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WHAT IS THE REAL DEBT LIMIT? 

HEARING 

BEFORE THE

JOINT ECONOMIC COMMITTEE 

CONGRESS OF THE UNITED STATES 

ONE HUNDRED TWELFTH CONGRESS 

FIRST SESSION 

SEPTEMBER 20, 2011 

Printed for the use of the Joint Economic Committee 

( 

(II) 

JOINT ECONOMIC COMMITTEE 

[Created pursuant to Sec. 5(a) of Public Law 304, 79th Congress] 

SENATE 

ROBERT P. CASEY, JR., Pennsylvania, 

Chairman 

JEFF BINGAMAN, New Mexico 

AMY KLOBUCHAR, Minnesota 

JIM WEBB, Virginia 

MARK R. WARNER, Virginia 

BERNARD SANDERS, Vermont 

JIM DEMINT, South Carolina 

DANIEL COATS, Indiana 

MIKE LEE, Utah 

PAT TOOMEY, Pennsylvania 

HOUSE OF REPRESENTATIVES 

KEVIN BRADY, Texas, Vice Chairman 

MICHAEL C. BURGESS, M.D., Texas 

JOHN CAMPBELL, California 

SEAN P. DUFFY, Wisconsin 

JUSTIN AMASH, Michigan 

MICK MULVANEY, South Carolina 

MAURICE D. HINCHEY, New York 

CAROLYN B. MALONEY, New York 

LORETTA SANCHEZ, California 

ELIJAH E. CUMMINGS, Maryland 

WILLIAM E. HANSEN, Executive Director 

ROBERT P. O’QUINN, Republican Staff Director 

(III) 

C O N T E N T S 

OPENING STATEMENTS OF MEMBERS

Hon. Kevin Brady, Vice Chairman, a U.S. Senator from Texas .......................... 1 

Hon. Jim DeMint, a U.S. Senator from South Carolina ....................................... 1 

Hon. Elijah E. Cummings, a U.S. Representative from Maryland ...................... 3 

WITNESSES

Dr. Allan H. Meltzer, The Allan H. Meltzer University Professor of Political 

Economy, Carnegie Mellon University, Pittsburgh, PA .................................... 5 

Mr. Chris Edwards, Director of Tax Policy Studies, Cato Institute, Washington, DC ............................................................................................................. 7 

Dr. Laurence Ball, Professor of Economics, Johns Hopkins University, Baltimore, MD .............................................................................................................. 9 

SUBMISSIONS FOR THE RECORD

Prepared statement of Representative Kevin Brady ............................................ 28 

Chart titled ‘‘Total U.S. Government Spending = 41% of GDP (2011)’’ ....... 30 

Chart titled ‘‘Rise in Fed’s Treasury Holdings Accounts for More Than 

One-Third the Rise in U.S. Debts Since March 2009’’ ............................... 31 

Chart titled ‘‘What is the Tipping Point?’’ ...................................................... 32 

Chart titled ‘‘Gross Government Debt as a Percent of GDP’’ ....................... 33 

Chart titled ‘‘Federal Reserve Balance Sheet = $2.9 Trillion’’ ...................... 34 

Chart titled ‘‘Long Term Budget Outlook; Debt to GDP Ratio’’ ................... 35 

Prepared statement of Dr. Allan H. Meltzer ......................................................... 36 

Prepared statement of Mr. Chris Edwards ........................................................... 39 

Prepared statement of Dr. Laurence Ball .............................................................. 48 

(1) 

WHAT IS THE REAL DEBT LIMIT? 

TUESDAY, SEPTEMBER 20, 2011 

CONGRESS OF THE UNITED STATES, JOINT ECONOMIC COMMITTEE, Washington, DC. 

The committee met, pursuant to call, at 10:04 a.m., Room 210, 

Cannon House Office Building, the Honorable Kevin Brady, Vice 

Chairman, presiding. 

Senators present: DeMint. 

Representatives present: Brady, Burgess, Campbell, 

Mulvaney, and Cummings. 

Staff present: Connie Foster, Robert O’Quinn, Michael 

Connolly, Rachel Greszler, Gail Cohen, Will Hansen, Colleen 

Healy, and Jesse Hervitz. 

OPENING STATEMENT OF HON. KEVIN BRADY, VICE 

CHAIRMAN, A U.S. REPRESENTATIVE FROM TEXAS 

Vice Chairman Brady. Good morning, everyone. Welcome to 

the Joint Economic Committee hearing. The topic is, ‘‘What is the 

Real Debt Limit?’’ We so appreciate the panelists we have here 

today. 

And I want to commend Senator DeMint, who leads Senate Republicans on the Joint Economic Committee, for spearheading this 

hearing on this very important and timely topic. And I would yield 

to Senator DeMint for the opening statement. 

OPENING STATEMENT OF HON. JIM DEMINT, A U.S. SENATOR 

FROM SOUTH CAROLINA 

Senator DeMint. Thank you, Mr. Chairman. And I appreciate 

all of your work and your staff’s work to put this together. 

And I want to thank all of our panelists for taking their time to 

be here. 

A couple of months ago in Washington, everyone was in a panic 

of what might happen if we couldn’t borrow any more money. And 

the President mentioned we might not be able to pay Social Security. We talked about reneging on payments to contractors. We 

talked about a pretty dire situation if the United States could not 

borrow any more money. 

But that debt limit was an arbitrary debt limit set by Congress, 

one that we could change by a simple debt-limit deal. My concern 

and I think that a number of Americans is, where is the real debt 

limit? When do we hit the wall where no one will lend us any more 

money and perhaps the Feds can’t even print enough money? At 

2 

what point is there not enough credit in the world to continue to 

finance not only the United States but all the debtor nations? 

You know, under CBO’s alternative budget forecast, their model 

essentially stops working in the early 2040s because of excessive 

U.S. debt. I just want to look at a couple of charts here of where 

we see the debt going relative to the GDP. There is no way we are 

going to get that far. My concern is, can we borrow another 21⁄2

trillion? The Federal Reserve is apparently buying a lot of our debt 

already. Is there still a market for the kind of debt that the United 

States needs to sell? 

Despite the commitment to reduce our deficit—and, again, ‘‘deficit’’ is a Washington term, the year-to-year shortfall—we have said 

we would reduce that year-to-year shortfall $2.1 trillion over the 

next 10 years, giving the impression to Americans that we are actually lowering the debt, when, as I am sure all of our panelists 

know, we are going to continue to increase the debt. It may be $8 

trillion, $10 trillion; we are not sure. But, again, if we look at our 

charts, I am not sure we can borrow that much money. 

But if we look here, at what we are trying to discover today, or 

determine, or guess at: Where is the tipping point for America beyond which the interest rates will rise sharply, economic growth 

will decline dramatically? As we look at the potential tipping point 

for Greece and Ireland and Portugal and U.S. as a percent of GDP, 

we see the United States is right there where these other nations 

are. Is the only thing that makes us different that we can print 

money and that we are the world’s reserve currency? These other 

countries can’t print their own. But hopefully our panelists will 

help us sort this out. 

And what does the United States look like once we reach that 

tipping point, when we hit a very real debt limit? How high will 

interest rates go? What will be the borrowing cost if we can, in fact, 

borrow the money? Will the Fed just print money? These are things 

we are trying to anticipate. 

The Fed is clearly engaged in unprecedented action, including 

the purchase of trillions of dollars of U.S. Treasuries and mortgagebacked securities. You know, since the financial crisis in 2008, the 

Fed’s balance sheet has tripled to $2.9 trillion. We can see here 

what the Federal Reserve has done, with very little notice by Congress, which effectively means we are printing money and buying 

debt. 

So how could the Fed’s policies affect the tipping point? What can 

we expect? There are a lot of questions. And, certainly, we need to 

know, how long can the Federal Reserve monetize our debt before 

the world begins to lose confidence in our currency? 

So my challenge to the panelists today is that, all politics aside, 

all partnership aside, our country is drowning in debt. The plan by 

this government is to continue borrowing money for the foreseeable 

future. Any talk of balancing the budget is considered extreme. 

What does that mean for our country? How much time do we have, 

and what is going to happen when we can no longer borrow money? 

Thank you, Mr. Chairman. 

Vice Chairman Brady. Thank you, Senator. 

The chair recognizes Representative Cummings for an opening 

statement. 

3 

OPENING STATEMENT OF HON. ELIJAH E. CUMMINGS, A U.S. 

REPRESENTATIVE FROM MARYLAND 

Representative Cummings. Thank you very much, Mr. Chairman. 

I want to thank you, Vice Chairman Brady, for calling today’s 

hearing to examine the effects of the national debt on our broader 

economy. 

I welcome our witnesses and extend, particularly, a warm welcome to Dr. Laurence Ball, professor of economics at Johns Hopkins University. And Johns Hopkins, of course, is located in Baltimore and smack-dab in the middle of my district. 

Last week, the Director of the Congressional Budget Office testified before the new Joint Select Committee on Deficit Reduction. 

He reported that if we proceed under current law—for example, allowing the Bush tax cuts to expire at the end of this year—by 2021 

debt held by the public will equal 61 percent of GDP, well above 

the annual average of 37 percent recorded between 1971 and 2010. 

Under the CBO’s so-called ‘‘alternative baseline,’’ in which the 

Bush tax cuts and the AMT patch are extended and other current 

policies continue, debt held by the public is expected to balloon to 

nearly 190 percent of GDP by 2035. 

The Director testified that, notwithstanding the latest long-term 

projections under the so-called Budget Control Act, interest payments on the debt and lost confidence in our ability to manage our 

budget would create a clearly unsustainable scenario. However, the 

CBO Director also told the committee that there is no inherent contradiction between using fiscal policy to support the economy today 

and imposing fiscal restraints several years from now. He instructed, if we want to achieve both a short-term economic boost 

and longer-term fiscal sustainability, a combination of policies 

would be required: changes in taxes and spending that would 

widen the deficit now and reduce it later in the coming decade. 

Thus, the CBO Director confirms what countless economists have 

been warning Congress about. Draconian spending cuts will not 

generate the economic growth we need now, right now, to put 

Americans back to work and enable them to compete and succeed. 

Moreover, such harmful cuts are unnecessary to rein in the debt 

and will only serve to slow our already tepid growth, ultimately reducing revenues coming in through taxes. 

In fact, one of the major causes of our current budget deficits, 

and, thus, a major cause of the growing debt, is our continued slow 

economic growth. The recession that started in 2007 is responsible 

for more than $400 billion of our annual deficits between 2009 and 

2011, according to the Center for Budget Policies and Priorities and 

the CBO. Therefore, one of the most effective steps we could take 

to tackle the debt right now is to start growing the economy again, 

which is also what the American people desperately need and desperately want. 

According to Laura Tyson, chairwoman of the Council of Economic Advisers and the National Economic Council in the Clinton 

Administration, which presided over one of the most sustained periods of economic growth and job creation in our Nation’s history, 

investments in infrastructure, job training, and research and development, which would address the immediate jobs gap and foster fuVerDate Nov 24 2008 12:29 Jan 18, 2012 Jkt 071033 PO 00000 Frm 00007 Fmt 6633 Sfmt 6633 C:\DOCS\71033.TXT DPROCT
4 

ture growth, would help reduce the deficit. An extra percentage 

point of growth over the next 5 years would do more to reduce the 

deficit during that period than any of the spending cuts currently 

under discussion. And over the next decade, an extra percentage 

point of growth would add about $2.5 trillion in revenue. 

