Chaired By: Rep. John M. Spratt, Jr. (D-Sc)
Witness: Douglas Elmendorf, Ph.D., Director, The Congressional Budget Office
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REP. SPRATT: We meet today -- we convene today to review the state of our economy, a dismal state and its interaction with the budget.
As Director Elmendorf, our witness this morning, told the committee back last January, our economy is clicking on only four out of six cylinders at best, running at 7 percent below its full employment capacity.
To help put the economy back on its feet Congress enacted the Troubled Assets Relief Program in October. This year Congress has passed and the president has signed into law a $787 billion recovery package to spur demand and create 3 million new jobs following investing, reinvesting in our physical and human infrastructure.
The Treasury, the Federal Reserve, the FDIC have all taken unprecedented actions. This morning we want to explore the present state of our economy, what's the course it's taking, very importantly what are the prospects for recovery.
We've been told there are glimmers of hope. Are these glimmers real? Are they simply a mirage? What effect, in particular, are the extraordinary steps we've taken having upon the economy, the stimulus package for example, the TARP package, the extraordinary intervention by the Fed and Treasury, what impact is this having?
What are the risk of deflation, and on the other hand, what are the risk of inflation given the extraordinary liquidity being pumped into the economy by the Fed among others?
What problems are we yet to face? I've noticed in the testimony -- reading the testimony last night that by the CBO's estimate and others' estimates that the banks of this country, the commercial banks, may face losses of nearly $1 trillion of which only about a third have yet been recognized.
All in all, we would like to know what is the state of the economy today? What can we expect for the immediate future, and what policy actions do we need to be taking?
To that end, Dr. Elmendorf, the director of CBO has prepared extensive testimony, excellent testimony if you've read it, and we will make it part of the record so that you can summarize as you see fit, but you're the only witness this morning. Now, you need to leave at 12:45.
We want to give you wide berth to take as much time as you would like to discuss and amplify your views of where the economy is going, what effect our policies have had today, and what policies we should be considering for the future.
Before turning to you for your testimony, let me turn to Mr. Ryan for his opening statement.
REP. PAUL RYAN (R-WI): Thank you, Chairman Spratt.
Welcome back, Dr. Elmendorf. First I just want to say you've lived up to your reputation in coming to CBO and providing integrity, intelligence, impartiality.
And you're doing a good job of upholding the tradition of CBO being a fair, honest broker with the facts. And I appreciate that, and we encourage you to continue doing what you all are doing. And you guys have a hard job ahead of you.
So it's nice to have you back here, and it's nice to see you doing well. No question, all of us want to see this economy turn around. And all of us hope that the turnaround may in fact be on the horizon. We see glimmers out there. But the economic and fiscal challenge that we face are far too complex and too great to simply hope we get it right.
We've got to address the effectiveness of what we're doing to address today's challenges. And we've got to consider where this path that we are speeding down will eventually lead us.
I have a great concern that the administration and Congress have exploited the current economic crisis and the fear and diverted attention of the American people to justify rushing through a sweeping and possibly irreversible expansion of the federal government.
Let me list just a few things beginning this year. TARP, which was signed into law last year and provided $700 billion in emergency funding intended to thaw credit markets, we've seen this program's scope expand beyond stabilizing the financial sector to auto-industry restructuring, auto-supplier support, mortgage loan modifications, and insurance industry assistance.
Worse, we've seen Washington use this program to pick economic winners and losers. I was part of those original conversations. The idea was to ensure or buy toxic assets.
Now, it's equity injections and owning shares of private corporations. Monetary policy; the Federal Reserve has pulled out all of the stops. They brought interest rates to all new lows; they've got massive assets on their balance sheets; they're actually monetizing debt.
Our concern is at some point the Fed is going to have to change direction. They're going to have to change course, and take back this considerable monetary stimulus in order to prevent a nasty bout of inflation in the coming years.
Getting the timing and magnitude of this adjustment right, while avoiding the political pressure to keep monetary policy loose will be critical, and quite frankly I'm skeptical that the Fed can pull it off.
We had the trillion dollar stimulus which may get us a temporary boost, but it's certain to result in debt and tax burdens that will hinder sustained economic growth. And then there's the president's budget, which this Congress has just adopted.
We've spent a lot of time here debating it, so I will be brief with a few concerns. The budget calls for record levels of spending, swelling this year's deficit to $1.8 trillion, more than triple its previous record; doubles the debt in five years and almost triples it in 10 years.
It puts us on a path of government controlled health care, and paves the way for a cap and trade energy tax on nearly every American family business, and individuals, meaning everyone.
It even adds almost $1.5 trillion to new entitlement spending, worsening our most severe fiscal problem.
The budget calls for $1.5 trillion in new tax hikes in the midst of one of the worst recessions in generations.
Clearly, this is a challenging time and it demands solutions. But I honestly fear the path that we are speeding down, that this path will only make the situation worse.
We're now debating this summer about to create a brand new entitlement program before we even solve the other three that are exploding just within the next decade.
At every juncture, we have offered alternatives that promote the kind of solid, sustained, economic growth we need to keep America great for generations to come, and we've made proposals on how to reign in these entitlement programs so that they're sustainable.
We certainly want to continue in this effort. I hope that we can shed some light on the details that are forthcoming in the economy with these programs.
And I yield back the balance of my time, and I thank you, Chairman.
REP. SPRATT: Thank you, Mr. Ryan.
And before you proceed, Mr. Director, let me echo the remarks made by Mr. Ryan with respect to the tradition of excellence at the CBO that you've continued. We're proud of the work you've done, and appreciate it very much.
And now the floor is yours, and I would encourage you to take your time as you work your way through your testimony.
MR. ELMENDORF: Thank you, Chairman Spratt, and Ranking Member Ryan. I appreciate your very gracious introductions, and to all of the committee I appreciate the invitation to testify to you today about the state of the U.S. economy.
In the CBO's judgment, the economy will stop contracting and start growing, again during the second-half of this year. But the hardships caused by the recession will persist for some time.
The growth and output later this year and next year is likely to be sufficiently weak, but the unemployment rate will probably continue to rise into the second-half of next year and peak above 10 percent.
Economic growth over time will ultimately bring the unemployment rate back down to the neighborhood of 5 percent seen before this downturn began, but that process is likely to take a number of years. On the positive side, the fiscal stimulus provided by the federal government is now beginning to boost the economy, and financial markets show clear signs of improvement since the fall and winter.
Moreover, the sharp reductions seen in manufacturing production will keep inventories to leaner levels than would have occurred otherwise, so that upturns in sales, when they come, will lead to faster and larger increases in output.
However, many factors will temper the strength of the recovery, the loss of household wealth, the fragility of financial institutions, persistently weaker growth in the rest of the world, a surplus of housing units, and the low utilization of manufacturing capacity.
How much those factors will dampen the recovery is uncertain. They may be overcome relatively quickly by the jumpstart provided by the stimulus and improvements in consumer and business confidence, or they may cause the economy to slump again next year as the effects of the stimulus begin to wane.
Recently released data are consistent with CBO's forecast in March that gross domestic product will bottom out this year. Indeed, a wide majority of economic forecasters share that view.
However, CBO's assessment of developments in the financial system, and in the non-financial parts of our economy and other economies, suggest that the initial stages of the economic recovery are likely to be more tepid than we had earlier projected.
CBO's March forecast of roughly 3 percent growth in real GDP in 2010 is more optimistic than the current consensus, as is the agency's March forecast for a peak unemployment rate of about 9-1/2 percent. We are now beginning the process of updating our previous forecast and will release a new forecast in August.
The uncertainty surrounding our forecast and the forecasts of private analysts deserves emphasis. Could you put up slide one, please?
The future course of the economy is always uncertain. This chart shows the confidence region around our March forecast of real GDP. The darker areas are the more likely outcomes, and the progressively lighter areas are less likely outcomes.
Uncertainty is especially great in economic forecasting though around turning points and in unfamiliar conditions such as the current financial crisis. Moreover, even if the economy returns to positive growth this year, as we and almost all other forecasters expect, the loss in output income during this downturn will be huge.
As shown in the next slide depicting our March forecast, the difference between the economy's actual and potential output, what could be produced if all factors for production labor and capital were being utilized, will average 7 percent of GDP this year and next. That's about $1 trillion per year of lost output.
And that gap in output will not close until 2013. Based on current information, our next forecast is likely to show even larger shortfalls in output over the next few years.
By this measure, the current recession and its aftermath will be the most severe economic downturn of the postwar period. The persistence of high unemployment in our forecast does not stem from a failure of fiscal stimulus.
We expect that the stimulus legislation will -- (audio break) -- GDP a little more than dollar for dollar of reduced tax collections and increased outlays. However, as large as the stimulus package is, the contraction underlying private demand is far larger. So the stimulus will offset only part of the contraction.
