push 
interest rates up a good deal over the course of the decade. 
Together with the very high level of Federal debt, that leads 
to interest payments being unprecedentedly large relative to 
the GDP by the end of the decade.
    Senator Nelson. Do your projections square with the 
projections of the Federal Reserve?
    Mr. Elmendorf. I mean, they are--the Federal Reserve does 
not release projections that go out over the entire decade. 
They do--the FOMC releases its projections for a period of 
several years. Our forecasts are generally fairly close to 
theirs, not every specific, but yes, in general, they are. I do 
not think our views in general about the state of the economy 
are idiosyncratic in any way to us.
    Senator Nelson. And the market would give us some idea of 
what the market thinks about interest rates. How do you square 
the fact that 10-year Treasury bills are being sold at such low 
rates in light of what you just said?
    Mr. Elmendorf. Well, I think that, again, part of it is the 
overall weakness in the demand for credit from private 
borrowers in this country. Part of it is the continued flow of 
money into this country. As bad as our financial crisis seemed 
to us, the U.S. market still seemed safer to many investors 
than markets overseas.
    I think the other part of that is that their financial 
markets seem to believe that you and your colleagues will put 
fiscal policy onto a sustainable path, and when fiscal crises 
erupt, and we released an issue brief about this a few months 
ago, it generally comes from a loss of that confidence, when 
investors feel that a government of some country is not acting 
in a way to put fiscal policy in that country on a sustainable 
path. It is very difficult to predict what sorts of events and 
what sorts of circumstances can lead to that loss in 
confidence. I think at the moment, investors believe that U.S. 
Fiscal policy will be put on a sustainable path. How that 
confidence will evolve in response to actions that are taken or 
not taken by you and your colleagues, I do not know.
    Senator Nelson. I would like for you to comment, if you 
will, on the wisdom of a tax policy given the fact that in your 
testimony you said that the national debt is going to amount to 
70 percent of GDP for the next 10 years. And in looking to find 
sources of revenue, the loopholes that we find in the system 
now allow multinational companies, and an example that is fresh 
in our minds is BP, to receive tax credits for--tax credits 
that were intended not for oil companies, but for manufacturing 
companies. Do you think that from a policy standpoint--I will 
not ask you the political question--that closing tax loopholes 
should be a priority in the debt reduction efforts?
    Mr. Elmendorf. I think that kind of policy choice has to be 
yours and your colleagues', Senator, but I think--and specific 
tax provisions can have positive or negative effects on 
economic outcomes, depending on the provision, and I do not 
want to just speak too generically about them, but I did say 
earlier and will repeat that I think a wide consensus of 
analysts would agree that a tax code with a broader base of 
income at the corporate or individual level to be taxed and 
lower rates would be more efficient than a tax code with a 
narrow base and higher rates. But the specific provisions that 
one would change to move from one to the other, we would have 
to look at on an individual basis.
    Senator Nelson. Before I go on to the next question, I will 
just opine that another example of a loophole is that the 
taxpayers are actually giving tax money to oil companies to 
encourage them to drill in deepwater, something that the oil 
companies vigorously want to do because of the oil reserves, 
and yet royalty relief, that is those payments that would 
normally be paid to the U.S. Government when U.S. Federal lands 
are utilized, that those royalty payments were forgiven to oil 
companies over a technicality. I do not think that a lot of 
people in America realize that tax dollars, their tax dollars, 
are actually being used to pay oil companies to drill in 
deepwater.
    I want to ask you about exports, and I want to ask you 
about the potential for U.S. exports to partially fill this 
void of the deficit. Give us your ideas about the impact of 
increased exports as a means of reduction and a reduction of 
our trade deficit, which would help our overall fiscal outlook.
    Mr. Elmendorf. So I think that if our exports could be 
increased, that would certainly--that extra demand for U.S. 
goods would lead to more production and more employment by U.S. 
firms. That kind of strengthening of the economy would be good 
for the Federal budget.
