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85–408 2013

S. HRG. 113–121 

THE WAY FORWARD FROM GOVERNMENT 

SHUTDOWN AND DEBT-CEILING CONFRONTATION 

TOWARD LONG-TERM FISCAL SUSTAINABILITY 

AND ECONOMIC GROWTH 

HEARING 

BEFORE THE

JOINT ECONOMIC COMMITTEE 

CONGRESS OF THE UNITED STATES 

ONE HUNDRED THIRTEENTH CONGRESS 

FIRST SESSION 

OCTOBER 11, 2013 

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] 

HOUSE OF REPRESENTATIVES 

KEVIN BRADY, Texas, Chairman 

JOHN CAMPBELL, California 

SEAN P. DUFFY, Wisconsin 

JUSTIN AMASH, Michigan 

ERIK PAULSEN, Minnesota 

RICHARD L. HANNA, New York 

CAROLYN B. MALONEY, New York 

LORETTA SANCHEZ, California 

ELIJAH E. CUMMINGS, Maryland 

JOHN DELANEY, Maryland 

SENATE 

AMY KLOBUCHAR, Minnesota, Vice Chair 

ROBERT P. CASEY, JR., Pennsylvania 

MARK R. WARNER, Virginia 

BERNARD SANDERS, Vermont 

CHRISTOPHER MURPHY, Connecticut 

MARTIN HEINRICH, New Mexico 

DAN COATS, Indiana 

MIKE LEE, Utah 

ROGER F. WICKER, Mississippi 

PAT TOOMEY, Pennsylvania 

ROBERT P. O’QUINN, Executive Director 

NILES GODES, Democratic Staff Director 
(III) 

C O N T E N T S 

OPENING STATEMENTS OF MEMBERS

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

Hon. Amy Klobuchar, Vice Chair, a U.S. Senator from Minnesota ..................... 2 

WITNESSES

Dr. Kevin A. Hassett, John G. Searle Senior Fellow and Director of Economic 

Policy Studies, American Enterprise Institute, Washington, DC .................... 3 

Dr. Mark Zandi, Chief Economist, Moody’s Analytics, West Chester, PA .......... 5 

SUBMISSIONS FOR THE RECORD

Prepared statement of Hon. Kevin Brady ............................................................. 26 

Prepared statement of Hon. Amy Klobuchar ........................................................ 27 

Prepared statement of Dr. Kevin A. Hassett ........................................................ 29 

Prepared statement of Dr. Mark Zandi ................................................................. 35 

(1) 

THE WAY FORWARD FROM GOVERNMENT 

SHUTDOWN AND DEBT-CEILING CONFRONTATION TOWARD LONG-TERM FISCAL SUSTAINABILITY AND ECONOMIC GROWTH 

FRIDAY, OCTOBER 11, 2013 

UNITED STATES CONGRESS, 

JOINT ECONOMIC COMMITTEE, 

Washington, DC. 

The committee met, pursuant to call, at 10:03 a.m., in Room 

1100, Longworth House Office Building, Hon. Kevin Brady, Chairman, presiding. 

Representatives present: Brady of Texas, Campbell, Amash, 

Paulsen, Hanna, Carolyn B. Maloney, Sanchez, and Delaney. 

Senators present: Klobuchar, Casey, and Murphy. 

Staff present: Doug Branch, Gail Cohen, Christina Forsberg, 

Connie Foster, Niles Godes, Colleen Healy, J.D. Mateus, and Patrick Miller, Robert O’Quinn, and Sue Sweet. 

OPENING STATEMENT OF HON. KEVIN BRADY, CHAIRMAN, A 

U.S. REPRESENTATIVE FROM TEXAS 

Chairman Brady. Well, good morning, everyone. Welcome to 

the Joint Economic Committee hearing today, titled, ‘‘The Way Forward from Government Shutdown and Debt-Ceiling Confrontation 

Toward Long-Term Fiscal Sustainability and Economic Growth.’’ 

And I want to welcome our witnesses and Members to a real 

committee hearing room, by the way. 

Vice Chair Klobuchar. It is nice. 

Chairman Brady. Had to kind of plug that in. 

I have a prepared statement, but today I am just going to submit 

that for the record. It seems to me, at this point in time, we need 

a lot less political posturing and talking points and a lot more 

meaningful discussion about how we go forward, both parties, on 

some rules and 21st-century approaches that really tackle the size 

of the government that we want, that will serve our country, that 

is sustainable and actually helps grow our economy. 

Vice Chairman Klobuchar and I have tried to set a nuts-andbolts approach on JEC hearings, sort of open, thoughtful, constructive dialogue. And I can’t think of a more important time to be 

doing exactly that. 

So I will submit my remarks for the record, and I will turn to 

Vice Chair Klobuchar. 

[The prepared statement of Chairman Brady appears in the Submissions for the Record on page 26.] 
2 

OPENING STATEMENT OF HON. AMY KLOBUCHAR, VICE 

CHAIR, A U.S. SENATOR FROM MINNESOTA 

Vice Chair Klobuchar. Well, thank you, Mr. Chairman. And 

thank you for having this at this gorgeous room. I feel honored to 

be here. 

And thank you for our witnesses for coming somewhat at the last 

minute here for this important hearing on the way forward, as we 

hope that the shutdown will end soon. 

Like the chairman, I will submit my remarks for the record. And 

I am hopeful. There are some discussions going on yesterday, today 

that we hope will resolve this soon so that we can work on those 

very important things that both of you have come and testified 

about in the past, which is bringing our debt down in a balanced 

way and doing it in a way that doesn’t set us back, which I believe 

this shutdown and the potential default on our debt ceiling could 

do. 

So I appreciate that people are in discussions and that we may 

have some positive news down the road here. 

Thank you, Mr. Chairman. 

Chairman Brady. All right. Thank you. 

[The prepared statement of Vice Chair Klobuchar appears in the 

Submissions for the Record on page 27.] 

Chairman Brady. And Members may submit their remarks for 

the record. 

Let me introduce our guests today, who are well-known to this 

committee and to the economic world. 

Dr. Kevin Hassett is the John G. Searle senior fellow and director of economic policy studies at the American Enterprise Institute. 

He was a senior economist at the Board of Governors of the Federal Reserve System and a policy consultant of the Treasury Department during the George H.W. Bush and Clinton administrations. He has written several papers on fundamental tax reform 

and has coauthored a book with renowned economist Glenn Hubbard, entitled ‘‘Tax Policy and Investment.’’ He has a B.A. from 

Swarthmore College and a Ph.D. in economics from the University 

of Pennsylvania. 

Dr. Mark Zandi is the chief economist for Moody’s Analytics. He 

has analyzed the economic impact of various tax and government 

spending policies and assessed the appropriate monetary policy response to bubbles in asset markets. He is well-known in this Congress and in, again, the economic world. Dr. Zandi earned his B.S. 

from the Wharton School of the University of Pennsylvania and his 

master’s and Ph.D. at the University of Pennsylvania. 

I, on behalf of Vice Chairman Klobuchar, welcome you. I think 

the timing is exactly right for this discussion. Both of you bring to 

the table ideas on how we tackle the big issues. 

My fear has always been, in Washington, we step over dollars to 

get to dimes, when it comes to taking the real steps forward. Both 

of you are thinking more long-term to a day when we are not facing 

shutdowns and debt ceilings every other month. 

So, Dr. Hassett, with that, I will invite your testimony. Welcome. 
3 

STATEMENT OF DR. KEVIN A. HASSETT, JOHN G. SEARLE SENIOR FELLOW AND DIRECTOR OF ECONOMIC POLICY STUDIES, AMERICAN ENTERPRISE INSTITUTE, WASHINGTON, DC 

Dr. Hassett. Thank you very much, Chairman Brady and Vice 

Chair Klobuchar. 

The first part of my testimony, which I will summarize very 

briefly, looks into the impact of struggles like that that we are currently having on measures of policy uncertainty. And I discuss the 

academic literature that suggests that debt-limit showdowns and 

budget poker, like we are playing, historically has led to very high 

levels of policy uncertainty and that that has harmed the economy 

quite identifiably. And so I think that it is crucial that we think 

of a better way to do it, and perhaps now is a good time to have 

that conversation. 

My next observation in my testimony is that most developed 

countries around the world have significantly more advanced budgetary rules than we do in the U.S., often encoding specific targets 

that constrain the action of policymakers. And I know you are all 

really busy, but if you have time to look at anything in my testimony, the chart that says ‘‘Percentage of OECD Countries with 

Fiscal Rules’’ is something that I would actually commend to your 

attention. 

The IMF recently compiled a database of 87 countries and then 

compiled the fiscal rules that they use in each country. And it is 

actually a pretty astonishing chart, if you see that almost 90 percent of countries have either a budget-balance rule, which constrains their deficit as a share of GDP—have a budget-balance 

rule; a debt rule, where aggregate debt as a share of GDP is capped 

at some number. That is about 70 percent of the countries. And, 

increasingly, countries are relying on expenditure rules, as well, 

and even revenue rules, where they cap these at some point. 

To fast-forward to the conclusion of my testimony before I go into 

the details a little bit more, my recommendation to Congress would 

be to look seriously at the practices of other countries—there is a 

lot of experience, a lot of, you know, legal language in how to do 

this—and consider adopting a firm budget rule that could even be 

a cap as a way out of future messes like the one that we are in. 

So if we had a cap of spending to GDP—and I will talk about the 

nuances of how to do that in a bit—then, if we are below the cap, 

the continuing resolution and the debt limit could automatically increase. We could agree to do that when we adopt the cap. Of 

course, negotiating the cap would be a challenge, but it is a challenge that I think that we should try to step up to. 

The evidence from Europe shows that, in many cases, limits to 

budget deficits are probably ineffective. And I think that economists have studied this, and they have found that the problem is 

that it is easy to tinker with projections to appear to come into balance. 

Imagine if we said, well, our budget rule is going to be that the 

10-year number needs to be this or that. Well, we can’t have a deficit bigger than X, you know, 10 years from now, of GDP, that that 

would be easy to game and highly dependent on assumptions. It 

creates a situation where one side will favor lower taxes and also 

be focused on deficits. One side favors lower taxes and lower spend-
4 

ing, for example, while the other side might favor higher taxes and 

higher spending. And each can point to their plan as meeting the 

deficit ceiling, when, in fact, I think the argument is ultimately 

going to be about the size of government. Because of that, my testimony suggests that what we ought to do is consider a rule that 

caps the size of government at some number that we all agree to. 

In order to help stimulate the thinking and debate about what 

that cap might look like, I have another chart that compares noninterest spending, which—a proposal of Mr. Brady’s from a few 

years ago helped convince me that you shouldn’t include interest 

spending if you are going to have a budget cap, because you don’t 

really control the interest rate, certainly, at the long end—and it 

compares it to potential GDP, which is something that would kind 

of smooth out the cyclical ups and downs of such a cap. 

We wouldn’t want to be in a situation where spending went up 

a little bit because of built-in stabilizers and GDP went down a little bit because we are in a recession, and then, all of a sudden, our 

spending-to-GDP goes above the cap and we are doing something 

harsh like sequestration. 

In order to think about what a rule might look like and to form 

your own opinion, I have another chart that shows U.S. noninterest 

spending as a percent of potential GDP, which, again, I think is a 

good measure to pin this to because it wouldn’t have the problem 

of fluctuating with the economy. That was about 16 percent in 

2001, climbed to a little above 22 percent in 2009, and is projected 

to go back down to about 181⁄2 percent by the end of the budget 

window. 

I think that if you took a number in there and agreed to set that 

as the limit of spending to GDP, potential GDP, and then agreed 

that if we were below the limit then we automatically increase the 

debt limit and automatically had a continuing resolution, then we 

would accomplish two goals: We would have a constructive debate 

about the size of government, about the thing that really is in dispute, and we would exit the world that is described in my first 

chart, which shows how much policy uncertainty has been skyrocketing at times when we have debates like this. 

I think that, to conclude, countries around the world have increasingly relied upon budget rules to help constrain the growth of 

government but also to make government fiscal policy more transparent. People know, sort of, how bad it can possibly be. Although 

these rules have been ineffective, it seems like the data suggests 

that increasingly countries are relying on spending rules because 

that is the direct target that is really in the end the thing that you 

have to constrain if you are worried about the deficit. 

Thank you very much for your attention. 

[The prepared statement of Dr. Kevin A. Hassett appears in the 

Submissions for the Record on page 29.] 

Chairman Brady. Great. Thank you, Dr. Hassett. 

Chairman Brady. Dr. Zandi, welcome. 
5 

STATEMENT OF MARK ZANDI, CHIEF ECONOMIST, MOODY’S 

ANALYTICS, WEST CHESTER, PA 

Dr. Zandi. Thank you, Chairman Brady, Vice Chair Klobuchar, 

and the rest of the committee. I am an employee of the Moody’s 

Corporation, but the opinions I express today are my own. 

I will make three points in my remarks. 

The first point is that the government shutdown and the brinkmanship over the debt limit are doing significant damage to the 

economy. Even if, let’s say, the government reopened on Monday 

and the debt limit were increased, I think the damage done so far 

would shave about a half a percentage point from GDP growth in 

the fourth quarter. So that is, before all of this, I expected growth 

this quarter of about 21⁄2 percent, and now I expect growth of closer 

to 2—still growth, but meaningfully lower. 

If the shutdown continues through the end of the month, even 

with an increase in the debt limit, let’s say, to November 22nd, I 

think that would result in a hit to GDP in the fourth quarter of 

about 11⁄2 percentage points, 11⁄2 percentage points. So it will still 

grow, but it will be a significant hit to growth. 

If the shutdown continues through to Thanksgiving, and, again, 

even assuming that the debt limit is increased to November 22nd, 

I think the economy will stall out, that we will basically go nowhere in Q4. And, obviously, at that point, the risks that we fall 

back into recession will begin to increase. 

Now, that is bad; not raising the debt limit is significantly worse. 

If we breach the debt limit and the Treasury misses a payment to 

somebody, a Social Security recipient or a bondholder, that would 

be the prescription for a very dark, deep recession. 