Let me conclude with a few words about the budget outlook. Most experts believe that larger budget deficits are appropriate during recessions, because higher spending and lower taxes can bring the levels of resource use and output closer to the economy's potential.
From that perspective, the extremely large deficit this year, roughly $1.7 trillion or nearly 12 percent of GDP in CBO's March projection, serves a purpose.
However, most experts also believe that persistent large budget deficits reduce capital accumulation, and thereby slow the growth of output in incomes in the medium and long-run. Thus the large deficits that we project for the years after the economy has returned to full employment, shown in the next slide, are more worrisome.
Moreover, the sharp increase in debt this year and in the next few years -- take the last slide please -- raises the risk that investors might lose confidence in government debt as a safe haven.
This risk heightens the importance of putting the budget on a sustainable path as the economy returns to full employment. Thank you; happy to take your questions.
REP. SPRATT: Dr. Elmendorf, one of the things you point out in your testimony is that the current economy, the current recovery efforts may peter out as the effect of what we've done thus far becomes attenuated into 2010 or may be 2011.
Would you expand upon that, just how big a risk is it that the effects will cease to have effect, and there might be a second slump?
MR. ELMENDORF: Yes, Mr. Chairman.
Would you put up the second table? I'm not sure where that stands in the number of slides. I think it will help to -- slide 9, please.
In our estimate, Mr. Chairman, the stimulus package provides the largest boost to the level of GDP this year, you know, the end of this year, in 2009, and the range of those effects are shown in the upper- left set of numbers in this table.
As you know, we offered a range of estimates given the great uncertainty. So we estimate that the effect of the stimulus package is to raise the level of real GDP between 1.5 (percent) and 3.75 percent at the end of this year.
And that reflects the initial burst of tax reductions and spending increases. But the effect wanes over time, as the stimulus package wanes over time. In other words, as the stimulus package principally cut taxes and raise spending in the near term, and as those effects wane, then the direct effects on GDP wane as well.
So we think the stimulus package will still be holding up GDP next year, but less so at the end of next year than this year, and even less so than that at the end of 2011.
That's really a designed feature of the stimulus package was to provide the biggest boost upfront. But the effect of that then is that as those -- the effect wanes, the economy will slow again unless private demand picks up.
And of course the expectation in designing the stimulus package was that private demand would pick up. We are not forecasting as our basic outlook, a renewed slump in the economy.
But as I said in the testimony that continued growth depends on private demand coming up as the stimulus package wanes, and that is I think a reasonable forecast. I think it's the best forecast now, but it's a forecast, it's not a -- by any means a fact that that will happen on the timetable that we project.
REP. SPRATT: The deficit for this year is likely to be ($)1.8 trillion, something to that order?
MR. ELMENDORF: Yes.
REP. SPRATT: And for next year, your forecast is somewhere in the range of ($)1.1 trillion to ($)1.2 trillion. Does that $600 billion decline in the deficit actually pose a threat to undermine the recovering growth for the economy?
MR. ELMENDORF: Well, it's -- yes, but I would say not as the deficit per se. It is -- the decline in the deficit from this year to next, in our forecast, reflects partly the strength in the economy, and also as I said some waning of the effects of the stimulus.
So the withdrawal of the tax boost, the withdrawal of the spending boost is almost equal with slow economic growth. And again as I said the presumption as this package was designed was that private demand would build up over time.
That's what we've seen in past recoveries. But the timing of that increase in private demand is very uncertain. And that's -- and that raises the question, I think, about whether the withdrawal of the stimulus -- as this initial package wanes, whether that withdrawal of that stimulus will come too quickly and leave the economy still very weak or not.
And I've got to emphasize, in our forecast, even with the private demand coming up and growth -- overall growth not faltering, it still takes a long time to catch up for the weak growth last year and this year.
And it's that catching up process, bringing the level of output back up to the potential level of output that corresponds to bringing the unemployment rate down from its current level, around 9 percent, and we think ultimately higher bringing that back down toward the 5 percent which is more standard outside of recessions.
And that's the process we think will take a number of years.
REP. SPRATT: Over the last year-and-a-half, some truly extraordinary steps have been taken including the so-called TARP program, the Recovery Act Program, and Fed's own actions to make an extraordinary amount of collateralized loans to its member banks.
Would you comment on each of these -- in retrospect, does it appear that these actions were well taken? And are they working as intended or at least having an impact on the economy, this policy?
MR. ELMENDORF: Mr. Chairman, I think it's a widely held view that all of those actions have had positive effects on the economy. There is plenty of dispute about whether they were the best possible actions.
And as is often the case, in unusual circumstances when decisions are made in real time, hindsight offers lessons or information that would have been helpful if it had been known at the time.
But the recovery package, as I said, we and the vast majority of private forecasters think is making, and will make over the course of this year and next year a very important difference in the level of economic activity and the level of employment.
REP. SPRATT: You quantify that as between 1.4 percent and 3.8 percent?
MR. ELMENDORF: For -- as of the fourth quarter of this year, and then tapering off to some extent next year, and even more in 2011. The effects of the TARP, and the financial -- and the actions of the Federal Reserve are harder to quantify.
I mean, one can count the dollars that have moved, but the effects on GDP are harder to quantify. But again I think a very widely held view that the aggressive actions in the fall and winter helped the financial system to step back from the edge of the abyss, and has -- those actions have brought down household borrowing rates, particularly mortgage rates.
They have brought down corporate borrowing rates and that enhanced supply of credit has helped the economy in very important ways. The uncertainty going forward that I highlighted in our forecast is whether that help is enough to make the economy strong again.
As one of my colleagues said to me, those actions have stabilized the health of the financial system at a low level. So stable is a lot better than where it looked like it might be going a few months ago. But the fact that it stabilized a low level of health raises concerns that there may not be enough loans provided to help the economy get on a robust growth path again.
REP. SPRATT: Had we not taken those actions, do you think we'd be faced with a much bleaker situation now than otherwise?
MR. ELMENDORF: Yes, absolutely.
REP. SPRATT: Now, the Recovery Act itself has been slow to get out of the starting blocks. Only a few billion dollars out of a huge amount, $787 billion has actually found its way into the real economy.
Can you account for that? Apparently, CBO did expect it. And can we expect it to pick up at a more rapid rate in the near future?
MR. ELMENDORF: Yes, Mr. Chairman. We warned in the time the recovery bill was being discussed that it was difficult to increase government outlays in the categories of the ways that were being proposed overnight. The -- some of the tax changes are having a larger initial effect.
The spending changes take a little longer, and you're seeing that now in the numbers. It's very early to judge whether our assumptions were precisely right. We didn't forecast outlays on a monthly basis and we're only a few months into the package.
But we are not surprised at the slow start. As I said the -- at the time the package had a number of elements. And one of the virtues of having a combination of elements is that they affect the economy in different ways with different speed.
So the details matter a lot about the sorts of tax cuts, or the sorts of spending increases, but a broad generalization would be the tax cuts work more quickly, but tend to have somewhat lower dollar- for-dollar effects on GDP in our judgment, in most economists' judgment.
And the spending increases work more slowly, but have a little more bang for the buck when they get there. So the estimates that I'm showing here reflect our going through the details of the bill, very -- on a fairly granular level, and trying to judge as best we can the size and timing of the effects.
So these estimates incorporate our view that some of the spending increases will be slow, and will have their biggest effects next year, whereas other pieces like some of the tax provisions were having big effects right away.
REP. SPRATT: In your testimony, you point to some weak spots in the economy which haven't been fully exploited yet, such as -- well, you don't indicate, but bank losses $950 billion of which only about ($)300 billion thus far has been recognized and declared a loss.
Are there some weak spots like that, some sandpits that we still are faced with? Commercial real estate loans, credit card loans, things of this nature that could trip up the recovery?
MR. ELMENDORF: Yes, Mr. Chairman. I'm not a golfer, but I think the number of sandpits that we see ahead would scare a good golfer.
REP. SPRATT: I was concerned by quicksand more than the sand.
MR. ELMENDORF: There are -- (laughter.) So as you know, the largest U.S. banks have recently undergone a stress test. And the stress test was examining what might happen to their balance sheets if the economy turns out worse than most people expect.
Not a lot worse; it's not the worst possible scenario, but it is a worse outcome for the economy than is the consensus view. And in those tests, most banks either had sufficient capital to weather that possible storm, or were close to having enough capital, and are now making plans to raise capital.
But I should emphasize the uncertainty there. These banks have trillions of dollars of assets, and even a small misjudgment in the value of those assets under a given economic scenario can have a -- make a world of difference in the amount of capital they need to raise.
Having said that, I think the consensus view is as you said. There's a lot more losses to be realized, but that the losses that are coming will come progressively over time.