    The challenge is to see what forces in the world or what 
policies you might enact would boost exports, and that is a 
little harder. As you know, much of the rest of the world, 
particularly the parts that tend to import our goods, that 
represent our exports, are also suffering from weakness in 
their economies, and if they had stronger economies, that would 
help us, too. But we do not control that, and, of course, they 
are trying to strengthen their own economies.
    I think the actions that firms have taken in the last few 
years to raise productivity in this country have been in the 
short-term bad for unemployment, but over time can make us more 
competitive in a way that could be good for exports and 
employment in other ways. But there are not, I think, a lot of 
policy levers that would have a very substantial effect on the 
total amount of exports over any sort of short-term period. So 
our projections are really looking at what is happening around 
the world and the weakness in other economies implies sort of 
only slow growth in demand for our products.
    Senator Nelson. In certain States, mine included, the 
economy is so down in the dumps because of the housing market. 
I was curious when talking to one of the Senators from Wyoming 
that they have less--or they are hovering around only a 6-
percent unemployment rate. Compare that to other States, mine 
included, which has been in the range of 12 percent. It may be 
down in the 11 percent range now, 11.5. For the record, I want 
you to tell us, how are we going to right our deficit situation 
without stabilizing the housing market?
    Mr. Elmendorf. So this map from our testimony shows 
unemployment rates across States as of August, and one can see 
that some of the States with the highest unemployment rates are 
exactly those that have the largest housing booms and then the 
largest housing busts to follow, and your State is one of them, 
Senator.
    The persistent weakness in the housing market is an ongoing 
drag on the economy. The number of houses started so far this 
year on a per month basis is a little above last year's 
extremely low level, but still much lower than would be 
required on a regular basis to house our growing population. 
The proximate cause of that is a lot of unoccupied houses 
today, and that stems both from the overbuilding that happened 
earlier, but also from the weakness of the economy. People who 
do not have jobs or who are afraid of losing jobs or working 
part-time jobs are much less likely to form their own 
households and seek their own places to live than they would be 
if they were confident in having a full-time job they would 
have for some period of time.
    And I think there is a reinforcing pattern of weak 
economies and reinforcing patterns in strong economies. Part of 
what is happening here is that the weak economy is limiting the 
demand for housing, not the demand people feel in their hearts, 
but the demand they can actually display in the market. They 
are not going out looking for new homes. And that weakness in 
the housing market is then reducing the number of people 
employed to build new houses. It is keeping down house prices, 
making people feel somewhat poorer, and those things are 
reinforcing the weakness in employment and spending.
    There are policies that have been discussed to try to 
strengthen the housing market. One particular policy that has 
been getting a lot of discussion in the last few months and 
that we have been looking into is ways to change what Fannie 
Mae and Freddie Mac do in terms of allowing people to refinance 
their mortgages. So a significant share of American households 
now owe more on their homes than the homes are worth, and a lot 
of others have a little bit of positive equity, but not very 
much. And that prevents them from refinancing in the way that 
they might otherwise refinance, given how far mortgage rates 
have fallen.
    There have been a number of proposals floated by analysts 
and advocates to relax the rules that Fannie and Freddie impose 
on being able to refinance your mortgage, and we are looking at 
this now, and I say our work is at a preliminary stage, but our 
view fits that of outside people that one could improve the 
cash-flow of homeowners by tens of billions of dollars per year 
through a relaxation of these rules about refinancing, 
essentially letting people take advantage of the decline in 
rates the way that they would have in the past but cannot now 
because of the decline in house prices.
    And there might be some consequences of that for the 
Federal budget. I do not want to suggest it is a free lunch. 
But there are reasons to think it actually is a fairly 
effective piece of stimulus working through the housing sector.
