25 February 2004, 18:14 Greenspan testimony to House Budget panel on economy
WASHINGTON, Feb 25 - Following is the full text
of Federal Reserve Chairman Alan Greenspan's written testimony
on the economic outlook and current fiscal issues before the
House Budget Committee on Wednesday:
"Mr. Chairman and members of the committee, I am pleased to
be here today and to offer my views on the outlook for the
economy and current fiscal issues. I want to emphasize that I
speak for myself and not necessarily for the Federal Reserve.
As you know, the U.S. economy appears to have made the
transition from a period of subpar growth to one of more
vigorous expansion. Real gross domestic product (GDP) rose
briskly in the second half of last year, fueled by a sizable
increase in household spending, a notable strengthening in
business investment, and a sharp rebound in exports. Moreover,
productivity surged, prices remained stable, and financial
conditions improved further. Overall, the economy has lately
made impressive gains in output and real incomes, although
progress in creating jobs has been limited.
The most recent indicators suggest that the economy is off to a
strong start in 2004, and prospects for sustaining the
expansion in the period ahead are good. The marked improvement
in the financial situations of many households and businesses
in recent years should bolster aggregate demand. And with
short-term real interest rates close to zero, monetary policy
remains highly accommodative. Also, the impetus from fiscal
policy appears likely to stay expansionary through this year.
At the same time, increases in efficiency and a significant
level of underutilized resources should help keep a lid on
inflation.
This favorable short-term outlook for the U.S. economy,
however, is playing out against a backdrop of growing concern
about the prospects for the federal budget. As you are well
aware, after having run surpluses for a brief period around the
turn of the decade, the federal budget has reverted to deficit.
The unified deficit swelled to $375 billion in fiscal 2003 and
appears to be continuing to widen in the current fiscal year.
According to the latest projections from the Administration and
the Congressional Budget Office (CBO), if current policies
remain in place, the budget will stay in deficit for some time.
In part, the recent deficits have resulted from the economic
downturn in 2001 and the period of slow growth that followed,
as well as the sharp declines in equity prices. The deficits
also reflect a significant step-up in spending on defense and
higher outlays for homeland security and many other nondefense
discretionary programs. Tax reductions--some of which were
intended specifically to provide stimulus to the economy--also
contributed to the deterioration of the fiscal balance.
For a time, the fiscal stimulus associated with the larger
deficits was helpful in shoring up a weak economy. During the
next few years, these deficits will tend to narrow somewhat as
the economic expansion proceeds and rising incomes generate
increases in revenues. Moreover, the current ramp-up in defense
spending will not continue indefinitely. Merely maintaining a
given military commitment, rather than adding to it, will
remove an important factor driving the deficit higher. But the
ratio of federal debt held by the public to GDP has already
stopped falling and has even edged up in the past couple of
years--implying a worsening of the starting point from which
policymakers will have to address the adverse budgetary
implications of an aging population and rising health care
costs.
For about a decade, the rules laid out in the Budget
Enforcement Act of 1990, and the later modifications and
extensions of the act, provided a procedural framework that
helped the Congress make the difficult decisions that were
required to forge a better fiscal balance. However, the brief
emergence of surpluses eroded the will to adhere to those
rules, and many of the provisions that helped to restrain
budgetary decisionmaking in the 1990s--in particular, the
limits on discretionary spending and the PAYGO
requirements--were violated more and more frequently and
eventually allowed to expire. In recent years, budget debates
have turned to choices offered by those advocating tax cuts and
those advocating increased spending. To date, actions that
would lower forthcoming deficits have received only narrow
support, and many analysts are becoming increasingly concerned
that, without a restoration of the budget enforcement
mechanisms and the fundamental political will they signal, the
inbuilt political bias in favor of red ink will once again
become entrenched.
In 2008--just four years from now--the first cohort of the
baby-boom generation will reach 62, the earliest age at which
Social Security retirement benefits may be claimed and the age
at which about half of prospective beneficiaries choose to
retire; in 2011, these individuals will reach 65 and will thus
be eligible for Medicare. At that time, under the intermediate
assumptions of the OASDI trustees, there will still be more
than three covered workers for each OASDI beneficiary; by 2025,
this ratio is projected to be down to 2-1/4. This dramatic
demographic change is certain to place enormous demands on our
nation's resources--demands we almost surely will be unable to
meet unless action is taken. For a variety of reasons, that
action is better taken as soon as possible.
The budget scenarios considered by the CBO in its December
assessment of the long-term budget outlook offer a vivid--and
sobering--illustration of the challenges we face as we prepare
for the retirement of the baby-boom generation. These scenarios
suggest that, under a range of reasonably plausible assumptions
about spending and taxes, we could be in a situation in the
decades ahead in which rapid increases in the unified budget
deficit set in motion a dynamic in which large deficits result
in ever-growing interest payments that augment deficits in
future years. The resulting rise in the federal debt could
drain funds away from private capital formation and thus over
time slow the growth of living standards.
Favorable productivity developments, of course, can help to
alleviate the impending budgetary strains, but no one should
expect productivity growth to be sufficient to bail us out.
Indeed, productivity would have to grow at a rate far above its
historical average to fully resolve the long-term financing
problems of Social Security and Medicare. Higher productivity,
of course, buoys expected revenues to the system, but it also
raises Social Security obligations.1 Moreover, although
productivity has no direct link to Medicare spending,
historical experience suggests that the demand for medical
services increases with real income, which over time rises in
line with productivity.