The banks hold some combination of loans and securities -- and again this is a generalization, but the securities tend to record losses in their value very quickly, whereas for loans, the losses can be realized over time.
So a lot of immediate losses have been realized, and the consensus view is that the losses they are going to suffer can be offset to a large extent by earnings they will have over the next several years and thus that they will weather the storm.
Again, as I said, the question of the overall economy is whether they are healthy enough to do enough new lending. Commercial real estate is, I think, another very important risk factor.
There's a lot more commercial real estate in the world now, and in our country now certainly, than there was demand for. And there is a lot of concern about the effects of that.
It matters directly for construction, but also on the financial side these -- and it's not even -- it's not just a matter of whether people can meet their current interest payments, but whether they would be able to obtain new financing to rollover loans as they come due say, given that there has been a tightening of credit standards since many of these loans were initially issued, because of the financial problems. And because of the recession, they may have difficulty rolling over those loans.
And that poses a very serious threat particularly to some of the medium and small banks that have received less attention over the last year-and-a-half than some of the biggest banks.
REP. SPRATT: I have a number of other questions, but let me let others ask questions. We'll come around for a second round.
REP. RYAN: Thank you. Let me just pick up of on the commercial real estate. That's something I wanted to get into. That's what a lot of analysts are saying is going to be the next shoe to drop is the commercial real estate market.
And we had the stress test on the big banks, but we know that there's a lot of exposure on commercial real estate in the small and medium sized banks. Have you seen or done any analysis on the kind of exposure to that segment of the banking system and just give me kind of an assessment of your risk to the small and medium-sized banking system, should that shoe drop, so to speak?
MR. ELMENDORF: We have -- we are monitoring the situation. I would -- you know, that's a big financial system, and we have a reasonably compact staff of people following it, and we report some of the -- some of the analyses that others have done that seem to us to be correct and relevant to the situation.
The fundamentals in the market are quite weak. People are looking for price declines of 35 (percent), 45 percent exceeding those in the early 1990s. Rent declines, the vacancy rates, may approach those of the early 1990s.
And it really is a demand side shock. In the '90s, there was more an issue of overbuilding, and in this case it really is just the pullback in the -- and we see this in employment as well, in the financial sector, in the retail sector, the businesses were contracting, not growing.
So the delinquency rate is rising, and is expected to peak at the level of the early 1990s, around 6 percent. So the Wall Street Journal in fact did an analysis of the exposure of banks to this sector.
And using the same scenario that the Feds used in the stress test, the Wall Street Journal concluded the total losses of these banks could surpass $200 billion. That's a good deal of money.
It's spread among a large number of banks, but nonetheless, these were not the Citi Groups and the Bank of America. So it's -- losses that level would likely exceed the revenue that those banks would otherwise take in.
That would mean a reduction in their capital over time, and I think a significant number of those banks may find themselves with capital low enough that regulators would become very concerned. We've not tried to calculate the expected effect of that on particular parts of the FDIC --
REP. RYAN: Yeah, that's what I'm trying to -- that's what I want to get a sense for. If the shoe drops, you know, what kind of percentage of the small to medium-sized banking system are we going to see shrink and be liquidated, if any?
MR. ELMENDORF: So that -- I'm sorry, we don't have estimates of. There are actions underway to try to help this market. The Federal Reserve has announced that it will -- parallel to a number of its other facilities, help investors finance for purchases of top-rated commercial mortgage-backed securities, CMBS issued before the crisis.
And there has been a rally in the market for those securities. So it's possible that there are already -- as we know, the Federal Reserve has a lot of levers that it's using and that may help to stabilize the market.
REP. RYAN: And they are going to prop up the secondary market in commercial paper -- commercial mortgage backed paper?
MR. ELMENDORF: Commercial mortgage-backed securities. I mean, prop-up would not be their language.
REP. RYAN: Right.
MR. ELMENDORF: They are providing liquidity to help, blah-blah.
REP. RYAN: Okay. Let me go to the bond markets. The bond markets are beginning to recover.
Investors seem to be getting some risk-appetite back, which means that many may start to move out of our treasuries, that safe haven, you know, is sort of dissipating it seems.
Meanwhile, many other countries along with the U.S. are tapping global debt markets to raise funding for economic recovery and to finance our deficits. The Treasury -- our own Treasury is going to issue about ($)2 trillion in fresh debt this year alone.
How might these factors, a higher risk-tolerance, and a flood of new sovereign bond issues, influence our government's borrowing cost going forward?
How significant might there be upward pressure on medium and long-term interest rates in your view, given this new climate we're kind of going into now?
MR. ELMENDORF: I think certainly over the next several years there is likely to be very significant upward pressure on Treasury interest rates. Whether it's now or later is much less clear.
REP. RYAN: Yeah.
MR. ELMENDORF: Although there are, as I've said, signs of improvement in the financial system and signs of improvement in -- around the world in financial markets and some equity prices and some improvements in confidence.
REP. RYAN: But that means our rates will go up then, right?
MR. ELMENDORF: We're still in a -- excuse me?
REP. RYAN: That means our rates will then go up because people --
MR. ELMENDORF: Yes.
REP. RYAN: -- will leave treasuries, yeah.
MR. ELMENDORF: Yes, but at the moment, despite some glimmers of hope, and green shoots in the economy, and other phrases like that in our view our economy, the world economy still have long way to go before they really come out of this slump.
And I think the judgment of most economists is that this increases in interest rates are likely to be delayed until we come out of the slump. But the factors you -- the forces you describe I think are the -- (audio break) -- which are that people will get greater risk tolerance, there'll be more demand for funds by the private sector as the economy improves. And that will divert investors' interest from treasuries.
REP. RYAN: I wonder if we're not a few years behind Great Britain with respect to the state of our finances. And what I mean when I say that is they had a bond auction fail a month or two ago.
Standard & Poor's said yesterday that they are about to downgrade their credit, which I think has put a severe slump in their stock market today. They are basically saying if Britain doesn't get its finances, their credit is going to go down.
The question is, are we coming close to that moment here? Our bond sale may not work. Our credit's going to get down greater.
And the reason I ask you that is in the context of your score of the president's budget, which is passed, and now is being implemented, our deficits never go below 3 percent of GDP.
We have a deficit this year of ($)1.8 trillion, and ($)1.2 (trillion) you're saying next year. Our publicly held debt is going to triple nearly in about 10 years. And now we're talking about creating a new entitlement program for everyone with the new health care option. And the -- so the question is twofold.
Are we risking our credit? Are we going to have a problem selling our bonds? And if we create this new entitlement without fixing the other entitlements that are exploding and we come up with a quote unquote "pay-for" for this new entitlement that really doesn't track with the growth of this new entitlement. And that's my -- one of my number of concerns.
I'd like your comments on this is if we come up with a pay-for for this new entitlement with the grab bag of revenue raisers, you know, a MedPAC recommendation on Medicare payment reductions here, a loophole closer there, you know, a small tax change here, and they all culminate to get the ($)1.2 trillion that everybody says is needed to make this health care plan work. A lot of that stuff goes away, but the entitlements grow; BBA '97, perfect example.
We had a lot of Medicare savings that which helped lead -- led to the surplus, but Congress gave all that stuff back after, you know, people pounded on Congress to you know, spend more.
And so it looks to me like we're beginning to create a new entitlement without really actually paying for it, creating now a fourth unfunded entitlement liability.
Given the state of that, given the state of your analysis that says our deficits are never going below 3 percent of GDP, we're prone to create a new entitlement that probably won't be really actually paid for.
Britain couldn't sell their bonds, their credits getting downgraded; are we about to go down that path in your judgment?
MR. ELMENDORF: Well, could we back up to slide 12 which I think is good to look at as we have this conversation. Let me first tackle the forecast as we have it --
REP. RYAN: Yeah, I gave you four questions, there's --
MR. ELMENDORF: And then I'll come to the new entitlement question.
REP. RYAN: Would you like to --
MR. ELMENDORF: As slide 12 shows, this shows debt held by the public as a share of GDP over the last four decades, plus, and then looking ahead roughly a decade. The baseline projection is the solid line and it's under current law.
Even under that projection, as you've noted, congressmen, the debt rises very sharply as a share of GDP. It rises to a level not seen since the 1950s, and we were working down the debts accumulated in the Depression and the Second Word War.
U.S. debt peaked a little over 100 percent of GDP at the end of the Second World War, and then declined. But we are launching with two successive years between them debt -- deficits of 20 percent of GDP. The debt is rising by roughly 20 percentage points of GDP.
Under current law that -- the debt recedes again, but it's worth remembering that current law assumes that the 2001, 2003 tax cuts expire. It assumes that the AMT remains as it is in current law.
It assumes that other expiring tax revisions expire. It assumes that Medicare physician payments fall by 21 percent next year, and more in subsequent years.
