S. HRG. 111–736 

A STATUS REPORT ON THE U.S. 

ECONOMY 

HEARINGS 

BEFORE THE

COMMITTEE ON THE BUDGET 

UNITED STATES SENATE 

ONE HUNDRED ELEVENTH CONGRESS 

SECOND SESSION 

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

September 22, 2010–ASSESSING THE FEDERAL POLICY RESPONSE TO 

THE ECONOMIC CRISIS 

September 28, 2010–OUTLOOK FOR THE ECONOMY AND FISCAL 

POLICY 

( 

A Status Report on the U.S. Economy 

A Status Report on the U.S. Economy 

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58–156pdf 2010

S. HRG. 111–736 

A STATUS REPORT ON THE U.S. 

ECONOMY 

HEARINGS 

BEFORE THE

COMMITTEE ON THE BUDGET 

UNITED STATES SENATE 

ONE HUNDRED ELEVENTH CONGRESS 

SECOND SESSION 

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

September 22, 2010–ASSESSING THE FEDERAL POLICY RESPONSE TO 

THE ECONOMIC CRISIS 

September 28, 2010–OUTLOOK FOR THE ECONOMY AND FISCAL 

POLICY 

( 

Printed for the use of the Committee on the Budget 

COMMITTEE ON THE BUDGET 

KENT CONRAD, NORTH DAKOTA, CHAIRMAN 

PATTY MURRAY, WASHINGTON 

RON WYDEN, OREGON 

RUSSELL D. FEINGOLD, WISCONSIN 

BILL NELSON, FLORIDA 

DEBBIE STABENOW, MICHIGAN 

BENJAMIN CARDIN, MARYLAND 

BERNARD SANDERS, VERMONT 

SHELDON WHITEHOUSE, RHODE ISLAND 

MARK WARNER, VIRGINIA 

JEFF MERKLEY, OREGON 

MARK BEGICH, ALASKA 

CARTE GOODWIN, WEST VIRGINIA 

JUDD GREGG, NEW HAMPSHIRE 

CHARLES E. GRASSLEY, IOWA 

MICHAEL ENZI, WYOMING 

JEFF SESSIONS, ALABAMA 

JIM BUNNING, KENTUCKY 

MIKE CRAPO, IDAHO 

JOHN ENSIGN, NEVEDA 

JOHN CORNYN, TEXAS 

LINDSEY O. GRAHAM, SOUTH CAROLINA 

LAMAR ALEXANDER, TENNESSEE 

MARY ANN NAYLOR, Majority Staff Director 

CHERYL JANAS REIDY, Minority Staff Director 

(II) 

iii 

C O N T E N T S 

HEARINGS 

Page 

August 3, 2010—A Status Report on the U.S. Economy ...................................... 1 

September 22, 2010—Assessing the Federal Policy Response to the Economic 

Crisis ..................................................................................................................... 71 

September 28, 2010—Outlook for the Economy and Fiscal Policy ...................... 165 

STATEMENTS BY COMMITTEE MEMBERS 

Chairman Conrad .............................................................................................. 1, 71, 165 

Ranking Member Gregg .................................................................................. 12, 78, 172 

WITNESSES 

Richard Berner, Ph.D., Managing Director, Co-Head of Global Economics, 

and Chief U.S., Economist, Morgan Stanley & Co., Inc.................................... 14, 19 

Alan S. Blinder, Ph.D., Gordon S. Rentschler Memorial Professor of Economics and Public Affairs, Founder and Co-Director, Center for Economic Policy 

Studies, Princeton University.............................................................................. 81, 85 

Douglas W. Elemdorf, Director, Congressional Budget Office ......................... 173, 177 

Simon Johnson, Ph.D., Senior Fellow, Peterson Institute for International 

Economics and Ronald A. Kurtz Professor of Entrepreneurship, Sloan 

School of Management, Massachusetts Institute of Technology ...................... 25, 28 

Joel L. Naroff, Ph.D., President and Founder, Naroff Economic Advisors, 

Inc. ......................................................................................................................... 34, 38 

John Taylor, Ph.D., Mary and Robert Raymond Professor of Economics, Stanford University, George P. Shultz Senior Fellow in Economics, The Hoover 

Institution ......................................................................................................... 128, 131 

Mark Zandi, Ph.D., Chief Economist, Moody’s Analytics ..................................... 91, 94 

QUESTIONS FOR THE RECORD 

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

(1) 

A STATUS REPORT ON THE U.S. ECONOMY 

TUESDAY, AUGUST 3, 2010 

U.S. SENATE, 

COMMITTEE ON THE BUDGET, 

Washington, DC. 

The Committee met, pursuant to notice, at 10 a.m., in room SD– 

608, Dirksen Senate Office Building, Hon. Kent Conrad, Chairman 

of the Committee, presiding. 

Present: Senators Conrad, Nelson, Sanders, Begich, Goodwin, 

Gregg, and Bunning. 

Staff present: Mary Ann Naylor, Majority Staff Director; and 

Cheri Reidy, Minority Staff Director. 

OPENING STATEMENT OF CHAIRMAN CONRAD 

Chairman CONRAD. The hearing will come to order. I want to 

welcome everyone to the Senate Budget Committee. We are going 

to be doing a series of hearings on the economy. This hearing is focused on the status of the economy now, how are we doing, where 

are things headed. We are going to do some followup hearings on 

what action we should be taking here in Washington to respond to 

the current economic conditions. So this will be the first in a series. 

I am delighted Senator Gregg is with us today, and I am going to 

begin with an opening statement. Then we will go to Senator Gregg 

for any remarks that he might want to make, and then we will go 

to our distinguished panel of witnesses. 

I think all of us know that we have just gone through the worst 

recession since the Great Depression. Economic growth in the 

fourth quarter of 2008 was actually a negative 6.8 percent; in other 

words, the economy was contracting at that point by more than 6 

percent. 

2 

In the first month of 2009, we actually lost 800,000 jobs, and unemployment was surging. The housing market crisis rippled 

through the economy. Home building and sales plummeted. We had 

record foreclosures. We had a financial crisis that threatened a 

global economic collapse, a lending lockdown, and we saw very severe effects throughout the financial sector. 

Let me just say I will never forget being called to a meeting— 

I believe Senator Gregg was there as well—when the Secretary of 

the Treasury and the Chairman of the Federal Reserve told us that 

they were going to be taking over AIG the next morning, and they 

told us that if they did not, they believed we would face a financial 

collapse in a matter of days. So this was an extraordinary crisis. 

We have just received a report from the economists Alan Blinder 

and Mark Zandi entitled ‘‘How We Ended the Great Recession.’’ 

With respect to the Federal Government’s response to the crisis, 

they say, in part, ‘‘We find that its effects on real GDP, jobs, and 

inflation are huge and probably averted what could have been 

called a ‘Great Depression II.’ For example, we estimate that without the Government’s response, GDP in 2010 would be about 6.5 

percent lower, payroll employment would be less by some 8.5 million jobs, and the Nation would now be experiencing deflation. 

When all is said and done, the financial and fiscal policies will 

have cost taxpayers a substantial sum,’’ they say, ‘‘but not nearly 

as much as most had feared and not nearly as much as if policymakers had not acted at all. If the comprehensive policy response 

saved the economy from another depression, as we estimate, they 

were well worth their cost.’’ 


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We can now look back at the economic performance. As I indicated, in the first quarter of 2008, there was a negative 6.8 percent; 

in the most recent quarter, the second quarter of 2010, a positive 

2.4 percent; but you can see in the fourth quarter of 2009, it was 

a positive 5 percent. So we are seeing the recovery decelerate. That 

has to be a concern to all of us. 


58156.137
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Going to the next slide, if we can, private sector jobs picture, as 

I indicated, in January of 2009 we lost over 800,000 jobs. In the 

most recent month for which we have figures, we gained 83,000— 

a remarkable turnaround, but well below where we need to be. 


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Let us go to the next slide, if we can. Unemployment remains 

stubbornly high at 9.5 percent. It is down from its peak but, nonetheless, too high. 


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If we go to the next slide, the housing slump continues. You can 

see the peak there. In January of 2006, we had 2.3 million housing 

starts on an annual basis. That was the peak. We are down dramatically off that peak to 549,000 in June of 2010. 


58156.140
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The next slide is a USA Today story headlined, ‘‘Expect lots of 

layoffs at State and local levels; Tight budgets, lack of Medicaid 

help put governments in a bind.’’ All of us know the States, most 

of them have a balanced budget requirement. So when there is an 

economic slowdown, revenue decreases, they are compelled to cut 

spending—in some cases cut it dramatically. 


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8 

The next slide is ‘‘Cuts in Europe stoke global fears; Britain and 

Germany plan drastic austerity measures that may hamper recovery in the United States.’’ I also want to indicate in my contacts 

with business leaders across the country, they tell me that the financial crisis in Europe has had a notable effect on the economy 

here; that is, they have told me, almost without exception, that the 

recovery was going quite well until the European debt crisis hit, 

and that has slowed economic growth here, and it certainly has affected those countries as well. 


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If we look at the deficit, we see that under the President’s proposal the deficit will come down quite sharply over the next 5 

years, but not sharply enough in the judgment of many of us. Most 

concerning to me are the years beyond the next five, where we see 

the deficit again rising. That cannot be the course for the country. 

That is why the fiscal commission has been put in place to come 

up with a long-term plan to deal with deficits and debt. But what 

has been outlined in the President’s budget for the long term cannot be the course that we take. That would simply add too much 

to the debt, and we are going to have to face up to that, as shown 


58156.143
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in the next slide, because this is a longer-term by the Congressional Budget Office looking at 2010 and beyond, going out to 2054. 

And if we stay on the current course, we will have a debt that approaches 400 percent of the gross domestic product of the country. 

Now, let me state that again. If we stay on the current course, 

the Congressional Budget Office tells us by 2054 we will have a 

debt that will be 400 percent of the gross domestic product of the 

country. Nobody believes that is sustainable. Nobody believes we 

would not face a financial crisis well before 2054. 


58156.144
11 

Let me go to the final slide, which is the Chairman of the Federal Reserve Board saying that we need a credible plan to achieve 

long-term fiscal sustainability. Ben Bernanke, the Federal Reserve 

Chairman, on April 7th said to the Dallas Regional Chamber, ‘‘A 

sharp near-term reduction in our fiscal deficit is probably neither 

practical nor advisable. However, nothing prevents us from beginning now to develop a credible plan for meeting our long-run fiscal 

challenges. Indeed, a credible plan that demonstrated a commitment to achieving long-run fiscal sustainability could lead to lower 

interest rates and more rapid growth in the near term.’’ 


58156.145
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So that is the challenge before us. It is absolutely imperative 

that we develop a plan and implement a plan to face up to our 

long-term debt. 

With that, I want to go to our witnesses, start with Dr. Berner, 

if we just go left to right—ah, we are going to hear from Senator 

Gregg first. 

Senator GREGG. Trying to shut me off again. 

[Laughter.] 

Chairman CONRAD. I would never try to shut you off. I was so 

eager—honestly, I am so eager to hear from these witnesses. I was 

going to go to them and then maybe turn to you after the hearing 

was concluded. 

[Laughter.] 

Senator GREGG. That would have been perfect timing. Perfect 

timing. 

Chairman CONRAD. Senator Gregg. 

OPENING STATEMENT OF SENATOR GREGG 

Senator GREGG. First off, I appreciate the Chairman holding this 

hearing, and I especially appreciate this very exceptional panel 

that has been put together, and I look forward to hearing from 

them also. 

I also want to commend the Chairman for putting forth some 

stark numbers that are accurate, as he always does, and once 

again pointing out that the path that we are on simply is not sustainable as a Nation. I asked my staff was that—off the top of my 

head, I did not know the answer to this question—what the Greek 

gross debt to GDP ratio is, of course, Greece having basically defaulted and then been saved. And they said it was about 100 perVerDate Aug 31 2005 10:00 Jun 08, 2011 Jkt 000000 PO 00000 Frm 00018 Fmt 6633 Sfmt 6601 C:\DOCS\58156 SBUD1 PsN: TISH

58156.146
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cent. I am not sure if that is their public debt or their gross debt. 

But, anyway, your number of 400 percent for gross debt is a staggering number. We know our public debt goes to close to 100 percent during the timeframe that you have discussed there. 

Let me just take a more global view of the issue. I know our witnesses are going to take sort of a macro view. Let me—or a micro 

view. Let me take more of a macro view. 

If we look at what is happening here, we are seeing a new normal, as is the term used, I guess, by Mohamed El- Erian, in the 

way we work as a Nation and the way we function as a Nation. 

And I am not sure it is a good new normal because basically we 

are taking American exceptionalism, which I believe has always 

been uniquely founded on the basis of fiscal responsibility, individual entrepreneurship, and the capacity of the country to grow as 

a result of people taking risks and creating jobs, which require access to capital and access to credit which was reasonably available 

at a fair price, and we have contracted all of this. We are contracting it because the Government is growing so far. The Government has gone from 20 percent of GDP just 2–1/2 years ago to now 

it is 24 percent of GDP; it is projected to go to 26 to 27 percent 

of GDP. Historically, it has always managed to be in the range of 

19 to 20 percent of GDP since the end of World War II. 

Even if our revenues recover to their historic levels—and it appears they will; in fact, under the President’s budget it looked like 

they will exceed our normal levels, the normal level of revenues 

being about 18.2 percent of GDP; the President is projecting they 

will go to 20 percent within 3 years—we cannot fill this gap. We 

cannot fill this gap because the Government has simply grown too 

much. And the question is: How do we bring the Government back 

down? But how do we do it in a way that does not stifle this recovery to the extent we are having recovery? 

That really becomes a very complicated two-step event for us as 

people who are the keepers of fiscal policy and for the keepers of 

monetary policy, because if we act precipitously to try to control the 

deficit, do we end up stifling the recovery? But if we do not act soon 

enough or put in place a reasonably acceptable plan which is perceived by the markets, both internationally and domestically, as legitimate to bring down the long-term debt, then do we aggravate 

the capacity to get a short-term recovery also? Because I happen 

to believe a short-term recovery depends on the markets, and specifically the marketplace, Main Street believing that we are going 

to get our fiscal house in order. But in getting it in order, how do 

we do it in a way that does not also dampen this slow recovery? 

So these are the complicated policy issues we face, and I would 

be interested to hear from our witnesses as to what they think. 

What can we do in the short term on the deficit, or what should 

we do, and what must we do in the long term on the deficit in 

order to give ourselves viability as a Nation that we are going to 

be serious about the fiscal insolvency of our country and, therefore, 

our recovery? 

So I look forward to hearing from our witnesses on whatever 

they want to talk about, but hopefully on these topics. Thank you. 

14 

Chairman CONRAD. I thank the Senator for his very good opening 

statement. Really, I agree with the way he has framed it. I think 

he has framed it very, very well. 

Before we turn to the witnesses, I also want to welcome the newest member to this Committee, Senator Goodwin of West Virginia, 

who is here. We very much regret the passing of Senator Byrd, who 

was a giant in the Senate, a valuable member of this Committee. 

But we are delighted that Senator—— 

Senator GREGG. Who wrote the bill that created this Committee. 

Chairman CONRAD. Wrote the bill that created this Committee, 

and many of the rules under which we operate. We are delighted 

that Senator Goodwin has agreed to join this Committee. Senator 

Goodwin, we look forward very much to working with you. This 

Committee has a heavy responsibility, and based on what I have 

seen of your past and your conduct as a new Senator, you will be 

up to the responsibilities that this Committee faces. Welcome. We 

are glad to have you here. 

Senator GOODWIN. Thank you. 

Chairman CONRAD. Next we will turn to our witnesses: Richard 

Berner, the managing director and co-head of Global economics, 

chief U.S. economist at Morgan Stanley; Dr. Simon Johnson, a senior fellow at the Peterson Institute for International Economics and 

a professor of entrepreneurship at MIT’s Sloan School of Management; and Dr. Joel Naroff, the president and founder of Naroff Economic Advisers. I hope I am pronouncing your name correctly, Dr. 

Naroff. 

Mr. NAROFF. That is correct. 

Chairman CONRAD. Great. 

Dr. Berner, welcome. Please proceed. 

STATEMENT OF RICHARD BERNER, PH.D., MANAGING DIRECTOR, CO-HEAD OF GLOBAL ECONOMICS, AND CHIEF U.S., 

ECONOMIST, MORGAN STANLEY & CO., INC. 

Mr. BERNER. Chairman Conrad, Ranking Member Gregg, and 

other members of the Committee, thank you for inviting me here 

to discuss the state of the U.S. economy and, with your permission, 

also to talk a little bit about what policymakers can do to improve 

it. 

First, a status report on the economy. As you noted, Mr. Chairman, we have emerged very slowly from the worst financial crisis 

since the Great Depression. But the legacy of that crisis is scattered across the landscape, and you noted some of the things that 

are important. I would add that one in four homeowners with a 

mortgage owes more than their house is worth. Lenders are still 

hesitant to lend to or refinance many borrowers. The process of 

cleaning up lenders’ and household balance sheets is incomplete, so 

additional, steady progress is required to achieve a sustainable recovery. 

Likewise, headwinds from the crisis linger. GDP is still 1 percent 

below its peak of 2 years ago. Federal, State, and local budgets are 

strained, as you noted. A faster pace of job and hours gains is required to generate needed income and also consumer confidence. 

This subpar recovery has left housing vacancy rates and the unemployment rate high, and other measures have slackened the 

15 

economy high. So there is a ‘‘tail risk’’ that inflation could sink too 

low and turn into deflation. While I see signs of a bottoming in inflation at low rates, not deflation, we cannot take that outlook for 

granted. 

What about the outlook for our economy? Nonetheless, despite 

those problems, moderated but sustainable growth of about 3 to 3.5 

percent through 2011 is likely. Now, I would note that is still pretty tepid for the first couple of years of a recovery, but four factors 

underpin that view. 

First, the shock from the European sovereign debt crisis that you 

noted earlier has begun to fade, and financial conditions over the 

past several weeks have improved, and that is essential for growth. 

Second, and more broadly, global growth, especially in the big 

emerging market countries where domestic demand is now strong, 

is still hearty. We expect global growth to be 4.7 percent this year, 

4.2 percent next year. And, for example, although the Chinese 

economy has slowed in respond to restraints on lending and tighter 

monetary policy, growth is still strong. We estimate it is slowing 

from about 10 percent this year to 9.5 percent next year. 

Third, the ongoing revival in job and income gains, although 

modest, will provide income gains sufficient to sustain 2 to 2.5 percent consumer spending growth. Now, that is a big step-down from 

the past but nonetheless sustainable. And we expect data this Friday to show that hours and payrolls improved somewhat in July. 

And, finally, infrastructure spending, the last part of the fiscal 

stimulus enacted in 2009, is now starting to gain steam. 

Five aspects of the recent data that we saw from our national income accounts I think support that reasoning. 

First, domestic demand accelerated in the second quarter to over 

4 percent. That pace is not sustainable, but I think around 3 percent probably is, and it is likely. 

Second, we have seen the personal saving rate ramp up very significantly, suggesting that American consumers have rebuilt their 

saving and balance sheets by paying and writing down debt more 

than previously thought. Most important, underlying income 

growth in the revised data that we got last week is now stronger. 

So I think the consumers will spend more of that income in the second half of the year. 

Third, a wider trade gap was a drag on growth in the first half, 

but I see signs that it is likely to narrow as global growth persists 

and U.S. producers satisfy more global and domestic demand. 

Fourth, the rebound in profitability has been sharper than expected, and peak profit margins still lie ahead. So businesses now 

have the wherewithal to replace worn-out equipment, and they are 

spending money on those things to do it. 

And, finally, inflation measured by the Fed’s preferred gauge of 

the core personal Consumer Price Index has run at about a 1.4-percent pace over the past year—still very low, but a couple of tenths 

higher than previously thought. And with rents now firming in 

apartments and elsewhere, those revisions reinforce our conviction 

that inflation is now bottoming and that the deflation scare will be 

just that—a scare. But there are obvious risks to any scenario, and 

I would mention two that are important to me. 

16 

First, it remains in housing. In addition to the payback following 

expiration of the first-time homebuyer tax credit, the downside 

risks to home prices, mortgage credit availability, and housing demand are still present. 

Second, policy and political uncertainty. We think increased uncertainty around taxes and the implementation of health care and 

regulatory reform is a key reason that consumer confidence slipped 

in the last couple of months. It is not the only reason, but I think 

it is an ingredient. 

In the rest of my time, I would like to discuss some policies that 

Congress might consider to improve the outlook for housing and 

employment, two key areas that need attention, and thus the overall economy. 

First, housing. As I noted when I testified before this Committee 

in January 2009, mitigating foreclosures is necessary to stem the 

slide in house prices, slow credit losses, and reduce the pressure on 

household wealth. But neglect in the past 18 months has created 

two related, additional risks. The first is from accelerating strategic 

defaults, which are now 18 percent of total defaults. These are borrowers who can pay but who are so far under water they choose 

to mail the keys back to their lenders. In addition, high loan-tovalue ratios, appraisal problems, unemployment, and low credit 

scores block refinancing opportunities. 

I think the best options for relief continue to be simple, act 

quickly, and spread the pain broadly. Unfortunately, one program, 

the Home Affordable Modification Program, or HAMP, has fallen 

short. 

Two policy changes announced in March—a new ‘‘earned principal forgiveness’’ initiative, and the short refinance program 

through the FHA—could help. Earned principal forgiveness gives 

the borrower a strong incentive to stay current on modified payments by turning a portion of initial principal forbearance into 

principal forgiveness for each year the borrower stays current. 

These programs should be strengthened. They are not working 

because the language in the forgiveness modification rules is weak, 

and the FHA short-sale program continues to be advertised as 

being de minimis, with lenders pushing back on both. 

Another proposal to enable borrowers to refinance Governmentguaranteed mortgages comes from my colleague David Greenlaw. 

Senator Gregg, I would note that Mr. Greenlaw hails from the 

great State of New Hampshire. The Government has guaranteed 

the principal value of the 37 million mortgages are backed by the 

agencies. There would be no credit risk for a mortgage originator 

who agreed to refinance these mortgages if the Government guarantee was extended to refinanced loans. I will not go into details. 

We can provide those to you. But Dave estimates that households 

would save $46 billion annually if half the mortgages among these 

37 million were refinanced. 

What about policies to improve employment? Private nonfarm 

payrolls obviously have been flat over the past year, much less 

than we would hope. And clearly, much of that weakness is cyclical, related to the tepid state of the recovery. 

In our view, however, there are four structural components also 

at work. One is the cost of labor resulting from the escalation of 

17 

benefits. The problem is that thanks to that high fixed costs of 

health and other benefits or labor costs are of line with other countries when adjusted for living standards. I say fixed because benefit 

costs do not vary with hours worked; they are paid on a per worker 

basis. So as employers seek to cut the cost of compensation in 

tough times, these benefit costs drive a growing wedge between 

total compensation and take-home pay and continue to escalate the 

cost. The recession made that wedge bigger, leaving benefits intact. 

Long-term solutions include implementation of health care reform to save costs and, of course, innovation to boost productivity 

and labor skills. The Affordable Care Act will possibly realize cost 

savings through Medicare, but more work is needed to reduce the 

soaring costs of health care for employers and employees alike. 

Short-term remedies: Perhaps a refundable payroll tax credit, we 

have one of those, but more aggressive implementation might be 

helpful. 

The second obstacle is a mismatch in skills. The problem is that 

for years employers have complained that they do not find the 

skills they need in today’s work force. Long-term solutions include 

policies that keep students in school and improve access to education, reorientation of our higher educational system toward specialized and vocational training and community colleges, and immigration reform. 

In terms of short-term remedies, beyond unemployment insurance, one remedy would pair training and basic skills that are 

needed for work with income support. Two other groups seeking 

employment—newly minted college students and unemployed 

teachers perhaps—could be an ideal nucleus for a Job Training 

Corps that would empower job seekers with new skills. 

The third obstacle is related to housing: labor immobility. Negative among a Nation of homeowners leads to substantially lower 

mobility rates—one-third less, according to one study. Long-term 

solutions obviously include some of the ones I have outlined before. 

Short-term remedies beyond the ones I talked about would include 

an effort to establish a protocol for short sales and/or principal reduction, which should be a useful tool. 

And the last obstacle is the policy uncertainty factor I mentioned 

above. Obviously we need to solve our long-term challenges, but the 

uncertainty around the implementation of the legislation and the 

solutions we have adopted I think is to some extent weighing on 

business and consumer decisions to hire, expand, buy homes, and 

spend. 

I can tell you as somebody who works in financial markets that 

market participants are used to thinking that political gridlock is 

good because it keeps politicians from interfering with the marketplace. Well, today gridlock is more likely to be bad for markets, as 

our long-term economic problems require solutions with political 

action. 

Long-term solutions obviously require bipartisan leadership, and, 

Mr. Chairman and Ranking Member Gregg, your work as Commissioners on the deficit reduction commission is obviously critical. I 

know you agree that crafting a long-term credible plan, as you just 

mentioned, to restore fiscal sustainability will ease concerns and 

18 

uncertainty about future tax hikes and the potential loss of our 

safety nets. 

In addition, reducing policy uncertainty now could be a tonic for 

growth, offering investors a chance to reassess the fundamentals 

again. For example, we assume that Congress will agree to a 1- 

year extension of all expiring tax cuts and other provisions. Doing 

so should reduce uncertainty as well as sustain fiscal stimulus. Obviously, the sooner such action is implemented, the sooner the reduction in uncertainty can be achieved. 

Mr. Chairman and members of the Committee, we have many 

challenges ahead. Our short-term challenge is obviously to enhance 

the odds for a more vigorous, and our long-term challenge to promote a sustainable fiscal policy and to reform our entitlement and 

other programs that represent claims on our future resources. 

Thank you for your attention and for the opportunity to offer advice. I would be happy to answer any questions you may have. 

[The prepared statement of Mr. Berner follows:] 

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Chairman CONRAD. Thank you very much, Dr. Berner. 

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

STATEMENT OF SIMON JOHNSON, PH.D., SENIOR FELLOW, PETERSON INSTITUTE FOR INTERNATIONAL ECONOMICS AND 

RONALD A. KURTZ PROFESSOR OF ENTREPRENEURSHIP, 

SLOAN SCHOOL OF MANAGEMENT, MASSACHUSETTS INSTITUTE OF TECHNOLOGY 

Mr. JOHNSON. Thank you very much, Senator. 

Compared to Mr. Berner, I think I am somewhat more pessimistic about our immediate prospects. I am also much more worried about policy and our ability to put in place effective countermeasures. 

I would have suggested we frame our discussion of the U.S. economy in the following rather stark terms: If you look at the latest 

numbers from the BEA and compare the first quarter of 2006 real 

GDP with the latest quarter, second quarter of 2010, real GDP has 

hardly changed. So we are on track, if we are pessimistic about the 

second half of this year, to experience essentially a lost half decade 

of growth in the United States. And I think this should remind us 

all of the lessons from Japan. I am not in the camp of thinking that 

we are going to enter into a Japanese-type deflation. But in terms 

of the damage that has been done to balance sheets, for example, 

of homeowners, the latest data there suggests around 20 percent 

of all homeowners still have negative equity, and this percentage 

has not declined much over the last four quarters. So the damage 

remains there, and I think you see this in the latest consumption 

data that came out today. Consumption is unlikely to rebound 

quickly. 

Our corporates, of course, have stronger balance sheets in the 

United States, but my experience talking to CEOs and CFOs in the 

U.S. and also from global companies is that they want to be careful 

now, that the big shock and the massive uncertainty that everyone 

experienced over the last 2 years was very much about the credit 

system, and most corporate leaders do not want to rely on borrowing and do not want to extend themselves and hire, obviously, 

as much as they would have done in the past. So, again, I think 

this undermines and slows growth. 

And, of course, on top of this we have the sovereign debt crisis 

and pressure toward austerity, which is most manifest in Western 

Europe, but we see it in other countries also. The ‘‘withdrawal of 

fiscal stimulus’’ is the term often used by the IMF now. This is 

prevalent around the world. 

I was just recently in China, and talking to some of the leading 

economists there, I was struck that they are the least bullish 

economists on China that I meet anywhere in the world. They were 

very much about the need for cutting back on their expansion programs. They were very worried about the waste of Government 

funds in infrastructure, and I can share more details with your 

staff if you are interested. 

My bottom line is that I think global growth on a fourth-quarterover-fourth-quarter basis—I think Mr. Berner’s data were annual 

26 

averages, but I am using Q4 over Q4. I think the global economy 

will struggle to break 4 percent this year. I think next year should 

be a little bit better. I am not calling at all for stagnation, but I 

think slow growth is going to be with us for a while, both globally 

and in the United States. 

The second point I would like to make is that while I completely 

agree with what both you, Senator Conrad, and you, Senator 

Gregg, said at the beginning about our longer-term fiscal issues— 

and, of course, the very careful and excellent analysis done by the 

Congressional Budget Office on these issues—I am very concerned 

that a major fiscal issue is completely missing from this discussion. 

This is the contingent liabilities created by our financial sector and 

the risks that, in my opinion and in the opinion of many, are 

caused by the continued existence of undercapitalized banks that 

have an incentive to take very big risks and that are, in the language that some people like, ‘‘too big to fail.’’ 

And this is a problem, obviously, in the United States. It is not 

unique to the United States. We will see it in Western Europe. But 

it is a very big fiscal issue in the U.S., and you can see this again 

from the CBO’s numbers. Compare the baseline that they put out 

in January of this year with the January 2008 numbers, and look 

at the projected debt level, net debt as a percent of GDP for 2018. 

It is 40 percentage points of GDP higher now than it was in the 

2008 projection, and you can decompose that increase in debt. You 

can see where the deficit comes from. It is mostly from the lost tax 

revenue due to the recession. There is a small part, about 17 percent, that comes from the discretionary fiscal stimulus, which I am 

sure we will have a discussion about. But with or without that discretionary stimulus, you still would have had a massive hit to the 

budget and to the debt from the lost tax revenue and, of course, 

the increased interest payments on top of the debt because the debt 

has increased. And this is assuming a low rate of interest. 

If the more difficult fiscal scenarios that you, Senator Conrad 

and Senator Gregg, were outlining in the beginning start to play 

out, we should expect an increase in long-term interest rates, 

which presumably will increase the debt even further. 

Now, we can obviously have a discussion about the extent to 

which the Dodd-Frank legislation has addressed these risks. I 

think it was a step in the right direction but did not go far enough. 

But surely we will agree, I think, in that discussion that these 

risks have not gone to zero, and the CBO’s methodology consistently across different kinds of problems, whether or not they are 

demographic or, for example, the way they treat the U.S.’ commitment to the International Monetary Fund, which is essentially a 

line of credit, and we actually spend money out of the budget only 

with some hopefully low probability. There is a budget scoring for 

that, and I think the two of you were leaders in insisting that the 

CBO score that appropriately. 

Well, we are not scoring in the budget, according to the CBO 

methodology, and I think as discussed by Congress, in any way a 

contingent liability, the damage to the Government budget that 

would arise from a future financial crisis. 

Now, we can, of course, argue about how frequently those crises 

occur, but leading people in the financial sector, including Mr. 