And I don’t really think it matters whether the Treasury 

prioritizes interest payments or not. Even if they do, and they decide to not pay their other bills, I think investors would take that 

as a signal that we have big problems, and at the very least they 

would stop buying bonds. And just as a note, there is about $100 

billion a week in Treasury bonds that roll over that need to be purchased. And I think they will start selling. 

So interest rates will spike, stock prices will fall, confidence— 

consumer business confidence, which is already weakening, will 

evaporate, and we will be in a deep recession. And there is no policy response to that. You know, I can’t see what the Federal Reserve would do in that kind of situation. And, by definition, Congress and the administration would be doing nothing. 

So point number one is what we are doing now is doing damage. 

And this is going to mount day by day. 

Point number two: Stopgap, temporary measures to extend the 

debt limit, reopen the government for a brief period, are better 

than not doing that, but that also does damage to the economy. 

Kevin mentioned political uncertainty, policy uncertainty, and I 

think that is a very significant constraint on economic growth, and 

it has been over the past 5 years. I have done a little bit of my own 

work in this area, and based on my assessment, if we hadn’t seen 

this increase in uncertainty, political uncertainty, over the past 5 

years, GDP would be roughly $150 billion greater than it is today, 

we would have over 1.1 million more jobs, and the unemployment 

rate would be seven-tenths of a percentage point lower. Now, other 
6 

folks are doing this work, as well, and they are finding similar 

kinds of estimates, even more significant impacts from this kind of 

political brinkmanship. 

So I think it is very important that policymakers figure out a 

way to get off the front pages. And I think if you do, we are off 

and running, that the private—a lot of good things going on in the 

private sector, and those good things will shine through if lawmakers can find a way to get rid of this brinkmanship for an extended period. 

Finally, point number three: I think it is entirely appropriate and 

reasonable for lawmakers, obviously, to address our long-term fiscal challenges. We have many. And I think it will require both entitlement reform and tax reform. 

I would make two recommendations in the current context. The 

first is, I think corporate tax reform is a good place to start. There 

is a fair amount of common ground here. And I think revenue-neutral corporate tax reform would go a long way to improving competitiveness and long-term economic growth. 

And I also would recommend that, once we have gotten through 

the current debate, extend the debt limit, reopen the government, 

that we should examine, as Dr. Hassett has said, implementing 

new budget rules. I am not entirely on board with the rule he has 

proposed, but I am entirely sympathetic with the intent of what he 

is trying to do. 

And I think that is an appropriate place for Congress to look, because we need to figure out a way. If we can’t repeal the debt-limit 

law, which is very anachronistic and counterproductive, we have to 

figure out a way to make this less of an issue going forward. 

Thank you. 

[The prepared statement of Dr. Mark Zandi appears in the Submissions for the Record on page 35.] 

Chairman Brady. Thank you, Doctor. 

Let’s begin with common ground. 

One, America is not going to default. We are going to raise its 

debt limit on time. The question is, can we come together to find 

a way to deal with government finances that are out of whack 

today, become more exacerbated over time, and just financially are 

unsustainable and also weigh, I think, on investors’ view of the 

country today. 

Secondly, I think we can agree, sequester was not built to last, 

for a number of reasons. And it also ignores, you know, a large 

swath of the government spending, as well. And I think there is 

agreement there has to be a better way, there has to be a better 

way than what we are doing today. 

So, looking at the rules that doctor—one, I was amazed at the 

chart, to see the number of countries that have some of those different type of rules in place. 

For us, as we look at issues, from balanced budget, which, clearly, you know, a number of us support, to spending rules—sequester 

would be an example of it—looking at debt to GDP, Dr. Hassett, 

your point is that the best measurement of government or the one 

we should focus on is the size of the government relative to the size 

of the economy. Can you tell us why? 
7 

Dr. Hassett. Sure. It is actually—there are many reasons. It 

goes back to work that I did more than a decade ago, when I started to look at political opinions about the deficit and found that it 

is very often the party in opposition that cares the most about the 

deficit and becomes the deficit-hawk party because it is—you know, 

maybe it is hard to say ‘‘I don’t want that tax cut’’ or ‘‘I don’t want 

that program to help children’’ or whatever it is that one party 

might be proposing, but it is easy to say, ‘‘Oh, the deficit is going 

to be really terrible.’’ 

And so I think that, really, in the end, my conclusion after studying a lot of American political history is that both parties, in equilibrium, have the same attitude toward the deficit, which is that 

they don’t like reducing it, that if you give people a free lunch, then 

they are happier voters, and that they don’t want it to be so big 

that it becomes a real problem, and that there is a space between, 

say, 2 percent of GDP and 6 percent of GDP where we have kind 

of wandered. 

And so I think that what parties disagree about is the size and 

the scope of government, and that if we are having a debate about 

something other than that, then we are not actually debating the 

true issue, is my view. That is the first reason why. 

The second thing is that I think that if we spend money, then 

we have to pay for it. And if you pay for it by paying all of it today 

or by borrowing from somebody and then paying, you know, 5 cents 

a year forever, that in present value it is the same. And so I think 

that, in the end, it is the spending that is the material thing that 

we need to address. 

And I would encourage Congress to think of this problem not as 

setting a goal for spending, which is a very controversial thing, but 

setting a cap, setting a cap. So, look, if spending gets above this 

percent of GDP, then we have to go back to the old world where 

we have to increase the debt limit and have showdowns like this, 

a world that we don’t like to be in. If we are below that cap, then 

we function normally as a government. 

And I think that if you could get to that debate, then you could 

start something that could be very positive in the long run and 

might, you know, if we continue to avoid our problems on entitlements, then we might start to run into that cap and then really 

have to have an entitlement reform down the road. 

And so I think the very first order of business should be to say, 

let’s get out of this world where we have to every year push these 

things forward, like the continuing resolutions and the debt limits, 

and let’s just agree that we will continue along the lines of your 

MAP bill if we are below the cap. 

And so I think that the argument for that is pretty sound and 

convincing to me but maybe not to Mr. Zandi. 

Chairman Brady. Well, thank you, Doctor. 

Dr. Zandi, as we look at the size of government, the debt, the 

spending rules, all that we have just discussed, should we be looking at the bigger picture, not just discretionary but entitlement 

spending as well? Is looking at that as a share of the economy the 

right goal? 

We may disagree on what the size of that government is; you 

have to fill in those blanks in both parties. But is that a measure-
8 

ment, is that a goal that would direct Congress toward looking at 

the right areas, how you grow the economy and how you deal with 

all of spending, not just a portion of it? Or is there a better way? 

Dr. Zandi. Right. Well, as I said, I am very sympathetic to the 

idea that we should have budget rules, more comprehensive budget 

rules, that consider, as you said, all of government spending and 

also tax revenue and other revenue. I think that is important, particularly if we can use these new budget rules as a way to reduce 

the brinkmanship we have around the current process, the debt 

limit being the most notable example. 

This is obviously becoming very counterproductive, so we need to 

figure a way to mitigate the threat posed by the debt limit. And 

I think the budget rules—using budget rules to do that is a logical 

approach and could reap some benefit in terms of better fiscal outcomes in the longer run. So I am very sympathetic with that idea. 

I am less sympathetic to the idea that we should have only 

spending caps. And I will give you a couple, three reasons for that, 

and then I will give you a suggestion as to how I would approach 

it. 

One is that it doesn’t account for—or it may, but it is difficult 

to see how it would account for changing demographics that are 

going to be quite significant. I will just give you a number. Today, 

13 percent of the population is over the age of 65. And if you are 

over the age of 65, you require a higher level of services than people that are of other ages. Over the next 25 years, that is going to 

rise to 21 to 22 percent of the population, according to the Bureau 

of Census. So that demographic fact is very important and significant and would affect how you would think about the size of government in terms of spending as a share of GDP. So that is something that needs to be considered in this context. 

The other thing I worry about is the economy goes up and down 

and all around, as we know. We need to have some flexibility both 

in terms of the automatic stabilizers in the budget and discretionary response to recessions. There is a lot of debate about discretionary fiscal stimulus, and I understand that. It is a legitimate, 

very appropriate debate. But I do think that it is important that 

we maintain flexibility. And, a spending rule with those kinds of 

caps, unless somehow it can be adjusted to account for this fact, 

would make me nervous, and uncomfortable. 

Chairman Brady. Well, I think Dr. Hassett’s point about using 

potential GDP rather than GDP smooths those out, so you don’t 

have government spending, you know, great in the boon times and 

then, you know, unsustainable cuts in the rough times when you 

actually need some of that spending to occur. 

I think your point was, look, let’s sort of put the guardrails, you 

know, in there that provide that. 

Dr. Hassett. Or—and I think that Mr. Zandi, Dr. Zandi, would 

probably agree with this. If you look at countries that save for the 

rainy day—Sweden is an example—that, you know, their view is 

that maybe you want to have a stimulus if a recession strikes, and 

that is why you need to be, say, below the cap before. 

And that is why I said that what we ought to do is start by having a cap, not a target, because then we have to stay below the cap 

enough so that if a recession hits then we can do something. 
9 

And the demographic point I could respond to, as well. It is just 

that that would affect your target, that as you think about—so, for 

example, some people say spending shouldn’t be a higher percentage of GDP than it has been historically. But that is kind of unreasonable if you look at the aging of the population. 

Chairman Brady. Yeah. 

Dr. Hassett. You know, it is driving the increase in spending. 

Chairman Brady. As I turn it over to the vice chair, I noticed 

in the 20 years from 1981 to 2000, the size of the government went 

from 22 percent of GDP to 18 percent. Population was still growing, 

entitlements were still continuing to expand. But during that period, as we lowered the size of government relative to the economy, 

you know, jobs along Main Street exploded—37 million jobs, about 

a 50 percent increase. 

Clearly, we do have some demographic factors there, but there 

is a role there where we, I think, could have a good discussion 

about what size we want this government to be and then have 

those rules, the guardrails, to sort of keep us within that. 

Dr. Zandi. And I think this is a great discussion. We are down 

into the weeds and the mechanics of it. I mean, I think that is appropriate. 

And I do agree with you that using potential GDP mitigates 

some of my concern about the cyclicality. But if you do a little bit 

of a calculation, it would have significantly constrained our ability 

to respond to the great recession. And that is the kind of thing that 

I worry about. 

And I won’t go on, but I will just say, in the same spirit, I think 

there are other approaches that I would take, or at least we could 

explore, that I think might mitigate some of these concerns and 

still address the issues that you have. 

Chairman Brady. All right. Thank you. 

Vice Chair Klobuchar. 

Vice Chair Klobuchar. Thank you very much, Mr. Chairman. 

Thank you. I feel like we are back again, ‘‘Groundhog Day.’’ We 

just had the hearing on brinksmanship, and I appreciated your testimony there. And at the time, we issued a report on our side about 

the cost of brinksmanship, and now we did a new one on the cost 

of shutdown. 

And I thought I would start, as we look at—the title of the hearing is ‘‘The Way Forward From Government Shutdown and DebtCeiling Confrontation.’’ And I guess our first order of business, 

then, is to get out of it, because we are still right now in a government shutdown. 

And I thought I would focus a little bit on that, Dr. Zandi. You 

talked about how we lost half a percent from GDP growth already, 

just from this 9, 10 days of a shutdown. And I think sometimes we 

have had some proposals to piecemeal-fund the government, to 

fund certain agencies. 

And I just want to make clear for the record that what I have 

been hearing from a lot of my businesses actually isn’t even the 

agencies that are suggested to be funded, which I have heard from 

citizens about. These are things like mining companies that have 

to get some simple permits approved, and that is by the EPA. And 

that is an example. 
10 

I have had a major manufacturer of planes come to me from our 

State. They can’t get their planes approved for export because it 

has to go through a registry within the Commerce Department that 

is clearly shut down. And despite the good, good work of the Secretary, we can’t change that right now, and it is millions and millions of dollars of inventory. 

And so I wondered if you could expand a little on why this is that 

we are seeing this decrease with the shutdown. And then, also, 

your second point, which was about how, because of the brinkmanship on both the debt ceiling and the shutdown, that we have already lost a million jobs that we could have had in this country. 

Dr. Zandi. Right. Well, the shutdown is increasingly disruptive 

with each passing day. The initial impact, rather modest, except for 

the poor folks that have been furloughed and aren’t getting paid. 

But as the days pass, the examples that you provided and others 

are becoming quite significant. 

Let me just mention a couple of other ones that are important. 

The mortgage market is being disrupted. If you want to close a 

mortgage loan, you need to get IRS tax records, you need to get a 

Social Security number. Those agencies are not open. Now, Fannie 

Mae and Freddie Mac are working hard to try to get around this 

problem, but it is a problem. And it is slowing down mortgage 

originations, the ability of potential buyers to get a loan. And, of 

course, that is key to housing and the housing recovery. And, as 

we know, that is vital to the economic recovery. 

Small Business Administration—an increasing number of examples of small businesses that are unable to close loans. And, you 

know, for a day or two or a week or two, that may not be an issue, 

but now if it drags on into the second half of the month, then people can’t open restaurants, they can’t expand their operations. 

These are things that are going to really matter. 

And you mentioned trade. A very good example, a lot of exports 

and imports need permits. And if you can’t get a permit, you can’t 

trade. And if we can’t trade, that is going to do increasingly a significant amount of damage to the economy. 

And just from my own parochial perspective as an economist, because I know folks that are sitting behind you worry about economic data, this is going to become a real problem pretty quickly, 

because it is this week that we collect the data to count the number of jobs in the month of October. And if we don’t collect the data, 

then we won’t even know what kind of damage we are doing to the 

economy very well. 

So this is becoming a very significant issue, and we can’t let this 

drag on. 

Vice Chair Klobuchar. Right. 

And then the second point you made in your testimony was 

about how, over time, the brinkmanship on either of these issues, 

keeping the government open or the debt ceiling, has resulted in 

lost jobs. Simply, is that because businesses are just sort of holding 

back because they don’t know what we are going to do next? 

Dr. Zandi. Yeah, exactly. You know, we have been put through 

an awful lot here. The last 5 years have been quite harrowing, and 

so people are really on edge. And so it doesn’t take a lot to spook 

people in this current environment. 
11 

And, of course, what is going on in Washington is a big deal for 

a lot of people. It is very scary to people when we are starting to 

talk about—even if we are not going to default on the debt, just 

talking about that makes people incredibly nervous. 