So it is the current law and our job is to follow that. But that list of factors embedded in current law, I think suggests very clearly that that is not a path that will feel to most Americans like a continuation of what is happening now, and is a path that would feel like a tightening.
That's what requires to get to that dark line, which as you see we use the debt as a share of GDP above what it has been at any point in my lifetime.
The top line is our estimate of the president's budget released in March. That shows a debt relative to the GDP rising essentially because the annual deficits exceed the growth rate of the economy and thus the debt rises.
The budget resolution is the dashed line in the middle. There is no doubt, I think, that this is a worrisome picture. This is a grim outlook for the federal budget.
And it poses the risk that you raised, Congressman, that at some point people may decide that the U.S. is not the safest haven.
Now, I don't think that we are that close to that point right now. At the moment, the U.S. government can borrow money at incredibly low interest rates.
And there are special factors and those factors will wane as we discussed. It's very difficult to assess how quickly they will wane and there can be a range of views about that.
I think in general -- Rudi Dornbusch, who had been a leading international economist and who passed away a few years ago had a line to the effect of "When something is unsustainable, it can go on longer than you would think possible, and then swing more sharply and quickly than you thought possible."
I think this maybe a situation like that. It's hard to know when sentiment will turn, but it could turn quickly. And that's a risk.
Now, on your question about the new entitlement; naturally, given that picture policy changes that make the medium and long-run budget deficit worse increase that risk that we've just discussed. Whether a particular piece of legislation does that is one that CBO will try to judge when the legislation is constructed.
I don't think in principle it's a matter of whether you're paying for something in little pieces or big pieces. It's more a question as I think you suggested about the permanence of the various pieces.
REP. RYAN: Yeah, the sustainability of it.
MR. ELMENDORF: And that's a difficult thing to judge. We don't produce budget estimates that go out beyond 10 years normally. I think the question you're getting at is something could be paid for within 10 years and not beyond that, and we don't normally produce formal estimates of that.
I think it's appropriate for you and the other members to judge yourselves what you think the political dynamic may be around certain changes that are being made.
But I would -- I do want to say one quick positive word on behalf of changes in Medicare reimbursements. MedPAC congressionally established agency studies it very closely with a great deal of rigor the reimbursements in Medicare, and the cost the providers receive.
And we don't duplicate that work, but we have tremendous respect for what they do. And I think in the cases where they think that there are overpayments in Medicare, I would commend those to your attention because I think that it's important -- although we talk now about trillions of dollars, obviously, it's important not to lose sight of the billions of dollars that can legitimately be saved in terms of delivering health insurance in the most efficient possible way.
REP. RYAN: Thank you. I agree basically with your MedPAC point. From being on Ways and Means for a number of years now, what ends up happening is we might pass a MedPAC recommendation or two, and what we find out is Congress then takes that away because of political pressures in time.
And if we use those kinds of things to finance creation of a new entitlement, the funding stream is specious in my opinion.
Thank you, Chairman.
REP. SPRATT: Ms. Schwartz.
REP. ALLYSON Y. SCHWARTZ (D-PA): Thank you, Mr. Chairman.
And thank you, Dr. Elmendorf. I appreciate some of your both clear caution about where things are in the economy and economic growth, but the positive feeling about the tax provisions, the tax cuts for 95 percent of Americans having an effect, and the fact that some of the dollars have already gone out fairly slowly.
Truthfully, it's only been a couple of months. That's not --
MR. ELMENDORF: Right.
REP. SCHWARTZ: -- in our timeframe really that slow. And for many of our states receiving those dollars being not only announced, but contracted. And so we'll start to see them in a number of months.
I wanted to follow a bit about something you touched on in the response to Mr. Ryan and ask about it in a slightly different way, if I may.
The president has made it very clear that in the economic recovery package we needed to make some real investments if we were going to both be more economically competitive, enable the private sector to really grow. And I'm -- particularly I'm talking about health care, but energy is obviously an issue as well.
And that both the effect in the economy and the effect on the federal budget requires us to tackle the growth in cost in health care, in particular. And so the -- now, what I want to ask you about is really to look at it in a different way. If we do nothing, we're going to see quite substantial growth in health care costs.
So the choice is to do nothing either to help the private sector or businesses that are saying to us we really need some action here to contain the growth of costs in health care, so we can continue to provide those benefits and have some stability so that we can invest those dollars in other ways and produce those jobs.
And secondly for the federal government, it is really not only a question about how do we address the issue that so many Americans spend dollars on health care or we spend dollars on health care in very inefficient ways.
The choice we're faced with is we do nothing, or do we actually tackle this issue, and do we do it for because of the concerns about the economy as well as the moral imperative around health care and around federal budget?
So could you speak to two things, one the consequences of doing nothing, and the growth that we might see -- I know you have a chart on this, that we do nothing -- in terms of federal budget and our lack of economic competitiveness.
And secondly, maybe more insider discussion, but we, many of us believe, and I think you do as well, that certain investments in health care particularly in redirecting dollars to primary care, to early intervention, to improving health care status of Americans and health outcomes will in fact have a savings.
It is difficult to score; as we say, it's difficult to calculate what those savings might be. But again, to not do those things we're going to continue to see this unsustainable growth in costs.
So if you could speak to both those aspects of doing nothing and then also some of the investments we're making that in fact could have a really enormously positive effect on the rate of growth in costs both for the private sector and for the federal budget.
MR. ELMENDORF: Congresswoman, the widely held view among budget experts and experts about their health system that changes in that system are urgently needed. In contrast to say financial markets where things can change overnight, health care does not.
And in that sense can appear to be less urgent. Next year will be much like this year. But in fact the inertia in the way that system works is viewed by most analysts as an argument for urgent action that the sorts of thoroughgoing changes that are desirable in the health care system in the views of most experts will not happen overnight.
And one needs to therefore get started --
REP. SCHWARTZ: Right.
MR. ELMENDORF: -- most analysts would tell you. The reason these thoroughgoing changes are needed in the views of most analysts is not just the health care costs are rising, but that a lot of the money that is being spent on health care is viewed by experts as not contributing that much to people's health.
And one of the most dramatic examples of this is that amount of money that Medicare spends in different regions of the country per patient, after controlling for differences in their ages and other aspects of their physical conditions, and after controlling for differences in underlying costs of living, Medicare will still spend much more, twice as much in some areas of the country as in others.
And -- but the people don't seem to be any healthier in the areas where more money is being spent. So there's a widespread view that a lot of money going into the health care system is not being used very effectively in terms of producing good health as the outcome.
And that fact combined with the rapidly growing share of the economy devoted to health care, with many people who believe that urgent action is needed both on behalf of -- in the private sector and for the government budget and --
REP. SCHWARTZ: But in the budget that we passed, we actually have setout a course to tackle some of these issues.
And that in terms of greater efficiencies, the right kind of investments, both containing costs, and expanding coverage could -- and my time is almost up -- but if you could just really say that that course of action, that we're going to tackle action, that we're going to take action, we're going to tackle these issues, would you say simply that that is an important path for us to be moving forward on, so that we in fact are reducing costs both for the government and for the private sector?
MR. ELMENDORF: I think tackling -- again, widespread view among experts that tackling those issues is very important and desirable. The precise nature of tackling however is very important.
And some of the -- some aspects of the proposals being discussed would expand health care entitlement in this country. Other aspects of the proposals being discussed would generate efficiencies in how public money is used and save public money.
And the budgetary effects of this piece of the proposal can cut in different directions. And there are obviously many important considerations apart from the budget. So it depends how this shapes out.
REP. SCHWARTZ: Which -- may be that's a topic for another hearing, but that is what we are working on of course, to get that right both for our budget, for the taxpayers, and for the private sector. That's what our job is and that's what we're working on. Thank you.
MR. ELMENDORF: Thank you.
REP. SPRATT: Mr. Hensarling.
REP. JEB HENSARLING (R-TX): Thank you, Mr. Chairman.
Welcome, Dr. Elmendorf. Following upon my colleague's questioning, I think everybody on the panel agrees that you'll never control federal spending until you find a way to control health care cost.
But my question is if the administration's plan is supposed to save us money with various efficiencies, why did the budget include an approximately $600 billion line item for health care and we were told that was merely a down-payment?
MR. ELMENDORF: Well, sir, I can't speak to the construction of the president's budget of course, but nobody disputes --
REP. HENSARLING: A funny way to save money.
MR. ELMENDORF: Nobody who studied the problem disputes the fact that expanding health insurance coverage to a significant number of additional Americans could be done without spending federal money.
I think nobody disputes the fact that there could be changes made in the way we run our current federal health programs, Medicare in particular, in a way that would save money.