    Senator Nelson. And a corollary to that, I just recently 
had a major car dealer get in touch of me, and it is typical of 
what is happening in the housing market, as well, only in this 
case it is small business, the bank has revalued the properties 
upon which the car dealer has the mortgages and the bank is 
unyielding. They are saying, since the value of your property, 
real estate, in this case the dealerships, has come down and 
your mortgage is here, you have got to pay off. Well, of 
course, in this economy, car dealers are not doing particularly 
well, although it is getting better, and so they do not have a 
lot of cash hanging around.
    And here, they are looking at the possibility of 
foreclosure on a major good business that has never missed a 
mortgage payment, and but for the uniqueness of this in a State 
like up there, those dark-colored States where the property 
values have dropped out of the bottom, but for that uniqueness, 
this would be a continuing taxpayer who is paying the bills and 
paying the mortgages. Your comments?
    Mr. Elmendorf. So I think you are just right to note that 
there are a lot of small businesses that are facing trouble 
obtaining the credit they need to continue. Senator Warner 
mentioned earlier, correctly, that large businesses in this 
country are mostly quite healthy financially. They are sitting 
on assets. They are not spending.
    It is much different for small businesses. And actually, if 
one looks at the patterns of layoffs and hiring across large 
and small businesses, large businesses have resumed hiring in a 
way that small businesses have not. So the lack of credit, but 
also very importantly just uncertainty about the state of the 
economy, and I think that always has to be put first on the 
list of uncertainties that businesses face, the uncertainty 
about the state of the economy and difficulty in getting credit 
has really restrained the hiring the small businesses are 
doing. They have not come back into the labor market looking 
for workers in the way that large businesses have. But I do not 
have a magic wand for the uncertainty and the weak demand.
    Senator Nelson. Could you comment on the fact that we have 
just passed and sent to the President a major small business 
lending bill? It had a series of tax credits for small 
business, but it sets up a $30 billion lending facility, and 
under the terms of the legislation, that has to go through 
healthy community banks to then be lent, and it is defined in 
the legislation, to small businesses. Do you have any 
prognostication of how that may affect the future?
    Mr. Elmendorf. I do not think I really do. Our cost 
estimate for that legislation said that we think the money will 
be taken up so that the banks will come to the Federal 
Government for--the healthy banks that you noted will come to 
the Federal Government for this capital up to the limit in the 
legislation. So in that sense, we think that the program will 
encourage the banks to do business with the government and then 
to do business with small borrowers. But we have not looked at 
the overall economic effects of that, and in particular the 
extent to which they will be finding ways to just take credit 
for more lending to small businesses versus the ways in which 
they actual supply more credit than they otherwise would have, 
I think is not so clear, and we just have not looked at that 
policy that carefully.
    Senator Nelson. So it must not have been CBO who made the 
estimate that the $30 billion lending facility would produce 
$300 billion of loans to small business.
    Mr. Elmendorf. Well, there is--I think that estimate comes 
from the capital requirements that banks have so that that $30 
billion can support $300 billion of loans. The issue I was 
raising is whether that lending really is incremental to what 
would have happened otherwise or not, and that is the challenge 
in many government programs, trying to encourage certain 
behavior, is trying to distinguish between things that really 
are newly induced by the legislation versus things that might 
have been going on anyway that are sort of allowed to count. 
And we have not looked, to my knowledge, at that part of the 
question carefully, but we do think that money will go out of 
the Federal Government and will support small business loans, 
but it is the incremental effect on the economy that we have 
not studied.
    Senator Nelson. Does any of the staff have any questions? 
OK.
    Dr. Elmendorf, we are starting a series of votes right now 
and the Chairman has asked me to adjourn the hearing. We want 
you to know how much we appreciate your public service and 
thank you for this testimony this morning.
    Mr. Elmendorf. Thank you very much, Senator.
    Senator Nelson. Thank you. The meeting is adjourned.
    [Whereupon, at 11:31 a.m., the committee was adjourned.]

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