Now, it is not like people in businesses pull back in that environment, but what they do is stop doing what they normally do. And 

that mere fact alone causes the economy to start to seize up. 

Vice Chair Klobuchar. So one of your main points here is, as 

we move forward, that we can’t keep doing this, basically. 

Dr. Zandi. We just—— 

Vice Chair Klobuchar. And so—yes, go ahead. 

Dr. Zandi. Well, I just wanted to say, in my view, we have come 

a long way. The private sector is in really unbelievably good shape. 

Nonfinancial American businesses have restructured to reduce 

their cost structures; they are highly competitive. The only thing 

that is missing to a much stronger economic recovery is to get rid 

of this brinkmanship. 

Vice Chair Klobuchar. And would the caps that we were talking about earlier, that both you and Dr. Hassett talked about, 

would they solve the problem, the fact that we have been blocked 

from going to a conference committee on the budget on the Senate 

side? We have a budget, the House has a budget. 

Dr. Zandi. No, this is looking forward. You know, once we get 

beyond this, then we have to think about how we can’t get back 

into this morass a year or two down the road. And these are the 

kinds of things I think you should be thinking about. But for the 

current point in time, we’ve got to get out of the mess. 

Vice Chair Klobuchar. Yes. 

And I want to hear—my last questions will just be your ideas, 

along the lines of what Dr. Hassett said, for these rules. But one 

of my points will be that we can put as many rules as we want in 

place, but if we don’t approach things with the spirit of compromise, it is going to be very hard to do that kind of long-term 

debt reduction that—you and I have talked about this before—we 

believe we need to do based on the debt commission, a mixture of 

reform that the chairman mentioned and also looking at some of 

these spending cuts and trying to replace sequestration with something that makes more sense in terms of spending cuts. 

Dr. Zandi. Precisely. 

Vice Chair Klobuchar. Okay. 

Could you just quickly at the end here talk about what—you 

were tailing off here because your time was up—some of the rules 

you thought would work? 

Dr. Zandi. Sure. And this has to be thought through very, very 

carefully because there are a lot of moving parts. But, conceptually, 

I would be focused on as my threshold—Dr. Hassett has been focused on spending as a ratio to potential GDP. I think we should 

be focused on the structural budget deficit as a percent of GDP. If 

we do that, then we address some of the concerns I brought up in 

the context of the spending-to-potential GDP ratio. 

Vice Chair Klobuchar. So you would use that as your measure? 

Dr. Zandi. Yeah, I think that would be my preference. 
12 

Vice Chair Klobuchar. And are there other countries that do 

that? 

Dr. Zandi. Yes. This has been increasingly used in European 

countries to address their fiscal issues. And since the crisis, they 

have been using that as a benchmark, and it has helped them to 

address their fiscal problems. So it has become more commonplace 

in countries that have significant fiscal problems. 

And, you know, it is not a panacea. I mean, ultimately, at the 

end of the day, lawmakers have to execute on any threshold or 

rule. But I think that addresses a lot of the concerns I have about 

the spending-GDP ratio that Dr. Hassett mentioned. 

Vice Chair Klobuchar. Dr. Hassett, do you want to respond to 

that idea? 

Dr. Hassett. Oh, sure. Dr. Zandi is right that most European 

countries have a target of 3 percent deficit or they have to be below 

a cap, and 60 percent debt-to-GDP. And the issue that motivated 

me to move toward spending is the realization that those caps 

haven’t been very effective. 

And I think that if we look at the data, they are increasingly 

adopting hard spending caps. And I think it is in part because the 

deficit projections—because we are doing structural deficits and so 

on that have been kind of vague and easy to waive. 

And I agree that if we just have a rule and we agree to ignore 

it, then it won’t accomplish anything. 

Vice Chair Klobuchar. Uh-huh. 

Dr. Hassett. If we want to get out of the world—I think, by the 

way, that Dr. Zandi is understating the economic damage from the 

uncertainty. I think Steve Davis’ work, which is very similar but, 

you know, I mean, it has a slightly different approach, is about 

twice as much, his estimates. 

Dr. Zandi. Yeah. Yeah. 

Dr. Hassett. And so we have to think about, well, what can we 

do in the spirit of compromise to make sure that we get out of this 

world where that first chart with all those spikes that cause economic damage is no longer the chart that we are looking at, or that 

it looks like a bad EKG after—— 

Vice Chair Klobuchar. Right. 

And, Dr. Zandi, your concern about short-term after short-term 

is you just keep creating that uncertainty if we keep doing shortterm deals. 

Dr. Zandi. Yeah. I mean, I think people have been on sort of a, 

every sixth month we kind of go down this path. And, you know, 

if we keep doing that, I don’t think we are going to get out of the 

box we are in, in terms of economic growth. 

We are stuck in a 2-percent-growth world. And the only reason 

we are not growing 3 or 4 percent, in my view—there are other reasons, but the key reason is literally what is going on in Washington 

around these issues. 

Vice Chair Klobuchar. Thank you very much. 

Chairman Brady. Thank you. 

Let’s focus, because this committee is a little different than others, about the way forward and how we find some common ground 

on the bigger issues facing us. 

Dr.—Mr. Campbell. 
13 

Representative Campbell. You promoted me to a doctor. 

Thank you very much, Mr. Chairman, but I don’t belong down 

there. 

You know, as you have suggested, we have had a little trouble 

getting along up here on the dais and with the White House, as 

well. So in the next 4 minutes, I just want to see if we can get you 

guys to get along or to agree. 

Following up on Senator Klobuchar’s things about talking with 

Dr. Hassett’s spending cap and now Dr. Zandi’s budget deficit or 

ratio to GDP—and, Dr. Hassett, you mentioned, just did in response to Dr. Zandi’s proposal, that hasn’t worked very well. 

Let me ask you both, any of these sorts of caps—I come from 

California, a State which has a balanced-budget constitutional 

amendment. Hasn’t had a balanced budget in the last 14 years in 

spite of a balanced-budget constitutional amendment. I am also a 

CPA, so I observed all of the different things that are done in order 

to create a balanced budget when it is, in some cases, $20 billion, 

$30 billion, which is 20, 30 percent, out of balance. 

How do you deal with that in either of these scenarios with any 

kind of cap, be it debt or deficit or be it spending? 

Dr. Zandi. Either of us? 

Go ahead, Kevin. 

Representative Campbell. Either, yeah. 

Dr. Hassett. Okay. I think that, first, Dr. Zandi and I have disagreed about a lot of stuff, but if he is here saying this current circumstance is causing economic harm and then I am saying it is 

probably twice as big as he says—and I think his team is more in 

favor of the economic-harm point right now—or the Democratic 

team, not necessarily your team—but if that is—we have to accept 

that we need to get out of that world. 

And I think that, you know, maybe one reason we are in that 

world is that people have recognized, some have recently written 

about this, that it seems like the minority party very often feels 

like the debt limit is one of the only times they have a chance to 

influence legislation. And it has been pretty common for that to 

happen. We need to get out of that world. 

And so, then, you know, if we adopt a rule, we adopt the rule 

because it is the cost or the price that we pay to get out of that 

world. And then, when we do that, we should all acknowledge that, 

well, if we don’t obey the rule, then we are going to have to go back 

into that world that is so damaging. And it ought to be that everybody should agree that we don’t want to do that. And I think that, 

absent that kind of almost economic patriotism, then of course the 

rule won’t work. 

But I think the rules need to be adopted so that we get out of 

this world where—you know, I mean, Steve Davis’ estimates were 

really astonishing, that GDP is probably about 3.2 percent lower 

and there are 2.3 million fewer jobs today because we have been 

playing these brinksmanship games. 

Representative Campbell. Okay. So are you—— 

Dr. Hassett. And so we have to adopt a rule so that those 2.3 

million people would have a job. 

Representative Campbell. Are you okay, then, or not okay 

with the rule that Dr. Zandi suggested relative to debt and—— 
14 

Dr. Hassett. Sure. You know what? I would rather have a 

spending rule, but I think that if, you know, one side is really adamant it is a deficit rule, then you could accomplish the same thing. 

You could accomplish the same thing, you know, because it is very 

hard to increase taxes as a share of GDP. 

I think a spending rule is more targeted, is more precise, it is 

a better rule, but I would take virtually any rule over the circumstance that we have today. 

Representative Campbell. Dr. Zandi. 

Dr. Zandi. Yeah, let me just say a few things quickly. 

One is that, to your point, no rule solves our problems, right? At 

the end of the day, it takes political will to come together. So a rule 

is helpful, but it is not a solution. 

The second point is the current rule we have de facto is the debt 

limit, and that is a counterproductive rule given what we are seeing happening on a regular basis. It is not, as Chairman Bernanke 

has said, the way to run a railroad. So we have to get rid of that 

or at least neuter that as the way we are operating, because it is 

doing significant damage to us. And it seems to me that if we don’t 

change that, it will continue to do so. And either party will do it 

to each other. 

Representative Campbell. Let me just, in the last 30 seconds, 

do you agree with that point, Dr. Hassett? 

Dr. Hassett. Yeah. 

Representative Campbell. You do. Okay. Thank you. 

Dr. Zandi. And then I think this next question, well, what do 

we replace it with, how do we make this better, that is a very good 

debate. And Kevin and I and others should fully engage on this 

and exactly how we would do that, because we each have our concerns about how to do it. 

But, in my view, the structural deficit to potential GDP fundamentally is important in this way. And this may be where we 

disagree a little bit. In my view, our long-term fiscal issues are 

both a spending problem and a revenue problem. It is a revenue 

problem because of the demographic reason I just gave you. Right? 

Just the simple aging of the population. You don’t want to say that 

we don’t need more revenue to pay for the services to people just 

because they went over the age of 65 and require more government 

services just by definition. 

So, in my view, it is a spending issue. I am on board with that. 

The cost of medical care is the key spending issue. But it is also 

a revenue issue because of the demographics. And we need a budget rule that is sensitive to both of those. 

Representative Campbell. Right. 

Chairman Brady. Thank you. The time has expired. 

Representative Sanchez. 

Representative Sanchez. Thank you, Mr. Chairman. 

Thank you, gentlemen, for being before us. 

You know, I represent a big manufacturing area, actually, out in 

Orange County, California. It is tied a lot to NASA and commercial 

air and defense industry. And I have a set of brothers, a pair of 

brothers, who went bankrupt in this recession, having a leasing 

company, because capital dried up. And now they are back at it, 

starting from nothing. And they have been at it for about 6 
15 

months, and they told me the other day that capital had finally 

started to flow, that banks are getting back into putting money out. 

It is a little bit more difficult for the very same triple A people 

they had before borrowing, in some cases for services like the trash 

cans that get picked up at our homes, but in a lot of cases big manufacturing equipment as with machine shops and things that are 

in my district. They are also, my brothers, located in my district. 

And so things had begun to loosen up a little bit. Triple A type 

of credit companies who had not been able to get anything in the 

last 3 or 4 years and had gone away were coming back and being 

able to make deals. They also work with SBA to get—you know, 

because it is about money for these companies so that they can expand and they can hire. 

And all of a sudden, in the last 2 weeks, everything shut down, 

everything shut down with respect to capital, because banks are 

afraid to loan, because people are afraid to sign on the line, because—— 

Dr. Zandi. What do they lease? 

Representative Sanchez. They lease equipment. 

Dr. Zandi. Equipment, okay. 

Representative Sanchez. They lease equipment. So it can be 

anywhere from, like I said, trash cans—— 

Dr. Zandi. Yeah. 

Representative Sanchez [continuing]. For the trash cans that 

sit on my driveway once a week, to big capital machinery. 

Dr. Zandi. Where in California? 

Representative Sanchez. Orange County, California, a very 

big manufacturing area for the aerospace and other industries. 

So all of a sudden, the brakes are on. And, actually, people are 

losing money, and some of them, as you know, are losing their 

homes, even if they have equity in them, because when you are a 

small business, you are putting everything you have on the line. 

And so I guess my question is, we keep seeing this every time 

that we play these games in Washington, DC. So if you had to pick 

one thing that maybe we do have a rule and hold constant to, 

would that be something like the debt limit? Would that be spending? Would that be caps? Would that be an aggregate amount on 

entitlement as a percentage of GDP? 

Is there any one thing that we should really consider to hold constant so that we stop doing what I see right now happening in my 

area? 

Dr. Hassett. Thank you for the question. 

And I think there is. I think that if we agreed 5 years ago that 

this is the range that we think is, you know, open to debate about 

what spending-to-potential GDP should be, and if we are outside 

of that range, then we will go back to the old world where we have 

these debt-limit struggles, but if we are inside of the range, then 

the debt limit automatically increases and there is none of this uncertainty and the government can’t be shut down, that if we had 

done that 5 years ago, then about 2.3 million more Americans 

would be working today. That is the estimate. And Mark says 

about half of that, I think. 

Representative Sanchez. And my—— 
16 

Dr. Hassett. And so that we need to adopt a rule like that. And 

if it is a deficit rule or a spending rule, that is something we will 

have to flesh out. But I think either rule that made it so that we 

accomplished our budgetary objectives but did so in a way that 

moved away from the brinksmanship could have significant benefits. 

And I really appreciate the fact that you put a human face, really, on the negative economic consequences. 

Representative Sanchez. Yeah. And my fear is that if we put 

a rule, like we did sequester—which we are now all under and we 

know is kind of backfiring on us. I think most economists have 

agreed that it is probably about 1.8 percent of less growth happening because we are under sequester. And yet, at the same time, 

we are cutting down that, but we are doing it in very inefficient 

ways. And, again, I see it getting right back into, for example, defense manufacturing in my district. 

So how do we—Dr. Zandi, do you agree that it should be that 

spending issue? Or do you think something is even more important 

than that for us to try to rally around to stop this every-2-weeks 

thing going on? 

Dr. Zandi. Right. Well, you know, this is the first time I have 

heard that credit has stopped flowing. That is an interesting anecdote. I would like to explore that a little bit more because I hadn’t 

heard that. So if that is the case and that is widespread across the 

country, that is a problem. So, interesting to hear that—sorry to 

hear that, but interesting to hear it. 