And as I suggested there's a balancing of those actions that's up to Congress to decide. And as you know the administration has clearly set aside in its budget a significant amount of money on net to fund this program.
REP. HENSARLING: Speaking of balancing, in your testimony you have -- I guess on page 17 entitled a section "The Conflict between Near-Term and Long-Term Fiscal Objectives," and you've touched upon this subject earlier.
I believe, Dr. Elmendorf, correct me if I'm wrong, in your testimony you have stated that it is your opinion that the stimulus plan that -- I guess, borrowing the president's phrase, has helped create the little green shoots that you may see in the economy; is that a fair assessment of your testimony today?
MR. ELMENDORF: Well, we think on balance that the stimulus package will improve GDP. I don't want to link it to any particular piece of news.
REP. HENSARLING: As I understand it though you believe it can have a beneficial impact on the economy in the short-term --
MR. ELMENDORF: Yes.
REP. HENSARLING: -- but a detrimental impact in the long term, which I believe was contained in an analysis of a letter that you sent to Senator Grassley in March; is that correct?
MR. ELMENDORF: Yes, that's right.
REP. HENSARLING: And I think you also testified that --
MR. ELMENDORF: Put up slide 9; then you can see the point to which you're referring, Congressman.
REP. HENSARLING: Please. Also did I understand in your testimony that -- well, forgive me -- when did you expect to see GDP growth turn positive?
MR. ELMENDORF: We think it will turn positive later this year.
REP. HENSARLING: Okay.
MR. ELMENDORF: And that's the view we've expressed in March as well.
REP. HENSARLING: And so you're projecting positive GDP for the latter part of this year. And when did you say under your projections that unemployment would peak?
MR. ELMENDORF: Later next year.
REP. HENSARLING: Later next year?
MR. ELMENDORF: Traditionally, in business cycle recoveries the unemployment rate peaks maybe 6 to 12 months --
REP. HENSARLING: Okay.
MR. ELMENDORF: -- after output growth turns up again. And in this particular case we expect a weak growth of output and in the not so delayed term --
REP. HENSARLING: Well, here's my question then, Dr. Elmendorf. Under your projections we have positive GDP growth at the latter part of this year.
We have unemployment peaking next year. You say the long-term impact of the stimulus program could prove to be detrimental to the economy.
Clearly, I believe you have said in your written testimony that any policy designed to provide short-term fiscal stimulus will have to contend with the long-term consequences.
My question is this; the administration presented a 10-year spending plan. That spending dips to a low point of 22.7 percent of GDP in 2012. After 2014, spending exceeds 23 percent of GDP through 2019.
We haven't seen spending like this since World War II. I think under one of your slides, the federal deficit decreases to about 2013, rises again, averages 5 percent of GDP over the 10-year budget horizon. By 2018 deficits exceed $1 trillion again.
I mean, the question is this; if you're predicting essentially that the economy is going to turn around in the next 18 months, what economic rationale for the explosion of -- (audio break) -- debt and deficits over a 10 year window?
MR. ELMENDORF: Congressman, as I said in my remarks, the widespread view among experts that deficits serve a useful purpose in recessions, equally widespread view among experts that persistent large deficits outside recessions are damaging to a country's long-run economic prospects.
And I don't think anybody has actually defended those deficits over the 10 years as a virtue. There is obviously an active debate about what changes in policy might be more or less desirable to put us on a different course.
REP. HENSARLING: Well, I may not see the virtue, but Congress just voted to approve it. I see I'm out of time.
Thank you, Mr. Chairman.
REP. SPRATT: Mr. Becerra.
REP. XAVIER BECERRA (D-CA): Thank you, Mr. Chairman.
Dr. Elmendorf, good to see you. Thank you for your testimony. Actually, if you could put that chart back up that was just on, that would be helpful.
Let me make sure I'm settled on what I've heard you say in your testimony in response to some of these questions. The economic recovery package which was deficit spending, but at a time when we were seeing credit markets freeze up, when the economy was on a downward slide, jobs are being lost, deficit spending so long as it's responsibly done can help avoid a further fall and perhaps help us see the trough come sooner, so we begin to see a pickup in the economy with -- pickup in economic activity which means a pickup in jobs in the near term.
MR. ELMENDORF: Yes, exactly.
REP. BECERRA: And your chart begins to reflect that in showing that the drop that we're seeing in the economic activity concludes sooner as a result of the economic recovery package.
MR. ELMENDORF: Yes.
REP. BECERRA: And so long as that spending in the economic recovery package is smartly done, focused, then an economist would agree that it is focused. We can have some reasonable projections by economists that we'll begin to see an upturn in the economy.
And there are some in fact signs right now that we may be seeing the end of the worst -- not that we're going to see sunshine overnight and blossoming of the economic flowers tomorrow, but we're beginning to see some signs that maybe there is the beginning of the end of this recession.
MR. ELMENDORF: The rate of decline has lessened. So we're going downhill, but there are signs that we're reaching a leveling out. Now, of course, people who know hills know sometimes it levels out and then worse things happen.
Sometimes you turn up the other side of the valley very steeply and that's the uncertainty. But we are declining at a slower rate than we intend.
REP. BECERRA: And so there are those who would have said, don't do this economic recovery package; don't do this. Who would have said, let's just close our eyes, let's not do anything, and let's just hope that this rollercoaster that we're on that's going down actually ends.
And that we can survive the steep drop of this rollercoaster, and if we just raise our hands and yell it will come to some conclusion on its own. That is a course we could have taken.
And we, at some point, probably would have seen the economy recover on its own naturally. But we might have seen millions more Americans lose their jobs, thousands of other American businesses go under, and may have seen the suffering extended quite some time.
So so long as we have some smart spending, it could help us out of this economic recession. And now on this chart, I notice that that rollercoaster drop didn't begin on January 22, 2009, when President Barack Obama was sworn in. It actually began -- I think the chart shows sometime around 2007.
And so we were already on this rollercoaster ride down not knowing how it was going to end very steeply, so in fact steeper than any rollercoaster ride we've been on in many decades, well before President Obama suggested we do this economic recovery package.
I think President Obama was saying for all of those who don't like the thrill ride of losing jobs and losing American businesses, let's try to get ourselves out of this sooner.
Now, health care you mentioned could make things worse or make things better. There are some who once again will say, let's close our eyes, let's not try to deal with this headache and heartburn that is now health care, because too many Americans aren't able to pay for their insurance or get the coverage they want. Some Americans don't even have any of that whatsoever.
And the president said, let's move boldly. Now some folks say we're not prepared to move boldly. We'd rather have status quo. But the president said we need to corral costs. There are ways to corral costs.
You can still give people their choice of doctors, but you can try to bring the price down of what they have to pay for; and there are whole bunch of folks who can't afford health insurance. And if we can get them to have health insurance they'll make wiser spending decisions on their health care, which could help us reduce the cost of overall health care.
If we could do a smart program on health care -- and I'm not going to ask you to give us the elements of what a smart health care reform would be, and I'm not going to tell you what they would be, I'm just going to ask.
If we could be smart, the way I think we were smart in this economic recovery package to help with the recession, would corralling the cost of health care help us get out of this economic recession and also help us avoid the massive budget deficits we've been experiencing?
MR. ELMENDORF: Reducing the path of federal spending on health costs is absolutely essential to bringing down budget deficits in the long run. If you look at the path of the deficit under that we estimate for the president's budget, tax revenue is about the same share of GDP there that's been on average historically in this country.
All spending, apart from social security, Medicare, and Medicaid is a smaller share of GDP, and has been for most of my lifetime.
What's different about that -- about the next 10 years relative to the history, what gives the line that slope that it does, is basically rising health costs. So producing the path of federal health spending is absolutely essential to the long-run deficit to addressing and solving the long-run deficit problem.
REP. BECERRA: Doing nothing keeps that line going down?
MR. ELMENDORF: Yes, but one has to -- as I've said, do the right sorts of things.
So as you said, smart reform and without either of us to defining what that means in this context, the reform has to be one that reduces federal health spending over time.
REP. BECERRA: Thank you, appreciate it.
Thank you, Mr. Chairman. I yield back.
REP. SPRATT: Mr. Garrett.
REP. SCOTT GARRETT (R-NJ): Thank you, Mr. Chairman. I'll have a couple of other charts if they can bring them up now.
Thank you, Doctor. Early on, January, the chief economist for the president released a study entitled "The Job Impact of the Stimulus." And while the final bill was at that time still a month away from passage, the broad outline of the so-called stimulus package was already basically in that document.
And they called for $775 billion. You know the final passage was ($)787 (billion). Now, in this study Dr. Romer and Bernstein said quote "A key goal enunciated by the president concerning the stimulus is that it should save or create at least 3 million jobs by 2010."