While this hearing is aimed at examining the impact of the Federal debt on our economy, I would submit that, at present, the debt 

is a nominal factor in our current economic outlook. Rather, slowed 

hiring, low consumer confidence and demand, skills mismatches between workers and jobs, reduced public investment, and the continuing foreclosure crisis are driving our economic conditions and 

our rising debt, rather than the other way around. 

Finally, until we recognize this reality and move to tackle these 

challenges, an exclusive focus on the debt crisis will essentially 

consign our Nation to chasing our economic tail—a wholly unnecessary and unproductive exercise. However, I anxiously look forward 

to hearing from our witnesses. I thank you all for being here today. 

And, with that, Mr. Chairman, I yield back. 

Vice Chairman Brady. Thank you. 

Two housekeeping notices. One, the clocks are not working, so we 

will be keeping the time manually. And we will make notice of that 

as we come up to the 5-minute time limit for both testimony and 

questions. 

Also, I have an opening statement I would like unanimous consent to insert into the record, without objection. 

[The prepared statement of Representative Kevin Brady appears 

in the Submissions for the Record on page 28.] 

[Chart titled ‘‘Total U.S. Government Spending = 41% of GDP 

(2011)’’ appears in the Submissions for the Record on page 30.] 

[Chart titled ‘‘Rise in Fed’s Treasury Holdings Accounts for More 

Than One-Third the Rise in U.S. Debts Since March 2009’’ appears 

in the Submissions for the Record on page 31.] 

[Chart titled ‘‘What is the Tipping Point?’’ appears in the Submissions for the Record on page 32.] 

[Chart titled ‘‘Gross Government Debt as a Percent of GDP’’ appears in the Submissions for the Record on page 33.] 

[Chart titled ‘‘Federal Reserve Balance Sheet = $2.9 Trillion’’ appears in the Submissions for the Record on page 34.] 

[Chart titled ‘‘Long Term Budget Outlook; Debt to GDP Ratio’’ 

appears in the Submissions for the Record on page 35.] 

Vice Chairman Brady. And the chair yields to Senator DeMint 

for introduction of the panelists. 

Senator DeMint. Okay. Thank you, Mr. Vice Chairman. It is 

my privilege to introduce our three distinguished witnesses to provide testimony on this matter of such enormous importance to the 

American people and to the future health of our economy. 

Our first witness, Dr. Allan Meltzer, is currently a professor of 

political economy and public policy at the Carnegie Mellon University’s Tepper School of Business in Pittsburgh, Pennsylvania. He 

has previously served as a member of the President’s Economic Policy Advisory Board, an active member of the President’s Council of 

Economic Advisers, and a consultant to the U.S. Treasury Department and the Board of Governors of the Federal Reserve System. 

5 

In 1999 and 2000, he served as the chairman of the International 

Finance Institution Advisory Commission, which was formed by 

Congress to review the role of the International Monetary Fund, 

the World Bank, and other world financial institutions. He is the 

author of numerous books on economic theory and policy, including 

a multivolume ‘‘History of the Federal Reserve.’’ 

Dr. Meltzer received his B.A. from Duke University and an M.A. 

and Ph.D. in economics from the University of California at Los 

Angeles. 

Next, we will be hearing from Mr. Chris Edwards, who is currently the director of tax policy studies at the Cato Institute and 

editor of Cato’s Web site, DownsizingGovernment.org. 

Before he began his work at Cato, he was senior economist for 

the Joint Economic Committee, as well as an economist for the Tax 

Foundation from 1992 to 1994. He is also the author of 

‘‘Downsizing the Federal Government’’ and co-author of ‘‘Global 

Tax Revolution.’’ 

Mr. Edwards holds a B.A. and an M.A. in economics. 

Our final witness is Dr. Laurence Ball. Dr. Ball is a professor of 

economics at Johns Hopkins University. He previously taught at 

Princeton University and New York University. Dr. Ball has done 

extensive research and writing on a variety of economic topics, including the foundations of Keynesian economic models. He has 

done in-depth studies of inflation and monetary policy in both the 

United States and in high-inflation countries, with a specific focus 

on how best to reduce inflation and the economic cost of inflation. 

Dr. Ball is currently a research associate at the National Bureau 

of Economic Research. He was previously a lecturer at the IMF Institute, a member of the Federal Reserve Board’s Academy Advisory Panel, and a consultant on the International Monetary Fund’s 

World Economic Outlook. 

Dr. Ball holds a B.A. in economics from Amherst College and a 

Ph.D. in economics from Massachusetts Institute of Technology. 

It is an honor to have all of you here today and to benefit from 

your expertise on this subject. 

Vice Chairman Brady. The chair recognizes Dr. Meltzer. 

STATEMENT OF DR. ALLAN H. MELTZER, THE ALLAN H. 

MELTZER UNIVERSITY PROFESSOR OF POLITICAL ECONOMY, CARNEGIE MELLON UNIVERSITY, PITTSBURGH, PA 

Dr. Meltzer. Thank you, Mr. Chairman. Thank you, Vice Chairman Brady, Senator DeMint, members of the committee. It is a 

pleasure to appear before the Joint Economic Committee. 

My association with this committee goes back to the days of Senator Paul Douglas. It was Senator Douglas who pushed and prodded the Federal Reserve to stop holding interest rates fixed and to 

permit monetary policy to do much more to prevent inflation. His 

views eventually prevailed. That should remind the Members of 

their responsibility. 

Today I will answer the questions that the hearing seeks to answer. They are good questions that show the rising concern for the 

consequences of recent Federal Reserve actions. I will introduce my 

answers with my explanations of why Federal Reserve policy is 

6 

misguided and mistaken, inflationary and inappropriate. There are 

several reasons; I will give three. 

First, in writing the three volumes of ‘‘A History of the Federal 

Reserve,’’ I read more minutes and transcripts than any person can 

endure. With very rare exceptions, notably in the years when Paul 

Volcker led the disinflation policy, one looks in vain for a statement 

of the medium-term consequences of the actions taken at the meeting. True, the staff and others provide forecasts of the future, but 

the FOMC never tries to reach agreement on the consequences of 

its actions for the public. It publishes forecasts, but there is no 

clear relation between the forecasts and the actions. 

Second, concerns at FOMC meetings are mainly about the near 

term. The Federal Reserve has little influence over what will happen in the near term but much greater influence on the medium 

term. The present is characteristic. The Fed Chairman and some 

of the members seem determined to, quote, ‘‘do something,’’ end 

quote, more about the excessive waste and the harm of high unemployment. They neglect the fact that there is no shortage of money 

and liquidity and that they have pushed and prodded market interest rates to the lowest levels ever achieved anywhere. 

The United States does not have a problem of too little liquidity. 

There is not much that the Federal Reserve can do by adding reserves or lowering interest rates. The last time they tried it, $600 

billion was added; $500 billion ended up in excess reserves. Don’t 

the Chairman and several members understand that there are limits to what the Federal Reserve can do? 

Banks hold more than $1.5 trillion of idle reserves. Money 

growth, M2, for the past 6 months is rising at an almost 15 percent 

annual rate. I attached a chart to my paper, or asked the staff to 

do that. Here is the chart, and it shows the enormous increase recently in the rate of increase in M2 growth. Inflation, as a result, 

has begun to rise. Prices are rising, and the U.S. dollar continues 

to sink. 

The most useful action that the Federal Reserve could take 

would be announcement of an enforceable inflation target that 

would give confidence that we will not inflate. 

Third, in 1977, Congress gave the Federal Reserve a dual mandate, interpreted as low unemployment and low inflation. It pursues these goals in an inefficient way by pursuing unemployment 

until inflation rises, shifting to inflation control until unemployment rises, and back and forth. That way, it achieves neither. 

The ‘‘Great Inflation’’ of the 1970s is an extreme example. Both 

unemployment and inflation rose. The current Fed repeats that 

pattern. In contrast, policy from 1985 to 2003 more or less followed 

a rule that included both goals. That gave the public one of the 

very few years of low inflation and stable growth in the Fed’s 100- 

year history. 

In Article I, Section 8, our Constitution gives Congress ultimate 

control of money. It should legislate an enforceable inflation target. 

I will amplify ‘‘enforceable’’ if you wish. 

Now, the three questions that the hearing has asked me to address. 

First, given the fiscal policy of the industrial nations, will government debt crowd out private investment? My answer is ‘‘yes.’’ ToVerDate Nov 24 2008 12:29 Jan 18, 2012 Jkt 071033 PO 00000 Frm 00010 Fmt 6633 Sfmt 6633 C:\DOCS\71033.TXT DPROCT
7 

day’s deficits and debt raise concerns about future tax rates. The 

prospect of higher future tax rates raises the rate of return that 

business investors expect to earn on new investment. And uncertainty about future tax rates and the persistent increase in regulation of health, labor, and energy, and finance has deterred investment and slowed recovery. Faced with heightened current uncertainty, many investors hold cash and wait. Cash is their friend. 

Government budget and regulatory policies deter and crowd out 

investment. One of the most effective things that the Congress 

could do was to pass a moratorium on new regulation for the next 

5 years, excepting national security. 

Vice Chairman Brady. Dr. Meltzer, the 5-minute time limit 

has expired. Would you conclude your testimony? And we will have 

a chance during questioning to pursue further. 

Dr. Meltzer. Yes. 

Let me say only this about the tipping point. Why wait for a tipping point and a crisis? 

We know that the debt is now a hundred percent, approximately 

a hundred percent, of GDP. That doesn’t include the unfunded liabilities. It doesn’t include Fannie Mae and Freddie Mac. It doesn’t 

include a number of other things. 

So there isn’t a point that we can mark down and say, after this 

crisis occurs. We don’t know when crises will occur. And the experience of Italy and Greece, especially, recently tell us that the market suddenly changes its mind without warning and without prior 

notification. So we shouldn’t wait for that to happen. We should 

begin. 

We have ample warning that we are on an unsustainable path. 

That unsustainable path—to respond to Congressman Cummings, 

is to say that we need to announce a plan that will reduce the deficit in a credible way, not beginning by taking everything off the 

table today, but announcing a plan which will put us on the path 

that we have to be on if we are going to restore the long-term 

growth rate of the United States with low inflation. 

[The prepared statement of Dr. Allan H. Meltzer appears in the 

Submissions for the Record on page 36.] 

Vice Chairman Brady. Thank you, Doctor. 

And I should note that all of the testimony of the three witnesses 

will be submitted in full in the testimony. 

The chair recognizes Mr. Edwards, 5 minutes. 

STATEMENT OF MR. CHRIS EDWARDS, DIRECTOR OF TAX 

POLICY STUDIES, CATO INSTITUTE, WASHINGTON, DC 

Mr. Edwards. Thank you very much, Vice Chairman Brady and 

members of the committee. 

Federal spending, as you know, has soared over the last decade. 

And looking ahead, the CBO projects that Federal spending will 

rise from 24 percent this year to 34 percent of the economy by 2035 

unless we make some serious reforms. And as your chart showed, 

the Federal debt, according to the CBO, will explode to almost 200 

percent of GDP by 2035 unless we make reforms. 

Now, some people and economists think it is okay if America 

raises taxes and spending in coming years because they think we 

have a uniquely small government in this country, but that is realVerDate Nov 24 2008 12:29 Jan 18, 2012 Jkt 071033 PO 00000 Frm 00011 Fmt 6633 Sfmt 6633 C:\DOCS\71033.TXT DPROCT
8 

ly no longer the case. If you look at OECD data, total Federal/ 

State/local spending in the United States now is 41 percent of 

GDP. That is only 4 percent less than the OECD average spending 

now of 45 percent of GDP. We used to have a 10-percentage-pointof-GDP advantage in terms of a smaller government, so that has 

shrunk now from 10 down to 4 percent. So, sadly, we are becoming 

just another sort of an average, bloated welfare state, which I think 

is really going to damage our economy. 