I think that, principle number one, to get to your issue about 

every couple of weeks, every few months, I think we really need to, 

again, rethink the debt limit. It is a very bad law. And it would 

be nice if we could repeal it and, if we could repeal it, replace it 

with something. 

And, in my view—and I am open, really I am, I am open to discussing and thinking about this more deeply with everybody. But 

at this point, my intuition is that you would want to do something 

like a cap related to the structural deficit to potential GDP. 

Structural deficit means abstracting from the impact of the ups 

and downs in the economy on the budget, right? And potential GDP 

means what can the economy produce in a normal state. 

If you do that, I think that is kind of a reasonable approach to 

addressing both our long-term spending issues and our long-term 

revenue issues, and it is a balance. 

But, again, at the end of the day, no rule will solve our issues 

unless we have the will to do it, to execute on it. 

Representative Sanchez. Thank you, Doctor. 

I am sorry, I have to—— 

Chairman Brady. No, no. All time has expired. 

We have votes called, but there are only two. Should not be long. 

So I will recognize Senator Murphy, and then we will recess briefly 

after that and hopefully be right back at it. 

Senator Murphy. Thank you, Chairman Brady. 

Thank you to both of our panelists for being here today. 

There was obviously a ripple of optimism in the markets yesterday that we were on the verge of getting at least a partial deal. 
17 

We will see by the end of the day as to whether that optimism was 

merited. 

But what we also heard yesterday was that JPMorgan is pulling 

their investments in Treasuries out of their mutual funds that mature between October 16th and November 6th. And that is mirrored by a decision that Fidelity made, as well. 

That is a limited action because they are only pulling out from 

Treasuries that mature during, essentially, the next 30 days, but 

I think it invites a conversation about whether we should be so optimistic that the United States is going to remain as the world’s 

reserve currency if we continue to go through these series of manufactured crises. If you sort of look at the history of reserve currencies, they, you know, tend to last 100 to 200 years, they change. 

Now, we haven’t gone through our 200-year cycle yet. 

But I wanted to ask two questions to both of you, I guess. 

Let me start with you, Dr. Zandi. A, are we at any risk of losing 

our position as the reserve currency of the world? Or is it just a 

matter of relativity, that as nervous as people are about the dollar 

these days, they are, frankly, more nervous about other currencies? 

And if that were to ever happen, what are the consequences to the 

United States of losing that position? 

Dr. Zandi. I think it is very unlikely in the current context that 

we would lose that position as the globe’s reserve currency for the 

key—one of the key reasons you just articulated, and that is what 

would take the place of the U.S. There is no obvious answer to 

that. 

But having said that, we are doing damage to our credibility, and 

it is going to cost us, right? I mean, investors are going to demand 

a higher interest rate to compensate for any potential risk. 

And they are now putting a number to that risk. And even if it 

is one basis point, one-one-hundredth of a percentage point, that is 

a problem because we have $12 trillion in publicly traded debt. 

That is a big number. You multiply anything by that, that is a big 

number. And so that is deadweight lost to us as taxpayers. 

So we are doing real damage by going down this brinkmanship 

path. And each time we go down the brinkmanship path, the cost 

is going to rise. 

And one other thing I will say: So far, at least, lawmakers have 

been able to sign a piece of legislation before actually breaching the 

debt limit and not paying a bill. If we keep going down this path, 

at some point we could make a mistake. And if we make a mistake 

and not pay a bill—and, by the way, it doesn’t really matter if we 

pay on the Treasury interest payments. If we don’t pay somebody 

our obligation, that is going to cost us very, very dearly, and the 

rest of the world is going to be looking for options at that point. 

So, no, I don’t think we are at significant risk of losing that reserve currency status, but we are certainly not making it easy for 

people to believe in us. 

Senator Murphy. Dr. Hassett. 

Dr. Hassett. Thanks for the question. It is a good one and one 

we should follow up on, too, because my knowledge of the literature 

is about 10 years old. 

But the question is that we are in a situation where we can print 

dollars that cost us nothing, really, to make and then give them to 
18 

people, and they give us BMWs, say, and because they really want 

to hold the dollars, and that that is an advantageous position for 

us to be in. 

The last time I checked, the estimates of this sort of seigniorage 

benefits of being the reserve currency were pretty small in the end, 

that it wasn’t a really big thing. And so, if we stop being the reserve currency, there is also potentially a benefit, which—some of 

my more left-wing friends actually wish we weren’t the reserve currency, said this at dinner parties and so on. Because then, you 

know, if everybody wants to hold dollars, then it bids up the price 

of a dollar and it makes it harder for us to have manufacturing 

jobs and so on. 

So the costs and benefits of being the reserve currency are, I 

think, not obviously hugely positive, the last time I checked. But 

I would like to follow up with you on that. 

That said, I don’t think that this episode is likely to change that 

calculus of what Mr. Brady said at the beginning of the hearing, 

that, look, there is no way that we are going to default or miss interest payments or miss payments. If that is true, then I don’t 

think this episode would influence it. 

But even if we did, I kind of wonder if the Treasury market effect 

would be large, in the sense that, suppose that your interest payment didn’t come on October 18th and you were holding a Treasury 

bill that was worth a dollar you thought, but then you were surprised by the fact that you didn’t get the interest payment, at what 

price would you sell it to me for? Would you sell it to me for 90 

cents? Like, in the end, I think you are probably going to believe 

that you are going to get that interest payment in the end, you are 

going to be made whole, and that you wouldn’t really want to take 

that much of a discount. 

But I think, as Mr. Zandi said, even if it is a one-basis-point 

change that we build into the system, that it could be a significant 

factor. 

Senator Murphy. I agree that we are likely safe in large part 

because there isn’t any other place to go. That is a really bad strategy to rely on; that we will continue to be the reserve currency simply because every other country’s currency or economic situation is 

more screwed up than ours. That is, frankly, a recipe for ultimate 

failure if that is essentially why you remain confident about your 

economy’s role in the world. 

Dr. Hassett. If I may add one point, too, which is if you look at 

Angus Madison’s data on world GDP back thousands of years, it 

has pretty much always been the case that China is about a third 

of world GDP, which we kind of peaked at about a little while ago. 

And China really messed things up starting in the 1850s. But my 

guess is that they are going to go back being about a third of the 

world GDP at some point in the next 50 to 100 years. And at that 

point, we are no longer even the biggest game in town, and we 

probably wouldn’t be the reserve currency any more. 

Dr. Zandi. Can I make just one quick point? You know, we do 

have—— 

Senator Murphy. Vice Chairman Klobuchar has completely ignored the fact that I am over my time. So go ahead. 
19 

Dr. Zandi. Well, Treasury did miss a payment back in 1979. It 

was an accident, and it was only to a few investors. And there has 

been some good academic research trying to assess what that 

meant in terms of the cost. And it was very costly. You know, investors were made whole very quickly. It was actually just a paper 

mistake. We didn’t have computers. It was a paper mistake. And 

it is not—you know, it is billions and tens of billions of dollars. So 

that kind of gives you a sense of what a mistake could mean for 

us, particularly in the current context with, again, with $12 trillion 

in debt outstanding. 

The other thing I just want to say, the reserve currency status 

is a very important status. It gives us enormous economic benefit. 

You know, the seigniorage is just one little piece of it. But the fact 

that trade in the world is done in dollars is huge. It is a significant 

advantage to us in many, many ways. So I think it is very important for us to work hard to continue to preserve the faith in our 

financial stability so that we maintain that reserve status. It is 

very important. 

Senator Murphy. Thank you. 

Vice Chair Klobuchar [presiding]. Thank you very much, Senator Murphy. 

We are going to now take a recess until our House Members return. I personally am going to go back and look at the library back 

there. Thank you. 

[Recess.] 

Okay. We are back for the hearing. And Representative Delaney 

is here to ask questions. Thank you. 

Representative Delaney. I join my colleagues in thanking Dr. 

Zandi and Dr. Hassett for joining us here today. When I think 

about your testimony, which was very thoughtful, it seems to me 

that we have to think about this issue in the context of really what 

the realities are of the situation we face today and are likely to face 

for a very long time, because I think those do inform, to some extent, how we think about this issue. 

One reality, unfortunately, is that we have a very large current 

debt burden in this country, $17 trillion, right, which is obviously 

a very big and significant number. The second reality is that that 

number is likely to grow across time, unless we make fundamental 

reforms to our entitlement programs, based on the demographic 

analysis that you both alluded to in your comments. 

The third reality, at least in my judgment, is that we are underinvesting in certain areas that actually have been proven and demonstrated to have a good economic payback: infrastructure, certain 

aspects of education, et cetera. 

So when you look at these facts, if you look at these kind of 

macro drivers of our fiscal situation over the next 20 or 30 years, 

it is hard to come to a conclusion that we will have anything but 

a reasonably high level of debt in this country. 

And so I think, Dr. Zandi, you made a good point about what effects the shutdown and the debt ceiling brinksmanship, if you will, 

are having on the economy on a very current basis. I also worry 

that it would seem to me that if I was one of our foreign counterparties right now, because unlike other countries that have managed high debt levels, like Japan, which largely borrowed from 
20 

itself, we are in a position where we borrow from foreign counterparties. And it would seem to me that these actions would somehow cause them to begin the process of slowly calibrating how they 

think about the United States as a counterparty, which will inevitably result on the margin and perhaps hard to measure in the 

short term, but on the margin, in higher debt levels or debt costs. 

And that is a particularly imprudent thing do if you acknowledge 

my first set of facts, that we will likely have high levels of debt for 

a very long time. And so I think we just have to have more of a 

conversation about the importance of these counterparties to us for 

a very long time, unfortunately, and think about our actions in that 

context, because if this was an enterprise other than government, 

you would be working very hard to instill confidence in your lenders so that they would lend you money at the lowest possible rate, 

as opposed to creating a situation of instability. 

But my question really goes to Dr. Hassett, because I think you 

framed very well the options we have around putting in place governors or mechanisms to deal with the fiscal situation of the country across the long term and again in the context of what we just 

discussed. And so it seems to me that there would be things you 

would want to do if this was an enterprise other than government. 

The first thing is you would want to have some current test to look 

at your current situation and say, is the fiscal—the current fiscal 

situation concerning? And that would be something along the lines 

of a current test of debt-to-GDP levels, et cetera. But you would 

also want that to somehow interrelate with a longer-term test, 

right? Because it is one thing to have low debt levels currently, but 

have an explosion occurring in 10 or 15 years, right? That is not 

a good situation. Similarly, if you have a high level of debt, but you 

are doing things across the long term that are going to bring it 

down, it may be more manageable. So how could we possibly come 

up with a framework for having effectively a current and a longterm measurement and having those interplay so that we could 

have a process for managing this somewhat inevitable fiscal situation we have as a country over the next 20, 30 years, that is sensible, that is kind of ratio-based, as opposed to absolute-dollarbased? Because again, you would only come up with an absolute 

dollar test if you were truly trying to have a forcing function to create conflict, right, which some may think we need. But you would 

never come up with that. You would come up with a percentage, 

or ratio, et cetera, to GDP or other things. So how do we come up 

with something that is logical and sensible, because this is likely 

to be a reoccurring theme, and how do we come up with something 

that both measures current and long-term situation, and how 

would those possibly interplay? 

Dr. Hassett. I will go first. 

Mr. Delaney, I think that your question actually is probably motivated from looking at the chart and figuring out something, which 

is that the only way that you get sort of 80, 90 percent of the people having both budget balance rules and debt rules is that a lot 

of people have both. A lot of countries have both. And so I think 

that having more than one rule is one way that countries have 

processed your thought, which is, let’s try to have a rule that looks 

at, say, debt. And ideally, if we were going to construct a perfect 
21 

measure we would include implicit liabilities in that. And then we 

will have a rule, a second rule that requires that our deficit not be 

bigger, our structural deficit not be bigger than 3 percent. So they 

have these multiple rules precisely because they want to keep their 

eye both on short-term violations of prudence and long term. 

Representative Delaney. And how do those rules interrelate? 

Can you violate the short-term rule provided you are on target in 

the long term? Do they have those kind of dynamics, or are they 

both viewed as kind of uncompromising standards that you can 

never violate? How does it work typically? 

Dr. Hassett. Yes, typically they are stand alone, independent 

rules, and you have to obey them all. It is kind of like when you 

tell a teenager, no drinking and be home by 11. So the rules are 

independent rules, and they have to obey them all. 

Representative Delaney. But therefore, you probably build 

more tolerance into each of them. So since you have two steps or 

two tests, theoretically, you would build in more tolerance in each 

of them because either of them—so I would just be interested in 

any thoughts you have as to what specific rules we put in place. 

I think that is my time. 

Dr. Hassett. I could follow up on that. 

Representative Delaney. Thank you, Doctor. 

Chairman Brady [presiding]. Thank you. 

One, before I recognize Representative Paulsen, I want to take 

this opportunity to thank the vice chairman for setting a great 

tone, bipartisan tone on this issue and others throughout the Joint 

Economic Committee. It really is a delight to work with you on 

these issues. They are all big picture issues. We need to find those 

solutions. And couldn’t find a better partner in doing it. 

Vice Chair Klobuchar. Thank you, Mr. Chairman. 

I really like the tone we have had in this committee. And this 

hearing is another example of it. Thank you. 

Chairman Brady. Now if Minnesota just would quit dominating 

this committee, I would feel so much better. 

Speaking of that, Representative Paulsen. 

Representative Paulsen. Thank you, Mr. Chairman. 

And let me just first echo the comments you made about working 

with Senator Klobuchar. This is a timely hearing. It is a timely 

hearing because this is a committee that includes both House 

Members and Senate Members, and looking at what is the way forward on some very significant issues. And it is an opportunity to 

find some solutions, so we don’t move from manufactured crisis, 

from one to the next, actually look at some long-term framework 

discussions to get spending under control, to rein in deficits, and 

ultimately to lower our debt pattern. 