27 

Dimon, the head of JPMorgan Chase, and Mr. Paulson, former Secretary of the Treasury and former head of Goldman Sachs, say 

these crises occur on a 3- to 7-year time horizon. So this is all within your short- to medium-term framework, Senator Conrad, and 

that is why I worry that many of Mr. Berner’s ideas, which are 

very sensible ideas taken individually, if I look at them together 

and consider that alongside this danger to the budget coming from 

the short term, I am very concerned about our scope for action. 

I do completely agree, I think, with all of you that over the 

longer term we must act, and the good news there, compared to 

other countries—and I was formerly chief economist at the IMF, so 

I look at these numbers very much in a comparative framework, 

including the Greek numbers, Senator Gregg, which I have right 

here if you are interested. My point would be there is some good 

news, which is that we have plenty of capacity for tax reform in 

the United States. Our tax system is relatively antiquated. It could 

be modernized fairly easily. I have some proposals in here. Many 

of the best ideas come from Greg Mankiw, former head of the 

Council of Economic Advisers under President George W. Bush. I 

see the beginnings of a bipartisan consensus at the technical level 

on tax reform issues that will, I think, generate somewhat more 

revenue than Senator Gregg was anticipating if we look out beyond 

a decade. 

Medicare, though, remains a huge problem, and I think that is 

the most difficult issue, and I think that is much more about ethics 

and about arithmetic than it is about economics, because the question of how much you are willing to pay for people who are relatively late in life is a very difficult and obviously emotional question. On that I agree the conversation has not moved forward very 

much over the past 2 years. 

The good news, though, is we do not face imminent fiscal crisis. 

We have time to make those decisions. We should deal with them 

now, as you gentlemen are already doing, and we should also deal 

with this issue of the contingent liabilities posed by, unfortunately, 

a still dangerous financial sector in this country. 

Thank you very much. 

[The prepared statement of Mr. Johnson follows:] 

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Chairman CONRAD. Thank you, Dr. Johnson. 

Now I will go to Dr. Naroff. Again, welcome to the Committee. 

Please proceed with your testimony. 

STATEMENT OF JOEL L. NAROFF, PH.D., PRESIDENT AND 

FOUNDER, NAROFF ECONOMIC ADVISORS, INC. 

Mr. NAROFF. Thank you, Chairman Conrad, Senator Gregg, 

members of the Senate Budget Committee. Thank you for the opportunity to discuss my views on the status of the economy and to 

provide some ideas on the direction that fiscal policy should take. 

The good news is that we have had one full year of economic 

growth, and the economy did expand by about 3.2 percent, which 

is pretty impressive given the problems that we faced over this period of time. Consumers have started spending again, though instead of ‘‘shopping ’til they drop,’’ they are really ‘‘shopping ’til they 

are tired’’ at this point. Business investment, which had collapsed 

during the recession, has made a strong comeback. Exports are 

solid, inventories are being rebuilt, and workers are being rehired. 

All these factors indicate, at least to me, that the recession is over. 

However, I am in the camp that is extremely concerned about 

growth over the next year. I believe that the economy, as Dick 

Berner said, will face a significant number of significant headwinds 

and that the damage done from the bursting of both the housing 

bubble and the near collapse of the international financial system 

cannot be cured in a relatively short period of time. 

While the banking industry is better, it is hardly in good condition. Bank failures this year are running at twice last year’s pace. 

Larger institutions are concentrating on rebuilding capital, not 

adding to their loan books. Credit, while slowly becoming more 

available, is still very limited. 

Bankers like to say that they are not turning down good loans. 

They are correct. But the devil is in the definition of a ‘‘good loan.’’ 

Credit decisions require reviewing in the past few years of corporate financials, and since many firms had to deal with that kind 

of economy, not many had stellar results over that period. Therefore, good credit risks are very hard to find. 

Unless the expansion is stronger than I expect, credit standards 

may not ease significantly for at least another 12 to 18 months. 

And given that the economy runs on credit, it is hard to see how 

growth could surge. The housing sector will also continue to restrain activity, possibly through 2011. 

There are too many challenges to overcome. First, it is ‘‘back to 

the future’’ when it comes to mortgage credit standards. The days 

of ‘‘no docs’’ and little or nothing down are over, thankfully. But 

that means fewer people will qualify for mortgages. 

But maybe more important is the loss of equity many homeowners have suffered, and that has been discussed a lot here. But 

the point in terms of housing demand is that, without rebuilding 

that equity, a smaller number of households are actually going to 

have the ability to make downpayments on additional homes, and 

without being able to do that, they are not going to be able to 

move. 

The diminution of demand is but one factor in the dismal forecast for new residential construction. There is also the foreclosure 

35 

crisis. Foreclosures are greatest in those parts of the country where 

construction has typically been strongest: California, Arizona, Nevada, and Florida. As long as builders face the competition of large 

numbers of relatively low-priced foreclosed units, new construction 

activity will be limited. 

The weak home construction recovery is especially worrisome because in previous upturns housing either led the recovery or within 

one quarter was once again growing robustly, often in double-digit 

rates. I do not expect that to happen now. 

So, where can growth come from? Normally, we look toward the 

consumer, who makes up about two-thirds of the economy. Indeed, 

except for the 2001 recession and recovery, consumers returned to 

the malls early, after the downturn ended. This time the upturn in 

consumption is being delayed. 

There are good reasons for households to be cautious and consumer confidence to be depressed. Two decades ago, workers believed that if they did well, their positions were safe. They defined 

‘‘job security’’ as the ability to work for one firm possibly for their 

entire careers. 

But businesses learned that in a globalized economy, productivity 

and cost containment are critical to long-term survival, and workers are, unfortunately, largely overhead. The employment compact 

between businesses and workers was broken. 

What has replaced this relationship? Several years ago I argued 

we should redefine ‘‘job security’’ as the ability to walk across the 

street and get another job.’’ In other words, job security is having 

a robust job market. People will feel comfortable about their economic situation when they can sell their labor easily and not feel 

they are stuck in their current position or with their current employer. 

This new definition has critical implications. Since labor is the 

largest expense for businesses, there must be tight controls over 

payrolls. You do that by limiting hiring and wage gains. In the 

early part of the recovery, that strategy allows profits to rise. The 

combination of modest payroll gains and rising earnings, though, 

has created a disconnect between Main Street and Wall Street. 

Firms will remain hesitant to hire until they believe the economy 

will expand strongly for an extended period of time. That creates 

a troubling cycle. If companies limit hiring, then workers, who define job security as the ability to get a new job, will be worried, and 

consumer confidence will remain low. And depressed workers do 

not usually spend lavishly. 

The cycle of sluggish spending and limited private sector job creation will be broken, but not until the expansion lengthens, becomes broader-based, and corporate balance sheets improve. Payrolls should continue rising as they have this year, but the increases are not likely to be large enough to rapidly reduce the unemployment rate. 

It should not be a surprise that we are having a jobless recovery. 

The reality is that the last couple of recoveries and most future recoveries will be defined by slow job growth. The perception that upturns lead to an immediate surge in jobs is an anachronism, popularized when we were a largely manufacturing economy. The massive industrial sector that created lots of jobs early in the recovery 

36 

by rapidly ramping up output and hiring is history. And as we saw 

with the latest GDP report, when our economy expands, we feed 

the growing economic needs with products not only from U.S. companies but with good produced around the world. We should stop 

using the phrase ‘‘jobless recovery’’ because it is normal that recoveries begin with anemic job growth. 

With employment and income growth modest and consumers uncertain, it is not a great leap to expect only moderate consumption 

growth over the next year. It should be enough to keep the economy going, but that is about all. 

If consumers are not spending lavishly, can business investment 

remain robust? Spending for software and equipment soared over 

the past three quarters. However, that too may change. 

From the summer of 2008 through the spring of 2009, firms dramatically reduced capital spending. More recently, businesses have 

started making up for the failure to invest in capital required to 

remain competitive and on depreciation. But that activity is just 

infilling delayed investments. Once that process is completed, firms 

will invest only when they believe their returns warrant the costs. 

Currently, it is hard to rationalize major new purchases of software, equipment, or structures if the economy is not expected to 

grow solidly. Uncertainty about tax policy is not helping either. As 

a consequence, investment could be limited to replacement and 

competitive factors. All this argues for decent but not spectacular 

gains in capital spending. 

Similarly, the inventory rebuilding that added greatly to GDP 

growth is likely over. In 2009, firms reduced inventories at a 

breathtaking but excessive pace. This year, they have been refilling 

their empty warehouses. Once more reasonable levels are reached, 

firms will need only to replace depleted stocks rather than refill 

emptied shelves. 

Can exports save the day? Yes, there have been strong gains in 

exports, and that should continue. However, as the recovery continues, imports will also grow faster. And I expect the trade deficit 

to widen further, and that will restrain growth. 

So let me summarize. We are facing a lack of credit, a stuck-inthe-mud housing market, an uncertain and cautious consumer, a 

wary business community that has already largely restocked empty 

warehouses, infilled depleted work forces, and replaced depreciated 

equipment and software, as well as a widening trade gap. And I 

have not even talked about the State and local governments that 

are cutting back dramatically. 

Without changes in fiscal or monetary policy, my forecast next 

year for growth is in the 2- to 2.5-percent range. This may appear 

to be modest, but we should not compare the pace with the past 

two decades when strong growth was closer to 3.75 percent. Over 

the past 20 years, the economy was hyped by the 1990’s tech bubble and the 2000’s housing bubble. Massive and excessive amounts 

of resources flowed to those sectors, creating outsized growth rates. 

Without another bubble, more moderate growth is likely, so do not 

evaluate this recovery on the basis of two artificial bubble-hyped 

expansions. Instead, look at what is now possible and, that is, a 

slow but steady recovery. 

37 

It is in this context of a badly weakened, slowly recovering economy that the structure of fiscal policy must be determined. While 

monetary policy is always evaluated on the basis of where we are 

in the business cycle, fiscal policy seems to be viewed in a vacuum. 

Fiscal policies are often proposed as if the impacts are the same regardless of the condition of businesses, households, or even the 

Federal budget deficit. 

I believe that policies intended to grow the economy should always be evaluated on the basis of whether they makes sense in the 

context of the current economic circumstances and where we are in 

the business cycle. Tax cuts should not be implemented—or should 

be implemented and retained only to the extent that they produce 

new growth and set the stage for further economic activity. Spending increases should be implemented only if they can quickly and 

efficiently increase domestic demand. 

We are moving from an economy that lacked demand to one 

where demand is growing slowly. We need to take that to the next 

level where businesses expand sharply, that implies phasing in the 

schedule of policies that meet the changing economic conditions. 

Thank you for your time. 

[The prepared statement of Mr. Naroff follows:] 

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Chairman CONRAD. Thank you, Dr. Naroff. 

Let me just go right to it, if I could. Obviously, there is a debate 

going on here about what is the correct fiscal policy to pursue now. 

I think the three of you have outlined in significant detail the economic conditions we confront now. The question for us is: What do 

we do about it? And the debate, to boil it down simply, is on the 

one hand there is a camp that says you should provide more stimulus to the economy. The very distinguished economist Paul 

Krugman says you have got to provide more stimulus. He recommends that we provide more aid directly to the States through 

FMAP and other provisions, perhaps do more in terms of infrastructure. 

On the other side are those who say, look, we have got record 

deficits and debt now; you have got to take immediate steps to reduce deficits and debt now, so no further stimulus. 

Dr. Berner, what would your recommendation be to us in terms 

of what course to pursue? 

Mr. BERNER. Well, Senator, thanks for the question. As I indicated earlier, I think we have a number of specific problems, and 

I think that we ought to address our policies more specifically to 

address those problems. And one of the biggest problems that I 

think all of us have talked about here today involves housing and 

housing finance and the state of balance sheets, the negative equity 

position in which many mortgage borrowers find themselves. So 

cleaning those problems up, mitigating those problems, really does 

involve fiscal policy. And, in effect, we are using fiscal policy currently to do that. So the losses incurred on agency-backed mortgages from Fannie and Freddie, the taxpayer, you and I are paying 

for that as those losses occur. 

The problem with that strategy is simply letting the foreclosures 

occur, letting the defaults occur, including the strategic defaults 

that I mentioned earlier, is that slow motion process really inhibits 

growth, it creates uncertainty, it prolongs the adjustment in housing and, by extension, in consumer balance sheets and, therefore, 

has a big impact on consumer spending and threatens further 

downside risks to home prices. 

Chairman CONRAD. So if I can say, from your testimony, you 

would be for more aggressive intervention to prevent foreclosures 

and to try to close this gap between some 20 percent the people are 

upside down in their mortgages. 

Mr. BERNER. Well, Senator, some foreclosures are not preventable, but the point here is that we want to try to mitigate those 

which are preventable, and we want to give an opportunity, as I 

indicated, with some ideas to allow homeowners to refinance where 

the only barrier is the refi process, where we have already got the 

responsibility and the liability on the Federal balance sheet for 

those mortgages that might default since they are backed with the 

full faith and credit of the Federal Government to allow them to 

reap the benefits of lower mortgage rates today, and they are not 

so doing; and, in addition, to accelerate the process of bringing borrowers and lenders together through proposals like the earned 

principal reduction or forgiveness program so that lenders have a 

performing asset which is not now performing, and the borrower 

can stay in their home with a reduced payment with some expectaVerDate Aug 31 2005 10:00 Jun 08, 2011 Jkt 000000 PO 00000 Frm 00051 Fmt 6633 Sfmt 6601 C:\DOCS\58156 SBUD1 PsN: TISH
46 

tion that they will share—maybe not gather completely—in any 

stability or upside from future home price appreciation. And I 

think that is the problem, that is why we have strategic defaults, 

because people do not have that expectation and they will not 

share in that future price appreciation if, in fact, it materializes. 

The policies that we are pursuing today practically guarantee that 

that appreciation is way, way off in the future. The policies that 

I am recommending would mitigate that, speed up the process, and 

reduce the imbalances in housing. 

The other things that I talked about also do involve fiscal policy. 

So, for example, if we were to start a job training corps, as I recommended, to bring together people who had skills with those who 

lack them, that is going to cost some money. But instead of giving 

people pure transfers, unemployment insurance, which is certainly 

needed in many cases, it puts money in the hands of people and 

gives them activities which are productive, which increase training, 

and which offer a lot more dignity to those activities. 

So those are some of my suggestions. 

Chairman CONRAD. Dr. Johnson, what would your advice be to 

us on what we do now? 

Mr. JOHNSON. Senator, obviously the risk that we face in terms 

of how the financial markets see our Government debt is whether 

there is a better alternative out there. We have benefited greatly 

from the fact that while we are not in particularly good shape, the 

rest of the world is struggling—certainly those parts of the world 

that issue large amounts of government debt. But I think it is dangerous to assume this is going to continue indefinitely or even continue necessarily into next year. The Europeans are getting their 

act together. I do not expect high growth there, but they may well 

be offering debt at the euro level, for example, by this time next 

year that could be regarded as relatively appealing. And if we see 

that sort of opportunity out there, I think you will see shifts in 

international portfolios. I think some of the foreign holders of our 

debt—as you know, about half of our debt outstanding is now held 

by foreigners one way or another. They could shift away from the 

U.S., and we would have an increase in interest rates. 

The best way to get ahead of this, in answering your question, 

is to undertake now measures that credibly reduce the deficit 10 

or 15 years down the road, which would be, for example, tax reform 

or some form of Medicare reform, if you can deal with that. That 

should lower interest rates. You are reducing the risk on our debt, 

and that would create what the IMF likes to call fiscal space that 

you could choose either to pay down debt or not run up a larger 

deficit, or you could put that into shorter-term stimulus programs. 

But I am afraid where we are today, while I am sympathetic to 

many of the constructive ideas that we have heard today and we 

are hearing elsewhere that would be trying to stimulate the economy, I would caution against doing it without a medium-term fiscal 

consolidation framework. That would never be what the IMF advises. Obviously, the IMF does not provide advice to the U.S. in 

this kind of context. But I think that is a sound principle that the 

U.S. uses when it talks to other countries and the IMF uses when 

it talks to other countries, and we should use it for ourselves. 

47 

Chairman CONRAD. So the debt commission that Senator Gregg 

and I serve on, the success of that commission in your mind takes 

on even more importance given the current economic condition? 

Mr. JOHNSON. Absolutely. I think that the deficit commission and 

related—any other initiatives along those lines is the key to being 

able to provide shorter-term stimulus in creating scope for whatever kinds of measures you think would be suitable for the economy over a shorter timeframe. If you do not address the mediumterm fiscal framework, then all of these additional measures are 

substantial risks, in my mind. 

Chairman CONRAD. Dr. Naroff? 

Mr. NAROFF. I look at the idea of fiscal policy in terms of a continuum rather than a specific set of policies. And, you know, if we 

go back to early 2009, you probably could have cut taxes to households and businesses all you want, but the return to those tax cuts 

would have been minimal because businesses and households were 

looking to survive rather than spend in any shape, form, or manner. That is the idea of where the fiscal stimulus made sense at 

that particular point. 

We are no longer at the point where businesses are not spending 

or households are not spending, so the extent of the fiscal stimulus 

I think has to be withdrawn, and that withdrawal needs to continue, which is already underway. And, therefore, we need to be 

transitioning from a situation where we are strictly looking at the 

demand side to I think we are at a phase at this point where we 

are looking to sustain some of the demand that is out there, but 

not nearly as heavily as we had. 

I think the key lesson that we did learn from the Great Depression from the 1930’s is that you cannot have a failed recovery. That 

is what extended those downturns. And I think that is, you know, 

the concept behind a lot of the arguments, we need significant 

amounts of stimulus at this point. I do not think we need significant amounts of spending at this point, but I think we have to 

move more toward the combination of sustaining elements of those 

spending, but only those that translate into demand immediately 

and then move toward the tax side of the policy, the supply side 

of the fiscal policy, which looks to generate some initial demand 

but starts the process of laying the foundation for stronger growth. 

I do not believe that we are going to be seeing a whole lot of activity through the interest sensitivity of businesses if we lower interest rates. I do not think that—well, I look at the levels of interest rates right now, and I find it hard to believe that we are going 

to go a whole lot lower than we are at this particular point. And, 

you know, businesses will be looking at, you know, what the conditions are to make those investments and the return on them, not 

just the costs. And I think what Simon is really saying, and where 

I agree, is that what you need to set up is the intermediate-term 

and long-term stability so businesses can begin the process of making those investments. But I think, you know, the rest of this year, 

those investments are going to be very, very cautious regardless of 

what the fiscal stimulus will be, whether it is tax cuts or low interest rates. And it is only as we move through really the first half 

of next year and maybe even into the second half of next year that 

we will get to the economic portion of the cycle where tax cuts can 

48 

become most effective on the business side. So I view it as a continuum in that respect. 

Chairman CONRAD. All right. Senator Gregg. 

Senator GREGG. Picking up on those comments and those of Dr. 

Simon, essentially what you are saying is that the uncertainty 

issue and to a significant extent the short-term stimulus issue will 

be addressed significantly if we put in place policies which address 

the long-term debt issue so that people have confidence in the outyears as to where the country is going on the issue of debt. Is that 

true? Is that a true summation of what you were saying? 

Mr. JOHNSON. Yes, Senator, that is exactly what I am saying. 

Senator GREGG. Can I ask a question, again following up on 

that? You all talked about this issue of consumption as being a big 

driver, and that has always been—our Nation has always been a 

consumer society. But I see this recession as substantively different 

than any other that we have been in for a lot of reasons, but primarily because the baby-boom generation, which is the defining 

economic engine of the 1960’s, 1970’s, 1980’s, and 1990’s—it was 

such a huge generation, so productive, driving so much of the 

wealth of the country—was right on the cusp of retiring when this 

recession hit. And a large percentage of the baby-boom generation 

retirement savings was in contributory savings as versus defined 

benefit plans. That shift had occurred throughout the 1980’s and 

1990’s. 

And so what happened here was that you had this huge generation, 70 million people, the population going from 35 million to 70 

million people, which suddenly found that all the money that they 

had saved for the purposes of retirement was significantly decreased in value, all their assets, by this recession. And now they 

are seeing some recovery of it, depending on how they were invested, but I think there is a fundamental mind-set shift in our Nation in this generation, which goes from consumption to savings to 

try to deal with the retirement they are into or about to start. But 

you are not going to see the consumerism that dominated our culture when this generation was so huge and was so productive and 

had an income. And, thus, you are going to see much less driving 

of the economy from the consumer side as this generation tries to 

adjust to the reality of retiring with less savings than they thought 

they had. Is that true? And if it is true, what are the implications 

of it? 

Mr. BERNER. Senator Gregg, if I could answer that, I totally 

agree with you. I think that we are in a period now where—it is 

what I call a new age of thrift, responding to the loss of wealth that 

consumers have experienced, not only as you describe but obviously 

also in their houses and pension plans. And I think there is enormous uncertainty about the promises that have been made to consumers by governments, both at the State and Federal level, and 

at the local level. So all those things I think are coming to bear 

at the same time, and so we should not expect to see a consumer 

who is spending as before. I think the new normal, if you will, for 

consumer spending is going to be the 2 to 2.5 percent kinds of 

growth rates that I have described. 

We should look, therefore, in my view, to other parts of our economy, you know, to provide growth, and I think for the first time 

49 

since the mid-1980’s, we are likely to see global growth as a source 

of stimulus for U.S. growth, and we should rely on that. So that 

means we want to keep our markets open; we do not want to adopt 

protectionist measures. We want to encourage the kind of global rebalancing that is needed to reduce the size of our external deficits, 

to reduce our dependence on global investors to hold our debt, and 

at the same time encourage the growth of other economies who will 

provide markets for our companies to export to and will provide income for people to save and to rebuild their balance sheets. 

That is not an unsustainable environment. In fact, I think that 

is a more sustainable environment than the one we had left, where 

saving rates were declining, both national and personal, and where 

we can rebuild the foundation for a stronger and more sustainable 

recovery. But I think, nonetheless, there are things that we need 

to do short run and there are things that we need to do long run. 

I just want to express my complete agreement with the idea that 

we need to have a credible plan to address our long-term fiscal 

challenges. That will reduce uncertainty. The way we do that is 

also important. Whether we do that through higher taxes or reducing spending growth is extremely important, and we have to get 

our arms around the promises that we made for the future that we 

are going to have difficulty in keeping by cutting the growth of 

those programs. 

Senator GREGG. Thank you. My time is running out, and I did 

want to get in another question. But I have heard this argument 

before that basically our society is going to have to look to trade 

and that the trade is going to be with the rising nations, the BRIC 

countries, for example. And I understand the logic of it, but I am 

not sure I accept that it is going to happen as being the driver that 

maintains our type of economy. Maybe it will be; maybe it will not. 

I think energy policy probably plays even a bigger role in that 

issue. 

But let me ask you, Dr. Johnson, about this issue of scoring the 

contingent liability in the financial system correctly. It is almost a 

catch–22 because we are telling the banks and the financial systems they have to significantly increase their capital. And then we 

are hearing from the markets that there is no credit available because the banks are significantly increasing their capital. And if we 

went to an even more aggressive process of saying we must score 

the contingent liability out there and, therefore, we must actually 

see even higher capital levels, I presume you are assuming the way 

you mute this issue is by raising capital levels. You are going to 

even contract credit more. 

I mean, don’t we have a catch–22 situation from the standpoint 

of fiscal policy here? 

Mr. JOHNSON. It is a great question, Senator. I do not think we 

do. There is a wonderful new authoritative paper on the effects of 

raising capital requirements by Professor Jeremy Stein of Harvard 

and Professor Anil Kashyap of Chicago University, which I commend and I will send to your staff. I do not think the effects—— 

Senator GREGG. You can send it by e-mail. 

Mr. JOHNSON. OK. I do not think the effects are at all as portrayed by the banking community and as widely feared even by the 

U.S. Treasury. I think that what is going to come out of the Basel 

50 

agreements, though, unfortunately, is very little by way of immediate raising of capital standards. And the quality of capital, which 

is more of an issue in Europe than here, but it is also an issue 

here, is going to be relatively low. So this is the ability of the financial sector to absorb losses. 

Given just as a political regulatory outcome I do not expect a lot 

of additional capital to be in the system, I think we should score 

the liability that this creates relative to the risks that it poses. 

That is your standard procedure for all—— 

Senator GREGG. Well, we do not score a lot of things around here 

for real. 

Mr. JOHNSON. Well, this is 40 percent of GDP, so it is a pretty 

big one, which I think not scoring that one would be—— 

Senator GREGG. So is Medicare’s contingent liability. But just 

quickly, you do not subscribe to the view that if you put more and 

more pressure on the need to increase capital, which is, I accept, 

necessary in order to make the system sounder over the long run, 

that you are going to end up with contractions in credit. 

Mr. JOHNSON. The point made by Professors Stein and Kashyap 

is it depends on how you raise capital requirements. So if you look 

at the way in which it was done after the stress tests, for example, 

last year—you know, we can have plenty of reservations about the 

stress tests in general. But requiring banks to raise a certain dollar 

amount of capital is the right way to do this, and these would be 

phased-in requirements. You do not want to tell people you must 

change your ratio of capital to assets tomorrow, because then you 

will certainly get a big credit contraction. 

There are ways to adjust capital requirements. There are ways 

to make banking safer. Banking becomes less sexy, becomes less of 

a high-octane, high-risk, high-return activity. That is for sure. And 

some bankers like that and some bankers do not like that. But it 

changes the nature of banking and changes what a bank is as a 

financial asset. It does not necessarily cause a big credit contraction. That is what the experts say. 

Chairman CONRAD. Senator Goodwin. 

Senator GOODWIN. Thank you, Mr. Chairman, and I would like 

to thank you and Senator Gregg for your warm welcome. It is certainly my immense honor to follow in Senator Byrd’s footsteps in 

serving on this Committee. And as I have said repeatedly over the 

past few weeks, although no one can replace Senator Byrd, what 

I hope to do is emulate his work ethic and his commitment to this 

Committee, the Senate, and the State of West Virginia. So thank 

you very much. 

Dr. Naroff, I have a bit of a tangential question for you. You alluded to some of the challenges facing our State and local governments in passing in your testimony, and I wanted to talk a little 

bit about the impact of the huge unfunded liabilities that so many 

of our State and local governments are facing. 

Now, I know in my limited experience in the State of West Virginia we were looking at billions of dollars in unfunded actuarial 

accrued liabilities in various pension retirement systems and other 

post-employment benefits. The State has strived aggressively and 

made courageous efforts to tackle that debt and amortize those liabilities over a period of years. But as you would expect, these deciVerDate Aug 31 2005 10:00 Jun 08, 2011 Jkt 000000 PO 00000 Frm 00056 Fmt 6633 Sfmt 6601 C:\DOCS\58156 SBUD1 PsN: TISH
51 

sions came at the expense of other spending priorities, priorities 

which were undoubtedly much more politically popular and needed 

in their own right. 

So my question for you is: What is the impact of these enormous 

unfunded liabilities that so many of our States and local governments are facing on future economic growth? And what sort of 

pressure does it place on the Federal Government’s efforts to tackle 

these issues? 

Mr. NAROFF. Well, that is really the thing that I think every 

State and local community is trying to get their arms around at 

this particular point, and there is no simple and quick resolution 

to that problem. I think that is the first thing to keep in mind. 

The unfunded liabilities in pensions, which States are simply not 

paying their shares to in order to have the temporary balancing of 

the budgets—and that is continuing and will likely continue—is 

going to mean that all of those, whether they were political or necessary, programs are going to have to be reviewed. So sometimes— 

and I think this is the time, you know, crises, if they are handled 

correctly, will create some fairly significant short-term pain, and I 

think that that is going to continue to be the case in State and 

local governments. But that is a pain that should have been felt 

over the last 5 to 10 years as these liabilities were building, but 

the unwillingness to recognize them continued. 

So my view is that at least in terms of Federal fiscal policy, I 

think the States need to come to grips with their spending patterns 

and their decisions and, to a very large extent, to the extent that 

they have to make the cuts that are necessary, at this point they 

need to get their fiscal houses in order. 

To the extent that there are some temporary cyclical issues that 

they might be eased through, then there may be a role for Federal 

policy. But for the most part, I think it is really time for the State 

and local governments to start recognizing that the costs that they 

have imposed upon themselves are just not sustainable anymore. 

And while I do not argue with some of the fiscal stimulus funds 

having gone to the States, because it was a sudden shock that you 

could not plan for, now they have had a couple of years to start 

dealing with that. And while you cannot address 10 or 20 years of 

fiscal irresponsibility overnight, I think they need to be forced to 

address those; otherwise, it never will end. 

Mr. JOHNSON. Could I just add and emphasize the importance of 

education in this entire adjustment process. I think what we are 

seeing at the State and local level is big cuts in education. If you 

think about the nature of our economy going forward and what we 

have seen over the past 20 years, the difficulties that people have 

if they do not get a college education, do not have at least 1 year 

of college education, how hard it is to participate in the modern 

economy, how hard it is to have wage growth. 

You know, Senator Gregg’s idea that we move away from consumerism, we have other motors of growth, I think we all would 

support that. But increasing wage inequality, people with only high 

school educations or failing to complete high school, not being able 

to participate and get a decent job in a more globalized economy, 

for example, with the lack of skills that Mr. Berner has been emphasizing is just getting worse, because long-term unemployment 

52 

causes all our human capital to go down. I think this is going to 

really come through as a huge weakness for our growth potential. 

But what can you do about it when you do not have space at the 

Federal level because of the longer-term fiscal issues? That is the 

question. Unless you deal with the long-term fiscal issues, you cannot create the space to deal with these pressing issues such as education. 

Senator GOODWIN. Thank you, Mr. Chairman. 

Chairman CONRAD. Thank you, Senator Goodwin. 

Senator BUNNING. 

Senator BUNNING. Thank you, Mr. Chairman. Thank you for 

showing up, panel. A lot of brains sitting at one table. 

I would like to give you a quote from a former Federal Reserve 

Chairman who, in my opinion—my opinion—caused three major recessions in this United States with his monetary policy. On ‘‘Meet 

the Press,’’ he said that the U.S. is experiencing ‘‘a pause in a modest recovery that feels like a quasi recession.’’ 

Do you agree with that characterization? What policies would 

you recommend to change that situation? What is the worst thing 

the Federal Government could do in this situation? Realizing that 

we have 15.5 million either full-time or part-time unemployed people, 8 million of which were unemployed in the year 2009. So are 

we going to have any jobs to get them back to work? Are we going 

to be able to raise our economic level so that we can create those 

jobs? 

I would like anybody’s opinion of that statement. 

Mr. NAROFF. Well, let me start the discussion. I do not necessarily think it is a pause. I think that given the headwinds, given 

the damage done by the blow-up of the housing market and the 

near collapse of the financial sector, the idea that we could get anything more than a modest, you know, slow-growth recovery I think 

was unrealistic. It was hopeful. The 5-percent growth we got at the 

end of 2009 was largely just making up for excessive inventory cuts 

and investment cuts that were done at the peak of what we could 

call the panic in the first half of 2009. Except for that, I think this 

2-, 2.5-percent growth forecast, which I have and I think the others 

are not far off of, is likely to be sustained. So I do not see it as 

a deceleration necessarily in growth or a pause in growth as much 

as that is the reality of what we are facing given the damage done 

to the economy. 

Senator BUNNING. Anybody else on this statement of Dr. Greenspan? 

