United States Government Publishing Office publisher pbl distributor dst United States Congress House of Representatives author aut Government Organization text government publication eng CRPT Congressional Committee Materials 109_cong_reports legislative 2010-08-09 U.S. Government Printing Office 2005-12-16 monographic deposited born digital 91 digital object pages Y 1.1/8: https://www.govinfo.gov/app/details/CRPT-109hrpt353 P0b002ee1803385bc 000902515 f:hr353.109.txt DGPO 2010-08-09 2024-11-09 CRPT-109hrpt353 machine generated eng fdlp Report together with minority views Report of the Joint Economic Committee on the 2005 Economic Report of the President U.S. Macroeconomic Performance * introduction and Background: This introduction provides a broad economic overview of the performance of the U.S. economy since about 2003. Beginning in about 2003, the macroeconomy finally began to shake off the throes or burdens of the adjustments required by bursting stock market and investment bubbles. When an asset price (or stock market) bubble bursts, banks necessarily have to contract their lending and consolidate their portfolios. Such adjustment is tantamount to a slowdown in investment: i.e., such a stock market adjustment is associated with a downward movement in investment. The stock market peak occurred in the spring of 2000. The Dow and Nasdaq stock price indices, for example, peaked in January and March 2000, respectively. Overall, then, stock market prices began to fall sharply in the spring of 2000. Notably, most of the Nasdaq's large decline took place prior to January 2001, and consequently, had nothing to do with the Administration's economic policy. As stock prices fell, the financial cost of investment increased and various measures of investment growth declined: i.e., declines in investment led to declines in economic activity. The investment sector, then, played a very important role in influencing recent cyclical economic activity. The seeds of this unsustainable stock market bubble, however, were sown in the period prior to the spring of 2000, since the stock market bubble burst beginning in the first quarter of 2000. Many economists have noted that the economic weakness of 2000-2001 (or the "Post Bubble" or "Adjustment Economy)" was inherited from earlier periods involving an asset-price contraction in the late 1990s. (See Figure 1). <GRAPHIC NOT AVAILABLE IN TIFF FORMAT> Furthermore, the economic and financial strength of the late 1990s was unsustainable, with some of that strength borrowed heavily from the "irrational exuberance" of sharp stock market and balance sheet gains. in sum, changes in the investment sector have been much larger and more prominent than changes in most other sectors, including real GDP. The investment sector, for example, was significantly weaker than real GDP during downturns and significantly stronger than real GDP during recoveries (see Figure 2). <GRAPHIC NOT AVAILABLE IN TIFF FORMAT> * Brief Overview: A brief overview of recent macroeconomic activity indicates that the economy is expanding robustly with little sign of any meaningful inflation. in the third quarter, for example, the most recent data indicate that real GDP growth was robust at 4.3%. Real GDP has grown at positive rates for 16 quarters in a row and at rates above 3.0% for 10 quarters in a row. Consensus forecasts have real GDP increasing by 3.5% to 4.0% for the next few years. Figure 2 highlights some of these facts. Components of real GDP suggest that expansions of real nonresidential fixed investment should continue at a healthy pace. The equipment and software component of real nonresidential fixed investment, for example, has been growing on average at a double digit rate (11.7%) since the third quarter of 2003. Its leading indicator, capital good orders, continues to trend upward. Another interesting observation relates to academic research relevant to U.S. economic growth. Recent research has thoroughly established that the volatility of U.S. GDP has consistently fallen for a number of years. This reduction of volatility means that the economy is not only growing robustly, but that growth is more stable than in the past. This fosters a reduction in risk premiums and lower interest rates. Significant improvement can be seen in other sectors. For example, 4.5 million jobs have been added to the existing payrolls since May of 2003. The U.S. has gained many more jobs than key European economies. Similarly, the unemployment rate, now at 5.0%, is historically low and below the average U.S. unemployment rate for the 1970s, 1980s, and 1990s. Further, the U.S. unemployment rate is lower than most European rates. The housing sector has performed much better than most analysts predicted. Housing sales have remained strong and residential investment elevated. Another prominent feature of the recent U.S. economy is the lower and more stable rate of inflation we have experienced. While most broad measures of inflation provide similar information, we nonetheless use the core PCE on a year-over-year basis, depicted in the accompanying figure (see Figure 3). The persistently lower rate of inflation