Let me just start here. The International Monetary Fund recently lowered the global outlook forecast this week, and it factored 

in, of course, the current U.S. Government shutdown, the impending approaching debt limit deadline that’s coming up. And compared to July, the IMF cut the U.S. forecast growth rate and 

shaved it down to 1.6 percent this year and then shaved it down 

to 2.6 percent next year. And so I remember when this debate was 

going on 2 years ago, of course, the ratings agencies were all giving 

their warnings at that time about if long-term liabilities aren’t ad-
22 

dressed, don’t be surprised if the outlook down the road is downgraded or you get a little nick on that from our bond rating, et 

cetera. 

So if the debt ceiling is raised without any plan nor sustainable 

government spending down the road, what signals would that send 

to the markets or to foreign investors down the road? So is it prudent now, would it not be prudent to make spending reductions 

part of the discussion for a way forward, if you will, as part of the 

debt ceiling? Does that make sense? 

Dr. Hassett. 

Dr. Hassett. Mr. Paulsen, in the piece I wrote on this topic in 

the Wall Street Journal last week, I stated what I think about this, 

which I think is kind of the correct fact, which is that we have got 

this strange debt limit rule that has led to a lot of brinksmanship 

over time. And it has been pretty common, 27 out of 53 times the 

debt limit was passed with some extra legislation, to include other 

stuff. And that a full assessment of whether this has had a complete negative effect would involve estimating the positive impact 

of the things that were attached over the years by often the opposition party to the debt limit increase. And then we would have to 

evaluate whether, well, could they have happened without the debt 

limit shenanigans? And I think there are a lot of unknowables 

there. 

But I think that you are correct that as we think about legislative accomplishments historically, you know, we have to recognize 

that because the debt limit is something that has to happen, that 

gives the minority power some leverage, then it has allowed legislation to pass that may have had a positive impact, even on net if 

you go back and tally it all up. But it is not completely knowable 

because there are so many different policies. 

And so I think that it is absolutely important to get spending 

under control. And that is why, so if it were me, I would take the 

deal, let’s adopt a spending cap and agree never to go down this 

road again, and then I will give you all the debt limit increase that 

you want. And that is a trade that I would make right now. 

Representative Paulsen. Okay. And Dr. Zandi, you mentioned 

earlier about the revenue problem with demographics being the 

way they are and support for corporate tax reform, revenue neutral, to kind of drive the economy. I mean, I tend to agree we need 

pro-growth policies in particular to bring in more revenue. Can you 

give us some other comments regarding the opportunity to have 

pro-growth tax reform, long term horizon, that can be a component 

of some of these discussions? 

Dr. Zandi. Well, I think tax reform broadly would be obviously 

ideal. But corporate tax reform feels doable to me in the current 

context. 

There is a general view that, and I think appropriately so, that 

if we can make the corporate tax code obviously more efficient, 

fewer loopholes and deductions, and use that extra revenue to 

bring down marginal rates for businesses, that that would be very 

important to improving the competitiveness of U.S. companies. So 

I think that is a very good place to focus. And I think there could 

bear some fruit. 
23 

You know, it is one of those things that isn’t going to matter a 

lot to the economy in any given year, but when you look back over 

a period of a decade or a generation, it could add up to significant 

benefit to the economy and ultimately help alleviate some of our 

long-term fiscal issues. 

Can I say, one thing, though, in response to your first point? 

Representative Paulsen. Yes. 

Dr. Zandi. Under current law, if you lawmakers do nothing, 

then under reasonable economic assumptions, they are CBO assumptions and they are pretty consensus-oriented, the deficits will 

continue to decline to a point where the Nation’s debt-to-GDP ratio 

will stabilize. And this is the case through the end of the decade, 

through 2020. 

So I think that the most important thing would be for us to just 

get beyond the brinksmanship. And I think it is less important to 

get those spending cuts in the near term if what it means is that 

we can just get moving forward and let the private economy start 

to shine through. I think that is the most important thing we need 

to do right now. 

Representative Paulsen. Thank you, Mr. Chairman. 

Chairman Brady. Thank you. 

Former Chairman Maloney will be here in just a moment. 

You know, as we work through this, Dr. Zandi, Dr. Hassett, what 

is the most important takeaway for us at this moment in time as 

we move forward from short-term brinksmanship to long-term solutions? What is the most important thing for us to keep in mind? 

Dr. Zandi. In my view, that what Congress and the administration are doing now, what Washington is doing right now is incredibly counterproductive. 

Chairman Brady. I agree. 

Dr. Zandi. Just simply get out of the way, do nothing, and we 

will be okay. The economy will engage. We will get a lot more jobs 

and growth. Unemployment will decline. And our long-term fiscal 

issues won’t be solved, but they will look a lot better. 

Chairman Brady. Dr. Hassett. 

Dr. Hassett. You know, I think that when I am thinking about 

the costs of things like what we are doing today, I often like to do 

the thought experiment, well, what if we had done the right thing 

in the past? And I would circle back to my earlier comment that 

if 5 years ago, we had sat down and adopted two rules, maybe a 

deficit rule and a spending rule, or something like that, and then 

agreed not to introduce these pockets of high uncertainty, then 

there might be 2.3 more million Americans working today and a lot 

fewer long-term unemployed. So when we don’t address these big 

policy problems, and we let them just sit there and fester, then we 

do really, really lasting damage to the economy. And it seems 

sometimes like it is easy to ignore the damage politically, but it 

really is true that if 5 years ago, we had done the right there thing 

there would be a couple million more people working today who 

really need jobs. And so the costs of ignoring this problem are enormous. And we need to do something so that we can get out of this 

brinksmanship game. 

Chairman Brady. That uncertainty chart, which is pretty compelling, I think certainly reinforced back home. 
24 

Are there other elements that contribute to this uncertainty? Fiscal issues, some regulatory issues, tax. I do think the Affordable 

Care Act has introduced uncertainty both in the health care world 

and along Main Street. Monetary policy is a question we deal with 

each day. Are there these other elements that we ought to be addressing as well? 

Dr. Zandi. Yeah. It goes beyond the brinksmanship, certainly. 

And I am not making any comment on the merits of financial regulatory reform or health care reform. In my view, in terms of health 

care reform, there are negatives from a macroeconomic perspective 

and there are positives from a macroeconomic perspective, and they 

wash out. I don’t know a professional economist who does this for 

a living that changed their economic forecast long run because of 

the passage of health care reform. But having said that—— 

Chairman Brady. Reference the uncertainty issue. 

Dr. Zandi. There are adjustment costs from moving from here 

to there. And that is what we are feeling right now. And that does 

create uncertainty. And it makes people nervous in the context of 

all the other things that are going on. 

But the political brinksmanship is at this point in time now the 

key factor driving this angst, this uncertainty. But you are right, 

there are other things going on. 

Dr. Hassett. And Mr. Brady, I could follow up with your staff 

that Steve Davis at the University of Chicago, his measure of uncertainty can be decomposed into submeasures, I think there might 

be about 10 of them, that measure the other kinds of uncertainty 

and the different types, like fiscal policy versus monetary policy uncertainty, the different types of policy uncertainty that contribute 

to the overall index. And you can watch how that evolves over 

time. And we can present a chart to you. 

Chairman Brady. It seems like that index is in inverse proportion to our popularity ratings in Congress. As the uncertainty goes 

up, the other one seems to go down. 

I don’t know if Representative Maloney will make it here today. 

Unless other Members wish to inquire, I would like to thank you 

both for being here today. Hugely helpful information. We would 

like to keep this discussion in a bipartisan manner going forward. 

With that, the hearing is adjourned. 

(Whereupon, at 11:20 a.m., the committee was adjourned.) 
(25) 

SUBMISSIONS FOR THE RECORD 
26 

PREPARED STATEMENT OF HON. KEVIN BRADY, CHAIR, JOINT ECONOMIC COMMITTEE

Vice Chair Klobuchar, distinguished witnesses, and my fellow Americans. 

Today, the federal government remains partially shut down, and the Treasury estimates that it will hit the debt ceiling on Thursday, October 17th. If President 

Obama and Congress cannot reach an agreement to increase the debt ceiling by the 

middle of next week, the United States could default on its obligations, the economic 

consequences of which are too grim to contemplate. 

Time is too short for the Washington ‘‘blame game.’’ America will not default on 

our debt. Nor will the debt ceiling be lifted without addressing the unsustainability 

of the government’s finances. Given our divided government, any solution therefore 

must be bipartisan. 

In the past, Democrats and Republicans have used the debt ceiling as a responsible means to shore-up America’s financial house—the Omnibus Budget Reconciliation Act of 1990 came about through debt ceiling and sequester negotiations between congressional Democrats and President Bush, and the Budget Control Act of 

2011 came about through debt ceiling negotiations between House Republicans and 

President Obama. 

Negotiations over the debt ceiling provide both parties with an opportunity to 

enact a 21st century strategy to put America’s finances in order for the long haul. 

Therefore, I’m proposing a way forward for President Obama, Leader Reid, and 

Speaker Boehner to reach a bipartisan solution. 

To build an office building, you start with the foundation, erect the steel skeleton, 

and then build out the specific offices. In past fiscal battles, however, Washington 

has often gotten the order wrong. Budget negotiations have often failed because we 

began by arguing over specific tax changes or spending cuts before we agreed on 

a goal and how to measure the progress toward the goal. 

As Nobel laureate Milton Friedman taught, the best single measure of Washington’s burden on Main Street is federal spending as a share of the economy. In the 

near term, the Budget Control Act of 2011 has helped to restrain runaway federal 

spending, producing the first back-to-back decline in federal spending in a half century. Yet, the Act wasn’t built to last, capping only discretionary spending. Indeed, 

the Congressional Budget Office (CBO) projects that the explosive growth of entitlements will cause federal spending to balloon to 26% of GDP over the next 25 years. 

That’s a long-term problem both parties agree we cannot ignore. 

Therefore, the first objective of any negotiations over the debt ceiling should be 

to set a reasonable limit for federal spending in comparison to the size of America’s 

economy. Then the negotiations should establish a glide path to bring federal spending within the limit over time and guardrails to keep future Congresses and Presidents within those limits. How you set those limits matter. 

A smart, bipartisan spending limit would restrain the spending that Congress can 

control—program and entitlement spending—while acknowledging the spending 

Congress cannot control—interest payments on the federal debt. 

So how best to tie controllable federal spending to the size of the economy? GDP 

as a measurement is revised looking backward and fluctuates with the business 

cycle, allowing unsustainable spending blowouts in boom years, but then requiring 

politically unsustainable, economically unwise reductions during recessions. A far 

more stable denominator for any sustainable spending limit would be potential 

GDP. This is a long standing economic metric that reflects what GDP would be at 

full employment with no inflation. The Congressional Budget Office already calculates potential GDP in its annual Budget and Economic Outlook. Its projections 

of GDP in years 6 through 10 are considered potential GDP. By using this metric 

as the denominator, we can eliminate the boom-and-bust problems associated with 

GDP and create a more solid foundation for lawmakers to build upon. 

What should be the target level of a spending cap? The prosperous 1990s can 

serve as a model. From 1981 to 2001, total federal spending declined from nearly 

23% of GDP to under 18% while the population soared and entitlements grew. The 

economy, far from suffering, generated more than 35 million new jobs along Main 

Street—an increase of nearly 50%. 

That’s why I would recommend a steady glide path that would lower controllable 

spending over 10 years to 16.5% of potential GDP, bringing the size of the federal 

government back to a long-term sustainable level close to its average in the second 

Clinton term. President Obama and congressional Democrats might prefer a higher 

spending cap. But once we agree on the metrics—the foundation of a modern, enforceable spending cap—we can negotiate on the appropriate level to right-size 

America’s government for the 21st century. 

Budget innovations should also change Washington’s thinking. Under this new 

foundation, to increase federal spending lawmakers would have to increase the na-
27 

tion’s economic output potential. That requires growing the labor force at a faster 

pace—a good thing—and increasing productivity, also a good thing. Savings can get 

us halfway back to sustainable fiscal ground, but economic growth is needed to finish the job. 

This would also create a strong incentive for the President and Congress to tackle 

tax reform and entitlement reform. Dave Camp, Chairman of the House Ways & 

Means Committee, has proposed establishing a firm timetable for each chamber in 

Congress to consider and pass their best idea of a simpler, fairer, flatter tax code. 

Lawmakers in both parties, non-partisan commissions, and the White House have 

proposed ideas to extend the life of Social Security and Medicare. Along with establishing smart, bipartisan spending guardrails, these are long-term approaches that 

could directly correlate with meaningful extensions of the debt ceiling. 

Now is the time to enact a 21st century solution to ensure America’s fiscal future. 

I look forward to the testimony of today’s witnesses. 

PREPARED STATEMENT OF HON. AMY KLOBUCHAR, VICE CHAIR, JOINT ECONOMIC

COMMITTEE

I would like to thank Chairman Brady for holding today’s hearing and thank our 

distinguished witnesses for being here this morning. 

I think the way forward is clear: we need to end the shutdown and pay our bills. 

The first order of business is for the House to approve the straightforward bill 

the Senate passed on September 27 that would have prevented the shutdown in the 

first place. The government has now been shut down for more than a week and a 

half, and the costs are mounting. 

I released a report this week that lays out 10 ways the shutdown is hurting the 

economy. Here are just a few examples. 

First, the shutdown is harming consumers and slowing economic growth. Our witness today, Mark Zandi, warned this Committee last month that shuttering the government for three or four weeks would do significant economic damage, reducing 

real gross domestic product by 1.4 percentage points in the 4th quarter. 

Housing is another area that is being hurt . . . and it has been a bright spot of 

the economic recovery. But now the Federal Housing Administration and the Department of Veterans Affairs are facing delays in insuring new home loans, likely 

holding up home purchases. More than 22 percent of all mortgages are backed by 

one of those agencies. 

The Small Business Administration is not processing new applications for loan 

programs, preventing small firms from accessing the capital they need. 

Our national parks are shuttered, harming surrounding communities that depend 

on the economic activity generated by the parks. In 2011, visitors spent nearly $13 

billion in local communities around the parks. 

There are public health implications, too. Cancer patients are being denied access 

to new clinical trials at the National Institutes of Health. The Centers for Disease 

Control and Prevention is unable to track flu outbreaks, just as flu season is 

ramping up. A typical flu season costs employers over $10 billion per year. 