Mr. JOHNSON. I agree. I do not think it supports—I think it is 

slow growth. It is a disappointing recovery. It is probably one of the 

slowest recoveries we have had since World War II. You need to 

deal with the long-term—— 

Senator BUNNING. Let me give you—Dr. Johnson, you are a 

member of CBO’s panel of economic advisers. I am sure that you 

are aware CBO has predicted that economic growth will actually 

fall by 1.4 percent if the 2001 and 2003 tax relief is allowed to expire. Why does CBO predict that it would slow down our economy? 

I am looking to get it going faster, and by removing the tax cuts 

of 2001 and 2003, it is CBO—I want CBO to be realized as the 

53 

independent scorekeeper here. You have predicted that a 1.4-percent decrease would occur. 

Mr. JOHNSON. Senator, I am on the panel of economic advisers. 

I am not responsible for the—— 

Senator BUNNING. I did not say you were, but maybe you can explain that. 

Mr. JOHNSON. Yes, sure. It is a sensible proposition that if the 

tax cuts expire completely, that will have an effect of slowing down 

the economy. By the way, if you are worried about stimulus, you 

should look at alternative ways of stimulating the economy. It is 

not clear that if you—— 

Senator BUNNING. I have looked at them. 

Mr. JOHNSON. And I for one expect and would support partially 

continuing some of the tax cuts. I think that would be a—— 

Senator BUNNING. Kentucky has got a $2 billion shortfall—$2 

billion out of an $18 billion budget over a 2-year period, and they 

are coming to the Federal Government for $240 million extra—are 

you kidding me?—so their budget can be balanced. What if all 50 

States did the same thing? 

Mr. JOHNSON. Well, Senator, we are obviously in a very difficult 

place from a fiscal point of view. I am not advocating unconditional 

massive transfers at the State level. My point is if you had an 

agreement on the longer-term budget, then that would create fiscal 

space that you could choose whether—— 

Senator BUNNING. I agree 100 percent. 

Mr. JOHNSON [continuing]. Or additional spending. But that is 

the problem. If you do not deal with the long-term issues, you have 

got a potential credibility issue, and the financial markets, much 

as they may like you now and let you borrow 2-year treasury notes 

that are at record lows, that will not continue indefinitely if they 

do not—— 

Senator BUNNING. Not if we have economic recovery, it will not. 

You obviously know that zero to one-quarter of 1 percent is what 

the Federal Government is borrowing short-term money at right 

now. Zero to one-quarter of 1 percent. What will happen if we do 

get some kind of economic recovery? Won’t our borrowing go up 

some? 

Mr. JOHNSON. Yes, and I would also emphasize, compared to 

other countries, we have a lot of relatively short-term borrowing. 

The average maturity on our debt is 4.4 years. So, yes, these are 

very real risks, Senator. I am not playing them down at all. I am 

emphasizing they all push in the same direction, which is you need 

a longer-term fiscal consolidation framework. Without that, we are 

really asking for trouble. 

Mr. NAROFF. And I also believe that when you look at the 2001 

and 2003 tax cuts, you should look at that in the context in which 

those tax cuts were actually implemented. It was a totally different 

economy, a totally different situation as far as budget—— 

Senator BUNNING. I do not disagree with that at all. 

Mr. NAROFF. And some of those tax cuts made total sense at that 

time. Under the current set of circumstances, they simply may not 

create any new economic activity. And that is my point about evaluating each of those cuts individually to see whether they make 

54 

sense in either sustaining them or allowing them to sunset in the 

context of where we are today. 

Senator BUNNING. I have one more question. I just want to get 

it in before my time is up. 

We have heard time and time again that consumer spending is 

weak because consumers save rather than spend any additional income. You all said the same thing. Is this not a result of cheap 

money over the last decade where we have achieved a negative real 

savings rate and the average American is already vastly overextended? How can we expect consumer spending to have increased 

when the debt levels are so high? 

Mr. BERNER. Well, Senator, that is in part why, you know, some 

of the remedies that we are talking about here involve helping consumers reduce those debt levels in a responsible way. And if we afford them the opportunity to—— 

Senator BUNNING. Are you talking about forgiving their debt? 

Mr. BERNER. Well, in some cases, Senator, you know, when you 

are in very deep difficulty, either there will be forgiveness or there 

will be a default. So those are the choices. 

Senator BUNNING. Are those the 18 percent that send their keys 

in? 

Mr. BERNER. Those are the 18 percent that send their keys in, 

plus the ones who are foreclosed upon because—— 

Senator BUNNING. Well, sure, because the bank has to inherit 

that decreased value. 

Mr. BERNER. So the choice we face is whether to let that process 

continue at the pace that it has gone and to have housing markets 

that continue to suffer, or whether we can choose policies that may 

speed up the process where the burden of the cost of that is shared 

between borrower and lender and taxpayer in a sensible way so 

that the situation we face now can be mitigated. 

Obviously, if we were to choose to rewind the tape and we were 

to choose to do things differently, we would have. But given that 

where we are involves these—— 

Senator BUNNING. I wish we could rewind the tape. 

[Laughter.] 

Mr. BERNER. We all do, Senator. 

Given where we are, we have a set of not-so-good choices from 

which to pick, and that is where we are. 

Mr. JOHNSON. I agree with you, Senator, I think, on your overall 

assessment of the Federal Reserve’s policy the way it led us here, 

including what Mr. Greenspan did, and the fact we are prone to repeat this because we have the same structure—— 

Senator BUNNING. Well, I understand that, and my complaint to 

Chairman Bernanke is the hesitant way in which the Fed has proceeded with the debt level that we have. And his balance sheet is 

now $2.8 trillion. I mean, I have a hard time getting my hand 

around $2.8 trillion on the balance sheet of the Federal Reserve. 

And what he does is he goes out and buys treasuries to sustain the 

treasury market, and that is how he fills up his balance sheet. So 

it is a very dangerous policy. 

Thank you. 

Chairman CONRAD. Thank you. 

55 

Senator Begich? And let me just say to all members, I have been 

very liberal today with everybody. 

Senator BUNNING. Thank you. 

Chairman CONRAD. No, Senator Bunning, I did not treat you any 

differently than anybody else. 

Senator GREGG. Progressive. 

Chairman CONRAD. We have gone over with everybody but Senator Goodwin. We appreciate very much your discipline. So I am 

going to treat everybody else the same way to—you are going to be 

able to go over by a couple of minutes, at least. 

Senator Begich? 

Senator BEGICH. Mr. Chairman, thank you very much. Thank 

you for that comment. I leaned over to Senator Goodwin, and I 

said, ‘‘You get credit points because you left time on the clock, 

which we will all consume.’’ 

Thank you all for being here. First, let me give you a little context. I represent the State of Alaska. I have been in the small business world since the age of 16, and my wife owns and operates four 

small businesses. We have built these businesses from scratch, so 

we understand what real life is about. It is great to hear all the 

theory and the discussion, but we have lived it, we have experienced it, and we have seen it in both good times and bad times. 

So I wanted to give you a little context there so as my questions 

come out, you will understand where I am kind of trying to drive 

to. And also it seems we have a short-term memory on the 1980 

recession when, if you were a small business person and you wanted any money out of the market, you were paying 19 points on 

prime plus, depending on what customer rate you were. People forget that. You talk about seizing up capital, that was an unbelievable time. Banks still wanted to loan you the money because it was 

a good return, but businesses were not anxious to touch it because 

of the rates and it was all short term. 

In Alaska in the 1980’s, we saw half a dozen, up to maybe I 

think eight banks, disappear overnight literally. We saw probably 

20,000 people leave our State in less than 6 months. So we have 

seen what can happen. We saw in Anchorage, the largest city in 

the State, its assessed valuation almost cut in half because of real 

estate. Sad to say I have been in the real estate business also for 

all this time, so I have seen it come and go. 

This recession, we did not lose anybody. No banks failed. We had 

the highest unemployment in probably two decades, but now 3 

months have gone by, and we have ratcheted down I think by almost six-tenths of a point, going the right direction. 

We have had housing pricing now moving up about 14 percent, 

which is very positive. Still, our new starts are very low, and I 

think that is what is experienced around the country. We learned 

something from the 1980 crash: diversification, focus on job growth, 

and quick stimulation to get money into the economy but look long 

term. 

So here is my first question. Do any of you agree with this statement: that the first thing we need to have is certainty in our debt, 

our tax policies, and spending? And when I say certainty, not just 

for the next election cycle but long term. Does anyone disagree 

with that? 

56 

[No response.] 

Senator BEGICH. OK. Silence is approval. That is how I operate. 

The second question is: In order to move the economy forward, 

do any of you disagree that the combination of your ideas, some 

short term and long term, is what is necessary, not one or the 

other? Does anyone disagree with that? 

[No response.] 

Senator BEGICH. OK. Now I am going to throw some ideas out. 

I want to see your response, and I am going to thank the Ranking 

Member, Senator Gregg, and Senator Wyden who have proposed a 

piece of legislation on tax policy, because I also heard—and correct 

me if I am wrong here—different levels of what those tax cuts 

should be or should not be implemented. I did not hear anyone said 

all of them 100 percent. What I heard was variations. 

So why not, instead of battle over that, which will be a bunch 

of special interest debate and discussion of which tax cut gets who, 

which one will benefit, what is the level, why not just reform the 

system? And the Gregg-Wyden piece of legislation on tax reform is 

dramatic, and I do not know if any of you have looked at it. But 

it seems like that sends a message to the business world we are 

bringing some down into the middle class, that we are protecting 

them, and simplification, which brings confidence level back into 

the consumer. And to me the biggest number I am interested in, 

unemployment is, you know, watching—it is consumer confidence. 

If people are not confident, they are not spending one dime. They 

are not investing. 

So give me first your thought on the Gregg-Wyden bill. Then I 

have another one, which is the Mark Udall bill, which is on credit 

unions who are capped on what they can invest or use to put out 

into the marketplace, right now 12.5 percent of their capital for 

small business loans. This would raise it to 25 percent, without 

putting one Federal dollar into it, just taking their capital and putting it out into small businesses. 

So, first, Gregg-Wyden, anyone want to comment on that tax policy? 

Mr. BERNER. Senator, why don’t I start? Gregg-Wyden would 

greatly simplify the Tax Code, which is something we all would like 

to see. It would add certainty to tax policy. And it would take away 

a lot of the special preferences that are built into the Tax Code. 

You know, all those things economists will tell you are good things. 

Senator BEGICH. And the business rate that is—correct me, Senator Gregg. I think it is 24 percent, if I remember that number 

right. 

Senator GREGG. That is correct. 

Senator BEGICH. That gives competitive edge to one of the questions you all said was our ability to compete worldwide. 

Mr. BERNER. Right, and that would more or less level the playing 

field with respect to other countries. It would broaden the tax base, 

which is extremely important in thinking about how we want to 

deal with our fiscal problems going forward. And so by taking away 

some of those preferences, it is going to hurt some people, but it 

would broaden the tax base, collect more revenue, give us a more 

stable tax system. All those things are to be desired. 

57 

Moreover, when you think about how we got to where we are in 

housing, for example, it was not just easy credit. That was certainly a contributor. It was not lax underwriting standards. That 

obviously was a contributor. But tax policy had a role to play in 

it as well, and we have endorsed that in the past as a society. 

Maybe it is time to rethink that so that we can rebalance our economy and have more resources for other things like education, like 

productivity-enhancing investment. Clearly we do not need more 

housing in terms of the stock of housing right now. 

Senator BEGICH. That is true. Inventories are high. 

Mr. BERNER. Right. And so as we think about the role that tax 

policy can play in all that, you know, I commend you to advance 

that argument in the Congress and your leadership in doing it. 

Senator BEGICH. Anyone else want to comment? 

Mr. JOHNSON. I do. 

Senator BEGICH. Then I will come back on the Udall one just 

quickly, but go ahead. 

Mr. JOHNSON. I must admit I have not studied this bill. I will 

remedy that this afternoon. 

Senator GREGG. I will e-mail it to you. 

Mr. JOHNSON. Thank you. I think, as I said before, now is the 

moment for tax reform for exactly these reasons, and the advantage is because we have such an antiquated, painful system, it is 

going to be pretty compelling to many people that this is a good 

idea. 

I would hope that we have on the table versions of the valueadded tax proposed by Greg Mankiw, for example, which I think 

are very sensible and middle of the road. We need to look at all 

the tax breaks hid in spending programs, including the mortgage 

interest tax deduction, as Mr. Berner said. 

Carbon pricing has to be on the agenda. Looking out 20 years, 

that is your horizon for this budget, your budget thinking, and you 

can decide what to do with the revenue. You can use that to reduce 

other parts of your taxation if that is your priority. But this is an 

important issue going forward for energy. 

And the financial activities tax, which is a form of value-added 

tax for the financial sector, as proposed by the IMF, again is an 

idea that will not come quickly, but will come over the next 20 

years. It will come through the G–20, for example, and we should 

be including that in a 20-year tax reform planning horizon. 

Mr. NAROFF. I cannot argue with that at all. I am now a small 

business myself, and—— 

Senator BEGICH. That is good and bad. You will be working 20 

hours a day. 

Mr. NAROFF. My accountant loves me and I do not like the accountant, for obvious reasons. 

You know, this is not a tax system that anybody would ever sit 

down and want to create from day one. And, you know, either—the 

problem we face in the issue of what do you do about taxes, what 

do you about the 2001 or the 2003? Do you do them all? 

Senator BEGICH. Right. 

Mr. NAROFF. It is the simple fact that we start with the current 

system, and if you start with the current system, you have to move 

from that current system in evaluating any changes that you make. 

58 

And under those circumstances there are always winners and losers. And that is what I think creates, you know, the havoc in any 

tax policymaking at this point. 

Massive reform, if it is at all done, would get around all of those 

individual decisionmakings. I do not think it is a good thing to simply say, well, we will keep all the 2001 and 2003 so we do not get 

into the discussion on it, because there is a lot of those taxes that 

will have limited or no impact on the economy and, you know, in 

the context of the budget deficit just be a loss of additional revenues. 

So by restructuring it to a large extent, you get away from these 

crazy debates that are always going on, and that would be wonderful. 

Senator BEGICH. Well, thank you very much. I would ask you 

about the Mark Udall bill, but I do not want to take up any more 

time, Mr. Chairman. But I appreciate the comments because I am 

in this—kind of growing into this camp that, you know, spending 

our time messing with these old cuts and trying to figure out what 

is right, what is the right number, who is in, who is out, when really that will not change the confidence level in the consumer. And 

part of this equation is that consumers have to feel—and I say consumer and business. Both are the same in this context. And it 

seems to me it is time to just rejigger it and have the community 

feel like maybe we have done something long term here that brings 

certainty to the business world, but also to the consumer, the middle class, who will determine spending habits or not. 

And so I appreciate all of your comments, and I will leave it at 

that, Mr. Chairman. Thank you very much. 

Senator GREGG. Mr. Chairman, I would just like to congratulate 

the Senator from Alaska for his insightful, thoughtful, substantive 

line of questioning. But, more importantly, I look forward to passing him the torch of this effort on tax reform, which is critical. 

Senator BEGICH. Thank you, Mr. Ranking Member. Thank you. 

Chairman CONRAD. Senator Nelson. 

Senator NELSON. You all testified that you do not think that the 

tax cuts in the stimulus bill had much effect. Tell us whether you 

think the spending in the stimulus bill had as an effect. 

Mr. NAROFF. Well, I am not sure I completely agree with the 

Blinder/Zandi totals there. But, you know, I look at it in the context of, you know, the strategy that they took, that if we did not 

have it, what would the economy look like, which is one way of 

looking at it. Clearly, the other alternative is if you took the same 

amount of money and you spent it in different ways, whether 

through different tax cuts or different spendings, you would also 

have a different outcome. 

But since all we had was that set of policies, I think it is hard 

to disagree that there was a significant impact, I think nothing 

close to what we had hoped when you spent the kinds of money 

that we spent, and a lot of that is still being spent, and I think that 

needs to be kept in mind. 

I think some of the concepts in terms of infrastructure spending 

made sense because I think most of us would agree that if Government is going to spend money, you want to spend something that 

provides long-term returns to the economy, and nothing does that 

59 

better than infrastructure. But there is a lot of other spending that 

just simply transition the economy from 2000 into 2008 to where 

we are right now, but I think you have to say that it has a moderate effect and really kept us out of a significantly longer and 

deeper recession. 

Senator NELSON. Do the rest of you agree? 

Mr. BERNER. You know, you get different bang for the buck out 

of different kinds of spending, Senator, and unfortunately, I think 

a lot of the spending that was done in haste and in an effort to 

help the economy get out of the recession, to help State and local 

governments who were hit with the shock of the downturn, you 

know, probably was not as productive as it could have been. 

I agree about the infrastructure spending piece. We need enormous infrastructure repair. We need a program of infrastructure 

repair in this economy that goes beyond short-term stimulus. And 

providing aid to State and local governments in the form of FMAP 

or other assistance was a short-term measure that probably avoided some job cuts. But there are other, more efficient ways to deploy 

Federal resources in terms of thinking about fiscal stimulus. I have 

identified some of them. 

Mr. JOHNSON. Senator, I testified to this Committee in the runup to the discussion of the fiscal stimulus, and I said at that time 

I am not a proponent of discretionary fiscal stimulus. But this is 

an unusual time, and I think the sense that we all had in that discussion was that something was needed to bolster confidence in the 

U.S. economy. 

I think as I look at Table 2 in the Blinder and Zandi paper, I 

think that the money was spread in some sensible ways. Of course, 

infrastructure spending was pretty small, actually, in terms of the 

spend-out. I think it was a good mix. I think it was a one-off. I do 

not think you can go back and do this sort of thing again. It was 

a very unusual problem. Hopefully we will never see it again in our 

lifetimes. I worry that we will. I worry that we have not fixed the 

financial sector and will have to go back to a point where we have 

to throw money at a problem in a sense to prevent it from becoming much worse. And, roughly speaking, it works in the short term, 

but it stores up lots of issues for the future, including the debt, including the financial sector. 

Senator NELSON. Mr. Chairman? 

Chairman CONRAD. Yes, sir— 

Senator NELSON. Do you remember when we tried to get a lot 

more infrastructure spending? 

Chairman CONRAD. Yes, sir. That is what the Ranking Member 

and I were just saying. We tried to get $200 billion. 

Senator NELSON. Let me ask you—these two esteemed gentlemen 

right here, the Chairman and the Ranking Member are on this 

Deficit Reduction Commission, which I hope and pray is going to 

be successful, but since they have a threshold that they have to get 

14 votes of 18 on the Commission, there is a lot of skepticism that 

they are going to be able to get that on whatever the package is 

that they come up with. 

So if that skepticism bears out to be true—which I hope it does 

not, and I am prepared to vote yes on their package, and I have 

not even seen it yet because I think, as you all have testified, we 

60 

have got to do something about the deficit. But if it fails, what happens? What do we do? 

Mr. BERNER. Senator, I am not sure that we have room for failure because, as Simon and Joel have talked about—and I have 

would echo their concerns—ultimately global investors who hold 55 

percent of debt held by the public are going to register their vote 

in financial markets, and they will look at our inability to deal with 

our long-term fiscal problems, and they will look at the lack of 

credibility in our willingness to deal with those problems. And that 

will raise the cost of borrowing not only for the Federal Government long term, but also for businesses and households here as 

well. 

Moreover, the debt service that will grow over time will take increasing resources out of our economy that we can use for other 

productive means. And so that is the longer-term cost of not addressing our fiscal problem. 

Senator NELSON. And creates an uncertainty and lack of confidence—— 

Mr. BERNER. Correct. 

Senator NELSON [continuing]. In the U.S. Government’s ability to 

manage its financial affairs. 

Dr. Johnson? 

Mr. JOHNSON. To go back to Senator Gregg’s point about Greece 

at the very beginning, according to the IMF’s numbers, Greece’s 

general government gross debt—this is the numbers which have 

the best comparable measures—was in 2010 133 percent of GDP; 

the United States by the same measure is close to 93 percent of 

GDP. So I think this is the answer—what happens if it does not 

work? You have some time. But you do not have a lot of time; however long it takes you to get from 90 to 133 would be a rough measure. 

Obviously on net debt terms, it is not quite as bad, not quite as 

dramatic, but you know what the trajectory is. The pressure will 

make us change sooner or later. We should do it now. We do not 

want to be forced, like the Greeks are being forced or the Spanish 

are being forced, to do things in a precipitant manner. That is really bad for productivity and really bad for small business, bad for 

everybody. Do it now when we still have plenty of time. That is the 

right approach. 

Mr. NAROFF. If you want to know what it is going to look like, 

look at most of the States. They have hit that point right now, and, 

you know, they are scrambling exactly in the way that you commented in order to deal with the expenses that have basically overwhelmed them, and that is what we will have to be doing. 

You know, to some extent that may force coming to grips—I 

know Dick has, you know, harped on this several times, on the 

longer-term programs for retirees, medical costs and so on that we 

have put into the entitlement programs. Crisis may be the only 

thing to cause us to deal with them, but we should not wait—we 

should not have to wait until a crisis to deal with them, because 

they are not- -you know, when we reach that point, it will be, you 

know, fairly significant on the kinds of cuts that have to be implemented. 

61 

Senator NELSON. And speaking of the States, we are going to 

vote on something today or tomorrow because the States have not 

provided the revenues in their States in order to fund their fair 

share of Medicaid or education. And so, of course, they come to us 

then in times like this and that want us to bail out those accounts 

and, of course, the more that we do that at the Federal level, the 

more we add to the national debt. It is a vicious cycle. 

Mr. NAROFF. Well, it is worse than a vicious cycle in that it is 

creating the incentives not to deal with the problem, and that is 

what you do not want to do. 

Senator NELSON. That is exactly right. 

Thank you, Mr. Chairman. 

Chairman CONRAD. Thank you. 

Senator SANDERS. 

Senator SANDERS. Thanks very much, Mr. Chairman. This is a 

great discussion, and if I did not have an appointment at 12 o’clock, 

I would prolong it. 

I wanted to maybe inject an aspect to this discussion which I 

have not heard yet. We keep talking about the economy in general, 

but you know what? This is—or we are talking about taxes in general. But the reality of life in the real world is somewhat different. 

For example, during the Bush years, median family income for 

the average American went down by $2,200. Seven million people 

lost their health insurance. Eight million people dropped out of the 

middle class and went into poverty. So while the middle class is 

shrinking and poverty is increasing, in this general abstract world 

that you are talking about, not everybody has been hurting, because during the Bush years, among other things, the people on top 

did very, very well. I think the top 400 wealthiest people in this 

country saw a doubling of their income. We now have a situation 

where the top 1 percent earn more income than the bottom 50 percent, and in terms of wealth, we have the most unequal distribution of wealth in the industrialized world. The top 1 percent own 

more wealth than the bottom 90 percent. So we are not talking— 

and we talk about tax reform. Does anybody in their right mind 

think that you are going to have equitable tax reform here in 

Washington where we are going to be descended on by all kinds of 

lobbyists representing the wealthiest people and loopholes are 

going to be put in and it is not going to happen? The rich and 

wealthy and large corporations have enormous influence over this 

institution. As a result of the Supreme Court decision in Citizens 

United, they are going to get more of their friends to be here representing—that is the real world. Sorry to, you know, bring forth 

some reality here. 

So now what we are talking about is we all acknowledge the 

economy is in terrible shape. We know that. And we all acknowledge that we have a very large national debt, $13 trillion, an 

unsustainable situation, a $1.3 trillion deficit. But I would hope we 

can hear some discussion that as we move forward, we do not see 

pain brought all about. Why should working-class people who have 

already experienced pain be asked to experience more pain? Should 

we really raise the Social Security age to 70 for those people? 

Should we do, as I gather some want to do this week, cut back on 

62 

food stamps when we have millions of families who are struggling 

to provide food for their kids? 

Let me suggest to you, as someone who believes the deficit is a 

serious problem, but also thinks that we have got to create jobs 

that our economy desperately needs. The American Society of Civil 

Engineers tells us that we have a $2.2 trillion need for investment 

in infrastructure in the next 5 years alone. I am a former mayor. 

Let me tell you something. The infrastructure does not get better— 

right?—unless you invest in it. Why are we not investing in it and 

putting people to work doing that? 

On the other hand, I do understand you cannot spend, spend, 

spend. You have got a deficit problem. Let me give you some situations here that I think we can address. 

About $100 billion a year—and the Chairman of this Committee 

has made this point many, many times—in taxes are avoided by 

large corporations and the wealthy by going to tax havens in the 

Cayman Islands. How many corporations existed in that one building, Mr. Chairman? 

Chairman CONRAD. Eighteen thousand. 

Senator SANDERS. A little bit crowded. A little bit crowded. It 

was hard to do their work with 18,000 corporations in one building. 

Now, it would seem to me if you can get—— 

Chairman CONRAD. It was five stories. 

Senator SANDERS. Oh, OK. Then that is no problem. 

[Laughter.] 

Senator SANDERS. But it would seem to me if—and the estimate, 

I think, Mr. Chairman, was something like $100 billion avoided in 

taxes. So why aren’t we beginning in a serious way to talk about 

that? In 2005 one in four large corporations paid no taxes at all. 

This year—ExxonMobil last year had a bad year. They only made 

$19 billion in taxes—$19 Billion in profits. You know how much 

they paid in taxes this year? Zero. They got a $156 million refund 

from the IRS. That is the tax system that the IRS and big money 

has helped create. 

So my question to you is: Shouldn’t we be focusing on creating 

jobs in infrastructure, stopping the absurdity of importing $350 billion a year of foreign oil, move toward energy independence, and 

at the same time go forward with deficit reduction in a fair and 

progressive way which does not hurt middle-class and workingclass families? Dr. Johnson, why don’t you start it? And I would 

like to hear from the others. 

Mr. JOHNSON. Thank you, Senator. Yes, of course, we can put 

more money into infrastructure, and I supported the Committee in 

that discussion over a year ago. It is not that easy given the way 

that our spending is set up. But that certainly is a sensible proposition. 

And in terms of tax reform, I think what is particularly interesting and intriguing about the value-added tax is that some of this 

idea is coming from people to the right of the political spectrum, 

like Professor Mankiw, as well as some people on the left, and how 

progress or regressive your VAT system is, we can see from the experience of other countries. It depends on how you design it, what 

exactly you are taxing, what are you zero-rating. 

63 

It is a relatively hard tax to avoid. It is a tax that focuses on consumption rather than on income, which has sensible effects on incentives. And I am somewhat encourage that people are moving at 

the technical level in the direction of thinking hard about those 

kinds of proposals. Obviously, it is a political decision how regressive it will be, and I am rather on your side in thinking that the 

vested interests, once they get their hands on it, will distort it. 

I do think in all of the issues that you raise, one thing that we 

must not avoid is Medicare. So Medicare is, if you look out at the 

30-year, 40-year horizon, that is a huge issue. And do we address 

Medicare, for example, by basing it on lifetime earnings, your access to Medicare? 

Senator SANDERS. But Medicare is part of our health care system, and as you well know, we end up spending almost twice as 

much per capita on health care as any other major country on 

Earth, and our outcomes in some cases are not as good. So I do not 

think it is just a question of Medicare. It is a question of a health 

care system geared toward profit in which people are making all 

kinds of money out of it and not necessarily providing quality care. 

Mr. JOHNSON. Well, that is a very good point, Senator, and I am 

sure you are right, the health care system as a whole needs to be 

addressed. Unfortunately, it is the case if you put all the European 

Union health spending projections on a comparable basis to what 

the CBO uses—the IMF has done this, but it is not that widely 

known—their numbers are just as bad as ours in terms of containing future health care spending. 

So all the systems across the industrialized world have a very 

similar problem, which is the demographics and—— 

Senator SANDERS. Aging population. 

Mr. JOHNSON. The aging population and the increasing cost of 

medical technologies. And so the question is: To what extent do you 

give people access to those technologies later in life? 

Senator SANDERS. But here we are getting back to the basic 

point. That is a reality. It is going to be a reality in Europe, a reality in the United States. People are getting older. Health care becomes more expensive. We want the most cost-effective best system 

we can. But I do not think in the midst of all of this—the point 

that I am making is we have got a whole lot of problems. Some of 

my good friends will end up concluding that the way you solve 

these problems is punishing working-class people, low-income people, middle-class people. That will ultimately be their solution. 

I think when you have a society which is moving in many ways 

toward oligarchy—I thought I heard laughter. 

Senator GREGG. I was asking who those good friends would be. 

Senator SANDERS. Well, some of them sitting right in this room, 

some of them who think it is funny when we talk about oligarchy 

when the richest 1 percent own more wealth than the bottom 90 

percent, and we see that trend growing even wider. That is what 

I would call oligarchy. 

But be that as it may, I think the key debate—and I think Senator Conrad earlier—I was watching on TV—you know, raises the 

issue. We have got a huge debt. We have got to deal with it. We 

have got a huge financial crisis. We have got to deal with it. How 

do you deal with it? 

64 

Well, I would suggest that, everything being equal, unless we 

rally the American people, working-class, low-income, middle-class 

people, it will be dealt with. It will be dealt with by making the 

poorest people poorer. It will be dealt with by seeing the middle 

class decline even more. It will be dealt with by seeing the gap between the very rich and everybody else grow wider. I think we can 

do better. 

Dr. Berner, do you have thoughts? 

Mr. BERNER. Sure, Senator, I think we can do better, and it is 

clear that the income inequality problem that you are talking about 

has been growing for a long, long time. It is clear that part of the 

source of that problem has to do with educational opportunities and 

other factors. And it is clear that Federal policy as well as policies 

at other levels of Government can do things to deal with that. But 

some of those things involve allocating resources away from some 

areas and into others, away from, as I think Simon indicated, more 

broadly health care so that we do get better outcomes at lower cost, 

so that we have more resources left over for education and infrastructure investment, both of which will provide jobs and human 

capital. 

Senator SANDERS. Right. 

Mr. BERNER. That is the kind of economy I think we want in the 

future, and, you know, what is required is your leadership. 

Senator SANDERS. OK. Thanks very much. 

Dr. Naroff? 

Mr. NAROFF. The problem we face right now—and I do not disagree with you in the least. You know, when people would say to 

me, well, you know, X percent of the top income are paying Y percent of the taxes, doesn’t that show that the tax system is fair or 

is taxing heavily, and my comment is it can be done through either 

the structure of taxes or the structure of income, how it is distributed. And you have to know the reasons for the change and the 

move. And that is obviously the important factor. 

But the reality where we are right now is that we have no longer 

any wiggle room. Ten years ago, if the deficit went up a couple 

hundred billion dollars, it was not going to create major long-term 

crises as far as the economy is concerned. All our ratios were in 

good shape. We do not have that luxury right now. And what that 

tells me is that getting out of this slow-growth environment and 

balancing—and moving to a lower level of a budget deficit is going 

to require some groups to pay more. It is the politicians that decide 

which groups to pay more. 

Senator SANDERS. Well, or maybe the campaign contributors play 

a role. 

Mr. NAROFF. Well, whatever. But the point is, you know, in the 

current set of circumstances, you know, who are the people that 

are not spending? And part of the problem is what I find most interesting is that when I give—I give lots of talks over the course 

of a year to business people and average groups, and I ask them 

how many think that the recession is still going on, and most of 

them still raise their hands. And most of these are middle to 

upper-middle class. A lot of them are business people, small business people, and they feel that. They do not feel that they are seeing what is going on. They are not getting the benefits of it. 