Now disregarding for a moment the difficulty in measuring the number of jobs that have been saved, I don't know how anybody could explain that yet by particular action by the federal government, this was a key metric by which the incoming administration wished to measure the results of stimulus.
Later in the report, the authors provided a useful chart -- there it is -- from which we could visualize potential outcomes our economy would experience if we had stimulus and without it. And if you look up on the chart there with the recovery, you see the bold line on the bottom, and without the stimulus plan you see things not going as well.
Now, on February 17th, the stimulus became law. Later after Congress had considered this legislation, you folks at CBO issued report on March 2nd outlining the bill's expected fiscal impact.
And in that report you noted that CBO estimates that the stimulus will increase employment by 0.9 million to 2.3 million by the fourth quarter of '09. But now we've had a little over three months to evaluate the impact of this legislation.
And so far the results have not been all that promising. So let's look at chart two. I think the chart two -- there we go. And as you can see, the chart two shows where we really are.
The actual unemployment rate jumped to 8.5 in March and then 8.9 in April. So this rate of job loss is considerably worse than what the president's top economic adviser predicted would happen without the stimulus.
So just doing it on the back of an envelop here, unemployment would now need to drop a full percentage point in the next three months simply to catch up with the projections outlined in their initial document.
So my first question, would you think that job creation of this magnitude, or in other words dropping of unemployment by 1 percent in three months, would that be totally unprecedented?
MR. ELMENDORF: Well, as you understand, Congressman, the -- everything about this sort of picture is uncertain. We don't know what would have happened without the legislation.
REP. GARRETT: Right, but we know where we are now.
MR. ELMENDORF: Yes.
REP. GARRETT: And that's where we are now.
MR. ELMENDORF: Yes.
REP. GARRETT: We know what they say we're going to be, and that's what's up there as well. Now, my question to you is would dropping by 1 percentage point in order to get us down to where they say we should be in the next three months, is that something that's ever happened before? Is that unprecedented or is that what we should anticipate?
MR. ELMENDORF: I'm not sure if it's ever happened before, but it would certainly be very unusual. And given the trajectory of the unemployment rate that you show, the kind of reversal level that would be required would be completely shocking.
REP. GARRETT: Right. Okay, so -- because the question on the other side was, oh, it's between doing something and doing nothing. I haven't heard anybody say do nothing, but now we can see what doing something did. Doing something put us at a -- well --
MR. ELMENDORF: But I mean, doing something in combination with everything that was going on in the economy apart from the stimulus package -- and my point in trying to emphasize about the uncertainty of the economic forecast is that one could have drawn around that line that they graphed with or without a very large confidence region of the sort that I showed you around our forecast that would encompass a whole range of possibilities.
REP. GARRETT: Yeah, but -- so they were wrong and the projections of where we would be even with it, they were wrong, and there were projections of where they would be without it, they were wrong.
And where we are right now having done it and spent almost $800 billion, we are in that sense worse than where they projected we would be even without doing anything. Just going by the facts.
MR. ELMENDORF: Yes, we are -- yes, the outcome has been worse than they projected at that time. As you know our own March forecast was more negative than the forecast the administration formed earlier in the year.
REP. GARRETT: The takeaway from your opening comments with regard to the stimulus is that the stimulus, I think, you said, started out slow and then sort of petered out altogether by next year.
MR. ELMENDORF: No, no.
REP. GARRETT: Well, because you said that by next year, you indicated that the stimulus will be, "winding down" was your words and that --
MR. ELMENDORF: Waning.
REP. GARRETT: Waning.
MR. ELMENDORF: So the peak affect of the stimulus on the level of GDP is the end of this year. And then --
REP. GARRETT: And why is that? Why do say that? Because previously CBO testified that most of the money will not be actually out the door and on to the projects until 2010.
So why is it that the peak positive effect is going to be this year if CBO testified that most -- matter of fact, I heard one person say, they will be celebrating the 4th of July, 2010 before most of the money will be outside -- out the door and actually in the ground doing projects.
MR. ELMENDORF: So the stimulus legislation include both the revenue and spending provisions. So in the estimate that we formed last winter -- and I have in front of me the letter to Senator Grassley in March -- we estimate that about three-quarters of the total amount of money, tax cuts and spending increases, would have flowed out by the end of Fiscal Year 2010, which is next September.
REP. GARRETT: Right.
MR. ELMENDORF: So three-quarters out by then. So the spending part, as I said earlier, lags the tax revenue effects. And that's why the spending is more lag than the overall economic impact of the plan.
I also want to be careful about stressing the fourth quarter of this year. The chart I showed looked just at the fourth quarters.
So on a fourth quarter basis the biggest effect is this year and then it wanes next year.
If we actually looked at this on a quarterly frequency, and I gave you a chart with more columns, we'd find a little more effect in the first half of next year and then waning after that.
So -- but the effect on the level of GDP is sort of goes up this year and then it starts to come down later next year and then wanes after that.
REP. GARRETT: You know, often -- you know, Chairman Bernanke has come here before and he's a great historian on the Great Depression, and he educated us on the fact that during the Great Depression you had basically sort of two depressions, you have the original depression most people -- and then during the Roosevelt administration you had sort of a second depression.
And I'm not saying that we're in a depression by any means. But hearing your testimony almost sounds like we had the one recession, and now we're going to have the next recession potentially going forward.
MR. ELMENDORF: So I think it's a risk. As I said, that is not our forecast, and it is not the consensus forecast. If you look at the -- I think, I have another chart which actually shows this.
If you look at slide three, you can see the forecast. These are private sector forecasts something called the "Blue Chip" which surveys private forecasters.
As you can see that for 2009, so I'm looking now at the -- to the annual averages on the upper-right corner -- for 2009, all of the forecasters obviously expect a decline in GDP.
For 2010, the most optimistic 10 of this group of about 50 expect growth pushing 3 percent. The average is about 2 (percent), and the bottom 10 expect growth of 1 percent.
So it is -- I wouldn't say that nobody predicts another dip in the recession next year, but that is very far away from the consensus. The issue at hand, I think, is how quickly private demand rebounds, whether it rebounds quickly enough to offset the waning of -- effect of the stimulus package.
And again, our forecast and almost everybody else's forecast is that it does, but it is -- as I've said, there is a -- risks. And there is a risk of faster growth than people expect, of course.
We've had faster growth than this in a number of previous recoveries but there's also a risk of slower growth.
REP. GARRETT: Right, because that was your projection before -- (inaudible) -- down. Thank you.
REP. SPRATT: Mr. Doggett.
REP. LLOYD DOGGETT (D-TX): Thank you very much.
When Dr. Peter Orszag appeared here in March, I asked him to explain why President Obama believes that American families will be better served by auctioning 100 percent of pollution allowances instead of giving polluters pollute free cards.
He responded that an approach which relies on giveaways instead of relying upon auctions would quote "Represent the largest corporate welfare program that has ever been enacted in the history of the United States." Do you agree with him?
MR. ELMENDORF: Yes, I do.
REP. DOGGETT: And on May 7th in your blog, you discussed this, and why simply giving away pollute-for-free allowances to certain industries doesn't work, that this would not hold down the price of the goods and services produced by these energy-intensive manufacturers, and would only result in windfall profits for them, which in turn would benefit the wealthy the most.
Can you explain why the pollute-for-free approach would have such a regressive effect and explain why the price of products to American families even after these pollute-for-free allowances are given out will not be held down?
MR. ELMENDORF: Certainly. As I explained in the testimony to the House, to the Ways and Means Committee, and also to the Senate Finance Committee, the critical aspect of a cap-and-trade program or of a carbon tax is to raise the price of carbon emissions.
And that increase in price is created by the cap, the limit that's imposed, and that will raise the price of products that embody a lot of carbon emissions. And it is by raising the price of those products that businesses and households will change their behavior, develop new technologies in ways that -- economize in carbon emissions, that's the point of that sort of plan.
The -- when the government sets this cap, and then has a set of allowances to distribute, it is holding something of great value, because the ability to emit emissions will be valuable when the cap is set.
And the distribution of those allowances matters critically for the distributional effects of the cap-and-trade plan. If you give an allowance to a business, then it can use that allowance itself or it can sell that allowance.
In either case the -- because the allowance has a price, it will -- that raises the cost of the businesses' activities, and it will pass that price along in general to those customers.
Giving it an allowance with no strings attached does not prevent it from raising the price. It doesn't ensure that it continues to hire the workers it's hiring to do the production its producing.
It's just handing over a no-strings-attached gift. And that's the sense in which my more colorful predecessor used the term "largest corporate giveaway."
The -- one can give allowances to companies with strings attached, and this is something I talked about in my testimony to the Senate Finance Committee -- for example, linked to continuing employment or continuing production in ways that would -- that could in fact diminish the disruptive effects of a cap-and-trade system. But without any strings attached it just amounts to giving the money.