Countless companies from aircraft manufacturers to mining companies to agricultural businesses have come to me reporting major delays because products cannot 

get approved and permits cannot get issued. Piecemeal funding of the government 

will not solve this since the delayed approvals reported to me cover every agency 

from the Food and Drug Administration to the Department of Commerce to the 

EPA. 

The federal agencies that are supposed to be gathering economic statistics aren’t 

doing so. That means that the Federal Reserve, businesses and investors are flying 

in the dark. 

This simply can’t go on. We need to open NIH so that cancer patients can get access to clinical trials . . . let the SBA guarantee affordable loans to small businesses 

again . . . let the FHA and VA insure loans so that people can get mortgages. 

Those are just a few examples of many we could give. We need to re-open all of 

the federal government, and we need to do it now. 

That’s the first hurdle. We also need to deal with the next critical deadline, the 

deadline for paying our bills—or face default. According to the Treasury Department, on Thursday, October 17, our country will hit its legal borrowing limit. Congress is being asked to do what it has routinely done 70 times over the past 50 

years, and that’s pay our country’s bills. 

Let me be clear, this is about making good on commitments we’ve already made. 

This is about doing what regular Americans do every month when they pay their 

credit card bills. 
28 

Let’s look back to 2011 and see what happens when we flirt with disaster by waiting until the last minute. 

Treasury Secretary Tim Geithner sent a series of letters to Congress about the 

looming debt ceiling in 2011, starting on January 6 of that year. On May 2nd, he 

announced that the debt limit would be reached on August 2nd. 

On July 14, 2011, Standard and Poor’s warned it may downgrade the U.S. credit 

rating. They followed through on that and downgraded our credit rating on August 

5th—the first time in history. 

The results of the game of chicken Congress played were ugly: the Dow Jones 

dropped more than 2,000 points in late July and early August of that year. Consumer confidence plummeted. $2.4 trillion in household wealth was lost. 

The delay in reaching an agreement to pay our bills, and the resulting uncertainty, meant that the Treasury had to pay higher yields than otherwise would have 

been necessary, costing taxpayers $1.3 billion for fiscal year 2011 alone. 

All of this harm occurred before we reached the debt limit. We can’t let that happen again. 

Despite the lessons of history, we’ve been hearing from a number of people who 

seem to think this is no big deal. Congressman Joe Barton said ‘‘We are not going 

to default on the public debt. That doesn’t mean that we have to pay every bill the 

day it comes in.’’ 

At last month’s JEC hearing on the debt ceiling, Dan Mitchell of the conservative 

Cato Institute said, ‘‘There’s no need to fret about a default.’’ 

No need to fret? That’s not what history teaches us. 

Make no mistake; this brinksmanship has consequences for our economy. We cannot afford to go down this path again, because this time around the fall could be 

much harder. 

And what if Congress doesn’t act by next week and our nation defaults? According 

to Fed Chairman Ben Bernanke, the results would be ‘‘catastrophic.’’ 

A default would disrupt financial markets, limit access to credit and raise fiancing 

costs. It would trigger a run on money market funds and force the federal government to renege on commitments to individuals, businesses and governments. 

For consumers, higher credit costs would mean less borrowing for purchases of 

homes, cars or other durable goods. Businesses could face difficulties accessing 

short-term debt to finance payrolls. 

As Warren Buffett said when talking about the threat of a default, ‘‘it ought to 

be banned as a weapon. It should be like nuclear bombs, basically too horrible to 

use.’’ 

I agree with Chairman Brady that we need to move forward on a long-term deficit 

reduction plan that addresses both revenue and spending. I have long advocated for 

a smart and balanced plan that puts our nation on a sustainable fiscal path. 

I have supported the Gang of Six, the Gang of Eight and the work of the Debt 

Commission. 

While Congress has already made significant progress—achieving $2.4 trillion in 

deficit reduction over 10 years—we all agree that more needs to be done to get our 

fiscal house in order. But our first order of business must be to open the government 

and raise the debt ceiling. We cannot negotiate long-term fiscal responsibility with 

the threat of economic chaos over the heads of the American people. 

Our country cannot afford to keep lurching from crisis to crisis. I hope today’s 

hearing will help make it clear that we need to end this current crisis. After we 

do that, both parties and both chambers will have a real opportunity for a bipartisan effort to reach a long-term deficit reduction strategy. 
29 

American Enterprise Institute for Public Policy Research 

Testimony before the Joint Economic Committee 

The Way Forward from Government Shutdown and Debt Ceiling Confrontation 

toward Long-Term Fiscal Sustainability and Economic Growth 

Kevin A. Hassett 

John G. Searle Senior Fellow 

Director of Economic Policy Studies 

American Enterprise Institute 

October 11, 2013 

The views expressed in this testimony are those of the author alone and do not necessarily represent 

the views of the American Enterprise Institute. 
30 

Chairman Brady, Vice Chair Klobuchar, and Members of the Committee, thank you for inviting me here 

today to discuss possible solutions to the government shutdown and debt ceiling debate and ways to 

move our country forward in a fiscally-sustainable way. 

We meet today in the midst of a historic government shutdown, with the government's debt limit 

rapidly approaching. In a recent article, my colleague Abby McCloskey and I reviewed the history of 

debt limit increases and concluded that debt limit struggles have been quite common in recent U.S. 

history, and have lead more often than not to legislation that ties increases in the debt limit to specific 

factors. While a full accounting of the costs and benefits of these prior actions would require estimates 

of the long run impact of the policies that were enabled by debt limit actions, there is little dispute in 

the economics literature that struggles like that of 2011 increase economic policy uncertainty, and this 

heightened uncertainty has negative economic consequences. A recent path-breaking paper by Baker, 

Bloom, and Davis" shows these effects clearly. The authors compile a unique index of policy 

uncertainty, which draws on news coverage of uncertainty in policy decisions, the number of federaltax-code provisions set to expire, and the disagreement among forecasters about economic variables 

one year in the future. They use this index to estimate the impact of policy uncertainty on the economy, 

finding massive negative effects; their results imply that a 112-point rise in their policy-uncertainty index 

- which occurred between 2006 and 2011 - would reduce real GDP by 3.2 percent and employment by 

2.3 million jobs. The chart below shows the large spike in uncertainty that occurred during the debtceiling debate in 2011. It should not be in dispute that we can do better. 

Economic Policy Uncertainty Index 

400 ~DebtCeiling 

350 

300 

250 

200 

150 

100 

50 

0 

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 

Source: FRED; Baker, Bloom, and Davis 

1 Baker, Scott R., Nicholas Bloom, and Steven J. Davis. "Measuring Policy Uncertainty." Working Paper. May 19, 

2013. 
31 

The purpose of my testimony is to review the budgetary practices of other countries, and draw lessons 

for U.S. policy, with the objective of helping lawmakers assure that this be the last time that our nation 

endures anything like our current mess. 

My first observation is that most developed countries around the world have significantly more 

advanced budgetary rules than we do in the U.s., often encoding specific targets that constrain the 

actions of policymakers. 

Budgetary Rules in Other Countries 

The IMF recently compiled a database of 87 countries' and the fiscal rules that they use in their 

budgetary processes. The analysis broke the fiscal rules into four categories - expenditure rules, which 

set limits on total spending or on certain types or spending; revenue rules, which set floors or ceiling for 

revenues; budget balance rules, which constrain deficits that contribute to central government debt 

(either by limiting the amount that a deficit can be in an individual year, or by specifying that there 

should be a balance over a certain cycle); and finally, debt rules, which set an explicit limit or target for 

public debt. The U.S. currently has one fiscal rule in place, according to the IMF - the sequester agreed 

upon in 2011 which acts as an expenditure rule. 

70% 

60% 

50% 

40% 

30% 

20% 

10% 

0% 

'" 00 

'" ~ 

'" ,... 00 00 

~ '" ~ 

Percentage of OECD Countries* with Fiscal Rules 

00 '" 0 ~ N M .". '" '" ,... 00 '" 0 ~ N M .". '" '" ,... 00 '" 0 ~ N M 00 00 '" '" '" '" '" '" '" '" '" '" 0 0 0 0 0 0 0 0 0 0 ... ... ... ... ~ ~ ~ ~ ~ ~ ~ ~ ~ '" '" '" 0 0 0 0 0 0 0 0 0 0 0 0 0 0 ~ ~ ~ N N N N N N N N N N '" N N N 

*Exdudes South Korea and Turkey 

Source: !MF 

OECD countries have clearly moved towards having a greater number of fiscal rules over time. As the 

authors of one IMF study3 state: 

"Over the past two decades, fiscal rules have spread worldwide. In 1990, only five countriesGermany, Indonesia, Japan, luxembourg, and the United States-had fiscal rules in place that 

l The Fiscal Rules dataset can be accessed at http://www.imi.org/external/datamapper/FiscalRules/map/map.htm 

3 Schaechter, Andrea, Tidiane Kinda, Nina Budina, and Anke Weber. "Fiscal Rules in Response to the CrisisToward the "Next Generation" Rules. A New Dataset." IMF Working Paper WP/12/187. July 2012. 
32 

covered at least the central government level. In Japan and Germany, fiscal rules have a long 

tradition dating back to as early as 1947 and 1969, respectively, though adherence to the rule 

was weak for most years. Over the next two decades, the number of countries with national 

and/or supranational fiscal rules surged to 76 by end-March 2012 ... This includes, most recently, 

responses to the crisis with a view to provide credible commitment to long-term fiscal 

discipline." 

In addition to countries adopting their own fiscal rules, there are some supra-national rules (by the EU, 

along with a few other currency unions in the Caribbean and Africa) that band countries together. In the 

EU, the Maastricht Treaty, signed in 1992, set a limit of three percent of GOP for deficits and 60 percent 

of GOP debt for EU member states. Following the financial crisis and recession from 2007-2009, in which 

many EU member states experienced large deficits and growing debt, a new Fiscal Compact was agreed 

to. Twenty five member states signed an agreement in 2012 requiring countries to adopt national 

legislation limiting annual structural deficits to 0.5 percent of GOP and implementing new rules on debt 

reduction to achieve the eventual goal of 60 percent debt to GOP ratios. 

Although many EU countries have relied upon budget rules to push deficits back to lower levels 

following the Great Recession, there are certainly exceptions, and one could not possibly assert that 

they have been a ringing success. In a recent study, Frankel and Schreger (2012)4 show that one of the 

reasons that Eurozone countries have frequently exceeded the 3 percent deficit rules is overly optimistic 

growth forecasts that allow central governments to project meeting deficit targets that they in fact end 

up missing. This is especially true of countries that have previously violated their 3 percent deficit cap. 

However, countries that have an independent fiscal institution that produces budget forecasts tended to 

have less overly-optimistic forecasts than countries that did not. 

The evidence from Europe shows that in many cases, limits to budget deficits can be ineffective because 

it is easy to tinker with projections to appear to come into balance, when a deficit limit is in fact going to 

be breached. Limits to budget deficits also have the disadvantage that they require agreement on both 

spending and revenue, without providing a guide to the proper level of either. This creates a situation 

where one side favors lower taxes and lower spending, for example, while the other side favors a higher 

tax and higher spending level- and each can point to their own plan as meeting the deficit ceiling. 

Perhaps because of these problems, countries have increasingly begun to rely on specific expenditure 

targets, either top line numbers, or as a percentage of GOP. The adoption of such targets makes a great 

deal of sense. Some policymakers may like the government to be larger, some might like it to be 

smaller, but everyone should agree that bills eventually have to be paid. By fOCUSing budget rules on the 

key variable in dispute, countries around the world are beginning to assure that the focus of policy 

debate is on the actual substance of the debate. 

The data suggest, then, that we might well seek to adopt a new set of budget rules that set a limit on 

spending, and then agree to automatically pass continuing resolutions and debt limit increases, provided 

4 Frankel, Jeffrey A. and Jesse Schreger. 2012. Over-optimistic Official Forecasts in the Eurozone and Fiscal rules. 

NBER Working Paper 18283. 
33 

that the government is spending at or below the target. While establishing that target would certainly 

be difficult, existing proposals, such as one put forward several years ago by Chairman Brady, provide a 

useful guide to the possible concerns. 

limiting Spending 

A hard limit on spending is impractical, because the cost of providing government would necessarily 

increase as the economy and wages grow. As such, I encourage you to consider a policy that limits 

spending as a share of GDP. A direct limit on such spending would also be poor long run policy, since a 

contraction in GDP might lead spending, which includes built in stabilizers, to increase as a share of GDP 

in a desirable fashion. There are several possible methods to adjust for this. One is to cyclically adjust 

the variables, another is to rely on spending as a share of potential GDP. Potential GDP is a measure 

calculated by the Congressional Budget Office that estimates the level that GDP in the U.S. economy 

would be if the economy were operating at a high level of resource use (including full employment). It is 

meant to be a measure of a sustainable output. In a recession, GDP generally falls below potential GDP 

as resources remain unused. Potential GDP then allows the estimate of GDP to be smoothed over peaks 

and troughs in the business cycle. 

Marking spending to potential GDP would be an effective way to enact budget legislation that is 

transparent and difficult to game. The CBO's methods for calculating it are well established, and it 

would be easy to agree to consequences that would reduce spending in real time in response to a surge 

in spending that pushed the government past the agree upon caps. 

The target percent of potential GDP that lawmakers might prefer would, of course, be in the eye of the 

beholder. As can be seen in the next chart, in recent years government's share of potential GDP has 

varied from about 16 percent to as bit more than 22 percent. That would seem to be a reasonable range 

to begin the discussion in. 