65 

Senator SANDERS. Right. 

Mr. NAROFF. And, consequently, they are not spending as a result of that. So something that provides them with the impression 

and the reality that the economy is moving in their direction, to the 

extent that improves confidence, is going to improve spending and 

get us out of the—— 

Senator SANDERS. Right. Well, thank you all very much. Mr. 

Chairman, thank you for your indulgence. 

Chairman CONRAD. Yes, thank you for your excellent questioning. 

I would like to go to this panel on a separate question, and that 

is, how we got into this mess, because I have my own view, and 

I am going to try it out on each of you. I would be interested in 

your reaction. 

You know, as I look back, it strikes me that we had a series of 

bubbles formed. We did not just have a housing bubble. We had an 

energy bubble, we had a commodity bubble, and the evidence is all 

around us. Housing, we all know what happened to housing prices. 

On energy, oil went to more than $100 a barrel. On commodities, 

wheat went to more than $20 a bushel. So that is evidence of bubbles forming in lots of different places in the economy. 

Well, how did we get so many bubbles forming simultaneously? 

As I look back, it seems to me you had an overly loose fiscal policy, 

the responsibility of Congress and the President; massive budget 

deficits in the good times. On the monetary policy side, you had an 

overly loose monetary policy after 9/11. We had unusually low interest rates for an extended period of time and substantial expansion of the money supply. And on top of it all, a policy of deregulation, so nobody was watching and nobody was enforcing laws that 

did exist and some of the laws were inefficient and insufficient to 

deal with the problems of, for example, an AIG. 

So when you have an overly loose monetary policy and an overly 

loose fiscal policy at the same time—which is very unusual in economic history, as I have studied it. Usually you have one or the 

other. It is unusual to have them both simultaneously. That provides the seed bed for bubbles to form. And so we got multiple bubbles. Ultimately bubbles burst, and there is enormous economic 

wreckage. 

I would just like to hear your observations on that view of economic history. Dr. Berner? 

Mr. BERNER. Sure. Senator Conrad, I think that you are pretty 

much on target, and I would start with the regulation piece of it. 

We had inappropriate regulation in the financial services industry 

and financial markets. We now recognize that in hindsight. We are 

trying to deal with that. 

What we failed to understand was that, you know, the more we 

want our markets in other respects to be open and free and to 

allow for failure since the failure impinges on the financial system 

and on lenders, that requires more not less regulation, appropriate 

regulation of the financial system. It includes the appropriate capital and liquidity requirements. It includes the appropriate regulations ruling underwriting standards and all the rest of it. 

So as I was listening to you talk, I thought to myself, well, the 

dimension of monetary policy that was too loose was in the reguVerDate Aug 31 2005 10:00 Jun 08, 2011 Jkt 000000 PO 00000 Frm 00071 Fmt 6633 Sfmt 6601 C:\DOCS\58156 SBUD1 PsN: TISH
66 

latory front, which allowed the credit bubble to form an excessive 

growth in credit. And the legacy of that bubble, if you will, is still 

with us because unless we defease or write off that debt against 

which the value of real estate and other things has gone down, 

then we are going to be stuck in a low-growth economy where we 

have misallocations of resources. 

So the misallocation of resources is also the legacy of that that 

we are dealing with, and, you know, we are going to have to deal 

with that. That is why I tried to—— 

Chairman CONRAD. Well, when you say misallocation of resources, what I understand you to mean by that, too much money 

into housing? 

Mr. BERNER. Too much money into housing, both because of the 

things that you mentioned on a macro sense, but also because of 

the incentives built into the Tax Code that encouraged that. And 

I would point, for example, to the 1997 act which changed the capital gains treatment of housing. That is something that most people 

have overlooked, but I think it encouraged churning in housing an 

added to the subsidies that we have for residential real estate. 

Chairman CONRAD. Very generous treatment of capital gains. 

Mr. BERNER. Very generous treatment. Now there are not any 

capital gains, so maybe we do not have to worry about that for a 

while. But the fact of the matter is that was the stance of policy, 

and so all those things, as you mentioned, came together, and that 

is why it is so appealing to think about using this moment not only 

to fix our long- term fiscal future to make it sustainable, but to address some of the things in the Tax Code through tax reform that 

would take away those incentives. 

If I could just take one more minute, Senator Gregg alluded to 

energy policy earlier, and I think that that is an extremely important aspect of what we are talking about here. For years and years, 

we have resisted the idea that we should have higher prices for energy, prices that reflected what they were in other parts of the 

world. And so we have subsidized, if you will, relative to other 

economies the cost of energy, and we have insisted on having lowcost energy. And as a result, we import a lot of our energy, and so 

that has added to our external imbalances and our dependence on 

overseas sources of energy. 

We have the power to correct that through appropriate policies, 

and so a focus on energy policy and the tax treatment of energy 

is something that we can deal with. And it means that some people 

will pay more, and we have to deal with that. But that is an important ingredient in thinking about where we are going in the productive use of those resources. 

Chairman CONRAD. All right. Dr. Johnson? 

Mr. JOHNSON. So I also agree, Senator, with the broad outlines 

of what you put forward, but I would suggest putting it in a somewhat longer framework and actually talking about the repeated cycles or what the Bank of England now calls ‘‘doom loop,’’ that we 

seem to be going through repeatedly. We had a big expansion in 

global credit in the 1970’s, the debt crisis in 1982. Big expansion 

in loans to U.S. commercial real estate in the 1980’s, the savings 

and loans crisis. Another emerging market crisis in the 1990’s, 

1997–98, and then we have a crisis based on U.S. housing. 

67 

Now, all the specific pieces that pushed us toward a bubble in 

housing are absolutely there, and I would agree with that. But this 

is not a housing-specific problem. This is a global financial sector 

issue. And monetary policy and fiscal policy get sucked in there. 

Well, fiscal policy probably should be pushing hard the other way, 

but it is not, for reasons you well understand. Monetary policy, 

though, as Senator Bunning alluded to, gets pulled into the cycle 

where you have a financial crash and there is the Greenspan put. 

You cut interest rates in order to reflate the economy, and nobody 

wants high unemployment, and it is very costly. So then you go out 

and you do it again. 

Unfortunately, regulation over a 30-year period, as these cycles 

have continued, actually deteriorated in the United States and in 

some other key countries, particularly in Europe. 

I think the Dodd-Frank legislation pushes us back some distance, 

but not far enough, in my view, and there is too much reliance on 

these international negotiations through the Basel Committee on 

capital standards, which we have already discussed. Those, in my 

assessment from many sources, are not going to deliver much by 

way of substantial change in the incentives here. 

So that means we are going to run another version of the cycle. 

It will not be housing. It will be our banks. They will be at the center one way or another. It will be global probably, perhaps involving emerging markets. There will be big capital flows around. 

Again, fiscal policy should be leaning the other way and preparing 

for the worst. But, again, as we have been discussing, it is very 

hard even to agree that if we manage in a rosy, smooth-sailing 

kind of future, we cannot even agree on how to sort out the budget 

over a 15-year time horizon. 

Chairman CONRAD. Dr. Naroff. 

Mr. NAROFF. I think what you said is what economists say is a 

necessary but not sufficient condition for all the bubbles that were 

out there. It is a start. There is unquestionably—you had to have 

a lot of—all of what you said to create the bubbles. And it was not 

even limited to tax policy. It was not limited to regulation. If we 

just look at the tech bubble, which was largely a private sector 

bubble where there were massive amounts of private sector capital 

that got misallocated. And what concerns me is that it is really, I 

think, the structure and the functioning of the financial system 

whereby almost anything can be securitized and almost anybody 

can invest in almost anything at this particular point. 

So while capital flows to the greatest return, it tends to flow to 

the greatest short-term return in a given period of time rather than 

the greatest long-term return. And I think that that is the implication that we have gotten from the bubbles that are formed here, 

that we are looking—you know, capital is flowing not in a longterm direction. We are looking for the shortest-term gains. It is the 

idea that, you know, universities can invest in energy futures as 

part of their endowments as a way to make money. You know, is 

this really a long-term investment that makes a whole lot of sense 

for a university to make in their endowments? But they do it because there is a rate of return there that they can take advantage 

of. 

68 

So, you know, while you can talk about all the things you have, 

I am not sure you get around it unless you deal with the way that 

the financial sector itself allows capital flow, and I am not sure 

how you do that without interfering with a lot of the good parts of 

the relatively free flow of capital that is out there. 

Mr. BERNER. Could I answer that? Maybe it is because of where 

I sit that—— 

Mr. NAROFF. I was going to say Dick may disagree with my commission here, but go ahead. 

Mr. BERNER. No, I do not disagree because obviously there is a 

balance. You know, the euphoria of creating credit and more leverage obviously creates economic activity, and it feels great while it 

is happening, but the point is there is a balance. And there is no 

handbook that gives us the exact number for that balance, but in 

financial institutions, you know, an appropriate level of capital that 

mitigates risk and that enables people to earn returns, that is 

where we can find that balance. In the financial system as a whole, 

we can find that balance. So does it make sense, just to pick housing again as an example, to lend money the way what we did? Obviously not. 

If you look to the north and you look at the Canadian financial 

system, you see that they have a requirement where nobody gets 

a mortgage loan with less than 20 percent down. You can put up 

more than that if you would like, but, you know, while 20 percent 

is arbitrary, it is sensible. And so, you know, common sense I think 

tells you where the regulations ought to be without being too precise about them and to limit the amount of leverage. No leverage 

is not good because it stifles growth. Too much leverage has left us 

with the kind of—— 

Chairman CONRAD. Hangover. 

Mr. BERNER [continuing]. Problems that we have. And while I 

did not come from New Hampshire, I grew up in New England, so 

that is where my values come from. 

Chairman CONRAD. I grew up in North Dakota. I was raised by 

my grandparents. My grandfather said, ‘‘If you cannot put 20 percent down on a house, you have no business buying it.’’ 

Mr. BERNER. There you go. 

Chairman CONRAD. Senator Gregg. 

Senator GREGG. That was my amendment in Committee and it 

lost. 

Chairman CONRAD. I supported it. 

Senator GREGG. I wish you had been there, Doctor. 

I just have one last question here. Dr. Johnson, you have on a 

couple of occasions, maybe three, mentioned Medicare as being one 

of the key elements of our long-term issues, and I think you alluded to the issue of how we deal with the technology and the expense of the last 6 months of life, for lack of a better term, which 

the Chairman has mentioned on numerous occasions. 

Do you have any specific proposals in the Medicare area that 

could be useful to the financial commission that were not incorporated in the original bill, the health care bill? 

Mr. JOHNSON. No, unfortunately. I think this is a tough—and I 

have spent time talking to leading health policy experts. I will 

share the names with your staff. There are obviously some indicaVerDate Aug 31 2005 10:00 Jun 08, 2011 Jkt 000000 PO 00000 Frm 00074 Fmt 6633 Sfmt 6601 C:\DOCS\58156 SBUD1 PsN: TISH
69 

tions, both within the VA system and within the private sector, 

Kaiser Permanente, for example, of health organizations that have 

really managed to get a grip on health care costs without severely 

or perhaps significantly compromising quality of care. But these experiments have proved very hard to replicate, and I think we do 

not actually understand how Kaiser Permanente, for example, in 

some instances has been so successful in cost control and not been 

able to replicate that within their own organization in other cities. 

This is a very tough problem, and I am not saying there are at 

all easy solutions here. I wish that I had a magic bullet for you, 

but I do not. 

Mr. BERNER. Actually, Senator, if I can interrupt there, there is, 

as you probably saw yesterday, the report from CMS that outlined 

the potential savings in Medicare that might come out of some of 

the changes that have been already proposed. But it seems to me, 

as important as Medicare is, I would point to the bigger problem 

of Medicaid, because Medicaid is the example of how our fiscal federalism is really broken. The States always come on the downturn 

to the Federal Government for assistance because the Medicaid 

rolls expand and because their revenues go down, and then you are 

asked to give them more assistance. So that system does not have 

permanence, it does not have stability over the longer term. If you 

think about Medicaid as a program, that is one that needs desperate attention. 

More broadly, if you look in—Simon and I are both on CBO’s 

commission, as I think Senator Bunning mentioned, advisory 

panel. If you look at in the CBO budget options book, you will see 

one big option that stands out, and I am sure you know what I am 

going to talk about, and that is, the tax treatment of health care 

benefits. And if we address that tax treatment in the broader context of our tax system and in the broader context of looking at 

health care, as difficult as I know that is, that is going to be something that both helps our deficit problem and changes the incentives for health care. 

Senator GREGG. Well, you are actually talking to the choir on 

that point. 

Mr. BERNER. I understand that. 

Senator GREGG. I appreciate your time. You have been an excellent panel. Thank you. 

Chairman CONRAD. Thank you very, very much, Dr. Berner, Dr. 

Johnson, Dr. Naroff. We very much appreciate the time and effort 

that you have extended and the assistance you have provided this 

Committee and this Senate. Thank you very much. 

The Committee will stand adjourned. 

[Whereupon, at 12:08 p.m., the Committee was adjourned.] 

(71) 

ASSESSING THE FEDERAL POLICY RESPONSE 

TO THE ECONOMIC CRISIS 

WEDNESDAY, SEPTEMBER 22, 2010 

U.S. SENATE, COMMITTEE ON THE BUDGET, Washington, DC. 

The Committee met, pursuant to notice, at 10:09 a.m. in room 

SD–608, Dirksen Senate Office Building, Hon. Kent Conrad, Chairman of the Committee, presiding. 

Present: Senators Conrad. 

[presiding], Nelson, Stabenow, Begich, Gregg, and Sessions. 

Index: Senators Conrad, Nelson, Stabenow, Begich, Gregg, and 

Sessions. 

OPENING STATEMENT OF HON. KENT CONRAD, U.S. SENATOR 

FROM NORTH DAKOTA 

The CHAIRMAN. First of all, I want to apologize. I was just on a 

lengthy call with the Vice President on other matters, and it was 

something that had to be dealt with because he is about to get on 

a plane. So I apologize. 

But I want to welcome everyone to the Budget Committee. Today’s hearing will focus on the Federal Government’s response to 

the economic crisis. We will examine the effectiveness of the Federal response and what lessons have been learned. 

Our witnesses are Dr. Alan Blinder, professor of economics and 

public affairs at Princeton and the founder and co-director of the 

Center for Economic Policy Studies. Welcome, Dr. Blinder. 

Dr. Mark Zandi, the chief economist at Moody’s Analytics, a good 

friend. Welcome. Good to have you here. Dr. Zandi has been to 

North Dakota at my invitation. 

Dr. John Taylor, is a professor of economics at Stanford and a 

senior fellow in economics at the Hoover Institution. We are delighted that you are here as well, sir. I am a proud graduate of 

Stanford myself. 

This is a really distinguished panel. I don’t think we could have 

done better in terms of having a diversity of views, and we welcome you all and your testimony. 

I would like to begin by highlighting the two challenges confronting our Nation—the near-term economic weakness and the 

longer-term budget crunch and the need to get to focusing like a 

laser on our long-term debt. In considering the near-term challenge, it is important to remember the crisis we faced just 2 years 

ago. By mid to late 2008, we were in the midst of the worst recession since the Great Depression. 

72 

The economy contracted 6.8 percent in the fourth quarter of 

2008. Unemployment was surging, with 800,000 private sector jobs 

lost in January of 2009 alone. A housing market crisis was rippling 

through the economy, with home building and home sales plummeting and record foreclosures. Much of that still remains with us. 

And we faced a financial market crisis that threatened to set off 

a global economic collapse. Credit markets and lending were largely frozen. 

We have come a long way since then. The Federal response to 

the crisis, I believe, has successfully pulled the economy back from 

the brink, and this year, we have begun to see a return to economic 

and job growth, although much weaker than I think all of us would 

like to see. 

The key elements of the Federal response included actions by the 

Federal Reserve. Efforts to stabilize the financial sector started 

with the Bush administration and continued in the Obama administration, and then we had last year’s economic recovery package 

as well. 

Two of our witnesses, Dr. Blinder and Dr. Zandi, have completed 

a study that measures the impact of that Federal response. To 

quote their report, they say, ‘‘We find that its effects on real GDP, 

jobs, and inflation are huge and probably averted what would have 

been called Great Depression 2.0. When all is said and done, the 

financial and fiscal policies will have cost taxpayers a substantial 

sum, but not nearly as much as most had feared and not nearly 

as much as if policymakers had not acted at all. If the comprehensive policy responses saved the economy from another depression, 

as we estimate, they were well worth their cost.’’ 


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The next slide compares the economic growth we have actually 

experienced recently with an estimate of the economic growth we 

would have experienced without the Federal response. I would note 

that the estimates of economic growth without the Federal response have been updated by Budget Committee staff to reflect revisions in the actual economic growth that were released after Dr. 

Blinder and Dr. Zandi submitted their report. 


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As you can see depicted in the yellow bars, actual economic 

growth in the fourth quarter of 2008 was a negative 6.8 percent. 

By the last quarter of 2009, economic growth had improved to a 

positive 5 percent. Growth has continued but has slowed, falling to 

1.6 percent in the second quarter. 

In contrast, as you can see in the red bars, without the Federal 

response, the economy would have contracted far more sharply, as 

much as 10.1 percent in the first quarter of 2009, and we would 

never have returned to positive economic growth during this time 

period. 


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The next slide shows the job picture following a similar trajectory. The green line on this chart depicts the actual number of jobs 

in our economy. We can see that in the first two quarters of 2010 

the number of jobs has begun to increase again. 

The red line shows Dr. Blinder and Dr. Zandi’s estimate of the 

number of jobs we would have had without the Federal response. 

According to their findings, we would have had 8.1 million fewer 

jobs in the second quarter of 2010 if we had not had the Federal 

response. 


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We see a similar picture in the unemployment rate. The green 

line on this chart shows the actual unemployment rate on a quarterly basis now hovering about 9.7 percent, still far too high. We 

have got to do more to create jobs, bring this rate down. But according to Dr. Blinder and Dr. Zandi, if we had not had the Federal 

response, the unemployment rate would now be 15 percent and 

would continue rising to 16.2 percent by the fourth quarter of 2010. 

So, clearly, the Federal response to the economic crisis has had 

and continues to have a significant positive effect, but we are clearVerDate Aug 31 2005 10:00 Jun 08, 2011 Jkt 000000 PO 00000 Frm 00082 Fmt 6601 Sfmt 6601 C:\DOCS\58156 SBUD1 PsN: TISH

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ly not out of the woods yet. The economy remains unsteady and 

faces strong head winds. That is why in the near term, probably 

in the next 18 to 24 months, I believe we need to focus on providing 

additional liquidity to boost demand. We can’t afford to repeat the 

mistake of the mid 1930’s, when recovery measures were curtailed 

too quickly and the depression was prolonged. 

Now let me be clear. That does not mean that we should be ignoring the looming budget crisis. Because the debt is the long-term 

threat, it must be confronted and it must be dealt with. The impacts on Federalspending from the retirement of the baby boom 

generation, rising healthcare costs, and our outdated and inefficient and noncompetitive tax system all need to be addressed. We 

need to face up to exploding deficits and debt. 

According to CBO, Federal debt could rise to almost 400 percent 

of GDP by 2054. Of course, that would be 40 years from now. Nevertheless, that is a completely unsustainable course. 

What we should be doing now is putting in place deficit reduction 

policies that will kick in after the economy has more fully recovered, but very soon. And by establishing and enacting those policies 

now, we will reassure financial markets that the United States is 

confronting its long-term fiscal imbalances. 

This is what Federal Chairman Bernanke said earlier this year 

about the need for a credible plan to address the long-term fiscal 

imbalance, and I quote, ‘‘A sharp near-term reduction in our fiscal 

deficit is probably neither practical, nor advisable. However, nothing prevents us from beginning now to develop a credible plan for 

meeting our long-term fiscal challenges. Indeed, a credible plan 

that demonstrated a commitment to achieving long-term fiscal susVerDate Aug 31 2005 10:00 Jun 08, 2011 Jkt 000000 PO 00000 Frm 00083 Fmt 6601 Sfmt 6601 C:\DOCS\58156 SBUD1 PsN: TISH

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tainability could lead to lower interest rates and more rapid growth 

in the near term.’’ 

I completely agree. That is why the work of the President’s fiscal 

commission is important. As a member of that commission, I can 

attest to the serious work that is being done there. Senator Gregg, 

of course, serves on that commission as well. 

I remain hopeful that we will come up with a serious and credible plan to face up to our long-term deficits and debt. The steps 

that must be taken will not be easy, but they will pay significant 

dividends for this country. 

I turn to Senator Gregg now for his opening comments. And 

again, I want to apologize for starting this hearing late. I don’t 

think in the time I have been chairman that has ever happened. 

But I apologize to Senator Gregg and my colleagues and the witnesses as well. 

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

HAMPSHIRE 

Senator GREGG. Thank you, Mr. Chairman. 

We certainly understand that you had other issues which had to 

be addressed. 

Let me associate myself, of course, with the second half of your 

comments, as I have on many occasions, and your concern about 

the long-term deficit and debt of this country. And it is, as you 

have described, critical that we address this. 

On the first half, though, I have to kindly disagree. You have attempted to put lipstick on a pig. The fact is that the Federal response in this area has been woeful, misdirected, and, unfortuVerDate Aug 31 2005 10:00 Jun 08, 2011 Jkt 000000 PO 00000 Frm 00084 Fmt 6601 Sfmt 6601 C:\DOCS\58156 SBUD1 PsN: TISH

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nately, has probably aggravated the problem, in my opinion, rather 

than assisted the issue. 

I had an economics professor when I was at Columbia, who tolerated my appearing in his class on occasion, named Raymond J. 

Saulnier. I also had the good fortune to have a fellow named Arthur Burns as an economics professor. And Raymond J. Saulnier 

had this wonderful saying. He said sometimes you have got to 

evaluate problems by looking at what is intuitively obvious and 

reaching a conclusion. 

And what is intuitively obvious here is that the stimulus package 

was misdirected. It was a massive expansion in deficit and debt, 

which has energized some economic activity, but which basically 

ended up being walking around money for a group of appropriators 

here in the Senate. And I am an appropriator. So I say that with 

some generosity. 

But the fact is that the money was spent out over too much time, 

and it was not focused on capital formation. It was not focused on 

immediate return in the economy. And so, to the extent a stimulus 

should have occurred, it was a misdirected stimulus, in my opinion. 

And you can look at whatever models you want, but the fact is 

that the unemployment rate has not come down. It has gone up. 

And the unemployment rate does not appear to be coming down in 

the future at any significant rate or at least consistent with most 

recoveries. 

And why is that? Well, I believe it goes to the second part of your 

hypothesis, which is that the American people, and especially the 

folks on Main Street who create the jobs in this country, are looking at our Government and saying it isn’t part of the solution. It 

is the problem. It is the concern for them. 

I have traveled throughout my State. I know you have in North 

Dakota. Every small business person I talk to is just worried to 

death about their coming costs in healthcare, just worried to death 

about it. 

You know, I was talking to a guy just a couple of weeks ago— 

last week, actually—last weekend, and he had a business that generates $2 million to $3 million a year. He is worried that he is 

going to have to pay $400,000 to $500,000 in new healthcare costs. 

He doesn’t know where he is going to get the money. But he knows 

he is not going to expand until he figures it out. 

On top of that, you have got the financial regulatory bill which 

passed, which is forcing a contraction in credit across this country 

because it was misdirected in the way it addressed the fundamental underlying issue, which is real estate and how we deal with 

real estate. Instead of setting up a responsible approach toward 

down payments, it basically created a massive regulatory overstructure, which is going to cause contraction in the short term as 

the credit markets try to adjust to it. 

You couple that with the tax policy, which is—the Senator from 

North Dakota has correctly disagreed with—the idea that we 

should raise taxes in this economy is not a good idea. And yet that 

appears to be the thing that we may end up doing because that is 

the policy of the presidency, and that is causing people to have uncertainties about their future, their economic future. 

80 

And then you throw on top of that this whole debt issue and the 

fact that most Americans look at this and they apply this test of 

intuitive—what is intuitively obvious, and they say it is intuitively 

obvious that we can’t support our debt or our deficits, and there 

doesn’t appear to be a plan to straighten it out. And so, they are 

worried. They are worried about the future of this country. They 

are afraid we are going to pass on a less prosperous nation than 

they have lived in and a less secure nation as a result of it. 

So my view is that in order to get the employment issue under 

control, we have to get the long-term problems that this Government is creating for the markets under control and for the guy or 

woman on Main Street who wants to create a job under control. We 

have to allow that person to be willing to go out and expand their 

business and take a risk without fearing that the Government is 

going to make it economically unfeasible for them to succeed either 

because of the costs which are being put on through regulatory burden or healthcare cost or because of the fear of taxes or because 

of the burden of the Government simply running up a debt it can’t 

afford and knowing that that price is going to have to be paid by 

the productive sector of the economy. 

And that is intuitively obvious through inspection, and that is 

what we need to address. 

Senator NELSON. Mr. Chairman? 

The CHAIRMAN. Senator Nelson? 

Senator NELSON. I have to leave to go to a meeting, and I will 

be back. But in light of what both you and the ranking member 

have said, what is extremely important right now is the two of you 

and your deliberations in this deficit reduction commission. Can 

you give us a brief progress report of how that is going? And do 

we really have any hope when we come back in a lame-duck session that we can pass a package that will seriously address the deficit? 

The CHAIRMAN. I would just say quickly in response to the Senator’s inquiry, the commission is working in a very serious, deliberative way. You know, I don’t think anyone knows at this point 

if 14 of the 18 of us can agree on a plan because that is a requirement. If 14 of 18 of us can agree, that plan will come to a vote before the end of the year in the Senate and the House. 

I am hopeful, but we have not gotten to the point of considering 

options. We don’t have a plan. So it is impossible to say at this 

point whether there would be agreement on a plan. 

But I am encouraged by the seriousness of the membership of 

this commission—six from the Senate, equally divided Republican 

and Democrat; six from the House, evenly divided Republican and 

Democrat; six appointed by the President, four Democrats, two Republicans. I think the membership of the commission really recognizes the seriousness of the responsibility that has been given to 

them. 

Senator Gregg? 

Senator GREGG. I would second the Senator’s statement. There is 

a seriousness of purpose amongst all the commissioners. And I 

think we all appreciate the fact that it is critical that we put forward a product that is substantive and that the American people 

81 

and the world markets will look at as a step in the direction of fiscal responsibility. 

But we are at 10,000 feet, and when you get down on the ground 

and put the details together, that is where the problems are, as the 

Senator from Florida certainly knows. But there is a real effort to 

try to do that. 

The CHAIRMAN. I thank the Senator for his inquiry. I thank Senator Gregg for his response. 

Let us go to the witnesses, and we will start with Dr. Blinder. 

STATEMENT OF ALAN S. BLINDER, PH.D., GORDON S. 

RENTSCHLER MEMORIAL PROFESSOR OF ECONOMICS AND 

PUBLIC AFFAIRS, FOUNDER AND CO-DIRECTOR, CENTER 

FOR ECONOMIC POLICY STUDIES, PRINCETON UNIVERSITY 

Dr. BLINDER. Mr. Chairman, Ranking Member Gregg, members 

of the committee, I would like to thank you for holding this hearing. I am going to confine my opening remarks to the historic subject of the hearing, the stated subject of the hearing—assessing the 

effects of the policies that were done in the past. 

I am sure we will come to the longer-run budget shortly, and I 

would like to compliment both of you for trying to do the right 

thing on this. The problem, of course, as you perceive, is that nobody quite agrees what the right thing to do is—other than that 

the deficit should be a lot smaller than it is. And I, of course, agree 

with that, too. 

Roughly 2 months ago, Mark Zandi and I published a paper, 

which you kindly cited several times, showing, among other things, 

the quite large estimated effects of the panoply of anti-recession 

and anti-financial-market-crisis policies that were promulgated 

and/or enacted in 2008–2009. Now, Mark is right here, and he will 

speak for himself. But in my view, the two of us wrote this paper 

for a quite simple reason, and it is this. That the public, and especially the political, debate over the policy responses seemed to us 

long on rhetoric, short on analytics, and, in many important ways, 

discordant with the facts. 

In particular, both TARP and the Recovery Act were being 

branded as failures or worse, while we viewed them as successes, 

although not without flaws. In a politically charged atmosphere 

nearly devoid of quantitative appraisals—notable exceptions being 

some of the work of John Taylor, who is right here to speak about 

it—prejudice and assertion seemed in danger of being accepted as 

fact and reasoning. So it looked like there was a void to be filled. 

The estimates that we produced have been subject both to unwarranted praise by those who liked them and unwarranted criticism by those who didn’t. Many of these attacks have actually been 

methodological in nature. So even though this is not really the 

right forum for a technical disquisition—and I won’t give one—I do 

want to say a few things about the methodology that we used. 

Mark and I used a large-scale econometric model of the United 

States economy to estimate the effects of a long list of fiscal and 

financial policies. These models are complicated beasts, but for 

present purposes, there are only two important aspects. 

One, they are statistical representations of the economy based on 

past history. That is what we have to go on. Two, at bedrock, they 

82 

are complicated algebraic renderings of the simple textbook models 

that you probably learned in Economics 101, and certainly that I 

teach in Economics 101, though vastly more complicated in the details. A number of the criticisms derive directly from these two 

points. 

Models of the sort that the two of us used are called ‘‘structural 

model’’ because they posit a structure of equations that allegedly 

describe the economy, and then they use real historical data to fill 

those equations with numbers. So they are not just conceptual 

frames, but they are actually numerical. By the nature of their construction, these estimated structural equations have to be tied 

closely to the data. If the models didn’t fit past experience tolerably 

well, the equations wouldn’t be there. 

Nonetheless, such models have been criticized on a variety of 

grounds, including that economists don’t know the true structure 

and that they don’t handle expectations about the future very well. 

And our work inherited those generic criticisms, which do have 

some validity. 

But when I think about this, I ask: What is the alternative? 

Some economists champion the use of purely statistical techniques 

that allegedly impose no structure at all but simply let the data 

speak for themselves. That might be a sensible approach when you 

are studying repetitive events that have happened many, many 

times in the past, but not when you are studying phenomenon that 

have never happened before, which we were. 

It is true that models based on history might be poorly equipped 

to deal with events that are outside the range of previous experience. Statisticians call this ‘‘out of sample.’’ The sensible version of 

this criticism warns against placing too much confidence in out of 

sample results, and we agree with that. But what, other than displaying appropriate modesty, is one to do about it? 

The silly version of this criticism would ignore the discipline imposed by the data, which are the facts, and simply assert the answers based on a priori reasoning. That approach allows either ideology or technical fascination to triumph over admittedly fallible 

science. 

Modern economic theory and econometrics offer a variety of alternatives to the brand of Keynesian economics that is embodied in 

the Moody’s model that we used and in other models of that style. 

Some academics reject the Keynesian approach entirely for reasons 

that need not detain us here, though I think we will probably hear 

some of them in Professor Taylor’s testimony. And that attitude 

has spawned several criticisms of our work as ‘‘old-fashioned.’’ 

Now, I must say that as I approach my 65th birthday, I feel compelled to say that old ideas are not necessarily bad ideas. The question should not be whether it is old-fashioned or newfangled, but 

whether it is close to a description of reality or far. As examples, 

I have noted in the testimony that both the Declaration of Independence and Adam Smith’s invisible hand date from 1776. I count 

them both as very good ideas, but very old-fashioned. 