And if you look at debt, I think one of your charts showed United 

States Federal debt, gross debt, at 101 percent of GDP now, higher 

than the OECD average of 78 percent of GDP. And if you look at 

growth and debt over the last 4 years, our debt has grown the sixth 

fastest out of the 31 OECD countries. So, you know, there are a 

lot of debt crises going on in Europe, but we are certainly getting 

up to that level of fiscal irresponsibility. 

Without reforms, government spending may represent about half 

of GDP by 2035, which, in my view, would create a dismal future 

for young Americans, with fewer opportunities. I think, historically, 

our high standard of living has been based on a relatively smaller 

government, and it would be really sad to lose that. 

In my view, there are three basic harms of all this—that all this 

deficit spending creates. 

The first basic harm is that additional spending, in my view, 

sucks resources out of the more productive private-sector economy, 

puts it in the less productive government sector of the economy. 

Again, if the government in America is already spending 4 out of 

every 10 dollars, it seems to me that marginal spending in the government sector is going to have a lower negative return. 

In a 2008 book, Texas A&M public finance professor Edgar 

Browning, he went through the whole Federal budget, looked at 

Federal spending, and he figures that the extent of Federal spending we do these days in the United States has lowered overall average incomes by about 25 percent. So we are above the tipping point 

or optimal level for the size of our government in terms of economic 

growth. 

The second basic harm that all this deficit spending is doing, of 

course, is creating deficits, which are essentially deferred taxes 

that will pinch the economy down the road. Economists look to the 

distortions caused by the Tax Code as damaging the economy. This 

is called deadweight losses. When you raise taxes, you create more 

distortions in the economy, which reduces GDP. 

And the third harm of all the deficit spending is the high debt 

itself, as we are seeing, is creating financial instability and economic uncertainty. And we can certainly see this in Europe. A 

number of economists now have written about how 90 percent 

seems to be sort of a tipping point for debt as a share of the economy, and, above that, economic growth starts to slow. 

And here is what I think a lot of people are missing in this debate. When you look at those long-term CBO projections—I think 

you had some on your charts—that show the rising debt and rising 

spending, it looks bad enough, but it is actually worse than that, 

because in CBO’s basic alternative fiscal scenario, their basic 

benchmark projection, they don’t take into account the fact that the 

rising debt and spending suppresses GDP. 

9 

In a special analysis, the CBO looks every year at how that rising debt suppresses GDP, and it is pretty scary. It could well be, 

according to the CBO under some of its scenarios, that real U.S. 

incomes rise for the next decade or so but then they stagnate and 

then they start falling. This would be sort of a reversal of American 

history if American incomes actually started falling over the long 

term. 

Last year, CBO compared Paul Ryan’s roadmap, which sort of 

keeps spending at today’s level, versus the sort of do-nothing alternative fiscal scenario. And they found, by the 2050s, U.S. average 

incomes would be 70 percent higher under the Paul Ryan roadmap 

plan than under the alternative fiscal scenario because of the buildup of debt. 

Some fear, of course, that spending cuts in the short term would 

hurt the economy. I would only point out that, you know, we have 

had $5 trillion of deficit spending since 2008, the most enormous 

sort of Keynesian stimulus you can imagine, and yet we have the 

slowest recovery since World War II. So I don’t think spending 

helps. 

And I think if you look around the world at real-world examples—your staff has put out a useful study looking at Canada and 

Sweden and other countries that have cut their spending. Canada, 

for example, dramatically cut their spending in the mid-1990s, and 

it didn’t depress the economy. Quite the reverse: The Canadian 

economy boomed for 15 years even as spending was cut pretty dramatically. 

So, you know, I think Congress should turn its attention to major 

spending cuts as soon as we can. And, you know, at Cato we have 

all kinds of ideas for cutting every Federal Government department. I don’t look at spending cuts as sort of painful medicine that 

we should fear; I think it would be a positive boom for economic 

growth. 

Thank you very much. 

[The prepared statement of Mr. Chris Edwards appears in the 

Submissions for the Record on page 39.] 

Vice Chairman Brady. Thank you, Mr. Edwards. 

The chair recognizes Dr. Ball for 5 minutes. 

STATEMENT OF DR. LAURENCE BALL, PROFESSOR OF 

ECONOMICS, JOHNS HOPKINS UNIVERSITY, BALTIMORE, MD 

Dr. Ball. Vice Chairman Brady and members of the committee, 

thank you for this opportunity to share my views on U.S. fiscal policy. 

Other witnesses have emphasized the dangers of rising government debt, and I agree that reforms are needed to put debt on a 

sustainable path. I will focus, however, on a different side of the 

issue: the costs of controlling debt by cutting government budget 

deficits. And here, this will be largely elaborating on a point raised 

by Congressman Cummings. I will argue that cutting deficits reduces economic growth and raises unemployment in the short and 

medium run. These costs are especially large if deficit reduction is 

too hasty and occurs during an economic slump. 

Now, opinions about the short-run effects of fiscal policy vary 

widely, as we all know. Most economics textbooks teach that a fisVerDate Nov 24 2008 12:29 Jan 18, 2012 Jkt 071033 PO 00000 Frm 00013 Fmt 6633 Sfmt 6633 C:\DOCS\71033.TXT DPROCT
10 

cal tightening slows the economy by reducing the demand for goods 

and services. Some economists disagree with this view, suggesting 

that tightening is expansionary because it boosts confidence in the 

economy. 

Both sides of this debate have reasonable arguments. If we want 

to know who is right, we have to look at the evidence. And, in my 

view, the evidence is clear: Cuts in budget deficits have adverse effects that last for 5 years or more. If Congress cuts spending or 

raises taxes today, its actions will slow economic growth and raise 

unemployment until at least 2016. 

Now, this conclusion is supported by numerous studies—admittedly, not all studies. I will focus on research performed over the 

past 2 years at the International Monetary Fund, work that many 

economists view as the best available evidence on the effects of deficit reduction. My written testimony describes this research in detail. In these remarks, I will summarize it briefly. 

IMF researchers reviewed the history of 15 countries over the period from 1980 through 2009. They identify a total of 173 years in 

which governments reduced budget deficits through spending cuts, 

tax increases, or a combination of the two. The research finds that, 

on average, a deficit reduction of 1 percent of GDP raises the unemployment rate by four-tenths of percentage point after 2 years, 

and unemployment is still two-tenths of a point higher after 5 

years. An important detail is that higher unemployment results 

mostly from higher long-term unemployment, meaning workers 

without jobs for 26 weeks or more. 

Making matters worse, these average effects of deficit reduction 

are likely to understate the effects in today’s U.S. economy. In a 

typical episode studied by the IMF, a country’s central bank responds to fiscal tightening by reducing short-term interest rates, 

and this monetary easing dampens the rise in unemployment. Currently, the Federal Reserve cannot reduce rates because they are 

already near their lower bound of zero. In this situation, the evidence suggests that the costs of deficit reduction are about twice 

their normal size. 

To better understand these findings, let’s consider one hypothetical fiscal policy: a deficit reduction of 3 percent of GDP. I 

picked this number because the Congressional Budget Office forecasts deficits of about 3 percent of GDP from 2014 through 2020. 

With a 3 percent cut, deficits would fall to roughly zero. 

How would this policy affect unemployment? The evidence says 

a deficit cut of 1 percent of GDP raises unemployment by about 0.8 

percentage points when interest rates are near zero. This means 

the 3 percent cut in my example would raise unemployment by 2.4 

percentage points. With a U.S. labor force of 150 million people, an 

additional 3.6 million Americans and their families would suffer 

the consequences of a lost job. 

Let me mention another important finding of the IMF study. Recent political debates have focused on the choice between deficit reduction through cuts in government spending and through tax increases. This choice, of course, matters a lot to the beneficiaries of 

government spending and to people who pay taxes. In one way, 

however, this choice is not important. The IMF performed separate 

analyses of spending cuts and tax increases and finds that the adVerDate Nov 24 2008 12:29 Jan 18, 2012 Jkt 071033 PO 00000 Frm 00014 Fmt 6633 Sfmt 6633 C:\DOCS\71033.TXT DPROCT
11 

verse short-run effects on economic growth and unemployment are 

similar in the two cases if interest rates are near zero. 

Now, the question, of course, is, can any policy rein in government debt without slowing the economy? And a possible answer is 

a fiscal consolidation in which spending cuts and tax increases are 

back-loaded in time. And, again, I think this is related to Congressman Cummings’ idea of something which is more stimulative in the 

short run but gets debt under control in the long run. 

Under such a policy, the government would commit to lower deficits in the future without sharply cutting the current deficit. Just 

as one example of how this might be done, one could imagine costsaving changes in entitlement programs, such as a higher retirement age, that could be phased in over time. 

With any luck, major spending cuts would occur only after the 

economy has recovered from its current slump. Deficit reduction 

will be less painful then, in part because interest rates will be 

above zero and the Federal Reserve could ease monetary policy. 

And let me thank you again for your attention. 

[The prepared statement of Dr. Laurence Ball appears in the 

Submissions for the Record on page 48.] 

Vice Chairman Brady. Well, thank you all for your testimony 

today. And we will begin a round of questioning. 

The question today, posited by Senator DeMint, is, what is the 

real debt limit for America? And the answer seems to be, it is dangerously near and not in our control. As Dr. Meltzer said, market 

perceptions and actions change quickly, and countries that act prudently ahead of the crisis are in a better position. 

And my question to Mr. Edwards and Dr. Meltzer is, do you 

think there are some lawmakers in Washington in denial about the 

seriousness of our debt crisis? Because, temporarily, the costs of 

borrowing for this country are low, are being masked by outside— 

well, both inside and outside, the Fed’s quantitative easing, lowering of interest rates, European crises which create a flight to 

safety, so our borrowing costs are temporarily lower. 

Do you think that, once the true costs of America borrowing are 

revealed, that there could be a more serious action by some in 

Washington to get this debt crisis under control? Dr. Meltzer? Mr. 

Edwards? 

Dr. Meltzer. I believe that steps that have been taken are preliminary steps—that is, to get $1.5 trillion or $1.2 trillion in reductions is just the beginning. 

What we need to do is to give people confidence that their future 

is going to be bright. We don’t do that by throwing a few dollars 

at them. We do that by giving them care that we are on a stable 

path, that we are going to go back to the future the way we knew 

the past. 

And that means that when, unlike Mr. Ball, models like the IMF 

model leave out is the fact that if you move resources from low-productivity goods—you know, it may be very desirable for people to 

receive transfers from the government. I don’t dispute that. But 

those have very low productivity use. If we transfer resources to 

higher-productivity use, we raise the future and their optimism. If 

we cut the deficit, we convince people that their tax rates are not 

going to be higher in the future. 

12 

The IMF model doesn’t allow for that. It doesn’t take into account the productivity change, and it doesn’t take into account the 

beneficial effects of expected lower tax rates. Those are important 

conditions. 

Let me close by comment by saying two things. If we look at the 

history of the postwar period, we find that there were three fiscal 

changes that really did enormous good. One was the KennedyJohnson tax cuts. Arthur Okun, who was the Chairman of the 

Council of Economic Advisers, said the most effective part of those 

tax cuts were the business tax cuts. They got the biggest bang for 

the buck. 

