Hearing of the Senate Budget Committee - U.S. Economic Outlook

Statement

Opening Remarks

I want to welcome everyone to the Senate Budget Committee today. Today we will focus on the U.S. economic outlook. This is one in a series of hearings on the economy. We are taking a close look at how the economy is performing and where it is headed. Later this week we will examine specific challenges the economy faces, such as in housing, unemployment, and state fiscal crises that are occurring around the nation.

Today, we are fortunate to have three really outstanding witnesses, economists who all have a long history of providing valuable testimony to this committee and others. We look forward to hearing from:

* Dr. Richard Berner, a Managing Director, Co-Head of Global Economics, and Chief U.S. Economist at Morgan Stanley. It is good to have you back here.
* Dr. Simon Johnson, Senior Fellow, Peterson Institute for International Economics and Professor of Entrepreneurship at MIT's Sloan School of Management. It is good to have you back, Simon. And
* Dr. David Malpass, President of Encima Global.

We thank all three of you for making yourselves available to the committee. We deeply appreciate that.

Let me begin by having a brief review of where we have been, my own analysis of what has brought us here and where we are headed. Let me just start by saying I believe TARP and stimulus were critically important to averting a global financial collapse.

I was in the room when the Secretary of the Treasury in the Bush administration and the Chairman of the Federal Reserve told us that if we did not act on TARP that there could be a global financial collapse in days. Those are the words they used. They minced no words with us. They were as clear and compelling as they could have been. So, the TARP was put in place.

Let me just put up the first chart that shows what I think is the very clear evidence that TARP was effective. This chart shows the TED spread, the difference between what the government can borrow for and what the private sector can borrow for. And during the height of the crisis, the TED spread was nine times normal. You can see its peak. When TARP was put in place, it came back very markedly to more normal levels and now has really gotten back to its historical relationship.

Again, the TED spread is the difference between what the private sector can borrow for and what the public sector can borrow for. And we have seen a normalization in the TED spread. In fact, one of the tip offs that we had that we were headed for trouble in 2008 is that we saw erratic behavior in the TED spread in the year before.

Let me go to the next chart, if we can. Economic growth -- we had a negative 6.8 percent in the fourth quarter of 2008. We now see economic growth has resumed. In the fourth quarter of 2010, we saw positive growth of 3.2 percent. We have now had six consecutive quarters of growth.

We see the same evidence, evidentiary pattern in the private-sector job growth. I think we all recall in January 2009, the economy was losing more than 800,000 private-sector jobs a month. In December 2010 -- the last month we have data for -- the economy gained 113,000 private-sector jobs. We have now had 12 consecutive months of private-sector job growth.

Third, we have also seen a dramatic rebound in the stock market. After falling to a low of 6,500 in March of 2009, the Dow has now risen back up, well above 11,000. In fact, approaching 12,000.

Two highly-respected economists, Dr. Alan Blinder, the former Vice Chairman of the Federal Reserve, and Dr. Mark Zandi, who was an advisor to the McCain campaign, completed a study last summer that measured the impact of federal actions, including TARP and stimulus, including both the Fed's monetary policy actions and the fiscal policy actions taken by Congress and the administration. Here is a quote from their report:

We find that its effects on real GDP, jobs, and inflation are huge, and probably averted what could 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.

The next chart shows Dr. Blinder and Dr. Zandi's estimate of the number of 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, specifically the TARP and the stimulus.

A similar story can be told by studying the unemployment rate. The unemployment rate averaged 9.7 percent in the second quarter of last year. According to Dr. Blinder and Dr. Zandi, if we had not had the federal response, the unemployment rate would have been 15 percent in the second quarter -- and would have continued rising to 16 percent in the fourth quarter of 2010.

There is no question that the unemployment rate has remained stubbornly high. Just a little over three years ago, it stood at 5 percent. It nearly doubled within a year's time and has fluctuated in the 9-percent-plus range ever since.

Last week, the nonpartisan Congressional Budget Office issued its Budget and Economic Outlook projecting the unemployment rate will fall only slightly to 9.2 percent by the fourth quarter of this year, and fall farther to 8.2 percent by the fourth quarter of 2012.

The economy is growing at a much slower pace when compared to past recoveries. When measured against the nine previous recoveries over the past 60 years, we see the current recovery lags considerably the nine previous recoveries. Why is that? I believe it is because so much damage was done to the fiscal and financial system in this downturn.

If you look at the previous recoveries since World War II, some of them have been relatively sharp, but none has seen the damage to the financial system done in this downturn. And so that dramatically effected the credit markets, and that dramatically effected business. That obviously effects economic growth and economic activity.

I will never forget when Ms. Romer [then chair of the White House Council of Economic Advisers] put out her forecast that we would see 8 percent unemployment. And I told the White House at the time, and told anybody listening, that they could throw that forecast right out the window because that forecast was based on the last nine recoveries since World War II. There was no basis for a comparison because there was not the damage to the financial system in the previous recoveries as we experienced in this one. So I thought it was a forecast that had no merit.

But we are now at a critical juncture. We have been borrowing about 40 cents of every dollar that we spend. That is clearly not sustainable. Spending is at its highest level as a share of the economy in 60 years. Revenue is at its lowest level as a share of the economy in 60 years. It seems to me, readily apparent, that we have to work on both sides of the equation.