24% 

22% 

20% 

18% 

16% 

14% 

12% 

10% 

U.S. Non-interest Spending as a Percent of Potential 

GOP 

, ......... - - ./ -- ".,-

~~~~~~~~##~~~~4~{ ~~~~~~~~~~~~~#### 

'projected 

Source: Congressional Budget Office; Office of Management and Budget 
34 

As each lawmaker forms his or her own opinion about the appropriate number, it will clearly depend on 

their own assessment of the possible benefits of government spending programs, such as infrastructure 

spending, or clean energy subsidies. But as those benefits are considered, I would also urge you to keep 

in mind the benefits of budgetary restraint. While there is a good deal of uncertainty concerning the 

size of the government multiplier effect in the short run, the long run impact of government spending 

on growth has a fairly robust underpinning in the empirical growth literature. Barro (19895

, 19916

) 

examines the impact of government consumption and investment spending on economic growth in a 

series of cross-country growth regressions. He concludes that public consumption spending has a robust 

negative relationship with growth and investment while public investment spending has an insignificant 

effect on economic growth. Grier and Tullock (1989)7 find that an increase of one percent in 

government growth reduces average GOP growth by 0.32 percentage points. In other words, there is a 

strong negative effect of the growth of government consumption as a fraction of GOP. Alesina, et al. 

(1999)8 find similar negative results of government spending on economic performance, as measured by 

business investment, in an analysis of DECO countries. Foister and Henrekson (2001)9 find a negative 

growth effect of large public expenditures in cross-country analysis. 

Conclusion 

Countries around the world have increasingly relied upon budgetary rules to help constrain the growth 

of government. I encourage Congress to consider adopting a budget rule that caps spending in the U.S. 

(other than interest payments) at some agreed upon fraction of GOP. If spending is below that cap, than 

government debt limits should be automatically lifted, and the government should stay open. The 

economic benefits from the reduced uncertainty that would follow could well be significant. 

5 Barra, Robert 1. 1989. "A Cross-Country Study of Growth, Saving and Government." NBER Working 

Paper No. 2855. January. 

6 Barra, Robert J. 1991. "Economic Growth in a Cross-Section of Countries." Quarterly Journal of 

Economics 106 (2): 407-43. 

7 Grier, Kevin. B, and Gordon Tullock. "An Empirical Analysis of Cross-National Economic Growth, 1951-

80." Journal of Monetory Economics 24 (2): 259-276. 

8 Alesina, Alberto, et. al. 1999. "Fiscal Policy, Profits, and Investment." NBER Working Paper 7207. July. 

9 Foister, Stefan, and Magnus Henrekson. 2001. "Growth Effects of Government Expenditure and Taxation in Rich 

Countries." European Economic Review 45 (8): 1501-1520.= 
35 

Written Testimony of Mark Zandi 

Chief Economist and Co-Founder Moody's Analytics 

Before the Joint Economic Committee 

"The Way Forward From Government Shutdown and Debt-Ceiling Confrontation 

Toward Long-Term Fiscal Sustainabilily and Economic Growth" 

October 11,2013 

The impasse in Washington over funding the federal government and increasing the 

Treasury debt ceiling is significantly damaging the economy. Stock prices are grinding 

lower and consumer confidence is weakening. The economic harm will mount 

significantly each day the government remains shut and the debt ceiling is not raised. If 

policymakers are unable to reach agreement on these issues by the end of October, the 

economy will face another severe recession. 

To resolve the budget impasse, policymakers should not add to the significant fiscal 

austerity already in place, which is set to last through mid-decade. Tax increases and 

government spending cuts over the past three years have put a substantial drag on 

economic growth. In 2013, this fiscal drag is as large as it has been since the defense 

drawdown after W orId War II. 

Moreover, because of fiscal austerity and the economic recovery, the federal 

government's fiscal situation has improved markedly. The budget deficit in just-ended 

fiscal 2013 was less than half its size at the recession's deepest point in 2009. Under 

current law and using reasonable economic assumptions, the deficit will continue to 

narrow through mid-decade, causing the debt-to-GDP ratio to stabilize. 

As part of any budget deal, lawmakers should reverse the sequester. The second year 

of budget sequestration will likely have greater consequences than the first, affecting 

many government programs in ways that nearly all agree are not desirable. A sizable 

share of the sequestration cuts to date has involved one-off adjustments, but future cuts 

will have to come from lasting reductions in operational budgets. 

It would of course also be desirable for lawmakers to address the nation's long-term 

fiscal challenges. Although the fiscal situation should be stable through the end of this 

decade, the long-term outlook remains disconcerting. If Congress does not make 

significant changes to the entitlement programs and tax code, rising healthcare costs and 

an aging population will swamp the budget in the 2020s and 2030s. Both cuts in 

government spending and increases in tax revenues will be necessary to reasonably solve 

these long-term fiscal problems. 

Page I 
36 

A grand bargain with comprehensive entitlement and tax reform is likely too much to 

hope for, but lawmakers can do some things now to address our long-term fiscal issues 

and help resolve the current impasse. 

Revenue-neutral corporate tax reform that scales back tax expenditures in exchange 

for a lower top marginal corporate tax rate would also be a significant policy 

achievement. This would significantly improve the competitiveness of U.S. businesses 

and the economy's long-term growth. Much of the hard intellectual work necessary to 

accomplish this has been done, and there is general agreement among economists that 

this would provide a meaningful boost. As part of corporate tax reform, multinationals 

could be encouraged to repatriate their overseas profits with a temporarily lower tax rate. 

The resulting onetime boost to tax revenues could be used to finance infrastructure 

development here at home, also improving U.S. competitiveness and long-term growth. 

New budget rules that recognize the magnitude of our long-term problems and 

encourage solutions would be especially helpful. These could include incorporating 

fiscal-gap accounting and generational accounting in the budget process, and 

significantly extending the current lO-year budget horizon to facilitate entitlement and 

tax reform. 

Congress should also use this opportunity to eliminate the statutory debt ceiling. It is 

an idiosyncratic, anachronistic and, as has been demonstrated, potentially destructive rule 

that is detrimental to sound economic policy. Absent repeal, an alternative would be to 

require debt-ceiling increases when spending, taxation and appropriations bills are 

passed. Another alternative would be to cap the ratio of the structural deficit to potential 

GDP for the coming year; as long as this remains below an agreed-upon threshold, the 

debt limit increase would be automatic. Taking these steps would restore the fundamental 

economic relationship between budgeting and borrowing and reduce the risk that political 

brinkmanship could damage the full faith and credit of the United States or the stability 

of world financial markets. 

The U.S. economy remains frustratingly far from full employment. While there are 

many reasons for this, political brinkmanship around the federal budget and Treasury 

debt ceiling has been a significant contributing factor. Much progress has been made 

since the Great Recession, and the economy's prospects are improving, but this will 

continue only if policymakers can resolve their differences in the next few days. 

Economic cost 

Financial market reaction to the events in Washington has been muted so far. It has 

become typical for Congress to run down the clock, but in the end it has never failed to 

Page 2 
37 

raise the debt ceiling when necessary. The motivation is clear: Any delay would have dire 

economic and political consequences. It is thus widely expected that Congress will do so 

again. Indeed, after several rounds of fiscal brinkmanship over the last few years, 

financial markets have become increasingly desensitized to it. 

Nonetheless, anxiety over the budget battles in Washington is building in financial 

markets. Notably, the price of a credit default swap on a one-year Treasury bill has 

surged above 60 basis points, up from 10 basis points just a couple of weeks ago. For 

context, during the showdown over the debt limit in summer 2011, one-year CDS spreads 

rose to 80 basis points (see Chart I). CDS spreads on five-year Treasuries are also on the 

rise. 

Chart 1: Financial Market Angst Is Rising 

Treasury CDS spreads, bps 

90,---------------------------------~ 

OO+------,~~~----~--~------------_4 +- 2011 debt-ceiling debacle 70 +-------11---------'----- Oct 8,2013 ...... 

60+---

50 ff1::.,--r:!li 

40f-~~~'_~~~--(-~~ 

30+-~.t---~-~~~--

20r-·~~-----_r--F~~~~~~~~ 

10 

O++++++++++++++++++HHHHHHHH~~~~~~ 

11 12 13 

Sources: Bloomberg, MoOdy's Analytics 

Yields are also increasing on short-term Treasury bills that mature after October 17. 

Investors are requiring compensation for the possibility that the Treasury might not pay 

on time. While equities have held up better than bonds, they have been slowly grinding 

lower since mid-September. The Standard & Poor's 500 is off some 4% over this period. 

Unfortunately, it appears that it will take a more substantial selloff in financial 

markets to give Washington the political will to reach agreement. A couple of days with 

the Dow Jones Industrial Average dropping several hundred points should generate 

enough heat for lawmakers to settle the conflict. Given investors' current complacency, 

however, this may not occur until just before October 17. 

Consumer confidence has also begun to weaken. Daily surveys from Gallup and 

Rasmussen show a sharp decline in sentiment in recent days. Private sector data on retail 

activity and anecdotal evidence indicate that consumers' darkening mood has begun to 

weigh on sales. 

Page 3 
38 

It is important to note that with the federal government's statistical mills shuttered, it 

will become increasingly difficult to gauge the economy's strength. The Bureau of Labor 

Statistics did not release September job numbers, the first such interruption in data since 

the last government shutdown in 1996. The longer the government shutdown drags on, 

the greater the disruption to the data collection process and the quality of the information 

available when operations restart. The muddied data will be difficult to interpret, at a time 

when it will be critical to know what economic damage political brinkmanship is doing. 

Even assuming lawmakers reopen the government and raise the debt ceiling just 

before the Treasury's announced deadline of October 17, the hit to fourth-quarter real 

GDP growth will be approximately half a percentage point. Instead of picking up pace at 

the end of the year as previously expected, the economy will remain stuck near a 

lackluster 2% real GDP growth rate. 

Government shutdown 

But if the government shutdown lasts longer, even assuming the debt limit is 

increased by October 17, the economic damage will mount quickly. A shutdown lasting 

through the end of October would by itself reduce real GDP growth as much as 1.5 

percentage points in the fourth quarter. An interruption longer than one month would 

likely cause growth to stall in the quarter, and one longer than two months could 

precipitate another recession. 1 

For context, the government shutdown in late 1995 and early 1996, the longest on 

record, lasted about three weeks. The economy's growth slowed notably as a result, even 

though the technology boom ofthat time made underlying growth much stronger than it 

is today. 

Although the shutdown only affects nonessential discretionary spending, or about a 

fifth oftotal federal spending, it is becoming increasingly disruptive to the economy.2 

Some 400,000 government employees have been furloughed, and while they will 

ultimately receive retroactive pay, this will not happen until after the government is 

reopened (see Chart 2). The same delays in pay affect another 800,000 employees who 

are still working. Not getting paid for a few days or even a couple of weeks will not make 

a big difference in their spending behavior, but these workers will likely tum much more 

cautious if this drags on much longer. Many do not have the financial resources to 

maintain spending for very long without current income. 

Page 4 
39 

Chart 2: Government Shutdown Is Disruptive 

% of agency employees furloughed 

NASA 

Treasury 

WhiteHouse 

NIH 

FDA 

SBA 

DHS 

VA 

; 

.. i • I 

I I t 

I 

I 

I 

I I I i I [ 

o 10 20 30 40 50 60 70 80 90 100 110 

Sources: OMB, Moody'sAnalytics 

Tourist destinations across the country from the Grand Canyon to Gettysburg PA are 

suffering. International trade is being impeded as exporters and importers are unable to 

get the requisite government permits needed to ship their goods. The housing recovery is 

increasingly at risk as lending by the Federal Housing Administration slows and other 

lenders have trouble getting tax and Social Security information needed to close 

mortgage loans. Small-business lending is also being hampered by the closing of the 

Small Business Administration. 

Treasury debt ceiling 

The economic cost of the government shutdown is significant, but it is small in 

comparison to the cost of not increasing the $16.7 trillion debt limit in a timely way. 

According to Treasury Secretary Jack Lew, October 17 is when the extraordinary 

measures the Treasury has been using since May to stay under the limit will no longer 

work. 3 Unable to borrow at that point, the government will only be able to pay bills with 

the cash it has on hand, about $30 billion per day. 

The Treasury might be able to pay holders of U.S. government securities first, as 

those payments are handled by a different computer system than other government 

obligations. But the Treasury believes it is not legally viable to do so, and politically it 

would be very difficult to pay bond investors before Social Security recipients. Even if 

the Treasury did pay bond investors first, this would not stop investors demanding a 

much higher interest rate for the legal uncertainty and the real possibility that they may 

not get paid on time in the future. Bond investors, especially those overseas, would 

reasonably ask whether Congress would actually allow them to be paid ahead of 

Page 5 
40 

American seniors. The Federal Reserve could increase its bond buying, but any benefits 

would likely be overwhelmed as global investors sold U.S. securities. Financial markets 

would surely be spooked. Sometime in late October, there would be a T ARP moment, 

harkening back to that day in October 2008 when Congress failed to pass the Troubled 

Asset Relief Program and stock prices cratered. 

Deciding which other bills receive priority would be all but impossible, as the 

Treasury could not sort through the blizzard of payments due each day. More likely, the 

Treasury would delay all payments until it received enough cash to pay a specific day's 

bills, as outlined in a 2012 report by the inspector general. Based on the timing of outlays 

and tax receipts, this would probably mean delaying more than a week more than $60 

billion in payments due November I to Social Security recipients, veterans and activeduty military. This would almost surely eviscerate consumer and business confidence. 

If the impasse over the debt limit lasts through November, the Treasury will have no 

choice but to eliminate a cash deficit of approximately $130 billion by slashing 

government spending (see Chart 3). This is approximately 9% of annual GOP. 

Chart 3: Someone Won't Get Paid on November 

Treasury's cumulative cash deficit, $ bil 

60r-~---'----~"-~~"~~""""'~"""""'~~'--'-"--,,~----,~-~-.. , 

-2012 

-150 

-1110 +-~---"!~-~--+"---f---~'---4~~'-'----4--~_J 

10/17 1111 

Sources: Treasury, Moody'sAnalytics 

In contrast with previous recessions, moreover, government would have no tools 

available to cushion the blow. With Congress and the administration still at loggerheads, 

there would be no fiscal policy response, and with short-term interest rates at zero and the 

Fed's balance sheet already bloated, it is unclear what the central bank could do to 

support the economy. 

Page 6 
41 

This would be a cataclysmic economic scenario. The downturn would be at least as 

severe as the Great Recession. That means real GDP would decline by about 5%, close to 