The second big fiscal change that worked well were the Reagan 

tax cuts of the early 1980s and again in 1986. And the third policy 

that gave people confidence were the Clinton tax increases, which 

assured people that their future tax rates were not going to go up, 

that they had seen what they were going to have to pay and there 

wouldn’t be any more. 

That is important. Give people confidence. That is what the public desperately needs at the moment, confidence that the policies 

that the government puts out are going to be sustainable and productive. 

Vice Chairman Brady. Thank you, Doctor. 

Mr. Edwards. 

Mr. Edwards. Yeah, I think your question goes to the right 

point, that because the United States is special, because we are a 

haven for international capital in a dangerous world, American policymakers have been able to get away with running giant deficits 

for far too long. I think if we were a smaller country like Australia, 

the crisis from our debt would have already happened. 

I noticed in a story yesterday on Bloomberg, Italy has just been 

downgraded. And one of the things that I think it was S&P noted 

is that they have been downgraded partly because they have a dysfunctional political system. And that seems to be sort of what is 

going on in the United States. 

Canada, again, to go back to the 1990s, hit the wall with their 

debt at 80 percent of GDP. Ours is up to 100 percent of GDP. So 

we have been skating along for so long, I think, partly because we 

are in this special situation. And Japan shows that you can run 

along sort of as a zombie economy for a decade or two with debt 

at 200 percent of GDP. 

So, you know, the real damage, though, I think, you know, is ultimately the spending. We have to get the spending under control. 

And that has been the key to success in places like Canada and 

Sweden that have cut their deficits. 

Vice Chairman Brady. Thank you. The point, I think, from 

both being: The key is to restore consumer and business confidence 

by getting our financial house in order with a credible way to 

shrink the size of government to restore that balance. 

Mr. Cummings. 

Representative Cummings. Thank you very much, Mr. Chairman. 

Just adding on to what was just said by Mr. Brady, Dr. Meltzer, 

did I understand you correctly to say—when you talked about when 

President Clinton raised the taxes, you said—you didn’t see that as 

13 

a negative thing. You saw it, in a way, I think—now, correct me 

if I am wrong—as something that created a level of certainty. And 

you are saying that the certainty is more important than some 

other factors? Is that accurate? 

Dr. Meltzer. Well, let me say, he also had the benefit of the end 

of the cold war. 

Representative Cummings. We really want to hear this. Is 

your microphone on? 

Dr. Meltzer. Sorry. 

Representative Cummings. Yes, don’t go silent on me. 

Dr. Meltzer. He really had the benefit of the end of the cold 

war. So he was able to cut spending. And he was able to cut—he 

had Mr. Rubin there. Mr. Rubin, being a finance person from Wall 

Street, told him, don’t run deficits. And he didn’t run deficits, and 

he gave people confidence. 

Now, does that mean that a tax increase now would do what a 

tax increase then did? I don’t believe so. 

Representative Cummings. Okay. 

Well, let’s pick up on that, Dr. Ball. In 1999, postwar, middleclass incomes peaked. And, by the way, during that Clinton era, we 

produced some 22 million jobs. Since 2000 they have steadily declined, notably notwithstanding the implementation of historically 

low tax rates due to the passage of the 2001 and 2003 Bush tax 

cuts. This reversal of growth has led some economists to describe 

the time period between 2000 through 2010 as ‘‘the lost decade’’ for 

America’s middle class. 

Therefore, I find particularly troubling your findings that the 

government-imposed austerity measures during economic 

downturns have lasting negative impacts on economic and employment levels and that the bulk of these negative effects falls on middle-class and working people. Specifically, I am concerned that, if 

the Select Committee on Deficit Reduction achieves the required 

$1.2 trillion in savings only through spending cuts, rather than 

through a balance of revenue and cuts, this could result in a lost 

lifetime for millions of Americans—for example, those who are 5 or 

10 years away from retirement. 

Dr. Ball, if throughout the last decade working Americans have 

watched their incomes stagnate or spiral downward and 25 million 

more Americans are unemployed or underemployed, are you concerned about the detrimental impact that the $1.2 trillion in cuts 

could have on America’s workers and middle class? Particularly in 

the context of the recent report that in America we have now 46.2 

million people living under the poverty level, meaning $22,000 for 

a family of four? 

Dr. Ball. Absolutely, I am very concerned about that. There has 

been this stagnation of middle-class living standards that has a variety of causes. But there is no question that a harsh fiscal contraction right now would exacerbate that. 

One thing I didn’t have time to mention in my testimony was another research finding, is that if you look at how total income of 

the economy goes down when there is a cut in government spending, it is disproportionately labor income or wages as opposed to 

capital income. So there is every reason to think that there would 

14 

be a shift in the income distribution away from workers, as well 

as a fall in total income. 

And, as far as unemployment I don’t think anybody really needs 

a lecture on how terrible a problem unemployment is. And there 

is a lot of research, but, again, it is also pretty obvious that losing 

your job is especially difficult, especially terrible during an economic downturn because then it takes a long time to find a new 

job. We have almost half the unemployed who are unemployed for 

6 months or more. And I could go in to some of the social science 

research about the damage that does to families, health, divorce, 

children’s performance in schools, but I am sure all of you understand that. 

Representative Cummings. Let me ask you this. You know, 

we constantly hear, get rid of this regulation, get rid of that regulation. You know, I wonder, when we get rid of all these regulations, 

does that guarantee that jobs are going to be added? In other 

words, you make it easier for the employer—you take away safety 

measures, in many instances, from the public—easier to make 

more money, but is that a guarantee that we will then see jobs expand? 

Dr. Ball. No, absolutely not. I mean, again, on any given regulation, there are a lot of pros and cons about the costs and benefits, 

but as a way of dealing with the current slump and 9 percent unemployment, that is really, honestly, a non-factor, because what we 

have is a classic shortfall of demand. 

Normally when that happens, historically, the Federal Reserve 

has dealt with that by cutting interest rates and, if the economy 

doesn’t recover, cutting interest rates some more. What is uniquely 

problematic about the current situation is that interest rates have 

hit zero, so the Fed has run out of ammunition, at least its usual 

kind of ammunition. And we need to somehow be creative and 

think about some other way to get firm spending on investment 

and to get consumers spending. 

Representative Cummings. Thank you, Mr. Chairman. 

Dr. Meltzer. Congressman Cummings, may I add to that? May 

I add to that? 

Vice Chairman Brady. Briefly, Dr. Meltzer, yes. 

Dr. Meltzer. Yes, briefly. 

Cutting regulation and giving people assurance about future 

taxes does a great deal. What it does is, if you are a businessman 

and you want to invest, the first thing you do, you learn in business school, is go out and figure out what the expected rate of return is going to be. You can’t do that, because every day or every 

week there are new regulations—for health care, for finance, for 

labor, also for environment—and the President is out campaigning 

for higher tax rates. So you don’t know what you are going to face, 

and so you sit on a bundle of cash and wait. 

We have never seen so much cash in the hands of banks and 

businesses as we do now. So we have to ask ourselves, why is that? 

And the answer is, because they are dreadfully uncertain and lack 

confidence about what the future is going to be. They don’t know 

what that future is, and they can’t estimate what the expected rate 

of return is. 

15 

If they invest, they create jobs. Most of the jobs that are created 

are created by firms that start up and in the first few years hire 

and expand. 

Vice Chairman Brady. Thank you, Dr. Meltzer. 

Senator DeMint. 

Senator DeMint. Thank you, Mr. Chairman. 

Dr. Ball, you have referenced an IMF study a number of times. 

Is it fair to assume that the study includes many nations with government workforces that are a larger percent than the U.S.? 

Dr. Ball. Yes. 

Senator DeMint. So, then, is a determination of when you are 

cutting government spending, that those nations would likely have 

a higher unemployment because of that, because that spending directly affects the government workforce? 

Dr. Ball. I don’t quite think that follows. The study is very careful in trying to measure, if we have a spending cut of a certain percentage of GDP, what are the average effects on output and unemployment. 

Senator DeMint. What we have seen with our deficit spending 

over the last few years, generally it is maintaining government employees at the State levels—teachers, others. But it would just 

seem to me, if your hypothesis that deficit spending is good for the 

economy and cutting that spending would cause higher unemployment, that using a study where most of the nations have a greater 

percent of government workers as part of the workforce, it may not 

necessarily be accurate. 

And do you not see the American economy, our free-market, capitalist system, as somewhat different than most of the other nations 

in the world? 

Dr. Ball. Well, I mean, this study includes Canada. It includes 

a variety of most of the world’s advanced countries. 

Senator DeMint. Right. 

Dr. Ball. And I think—I mean, that is an interesting thing—that 

they could follow up, looking at different types of economies. But 

I think we are talking here about fairly general principles of economics that I would think apply to Europe, to Australia, to the 

U.S. 

Senator DeMint. Well, one of the challenges we have here is I 

think there are a lot of folks that want us to be more like European 

economies that are centrally planned. That is part of our different 

world views that we are dealing with right here. 

But let me just—maybe a question to the whole group. And, Mr. 

Edwards and Dr. Meltzer, maybe I will go to you first on this. But 

we are clearly in uncharted territory right now. 

Dr. Meltzer. Yes. 

Senator DeMint. We can have different opinions about that. 

But the Federal Reserve interventions are unprecedented. Stimulus 

spending is at unprecedented levels. The bleak and unsustainable 

fiscal outlook that we are dealing with is unprecedented. The weak 

and almost nonexistent recovery, despite the incredible levels of 

stimulus spending, is unprecedented. 

So how do these factors affect the nearness to the tipping point? 

And I know we can’t determine exactly where that is. But I am 

wondering, where are we going to borrow the money from? We are 

16 

projecting a trillion dollars a year, about, that we have to borrow 

or print. Where is that going to come from? And aren’t we in such 

uncharted territories now that we need to do more than just sound 

an alarm, or am I just unnecessarily seeing a bleak situation? 

And, Mr. Edwards, I will start with you. 

And, Dr. Meltzer, I would like to get your opinion very quickly, 

too, if I could. 

Mr. Edwards. Yeah, I mean, we don’t know where the tipping 

point is, where the next financial crisis is. I mean, recent academic 

research by Rogoff, Reinhart, and others points out that different 

countries are hitting that sort of wall in different sorts of places. 

As I mentioned, I mean, Japan’s debt is 200 percent of GDP and 

has been for a couple decades. They are in a unique situation because most of their savings to finance that debt comes domestically. 

So we are not in that, you know, lucky camp. Half of our borrowing 

now comes from abroad. That is a real problem, as the CBO points 

out in their long-range projections. That means that, in the future, 

if we keep this up, we will be producing GDP but a bigger and bigger chunk of that GDP won’t be going to Americans; it will be going 

to foreign creditors. So that is why our standard of living will be 

suppressed by this buildup of debt. 

I must say that, you know, hitting the tipping point isn’t—I 

mean, that is not the end of the story. Ireland hit the tipping point, 

but recent news reports are indicating that they have taken some 

very good policy actions, cutting spending, and they are on the 

brink of recovery. They are in a much different situation than 

Greece, even though both of those countries had these massive 

spikes in debt. Ireland has taken the right policy courses, and they 

are headed now in the right direction. 

So, again, I don’t think the biggest issue facing you is where the 

tipping point is. I think it is just, you know, stopping the bleeding 

as soon as we can. 