Everyone agrees that all statistical models are fallible. So it is 

incorrect to say, as some of our supporters have, that Mark and I 

have ‘‘proven’’ or ‘‘demonstrated’’ that these policies had large effects. No, that is not right. We just estimated the effects to be large 

83 

with a statistical representation of the U.S. economy. Other such 

representations would give different estimates, as thoughtful critics 

such as John Taylor have pointed out. 

One last methodological point. Some critics have argued that the 

counterfactual that we used in our thought experiment, which was 

what would have happened with no policy responses at all—just 

laissez-faire—is either unrealistic or uninteresting, a kind of a 

straw man. We disagree with that criticism. 

In fact, every single policy initiative on that lengthy list of Table 

1 in our paper had opponents who argued strenuously against it. 

In fact, one of them is sitting right here two seats to my left pretty 

much, and you will hear from John Taylor shortly. 

That brings me to current policy, very briefly. The recovery looks 

to be sputtering right now. Recent data may prove to be nothing 

more than one of those pauses that happen now and then during 

recoveries. I hope so, but I fear they may indicate something worse. 

I want to be clear. I am less worried about the feared double-dip 

recession, which doesn’t look likely, than I am about the prospect 

that GDP growth will continue to undershoot capacity growth, widening the GDP gap instead of narrowing it, and that does look realistic, unfortunately. 

My conclusion is that monetary and fiscal policy should be spurring growth right now. Given the parlous state of the budget, it 

seems natural to rely on monetary policy, and we heard from the 

Federal Open Market Committee yesterday that they are certainly 

thinking in that direction. But if the Fed can’t or won’t do much 

more to spur growth, then I think Congress should. 

Now I realize that this committee is properly concerned about 

the budget deficit, as it should be. You all know that we are now 

on an unsustainable long-run fiscal path. But the deficit does not 

pose a short-run problem. The Treasury is now borrowing huge 

sums of money at extremely low interest rates, and it can borrow 

more. Today, I believe the jobs deficit is more urgent than the 

budget deficit. 

That said, the days of what I like to call the ‘‘Field of Dreams’’ 

strategy are over. The ‘‘Field of Dreams’’ strategy is build a bigger 

GDP, and the jobs will come. And that is the way we usually think 

about fiscal policy. 

Unfortunately, the ‘‘Field of Dreams’’ strategy has two serious 

drawbacks in the present situation. The first is obvious. It is working very slowly because firms are extremely reluctant to hire, for 

whatever reasons. Second, it is expensive, costing in the neighborhood of $100,000 of either government spending or tax cutting for 

every job that is saved or created. We need to do this job cheaper, 

given the state of the budget. 

To me, those two considerations point toward two policies, and 

I will finish by mentioning them. One is a substantial broadening 

of what Congress did earlier this year with the HIRE Act, a temporary tax credit for new jobs. The other is also temporary: public 

employment centered on relatively low wage workers. 

Simple calculations suggest that either of those options or both 

can create jobs with a price tag in the $30,000 to $40,000 per job 

range, not $100,000 per job. And given where we are and where we 

have been, that seems like a pretty good deal to me. 

84 

Thank you all for listening. 

[The prepared statement of Dr. Blinder follows:] 

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The CHAIRMAN. Thank you. 

Dr. Zandi, welcome. 

STATEMENT OF MARK ZANDI, PH.D., CHIEF ECONOMIST, 

MOODY’S ANALYTICS 

Dr. ZANDI. Thank you, Senator Conrad, Senator Gregg, and the 

rest of the committee, for the opportunity to speak today. My remarks are my own and not those of the Moody’s Corporation. 

I am going to make three points in my time. Point No. 1, I believe that the policy response to the economic crisis was very successful. I think the merits of any individual aspect of the policy response—and of course, there were many—are debatable. If I were 

king for the day, I probably would have designed it differently myself. But the totality of the response was very impressive. And 

without that response, I think it is fair to say we would have suffered a 1930’s-style Great Depression, and that is borne out in the 

results that Alan and I came together on in our study. 

Broadly speaking, the policy response had two objectives. The 

first objective was to stabilize the financial system, and the second 

was to jumpstart an economic recovery. 

In terms of stabilizing the financial system, let me focus on three 

particular aspects of the response, and I am going to illustrate it 

in the context of the spread between—the interest rate spread between 3-month LIBOR, which is the interest rate that banks 

charge each other for borrowing and lending to each other, and 

Treasury bill yields. This is the so-called TED spread. It is a very 

good measure, perhaps the best measure of the angst in the financial system, the banking system. And you can see prior to the beginning of the crisis back in early 1907, it was running around 20, 

25 basis points, which is where we are today. 

And you can see the increase that occurred as the financial crisis 

gained steam. And then in the wake of the Lehman failure, the 

Fannie and Freddie takeover, it gapped out, peaking in October, 

early October at just under 500 basis points, 5 percentage points. 

Three key policy responses stemmed this financial panic and stabilized the system. A first was the Capital Purchase Program, 

which was the bank bailout, which was funded by TARP. The peak 

was $250 billion. That has been a slam-dunk success. Taxpayers 

are making money on the deal. The banking system is intact. 

Banks are lending to each other and beginning to lend to businesses and consumers. 

Without that capital from the Capital Purchase Program, which 

again was funded by TARP, the banking system would have collapsed, and the result would have been devastating. 

The second policy step I would like to point to is the FDIC’s Temporary Liquidity Guarantee Fund, and you will note that on the 

precise day that that fund was implemented—October 13th—that 

is the precise day that this TED spread hit its apex. This program 

was guaranteeing bank debt issuance. This addressed the liquidity 

problem in the banking system. Banks could issue debt. The liquidity problem faded very rapidly. The banking system found its bearings. 

And then the third policy step that I would like to point to would 

be the bank stress tests that were conducted in the spring of 1909, 

92 

the results of which were publicly announced on May 7th. And you 

can see that they were very successful and put an end to the financial crisis, and you will note that the TED spread is now back to 

where it was prior to the crisis. The financial system has stabilized. 

I don’t think there was any possible way that could have happened 

without the policy response. 

With regard to fiscal stimulus, in my view, it is no coincidence 

that the recession ended, the great recession ended precisely when 

the stimulus was providing its maximum economic benefit. The 

NBER, the National Bureau of Economic Research, told us earlier 

this week the recession ended in June of 2009. That is the precise 

month in which the stimulus spend-out was at its maximum, when 

the temporary tax cuts and spending increases were at their maximum, that precise month. It is no coincidence of the timing of this. 

The turnaround in the economy occurred exactly when the stimulus 

was providing its maximum benefit. 

Now, of course, the stimulus has many different moving parts. 

Some have worked better than others. I just want to mention one 

other, and that is the Cash for Clunkers. That was very successful. 

It ended a freefall in that very key industry, and it is very clear 

in this slide. You can see here this shows industrial production in 

the motor vehicle industry. That is the orange line, left-hand scale. 

And employment in the motor vehicle industry. That is the green 

line, right-hand scale. 

You can see the complete freefall in production that occurred 

during the recession. The precise bottom in production in jobs in 

the motor vehicle industry was August of 2009. That was the precise month in which Cash for Clunkers was in full swing. It is no 

coincidence. Cash for Clunkers worked. It is a very good example 

of a good program—very cheap, $3 billion—that was very effective, 

and many of the other aspects of the stimulus were as well. So, in 

my view, point No. 1, the policy response was incredibly successful. 

Point No. 2, the recovery is intact. It is now over a year old, but 

it is very fragile. Growth has slowed. GDP growth, which has been 

3 percent over the past year, is now tracking about half that—1.5 

percent in Q3. That is still growth, but it is insufficient to forestall 

a further increase in unemployment. Unemployment will rise. The 

unemployment rate is 9.6 percent. I expect it to drift back closer 

to double digits by year’s end or early next. 

It should be no surprise that the recovery is a fragile recovery. 

Very well respected research has shown that in previous examples 

where countries have gone through financial crises like the one we 

have experienced, recoveries are difficult. They are not easy, largely because of the deleveraging that has to occur in the economy. 

People have to reduce their debt loads. Businesses and consumers 

have to deleverage, and in that process, it is a significant weight 

on economic growth. 

Moreover, it is not surprising that the benefit of the fiscal stimulus is fading. That is by design. The stimulus had its maximum 

impact back last summer or late last year, early this. The stimulus 

spend-out is now going back to zero unless Congress does more, 

and thus, you are going to see economic growth slow. So it should 

be no surprise. 

93 

The slowdown has been more than I would have anticipated. In 

my view, that is largely the result of the European debt crisis, 

which undermined confidence at a critical juncture. We created 

400,000 private sector jobs in April and May of this year. The European debt crisis hit in May and June. The stock market fell 15 

percent. It knocked the wind out of business confidence, and hiring 

has stalled out. So that was something that no one expected. And 

it didn’t derail the recovery, but it certainly has sidetracked the 

economic recovery. 

Finally, point No. 3, if one believes that the policy response was 

effective, and moreover, if one believes that the recovery is still too 

fragile, point No. 3 is that policymakers must remain aggressive. 

They should not exit out. At the very least, they should not exit 

out of their policy support for the economy until the recovery has 

engaged in a self-sustaining economic expansion. And my definition 

of that is a steadily consistently falling unemployment rate. Until 

that happens, I think it would be imprudent for policymakers to 

pull back. 

Let me quickly name, articulate three things that I would do in 

the very immediate term. First is decide what we are going to do 

about the expiring tax cuts. That uncertainty, I agree with the Senator, the policy uncertainty is a problem. The tax cuts, the uncertainty with regard to the tax cuts is a problem. We have got to nail 

that down. 

I would not raise anyone’s taxes in 2011. The recovery is just too 

fragile. 2012, 1913, I don’t think—when the economy is on sound 

ground, I think it is reasonable to allow the tax rates in upper-income households to rise. I think we need to address our long- term 

fiscal problems, and that has got to be at least part of that solution. 

Second, one easy thing that could be done is to require Fannie 

Mae and Freddie Mac to be more aggressive in facilitating mortgage refinancing. One of the ways the Federal Reserve is trying to 

help support the economy is to keep mortgage rates at record lows. 

The key link between those low rates and the economy, the most 

direct, fast key link is refinancing. That is disturbingly low, given 

the low rates. This can be easily facilitated. I would be happy to 

go into how that could be done if you care to go down that path. 

And then, finally, the third thing I would do, I would endorse a 

proposal that Alan gave. If we get into early next year and the recovery is not engaging and we are still struggling, I would advocate 

a payroll tax holiday targeted at companies that hire and add to 

their payrolls. The HIRE Act was insufficient. It was too small. It 

was too restrictive. It is not working. It could be quite effective if 

we did it in a better way, and I think that would be very important 

for our recovery next year. 

Thank you. 

[The prepared statement of Dr. Zandi follows:] 

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The CHAIRMAN. Thank you very much. 

Dr. Taylor? 

STATEMENT OF JOHN TAYLOR, PH.D., MARY AND ROBERT 

RAYMOND PROFESSOR OF ECONOMICS, STANFORD UNIVERSITY, GEORGE P. SHULTZ SENIOR FELLOW IN ECONOMICS, 

THE HOOVER INSTITUTION 

Dr. TAYLOR. Thank you, Mr. Chairman, Senator Gregg, for inviting me and other members of the panel. 

I want to first start out by reminding everybody of the obvious. 

It has been 3 years, more than 3 years since this crisis began in 

August of 2007, and the economy is still operating way below its 

potential. We have got an unemployment rate of 9.6 percent and 

a growth rate of 1.6 percent. 

What I have tried to do, and I will testify about this briefly, is 

to look at the impact of the policy responses to the crisis. But just 

on the face of it, it seems like they haven’t done very good. But we 

have got to go beyond that and look at the details, look at the facts. 

For the last 3 years, we have been working on this at Stanford 

University, at the Hoover Institution, trying to look at all aspects 

of these policies. And I have listed on three pages of my testimony, 

which I would like to refer to, a summary of that research. It is 

empirical. It is fact based. It is looking at the details of as many 

programs as we can possibly do. And based on that, I come to some 

conclusions, which I am prepared to defend. 

First, if you look at the fiscal policy response to the crisis, it has 

been mainly in the form of what I would call discretionary shortterm stimulus packages. In my view, these packages did not stimulate the economy much, if at all. And I based my conclusion on empirical research, looking at the specific actions taken. 

So, for example, some part of the stimulus package was to send 

checks to people or to temporarily reduce their withholding. When 

you look at these changes, you don’t see any impact on consumption in the aggregate. In other words, the purpose of these changes 

was to jumpstart consumption and thereby jumpstart the economy. 

You can look at the timing. You can look at the increases in the 

income associated with this, and you see almost no changes in consumption at those times. So, again, if you look at the details, you 

don’t see the impact of these policies. 

Another big part of the stimulus packages was to increase Government purchases. We have the various kinds of models that 

might predict that those increase in Government purchases would 

stimulate demand and stimulate the economy. Well, here, I also 

find very little impact on the recovery. And if I could ask you to 

look at page 3 of my testimony, I have a couple of charts, which 

I think illustrate this quite well, and if I just could dwell on these 

for a minute or so? 

The chart at the top shows real GDP growth. That is the blue 

line. Real GDP growth, and you can see how it plummeted in the 

recession and how it has recovered to some extent, but it is slowing 

down again now. You can also look at how much Government purchases has contributed to those changes in growth, and you can 

look at other parts of spending that has contributed. 

129 

The top part of the graph shows the contribution of investment— 

business fixed investment, inventory investment—to those changes 

in real GDP. They are part of real GDP. So the Commerce Department tabulates these data, and you look at them very clearly, and 

what you can see is the recovery, to the extent we have had one, 

has been due to investment. 

If you look at the bottom part of the chart, you can also see how 

much of the contribution to this up-and-down, down-and-up in the 

economy has been due to purchases, both at the Federal level— 

non-defense Federal purchases are indicated—and also at the State 

and local level. And you see almost no impact of these changes. So, 

to me, this is what I mean by looking at the facts, looking at the 

numbers, and there is very little impact. Now you might ask, how could an $862 billion package have so 

little impact on Government purchases? Well, the truth is, much of 

this package has not been in Government purchases. Believe it or 

not, in the six quarters since the package has been in place the 

total amount of Federal purchases for infrastructure projects has 

been $2.4 billion. That is 0.3 percent of the total package. 

Now more of it could have been at the State and local level. After 

all, the package did send grants and aid in capital grants to the 

States. But if you look at this, you see very little connection between the grants being spent and the infrastructure that is actually being constructed. It is very hard to trace any difference, and 

my statistical work shows very little connection. So I think that is 

why you see that this just really has not worked. 

Now you can also use models, and Professor Blinder and Professor Zandi have looked at models. The problem with models—and 

I have been a modeler for almost my whole career—is that you get 

different models, and they disagree. So the work that has been 

used by Blinder and Zandi uses a particular model—Mr. Zandi’s 

model, I believe. But if you look at other models, you get different 

results. 

In January of last year, when the administration put out a study 

to show that the stimulus package would work, my colleagues and 

I did a study showing with another model, a model we favored, 

that it wouldn’t have much impact, maybe a quarter of the amount 

or a fifth of the amount. 

And so, you could look at models—the IMF has a model. They 

have very small impacts. So the models differ, and that is why I 

think it is so important to go beyond the models—models are useful—but go beyond the models and look at the data themselves. 

Now, of course, the other big part of the Federal response was 

monetary policy, and I have looked at this extensively. I don’t have 

time to look at the details, but I think it is useful to divide the crisis, which again began in August of 2007, into three periods. The 

first period I will call the pre-panic. That occurred from August 

2007 until the panic in the fall of 2008. 

Then you had the panic, and that was when the stock market 

plummeted. The interest rate spreads that Mark Zandi showed you 

rose tremendously. That is the panic. And then you had the postpanic period, which I think really begins in November of 2008. 

So if you look at the policies in these three periods, I look at the 

pre-panic period. I see the impact of the monetary policy actions as 

130 

not being very constructive. The Fed used its balance sheet to bail 

out some firms and not other firms. It established some programs 

which drew attention away from counterparty risk in the banking 

sector and I think ultimately was part of the reason we had this 

panic in the first place, the confusion over those ad hoc bailouts. 

Then you had the ending of the panic, which I believe was finally 

when the TARP was clarified what the TARP was used for. There 

was tremendous uncertainty in the first 3 weeks after the TARP 

was proposed. That was the panic period. As soon as it was indicated that the money would be used for equity injections, the panic 

stopped, and we saw mass improvements. 

I think some of the Federal Reserve’s actions during the panic 

period were helpful in stemming the panic. But if you think that 

they may have caused the panic in the first place, you might not 

applaud so much. 

And then, finally, in the post-panic period, these are the largescale purchases of assets by the Fed, the mortgages. My estimates, 

my statistical work on this shows that they did not have very much 

effect on reducing mortgage spreads, and those are based on looking specifically at the risk premiums in the mortgage market. 

So it seems to me that you look at these details, these packages 

did not do very much good. In fact, now with the legacy of the debt, 

the legacy of the uncertainty in the economy that they have caused, 

I think very well they could be causing harm and holding back the 

recovery. 

There were other policies that could have worked better. In fact, 

in testimony before this committee almost 2 years ago, November 

2008, I recommended a set of policies. First of all, there would have 

been a commitment not to raise taxes for the foreseeable future. I 

hope that can still be a policy. 

Second, it would have been to make President Obama’s middleclass tax cut permanent. It was a temporary tax cut. Why would 

you do that? It doesn’t affect the economy much at all. Should have 

made it permanent. That is what I recommended. 

Should have had a Government spending policy that was dedicated to moving up the spending that was already on the books in 

a responsible way that laid out then a policy to get the budget deficit down in the long run. Not wait until now or not to wait until 

the commission has finished. It would have been far much better. 

But instead, rather than being predictable, the policy I think created uncertainty. Rather than being permanent, we had these temporary changes, and that is why we don’t have a lasting recovery. 

So I think the good news is that we can change things. We can 

go back to the kind of principles that we know have worked in the 

past and get away from these temporary targeted types of policies, 

which are really leading to uncertainty and, I believe, holding the 

economy back. 

Thank you very much. 

[The prepared statement of Dr. Taylor follows:] 

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The CHAIRMAN. Thank you, Dr. Taylor, for your thoughtful comments. 

You know, this is very healthy. This is the kind of debate we 

need. I wish this kind of debate, this kind of discussion were more 

prevalent more broadly in our society at this point. 

You know, I don’t know why it is that we seem to get off on tangential, insignificant issues. This is what the American people deserve to hear, this kind of discussion at this level. So I thank the 

three of you for contributing in a serious way to a discussion. 

The first thing I would like is to give each of you a chance to respond to anything that you heard from others testifying here that 

you—something you heard that you feel should be responded to. 

Dr. Blinder, anything that you heard here from Dr. Zandi or Dr. 

Taylor that you would want to take issue with or respond to? 

Dr. BLINDER. Just a couple of things. I am sorry. Very briefly, a 

couple of things that Dr. Taylor mentioned, starting with the last. 

He is quite correct that when it comes to income taxes, though 

not to many other kinds of taxes, if you make the cut temporary, 

you dull its effect. But I don’t think you eliminate its effect. I think 

there is lots and lots of evidence that cash income matters. But you 

do reduce the effects. 

The problem, however, is where you sort of started the hearing, 

that we are in a simply horrendous long-run fiscal position and unable to afford permanent tax reductions anymore. I don’t think we 

could afford the ones we did in 2001, 1902, 1903. But we certainly 

can’t afford more, given the state of the economy, and that is what 

leads you to temporary. 

And under that heading, it is sensible to come up with ideas 

where temporariness may either not undermine or possibly even 

enhance the effectiveness of a tax cut. For example, the liberalization of depreciation, if done on a temporary basis, probably has 

stronger effects than it does if it is done permanently. 

Following that point, the argument is often made that well, you 

are just pulling spending forward, so you will create a dearth of 

spending later. That is true, but it is not an argument against the 

policy. Recessions are not going to last forever. 

Anti-recession policy is, in large measure, about pulling spending 

forward to fill in holes that we have on the belief, supported by lots 

and lots of evidence, that economies do recover on their own and 

are going to need support in the future, although they need it 

longer in really deep recessions, such as the one we are having. 

That is germane, for example, to tax Cash for Clunkers program 

that Mark Zandi was speaking about. Yes, it pulled spending forward and caused there to be less automobile spending after the 

Cash for Clunkers program expired. That is what it was supposed 

to do. 

Now, I think Congress made it much too short. I don’t think it 

made a lot of sense to pull spending 3 months forward. We needed 

to pull it a year forward or something like that. But nonetheless, 

the principle was correct. 

The CHAIRMAN. Dr. Zandi? 

Dr. ZANDI. I would like to focus on an area of agreement that I 

have with Dr. Taylor, and that is with regard to the need for consistent and clear policy. And I think the need for this is vividly ilVerDate Aug 31 2005 10:00 Jun 08, 2011 Jkt 000000 PO 00000 Frm 00148 Fmt 6601 Sfmt 6601 C:\DOCS\58156 SBUD1 PsN: TISH
143 

lustrated in what Dr. Taylor labeled the pre-panic period. I do 

think it is fair to say that the lack of consistency with respect to 

how policymakers treated financial institutions during that period 

is what caused the financial crisis to devolve into a panic, beginning with Bear Stearns, extending to Fannie Mae and Freddie 

Mac, to Lehman Brothers, and then some of the other subsequent 

failures. 

Each institution was treated very differently, and it created a 

great deal of uncertainty in the minds of creditors, who ultimately 

provide the liquidity to the financial system that makes it all work. 

So they just ran for the door. 

So it was that lack of consistency and clarity that I think precipitated the panic and the mess that we got ourselves into. We would 

have had a financial crisis regardless and a recession regardless, 

but we got a panic and a great recession because of those missteps. 

So I would agree with that, and I think that is important to try 

and guide policy going forward. I think it is now very key for policymakers to try to provide clarity and consistency, that the uncertainty is a real problem. 

I am not arguing that we shouldn’t have had these big debates 

in healthcare reform and financial regulatory reform. How could we 

go through a financial crisis and not have regulatory reform? You 

may disagree with the reform we got, but we had to go through it. 

It is just part of the process, and I think, in my view, ultimately, 

it will be therapeutic. 

But at this point, I think it is very, very important that policy 

work much more judiciously so that everyone knows what the rules 

of the game are. Because, otherwise, businesses aren’t going to 

start deploying that cash, and we are not going to get the job creation that we need. 

The CHAIRMAN. Dr. Taylor? 

Dr. TAYLOR. One of the problems with the temporary policies 

that Professor Blinder is referring to, in addition to the fact that 

they don’t stimulate consumption very much, is that they don’t get 

the economy growing. It is not true that you want to have policies 

that just push some money out there and then take it away. That 

is not—we want a strong, growing economy, a sustainable growth. 

So, for example, keeping the tax rates from rising now. That is 

something that affects incentives, that affects longer-term growth, 

businesses can plan for the next 2, 3, 4 years. And so, I think the 

permanency has to do with predictability, and it is very important 

to stress. 

I would just say one other thing in terms of permanent leaving, 

say, the tax rates where they are for the foreseeable future. I think 

it is important to note that we have had a massive increase in Government spending recently. 

Just some statistics—last week, I had an op-ed in the Wall Street 

Journal, along with George Shultz and Michael Boskin, John 

Cogan and Allan Meltzer, kind of outlining a strategy for the future. But we noted that Government purchases as a share of GDP 

were 18.2 percent in 2000. They are now 24 percent. And as you 

know from the chart, CBO is projecting they are going up to 30, 

40, 50, and who knows what. 

144 

So 18.2 percent in the year 2000. They are now 24 percent of 

GDP, and they are going up. I think there is a lot of room here on 

the spending side, and that is really the problem with our deficit. 

It isn’t the taxes. 

Thank you. 

The CHAIRMAN. Senator Gregg? 

Senator GREGG. Thank you, Senator Conrad. 

Gee, so much has been said here that is thoughtful and extraordinarily informative, but also very, hopefully, listened to. This is an 

exceptional panel of talented people—Princeton, Stanford. I know 

that Dr. Zandi would want to affiliate himself with Dartmouth because it doesn’t appear to be identified with anybody. 

[Laughter.] 

The CHAIRMAN. You will have your chance, Dr. Zandi. 

Senator GREGG. One message I think I am hearing, and disagree 

with me if I am wrong, is that to the extent temporary is done in 

this type of an atmosphere where we are facing a long-term debt 

crisis of inordinate proportions, it should have been coupled with 

long-term action that corrected the long-term debt crisis, as well as 

addressed a temporary solution. Is there a consensus that that was 

what we should have done? 

Dr. ZANDI. In an ideal world, yes. 

Dr. TAYLOR. Yes. 

Dr. BLINDER. Yes, but, and it is the ideal world. Having participated in the frenzy of redoing the Federal budget, a thorough-going 

deficit reduction program at the beginning of the Clinton administration, I think to have asked the Obama team, in addition to all 

the short-run things they were doing, to also remake the Federal 

budget in 6 weeks would have been asking a lot. 

Senator GREGG. Yes, but that is when they had the opportunity 

and we probably had the Congress, which was ready to act, hopefully, because it was a new Congress—— 

Dr. BLINDER. I agree with that in principle completely. 

Senator GREGG. And as a very practical matter, an economic recovery is—I think a lot of people have been talking about uncertainty—would have been significantly increased and would be significantly increased if we could give some certainty to the American 

people and to the international community that we were actually 

going to address our long-term financial problems. Is that not true? 

[Witnesses nodding.] 

Senator GREGG. I will take the nods as yes. Which we aren’t. I 

mean, it is a simple statement, but we haven’t done it. 

The CHAIRMAN. Can I just give them a chance to answer your 

question because the nods will never be captured on the record. 

Senator GREGG. OK. Please, to what extent is getting some longterm action—getting some action on our long-term fiscal instability 

critical to a stronger, healthier economy that produces jobs? If you 

could just give us your one-sentence thoughts on that? 

Dr. ZANDI. I think that would be critical. I think if we could do 

that, that would lay the foundation for much stronger economic 

growth and much stronger growth in our living standards for a 

long time to come. That would be a vital thing that we could do. 

Dr. TAYLOR. I agree. It would have to be credible, of course, not 

just a matter of laying out a plan. An especially, I think, bad apVerDate Aug 31 2005 10:00 Jun 08, 2011 Jkt 000000 PO 00000 Frm 00150 Fmt 6601 Sfmt 6601 C:\DOCS\58156 SBUD1 PsN: TISH
145 

proach would be to say we will start in 2 years. You have got to 

start when you make the plan. I think that would be very helpful 

in terms of creating certainty. 

Dr. BLINDER. Well, I think—I do agree that it is important for 

the long run. The tricky aspect of this comes exactly where John 

Taylor just finished off, which is what do you do about the short 

run? 

The economy is not in a position where it can take a fiscal contraction right now, whether that means higher taxes or lower 

spending. So the key difficulty facing the Congress now, I think, is 

to legislate or in other ways lock in future deficit reduction. This 

is a hard thing to do, as you all know. Again, in an ideal world, 

that is exactly what you would do. You would commit the Government to do substantial fiscal contraction, starting a few years from 

now. But since you don’t do it now, that is hard to make credible, 

quite hard. 

Senator GREGG. Dr. Taylor, you made one statement that sort of 

startled me because I didn’t realize this number was so out of 

whack. You said that in the first six quarters of the stimulus, only 

$2.4 billion has gone into infrastructure, of the $861 billion, which 

is actually $1.1 billion when you throw the interest rate cost on top 

of it. Is that correct? 

Dr. TAYLOR. Yes, that is the Federal—at the Federal level, and 

that is data produced by the Bureau of Economic Analysis. I can 

give you the tables for that. 

Senator GREGG. No, I just wanted to confirm that number. If the 

stimulus had been—let us take a threshold assumption here, which 

a lot of my colleagues and maybe myself wouldn’t even go to. But 

if the stimulus was going to be done, shouldn’t it have really 

pushed the money out the door on infrastructure improvement for 

long-term benefit and for immediate activity? 

Dr. TAYLOR. Absolutely. I think there were lots of projects that 

had passed cost-benefit tests that were useful. Probably some of 

them were process already. They could have been brought forward 

so you actually get the people with the jobs at the start. And for 

many reasons, this has been delayed. I think sometimes this is the 

way Government works. It is hard to—— 

Senator GREGG. Well, you are absolutely right. That is the way 

Government works. When this stimulus was put together, so much 

of it basically became, as I said earlier, walking around money for 

appropriators. You had your program that you had been trying to 

fund for years. You hadn’t been able to find the money. Suddenly, 

you funded it, and the funding may be spent 2 or 3 years from now. 

Well-intentioned programs, but I don’t think they really encouraged economic activity, and I don’t think they went—another corollary issue which infrastructure does, which is it makes us a more 

competition nation of capital investment. 

Dr. ZANDI. Senator, can I make a quick point about that? 

Senator GREGG. Sure. 

Dr. ZANDI. The total amount of infrastructure spending appropriated in the all of the stimulus back to the Bush tax rebates, if 

you total up all the stimulus, all the money appropriated, it is $1.1 

trillion. That is the total amount of stimulus. Of that, $38 billion 

146 

was infrastructure spending. So it was always a very, very small 

piece of the pie. 

Senator GREGG. That was a problem. My point is that was why 

the stimulus—— 

Dr. ZANDI. And even under the best of circumstances, it is hard 

to see how you get that out quickly if you want to make sure that 

you are doing good projects. 

Senator GREGG. Well, there are a lot of bridges that need to be 

fixed in New Hampshire. We had a highway director when I was 

Governor who said about the bridges ‘‘drive fast and don’t look 

back.’’ So—— 

[Laughter.] 

Senator GREGG. He was a good director. He just shouldn’t have 

been quoted so often. 

Just on aside here, I was interested in your chart which showed 

the effects of TARP and your argument that the TARP was a slam 

dunk. It has obviously become a pejorative because I think it has 

been misrepresented as to what it actually it did, and terminology 

has picked up its own purposes as versus being tied to what actually it did. 

But, really, the bringing down the LIBOR rates was purely an 

exercise of intervention by the Treasury through TARP, by the 

FDIC, and by Federal Reserve action, wasn’t it? 

Dr. ZANDI. Yes. Those actions were key to restoring financial stability, which was represented in the narrowing of that spread. 

Senator GREGG. They weren’t tied to the stimulus initiative, however? 

Dr. ZANDI. No. That is a separate policy response. 

Senator GREGG. Right. I mean, the two policies get wrapped up 

together. 

Dr. ZANDI. Yes. Yes, I am sorry. Yes. 

Senator GREGG. One was trying to address a crisis where we 

were at a cliff. We were going over the cliff, or we were on a bridge 

that was about to fall in, and we decided to fix the bridge. The 

other addressed the issue of economic activity—— 

Dr. ZANDI. But I should say in the work that Alan and I did and 

the results that were presented, they represented the impact of 

both aspects of that response, the stimulus as well as—— 

Senator GREGG. Right. I noticed you had a whole lot of things in 

there, and I was just trying to separate out the parts that I happen 

to think actually worked right—— 

Dr. ZANDI. OK. 