depicted there has helped to calm financial markets and reduce risk premiums. This persistently lower rate of inflation has in turn fostered lower expectations of future inflation and, consequently helped to lower interest rates. in short, the macroeconomy has established a remarkably solid record with measures of aggregate economic activity registering not only relatively rapid growth figures, but exceptionally stable non-inflationary growth. These surprisingly strong results, it will be remembered, occurred in the face of a literal barrage of supply side shocks (discussed below) that were readily absorbed by this exceptionally resilient economy. Figure 3 * Policy Contribution With this impressive record as a backdrop - particularly in the face of the many negative shocks absorbed by the economy - a question facing policymakers is: Why has the economy performed so well? Put bluntly, the economy has advanced at a healthy, stable pace with little sign of meaningful inflation because of the economic policies that have been adopted. These policies will be briefly summarized. Monetary Policy: in adopting a flexible, implicit inflation targeting strategy, the Federal Reserve's monetary policy contributes to minimizing inflation, reducing the volatility of inflation, and anchoring the price system. Over time, the credible implementation of this strategy works to calm and stabilize markets, such as the money, capital, and foreign exchange markets. Some argue that this strategy also works to reduce macroeconomic volatility. This more stable set of markets works to promote economic growth. Recent monetary policy, then, has likely made a number of contributions to the workings of the macro economy. in particular, this credible, implicit inflation targeting approach works to lower inflation, lower the volatility of inflation, lower the volatility of economic activity, and promote economic growth (see Figure 4). <GRAPHIC NOT AVAILABLE IN TIFF FORMAT> * Tax Policy Whereas the Federal Reserve's current monetary policy performs a number of important functions, tax policy can play a major role in promoting investment or capital formation and consequently, economic growth. Accordingly, the tax-policy endorsed by the Administration is, for the most part, focused on a limited number of key objectives that often relate to economic growth. in assessing initial economic conditions during the current expansion, it became obvious that investment and capital formation were weaker than desirable. The argument that with an entrenched income tax in place, saving, investment, and capital formation were over-taxed and further, taxed multiple times, seemed to be underscored by the data. Accordingly, a tax program was proposed which lowered the tax rates on dividends and capital gains, and expanded expensing for business investment. More specifically, the "Jobs and Growth Tax Relief Act of 2003" was passed and contained a number of provisions, most notably, a reduction in both dividend and capital gains tax rates.1 There were a number of reasons to lower these tax rates on capital: o Removing some of the bias toward the multiple taxation of capital and investment. o Lowering tax rates so as to affect behavior and promote additional incentives to save and invest. o Removing some of tax burden's dead-weight loss. o Maintaining the U.S. as an attractive investment outlet for international investors. o And, most importantly, fostering capital formation so as to promote economic growth. As the data in Figure 2 suggest, these tax cuts are associated with higher trend growth in business investment spending and increases in the value of stock market. The NIPA data, for example, suggest that after the 2003 tax cuts, various categories of non-residential fixed investment began trending up at more rapid rates. Similarly, most common measures of stock market value (e.g., Dow Jones, Nasdaq, or S&P) began advancing at a faster pace. in addition, since the tax cuts were implemented, the country has experienced higher economic growth, increases in payroll employment, lower unemployment, and more tax revenue. in short, the timing of investment and stock market activity appear to be consistent with the case made by proponents of the tax cuts. Furthermore, a number of studies (and empirical evidence) support this conclusion. The findings of several studies tend to support the view that changes in the tax law have significant impacts on economic activity and economic growth. A review of the problems caused by high dividend taxes shows that the U.S. had the second highest dividend tax rate in the OECD. in light of this finding, lowering the dividend tax rate in the US may be more potent than if undertaken elsewhere. Furthermore, Auerbach and Hassett (2005) find strong evidence that the 2003 change in the dividend tax law had a significant impact on US equity markets. It could be, therefore, that by reducing those forms of taxation that work to tax capital in multiple ways a more rational system can result. A similar view was outlined by Ben Bernanke (then CEA Chairman): "...tax legislation passed in 2003 provided incentives for businesses to expand