Senator DeMint. Dr. Meltzer, quickly—I am almost out of 

time—just a comment? 

Dr. Meltzer. Let me just say that Ireland did not have a large 

debt. It got a large debt because it assumed the debt of the banking 

system. It was a private debt. It assumed it as a public debt. That 

was a huge mistake that got Ireland into a problem. 

Take the case of Italy, which is a good case for us to study because it went along for decades with low growth and high deficits 

over 100 percent. When it jointed the ECB, it hid some of its debt, 

but it was basically over 100 percent, instead of the 60 percent that 

was required. Suddenly, that same situation gave rise to a loss of 

confidence. That was the tipping point. Why didn’t it occur 2 years, 

5 years, 10 years earlier? I don’t think anyone can answer that. 

Senator DeMint. Thank you. 

I yield back. 

Vice Chairman Brady. Thank you, Senator. 

Representative Mulvaney of South Carolina is recognized. 

Representative Mulvaney. Thank you, Mr. Chairman. 

Dr. Ball, I am going to take the unusual step of asking you some 

questions. I have learned not to get into a battle of wits when I am 

woefully underarmed. It has been a long time since I have taken 

17 

economics, so I am going to ask a couple questions and try not to 

make too big of a fool of myself. 

But let me ask you this question to start off. Do you believe that 

there is such a thing as a tipping point in the size of this debt? 

Dr. Ball. Oh, absolutely. And I think probably all three of us 

agree there is a tipping point and we don’t know where it is and 

it would be prudent not to find out. So by no means do I want to 

say that we shouldn’t be very concerned about long-run sustainability. 

Representative Mulvaney. And that is sort of where I was 

hoping we could get. I think one of the things that all three of you 

could agree on is that, if we get past that point, it would be actually much worse than the situation we find ourselves in today. Is 

that a fair statement? 

Dr. Ball. Probably. I think, again, because the U.S. is special 

and this is unprecedented, when it would happen or how bad it 

would be—again, it is the kind of thing we don’t want to learn 

about. 

Representative Mulvaney. And that is one of my frustrations 

with the classical Keynesians is that they seem to lack, in my opinion, a long-term outlook. We are always looking quarter to quarter, 

we are looking year to year; there is no long term. And you remember what Dr. Keynes’ comment was regarding the long term that 

we are all dead. 

We have sat in this room this year with a board of experts regarding entitlements. And I am talking; there were two Republican 

witnesses, an independent witness, and a Democrat witness. And 

the window of opportunity that that broad group gave us to fix entitlements was someplace between 2 years for the most conservative and 5 years for the most progressive or liberal witnesses that 

we had. 

And one of my concerns is that when I read your analysis, when 

I read your testimony, is that we lack any type of mid- to long-term 

outlook; that we are simply looking at the next quarter in an effort 

to try and boost the GDP. 

You go to the end of your testimony, for example, you talk about 

why printing money, why expansionary policies might not have the 

same type of inflationary outcomes that we have seen or that many 

of us, including many of the members of this board, and I know Mr. 

Edwards and Dr. Meltzer fear, because you say that businesses 

generally do not monitor the Fed’s balance sheet and they do not 

base their pricing decisions on changes in the monetary base. 

I used to run a business. I can assure you that I didn’t watch 

the Fed Reserve and I didn’t watch expansionary policies. But what 

I did watch was my costs. And when my costs went up, I had to 

raise my prices. And I can assure you, while I wasn’t watching the 

Fed, the brokers in food and fuel certainly were. And as my costs 

went up because of expansionary policies, I had no choice but to 

raise my prices or to go out of business. 

You go back to the Weimar Republic. You saw a tremendous inflation—in fact, hyperinflation—without an overheated economy. It 

was driven entirely by the printing of money. There was high unemployment at that time. There was fairly low productivity. And 

18 

what we had was—well, we had middling productivity but you had 

tremendous inflation. 

One of the things that I fear when I look at your proposals is 

that we are underestimating the risk of inflation and hyperinflation. Take a minute and tell me why I can sleep at night and 

I shouldn’t be too worried about that. 

Dr. Ball. Well, first of all, on the fiscal issues, you talked about 

the long run and the short run. I think the quote about, ‘‘In the 

long run, we are all dead,’’ is something that people are a little bit 

embarrassed about now, because the long run is important. 

Again, I think there is a lot of agreement about the long-run dangers of the debt. It is just, we need to be realistic about if we are 

very aggressive right now at cutting the debt, there will be major 

costs in the—— 

Representative Mulvaney. If we believed that we were closer 

to the tipping point rather than further, if we believed that we 

were closer than you think that we may be—let’s say that we are 

the 2 years, you are the 5 years—isn’t it entirely rational for us to 

be taking the steps that we are proposing? 

Dr. Ball. Well, I think at some level the right steps are obvious, 

and maybe everybody could even agree. It is addressing the looming—I mean, there is the CBO chart of the debt going off. That is 

because of primarily entitlement programs. So, in a perfect world, 

Congress would get together and have a friendly discussion and figure out some nice moderate compromise on how to fix entitlement 

programs, and that would solve the long-term problem without giving a big negative jolt to the economy today. 

I mean, if we address the deficit just by willy-nilly spending cuts 

over the next decade, I mean, maybe—I am not going to say whether that is, overall, good or bad, but there are going to be—there is 

going to be higher unemployment. There are going to be costs. So 

we should be realistic about that. 

Representative Mulvaney. You mentioned—very quickly, I 

have just a few seconds—you mentioned willy-nilly cuts. I agree 

with you that simply going in and cutting randomly might have a 

different output than coming in and cutting specifically. The Canada example is one that several of you have mentioned. And there, 

if you go back and you look at the history, it appears as if their 

cuts focused primarily on wealth-transfer programs and not on infrastructure. 

Would you agree, sir, with the premise that cuts in wealth-transfer programs might have less of an impact on employment than 

cuts to infrastructure spending? 

Dr. Ball. I think that is plausible because infrastructure spending has a substantial effect on employment. 

Let me say very briefly on the inflation issue, that is something 

where maybe I do differ from others. I think the fears of inflation 

really are quite unwarranted, and that is a bogeyman that doesn’t 

really—again, without a long economic debate, I think historically 

in the U.S. inflation pressures have taken off when the economy is 

overheated. Unemployment has been low, so workers push for higher wage increases. Firms are straining their capacities, so they 

have more of an incentive to raise their prices. An overheated economy is obviously the last thing we need to worry about right now. 

19 

Representative Mulvaney. Thank you, Doctor. 

Thank you, Mr. Chairman. Sorry to go over my time. 

Vice Chairman Brady. No. Thank you. 

Mr. Campbell of California is recognized. 

Representative Campbell. Thank you, Mr. Chairman. 

The subject of this hearing is something I have been talking 

about for some years: the real debt limit; and I have been saying 

that, although we have had a lot of debates and disputes here in 

Congress over the statutory debt limit, that the statutory debt limit 

is an arbitrary number, and the real debt limit is when we reach 

what we are all today calling as the tipping point. But the 

pushback I get on that from some people—and I would like to ask 

Dr. Meltzer and Mr. Edwards to respond to this—is that people 

say, well, we are really a long ways from that. 

Look at what is happening with Treasury debt today. Look at the 

10-year Treasury dropping—I don’t know where it is right now— 

right around 2—but dropping at some point below 1.9 or so forth. 

The auctions are going out. There is a tremendous appetite for 

Treasury debt. The interest rates on Treasury debt are dropping 

dramatically. And this is an indication that we are a long, long 

ways from that tipping point. 

Would either or both of you like to respond to that? 

Dr. Meltzer. First, I would say the size of the unfunded mandate, which is not included in most of the numbers we talk about— 

not in the 90 percent, not in the 100 percent—is six to seven times 

the size of the deficit, depending upon what interest rate you use 

to discount it back for the future. So that puts us at an enormous 

amount. It is just as the chart shows. Mr. Ball and I agree. It is 

the Medicare and Medicaid expenditure that is going to cause us 

the problems we have. Social Security is a minor but important 

part of the problem, but it pales in significance compared to Medicare and Medicaid. 

So there are lots of things we can do, and there are a lot of 

things we can do to Medicare and Medicaid that don’t require taking away promised benefits to people but changing them. For example—and just one of many examples—we have to ask: Why do 

we spend about 50 percent of the Medicare money on people who 

are within 6 months of dying? Now, they don’t all die. So, for some, 

there is a benefit. But there is no copay attached to that. If we attached a copay and graduate it according to income, we would reduce a lot of—— 

Representative Campbell. Dr. Meltzer, just because of the 

time, how do you respond to those people that say, in spite of all 

this, that we have considerably more debt that we can run up and 

that the evidence of that is the appetite for and the low interest 

rate on Treasury bills? 

Dr. Meltzer. The reason we have the low interest rate is because the Fed enforces it. If you want to look at where the pressure 

is coming from, look at the fact that the dollar has depreciated by 

about 15 percent against a weak currency like the Euro and by an 

even larger percent against a weak currency like the Japanese Yen, 

that the most recent inflation number was 3.8 percent—well above 

the Fed’s target. 

20 

So I don’t buy the argument that in a weak economy you don’t 

get inflation. You gave the example of Germany. Spain at the moment has 20 percent unemployment. Prices are rising. Britain has 

a high unemployment rate. Prices are rising. So there are other 

sources other than the labor market to give you inflation. And we 

are going to get them. 

Representative Campbell. Mr. Edwards. 

Mr. Edwards. There are these gigantic negative risks out there 

that something big and bad is going to happen to the American 

economy. We don’t know what it is. If you go back and look at the 

January, 2008, CBO projection, they didn’t project a recession. 

They said, well, maybe a recession would happen. But they actually 

projected growth would be strengthening in coming years. So we 

are going to be surprised by the next big recession or negative factor. 

If you look at CBO projections, I mean, there are no recessions 

in their 10-year outlook. But what if we have a gigantic recession 

a few years from now, another major recession? Tax revenues 

would plunge again, unemployment comp costs would soar, a lot of 

policymakers would want to do another giant stimulus, and we 

would be in this spiral downward of debt and poor economic 

growth. 

So we have got to start planning now. The risk factors are all on 

the negative side. European countries have this horrible demographic problem—worse than ours. Their debt loads are going up. 

So the higher their debt loads become and the higher ours become, 

the more risk of an international sort of a contagion, the more we 

are all at sort of a tipping point. If Europe can go into another deep 

recession, it would cause a deep recession here. The risks are all 

on the ugly side. 

Representative Campbell. In my last 15 seconds, do any of 

you want to comment on the thing the Fed is discussing to change 

the maturities of the debt that they hold? 

Dr. Meltzer. It won’t do much. They tried it back in the 1960s. 

They had a big experiment. It didn’t work. That is, their own research at the Fed said it didn’t work. Why? Well, think about it. 

If you suppress long-term rates and raise short-term rates, what do 

you think the market people are going to do? They are going to go 

the other way. 

Representative Campbell. All right. My time is expired. 

Vice Chairman Brady. Thank you. 

The chair recognizes Dr. Burgess of Texas. 

Representative Burgess. Dr. Meltzer, you referenced just a 

moment ago about the costs of Medicare for patients in the last 

months, even weeks, of life. I will just tell you, as somebody who 

practiced medicine for a number of years, the principal problem we 

have there is the lack of transparency on the part of the patient. 

They don’t tell us when that last 2 weeks begins. So it makes it 

very, very difficult for us to balance our decisions. 

Dr. Meltzer. Of course. 

