Hearing of the Senate Finance Committee- Strengthening America's Economy Part I

Interview

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SEN. GRASSLEY: Thank you.

There are two opposing points of view on the economy. Some people say that consumption is the key to economic growth. When people go shopping, business is good. When people stay home, business is bad. Now, according to this view, then we need to spend more.

Now, other people would say investment is the key. When people invest, business is good. When people don't invest, business is bad. According to this view, then we need to save more.

Some economists try to reconcile these opposing views by suggesting the correct view depends on the circumstances. When workers are fully employed and factories are fully utilized, they say we need to save more and increase supply. But when workers are unemployed and factories are idled, they say we need to spend more and increase demand.

While this explanation is appealing, it does not withstand careful scrutiny. As a family farmer, I'd like to consider a barnyard example. I'm talking about the proverbial chicken and egg. In the first example, we have five chickens that each lay five eggs a week, but people want more eggs. The solution is to save some eggs, let them hatch, and then you have more chickens to lay more eggs. In the second example you have five chickens that lay five eggs a week, but people want fewer weeks. The solution cannot possibly be to buy more eggs, because that is a problem. There is a surplus of unwanted eggs.

Now, when economists talk about stimulating consumer demand, they give the impression that we can grow our economy by getting people to go shopping, and it doesn't matter what they buy. But such talk obscures the fact that at any given point in time, our economy is comprised of a specific set of goods, a specific set of services, each with its own unique factors of supply and demand.

When market conditions change, either because of fickle consumers, maybe foreign competition, maybe rising oil prices, or a stock market bubble or housing bubble, and maybe a lot of other things, the goods and services that existed before the change are no longer suitable to meet the market conditions that exist after the change.

For example, if consumers decided they want more milk and fewer eggs, no amount of consumer demand is going to magically turn eggs into milk. Farmers are going to have to raise fewer chickens and get more cows. And that, of course, takes time.

When workers are unemployed and factories are idled because of changing market conditions, those workers and those resources must often be re-employed or redeployed in a new occupation or industry. Economist Joseph Schumpeter refers to this process, in his words, "creative destruction."

This process, as we know, is ongoing. Millions of jobs are created and destroyed each year. Most of the time we end up with more jobs than we started with at the beginning of the year. Regardless of how many were created or destroyed, more are created. But whenever our economy falters and millions of Americans are out of work, it's only natural to want to help.

As the president said during the last economic downturn, which occurred earlier in his first term, quote, "Everyone who wants a job ought to be able to get a job." Thankfully, we've had several years of robust economic growth since. The question is, how do we get the desirable level of economic growth? How do we put in place policies to assure the economy provides enough jobs for workers? How do we respond to the near-term economic problems without doing long-term damage?

The last question is really a critical question for today's hearing. Chairman Bernanke has said there should be fiscal stimulus. And we found out this morning that he is trying in that direction. Leading economic thinkers on the Democratic side, such as former Secretary of Treasury Summers, have agreed, as has Dr. Martin Feldstein, a leading economic thinker on our side of the aisle.

So, turning to another farm analogy, the fiscal stimulus horse has left the barn. And I'd prefer that horse to be a thoroughbred rather than a swayback. So with the die cast that we need some kind of fiscal stimulus again, how do we best respond to the immediate situation and not damage the economic growth over the long term?

We are told that in order to stimulate the economy, all the government has to do is put money into the hands of consumers and they will spend it, and, in the process, spend us back to prosperity. The problem with this approach is that the only way the government can put money in somebody's hands is by taking it from somebody else's pockets. That power is exercised either in the form of higher taxes or more borrowing.

Over the long term, this can be a zero-sum gain which one person's loss is another person's gain. Some economists try to obscure this fact by introducing a concept known as the marginal propensity to consume. That's a fancy way of saying some people spend more of their money than others spend. According to this concept, low-income people are more likely to spend the extra dollar than high- income people. Thus taking money from the rich and giving it to the poor will stimulate consumer demand and boost the overall economy.

They will point then to the multiplier effect. This concept is flawed, because it ignores the role of saving. Money that is saved does not disappear. It flows back into the economy in the form of investment. Investment is just another form of spending, specifically spending on capital goods like factories and equipment. Thus money spent on capital goods adds to the overall economy not just like money on consumer goods.

Designing and effective policy requires a clear understanding of why the economy is slowing and unemployment is rising. The idle workers and resources that exist today are the result of changing market conditions, primarily rising oil prices and falling loan prices. Government efforts to stimulate consumer demand can neither force people to buy things they no longer want nor transform unwanted items into things that they do want. I don't think that we'll find many folks who feel that currently over the long term, Americans are saving too much.

Realigning our economy in a manner consistent with the changing market conditions will take time. Efforts to stimulate more consumption will only come at the expense of investment needed to bring about necessary realignment. Everyone agrees investment is the key to higher productivity and a rising standard of living. We should not let our desire for a quick fix divert our attention from this fact.

Thank you, Mr. Chairman.