REP. DOGGETT: And don't giveaways to local utilities or local distribution companies just hoping they'll pass along some of the benefit to the consumer, don't they have some similar problems?
MR. ELMENDORF: Yes, similar, but the -- because many electric utilities are regulated, the ultimate effects depend on the specifics of regulation as they vary across the country.
REP. DOGGETT: On the other hand, if we fail to address this problem of global warming and climate change, hasn't CBO measured the effect on the economy? And won't we have real long-term reduction in growth and economic production because of the effect of climate change on agriculture, fisheries, and a number of other industries?
MR. ELMENDORF: So climate -- as you know, Congressman, it's a very uncertain -- a growing conviction and consensus that climate change aided by people's emissions of carbon-dioxide is occurring, and it's occurring at a pace that will be very damaging to the natural world.
The further link to economic conditions is a difficult one and one that's I think in its infancy of analysis. I think the consensus view is that climate change will have some costs for overall U.S. economic activity.
In fact, the aggregate costs are much smaller than the costs for particular regions or sectors. Some parts of the country would be able to grow a wider range of crops and -- for example, and the people who own that land might become richer over time.
Other parts of the country that -- particularly say in the southwest will become drier, much more difficult.
So there's tremendous geographic differences, and sectoral differences, depending what part of the economy one is part of that are probably more important, in fact, than the aggregate economic impacts.
And that's why I think it's -- most experts think it's appropriate for Congress to think about how to ameliorate some of those effects. It turns out that just giving over allowances with no strings attached does not seem to be a particularly good one.
REP. DOGGETT: Mr. Chairman, just one quick health care question.
Last week, as you are aware, a number of major lobby groups met President Obama, the health insurance lobby, the pharmaceutical lobby. And they said, quote, "We'll do our part to achieve your goal of decreasing by 1.5 percent health care spending growth rates and we'll save you at least $2 trillion."
And then shortly thereafter at least one of those lobbies said quote, "Our savings are not subject to the rigid scoring rules used by the Congressional Budget Office." Aren't alleged savings that don't meet PAYGO fiscal responsibility rules truly illusory?
And hasn't the Congressional Budget Office, in the budget options document that you provided this committee earlier in the year, outlined real ways to produce savings that could amount to ($)2 trillion, such as your $110 billion in savings by requiring manufacturers to pay a minimum rebate on drugs covered under Medicare Part D?
MR. ELMENDORF: Yes.
REP. DOGGETT: Thank you. You may want to -- you want to add to that?
MR. ELMENDORF: Well, I would just say that we -- one of the points in which I testified several times about health care is that there is a widespread consensus, I think, around the types of changes that our health systems should make to ensure that we're getting better value for our money, but much less agreement about exactly who should do what differently to which patients.
And I think the question -- I think this discussion among the -- these representatives of the health sector with the president reveals both sides of that essentially that there -- they came together with a widespread view that something different should be done, and I think some sense about the general direction, but much less specificity and willingness to be subject to --
REP. DOGGETT: Exactly.
MR. ELMENDORF: -- particular changes affecting particular providers over any sort of predetermined time period. And I think that is the fundamental challenge in this -- in health care reform is to develop the specific approaches that one could have confidence will lead to greater efficiency and save money.
REP. DOGGETT: Thank you.
Thank you, Mr. Chairman.
REP. SPRATT: Thank you, Mr. Doggett. I give you credit for being a better trial lawyer. You got your answer and you still want it elaborated.
REP. MARIO DIAZ-BALART (R-FL): Thank you, Mr. Chairman.
Good to see you, sir.
MR. ELMENDORF: Thank you.
REP. DIAZ-BALART: Your former predecessor -- your predecessor and current OMB Director Mr. Orszag, testified in the September 18th, and I'm going to quote him, he said speaking about energy, "Decreasing emissions would also impose a cost on the economy."
He went on to say that much of those costs will be passed along to the consumers in the form of higher prices for energy and energy intensive good -- goods.
March 17th, Energy Secretary Chu testified before the Science Committee and he said quote, "The cap-and-trade bill will likely increase the cost of electricity," to the point where he advocated adjusting for trade duties, et cetera, et cetera.
The secretary also testified quote, "If other countries don't impose a cost on carbon when we -- then we will be at a disadvantage." Do you disagree with any of the statements of the secretary -- or those statements by Secretary Chu, or by your predecessor, Mr. Orszag?
MR. ELMENDORF: I think I agree with all of them. We've been -- CBO has been very clear that a cap-and-trade system where carbon tax would raise the price of carbon emissions and the cost would ultimately be borne by households.
It's also widely understood that if we put a -- if we raise the price of carbon emissions, and our trading partners do not, that that is -- creates an additional challenge for our carbon emitting industries.
A number of course of -- a number of foreign countries, of course, are imposing caps on their emissions, or taxes, or establishing cap-and-trade systems, or in other ways moving down this path.
But I think it again is not controversial that other countries would need to be brought into such a system or that some sort of adjustments would need to be made at the border as affecting trade, or that some other thing would be done for domestic producers to try to redress the imbalance that --
REP. DIAZ-BALART: Right. Because otherwise you agree that it would -- otherwise it would put us at a disadvantage. So if China and India, as they have stated, don't do it, and we do, that would put us at a disadvantage.
MR. ELMENDORF: If we just put the price on carbon emissions and don't either get other countries onboard, or do some adjustments at our border to address that differential, or do anything else to help those manufacturers, then they would be at a disadvantage. I'm trying to suggest here there are several courses of action that could be taken.
REP. DIAZ-BALART: True, absolutely. Now, have you had a chance to -- you know, the president has mentioned Spain as one of the countries that the United States needs to look at and follow. They -- as you know they are number one in green jobs.
They went however from being a country a few years ago that created more jobs than Germany, France, and Italy combined to now be the country that has lost more jobs than Germany, Italy, and France combined. There are a number of factors obviously.
It's not just their energy policies. But clearly I think there's a consensus that their energy policy has been a major factor in losing jobs. Have you had an opportunity to study the Spain example?
By the way, they're also now having blackouts, which is -- I grew up in Spain. It's hard to believe that an industrialized country like that will now have to impose, you know, shut off electricity at certain times of the day to industry. But have you had an opportunity to look at that?
MR. ELMENDORF: Congressman, I don't know much at all -- I've now learned a fair bit about the Spanish situation. But I want to emphasize -- I'll read a line from the testimony I gave on cap-and- trade a few weeks ago. "CBO expects total employment to be only modestly affected by a cap-and-trade program to reduce greenhouse gas emissions."
And we go on to explain that in -- except during recessions of course, most Americans who are interested in working can find a job, and that's a very desirable feature of our labor market and economic system.
The biggest effects of cap-and-trade are felt regionally and in particular sectors, and the transition from current patterns of employment toward the patterns of employment that would prevail if we had a price on carbon, but then changed our output and so on.
It's a transition that is -- can be costly, particularly to the workers who are most affected. And I think most economists would say that it's not that green jobs are necessarily better or more numerous.
But it is the case that is -- the whole nature of trying to limit carbon emissions is trying to change the production structure of the economy. And that -- so some jobs are lost, and some jobs are created, and it's the process of helping workers or communities move from one world to the other that's disruptive and that warrants the attention of policymakers.
REP. DIAZ-BALART: I just -- it is important although to look at Spain as an example. The president himself has mentioned Spain as an example, and Spain now has 18 percent unemployment.
Forecasts go to 20 (percent); so I think we just need to make sure we look at that, and I hope you have an opportunity to do so.
And Mr. Chairman, I know my time has expired.
Thank you, sir.
REP. SPRATT: Mr. Yarmuth.
REP. JOHN YARMUTH (D-KY): Thank you, Mr. Chairman.
Welcome back, Dr. Elmendorf.
MR. ELMENDORF: Thank you.
REP. YARMUTH: Referring to Mr. Garrett's questioning about the effects of the Recovery Act, he made the statement having spent $800 billion; that's not an accurate statement, is it? I mean, we have not spent $800 billion.
MR. ELMENDORF: No.
REP. YARMUTH: But approximately how much of the total appropriation have we spent? Do you know?
MR. ELMENDORF: To date the amount spent is quite small. I think I have that number with me. I don't have it at hand, only a very small fraction of the spending has gone out the door.
I think that's sometimes raised questions, but as I said, it's not surprising to us.
REP. YARMUTH: So while that -- the chart you showed about employment may have -- indicate that the projections so far haven't been what they were projected to be before the stimulus package, it's a little premature when you say to project what the ultimate outcome in terms of employment for the country will be.
MR. ELMENDORF: Yes, absolutely. As I tried to suggest before the crucial question is what would have happened otherwise? And that can't be seen -- that can't be directly observed, and you can't -- as I said in my opening remarks the -- in our forecasts the persistence of high unemployment is not because the stimulus didn't work, it's because that there were larger offsetting forces.