Senator GREGG [continuing]. Which was the TARP part and the 

financial intervention by the Fed and the FDIC to stabilize the financial markets as versus the stimulus package, which I found to 

be less than—well, I think the comment, which was made by you, 

Dr. Taylor, which is, in the long run, it may end up being a negative because it is going to add to the debt in a way that basically 

gets us very little for it. 

My time is up, but I thank you for the panel. Yes, did you want 

to make a comment? 

Dr. TAYLOR. On the issue about the end of the panic, the panic, 

as measured by the TED spread, my paper has—my testimony has 

147 

the spread between LIBOR and the Federal funds rate at I think 

a slightly better measure, but it is very similar. 

The worst part of the panic was the period from the announcement of the TARP until the TARP was clarified how it was going 

to be used. There was a tremendous uncertainty. ‘‘How are we 

going to buy these toxic assets?’’ is the way it was frequently put. 

And that really stopped as soon as there was some clarification. 

You might not like the clarification. But on October 13th, a meeting of the Treasury, it was made clear that these were for equity 

injections, and then things improved. That is how I think of this. 

So, in some sense, the cause of these spreads was the action. And 

fortunately, people reacted and fixed the problem before it was finished. 

Senator GREGG. And just as a point of editorial comment, it was 

lucky that we drafted the TARP in the way that gave the Treasury 

Secretary that flexibility because he could never have bought the 

toxic assets as it turned out and gotten the bang for the buck that 

he got by buying equity. 

The CHAIRMAN. Let me just make three kind of parenthetical observations. One, when the President was elected, but before he took 

office, I wrote him a letter urging that when we do stimulus, we 

simultaneously make a commitment to long-term deficit reduction 

so that we signal the markets and we signal people that we recognize the increase in deficits and debt have got to be dealt with and 

that the debt is a serious overhanging threat. 

Second, as we went through the question of recovery package, I 

fought for $200 billion of infrastructure rather than $38 billion. We 

lost that fight. I still believe we would have been much better off, 

for the reasons the Senator gave. And you know, we will never 

know. 

But I think if you look at the Recovery Act package, the parts 

of that package that are the weakest are the exact ones Senator 

Gregg is referencing that were basically appropriators taking 

money for programs they had long wanted to fund, regardless of 

bang for the buck. And a lot of it was stuff that wasn’t particularly 

strong on a bang for the buck evaluation. 

Senator Stabenow? 

Senator STABENOW. Well, thank you very much, Mr. Chairman. 

And I first start by agreeing with the chairman that this is a 

very important, thoughtful discussion, and there are differences in 

approaches that are legitimate and I think are very important to 

talk about. 

I also want to stress, as we look at long term, one of the frustrating parts of being around here for a while, coming in 2001, in 

this committee. At that time, we were talking about the largest 

surpluses in history of the country. And being in the House when 

we balanced the budget, I thought we were dealing with that. And 

we did balance the budget, and we did put in place the largest surpluses in the history of the country and debated that—what do we 

do with that? 

Unfortunately, I believe the wrong structure was put in place. 

And as my mother would say, proof is in the pudding. We are now 

in the largest deficit in the history of the country. If we had listened to our chairman at the time in looking at the possibility on 

148 

what do we do with the surpluses, he had—our current chairman 

had recommended a third for strategic tax cuts to grow the economy, a third for strategic investments and innovation in education 

and so on, and a third to pre-pay down the liability of Social Security. 

Looking back on that now, as before, I think that would have 

been a pretty good plan to put us on a solid footing. But we are 

where we are. And so, now we have a hole, and we have to once 

again dig out of a very, very big hole. 

I also want to agree with the ranking member and the chairman 

on infrastructure spending. We tried to do that. As the chairman 

indicated, he was advocating for much more. In all honesty, Mr. 

Chairman, I think it is important to say we didn’t get the bipartisan support, or we would have done it. 

Because I remember school construction and water and sewer 

and roads. We are at a point in our country where we need to give 

the country a facelift. You know, all of us baby boomers may feel 

the same. So we tried, and we will try again to be able to do that. 

When we look at this—and I have a couple of specific questions 

for you. Very much appreciate your comments. But I do want to 

make two other points. We have to deal with long-term debt. In my 

judgment, we will never be able to deal with that with more than 

15 million people out of work, which is why we started with jobs. 

You have to start with jobs so that people are contributing, buying things, paying their taxes, or we will never get out of debt if 

people aren’t working. And so, I believe jobs in the short run and 

moving forward has to be a huge part of that. 

And with all respect to colleagues who feel differently, we have 

had a set of tax strategies in place for 10 years, and the argument 

about extending the top rates, I guess my question is where are the 

jobs? People in Michigan have lost 1 million jobs. If that had 

worked as an incentive, I would have been very happy—very, very 

happy. And, but we didn’t see the jobs from that strategy. 

So that brings us to now, and I want to thank you. I have a big 

smile on my face about Cash for Clunkers. I appreciate the comments on that. The coming together on timing was more luck, but 

strategically really was the right program at the right time. And 

I agree with you that I wish we could have made it longer. But I 

am appreciative of your comments about the fact that this did come 

at the right time. 

It got people into showrooms. It gave them an opportunity to put 

some money in their pocket on the demand side and go look at vehicles. And they cleared out showrooms, and we put second shifts 

on in plants. So caring about demand is important, not just supply. 

Question on manufacturing. A lot of what we did in the Recovery 

Act was focus on manufacturing for the first time in a long time. 

The 30 percent advanced manufacturing tax credit for new equipment and vehicles, for clean energy, the battery dollars, which have 

created many, many new opportunities for us in Michigan, are 

going to take us from 2 percent of the world’s advanced battery 

manufacturing to 40 percent of the world’s battery manufacturing 

in the next 5 years. 

I wonder if you might speak about building on those kind of 

things. We have seen manufacturing numbers going up, not as fast 

149 

as I would like, but certainly going in the right direction. And what 

role do you think manufacturing will play in recovery? What more 

should we be doing? 

I am wondering, Dr. Blinder, if you would like to? And then Dr. 

Zandi and Dr. Taylor. 

Dr. BLINDER. Sure. Manufacturing is pretty much—through 

housing is another contestant—the most cyclical aspect of the economy. So when we have a slump, manufacturing gets hit worse. 

Usually when we have a recovery, manufacturing is going to go up 

faster than GDP. I think that is happening now. 

Second, however, and I hate to say this to the Senator from 

Michigan, but there has been for 50 years about now, and it will 

continue, a secular decline in the share of employment that is in 

manufacturing. 

Senator STABENOW. Right. 

Dr. BLINDER. And we should not expect that to change. What is 

in that manufacturing bucket has changed dramatically over 50 

years, and I want to come back to that in my third point. But I 

think we have to accept it as more or less a fact of life that the 

share of employment in manufacturing is on a secular decline. 

It has to do with consumer taste. It has to do with productivity. 

It has to do with a lot of things. The only point I want to make 

is that it is happening in every single advanced country in the 

world. We are just ahead of the pack. France, Britain, Germany— 

they are all following us with a lag. Theirs are declining also, and 

we are just ahead of them. 

Third, however, there are some things we can do, and this has 

to do with what is inside the bucket. Ironically, I think one of the 

best things we could do to spur more manufacturing in the U.S., 

and this bears on the long-run deficit also, is to enact now a carbon 

tax or some variant on that that would start at essentially zero and 

rise on a predictable schedule, that would get American businesses 

focused on the kind of innovation which leads to production that 

they are capable of, if they have the incentive. 

If people knew that fossil fuels were going to be vastly more expensive 10 years from now than they are now, American business 

would get to work right away in developing energy-saving technologies. We have seen this in the past. We have seen what American industry is capable of in terms of innovativeness. 

And I don’t believe any of these doomsday scenarios that we have 

lost the edge or anything like that. But you need to give than the 

incentives, and I think, ironically, even though it is a tax increase 

for the future and not for the present, I think that is one of the 

best things that we could do to spur manufacturing activity in the 

U.S. 

Senator STABENOW. Thank you. 

Dr. ZANDI. I rarely disagree with Alan. In fact, I can’t even remember the last time I disagreed, but with regard to the prospects 

for the Nation’s manufacturing base, I take a very different perspective. My view is that if you are a manufacturer and you survived what we have been through, you are mettle tested. You have 

a market niche. You are very cost competitive. Your prospects are 

incredibly bright. 

150 

And I think manufacturing has to be key, a key source of growth 

in our economy going forward. It is key to good, solid, high-paying 

jobs in parts of the country that we have got, for goodness sakes, 

a lot of unemployed workers that can’t move because they are 

under water on their homes. So we need manufacturing to come 

back, and I think we are poised for very good, solid growth. 

A different kind of manufacturing than we have done in the 

past—aircraft, aerospace, electronics, battery technology, machine 

tools, sophisticated instrumentation, construction equipment. I 

mean, we do a lot of things very well, and we are going to do them 

very competitively going forward. 

Now there are a few things that could help. In the very near 

term, I think the President’s proposal for accelerated depreciation 

benefits in 2011, that is a darned good idea. For 2011, that is going 

to juice up investment spending. It doesn’t cost taxpayers very 

much because of the way the tax liabilities are distributed, and we 

are going to get a real boost to business investment, which helps 

long-run productivity growth and a growth in our living standards. 

And for goodness sakes, that is key to manufacturing. So I would 

be very supportive of that. 

Second, another important policy effort where you have less control but we have some influence, it is very important for the Chinese to continue to allow their currency to revalue. They are on a 

path. My sense is they go 3, 5 percent on the currency, let it revalue every year. 

Hopefully, 5, 6 years down the road they are fairly valued 

against the U.S. currency. Then U.S. manufacturers are going to 

be in a much better place competitively. But we need to continue 

to convince and educate the Chinese that this is the appropriate 

policy response not only for us and the global economy, but for 

their own economy it makes perfect sense. 

And finally, third, fitting right in with infrastructure, you know, 

infrastructure I think is the best way to get persistent unemployment rates down, and it can be self financed. We have got lots of 

private capital. I get calls from hedge funds every day saying can 

we figure out a way—we want to invest in the Nation’s infrastructure. We want to partner with Government. If Government can 

give us some catastrophic backstop, then we are in. And we are 

going to provide capital, and we can do this. And it is going to create jobs in those communities that are trapped right now. 

And that is—when you build infrastructure, you are driving 

manufacturing activity, right? So I think that would be a very effective way of promoting long-term growth maybe. My view is manufacturing, as Alan has said, for the last—sorry, I am on a soapbox 

for a second, but I will get off—last 25 or 50 years, but I think its 

prospects for the next quarter century are very bright. 

Senator STABENOW. Thank you. 

I know we are out of time. I didn’t know if Mr. Taylor wanted 

to comment or not. But, Mr. Chairman, I know I am out of time. 

So thank you. 

The CHAIRMAN. We will go to Senator Sessions. 

Senator SESSIONS. Thank you, Mr. Chairman. 

I do have to go to the floor. So I just have a few minutes. I will 

cut it short. 

151 

One of the things you discussed was instability arising now from 

uncertainty about tax rates, which could be fixed, should be fixed, 

and there is no reason that instability stays out there. But the 

President apparently is not willing to step up and make that plain 

statement. 

In addition, we have the announcement that Larry Summers is 

leaving, following Christina Romer and Peter Orszag, the key 

team. And if this was a change because we have a new plan for 

the economy, perhaps that could be a positive. But in fact, it leaves 

us only with more uncertainty. It is not a healthy thing that is occurring. 

And Dr. Blinder and Dr. Zandi, you talk about infrastructure, 

and Senator Conrad said he fought for more infrastructure in the 

bill. That was one of my biggest criticisms of it. It was sold as an 

infrastructure bill. The President and the Democratic leadership 

said this was for roads and bridges, we are going to fix our crumbling infrastructure, and only 3 percent or so of that money went 

to that. 

And it didn’t create jobs, unfortunately. I want to ask about that. 

But one thing about infrastructure. You have got the bridge. You 

have got the road that helps make the economy a little more productive at least, maybe for generations to come. 

During the debate about the stimulus package, I remember reading on the floor from a Wall Street Journal article by Gary Becker, 

the Nobel Prize Laureate, and Kevin Murphy, and they posed the 

question, ‘‘How much will the stimulus package moving in Congress really stimulate the economy?’’ Now that was a good question 

to ask. And their conclusion was not much. 

And it appears that they were proven correct. He says, quote— 

and this was in February 10, 2009. ‘‘In fact, much of the proposed 

spending would be in sectors and on programs where the Government would mainly have to draw resources away from other uses.’’ 

He notes that, ‘‘Our conclusion is that the stimulus to short-term 

GDP will not be zero.’’ 

For heaven sakes, it couldn’t be zero with that much money getting spent. ‘‘And will be positive, but the stimulus is likely to be 

modest in magnitude. Some economists have assumed that every 

$1 billion spent by the Government through the stimulus package 

would raise short-term GDP by $1.5 billion, or in economics jargon, 

a multiplier of 1.5. That seems too optimistic, given the nature of 

the spending programs being proposed. We believe a multiplier 

well below 1 seems much more likely.’’ 

Mr. Taylor, do you think that Professor Becker and Murphy were 

correct in their prediction? 

Dr. TAYLOR. Basically, yes. My empirical research, simulations of 

models, finds that for this particular package, multiplier was less 

than 1—0.7, sort of a round number we found, to some extent. But 

in addition, those multipliers, so to speak, refer to purchases of infrastructure or goods and services. And, in fact, as you have pointed out, that has been very small. So, on top of the fact that the 

multiplier is smaller than some people argued, the thing that is 

being multiplied was quite small. 

152 

So, for those two reasons, I think that the conclusion of Becker 

and Murphy is basically correct. It certainly coincides with what I 

have been finding. 

Senator SESSIONS. Well, one of the concerns I had, in retrospect, 

over what happened in the early Bush years and Alan Greenspan’s 

leadership, was that we had surpluses, and they seemed to think 

that we could carry more debt. And even some were saying deficits 

don’t matter. Do you remember that, Senator Conrad? I remember 

Alan Greenspan saying, ‘‘Well, I felt that we could carry some more 

debt.’’ 

But they didn’t understand the politics of it, the economists. 

Once we lost the high ground of defending balanced budgets, it just 

roared out of control. The spending took over in ways that now 

jeopardize us. 

Dr. Taylor, would you say that with regard to Professor Blinder’s 

comment that we can’t stand fiscal restraint right now that that 

does have some cost, in terms of creating more debt. Also, does it 

not create instability and concern in the financial markets when 

they don’t see Congress commencing any fiscal restraint, and can 

we continue to just put off the day that we start showing restraint? 

Dr. TAYLOR. I believe that it would be best to start right away, 

start when you announce the program. It doesn’t have to be draconian, although quite frankly, if you look at my numbers, 18.2 percent of GDP in 1980, 24 percent now. It looks like we have capabilities of doing something. 

But I think that, basically, it is important to start at the same 

time, not to put it off for a couple of years. Again, it doesn’t have 

to be draconian. It can basically start making progress now, and 

that is where the credibility will come from. It is so easy to promise 

we are going to do something next year or the following year. It 

is hard to get started now, and that is where the credibility will 

come from. 

So I strongly view that that is a positive for the economy. The 

reduction of uncertainty, the demonstration that our Government 

is dealing with these problems I think would be very beneficial and 

would help us get out of this really unfortunate situation of high 

unemployment and very low growth. 

Senator SESSIONS. Well, as one constituent told me in Evergreen, 

‘‘As my granddaddy said, you can’t borrow your way out of debt.’’ 

And I believe the old verities, if applied with minimal ‘‘masters of 

the universe’’ influence with the marketplace—no disrespect intended—by the people who think we can do this and we can do 

that, and we can stimulate this and we can reduce that, and allow 

the strength of the American economy to surge would be the best 

approach for us. And we need some firmer leadership than we have 

had, in my opinion. 

The CHAIRMAN. Thank you, Senator Sessions. 

Senator Begich? 

Senator BEGICH. Thank you, Mr. Chairman. 

Let me first ask a very simple question. Hopefully, a simple answer. 

Compared to January 1909 to where we are today, is the economy better off? 

Dr. BLINDER. Vastly. 

153 

Dr. ZANDI. Measurably better. 

Dr. TAYLOR. January 1909, the unemployment rate was 

lower—— 

Senator BEGICH. That is not what I asked you. I don’t want to 

get into the unemployment rate. I want to ask you the general, 

overall question. Is the economy better today than it was in 1909? 

It is a very simple question. It is a yes or a no. 

Dr. TAYLOR. Well, I think—the dimensions I am looking at, we 

are in worse shape. The unemployment rate is higher. Our growth 

rate is better. It is 1.6, rather then I guess it was about minus 6 

at that point. That is definitely an improvement. 

But it is very disappointing, Senator. I mean, this is 3 years— 

the crisis really started in August 2007. So in terms of what is better and what is worse, I think it is not in a good shape, and we 

need to think about fixing it. 

Senator BEGICH. So I want to make sure I got your commentary. 

I am not disagreeing that there is more work to be done. That is 

a question over here. In 1909 to where we are today, are you telling me the economy is worse off? 

That is the—it is not a complicated question. 

Dr. TAYLOR. Growth is higher, which is good. 

Senator BEGICH. Now see—— 

Dr. TAYLOR. Unemployment is higher, which is bad. 

Senator BEGICH. OK. I am not going to get an answer from you. 

I can tell that because—now maybe I am missing something. Now, 

and I know I have these discussions in budget, and I appreciate, 

Mr. Chairman, your graciousness to allow me on this committee in 

kind of midstream. But I will be very blunt with you, all three of 

you. 

First off, I agree with I think there is a lot of issues that Senator 

Gregg and I agree on. The ranking member, Senator Sessions, and 

I are cosponsors of some budget bills, some deficit control bills. But 

I am one of the few in this whole U.S. Senate that is a small business person, that has had to go scrape capital together, that actually had to go talk to a bank and understand what it is like. Had 

to fill out a 1099, to actually decide what is going to get an employee to work for me and how to grow the customer. 

I appreciate your comment on the HIRE Act. For a small business person, that doesn’t incentivize me to hire someone. There is 

only one thing that incentivizes me is my business increasing. And 

I will be very blunt with you, people who—and I hear this, and it 

is the political jawboning that goes on in this place. They always 

try and figure out what side they need to be on. 

The economy is better. The amount of cash that corporations 

have today than they had before is greater. Their stock prices are 

better today than they were in 1909. When people get their third 

quarter retirement, 401(k), education statements, which they will 

get in a few weeks, it is like the best direct mail program ever because they are going to see that their portfolios are better than 

they were in 1909. 

Now what I hear a lot, and I will say also on the recovery, I also 

like the way creation of history happens around here. I was in 

those negotiations in February on that stimulus bill, and all due 

respect to my colleagues on the other side, if I now know all these 

154 

people who wanted infrastructure because I am a guy—I am a 

mayor, a former mayor. We build stuff. That is what we love to do. 

Because when we build stuff, it changes the economy immediately. 

Now that there is all this new support for infrastructure, that 

stimulus bill should have had $800 billion for infrastructure. But 

that is not the case because the other side had all this about tax 

cuts and all this other stuff, and that amount of infrastructure dollars shrunk and shrunk. But it is interesting to find out today that 

so many people supported it, I just missed them back last February. Because that is just a fact, I agree. I think everyone agrees 

infrastructure investment is a great way to stimulate an economy. 

My problem is of how we distributed it. I am a believer that you 

have got to put it out on the local end. You want it to hit the 

streets to people who actually can get the jobs done. I am biased. 

I am a former mayor. Mayors know how to do it. School boards how 

to do it. 

So I just—you know, when I hear some of this jawboning that 

goes on in these committee meetings and some of the re-creation 

of history, it is amazing to me. If this was the case, we would have 

had 100 votes for an infrastructure bill at $800 billion. 

And I know the Democrats worked very hard on it. I sat in a 

meeting about education construction dollars, and what we heard 

from the other side is, well, we have never really done that. We 

don’t do that. 

My view was a double. If we put money in a school budget for 

school construction, first off, it gets distributed down at a local 

level, which means actually you would build something. Second, 

you would offset the property taxes that are usually paying for 

those, and therefore, you will have another opportunity to hit 

homeowners in a positive way. 

Also, a property tax makes a difference. If you can lower property 

taxes, it makes more properties more financeable because that is 

a piece of the equation for a mortgage. It seems so simple, but this 

place is not a simple place, as we all learn. 

But I will just say again that the record to me is so clear. Are 

we a fragile economy? Yes, we are. Is there more work to be done? 

We can debate that. How that will occur is the work that we are 

all here to try to do. And in my view, I just sit here patiently listening, and I just get frustrated when I see history re-created 

based on the needs of a political cycle rather than what is right for 

this country. 

The second thing is—and I know these two words. If you ask any 

pollster, they say don’t mention ‘‘TARP.’’ Don’t mention ‘‘stimulus.’’ 

But the fact is, and I don’t think anyone would disagree, TARP, in 

its own way, painfully worked. I didn’t like it. I campaigned 

against it. 

But when we look back and see the repayment schedules that 

has occurred and the infusion that occurred to create certainty to 

the financial institutions, it was a huge plus. It may not have been 

the amount of dollars. But I think you mentioned earlier about 

once they knew kind of what was going on, certainty is the name 

of the game in business—certainty. Not a few dollars on the table 

to build something, but certainty. 

155 

If they knew there was a long-term infrastructure plan, they 

would know certainty. They knew there was a tax policy, not one 

that is going to be extended for a year or 6 months or—people don’t 

plan multibillion dollar businesses on a thing Congress does for 6 

months. That is the most ridiculous thinking I have ever seen. It 

is based on certainty. And so, I got on a little rant because I got 

a little frustrated when I hear people re-create history and then repackage it in a way that makes it sound so bad. 

I will tell you I have never seen more panic sitting in a political 

office in January 1909 when I came here and was sworn in. More 

panic in members that have been around here for ages because this 

economy was over the cliff and hanging on by just a thread. So I 

feel like we have moved a little bit further. 

Now saying that, I have got two quick questions. I am sorry I 

went on a rant. I just get a little frustrated when people want to 

re-create things for political purposes. Two things. Do you believe 

my statement that I made on businesses want certainty to determine the long- term investments they make? 

And this should be simple. I try to keep my questions simple. I 

know, as economists, you want to give long answers, and I recognize that. But can you answer that? And then it leads to the next 

question. 

Dr. BLINDER. Can I just make a—— 

[Laughter.] 

Dr. BLINDER. This is going to sound slightly pedagogical. There 

is no such thing as certainty in business. You have been in business. I am in a business myself. 

Senator BEGICH. That is fair. That is a fair statement. 

Dr. BLINDER. But I think what you mean is reduction of uncertainty. 

Senator BEGICH. Yes. 

Dr. BLINDER. Especially the uncertainty about the rules of the 

game, and absolutely. 

Senator BEGICH. Yes. That is a better way to phrase it. Yes. That 

is the question then. 

Dr. ZANDI. You should know I am not just an egghead. I started 

my own company—— 

Senator BEGICH. So you know what it is like. 

Dr. ZANDI [continuing]. In 1990, me and my brother. And we sold 

it 15 years later. So I know exactly what you are talking about. 

And yes, you need to know what the rules of the game are. Until 

you do—and it is down to the crossed T and the dotted I. Until you 

do, you are not going to make a big investment decision or a hiring 

decision. 

Dr. TAYLOR. I agree 100 percent. Certainty is important, and predictability of policy—— 

Senator BEGICH. Microphone? Dr. Taylor? 

Dr. TAYLOR. I agree 100 percent. Certainty is a great benefit to 

businesses, and I think that the greater policy can be predictable, 

the more certain the environment will be for businesses. 

Senator BEGICH. Excellent. Let me, if I, Mr. Chairman, could just 

ask one quick question, and then I will stop. And I appreciate—— 

The CHAIRMAN. No, go ahead. 

Senator BEGICH. I thank you for the additional time here. 

156 

Thank you for all agreeing on that. 

Now, and I have pitched this before in this committee, you know, 

we are going to contemplate this tax policy, and I could argue that 

some people think there is no leadership on this issue. I don’t 

know. I have heard the President talk about 98 percent of the people getting a tax reduction. Some are fighting over the last 2 percent. I mean, in politics, if you get 98 percent on anything, that is 

a pretty good deal. 

But leaving that aside, I am a believer that, again, certainty is 

the name of the game. I have saddled up to the Wyden-Gregg tax 

policy legislation, which takes corporate rates down to a flat of 24 

percent, taking it from the second highest in the world down to 

about midstream, compressing the six individual rates down to 

three—35, 25, 15. It gets rid of a lot of loopholes, simplifies it, deals 

with capital gains, reinvestment, really focused on small business 

and how to make sure those dollars. 

I recognize we have to debate the Bush tax cuts because that is 

what is in front of us, but isn’t it wiser for us to really think about 

a longer-term reform? There has not been really tax reform for so 

long that the uncertainty in business is they just don’t know what 

we are doing. Are we going to have an energy tax credit? Are we 

going to have a capital gains reduction? Are we going to have 

what? 

Isn’t that the better approach if we are serious about reviving 

the economy, just have some rules of the game, at least on tax policy? I am putting infrastructure aside because that is a different 

ballgame. Who wants to respond to that? 

Dr. TAYLOR. Very briefly, your points about the corporate rate 

and a need for tax reform are very well taken. I think in this environment, though, Senator, for certainty, which is really what you 

are emphasizing, just the certainty that the tax system will not 

change for a while, just leave it alone for a while, that will create 

certainty. We know what the tax rates are. Leave them where they 

are. 

I think in this situation where the very credit worthiness of the 

United States is going to be at stake, maybe postpone these important things and just create stability right now. That is what I 

would argue for. 

Dr. BLINDER. I am actually quite sympathetic to that. I have 

been a longtime advocate—forever, as far as I can remember—of 

tax reform and especially tax simplification. But I must say, given 

all the tumult of recent years, I am pretty sympathetic to what 

John just said, that we sort of can’t do everything at once. You 

can’t throw everything into the hopper at once. 

For example, doing something about the long-run budget deficit 

may right now be more important than tax reform. That is something I never thought I would hear myself saying, but I think there 

is validity to that right now. 

Dr. ZANDI. I would just say I would think to address our longterm fiscal problems we are going to need tax reform. I don’t know 

how we are going to be able to do it in a credible way unless that 

reform includes spending restraint and some substantive changes 

to the tax code. 

157 

And I think part of that would be consistent with what you are 

saying. I do think it would be prudent to lower the corporate tax 

rate. I do think that that would be an appropriate way to move. 

Of course, you have to put that into the context of the long-term 

fiscal situation. 

Senator BEGICH. Correct. Let me end there. 

Mr. Chairman, thank you for letting me extend further than I 

should have, but I thought it was some interesting dialog. 

The CHAIRMAN. That was very good. 

Senator BEGICH. Thank you very much, Mr. Chairman. 

The CHAIRMAN. That was very good. I am glad that you did it. 

Let me just say with respect to answering your question on 

whether or not we are better off now than 2009, I don’t think there 

is any question. Just on the facts, the economy contracted about 5 

percent in the first quarter of 1909. We have positive economic 

right now, although not as strong as we would like. But it is positive 1.6 percent. 

On the employment front, in January 1909, we were losing 

800,000 private sector jobs a month. Now we are in positive territory. Jobs are being created, again, though not at the rate we 

would like. 

Look to the markets. Look where the stock market was in January of 2009. Look where it is today. It has dramatically improved. 

Now, what hasn’t improved is our long-term fiscal outlook, and 

that does require our attention. I personally am in the camp of Dr. 

Blinder. I would not do something draconian in terms of fiscal discipline at this moment. 

I would put in place the plan that brings us to a debt that would 

be lower as a share of our economy than the debt we have now because I think we are at a very—a tipping point, if you will, at a 

debt, gross debt of 90 percent of GDP. If we look at economic history, that has been a tipping point. We had testimony to that effect 

before the fiscal commission. 

And clearly, it is going to take attention on both the spending 

and the revenue side. On the spending side, spending is the highest 

it has been as a share of GDP in 60 years. Revenue is the lowest 

it has been as a share of GDP in 60 years. 

So I think it is going to take a response on both sides, and I personally believe tax reform, fundamental tax reform has got to be 

part of it. I think Gregg-Wyden is a very good beginning. I can tell 

you it is getting a great deal of attention on the commission. No 

decisions have been made, but I think it is a very thoughtful beginning. 

And you know, we have got a tax system that was designed when 

we didn’t have to worry about the competitive position of the 

United States. We were so dominant when this tax system was 

constructed we simply did not have to worry about the competitive 

position of the United States. We do now. And we have got to write 

a tax system that helps us compete as effectively as we can as a 

country. 

It would be very foolish not to take this opportunity to work on 

that but without changing the tax code in the next several years, 

but put in place the reforms that I think most of us know really 

are needed. 

158 

With that, I want to thank this panel. Senator Gregg said to me 

as he left, ‘‘Boy, that is an all-star panel.’’ And it is. These are 

three of America’s very best. And we owe a deep debt of gratitude 

to not only testimony here today, but much more than that—a career of contributing to the dialog in this country on very complex 

issues. 

Three of America’s very best—Alan Blinder, Dr. Mark Zandi, and 

Dr. Taylor. Thank you so much for being here. We appreciate it. 

[Whereupon, at 11:48 a.m., the hearing was adjourned.] 

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QUESTIONS FOR THE RECORD 


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Answers from Dr. Mark Zandi 


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OUTLOOK FOR THE ECONOMY AND FISCAL 

POLICY 

TUESDAY, SEPTEMBER 28, 2010 

U.S. SENATE, 

COMMITTEE ON THE BUDGET, 

Washington, DC. 

The Committee met, pursuant to notice, at 10:01 a.m., in room 

SD–608, Dirksen Senate Office Building, Hon. Kent Conrad, Chairman of the Committee, presiding. 

Present: Senators Conrad, Wyden, Nelson, Whitehouse, Warner, 

Gregg, Bunning, and Ensign. 

Staff present: Mary Ann Naylor, Majority Staff Director; and 

Cheri Reidy, Minority Staff Director. 

OPENING STATEMENT OF CHAIRMAN CONRAD 

Chairman CONRAD. The hearing will come to order. I want to 

thank my colleagues and thank our witness for being here. Today’s 

hearing will focus on the outlook for the economy and fiscal policy. 

Our witness today is CBO Director Doug Elmendorf. 

Director Elmendorf, welcome back. We look forward to your testimony. 

I would note that this is our third hearing on the economy in the 

last 2 months. We have heard from six outstanding economists so 

far. Director Elmendorf will make it seven. 

Let me begin by providing an overview of our fiscal and budget 

outlook. I think it is critically important to remember the economic 

crisis we faced just a short time ago. By late 2008, we were in the 

midst of the worst recession since the Great Depression. The economy shrunk at a rate of 6.8 percent in the fourth quarter of 2008. 

Unemployment was surging, with 800,000 private sector jobs lost 

in January of 2009 alone. A housing crisis was rippling through the 

economy, with home building and home sales plummeting and 

record foreclosures. And we faced a financial market crisis that 

threatened to set off a global economic collapse. 

166 

I will never forget being called to an emergency meeting in the 

Leader’s office in the fall of 2008. I arrived at about 6 o’clock. There 

were the leaders of Congress, Republicans and Democrats, Senate 

and the House, the Chairman of the Federal Reserve, the Secretary 

of the Treasury in the previous administration, and they told us 

they were taking over AIG the next morning. They believed that 

if they did not, there would be a financial collapse. 