10 million jobs would be lost, and unemployment would rise to 12%. With this economic 

backdrop, stock prices would likely be cut in half, wiping out about $10 trillion in 

household wealth. Treasury yields would likely spike, at least until the debt limit is 

increased and debt payments are resumed. 

Political uncertainty 

Even iflawmakers come to terms in coming days, the harsh political vitriol and 

repeated threats to shut government or not pay its bills have weighed heavily on 

sentiment and meaningfully harmed economic growth. Businesses are more reluctant to 

invest and hire, and entrepreneurs are less likely to attempt startups. Financial institutions 

are more circumspect about lending and households are more cautious about spending. 

While many factors are at work here, Washington's heated budget battles are a significant 

contributor. 

Half the CEOs in the Business Roundtable's third-quarter outlook survey said 

Washington's battles have affected their hiring plans over the next six months. Shaky 

nerves stifle risk-taking and entrepreneurship, which is key to stronger growth. 

The uncertainty created by Washington is evident in the Moody's Analytics political 

uncertainty index. The index is based on the credit default swap-implied expected default 

frequency for five-year Treasury bonds; the present value of future expiring tax 

provisions; and the share of businesses that cite legal and regulatory issues as their 

biggest problem in the Moody's Analytics weekly business survey. The index is set to 

equal 0 in 2007, the year before the recession. The higher the index, the greater the 

uncertainty. 

The Moody's Analytics index rose significantly during the heated debate over the 

American Recovery and Reinvestment Act-the $830 billion fiscal stimulus-in early 

2009. It surged during the budget debate in early 2010 and rose to a record high during 

the Treasury debt-ceiling showdown in the summer of2011(see Chart 4). Uncertainty 

also increased as the fiscal cliff approached in late 2012 and has been rising in recent 

weeks as the current fiscal impasse unfolded. 

Page 7 
42 

Chart 4: Political Uncertainty Remains High 

Fiscal policy uncertainty, 2007Q4=0 

250~----------------------------------~ 

200+--------------~~-~~--

100 ARRA 

50 

-50 +----+---;----+---+---1----+---' 

07 08 09 10 11 12 13 

Source: Moody's Analytics 

Political uncertainty constrains business investment, especially in research and 

development, reduces hiring, and slows GDP growth. A statistical analysis shows that 

increased political uncertainty since the recession hit in 2008 has lowered real GDP by 

close to $150 billion, reduced employment by 1.1 million jobs, and increased 

unemployment by 0.7 percentage point.4 Ifpolitical uncertainty had simply remained 

unchanged from its 2007 level, the unemployment rate today would be 6.6% instead of 

7.3%. Ifnot for the logjam in Washington, the economy would now be much closer to 

full employment. 5 

No additional near-term fiscal austerity 

In any agreement to increase the debt ceiling or extend funding for the federal 

government, lawmakers should avoid adding to the fiscal austerity in place through middecade. Congress has been appropriately focused on reducing the government's large 

budget deficits, but recent tax increases and government spending cuts have put a 

significant constraint on growth. Under current law, fiscal headwinds will continue to 

blow hard in 2014 and 2015. It would be wise not to add to those headwinds, and allow 

the private economy to gather momentum. 

Although the U.S. economy has begun its fifth year of recovery from the debilitating 

Great Recession, it remains fragile. Growth has been modest, with real GDP expanding 

close to 2% per year since the recovery began, and payrolls are still nearly 2 million jobs 

shy of their prerecession peak. The nation's 7.3% unemployment rate remains well above 

most estimates of full employment, which is closer to 5.5%. And this understates the 

stress in the job market given the large number of potential workers who have left the 

labor force because of a lack of perceived job opportunities. 

Page 8 
43 

The private economy has made significant strides since the recession. American 

companies have strong balance sheets with low debt and lots of cash, and they have done 

an excellent job reducing their costs. By most measures, they are highly competitive. The 

financial system is much better capitalized and liquid, and increasingly willing and able 

to extend credit. Households have also significantly reduced their debt loads, which are 

now about as low as they have ever been. Higher house prices and stock values are also 

supporting households' better financial condition. 

But the strengthening private economy is not evident in the nation's overall 

performance because of fiscal austerity. In calendar year 2013, the drag on the economy 

from federal tax increases and spending cuts will amount to 1.5 percentage points of real 

GDP growth. That is, if fiscal policy were simply neutral with respect to the economy, 

real GDP growth this year would be closer to a strong 3.5% (2 percentage points in real 

GDP growth plus 1.5 percentage points from the elimination of the fiscal drag). The 

fiscal drag will reach its apex in the current quarter, and over the course of 20 13 will be 

greater than in any other year since the defense drawdown that followed World War II 

(see Chart 5).6 

Chart 5: Fiscal Headwinds Are Blowing Hard 

Real GOP growth impact of federal fiscal policy, fiscal yr, ppt 

3.5 

3.0 

2.5 

2.0 

1.5 

1.0 

0.5 

0.0 

-0.5 

Recovery Act 

Bush tax cuts 

~--i---'I-'--'---'--"--' 

,I III I III "',-' I .1 

.. 1.,1,1 .. ,1, ,1,1.1 .I. .. 1.1.1, .. I, ,1.,1, ,1.1, 

'n '1'1 'IT 'IT 'I' T'nl'/''/' H' --- I /I I I' 'I 

'IT 

II -1.0 

-1.5 1 Fiscal austerity 

-2.0 

60 65 70 75 80 85 90 95 00 05 10 

Source: Moody's Analytics 

The federal government's improved fiscal situation also gives lawmakers some 

leeway. Tax revenues are rising at a double-digit pace and government spending is 

falling. The budget deficit for fiscal 2013 is set to come in well below $700 billion. 

This is still large, but it is half of what it was at its peak in fiscal 2009. Under current 

law and assuming the economic recovery stays intact, the deficit will continue to narrow 

through mid-decade. The nation's debt-to-GDP ratio, though uncomfortably high at more 

than 70%, will stabilize. 

Page 9 
44 

Given the still-fragile economic recovery, the austerity already in place, and a better 

near-term federal budget situation, policymakers should not add to the fiscal burden on 

the economy through mid-decade. This will help the private economy kick into higher 

gear, hasten a self-sustaining economic expansion, and promote a quicker return to full 

employment. 

Replace the sequester 

Policymakers should replace the cuts scheduled for the coming year as part of the 

sequester with other budget savings. 

The impact of the current year's sequester, which began in March, is becoming more 

visible in the economic data. Hiring freezes announced early this year appear to have 

accelerated the decline in federal government employment. There has been an even larger 

impact on hours worked and personal income. Federal furloughs caused government 

wages and salaries to decline by half a percent in August alone. Cuts in procurement 

spending are also reducing support for private sector jobs, particularly among defense 

contractors, although the impact of the sequester on private employment is occurring 

gradually, with a significant lag. 

A second year of sequestration will have greater consequences for the economy. The 

cuts will be larger and will start immediately, rather than beginning six months into the 

fiscal year as occurred this year. Because of lags between budgeting and actual spending, 

and between federal spending and its impact on the job market, the fallout from this year's 

cuts will carry over into 2014. A sizable share of the fiscal 2013 sequestration cuts was 

also made through one-off adjustments such as temporary furloughs or zeroing-out 

unobligated funds that were authorized but not spent. With this low-hanging fruit now 

gone, future cuts will have to come more from reductions in operational budgets. Given 

the indiscriminate nature of sequestration, this will be especially disruptive to government 

programs. 

Continuing the sequester would have particular implications for the Pentagon. While 

in fiscal 2013 sequestration cuts were divided evenly between security spending--on 

defense, homeland security and international affairs-and nonsecurity spending, in 2014 

and beyond the split will be between defense and nondefense, requiring that a greater 

share of cuts comes from the Pentagon's budget. The Defense Department also paid for a 

substantial portion of its 2013 cuts by eliminating unobligated balances and, without that 

cushion this year, will be forced to make deeper cuts from payrolls and operations. The 

potential for an escalation in military operations in Syria could increase the overseas 

contingency operations budget, which is not exempt. 

Page 10 
45 

Enact budget reforms 

The statutory debt ceiling is an anachronistic law that if not repealed should be 

reformed so that it can no longer lead to a voluntary default on U.S. government 

obligations. Fiscal-gap and intergenerational accounting should also be adopted in the 

budget process. 

Using the threat of a default on U.S. government obligations as a tool in fiscal policy 

negotiations has meaningful economic costs. Short of a repeal of the debt ceiling, 

policymakers should consider strengthening the link between borrowing, tax and 

spending policy, by requiring "ability to pay" language in any legislation that adds to 

future deficits. Ability to pay is defined as sufficient projected tax revenue and borrowing 

authority to cover the current Congressional Budget Office deficit forecast. This 

requirement would be applied to all direct spending, taxation and annual appropriations 

bills. Any discrepancies that result from changes in the CBO forecast could be reconciled 

in the annual budget process. 

The debt ceiling would still force lawmakers to think about the long-term fiscal 

impact of any legislation, but it would do so in the context of the spending and taxation 

bills that create the need for that debt. This proposal makes use of current CBO budget 

projections and scoring practices, and thus should cause no new compliance costs. 

Policymakers should also adopt the INFORM Act, which would require the CBO and 

General Accounting Office to adopt fiscal-gap and generational accounting. 7 This 

provides a more accurate calculation of the nation's long-term fiscal obligations and thus 

would create the basis for sounder budgeting and fiscal decision-making. 

The fiscal gap describes the difference between the present value of projected 

government expenditures, including interest and principal payments on outstanding 

federal debt, and taxes and other receipts, including income accruing from the 

government's ownership of financial assets. Generational accounting measures the burden 

of closing the fiscal gap on today's and tomorrow's children, assuming they must do so on 

their own and that the burden on each generation is proportional to its labor earnings. 

Fiscal-gap accounting and generational accounting are comprehensive and forwardlooking, and determine the sustainability of fiscal policy and the burden of that policy on 

future generations. Fiscal-gap accounting has already been adopted by the Social Security 

Trustees and Medicare Trustees and is becoming more widely used in other countries. 

Page t t 
46 

Pass corporate tax reform 

To break the budget impasse, policymakers should consider adopting revenue-neutral 

corporate tax reform. Reform that resulted in a lower marginal corporate tax rate would 

also help the competitiveness of U.s. companies and thus support stronger long-term 

economic growth. 

Corporate tax reform, which involves reducing or eliminating tax expenditures in the 

corporate tax code and using the resulting additional revenues to reduce marginal rates 

for businesses, would also be a positive economic step. U.S. marginal corporate tax rates 

are high by international standards, even after accounting for exemptions, deductions and 

credits that result in lower effective tax rates. All the loopholes also make the tax code 

complex and inefficient. Permanently lowering marginal corporate tax rates would 

improve the competitiveness of U.S. companies and thus long-term economic growth. 

As part of corporate tax reform, multinational corporations would be encouraged to 

repatriate their sizable overseas profits through a temporarily lower tax rate. This would 

give a onetime boost to tax revenues that could be used to finance needed infrastructure 

development in the U.S. This too would help the competitiveness of U.S. companies and 

thus long-term economic growth. 

Conclusions 

Washington's recent budget battles have been painful to watch and harmful to the 

economy. Political brinkmanship creates significant uncertainty and anxiety among 

consumers, businesses and investors, weighing on their willingness to spend, hire and 

invest. 

Despite this, the economic recovery is more than four years old, and the private 

economy has made enormous strides. Business balance sheets are about as strong as they 

have ever been, the banking system is well capitalized, and households have significantly 

reduced their debt loads. The private economy is on the verge of stronger growth, more 

jobs and lower unemployment. 

The key missing ingredient is Congress' willingness to fund the government and 

make sure all its bills can be paid. Ifpolicymakers can find a way to do these things in the 

next few days, almost regardless of how awkward the process is, the still-fragile recovery 

will quickly become a self-sustaining expansion. 

We are close to finally breaking free from the black hole of the Great Recession. All 

it takes is for Washington to come together. 

Page 12 
47 

Æ 

I A thorough analysis of the causes, processes and effects offederal government shutdowns, 

including potential issues for Congress, can be found in "Shutdown ofthe Federal Government: 

Causes, Processes and Effect." Congressional Research Service Report for Congress. August 6, 

2013. http://www.fas.org/sgp/crs/misc/RL34680.pdf 

2 This includes programs that are funded through congressional appropriations, but are not 

considered vital such as national security, air traffic control, law enforcement, or the processing 

of benefit payments. Mandatory spending is not affected. 

3 Secretary Lew's letter to Congress can be found at 

http://www .treasury.gov/initiatives/documents/0826l3%20debt%20Iim it%20Ietter''1020to%20con 

rress.pdf 

These results are based on a structural vector autoregressive model of the U.S. economy. The 

model is used to estimate the extent to which surprise changes in political uncertainty produce 

changes in GDP, unemployment, the hiring rate, investment, jobs, and several other economic 

variables. 

5 It is difficult to statistically distinguish between political uncertainty and policy uncertainty. 

Political uncertainty is created by political brinkmanship and dysfunction in government. Policy 

uncertainty is created by potential changes in government spending, taxes and regulation. The 

2011 showdown over the Treasury debt limit was especially hard on the economy as it created a 

great deal of political uncertainty, but also involved large changes to spending and tax policy. The 

current government funding and debt limit debates may have less economic impact, as they 

appear to involve more political than policy uncertainty. Despite current legislative efforts to 

defund Obamacare, such defunding seems very unlikely, and no other major policy changes are 

being debated, at least so far. Also mitigating the economic impact of the current debate is that 

businesspeople, consumers and investors appear to be increasingly desensitized to the political 

vitriol with each budget battle. 

6 If fiscal austerity measures had not been implemented since early 2011, making federal fiscal 

policy neutral with respect to the economy, then real GDP would be nearly $300 billion greater, 

there would be almost 2 million more jobs, and the unemployment rate would be more than a 

percentage point lower. This is based on a simulation of the Moody's Analytics structural model 

of the U.S. economy. The simulation assumes that monetary policy would not have changed; that 

is, the Federal Reserve would have engaged in the same amount of quantitative easing despite the 

stronger economy. 

7 The INFORM Act is described in detail at http://www.theinforrnact.orgicontent/text-bill 

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