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SEN. GRASSLEY: On page five of your testimony it says that a spending increase or tax cut of a dollar, if it is well-timed and directs the money to people who will spend it quickly, adds a but a dollar to GDP in the short-term in times of economic weakness.

So this raises a number of questions. First where does a dollar increase in GDP come from, since we're talking about fiscal policy and not monetary policy -- the Fed's not going to create it out of the thin air?

Since we are talking about stimulus, as you're testimony says on page eight, "We cannot assume it is paid for with tax increase or spending cuts. Thus, it would appear that the government would have to borrow the dollar from the credit markets." How does the government borrow a dollar then without reducing investment or net exports by that dollar?

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SEN. GRASSLEY: For a little while.

My next question deals with savings versus expenditures. Everyone agrees investment is the key to higher productivity and a rise of standard of living. However, some economists say that during a recession we have idle resources and unused capacity, so the money that people save won't be invested. Presumably they think that it just sits around gathering dust, and I don't think there's evidence to back that up.

This argument is used to support the claim that additional consumer spending will provide a boost to the economy, whereas additional savings will not. However, in America we have a very diverse and dynamic economy. There's always opportunities for new investment, while some sectors are shrinking, others expanding. Financial markets are designed to direct savings to those areas that need it.

In addition, many consumers finance major purchases. And I would use autos and appliances as a couple of examples. And they do that through consumer loans. Savings that are not invested are available to consumers.

So the question to you: Are you aware of any evidence, any evidence, to support the view that during a recession a dollar of savings does not boost business investment or consumer credit by a dollar?

MR. ORSZAG: I guess the way I would put it is it is true it's an identity, it's a mathematical accounting identity, that the total amount that we save will equal the total amount that we invest plus our transactions with the rest of the world.

But it is also true that during these unusual periods of economic weakness that one can move the overall levels of savings and investment to a higher level and that the way to do that tends not to be to increase savings rates. So there is an unfortunate tension between these unusual periods of economic weakness when higher consumption rates and lower savings rates can be beneficial in leading to a higher overall level of income, which is exactly the opposite of what's beneficial in the long term, where higher savings leads to higher rates of investment and higher rates of economic growth.

And that tension, I know, is very awkward. And the policies that are appropriate to accomplish one objective are typically the opposite of the policies appropriate to another. But that's unfortunately the situation in which we sometimes face ourselves.

SEN. GRASSLEY: On another point, you commented in your statement that extending the AMT patch for individuals would have a near-term effect on demand. Is it your recommendation that a stimulus package should either extend an AMT patch or even possibly repeal it altogether?

MR. ORSZAG: Again --

SEN. GRASSLEY: Sorry -- with more emphasis upon the patch than the repeal.

MR. ORSZAG: Yes. The way I would put it is failure to enact an additional patch for the 2008 tax year would likely have a significant effect, albeit probably more in 2009 than in 2008, where taxpayers who may have been expecting another patch all of a sudden realize that it's not -- it hasn't happened. And you could have a significant -- you would likely have a noticeable impact on behavior in 2009 if a patch that was expected was not actually enacted.

SEN. GRASSLEY: Okay. Your written statement indicated that the corporate AMT could effectively undo investment stimulus. How would you recommend that the corporate AMT be modified to make other business incentives more effective?

MR. ORSZAG: Well, there's important questions about the short term and the long term.

Over the long-term, again, on the structure of the corporate income tax, I would just come back to saying there are important issues that need to be addressed, and that we, and the Joint Committee on Taxation, can help the Congress evaluate in terms of the structure of both the regular corporate income tax and the corporate AMT.

In the short-term, there are targeted fixes that can be made to the AMT to try to boost the carry-through, or the effectiveness of changes made in the regular corporate income tax. Just like there could also be changes on the individual AMT made to extend the impact of -- if you chose to, I'm not saying one should, but if you chose to, to extend an individual rebate to those taxpayers on the individual AMT.

SEN. GRASSLEY: You mentioned that the 2002 and 2003 bonus depreciation provisions had a modest impact on business activity. However, don't you think that the partial expansing, coupled with other business tax relief, such a extending the net operating loss carryback period, would result in a more substantial impact overall on investment in the economy?

And then I'll follow with this question: Moreover, aren't we dealing with apples and oranges here, since there's -- was such a huge overhang in an investment back in 2002 and 2003?

MR. ORSZAG: First let me answer that question. Yes, economic conditions are different, and it may be the case that the response to additional tax incentives on the corporate side will be stronger than it was at that time. And we also do point out that it is correct that the combination of, for example, a net operating loss carryback provision, with things like bonus depreciation, could be stronger than the two pieces individually.

SEN. GRASSLEY: Yeah.

Senator Salazar.

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SEN. GRASSLEY: (Off mike) -- for Senator Baucus, and me, and the rest of the committee, we appreciate very much your helping us get started on one of the most important things we have to work on this year -- a stimulus package. Thank you very much.

Meeting adjourned. (Gavel sounds.)

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