Those were very, very serious days. And the Federal response to 

the crisis I believe has successfully pulled the economy back from 

the brink. And this year we have begun to see a return to economic 

and job growth, although both are weaker than we would hope. 

Two of our witnesses from last week’s hearing, Dr. Blinder and 

Dr. Zandi, completed a study that measures the impact of the Federal response to the crisis. I would like to highlight their findings 

and then ask Dr. Elmendorf to comment in his testimony on 

whether CBO has found a similar impact and result. 

Dr. BLINDER AND DR. Zandi’s report said, in part, and I quote, 

‘‘We find that the Federal response effects on real GDP, jobs, and 

inflation are huge and probably averted what could have been 

called Great Depression II. When all is said and done, the financial 

and fiscal policies will have cost taxpayers a substantial sum, but 

not nearly as much as most had feared and not nearly as much as 

if policymakers had not acted at all. If the comprehensive policy responses saved the economy from another depression, as we estimate, they were well worth their cost.’’ 


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

Federal response. 


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Let me go to the next chart. You see a similar picture with the 

unemployment rate. The actual unemployment rate on a quarterly 

basis is now hovering at about 9.7 percent. That is still far too 

high, and we must do more to create jobs and bring this rate down. 

But if we had not had the Federal response, the unemployment 

rate would now be 15 percent—again, this is according to the analysis by Dr. Blinder and Dr. Zandi—and would continue rising to 

16.2 percent by the fourth quarter of 2010. So, clearly, the Federal 

response to the economic crisis has had and continues to have a 

significant positive impact on the economy. 


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But, clearly, we are not out of the woods. The economy remains 

unsteady and faces strong head winds. That is why in the near 

term I believe we need to focus on providing additional liquidity to 

boost demand and promote job creation. We cannot afford to repeat 

the mistake of the mid-1930’s when recovery measures were pulled 

back too quickly, and the Great Depression was prolonged. 

At my request, CBO has previously provided Congress with the 

ranking of the bang for the buck we get from various Federal policies designed to spur economic growth. This chart depicts some of 

the policy options ranked by CBO. 


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On the upper end of the scale, it shows that policies like extending unemployment insurance and providing payroll tax relief for 

firms hiring unemployed workers give you a higher impact on GDP 

for each dollar spent. Also at my request, CBO has now done further refinements of these rankings to help Congress as it considers 

options going forward. I look forward to hearing from Director Elmendorf about CBO’s latest findings in this area. 

In addition to the near-term economic challenge, we must also 

confront the looming long-term budget crisis. The retirement of the 

baby-boom generation, rising health care costs, and our outdated 

and inefficient tax system are projected to explode deficits and debt 

in the years ahead. I might say if we extend all the tax cuts permanently, that would have a profound effect on increasing deficits and 

debt as well. 

According to CBO, Federal debt could rise to 400 percent of gross 

domestic product by 2054. That is 44 years from now. That is a 

completely unsustainable course. What we should be doing now is 

putting in place deficit reduction policies that will kick in after the 

economy has more fully recovered. By establishing and enacting 

these policies now, we will reassure the financial markets the 

United States is confronting its long-term fiscal imbalances. 


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Let me just conclude by what Chairman Bernanke has said earlier this year about the need for a credible plan to address our 

long-term fiscal challenges. He said, and I quote, ‘‘A sharp nearterm reduction in our fiscal deficit is probably neither practical nor 

advisable. However, nothing prevents us from beginning now to develop a credible plan for meeting our long-term fiscal challenges. 

Indeed, a credible plan that demonstrated a commitment to achieve 

long-run fiscal sustainability could lead to lower interest rates and 

more rapid growth in the near term.’’ 


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I believe that. That is why I believe the work of the President’s 

Fiscal Commission is so important. As members of that Commission, Senator Gregg and I can attest to the hard work being done 

by the Commission. I remain hopeful that we will come up with a 

bipartisan plan that puts the Nation back on track. 

With that, I would turn to Senator Gregg for his observations, 

and then we will go to the witness for his testimony. 

OPENING STATEMENT OF SENATOR GREGG 

Senator GREGG. Thank you, Mr. Chairman, and I look forward 

to hearing from the Director on his view of where the economy is 

going. I would like to associate myself with the second half of your 

presentation, which is that I do not believe economic recovery will 

occur until we make it clear to the markets and to the American 

people that we are going to be serious about dealing with the debt 

of this country and the rising deficits and their impact on the markets, their impact on confidence. 

I believe the American people have pretty much lost their confidence in their Government. They are seeing a Government which 

has grossly overexpanded, which has exploded in its size from 20 

percent of GDP when this administration came into office and now 

to 24 percent of GDP, headed up to 26, 27 percent of GDP; a Government which has exploded not only in size of its spending but 

also in size of regulatory activity, to the point where it is very hard 

for small businesses to be able to do business because they are 

weighed down by this massive expansion in regulatory activity, especially from the health care bill, creating huge uncertainties in 

the future of small companies or small businesses as to whether or 

not it should expand. 


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That is coupled with the fact that we passed laws which have 

significantly retarded the availability of credit by being a misdirected effort to try to correct the very serious problems with our 

banking system, the financial reform being a specific act of transgression here in that it is a bill which has caused credit to contract 

and will cause credit to continue to contract, without doing anything substantial, at least significant in the area of addressing the 

underlying problems which drove the credit contraction, which 

were the real estate bubble and the excessive and inappropriate 

lending that was occurring in the marketplace. Instead of addressing those issues, it created, again, layers and layers of new regulatory activity, hundreds literally of new regulatory agency initiatives, including a brand-new agency called the Consumer Protection Agency, which is going to be headed up by an ad hoc individual who is not even going to appear before the Congress for confirmation. What a transgression of the constitutional process that 

is since this person will probably be one of the most powerful people in Washington with a stream of funding which has no, absolutely no accountability to the Congress because it comes from the 

Federal Reserve and, therefore, is not subject to annual appropriations, and a Director who it appears will also have no accountability to Congress because the Director will not even come to the 

Congress to be confirmed as the law requires. And that agency, I 

predict, will be an agency not for the purposes of protecting consumer credit, but for the purposes of pursuing a political agenda 

of social justice as defined by the leader of that agency. 

So the American small business person is being inundated with 

a Government of excess spending, excess regulation, excess concern 

about the capacity to know what is going to happen in the future 

in the area of credit, and that is why the economy is not moving 

forward. 

So if we want to get the economy moving forward, we should 

begin by putting in place financial systems in the Federal Government which will control the deficit and debt in the out-years and 

give people confidence that we will get that under control. 

And we should begin the process of an orderly reorganization of 

our health care system that will make it function rather than become more bureaucratic. And we should take a look at our credit 

markets and see how we can make them function more efficiently 

and effectively in a responsible way, all of which we have not done. 

So I would say that if we want to—you know, there is that old 

‘‘Pogo’’ saying, the cartoon ‘‘Pogo’’: ‘‘We have met the enemy and he 

is us.’’ Well, the enemy of economic expansion in this country is the 

Federal Government, especially the way it has been pursuing policies for the last 2 years. And we need to change, and I look forward 

to Director Elmendorf’s thoughts. 

Chairman CONRAD. Welcome back, Director Elmendorf, and 

please proceed with your testimony, and then we will go to questions. 

STATEMENT OF DOUGLAS W. ELMENDORF, DIRECTOR, 

CONGRESSIONAL BUDGET OFFICE 

Mr. ELMENDORF. Thank you, Chairman Conrad, Senator Gregg, 

and members of the Committee. I appreciate the opportunity to disVerDate Aug 31 2005 10:00 Jun 08, 2011 Jkt 000000 PO 00000 Frm 00179 Fmt 6601 Sfmt 6601 C:\DOCS\58156 SBUD1 PsN: TISH
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cuss the economic outlook and CBO’s analysis of the potential impact on the economy of various fiscal policy actions. My comments 

will summarize our lengthy written statement. 

Although the recession ended officially more than a year ago, the 

economy has not bounced back quickly. Employment now stands 

roughly 10 million below the level it would have reached if the recession had not occurred. Measured unemployment would be even 

higher today had there not been a considerable fall-off in the rate 

of participation in the labor force as the lack of available jobs 

caused some people to stop looking for one. 

CBO expects, as do most private forecasters, that the economic 

recovery will proceed at a modest pace during the next few years. 

International experience shows that recoveries from recessions that 

began with financial crises tend to be slower than average. Following such a crisis, it takes time for equity in other asset markets 

to recover, for households to replenish their resources and boost 

their spending, for financial institutions to restore their capital 

bases, and for businesses to regain the confidence needed to invest 

in plant and equipment. Weak demand for goods and services resulting from these and other factors is the primary constraint on 

the recovery. 

Under current laws governing Federal spending and revenues, 

CBO expects the unemployment rate to remain above 8 percent 

until 2012 and above 6 percent until 2014. And we released an 

issue brief in April that reviewed the evidence on the effects on 

people of losing jobs during recessions. 

Policymakers cannot reverse all of the effects of the housing and 

credit boom, the subsequent bust and financial crisis, and the severe recession. However, in CBO’s judgment, there are both monetary and fiscal policy actions that, if applied at a sufficient scale, 

would increase output and employment during the next few years. 

But there would be a price to pay. Those fiscal policy options would 

increase Federal debt, which is already larger relative to the size 

of the economy than it has been in more than 50 years and is headed higher. 

If taxes were cut permanently or Government spending increased 

permanently, and no other changes were made to fiscal policy, the 

Federal budget would be on an unsustainable path and the economy would suffer. Even if tax cuts or spending increases were temporary, the additional debt accumulated during that temporary period would weigh on the economy over time. 

But there is no intrinsic contradiction between providing additional fiscal stimulus today while the unemployment rate is high 

and many factories and offices are underused and imposing fiscal 

restraint several years from now when output and employment will 

probably be close to their potential. 

If policymakers wanted to achieve both short-term stimulus and 

medium- and long-term sustainability, a combination of policies 

would be required: changes in taxes and spending that would 

widen the deficit now but reduce it relative to baseline projections 

after a few years. 

To assist policymakers in their decisions, CBO has quantified the 

effects of some alternative fiscal policy actions. In a report last January to which the Chairman referred, we analyzed a diverse set of 

175 

temporary policies and reported their 2-year effects on the economy 

per dollar of budgetary cost—what you might call the ‘‘bang for the 

buck.’’ The overall effects of those policies would depend also on the 

scale at which they were implemented. Making a significant difference in an economy with an annual output of nearly $15 trillion 

would involve a considerable budgetary cost. 

This figure summarizes CBO’s key findings. A temporary increase in aid to the unemployed would have the largest effect on 

the economy per dollar of budgetary cost. A temporary reduction in 

payroll taxes paid by employers would also have a large bang for 

the buck as it would both increase demand for goods and services 

and provide a direct incentive for additional hiring. 

Temporary expensing of business investment and providing aid 

to states would have smaller effects. And yet smaller effects would 

arise from a temporary increase in infrastructure investment or a 

temporary across-the-board reduction in income taxes. 

In that January study, we explained that those temporary policy 

actions would lead to the accumulation of additional Government 

debt that would reduce incomes beyond the next few years unless 

other policies were adopted that had offsetting effects. However, we 

did not quantify those future reductions in income at that time. 

At the request of the Chairman, we have now estimated the 

short-term and longer-term effects of extending the 2001 and 2003 

tax cuts, extending higher exemption amounts for the AMT, and reinstating the estate tax as it stood in 2009 adjusted for inflation. 

The methodology for our analysis was quite similar to the methodology that we follow in analyzing the President’s budget each 

spring. We used several different models and made different assumptions about people’s behavior. The models used to estimate 

the effects on the economy in 2011 and 2012 focused on the policy’s 

impact on the demand for goods and services because we think that 

economic growth in the near term will be restrained by a shortfall 

in demand. 

In contrast, the models used to estimate effects on the economy 

in 2020 and beyond focused on the policy’s impact on the supply 

of labor and capital because we think that economic growth over 

that longer horizon will be restrained by supply factors. 

As shown on the left side of this figure, we examined four alternative approaches to extending those tax cuts, and working my 

way down in order: a full, permanent extension that would extend 

all of the provisions permanently; a partial permanent extension 

that would extend permanently all of the provisions except those 

applying only to high-income taxpayers; a full extension through 

2012 that would extend all provisions but only through 2012; and 

a partial extension through 2012 that would extend through 2012 

all provisions except those applying only to high-income taxpayers. 

As CBO has reported before, permanently or temporarily extending all or part of the expiring income tax cuts would boost output 

and employment in the next few years relative to what would occur 

under current law where those tax cuts expire. That would occur 

because, all else being equal, lower tax payments increase demand 

for goods and services, and thereby boost economic activity. A permanent extension, whether full or partial, would provide a larger 

boost to income and employment in the next 2 years than would 

176 

a temporary extension. And a full extension would provide a larger 

boost than with a corresponding partial extension. However, the effects of extending those tax cuts on the economy in the longer term 

would be very different from their effects during the next 2 years. 

The long-term effects would be the net result of two competing 

forces. On the one hand, lower tax revenues increase budget deficits, all else being equal, and thereby Government borrowing, 

which reduces economic growth by crowding out investment. 

Chairman CONRAD. Excuse me, just on that point. Do you have 

a slide that shows the longer term? 

Mr. ELMENDORF. Yes. I was going to make the point and then 

show you the results, but those are the longer-term results. What 

you cannot see in the picture is the netting of these two forces. So, 

on the one hand, there is the effect of increasing Government borrowing which crowds out investment and reduces economic growth. 

On the other hand, lower tax rates boost people’s work effort and 

saving, which increases economic activity and income. And the net 

effect of these policy changes—or the overall effect is the netting 

of these two different forces. 

For some of the options, our estimates of the net effects of the 

forces based on different models and assumptions span a broad 

range. This figure, however, shows the averages of the estimates 

across different models and assumptions for 2020. It indicates that 

all four of the options for extending the tax cuts would probably reduce national income in 2020 relative to what would occur under 

current law where those tax cuts expire. Beyond 2020, the reductions in national income from all of the alternative tax extensions 

become larger, especially for the permanent extensions. 

Moreover, a permanent extension of the tax cuts combined with 

the budgetary pressures posed by the aging of the population and 

rising costs for health care would put Federal debt on an 

unsustainable path. Specifically, a permanent extension that was 

not accompanied by future increases in other taxes or reductions in 

Federal spending would roughly double the projected budget deficit 

in 2020 from about $700 billion to about $1.4 trillion. 

A permanent extension except for certain provisions that would 

apply only to high-income taxpayers would increase the budget deficit by roughly three-quarters to four-fifths as much. Similarly, and 

also shown in the picture, permanent large increases in spending— 

for example, increases in discretionary appropriations in step with 

GDP rather than with inflation, as assumed in our baseline—that 

were not accompanied by reductions in other spending or tax increases would also put Federal debt on an unsustainable path. 

If policymakers adopted either of those policies shown, putting 

Federal debt back on a sustainable path would require future increases in taxes or reductions in spending that would amount to a 

large share of the budget. 

Thank you. 

[The prepared statement of Mr. Elmendorf follows:] 

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Chairman CONRAD. Thank you very much. 

Let me go first to the question of ‘‘bang for the buck.’’ In terms 

of economic policies we might enact now to strengthen an economy 

that is too weak, your analysis shows that the largest effect would 

arise from a temporary increase in aid to the unemployed. The next 

largest effect would be a temporary reduction in employers’ payroll 

taxes. Smaller but still significant effects would come from other 

policies such as temporary reduction in the employees’ payroll 

taxes, additional one-time Social Security payments, additional 

temporary refundable tax credits for lower- and middle-income 

countries households. And going down the line, other things that 

would have an effect but would be still smaller would be a temporary increase in investment in infrastructure. And the final option you looked at was tax reduction, a 1-year deferral of the increase in income taxes that you also found would have a positive 

effect, although it would be the least bang for the buck of the options analyzed. Is that correct? 

Mr. ELMENDORF. Yes, that is right, Mr. Chairman. Let me just 

make two quick points. One is that this analysis we did in January 

assumed that these policies would be enacted in early 2010. Of 

course, that is not possible at this point. We have not updated all 

of these estimates. One that would look somewhat different—actually, if this picture could go back up there on my screen, that would 

be helpful, whoever is controlling that. 

Chairman CONRAD. Is that the slide you wanted? 

Mr. ELMENDORF. Yes, that is the slide I had in mind. 

If we updated the numbers now, they would change a little bit. 

The basic pattern would not be different. But it is true that the effect of extending the tax cuts would look a little stronger because 

this extension was one that actually began in 2011—in other 

words, 1 year into the 2-year window we were focusing on at the 

time—and that diminished its effect a little bit. But if we updated 

all these numbers, the options of extending the tax cuts would still 

have lower bang for the buck than almost all of the options on this 

list. 

The other thing I just want to add, Mr. Chairman, is that it is 

important to recognize this is the effect per dollar of budgetary impact. As I mentioned in my remarks, if one wants to have an effect 

of a certain size on the economy, it also matters the scale at which 

these things are done. Some of these options can naturally be done 

at a larger scale than others, and that is a consideration for you 

and your colleagues as well. 

Chairman CONRAD. So let us go to the question of the tax cuts 

because that is one of the key issues Congress will confront when 

we return. As I analyze the results of your work, it is that although 

they are pretty modest with respect to bang for the buck, extension 

of the tax cuts would be positive in the short term, 2011 and 2012, 

but actually be negative in the long term; that is, permanent extension of the tax cuts, all of them, would actually be the most negative in terms of its effect on economic growth in the long term. Is 

that correct? 

Mr. ELMENDORF. As you know, we have not looked at all of these 

options over the longer term, but of the tax options that we studied, the four different ways of extending the expiring tax proviVerDate Aug 31 2005 10:00 Jun 08, 2011 Jkt 000000 PO 00000 Frm 00224 Fmt 6601 Sfmt 6601 C:\DOCS\58156 SBUD1 PsN: TISH
219 

sions, the permanent extensions would have the largest negative 

effect on national income over the longer run—the largest boost in 

the short run, as you said, but the largest negative effect in the 

long run. And that would occur because the extra Government borrowing from the significantly larger deficits would drag down income more than the extra work effort or saving that would be generated by the lower tax rates. 

Chairman CONRAD. So the effect of tax cuts, which many of us 

associate as being positive with respect to economic growth, your 

conclusion is in the short term additional tax cuts, extending the 

tax cuts, the expiring provisions, would be positive, although the 

least positive of the policies that you have looked at in terms of effect on the economy, would give us the least bang for the buck, but 

longer term the tax cuts are actually harmful to economic growth 

because they are deficit financed. Is that correct? 

Mr. ELMENDORF. Yes, that is correct, Mr. Chairman. 

Chairman CONRAD. So that really creates a conundrum because 

we have two things that kind of work against each other here. On 

the one hand, we have got a series of policies that have been rated 

in terms of bang for the buck. Extending the tax cuts is among the 

weakest in terms of helping boost economic growth, although it is 

positive. So extending tax cuts would have a mildly positive effect 

short term, but it would have a negative effect long term because 

they are deficit financed, just as additional spending would help us 

short term but be negative long term. 

Mr. ELMENDORF. Yes, that is right. The effects are really rather 

symmetric in that way. We have written this on a number of occasions, that the sorts of policies that lead to short-term boosts, higher Government or lower taxes, if not accompanied by other offsetting changes over time, if just allowed to increase deficits and debt 

over time, will have negative effects in the medium and long run. 

Chairman CONRAD. Let me just say for many people it is 

counterintuitive that tax cuts could somehow hurt future economic 

growth. How is that? Why is it that in your analysis tax cuts could 

be actually harmful to long-term economic growth? 

Mr. ELMENDORF. I think the natural intuition is people thinking 

about their own situations and thinking, correctly, that if their tax 

rates were lower, that would give them an incentive to work more, 

to save more, to invest more. And that is right as far as it goes. 

The problem is that if those tax cuts are not accompanied by other 

changes in the Government budget and are simply funded through 

borrowing, that that borrowing crowds out other private investment in productive capital in the sorts of equipment—the computers, the machinery, the buildings—that are the source of longterm economic growth. And that connection is less visible, and I 

think this is less apparent in most people’s intuition. But it is no 

less important for being not so visible, for being more indirect. 

Chairman CONRAD. Well, I think that is incredibly important testimony that you are giving us here today. I hope people are listening because what I hear you saying is, short term, anything we do 

to provide stimulus, whether it is increased spending or additional 

tax cuts, will give you a short-term boost; but either of them, additional spending over what is projected or additional tax cuts, will 

actually hurt longer-term economic growth because the impact of 

220 

the deficits and debt will serve like a weight around the neck of 

the economic engine of this country. 

Well, I thank you very much for that testimony. I hope people 

are paying attention. 

Senator GREGG. Picking up on that point, because there is another side to the coin if you use your logic, it would be, would it 

not be true that spending would all have the exact same effect of 

crowding out economic activity if it were borrowed to spend, if you 

had to borrow to spend? 

Mr. ELMENDORF. Yes, that is exactly right. As I said, it is symmetric. 

Senator GREGG. And I do not know that you have done this analysis, but which generates more economic activity, the spending or 

the tax cuts? 

Mr. ELMENDORF. So if you—so actually, I did not have time to 

show it, but there is a table in the report, which I think I have 

here. It is a rather complicated table. You can read along if you 

want, but I will try to make the points more directly. 

If one looks out—the right-hand column is where we modeled the 

effects over time both in 2020 and beyond that, and what we have 

done here is we have modeled not just the effects of the initial cut 

in taxes, but also the policies that we needed later to put fiscal policy back on a sustainable path. It is actually required for this 

model. And you can see in the far right columns the changes that 

we assume for later to put policy back on a sustainable path, either 

decreases in government spending or increases in tax rates. 

In the middle columns, it was a later dencrease in government 

spending. And, in fact, as you are suggesting Senator Gregg, the 

increases in tax rates have a much more negative effect on the 

economy over the longer term than if the budget is returned to sustainability through a reduction in government spending. 

Senator GREGG. That is very important testimony. 

Let me ask you another question. Your projections going forward, 

the size of government spending as a percent of GDP goes from 

what to what, starting, say, 2 years ago and working forward 10 

years? 

Mr. ELMENDORF. So in our latest baseline projections, government spending would be about 24 percent of GDP in 2020 compared with an average in the past 40 years that I think is closer 

to 20 or 21 percent of GDP. So much higher than we have experienced before in this country. 

Senator GREGG. That being the case, is it not reasonable to presume that spending is the problem that is driving the debt? 

Mr. ELMENDORF. Umm—— 

Senator GREGG. Primarily. I mean, accepting your argument that 

if you raise taxes, you know, we have a present tax law and you 

raise taxes, yes, you are going to get more revenues. But if I understood what you said, four-fifths of the tax increase or the tax revenues that are lost are not high-end people paying taxes. They are 

middle- income people paying taxes, correct? 

Mr. ELMENDORF. So let me clarify that. Extending the top brackets is about a fifth or a quarter of the cost of extending all of it. 

Senator GREGG. So—— 

221 

Mr. ELMENDORF. The trick is that the people below—the tricky 

part is the people who are—the lower tax brackets affect the highincome people, as well. 

Senator GREGG. If there is consensus—I did not mean to interrupt. If there is consensus in the Congress and the President is 

calling for an extension of middle-class tax cuts and the only thing 

that the President is calling for is the increase in the taxes of highincome individuals or people or small businesses earning more 

than $250,000, if that is the case, then your numbers are still 75 

to 80 percent off, right? I mean, your revenues. 

Mr. ELMENDORF. Yes, exactly. Extending all the tax cuts except 

for those affecting higher-income people has three-quarters or fourfifths, roughly, of the positive effects and the negative effects of extending all of the tax cuts. 

And I want to say to your question about the problem, I do not 

want to use the word ‘‘problem’’ because it is a choice of people how 

big the government should be. But relative to historical experience, 

the thing which is different going forward is the high share of 

spending, due as we have written, as you know, to population 

aging, changes in health system and other aspects of the government budget. 

Senator GREGG. Well, I think that is an important point that we 

need to keep in mind, that dealing with reality as it is coming at 

us, the government is going to go from 20 percent of GDP to 24 

percent of GDP. That spending is the driver, in large part, of the 

gap that is causing the deficit and the debt which is going to bankrupt the country. That is how I phrase it. 

Mr. ELMENDORF. Yes. 

Senator GREGG. Thank you. And this debate over taxes is really, 

in my opinion, a bit of a straw dog debate, because as you have 

pointed out, 75 to 80 percent of the revenues that will not be received because we are not going to raise taxes, everybody agrees 

are not going to be received because everybody agrees those taxes 

are not going to be raised. So it really is—this whole tax debate, 

in my opinion, is really not what we should be focusing. We should 

be focusing on the growth of this government from 20 percent to 

24 percent and how do we get that back under control. How do we 

get that into a manageable number, considering our revenue base. 

I think that summarizes my points, come to think of it, and I 

thank you for your testimony. I also want to thank you for your 

professionalism, your staff’s professionalism. You folks get a lot of 

pressure from a lot of different people, including myself, and you 

are always very professional and you always give us a straight answer as you see it and that is the way it should be. You are the 

fair umpire around here and we appreciate it. Thank you. 

Mr. ELMENDORF. Senator Gregg, thank you very much, and let 

me just say on behalf of all of us at CBO, we very much have appreciated your support for many years for the work that we do. 

Chairman CONRAD. Thank you, and Senator Wyden. 

Senator WYDEN. Thank you, Mr. Chairman, and Director Elmendorf, I share Senator Gregg’s view about your professionalism. We 

thank you. 

And I want to take this tax discussion in a bit of a different direction, because right now, there is a comparison underway beVerDate Aug 31 2005 10:00 Jun 08, 2011 Jkt 000000 PO 00000 Frm 00227 Fmt 6601 Sfmt 6601 C:\DOCS\58156 SBUD1 PsN: TISH
222 

tween the tax policies of George W. Bush and the proposals that 

have been offered by President Obama. And I am of the view that 

that tax debate misses the point because both of those approaches, 

George W. Bush and now what has been offered by President 

Obama, in my view, involve tinkering with a badly flawed, discredited tax system. 

And to me, the much more relevant comparison—I want to walk 

you through the numbers and just get your reaction—are the numbers that you have when Ronald Reagan got together with a big 

group of Democrats and reformed the tax system, and compare 

those and what we saw in our country for job growth and economic 

growth, payroll growth, to what we saw during the years of George 

W. Bush in 2001 to 2008 and get your reaction. 

Now, here are the numbers. When Ronald Reagan and Democrats worked together, 16 million new jobs were created. There was 

a 17.6 percent expansion in payrolls. That is when Democrats and 

Republicans worked together to create a tax system that was more 

pro-growth and more of an engine for job creation. By comparison, 

from 2001 to 2008, when there was just partisanship in the tax 

area, three million jobs were created. There was only a 2.3 percent 

expansion in payrolls. 

Now, you have to look at the entire challenge for the American 

economy, and tax policies are not the only thing behind economic 

growth and job creation. But are not those numbers relevant with 

respect to this question of job growth that you saw? With tax reform, the Democrats and Republicans worked together. You certainly saw more positive numbers, numbers that were pro-growth, 

pro-job creation, than you saw in the years of 2001 to 2008. 

Mr. ELMENDORF. So as you mentioned, Senator, there are a lot 

of forces affecting the economy in addition to tax policy and it is 

difficult to isolate the effects of tax policy. But I think you raise a 

very important point about the nature of the tax system matters 

just as much, if not more, than the level of revenue collected, and 

we mention that a number of places in the written testimony, that 

the experiments we conduct would have different results if the tax 

code were constructed in different ways, if the nature of the tax 

changes over time were different. 

In particular, what is very important for the incentive effects are 

the marginal tax rates, and there are ways to raise revenue or 

lower revenue that involve changing marginal tax rates, but there 

are also ways that involve changing the base, the amount of income 

that is subject to tax at the corporate or individual level, and those 

are very important decisions for you and your colleagues—— 

Senator WYDEN. Would you agree that the fundamental model of 

1986, which is what Senator Gregg and I have picked up on in our 

bipartisan legislation, that that model of radically simplifying the 

code—we have a one-page 1040 Form, 29 lines long—broadening 

the base and lowering rates, lowering rates for both individuals 

and businesses, would you agree that that model is more economically efficient than just going out and extending this vast array of 

loophole-ridden tax breaks that constitute the code today? 

Mr. ELMENDORF. So I cannot speak to the details of your specific 

proposal, which I am sorry, we have not studied carefully, but I 

think there would be widespread agreement among analysts that 

223 

a tax system with a broader base and lower tax rates would be a 

much more efficient way to raise revenue and thus a better way 

to strengthen the economy while raising revenue. 

Senator WYDEN. Why would one think that the tax policies that 

produced anemic job growth and declining real income for the middle class—those were the policies between 2001 and 2008—why 

would one think that just reenacting them would create substantially more jobs and substantially more income in the pockets of 

middle class folks? I mean, we have what occurred. Now someone 

is talking about redoing it. People like Senator Gregg and I are 

saying, no. Why not go with a model we know worked when Democrats and Republicans get together. And my question is, why would 

you re-up for something that showed such anemic economic growth, 

job creation, payrolls between that 2001 and 2008 period? 

Mr. ELMENDORF. So as you know, Senator, I am not in a position 

to re-up or not re-up any policy, but—— 

Senator WYDEN. I am just talking about the analysis. 

Mr. ELMENDORF. In our analysis, the only distinction I would 

make is between the short-run effects and longer-run effects. In the 

short-run, the principal effect of tax changes on the economy is 

likely to be through the additional income that households would 

receive. But over time, in the medium-run and long-run, the most 

important effect of tax policy is likely to be not just the changes 

in total revenue, but also the changes in incentives, and our modeling reflects that. And I think the points that you were making 

about the proposal that you put forward are focused principally on 

the medium- and longer-run effects of tax policy and economic 

growth. 

Senator WYDEN. Let me ask you about the international economic challenge and the tax law as it relates again to job creation. 

When you talk to American businesses, they say they have to have 

this array of breaks for going overseas, because the United States 

has a high, comparatively, tax rate to other countries with respect 

to the business rate. So along came these various breaks, deferral 

and others, the American people do not understand. 

What Senator Gregg and I did is, in effect, go to American business and say, how much would you have to reduce these American 

rates in order to junk a lot of the stuff that you have overseas? So 

we came in with a rate of about 24 percent, significantly lowering 

the corporate rate. But it is paid for. Every single dime of it is paid 

for in our tax reform bill, because we, in effect, take away those 

overseas breaks to use it to strengthen American manufacturing. 

Would not that, again, just apart from our bill, and in theory, 

would not that particular change make it more attractive to grow 

businesses and generate job growth in the United States? 

Mr. ELMENDORF. Yes, Senator. I think most analysts would agree 

that broadening the corporate tax base and lowering the tax rate 

would be a more efficient way to raise that revenue. 

Senator WYDEN. Thank you, Mr. Chairman. My time is up. I 

would also ask, Mr. Chairman, to put into the record several studies that have been very supportive of the bipartisan tax reform bill, 

particularly that done by the Manufacturing Alliance, the Brookings Association, and the Heritage Foundation. They would just be 

short summaries, if we could put that in. 

224 

Chairman CONRAD. Yes, without objection. I also want to commend you and Senator Gregg for coming up with really a very 

thoughtful tax reform proposal. 