their capital investments and reduce the cost of capital by lowering tax rates on dividends and capital gains...the effects are evident in the investment and employment data. From its trough in the first quarter of 2003, business fixed investment has increased over 21 percent, with the biggest gains coming in equipment and software."2 in sum, the macroeconomy has advanced sharply in recent years in part because of the contribution of a tax relief effort that lowered taxation on capital, promoted economic growth, and provided potent tax relief. * Conclusion Recent economic data indicate that the economy is quite robust and advancing at a healthy pace. Our economy has weathered a barrage of negative supply shocks (including a stock market bubble-bursting, a terrorist attack, a severe hurricane followed by a severe flood, two wars, corporate scandals, and a sharp increase in the price of oil). Given this array of significant hurdles, the economy's performance is remarkable. Part of the reason for this performance relates to the contributions of monetary policy's focus on price stability, which leads to a lowering of inflation, the volatility of inflation, and the volatility of economic activity, thereby fostering economic growth. Another reason for this remarkable performance is the pro-growth tax policy that has been embraced and allowed to lower the cost of capital. A further contribution relates to our flexible price system, which has enhanced the economic resiliency we enjoy. Consequently, the economic outlook remains positive. According to Federal Reserve and private economic forecasts, the economy is expected to grow at a healthy pace through 2006. Jim Saxton Chairman Joint Economic Committee Robert F. Bennett Vice Chairman Joint Economic Committee Union Calendar No. 194 MAJORITY STAFF REPORTS Economic Effects of inflation Targeting introduction The theoretical case for inflation targeting (IT) has been spelled out during the course of the last 15 years in a number of publications, including several JEC studies. The case for IT is a strong one, supported by a number of compelling arguments. According to proponents, adopting IT certainly does make a difference by improving the performance of the economy, the financial system, and the inflation rate. The arguments supporting this approach, however, will not be repeated here; these arguments have been amply described elsewhere. instead, one component of the arguments supporting the adoption of IT will be reviewed and assessed. in particular, IT proponents contend that its adoption will help to calm and stabilize financial markets. More precisely, the adoption of credible IT will provide an anchor to the financial system and to financial markets. in so doing, financial markets will stabilize as inflation is driven from the price system. Temporary deviation of inflation will be ignored. This credibly-reduced inflation is associated with less volatile financial markets, smaller risk premiums, and lower inflationary expectations. in this view, then, IT is associated with more stable financial markets. On the other hand, some economists contend that IT is associated with asset price bubbles, and thus, asset price volatility. in particular, as credible IT works to stabilize conventional measured inflation, to reduce risk premiums, and to tame economic fluctuations, economies experience more risk taking and more risky investment. Economies will also experience increased stock price volatility and associated asset price bubbles. According to this view, there is a kind of "moral hazard" of economic policymaking: the more stable/predictable the economic environment, the more risk taking and risky investment take place. Proponents of this view point to several classic episodes in which asset price bubbles followed periods of price stability; e.g., the U.S. during the 1920s as well as more recent episodes in Japan and the U.S. in this view, then, IT is associated with more volatile asset prices and financial markets, the opposite contention of the above, more conventional view. This paper briefly describes these alternative views, reviews relevant empirical evidence, and attempts to reconcile these seemingly conflicting positions. HRPT CRPT-109hrpt353 HOUSE 109 353 1 false true https://www.govinfo.gov/app/details/CRPT-109hrpt353 https://www.govinfo.gov/content/pkg/CRPT-109hrpt353/html/CRPT-109hrpt353.htm https://www.govinfo.gov/content/pkg/CRPT-109hrpt353/pdf/CRPT-109hrpt353.pdf H. Rept. 109-353 THE 2005 JOINT ECONOMIC REPORT;H. Rept. 109-353 Committed to the Committee of the Whole House on the State of the Union and ordered to be printed FIRSTPART CRPT-109hrpt353 Committed to the Committee of the Whole House on the State of the Union and ordered to be printed 1 MR. SAXTON, from the Joint Economic Committee, submitted the following Joint Economic Committee Joint Economic MR. SAXTON Jim Saxton Saxton, Jim H. James Saxton Jim Saxton United States House of Representatives sponsor spn United States Congress Member United States Congress Joint Economic Committee associated name asn Government Organization H.R. 13 109 OTHER H.R. 25 109 OTHER S. 1998 109 OTHER