Representative Burgess. But along that line, you talk about 

the cost drivers contained within Medicare and Medicaid and you 

talked about perhaps changing things so that they don’t take away 

future benefits. I will submit within the health care realm there is 

21 

probably $1.3 trillion in immediate savings that will not take away 

future benefits, and that would be to delay the implementation of 

the Affordable Care Act, which nobody seems to seriously consider 

when they have deficit commissions or talk to the President. Is 

that something that this Congress should take under serious consideration? 

Dr. Meltzer. Yes. 

Representative Burgess. Thank you. 

We also talked—and this is for any one of you—we talked a great 

deal about cash on the sidelines. I have talked to a number of my 

community bankers, not just in the August recess but going back 

this past year and a little bit longer. The community bankers tell 

me that they are hampered by the fact that they must keep their 

loan-to-deposit ratio under 80 percent or they will invite a visit 

from some type of bank examiner, and that visit may not be pleasant. So they take pains to not go that last—to not touch that last 

20 percent as a consequence. They are not making money on that 

20 percent of deposits. The community is deprived of the loans that 

those 20 percent of deposits could create. 

Do any one of you have a sense that that is a bigger problem 

than what has been talked about before? 

Dr. Ball. If I may comment, I think that is a problem. I think 

probably depressed lending by community banks is one factor holding back the recovery. And perhaps regulators could change their 

attitude a little bit or think of creative ways to encourage lending 

and perhaps help recapitalize community banks. 

Representative Burgess. But we have kind of gone the other 

way in the past 18 to 24 months; and rather than making the regulations, perhaps clarifying them even, we have made them more obscure, as has been previously mentioned. We frighten people with 

what is the future regulatory environment that they are going to 

encounter. 

Dr. Meltzer, is that one of the reasons this cash is staying on the 

sidelines? 

Dr. Meltzer. That is one of the reasons. That is generally regulation. As Speaker Boehner said so well in his speech the other 

day, you can move your plant to China, but you can’t move it to 

South Carolina. That sounds funny, but at the same time it really 

tells us a serious thing about what regulation does to the attitudes 

of businessmen. 

Representative Burgess. And we are talking right now and the 

President is talking about raising taxes to create jobs, and yet this 

is the same White House that just this weekend said that Lockheed 

in Fort Worth can’t sell F–16s to Taiwan. 

Their National Labor Relations Board said you can’t build Boeing 

aircraft in South Carolina, and American Airlines biggest jet purchase in the history of the country, probably, is buying non-Boeing 

products for perhaps the first time in their company’s history. 

American Airlines is buying non-American-produced jets. 

Eight to 18 power plants are going to close in Texas on January 

1 because the Cross-State Air Pollution Rule is going to be a significant detriment on jobs. 

22 

The Keystone Pipeline, argue the environmental effects one way 

or the other, but the White House simply will not make a decision, 

whether they say yes or no. 

Drilling in the Arctic for Shell Oil, they just will not make a decision. 

The problem, as I see it, is not that taxes are not high enough. 

It is that the White House is so risk averse, it is afraid to act. 

Do any of you have an opinion about that? 

Dr. Meltzer. I agree with that completely. You don’t know what 

the future is going to be. Cash is your friend. 

Mr. Edwards. Just a general sort of a comment. There has been 

so much focus in the last few years by policymakers in Washington 

on macroeconomics—a misguided focus in certain ways, in my 

view. Microeconomics is extremely important. If you go back, for 

example, and look at what Margaret Thatcher did after a decade 

of stagnation in the 1970s in Britain, sure she got the macroeconomics in order, but she did a heck of a lot of on the microeconomic side. Tax reform, deregulation, privatization, all those 

things, it is hard to quantify the impact on the economy. But there 

is no doubt that fast-growth economies, they are getting both the 

macro and microeconomics right. 

Dr. Meltzer. I would like to second that. I worked with Mrs. 

Thatcher some of the time. She was a real leader. She was willing 

to make tough decisions. 

Representative Burgess. Thank you, Mr. Chairman. 

Vice Chairman Brady. Thank you. 

We are going to undergo a second round of questioning by Mr. 

Cummings and Senator DeMint. 

Mr. Cummings is recognized. 

Representative Cummings. Dr. Ball, to what extent are our 

current deficits being driven by slow economic growth and what impact would more robust economic growth have on our ability to reduce the deficits and rein in the debt? And the proposals—the most 

recent jobs proposals that were presented by the President, I just 

wanted to know what your opinion of those might be and do you 

feel that they would be helpful, as many economists have projected? 

Dr. Ball. I think there is absolutely no question that the main 

driving force behind the big run-up in the budget deficit is the economic slump. Somebody else referred to lower tax revenues, higher 

unemployment insurance. It is a very strong economic regularity 

that deficits go up in recession. So we have had a big recession. 

And that is the main thing. 

The stimulus program added to the debt, but it was secondary 

just compared to the recession. And, absolutely, if we can find a 

way to restore robust growth, that is the best possible deficit reduction plan. Anything which retards growth is going to be somewhat 

self-defeating as far as the fiscal situation because of the effects of 

growth on the deficit. 

As far as the President’s jobs plan, I haven’t studied it in detail. 

It seems like a step in the right direction. 

It stills seems, frankly, we face a huge problem. Actually, whether it is the President’s jobs plan or various deregulation or things 

the Fed can do, it is not clear that any of the measures we have 

23 

are really sufficient, that we may have to either really try something more radical or accept that we are going to live with high unemployment for quite a while. 

Dr. Meltzer. Mr. Cummings, that jobs plan costs $200,000 per 

job. My wife, who is not an economist, listened to that and said, 

why don’t we pick the same people, give them $150,000, and we 

will be ahead of the game? We are not going to get out of this problem by spending $200,000 per job. 

Representative Cummings. So, Dr. Meltzer, you are saying 

that you can’t—one of the things that has always bothered me 

about all of this is you look at something like infrastructure, and 

in Maryland they say we have got a sinkhole developing every 8 

minutes. 

Let me finish, Dr. Meltzer. I see you shaking your head. 

Dr. Meltzer. I agree with that. 

Representative Cummings. Every 8 minutes. We have got 

bridges falling apart. I told some people the other day, you can 

erode from the inside. You can die from the inside. If you are not 

educating your people, if you are not innovative, you can’t be competitive. So at what point—I mean, seems to me, you have got to 

spend carefully to get the economy going and get people moving— 

carefully—but at the same time you can’t die in the process. Because by the time you get out of the mess, you don’t have a country. 

Dr. Meltzer. I agree, Mr. Cummings. 

Representative Cummings. You agree with me? 

Dr. Meltzer. I agree the infrastructure in the United States is 

bad. I live in Pittsburgh. I will match you bridge for bridge, and 

I will have a whole bunch left over. So, absolutely. But if you think 

that you are going to take carpenters and bricklayers and convert 

them into road builders and bridge builders overnight, you are kidding yourself. Building a bridge is a big job, and it requires people 

who are trained in steel. 

The President says, well, just let’s take some of the unemployed 

construction workers and make them road builders. Have you 

watched them build roads? They use heavy equipment. You have 

to learn how to drive that. That is not going to be a solution. 

I agree. We have a long-term problem of infrastructure, and we 

are to do what we can about infrastructure. That is a constructive 

thing. We have waited way too long to do something about it. 

Education. We really have tried with education. It is terribly important. The gap in incomes between the poor and the rich is driven mainly by the fact that technology has changed. 

I was a corporate officer or director. If you didn’t have an education, you couldn’t read the computer that was beside your work 

station, you swept the floor. That is a loss of people. We need to 

do something about that. I wish I thought I knew what we needed 

to do. 

Representative Cummings. Thank you very much. 

Vice Chairman Brady. Thank you. 

Senator DeMint is recognized. 

Senator DeMint. Thank you, Mr. Chairman. 

I want to thank Congressman Cummings and Dr. Ball for kind 

of presenting the alternative view today. Obviously, we have a big 

24 

difference of opinion in Washington about what we need to do to 

fix the problem. 

I, frankly, don’t think I am looking at this through a political 

prism. I am thinking of it as a guy who was in business for many 

years. I consulted with a number of other businesses. So my political perspective is really not a political perspective. And what I am 

looking at today, by any measure from a business perspective, our 

Nation is bankrupt, if you look at the balance sheet. We have got 

a negative cash flow projected continuously, indefinitely. Most of 

our operating capital is borrowed money. Every new program we 

suggest has to be borrowed or printed. 

So our fate is in the hands of our creditors. That is a worrisome 

situation. I don’t know how we can get around that. 

And the solution, if you use a business parallel, the 3 percent of Americans who make over $200,000 also happen to create most of 

our jobs and give the most to charity, provide 60 percent of all investment capital. They happen to be the ones making things happen. Taking more money from them and giving it to the people who 

are creating the debt does not seem to be making a lot of common 

sense. 

So just like a business whose revenue is down and they decide 

the best way to get out of that is to raise their prices, that is what 

we are talking about doing here. Our business is down. Our revenue is down. So we want to raise the prices on who are effectively 

our customers, those who are creating the revenue for us. And that 

is a difficult thing to swallow when we know in economy—it may 

not be true in IMF economies, but we have got a economy where 

3 percent of Americans are already paying over half of the taxes. 

They are the ones creating the jobs, providing the investment capital. Frankly, that is not going to solve our problem. 

If you look at the data for the last 10 years, the increase in our 

deficit is mostly attributable to an increase in spending, and that 

includes a lot of discretionary spending. 

Social Security has not contributed to our debt at all. In fact, if 

we hadn’t borrowed $3.6 trillion from Social Security, we would be 

a whole lot more in debt than we are today. 

So this is not all on the entitlements. This is on a belief of government that we need to direct the economy. And I think the difference of opinion here is that the government is the primary stimulator of the economy versus those of us who think the reason 

America was so exceptional and prosperous was that we were a 

bottom-up economy with millions of people starting businesses, innovating, being entrepreneurs. Those are the people we seem to 

want to attack right now. Of those who have income over $200,000, 

40 percent of their income is small business income. 

So I understand the need to balance revenue as well as spending 

cuts, but we can get new revenue by making the economy grow. 

Frankly, if you look at 20-year data, you can raise the taxes as 

much as you want, but the revenue is going to be about 20 percent 

of our GDP—excuse me—18 to 19 percent of our GDP over time. 

So I appreciate all of our panelists helping us to talk through 

this. To me, this is a situation where, like all of you have said, let’s 

not wait to find out. Because all this is going to take is China to 

say they are not going to lend us more money, to dump our debt 

25 

at 80 cents on the dollar. And the faith that keeps us up—and that 

is what we do have to admit, that the only thing keeping our dollar 

up, keeping what economy we have going is faith and the fact that 

other economies are worse off than we are right now. 

But thank you for helping us talk through this. Mr. Chairman, 

to you and your committee staff, I appreciate all the work you have 

done. I appreciate all the folks who have answered questions, and 

I hope we will follow up with some decisive action that will solve 

our problem. 

Vice Chairman Brady. First, let me thank Senator DeMint for 

leading this hearing today and the members of the Joint Economic 

Committee, both parties, for engaging. I so much appreciate the insight and thoughts provided by our panelists as well. 

To borrow from the President’s current speech, it is clear the real 

debt limit is upon us now. We have to act credibly to reduce that 

debt—and now—and we need to get Washington out of the way of 

our recovery now. 

With that, the meeting is adjourned. 

[Whereupon, at 11:21 a.m., the committee was adjourned.] 