Let me just say, just quickly, if I could, Senator Ensign, it is very 

clear we are going to have to cut spending as a share of the economy. It is also clear to me we cannot afford to make permanent all 

of the tax cuts that are currently in the code, which kind of jumps 

out at you that what we need is tax reform. The tax code is now 

7,500 pages long, and it was never designed with competitiveness 

in mind. The world has changed since that tax code was written. 

And if we do not write a new tax code that relates to the reality 

we confront today, that we are in a fully competitive global environment, and we write a tax code with that in mind, I think we 

are making a profound mistake. Just to double-down on this current tax code is just a huge mistake. 

Senator Ensign, I thank you for your courtesy. 

Senator ENSIGN. Thank you, Mr. Chairman. I want to associate 

myself with the remarks that Senator Wyden just talked about. 

There is no question that some of the economic effects of our tax 

code are just complying with the tax code. It is a huge burden on 

individuals as well as businesses in complying with our tax code. 

Just look at the estate tax, death tax, whatever you want to talk 

about. There are many complexities of trying to avoid taxes, the 

huge costs. Businesses make investments based on the tax code instead of what necessarily makes good economic sense, and so there 

is no question. I believe very strongly that the best thing that we 

could do is what you just talked about, Mr. Elmendorf, and that 

is broadening the base and lowering the tax rates. I think that it 

is absolutely the best way to go. 

I do want to pick up on something that you said a little while 

ago. You said that if we lower tax rates, in one of your charts, over 

the next couple of years, it will increase GDP. Is the opposite true? 

If we raise taxes over the next couple of years—if we raise—in 

other words, if we let the tax rates that are on the books currently 

expire, will GDP go down? 

Mr. ELMENDORF. Well, so our economic baseline, as you know, 

has to be conditioned on current law. So our economic forecast assumes that those tax cuts expire, and relative to that, an extension—so it is relative to that that we have done our estimates. Relative to that, an extension of the tax cuts would, in fact, boost GDP 

and would boost employment. Conversely, if one pictured starting 

from that point, then having the tax cuts expire would lower GDP. 

I just want to be clear that that effect is essentially in our economic 

forecast—— 

Senator ENSIGN. Right, but it does make sense that raising taxes 

will decrease the GDP? In other words, if taxes go up, there is no 

question that GDP will go down versus keeping those tax rates 

where they are today. 

Mr. ELMENDORF. Yes. Over the next few years, that is the shortterm effects—— 

Senator ENSIGN. Yes. I think that is important. And I also—I 

think some of the analysis that you have done as far as the longterm is very, very important, and like you said, it is not just the 

tax cuts, the spending, both of those things. I agree with you. I 

225 

think if we are going to do these tax cuts, we should actually be 

looking at ways to cut spending, because it is not just the shortterm economy that we need to think about here. We need to be responsible in the long-term, and while ideally doing what Senator 

Wyden is talking about, to me, that would be the best way to do 

it, and if we could lower the rates low enough and do that, paying 

for it through lowering spending, in the long run, we are going to 

be better off as an economy, as a country. Obviously, those are 

tough choices to make along the way, but the responsible thing to 

me, because the biggest threat to long-term economic output is the 

debt, is it not? 

Mr. ELMENDORF. Yes, I think that is right, Senator. I think the 

challenge on the spending side is that the revenue lost from extending the tax cuts is a very large number, as we have reported, 

based on estimates from the staff of the Joint Committee on Taxation. And the full extension would reduce revenue by nearly $4 

trillion over the next 10 years. 

Senator ENSIGN. What percentage of revenues is that, over 10 

years? 

Mr. ELMENDORF. That, I do not know offhand. I think we do report in our—so I guess we report in this testimony that a full extension would reduce tax revenue by about 2 percent of GNP in 

2020 against a base that is around 20 percent or so of GNP—— 

Senator ENSIGN. I am talking about as far as—— 

Mr. ELMENDORF [continuing]. I think it is about a 10-percent reduction in revenues. About a 10-percent reduction in revenues. 

Senator ENSIGN. A 10 percent reduction in revenues over that period of time. Have you looked at what States and cities are doing 

as far as cutting their budgets? 

Mr. ELMENDORF. We follow it a little bit, not as closely as we follow the Federal Government. 

Senator ENSIGN. Do we think there is 10 percent waste in the 

Federal Government? 

Mr. ELMENDORF. Well, I think the problem turns out to be that 

one person’s view of what is the waste differs from the other person’s view of what is the waste. 

Senator ENSIGN. OK. Let us take it this way. Every family, every 

business, local government, State governments across America 

right now are cutting their budgets and they are basically wringing 

out the waste. You talk to every business in America and that is 

what they have done over the last 2 years, and this is the private 

sector, and they had a lot of fat. The private sector did. Local governments had a lot of fat. State governments had a lot of fat, and 

they are wringing that out. 

The one place where we have not wrung out and cut the fat is 

at the Federal level. If we can sit here and honestly say that we 

do not think there is at least 10 percent waste in the Federal Government, then that is a completely preposterous statement to think 

that we do not have at least 10 percent waste in this government. And so all I am saying is that $4 trillion is a big number. It 

sounds like a big number. Except when you look at it, it is 10 percent. And if we do not think that we can take 10 percent and get 

this government more efficient by 10 percent by cutting out inefficient programs and streamlining programs, eliminating duplicaVerDate Aug 31 2005 10:00 Jun 08, 2011 Jkt 000000 PO 00000 Frm 00231 Fmt 6601 Sfmt 6601 C:\DOCS\58156 SBUD1 PsN: TISH
226 

tion, eliminating waste, I think that if this Congress cannot find 

10 percent waste, then they should throw this Congress out. That 

is all I am saying. And that is why I think that the 10-percent 

number is really, really important. 

Mr. ELMENDORF. So, Senator, it is up to you and your colleagues. 

It is not our place to say what parts of the government should be 

bigger or smaller in what ways. But I do want to just emphasize 

the magnitude of the problem here. So the left set of bars show revenues and then spending under current law and the right set show 

them with the tax cuts extended and the AMT indexed, kind of the 

full extension through 2020 we have been talking about. 

So on the right-hand set of bars, that red box is the size of the 

deficit. You can see that that amount is larger than all of the 

spending on Social Security in 2020. It is, I think, a little smaller 

than all of the Federal spending on Medicare and Medicaid and 

health insurance subsidies. It is much larger than all spending on 

defense. It is much larger, you can see, than the box right next to 

it, which is all spending apart from those handful of the largest 

programs. 

Senator ENSIGN. And a big part of that, a big part of the reason 

for those deficits is because in that year, that $1.4 trillion deficit, 

at that point, how much of that is interest on the debt? 

Mr. ELMENDORF. Well, so interest is large, and you can—— 

Senator ENSIGN. It is over $900 billion, is that not correct? 

Mr. ELMENDORF. Exactly. With those tax cuts extended, that is 

a fair estimate. 

Senator ENSIGN. That is because we are adding to it every year 

right now with such huge numbers. And what Senator Gregg 

talked about, about spending being the largest part of the problem, 

that is why at the Federal level we need to get spending under control. That is why we are at a critical point, because this is 

unsustainable. The numbers you are putting up here, it is 

unsustainable. This country is going to become Greece, except we 

do not have the European Union to bail us out. If we have these 

kind of debt and deficit numbers going into the future, it is 

unsustainable, and that is why this Congress needs to heed the 

warning that we have to get our spending habits under control. It 

is critical for the future of this country. 

Thank you, Mr. Chairman. 

Chairman CONRAD. Senator Warner? 

Senator WARNER. Thank you, Mr. Chairman, and thank you, Director Elmendorf, for your comments. I concur with my colleague 

from Nevada on streamlining, as somebody who was a Governor 

who did some of that. 

But I also think the notion, and I think your testimony reflects 

this, that the problem is of such a magnitude that if we are only 

going to do it on one side of the balance sheet, this challenge is 

going to require us to recognize sufficient revenues to meet core 

functions of the government. Cutting the revenue side constantly 

and saying we are going to simply find all of the spending through 

waste and fraud is a tired and true political axiom that has never 

proven to be the case. 

But at the same time, those who say we can simply tax on the 

top end and continue to spend at the rate, I think it is going to 

227 

take both sides. I would have preferred, frankly, the statutory approach that the Chairman and the Ranking Member had on a fiscal 

commission. Unfortunately, many of our colleagues on the other 

side of the aisle would not join us on that statutory approach that 

would have forced our feet to the Fire. I am hopeful that the Presidential Commission, and I hope that all the members will keep 

their powder dry to let this Presidential Commission work its way 

through, and I hope it comes up with very bold and challenging 

courses that challenges the orthodoxies of both political parties to 

make hard choices, because the notion that we are going to do it 

on simply the spending side or simply the revenue side, is false. 

Let me turn my questions back to your first chart, sir, where you 

looked at things that could have effect on unemployment in the 

next couple of years. We seem to be having a binary discussion 

here, either extend the so-called Bush tax cuts for everyone, or 

some on my side, extend them for the 98 percent and let them expire for the top end, and a lot of debate about the value of that topend 2 percent, $700 billion over 10 years in terms of lost revenue, 

approximately, I think since it is an accelerating number, more in 

the $70 billion over the two-year period. I know some have said, 

let us simply extend for the top 2 years [sic]. 

The question I would have, is if we say that taking that money 

out of the economy on the short-term basis may have some negative effects, and then the only choice becomes, let us just leave it 

with the top income earners, some of which may spend, but many 

of whom will, evidence will show, would simply save those dollars 

and deposit them, which would not have the kind of short-term effect we might need to get employment restarted and the recovery 

continued. 

You have looked at payroll tax. You have looked at full and partial expensing of investment costs. What I am asking is, if we said 

what we could do for a 2-year period, $70 billion of targeted shortterm tax cuts that might have the most bang for the buck, are 

those the two that you have analyzed, and are there others? 

I would argue that at the macro level, we in government have 

used most of our bullets. We have used monetary policy and lowered interest rates to historic lows. And while perhaps not as efficiently as many, including myself, would have liked, we have used 

stimulus. The one good piece of news in our economy that does not 

get as much attention is that during this recession, large-scale enterprises have dramatically retooled and their balance sheets are 

healthier than ever. The balance sheets of American corporate 1000 

companies today are healthier than they were pre-recession, north 

of $2 trillion sitting in cash on those balance sheets. Now, we can 

argue regulatory uncertainty, policy uncertainty. I will grant that 

is one of the issues. 

But if you, and I am asking you to speculate here, had $70 billion of short-term targeted tax cuts that would expire in 2 years 

to try to get that $2 trillion off that corporate balance sheets, into 

the economy, reinvested as the economic engine, private sector engine that would jump-start it, would you choose either employers’ 

payroll tax reduction, the immediate expensing, or are there other 

tax reduction tools on a short-term basis we could use to get that 

$2 trillion reactivated into the economy? 

228 

Mr. ELMENDORF. So, Senator, there may well be some other policies. We cast a fairly wide net in January, but I am sure we did 

not catch everything. Among the policies that we studied, as this 

chart shows, reducing employers’ payroll taxes or allowing full or 

partial expensing of investment costs would have much more bang 

for the buck, much more positive impact on the economy per dollar 

of budgetary cost than would a broad extension of the expiring tax 

cuts. 

Senator WARNER. And your assumption was that those would be, 

whether it is the payroll taxes or the immediate deducting, shortterm, targeted, and during—— 

Mr. ELMENDORF. We studied simply temporary policies—— 

Senator WARNER. Temporary, year, 2-year, what have you? 

Mr. ELMENDORF. Yes. 

Senator WARNER. There are a host of other things, R&D tax credit, other issues out there. Did you go through the whole analysis? 

The business community has laid forward a series of other options, 

or—— 

Mr. ELMENDORF. So we have not looked as carefully at extending 

the research and experimentation tax credit. It is tricky. Because 

that tax credit has been extended many times before—— 

Senator WARNER. Right. 

Mr. ELMENDORF [continuing]. Many businesses probably expect it 

to be extended. That probably means that if it were extended now 

and that uncertainty were resolved, that would have a little positive effect. But if you and your colleagues were going to enact an 

extension anyway, than it is not as incremental as—— 

Senator WARNER. Of course, if it was at 14 and the President has 

proposed raising it to 17, many OECD countries are at 20, and I 

am not—— 

Mr. ELMENDORF. So we looked a little bit at that. A small increase in the rate would matter a little bit. It probably would 

not—— 

Senator WARNER. And I do not want to just lay on that, but what 

I would ask—the Chairman has left, but I guess what I would love 

to see your office do some analysis is recognizing that if you take 

the dollar of 1 year or 2 year of that top 2 percent. Could those 

funds be better put to use, recognizing that perhaps taking those 

dollars out of the economy right now might not make that much 

sense, but where are we going to get our best bang for the buck? 

You are saying at this point your analysis says—— 

Mr. ELMENDORF. The policy—— 

Senator WARNER [continuing]. Payroll taxes or immediate expensing are the best bang—— 

Mr. ELMENDORF. Right. 

Senator WARNER [continuing]. And you have—— 

Mr. ELMENDORF. Would be significantly more bang for the buck 

than extending all of the tax cuts. And within this bottom bar, extending all of the tax cuts, the extending the tax cuts in the higher 

brackets is actually the less effective piece of that because those 

people would be likely to spend a smaller share than people receiving the bulk of the rest of the tax cuts. 

Senator WARNER. My time is about expired, but I would love to 

have your office go back and maybe scrub those a little bit more, 

229 

and if you could give us with some more specificity bang for the 

dollar invested in terms of these targeted tax cuts, and I would ask 

you, as well, to look at some of the other menus of suggestions that 

the business community has laid out, because, again, my point is 

we have $2 trillion. That is the last bullet that we have not used. 

Getting those resources back invested in our economy, would be a 

great value. 

Thank you, Mr. Chairman. 

Mr. ELMENDORF. Thank you, Senator. 

Senator NELSON [presiding]. Senator Bunning? 

Senator BUNNING. Thank you, Mr. Chairman. 

Dr. Elmendorf, thank you for coming. My question is one of kind 

of comparisons. Over the last two to 3 years, we have stimulated 

or spent or printed about $4.5 trillion if you count what the Federal 

Reserve has put in and taken out and put in, taken out, over the 

past two to 3 years, besides the money that the Congress has allocated either through TARP or through the stimulus program. So it 

is about $4 trillion, give or take. 

The unemployment rate as of January 2009 was 7.7 percent. In 

August of this year, the unemployment rate was 9.6 percent. It has 

been in excess of 9 percent for over 16 consecutive months. With 

the stimulus that we used, can you estimate or have you the ability 

to estimate—I am not sure you do—when we are going to see 7.7 

percent or pre- recession 5 percent unemployment rate? Can you 

give me an idea? 

Mr. ELMENDORF. Well, so we do make projections, and you understand the uncertainty that—— 

Senator BUNNING. I understand the uncertainty because I have 

been here for 12 years and have looked at all the projections. 

Mr. ELMENDORF. So our current projection, the projection we 

published in August is that under current law, the unemployment 

rate would fall back to the 7.7 percent you have in mind, I think 

in 2012 at some point. 

Senator BUNNING. Twenty-twelve? 

Mr. ELMENDORF. Twenty-twelve. 

Senator BUNNING. Are you telling me that the 15 million parttime or totally unemployed people will be back to work? 

Mr. ELMENDORF. Well, there is a lot of churning, of course, in the 

labor force, so many people who are without work today will find 

jobs, but others will lose jobs, so on balance, we think the unemployment rate, as we say in the testimony, will remain above 8 percent until 2012 and remain above 6 percent until 2014. 

There is a significant and growing literature on the effects of— 

on the longer-term effects of financial crisis, and in addition to the 

severe recessions that often follow immediately, that literature 

shows very clearly that economic growth can be weak for many 

years to come. 

And the question about the 5-percent unemployment rate that 

you raised, we do project the unemployment rate going back down 

to 5 percent, but there are reasons other people are more concerned 

that that may not happen, or may not happen for quite a long time, 

because of tremendous dislocations in the financial system and the 

economy and the longer-term effects of that. 

230 

Senator BUNNING. Well, use a personal family unemployed. I 

have a grandson who is unemployed. He has been unemployed now 

for 8 months. His job is never going to come back. Delta Airlines 

used to have 400 flights out of the Greater Cincinnati Airport. 

They are at one-third the number of flights now, not to ever return 

to the 400-plus that they had at one time. So his job is never going 

to come back. He is going to have to be reeducated into some other 

type of position. 

Tell me this, and I have seen all your wonderful charts on the 

employment, the tax, the changes or the non-changes in the tax 

code, the expiration of the tax at the end of this year. Have we ever 

been successful in raising taxes to help our economy in a recession? 

Mr. ELMENDORF. Not that I am aware of, Senator. Raising taxes 

in a recession will tend to slow economic growth, and that is, as 

we have explained in our report, part of why we have such a slow 

growth rate projected for 2011 under current law. 

Senator BUNNING. And how do you get out from under that? 

Mr. ELMENDORF. Well, so in the short run, tax cuts or government spending increases provide a boost. The challenge, as you understand—— 

Senator BUNNING. Is the balance. 

Mr. ELMENDORF [continuing]. Is what happens beyond that, and 

over the medium- term and long-term, unless those actions are undone, offset in some way by other actions, then there is a mediumterm and long-term drag on the economy. 

Senator BUNNING. We talked about debt and other things, and 

we did not talk about interagency debt. Right now, to pay our Social Security benefits, the Federal Government has borrowed right 

at a trillion dollars from the Social Security Trust Fund, right at. 

We have written IOUs. They are kept in Parkersburg, West Virginia, and there is nothing to back it except the IOU, which means 

that the Federal Government has to make good on those IOUs—— 

Mr. ELMENDORF. Yes. 

Senator BUNNING [continuing]. And they do not have anything to 

do except to print the money, or—— 

Mr. ELMENDORF. Raise taxes or—— 

Senator BUNNING [continuing]. Raise taxes or raise—— 

Mr. ELMENDORF [continuing]. When the IOUs come due. 

Senator BUNNING. Yes, any way you can pay off that trillion dollars. So my question—this is a little off the wall, and it is the last 

question I will do—according to the Social Security and Medicare 

Board of Trustees’ most recent report, Social Security is projected 

to begin permanently facing deficits in 2015—permanently—and 

Medicare will become insolvent in 2029. However, if this was not 

bad enough, the report indicates that Social Security will begin operating with a cash-flow deficit this very year. 

Should we not be concerned about the impact this, paired with 

the large budget deficits that this administration has projected, 

will have on my 40 grandchildren and future generations? 

Mr. ELMENDORF. Senator, yes. I think the concern, the effects of 

mounting debt, will be felt particularly by future generations. 

Senator BUNNING. Is that not just kind of a transferring of what 

we cannot pay for and what our excesses are presently to my chilVerDate Aug 31 2005 10:00 Jun 08, 2011 Jkt 000000 PO 00000 Frm 00236 Fmt 6601 Sfmt 6601 C:\DOCS\58156 SBUD1 PsN: TISH
231 

dren and grandchildren? Is that not kind of a wealth transfer or 

a debt transfer? 

Mr. ELMENDORF. The issue about how large the Federal debt is 

is importantly a distributional issue across generations. 

Senator BUNNING. Thank you very much for your answers. 

Mr. ELMENDORF. Thank you, Senator. 

Senator NELSON. Dr. Elmendorf, would you explain the phenomenon of the fact that the U.S. Government is borrowing more 

and more money, albeit the Federal Reserve is trying to hold down 

the rates, and why those rates projected well into the future, interest rates, are staying so low? 

Mr. ELMENDORF. So I think most analysts believe that interest 

rates are low because although the Federal Government is borrowing a tremendous, unprecedented amount, private borrowers 

are borrowing much less than they generally borrow, and interest 

rates will reflect the overall balance between the demand and supply of credit. So one can think about the decline in private borrowing as reflecting and reinforcing the slow private spending. The 

Federal Government has stepped in, partly through automatic stabilizers and partly through deliberate actions, to try to boost spending and is boosting its borrowing as part of that, and it is the balance of those forces with a supply of funds, some coming in from 

overseas and some from domestic saving, that leads to the level of 

interest rates. 

In our forecast, interest rates rise a good deal over the coming 

decade as the economy recovers and private credit demands go up. 

And meanwhile, Federal borrowing would be very high, and the 

combination of that demand, we think will push interest rates up 

a good deal over the course of the decade. Together with the very 

high level of Federal debt, that leads to interest payments being 

unprecedentedly large relative to the GDP by the end of the decade. 

Senator NELSON. Do your projections square with the projections 

of the Federal Reserve? 

Mr. ELMENDORF. I mean, they are—the Federal Reserve does not 

release projections that go out over the entire decade. They do—the 

FOMC releases its projections for a period of several years. Our 

forecasts are generally fairly close to theirs, not every specific, but 

yes, in general, they are. I do not think our views in general about 

the state of the economy are idiosyncratic in any way to us. 

Senator NELSON. And the market would give us some idea of 

what the market thinks about interest rates. How do you square 

the fact that 10-year Treasury bills are being sold at such low rates 

in light of what you just said? 

Mr. ELMENDORF. Well, I think that, again, part of it is the overall weakness in the demand for credit from private borrowers in 

this country. Part of it is the continued flow of money into this 

country. As bad as our financial crisis seemed to us, the U.S. market still seemed safer to many investors than markets overseas. 

I think the other part of that is that their financial markets seem 

to believe that you and your colleagues will put fiscal policy onto 

a sustainable path, and when fiscal crises erupt, and we released 

an issue brief about this a few months ago, it generally comes from 

a loss of that confidence, when investors feel that a government of 

232 

some country is not acting in a way to put fiscal policy in that 

country on a sustainable path. It is very difficult to predict what 

sorts of events and what sorts of circumstances can lead to that 

loss in confidence. I think at the moment, investors believe that 

U.S. Fiscal policy will be put on a sustainable path. How that confidence will evolve in response to actions that are taken or not 

taken by you and your colleagues, I do not know. 

Senator NELSON. I would like for you to comment, if you will, on 

the wisdom of a tax policy given the fact that in your testimony you 

said that the national debt is going to amount to 70 percent of GDP 

for the next 10 years. And in looking to find sources of revenue, the 

loopholes that we find in the system now allow multinational companies, and an example that is fresh in our minds is BP, to receive 

tax credits for—tax credits that were intended not for oil companies, but for manufacturing companies. Do you think that from a 

policy standpoint—I will not ask you the political question—that 

closing tax loopholes should be a priority in the debt reduction efforts? 

Mr. ELMENDORF. I think that kind of policy choice has to be 

yours and your colleagues’, Senator, but I think—and specific tax 

provisions can have positive or negative effects on economic outcomes, depending on the provision, and I do not want to just speak 

too generically about them, but I did say earlier and will repeat 

that I think a wide consensus of analysts would agree that a tax 

code with a broader base of income at the corporate or individual 

level to be taxed and lower rates would be more efficient than a 

tax code with a narrow base and higher rates. But the specific provisions that one would change to move from one to the other, we 

would have to look at on an individual basis. 

Senator NELSON. Before I go on to the next question, I will just 

opine that another example of a loophole is that the taxpayers are 

actually giving tax money to oil companies to encourage them to 

drill in deepwater, something that the oil companies vigorously 

want to do because of the oil reserves, and yet royalty relief, that 

is those payments that would normally be paid to the U.S. Government when U.S. Federal lands are utilized, that those royalty payments were forgiven to oil companies over a technicality. I do not 

think that a lot of people in America realize that tax dollars, their 

tax dollars, are actually being used to pay oil companies to drill in 

deepwater. 

I want to ask you about exports, and I want to ask you about 

the potential for U.S. exports to partially fill this void of the deficit. 

Give us your ideas about the impact of increased exports as a 

means of reduction and a reduction of our trade deficit, which 

would help our overall fiscal outlook. 

Mr. ELMENDORF. So I think that if our exports could be increased, that would certainly—that extra demand for U.S. goods 

would lead to more production and more employment by U.S. firms. 

That kind of strengthening of the economy would be good for the 

Federal budget. 

The challenge is to see what forces in the world or what policies 

you might enact would boost exports, and that is a little harder. 

As you know, much of the rest of the world, particularly the parts 

that tend to import our goods, that represent our exports, are also 

233 

suffering from weakness in their economies, and if they had stronger economies, that would help us, too. But we do not control that, 

and, of course, they are trying to strengthen their own economies. 

I think the actions that firms have taken in the last few years 

to raise productivity in this country have been in the short-term 

bad for unemployment, but over time can make us more competitive in a way that could be good for exports and employment in 

other ways. But there are not, I think, a lot of policy levers that 

would have a very substantial effect on the total amount of exports 

over any sort of short-term period. So our projections are really 

looking at what is happening around the world and the weakness 

in other economies implies sort of only slow growth in demand for 

our products. 

Senator NELSON. In certain States, mine included, the economy 

is so down in the dumps because of the housing market. I was curious when talking to one of the Senators from Wyoming that they 

have less—or they are hovering around only a 6-percent unemployment rate. Compare that to other States, mine included, which has 

been in the range of 12 percent. It may be down in the 11 percent 

range now, 11.5. For the record, I want you to tell us, how are we 

going to right our deficit situation without stabilizing the housing 

market? 

Mr. ELMENDORF. So this map from our testimony shows unemployment rates across States as of August, and one can see that 

some of the States with the highest unemployment rates are exactly those that have the largest housing booms and then the largest housing busts to follow, and your State is one of them, Senator. 

The persistent weakness in the housing market is an ongoing 

drag on the economy. The number of houses started so far this year 

on a per month basis is a little above last year’s extremely low 

level, but still much lower than would be required on a regular 

basis to house our growing population. The proximate cause of that 

is a lot of unoccupied houses today, and that stems both from the 

overbuilding that happened earlier, but also from the weakness of 

the economy. People who do not have jobs or who are afraid of losing jobs or working part-time jobs are much less likely to form 

their own households and seek their own places to live than they 

would be if they were confident in having a full-time job they would 

have for some period of time. 

And I think there is a reinforcing pattern of weak economies and 

reinforcing patterns in strong economies. Part of what is happening 

here is that the weak economy is limiting the demand for housing, 

not the demand people feel in their hearts, but the demand they 

can actually display in the market. They are not going out looking 

for new homes. And that weakness in the housing market is then 

reducing the number of people employed to build new houses. It is 

keeping down house prices, making people feel somewhat poorer, 

and those things are reinforcing the weakness in employment and 

spending. 

There are policies that have been discussed to try to strengthen 

the housing market. One particular policy that has been getting a 

lot of discussion in the last few months and that we have been 

looking into is ways to change what Fannie Mae and Freddie Mac 

do in terms of allowing people to refinance their mortgages. So a 

234 

significant share of American households now owe more on their 

homes than the homes are worth, and a lot of others have a little 

bit of positive equity, but not very much. And that prevents them 

from refinancing in the way that they might otherwise refinance, 

given how far mortgage rates have fallen. 

There have been a number of proposals floated by analysts and 

advocates to relax the rules that Fannie and Freddie impose on 

being able to refinance your mortgage, and we are looking at this 

now, and I say our work is at a preliminary stage, but our view 

fits that of outside people that one could improve the cash-flow of 

homeowners by tens of billions of dollars per year through a relaxation of these rules about refinancing, essentially letting people 

take advantage of the decline in rates the way that they would 

have in the past but cannot now because of the decline in house 

prices. 

And there might be some consequences of that for the Federal 

budget. I do not want to suggest it is a free lunch. But there are 

reasons to think it actually is a fairly effective piece of stimulus 

working through the housing sector. 

Senator NELSON. And a corollary to that, I just recently had a 

major car dealer get in touch of me, and it is typical of what is happening in the housing market, as well, only in this case it is small 

business, the bank has revalued the properties upon which the car 

dealer has the mortgages and the bank is unyielding. They are saying, since the value of your property, real estate, in this case the 

dealerships, has come down and your mortgage is here, you have 

got to pay off. Well, of course, in this economy, car dealers are not 

doing particularly well, although it is getting better, and so they 

do not have a lot of cash hanging around. 

And here, they are looking at the possibility of foreclosure on a 

major good business that has never missed a mortgage payment, 

and but for the uniqueness of this in a State like up there, those 

dark-colored States where the property values have dropped out of 

the bottom, but for that uniqueness, this would be a continuing 

taxpayer who is paying the bills and paying the mortgages. Your 

comments? 

Mr. ELMENDORF. So I think you are just right to note that there 

are a lot of small businesses that are facing trouble obtaining the 

credit they need to continue. Senator Warner mentioned earlier, 

correctly, that large businesses in this country are mostly quite 

healthy financially. They are sitting on assets. They are not spending. 

It is much different for small businesses. And actually, if one 

looks at the patterns of layoffs and hiring across large and small 

businesses, large businesses have resumed hiring in a way that 

small businesses have not. So the lack of credit, but also very importantly just uncertainty about the state of the economy, and I 

think that always has to be put first on the list of uncertainties 

that businesses face, the uncertainty about the state of the economy and difficulty in getting credit has really restrained the hiring 

the small businesses are doing. They have not come back into the 

labor market looking for workers in the way that large businesses 

have. But I do not have a magic wand for the uncertainty and the 

weak demand. 

235 

Senator NELSON. Could you comment on the fact that we have 

just passed and sent to the President a major small business lending bill? It had a series of tax credits for small business, but it sets 

up a $30 billion lending facility, and under the terms of the legislation, that has to go through healthy community banks to then be 

lent, and it is defined in the legislation, to small businesses. Do you 

have any prognostication of how that may affect the future? 

Mr. ELMENDORF. I do not think I really do. Our cost estimate for 

that legislation said that we think the money will be taken up so 

that the banks will come to the Federal Government for—the 

healthy banks that you noted will come to the Federal Government 

for this capital up to the limit in the legislation. So in that sense, 

we think that the program will encourage the banks to do business 

with the government and then to do business with small borrowers. 

But we have not looked at the overall economic effects of that, and 

in particular the extent to which they will be finding ways to just 

take credit for more lending to small businesses versus the ways 

in which they actual supply more credit than they otherwise would 

have, I think is not so clear, and we just have not looked at that 

policy that carefully. 

Senator NELSON. So it must not have been CBO who made the 

estimate that the $30 billion lending facility would produce $300 

billion of loans to small business. 

Mr. ELMENDORF. Well, there is—I think that estimate comes 

from the capital requirements that banks have so that that $30 billion can support $300 billion of loans. The issue I was raising is 

whether that lending really is incremental to what would have 

happened otherwise or not, and that is the challenge in many government programs, trying to encourage certain behavior, is trying 

to distinguish between things that really are newly induced by the 

legislation versus things that might have been going on anyway 

that are sort of allowed to count. And we have not looked, to my 

knowledge, at that part of the question carefully, but we do think 

that money will go out of the Federal Government and will support 

small business loans, but it is the incremental effect on the economy that we have not studied. 

Senator NELSON. Does any of the staff have any questions? OK. 

Dr. Elmendorf, we are starting a series of votes right now and 

the Chairman has asked me to adjourn the hearing. We want you 

to know how much we appreciate your public service and thank 

you for this testimony this morning. 

Mr. ELMENDORF. Thank you very much, Senator. 

Senator NELSON. Thank you. The meeting is adjourned. 

[Whereupon, at 11:31 a.m., the committee was adjourned.] 

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