Gross federal debt is already expected to reach 100 percent of gross domestic product this year, well above the 90 percent threshold that many economists see as the danger zone. Let me just recommend to my colleagues the work that has been done by two of our most distinguished economists. Carmen Reinhart is the lead author of the book reviewing 800 years of financial crisis. In her work, and the work of Professor Kenneth Rogoff of Harvard, they concluded that when countries reach a gross debt of 90 percent of GDP, they see future economic growth reduced substantially. And we are at 90 percent, gross debt to GDP.

Now, one thing I want to be clear on is in the press, typically, you don't read about gross debt. You read about the publicly-held debt. Publicly-held debt is about 30 percentage points lower than the gross debt. So, our publicly-held debt today is in the 60 percentile range, but the gross debt is over 90, and will be at 100 by the end of this year. Again, the work that was done by Carmen Reinhart of the University of Maryland and Dr. Rogoff of Harvard, concluded that when your gross debt reaches 90 percent, you see future economic growth impaired. And impaired in such a way that translates into a million fewer jobs. That, at the end of the day, is what we must keep in mind.

I believe that the deficit and debt reduction plan assembled by the President's Fiscal Commission on which I served got it about right. The plan would stabilize the debt by 2014, lower it to 60 percent of GDP -- let me emphasize that is on a publicly-held debt measure -- by 2023, and roughly 30 percent by 2040. So, publicly-held debt would first be stabilized, and then be brought back from the brink, and over time worked down to what most economists say is a far more sustainable level.

There were 18 members on the commission, 11 supported the report -- 5 Democrats, 5 Republicans, one independent -- that's 60 percent of the commissioners supported the conclusions of the report that would reduce the debt by $4 trillion over the next 10 years. I believe that proved that Democrats and Republicans can join forces when we face an imminent threat to this country. And I believe this debt threat is an imminent threat to the nation.

We can put together a credible, responsible, realistic bipartisan budget plan. This year, we need to finish the job. It will require Presidential leadership and it will require a Congress that is willing on both sides to come together, to do things both of us would prefer not to have to do. I hope very much we face up to this, because a failure to do so would mean very serious consequences for the country in the future.
Additional Comments on Need for Summit

Let me just say to members of the committee. What I said at the last hearing, I think even more strongly today. It has to start somewhere. And in a congressional process, we are it.

I don't know what other committee is going to take this on. Appropriations Committee? They are not in a position to do it. Finance Committee is not in a position to do it. So, I think very clearly it is going to fall to us.

I would much prefer that there would be a summit with the White House, the Congressional leaders, Republican and Democrat, House and Senate, sit down and craft a long-term plan to get us back on track. I think that would be the best way to proceed because I think it is very important this be done before we get into a debate on the debt limit extension. Because if a debt limit extension has to be the way of getting a result, to get a plan, that in itself has serious risks attached to it. We could lose credibility in the bond markets globally if that is the leverage that has to be used.

So we are much better off as a country if a plan is put in place prior to getting to the debt limit debate. But if there is not going to be that kind of summit, then I don't know of an alternative to this committee and the committee in the House trying to craft a long-term plan and begin sort of bottom-up.

So, again, I issue a call for a summit involving the leaders of the House and the Senate and the President, or his designees, to come up with a credible, long-term plan before we get to the debt limit crunch which I think will come in May. I don't think we can wait for that. I think we have to prepare ourselves to begin crafting a plan here. Look, it is not going to be easy. We've got a good beginning. We had an excellent hearing with the head of the Congressional Budget Office. We have an excellent hearing today.

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I again ask for a summit. I think if we want to send a signal that America is going to face up to this problem and we're going to put together a credible plan, nothing would be more effective than the leadership of this country sitting down and coming up with that plan and not wait for the debt limit.
Additional Comments on Need for Balanced Approach to Deficit Reduction

One of the concerns I have in listening to the discussion that's unfolding in this town is the focus on non-defense discretionary spending, because non-defense discretionary spending is about 16 percent of our budget.

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Non-defense domestic discretionary spending is about 16 percent of our budget, and yet it is getting almost all of the attention for how we solve this problem. And we're borrowing 40 cents of every dollar we spend. You eliminate it all, and you haven't solved this problem.

The part of our budget that is growing as a share of the size of the economy are our entitlement accounts, Medicare, Social Security, primarily the health care accounts, much bigger than Social Security. That's seven times the problem of Social Security.

And yet, somehow we don't want to talk about it. I think I know why we don't want to talk about it, because if you ask the American people they say you don't need to touch Medicare, you don't need to touch Social Security, you don't need to touch defense, you don't need to touch revenue.

Well, I just say this. If that really is the conclusion, that Social Security doesn't have to be touched, and it is cash negative today, Medicare doesn't have to be touched, defense doesn't have to be touched, revenue doesn't have to be touched, you can't solve the problem. It is a mathematical certainty you cannot solve the problem.

So, some of us are going to have to help the American people understand the unfortunate reality here. And the unfortunate reality is I believe all those things are going to have to be touched, and the sooner we do it the better, because the less draconian the solutions will be later on. The worst time to deal with this is when you are in a crisis. If there is anything Greece should have taught us, and Ireland should have taught us, and Portugal should teach us, is the worst time is when you are in a crisis.

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