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SUBMISSIONS FOR THE RECORD 

28 

PREPARED STATEMENT OF REPRESENTATIVE KEVIN BRADY, VICE CHAIRMAN, JOINT

ECONOMIC COMMITTEE

When the Joint Economic Committee must hold a hearing on what the real debt 

limit is, the American people know instinctively that their federal government is 

borrowing too much. One does not really want to contemplate the grave consequences if creditors were to lose faith in the federal government to repay its debts. 

The United States supplies the world’s primary reserve currency; has the world’s 

largest economy; and is source of much of the world’s technological progress and economic development. The federal government should never violate its real debt limit 

because the consequences of exceeding it would be calamitous not just for the 

United States but indeed the entire world. 

Nevertheless, the JEC must hold this hearing because the question now is asked: 

What is the real debt limit? Amazingly there are some that do not believe the U.S. 

has a serious debt problem. Given the anemic recovery, these individuals argue that 

President Obama’s deficit spending splurge should continue. ‘‘Don’t worry because 

interest rates on Treasuries remain low, and the federal government can print more 

money to pay all its debts,’’ they say. 

I hope that today’s hearing sheds light on the fallacy of this mindset and puts 

an end to it. 

Keynesian theory tells us to ignore the level of federal debt and continue deficit 

spending until full employment has been achieved. Well, we simply cannot ignore 

the debt anymore. 

According to recent economic studies, when gross government debt relative to size 

of the economy exceeds a certain threshold, the economic growth and job creation 

slow dramatically. Economists Carmen Reinhart and Kenneth Rogoff put the 

threshold at 90%, while another study by economists at the Bank of International 

Settlements put it at 85%. The page in the Keynesian playbook on what policymakers should do when gross government debt exceeds this threshold and high unemployment persists is—blank. 

Gross federal debt already exceeds 98% of GDP and is on course to exceed 100% 

next year according to the Congressional Budget Office (CBO). Now that we are 

staring at that empty page in the Keynesian playbook, we have to forge a new path. 

The dynamics of rising federal debt relative to our economy are dangerous. The 

federal government must stay clear of the undertow of deteriorating economic performance, rising interest rates, and higher tax rates. 

To begin, we must discard fiscal policies that have not been working. Economists 

John Taylor and Michael Boskin have detailed how the Obama ‘‘stimulus’’ and other 

federal spending were wasted on transfers that produced no lasting growth. We cannot afford another round of ‘‘stimulus’’ disguised as a ‘‘jobs’’ bill. 

Growth is what we need. In the following chart, the top line shows the gross debtto-GDP ratios for the next ten years, as implied by CBO’s projections since the 

Budget Control Act was adopted. The average annual growth rate during the forecast period is 4.2% for gross debt and 4.6% for nominal gross domestic product 

(GDP)—just slightly higher. This is why the ratio of the two ends close to where 

it starts. The blue line shows the ratio if the debt grew only 2% while nominal GDP 

grew 6% per year. 

The U.S. economy must grow significantly faster than federal debt to move the 

ratio down from the dangerous levels around 90%. In the CBO’s outlook for the AdVerDate Nov 24 2008 12:29 Jan 18, 2012 Jkt 071033 PO 00000 Frm 00032 Fmt 6601 Sfmt 6621 C:\DOCS\71033.TXT DPROCT

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ministration’s budget, that fails to happen; the spread in trajectories of debt and 

economic growth is too small. 

Viewed this way, it is obvious that the country’s economic policies must change, 

and not only with regard to federal spending and borrowing. Myriad regulations 

that hamstring economic activity and discourage private investment must be reversed, and the anti-employer attitude must go. 

We know that entrepreneurs, investors, and consumers on Main Street fear the 

consequences of the rising federal debt. The real debt limit is upon us. We must 

act credibly to contain federal debt and release the private economy so that it can 

grow as it has in the past and how it must grow again. 

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36 

PREPARED STATEMENT OF DR. ALLAN H. MELTZER

Vice Chairman Brady, Senator DeMint, Members of the Committee. 

It is a pleasure to appear again before the Joint Economic Committee. My association with this committee goes back to the days of Senator Paul Douglas. It was Sen. 

Douglas who pushed and prodded the Federal Reserve to stop holding interest rates 

fixed and permit monetary policy to do much more to prevent inflation. His views 

eventually prevailed. That should remind the members of their responsibility. 

Today, I will answer the questions that this hearing topic seeks to address. The 

question of ‘‘what is the real debt limit’’ includes some good questions that show rising concern for the consequences of recent Federal Reserve actions. I will introduce 

my answers with my explanations of why Federal Reserve policy is misguided and 

mistaken, inflationary and inappropriate. There are several reasons. I will give 

three. 

First, in writing the three volumes of ‘‘A History of the Federal Reserve,’’ I read 

more minutes and transcripts than any person can endure. With very rare exceptions, notably in the years when Paul Volcker led the disinflation policy, one looks 

in vain for a statement of the medium-term consequences of the actions taken at 

the meeting. True, the staff and others provide forecasts of the future, but the 

FOMC never tries to reach agreement on the consequences of its actions for the public. It publishes forecasts but there is no clear relation between forecasts and actions. 

Second, concerns at FOMC meetings are mainly about the near-term. The Federal 

Reserve has little influence over what will happen in the near-term but much greater influence on the medium-term. The present is characteristic. The Fed Chairman 

and some of the members seem determined to ‘‘do something’’ more about the excessive waste and harm of high unemployment. They neglect the fact that there is no 

shortage of money and liquidity and that they have pushed and prodded market interest rates to the lowest levels ever achieved. THE UNITED STATES DOES NOT 

HAVE A PROBLEM OF TOO LITTLE LIQUIDITY. THERE IS NOT MUCH THAT 

THE FEDERAL RESERVE CAN DO BY ADDING RESERVES OR LOWERING INTEREST RATES. Doesn’t the Chairman and several members understand that 

there are limits to what the Federal Reserve can do? Banks hold more than $1.5 

trillion of idle reserves. Money growth (M2) for the past 6 months is rising at almost 

15 percent annual rate. (See chart.) Prices are rising and the U.S. dollar continues 

to sink. THE MOST USEFUL ACTION WOULD BE ANNOUNCEMENT OF AN 

ENFORCEABLE INFLATION TARGET TO GIVE CONFIDENCE THAT WE WILL 

NOT INFLATE. 

Third, in 1977 Congress gave the Federal Reserve a dual mandate, interpreted 

as low unemployment and low inflation. It pursues those goals in an inefficient way 

by pursuing unemployment until inflation rises, shifting to inflation control until 

unemployment rises, and back and forth. That way, it achieves neither. The Great 

Inflation of the 1970s is an example. Both unemployment and inflation rose. The 

current Fed repeats that pattern. In contrast, policy from 1985 to 2003 more or less 

followed a rule that included both goals. That gave the public one of the very few 

years of low inflation and stable growth in the Fed’s 100 year history. In Article 

1, Section 8, our constitution gives Congress ultimate control of money. It should 

legislate an enforceable inflation target. I will amplify ‘‘enforceable’’ if you wish. 

Now to the more specific questions of the real debt limit. 

First, given the fiscal policy of the industrialized nations, will government debt 

crowd out private investment spending? My answer is yes. Today’s deficits and debt 

raise concerns about future tax rates. The prospect of higher future tax rates raises 

the rate of return that business investors want to earn on new investment. And uncertainty about future tax rates and the persistent increase in regulation of health, 

labor, energy, and finance has deterred investment and slowed recovery. Faced with 

heightened, current uncertainty, many investors hold cash and wait. Cash is their 

friend. Government budget and regulatory policies deter, crowd out, investment. 

Second, the original Federal Reserve Act prohibited loans to the Treasury. Early 

in its history the Federal Reserve circumvented the prohibition by buying Treasury 

bonds from the market after the Treasury sells them. This monetizes debt. With the 

exception of wartime, the Federal Reserve bought mainly very short-term Treasury 

bills. In the 1950s, it ran a ‘‘bills only’’ policy. Recently it has done what no central 

bank should do: It has implemented the government’s fiscal policy by buying longterm Treasury bonds and $1 trillion worth of mortgage-backed securities. Ask them 

how they plan to sell mortgages in this mortgage market. The screams from homebuilders would be heard all across the country. A straightforward way of saying the 

same thing is that THE FEDERAL RESERVE DOES NOT HAVE A CREDIBLE 

PROGRAM FOR SHRINKING ITS BALANCE SHEET. 

37 

If Treasury rates rise, the Federal Reserve portfolio will lose value. Until DoddFrank, 90 percent of the Fed’s earnings became Treasury receipts, so the Treasury 

and the taxpayers bear the cost of the recent change. Dodd-Frank authorizes the 

new consumer agency to sequester Federal Reserve earnings without approval by 

the Congress or the Fed. I have been told that this off-budget finance is not unconstitutional. I continue to believe that the Congress should prohibit ALL off-budget 

finance. The constitutional provision that makes Congress responsible for spending 

should be strengthened. 

The question regarding the implications of our enormous debt has several parts. 

Some ask for more precise answers than anyone can give correctly. 

The ‘‘tipping point’’: Some authors say a ratio of 90 to 100 for government debt 

to gross domestic product (GDP) is a ceiling. Beyond the ceiling, interest rates rise 

suddenly because bond investors fear inflation, default, or sharply rising interest 

rates and losses in the value of bond holdings. We are there. Public debt is $14.7 

trillion, and second quarter nominal GDP is $15 trillion. If we add, as we should, 

to the current U.S. government debt, the promises to pay obligations of Fannie Mae, 

Freddie Mac, the Federal financing bank and the unfunded liability for Medicare, 

Medicaid, and Social Security, the debt of the United States government passed the 

90 percent ratio years ago. Currently, unfunded debt in the medical programs 

reaches $70 to $100 trillion, as much as 6 or 7 times the reported debt, depending 

on the rates used to discount future promises. The ‘‘full faith and credit of the 

United States’’ is stretched far above the ability to pay. Yet interest rates on government bonds are lower than they have ever been. There is no sign in current interest 

rates of the looming debt problem. Exchange rates tell a different story. 

Why wait for a ‘‘tipping point’’ and a crisis? We have ample warning that we are 

on an unsustainable path. We don’t know when a crisis will occur, and we should 

not wait to learn whether it does. PRUDENT POLICY ANTICIPATES 

CALAMATIES BEFORE THEY OCCUR. RESPONSIBLE POLICY MAKERS DON’T 

WAIT FOR CRISES. 

Japan’s outstanding public debt is at least double its GDP. Government debt for 

Italy and Belgium has long been above 100 percent of GDP. I do not know what 

unfunded liabilities may add to these sums. They suggest that we will not find a 

precise number like 90 percent of GDP to warn us of impending interest rate increases. But we also know from the recent experience of Greece and Italy that sudden changes in market perceptions occur. What was acceptable suddenly becomes 

unacceptable. This is a warning that prudent folks will heed. 

Perhaps we should see a warning in the fact that our debt and deficits are 

unsustainable. Every knowledgeable observer recognizes that. Why wait for a market crisis to tell us what we already know? 

At a time of considerable uncertainty about the future of currencies and economies, the large, open market for U.S. debt is a refuge for frightened investors. The 

Federal Reserve does not let interest rates increase, so holders think they are protected from losses caused by rising interest rates. Some hope for additional gains 

if the Fed lowers rates by making additional large-scale purchases. The result is 

that for the present holders are willing to accept negative real returns on their 

bonds. Negative real returns subtract the current inflation rate from the current 

market interest rate. 