REP. YARMUTH: Right. I want to go to the question of -- related question about employment. I have a brother who is in the barbecue business. And he's done very well over the years in the barbecue business, and he's always been very concerned about his tax rate.
And last year, I talked to him last fall and he said he'd had an epiphany of sorts. And he said he realized that unless people could afford barbecue, it didn't really matter what his tax rate was.
And in a sense we are in that same position that he is in as the government, unless people make money, and create income, and so forth we're not going to have any revenues to do anything.
So my question is looking at the forecasts in terms of spending, you have spent a lot of time on consumer spending, but very little on wage and income and in terms of projections.
Do you have projections about when per capita income in this country can -- will increase and what the long-term projection for that is? Because we know over the last seven or eight years that there's been a real decline in average income.
MR. ELMENDORF: Can you put up Slide four? It doesn't quite answer your question, but it starts in that direction, then I will try to add to that. Slide four shows overall income from wages and salaries and overall disposable income.
So wage and salary income is the bottom-line. As you can see that's been declining for the last couple of years. That's just a reflection of the weak labor market. Disposable income at the top has done better.
The little tent that you see in 2008, owes importantly to the rebates passed last year. And the turn up at the end owes -- this predates the --the data point here predates the effect of the stimulus that really is the -- but owes it importantly to the larger social security, cost-of-living adjustments in the beginning of the year, and so on.
This chart does not show projections, and I don't have them offhand. One very important risk in the economic forecast is the -- how long labor market weakness persists, and how that affects the income, and how that affects the ability of households to spend.
And although spending data since our March forecast have been pretty closely aligned with what we'd expected, global market has looked weaker. And the employment loss last month was very large.
Initial claims for unemployment insurance remain quite high including this morning's data. And the longer that persists, and the more that drains income from households, the worse the economic prospects are.
And you also raised I think, a different important issue which is that these are aggregate numbers, the economy as a whole. The distribution of income, of course, has become much wider over the last several decades.
And that means that the income of a typical person hasn't necessarily tracked the overall income, and that is probably being reversed to some extent during this economic downturn, and particularly with the problems in the financial sector which was a source of some of those very high incomes.
But I don't think anybody expects that it's being completely reversed. And that's -- I think, that's a important issue for policymakers to consider. It's not one that's very readily addressed through macroeconomic policy, the actions of the Federal Reserve, or the amount of federal spending and taxes, although there are more specific changes in spending and taxes that one might make to address that.
REP. YARMUTH: Good, thank you very much.
REP. SPRATT: Mr. Langevin.
REP. JIM LANGEVIN (D-RI): Thank you, Mr. Chairman.
REP. SPRATT: Mr. Langevin, we've got about nine minutes before we get to the floor -- or to the vote. And I'll stay here long enough for the -- (off mike.)
REP. LANGEVIN: Thank you, Mr. Chairman.
And Dr. Elmendorf, thank you. Welcome back here.
I beg to turn, I think it's to slide 12. This is debt held by the public 1965 to 2019. I think it's the -- it was the last slide in the pile (ph).
Can you just give us your -- little more perspective in terms of what went into coming up with this percentages, and what will the practical effects be on each of these levels on the economy, interest rates, and such other fallout if you know, each of these were to -- at each level were to come to pass?
MR. ELMENDORF: So the baseline projection that follows current law --
REP. LANGEVIN: And if you could also talk about may be some -- you know, may be some you know some historical practical effects of other countries that have had publicly held debt that high at levels of GDP?
MR. ELMENDORF: So the baseline projection follows current law. Obviously debt jumps quite sharply in these couple of years with very large deficits because of the recession and because of the policy actions that have been taken.
It jumps to a level above of what we have seen for some time; not a level that's out of the ordinary of other countries, I would say. And we have some advantages over other countries in that our financial markets are viewed despite the problems as a relatively safe place to put money and our Treasury securities are viewed as a particularly safe place to put money.
That advantage could be squandered. I don't think most experts would say we're at that point yet. The highest line, our projection of what would happen to debt under the President's Budget, does push our debt up to levels that are -- have been seen by other countries, but are not common.
And the slope of that line, of course, as one that beyond this picture comes into greater population aging, and continued rise in health costs, I think is a very grim picture.
And under that we are in the process right now of producing a formal analysis of the economic effects of the president's budget preplanned to release next month. But qualitatively that path certainly would lead to higher interest rates, less capital accumulation, less long-term growth than the lower path.
REP. LANGEVIN: Okay. Thank you.
Let me just talk about the -- obviously the economic downturn and some of the responses that Congress and the administration have enacted, TARP, and American Recovery and Reinvestment Act.
In your estimation, which of the federal responses to the financial and economic turmoil have shown the most success in containing and alleviating the crisis? And thinking more broadly, what additional government measures really need to be taken to address both the housing and the financial crisis?
MR. ELMENDORF: I think most experts would say that it -- the collection of policy measures taken was important in that they served -- that the different policy measures address different aspects of the problem that an overall weakness in private demand and house loan business spending is being offset to some extent by the greater government spending and lower taxes.
And that most experts would have said was the role of fiscal policy. At the same time in this particular recession we have a very serious financial system problem.
And the actions of the Federal Reserve and the Congress through the TARP, and the Fannie Mae and Freddie Mac and so on were focused on those problems. And I think, again, most experts would say that one needed the combination of actions to address the different aspects of the underlying problem.
I think further actions at this point, you know, the administration is trying to implement a plan to reduce mortgage foreclosures.
Analysts have wrestled now for two years with what one might do -- or a year-and-a-half at least, one might do on the housing -- on the foreclosure front, and it is a very difficult problem to solve.
And it is difficult for various reasons including particularly that underwriting standards, the standards for getting into housing became so lax that there are unfortunately a significant number of people who are in houses that they cannot reasonably afford.
And they were counting on appreciation or other good things to happen that are not happening. So not everybody who is in a house can plausibly stay in it.
Moreover among those who with some amount of help might be able to stay in the house in a way that might be viewed as socially beneficial, helping them also changes the incentives of all the other people who are currently struggling, but meeting their mortgage payments.
And that one can -- actually the cost of the government in a number of foreclosures might rise sharply if one designed a plan to help some people that ended up providing incentive for others to engage in behavior that's less desirable.
So it's a real -- it's been, I think, a very problematic area for analysts who've tried to develop better solutions and have been unable to.
REP. LANGEVIN: I'll ask some other questions for the record, but I see my time has expired, so I yield back. Thank you.
MR. ELMENDORF: Thank you, Congressman.
REP. SPRATT: Mr. Etheridge.
REP. BOB ETHERIDGE (D-NC): Thank you, Mr. Chairman. I just have one question; I mean, you may have covered indirectly.
Because being a state where unemployment has doubled in the last 12 months, we are the fourth highest in the nation and North Carolina. And you know, all these things, we talk about the future.
Folks at home aren't really concerned about that. They're worried about where they are right now. And they are in a depression, those who have lost their jobs.
In your professional opinion, given all the factors because we have probably one of the diverse economies in North Carolina and the country, from manufacturing automotive parts to housing et cetera.
What are your best guesses as to when we're going to start seeing unemployment changing -- go up rather, I mean, go down rather than go up, because that's a critical issue that I hear every weekend and I'm sure next week I'm going to get it everyday.
MR. ELMENDORF: So we shall have better news for you Congressman. In our March forecast, we -- (audio break) -- unemployment would peak in the first half of next year, around 9.5 percent.
If we were writing down a new forecast today, we would go off that peak and we would raise it, so that we would now -- currently we expect the unemployment rate might peak around 10.5 percent in the second-half of next year.
Now, a lot can -- we'll learn a lot more before we actually write down the forecast in August. And the worsening in the last few months in our outlook, you know, just reveals the uncertainties that surround this.
But we think it will be a slow, a painfully slow recovery because there are still substantial overhang of housing; because the financial system, although it has crawled back from the edge of the abyss is still in a weakened state; because households have lost a lot wealth through house prices and stock prices and thus will be pulling back on their spending; because economies around the world, and thus the demand for our products remain weak.
And all those factors we think will lead to a tepid recovery and somewhat more tepid than we thought when we assessed the conditions a few months ago.
REP. ETHERIDGE: Thank you, Mr. Chairman. I'd like to go further. I know we're running out of time. But thank you.
REP. SPRATT: Thank you, Mr. Etheridge.
And Mr. Elmendorf, thank you very much for your excellent testimony and for your very responsive and complete answers. We'll be working with you further on these issues and we'll probably want to do this again in the next quarter.
MR. ELMENDORF: Thank you, Mr. Chairman.
REP. SPRATT: Thank you very much indeed.