Japan’s relatively large debt is almost entirely owned by Japanese citizens. Unlike 

our current citizens, Japanese save and put much of their saving into Japanese institutions that buy government debt. The nominal interest rate on long-term Japanese debt has remained between 1 and 2 percent for many years. Investors expect 

that pattern to continue, so there is no sign of an impending debt crisis. Japanese 

experience should not make us sanguine. We depend on the rest of the world to finance at least half our annual budget deficit. That’s a risk for us but not for Japan. 

Italy is instructive. The debt-to-GDP ratio remained above 100 percent for years. 

Italian savers bought a large part of the debt. As concerns about the future of the 

euro rose, Italian debt suddenly and unexpectedly rose in yield and fell in price. The 

European Central Bank made large purchases to reassure investors that there was 

a residual buyer. Uncertainty about what will happen in the future, not the distant 

future, remains. 

German and French banks hold large amounts of Italian debt. They would like 

a government bailout, so they pressure governments. Meanwhile, they sell as much 

of the Greek, Italian, and Spanish debt as they can. 

The sudden crisis affecting Greece and Italy teaches two things of value to us. 

One is market perceptions and actions can change quickly. The other is that prudent policy does not wait for the crisis. It acts before when many more options are 

available. It would be better to adopt Congressman Ryan’s budget plan that leaves 

38 

current and near-term health care beneficiaries unharmed than to wait for a crisis 

that forces much more immediate, drastic action and harms current recipients. 

If rates spike up, without warning, we will be forced to make sharp, sudden 

changes in spending and tax rates. The alternatives are default and inflation. Default would harm the credit of the United States for years, even decades. It should 

be unthinkable. 

Many now propose to ease the debt burden by raising the inflation rate to 5 or 

6 percent. That would reduce the burden of long-term debt and mortgages, but it 

would raise interest rates for new debt issues and refunding. The average maturity 

of outstanding debt is between 3 and 4 years, so we would face higher interest rate 

expense very soon. I would like the proponents of a higher inflation target to tell 

us how they propose to bring the inflation rate down in the future. It is unlikely 

that we can reduce inflation without causing a new recession. People invest expecting inflation to continue. Farmers borrow to buy land. Home builders suffer a collapse when disinflation raises interest rates. Moreover inflation will not put much 

of a dent in the enormous unfunded liability for health care. And it cheats the principal holders of U.S. debt, especially China and Japan, with unforeseen consequences. 

Recent unprecedented actions by the Federal Reserve solicit questions about limits to Federal Reserve monetary expansion. There are no legal restrictions. The only 

limit I know comes from the public. At some inflation rate, the public will demand 

less inflation. In 1979, inflation reached double digits. The public declared inflation 

to be the major economic problem. President Carter responded by appointing a 

known anti-inflationist, Paul Volcker. In his interview, Volcker told the president 

that he would reduce inflation. President Carter responded that was what he wanted. He had not taken effective action before, but he faced an election in which the 

public wanted lower inflation. 

Increasing inflation until the public responds is not the right answer. One part 

of the right answer is to reach a long-term budget agreement that brings government spending below sustained GDP growth. That will be difficult but there is much 

waste in health care and other spending. I will expand a bit if you wish. The other 

part of the right answer is to rein in the unrestricted power of the Federal Reserve 

by imposing an inflation target. 

And finally, what might be the consequences of adopting stabilizing policies? Ten 

years from now, we will export more and import relatively less. We will grow family 

incomes at about our long-term trend. Consumption will grow more slowly than in 

recent years because we must export more and import less to service the nearly $ 

5 trillion of debt owed to foreigners. Foreigners will have to find a substitute for 

export-led growth because we can no longer be the importer of last resort. Of major 

importance for the future is the smaller role we will play in maintaining world 

peace. The United States cannot be the world’s policeman. But political stability is 

vital. That’s a big, separate set of issues that take us far afield. 

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48 

PREPARED STATEMENT OF DR. LAURENCE BALL

Chairman Casey, Vice Chairman Brady, and members of the Committee, 

I am grateful for the opportunity to discuss the challenges to the U.S. economy 

posed by the combination of rising government debt and high unemployment. I will 

also comment briefly on current Federal Reserve policy, which your committee is 

also considering. 

THE COSTS OF FISCAL CONSOLIDATION

Indisputably, Congress must address the problem of rising debt to prevent a fiscal 

crisis that could gravely damage the economy. How to solve this problem is a complex issue. We need policies that will keep debt on a sustainable path while providing essential government services and minimizing the economic distortions 

caused by taxation. I will not analyze all these issues or presume to say what fiscal 

policies Congress should adopt. Instead, I will focus on a more narrow question: 

What are the short- and medium-run impacts of fiscal consolidation—of cuts in government spending or tax increases—on economic growth and unemployment? Congress must understand these effects to choose the best response to rising government debt. 

Opinions about the effects of fiscal policy vary widely. Most economics textbooks 

teach that a fiscal consolidation slows the economy in the short run. Higher taxes 

or lower government spending reduce the demand for goods and services, reducing 

growth and increasing unemployment. Yet some economists and policymakers disagree with this view, suggesting that fiscal consolidations are expansionary. One 

view is that lower budget deficits strengthen confidence in the economy, leading to 

higher consumption spending and more investment by firms. 

Both sides of this debate present logical and plausible arguments. If we want to 

know who is right, we have to look at the evidence. Fortunately, history provides 

numerous examples of fiscal consolidations that we can study. And in my reading 

of the evidence, the verdict of history is clear: fiscal consolidations slow the economy, with adverse effects that last for five years or more. That is, if Congress cuts 

spending or raises taxes today, the consequences will include slower economic 

growth and higher unemployment than we would otherwise expect until at least 

2016. 

Numerous studies (admittedly, not all studies) support the conclusion that fiscal 

consolidations are contractionary. I will focus, however, on several studies performed over the past two years in the Research Department of the International 

Monetary Fund. In my view, this work provides the best available evidence on the 

effects of fiscal consolidation, because of the wealth of data that it examines and 

its straightforward and compelling methodology. In addition, the expertise of the 

IMF’s staff and its history of promoting responsible fiscal policy lend credibility to 

its analysis. (I should note that I am a part-time visiting scholar at the IMF, but 

not a lead researcher in its work on fiscal policy.) 

The basis of the IMF research is a painstaking review of history in 15 countries 

over the period from 1980 through 2009. Based on records of fiscal policy decisions, 

the researchers have identified a total of 173 years in which governments adopted 

policies to reduce budget deficits—either spending cuts, tax increases, or a combination of the two. 

Having identified fiscal consolidations, the IMF researchers measure the effects 

with very simple statistical techniques. They ask whether economic growth and unemployment were higher or lower after consolidations than one would expect based 

on their normal behavior. The central conclusions concern the average effects of consolidation across the 173 episodes. It is essential to average over many episodes to 

eliminate the influences of factors besides fiscal policy that may affect the economy 

in any one case. 

How does a fiscal consolidation affect growth and unemployment? The IMF research finds that a consolidation that reduces the budget deficit by one percent of 

GDP reduces future GDP by 0.6 percent after two years. The effect then diminishes, 

but GDP is still 0.4 percent lower after five years. The consolidation raises the unemployment rate by 0.4 percentage points after two years and 0.2 points after five 

years. 

The research also finds that the effects of fiscal consolidations vary with economic 

circumstances. In particular, the average effects I have just cited are likely to understate the contractionary effects of consolidation in today’s U.S. economy. In a typical episode in the IMF data set, a country’s central bank responds to fiscal consolidation by reducing short-term interest rates, and this monetary easing dampens the 

effects of the consolidation. In the United States today, the Federal Reserve cannot 

reduce interest rates because short-term rates are already near their lower bound 

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of zero. According to the IMF study, the effects of fiscal consolidation are about 

twice their normal sizes if interest rates are near the zero bound. This doubling 

means that a consolidation of one percent of GDP reduces GDP by 1.2 percent after 

two years and raises unemployment by 0.8 percentage points. 

What do these numbers mean? To understand them better, let’s focus on unemployment effects and consider one hypothetical fiscal consolidation. The Congressional Budget Office forecasts that the budget deficit will be about 3% of GDP in 

2014 and stay near that level through 2020. Suppose that Congress chooses to eliminate this 3% deficit: it cuts spending and/or raises taxes by a total of 3% of GDP, 

so the deficit settles near zero. What will happen to unemployment? 

As I have discussed, the IMF research suggests that a consolidation of one percent 

of GDP under current circumstances raises unemployment by 0.8 percentage points 

after two years. This implies that the 3% consolidation in our example would raise 

unemployment by 2.4 percentage points. With a U.S. labor force of 150 million people, an additional 3.6 million Americans and their families would suffer the consequences of a lost job. 

Let me mention another important finding of the IMF study. Recent debates 

about U.S. fiscal policy have focused on the choice between deficit reduction through 

cuts in government spending and through tax increases. This choice matters greatly 

to the beneficiaries of government spending and to taxpayers. In one way, however, 

the choice is not important. The IMF researchers perform separate analyses of 

spending cuts and tax increases and find that the adverse effects on economic 

growth and unemployment are similar (at least in the case when interest rates are 

near zero). 

Is there any way to control government debt without harming the economy in the 

short run? The IMF’s findings suggest a type of policy that could achieve this goal: 

a fiscal consolidation in which spending cuts and tax increases are backloaded in 

time. Under such a policy, the government commits to lower deficits in the future 

without sharply cutting the current deficit. An example is a cost-saving change in 

entitlement programs, such as an increase in the retirement age, that is phased in 

over time. Such a policy could put government debt on a sustainable path without 

raising unemployment sharply. By the time major spending cuts occur, we can hope 

the economy has recovered from its current slump and unemployment is lower. 

Spending cuts would be less painful at that point than they would be now. One reason is that interest rates would be above zero, allowing a monetary easing. 

WILL INFLATION RISE?

I have mentioned the fact that the Federal Reserve is holding short-term interest 

rates near zero—a highly unusual policy by historical standards. The Fed has also 

purchased large quantities of Treasury bonds and mortgage-backed securities, causing the monetary base to triple. Further asset purchases appear to be under consideration. Some economists and policymakers have expressed concern that these policies will cause inflation to rise to undesirable levels. Let me comment on this issue 

briefly, explaining why I believe that fears of inflation are unwarranted. 

At first blush, the Fed’s near-zero interest rate target and its expansion of the 

monetary base are highly expansionary policies. In normal times, such policies 

would indeed cause inflation to rise. But these are not normal times. 

We need to remember why expansionary monetary policy normally causes inflation. Inflation occurs when businesses around the country raise their prices. These 

businesses generally do not monitor the Fed’s balance sheet, and they do not base 

their pricing decisions on changes in the monetary base. Instead, monetary policy 

affects inflation indirectly, through its effects on aggregate spending. If policy is too 

expansionary, the economy overheats. Firms see their sales rise and their productive capacity is strained, and workers find that jobs are plentiful. Under these conditions, firms are likely to raise prices rapidly and workers push for large wage increases. 

Given this mechanism, inflation is a danger only if the economy is overheated— 

regardless of what the Fed is doing to its balance sheet. In today’s environment, 

with unemployment above 9% and likely to stay high for years, an overheated economy is the last thing we should worry about. Some day the economy will recover 

and the Fed will need to exit from its current expansionary policy. But today’s challenge is the terrible problem of 9% unemployment. Rather than scale back its policies, the Fed should redouble its efforts to stimulate the economy and push unemployment down. 

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