Today, federal outlays under Social Security and Medicare
amount to less than 7 percent of GDP. In December, the CBO
projected that these outlays would increase to 12 percent of
GDP by 2030 under current law, using assumptions about the
growth of health-care costs similar to the intermediate
assumptions of the Medicare trustees; when spending on Medicaid
is added in, the rise in the ratio is even steeper. To be sure,
the rise in these outlays relative to GDP could be financed by
tax increases, but the CBO results suggest that, even if other
non-interest spending is constrained fairly tightly, ensuring
fiscal stability would require an overall federal tax burden
well above its long-term average.
Most experts believe that the best baseline for planning
purposes is to assume that the demographic shift associated
with the retirement of the baby-boom generation will be
permanent--that is, it will not reverse when that cohort passes
away. Indeed, so long as longevity continues to increase--and
assuming no significant changes in immigration or fertility
rates--the proportion of elderly in the population will only
rise. If this fundamental change in the age distribution
materializes, we will eventually have no choice but to make
significant structural adjustments in the major retirement
programs.
One change the Congress could consider as it moves forward on
this critical issue is to replace the current measure of the
"cost of living" that is used for many purposes with respect to
both revenues and outlays with a more appropriate price index.
As you may be aware, in 2002, the Bureau of Labor Statistics
introduced a new price index--the chained consumer price index
(CPI). The new index is based on the same underlying individual
prices as is the official CPI. But it combines those prices so
as to remove some of the inadvertent bias in the official price
index, and thus it better measures changes in the cost of
living, the statutory intent of the indexing.2 All else being
equal, had a chained CPI been used for indexing over the past
decade, the cumulative unified budget deficit and thus the
level of the federal debt would have been reduced about $200
billion; higher receipts and the reduction in debt service
associated with those higher receipts account for roughly 60
percent of the saving, with the remainder attributable to lower
outlays. Shifting to the chain-weighted measure would not
address perhaps more fundamental shortcomings in the CPI--most
notably the question of whether quality improvement is
adequately captured--but it would be an important step toward
better implementation of the intention of the Congress.
Another possible adjustment relates to the age at which Social
Security and Medicare benefits will be provided. Under current
law, and even with the so-called normal retirement age for
Social Security slated to move up to 67 over the next two
decades, the ratio of the number of years that the typical
worker will spend in retirement to the number of years he or
she works will rise in the long term. A critical step forward
would be to adjust the system so that this ratio stabilizes. A
number of specific approaches have been proposed for
implementing this indexation, but the principle behind all of
them is to insulate the finances of the system, at least to a
degree, from further changes in life expectancy. Sound private
and public decisionmaking will be aided by determining ahead of
the fact how one source of risk, namely demographic
developments, will be dealt with.
The degree of uncertainty about whether future resources will
be adequate to meet our current statutory obligations to the
coming generations of retirees is daunting. The concern is not
so much about Social Security, where benefits are tied in a
mechanical fashion to retirees' wage histories and we have some
useful tools for forecasting future outlays. The outlook for
Medicare, however, is much more difficult to assess. Although
forecasting the number of program beneficiaries is reasonably
straightforward, we know very little about how rapidly medical
technology will continue to advance and how those innovations
will translate into future spending. To be sure, technological
innovations can greatly improve the quality of medical care and
can, in theory, reduce the costs of existing treatments. But
because medical technology expands the range of treatment
options, it also has the potential of adding to overall
spending--in some cases, significantly. As a result, the range
of possible outlays per recipient is extremely wide. This
uncertainty is an important reason to be cautious--especially
given that government programs, whether for spending or for tax
preferences, are easy to initiate but can be extraordinarily
difficult to shut down once constituencies for them develop.
In view of this upward ratchet in government programs and the
enormous uncertainty about the upper bounds of future demands
for medical care, I believe that a thorough review of our
spending commitments--and at least some adjustment in those
commitments--is necessary for prudent policy. I also believe
that we have an obligation to those in and near retirement to
honor what has been promised to them. If changes need to be
made, they should be made soon enough so that future retirees
have time to adjust their plans for retirement spending and to
make sure that their personal resources, along with what they
expect to receive from the government, will be sufficient to
meet their retirement needs.
I certainly agree that the same scrutiny needs to be applied to
taxes. However, tax rate increases of sufficient dimension to
deal with our looming fiscal problems arguably pose significant
risks to economic growth and the revenue base. The exact
magnitude of such risks is very difficult to estimate, but they
are of enough concern, in my judgment, to warrant aiming to
close the fiscal gap primarily, if not wholly, from the outlay
side.
The dimension of the challenge is enormous. The one certainty
is that the resolution of this situation will require difficult
choices and that the future performance of the economy will
depend on those choices. No changes will be easy, as they all
will involve lowering claims on resources or raising financial
obligations. It falls on the Congress to determine how best to
address the competing claims. In doing so, you will need to
consider not only the distributional effects of policy change
but also the broader economic effects on labor supply,
retirement behavior, and private saving.
History has shown that, when faced with major challenges,
elected officials have risen to the occasion. In particular,
over the past twenty years or so, the prospect of large
deficits has generally led to actions to narrow them. I trust
that the recent deterioration in the budget outlook and the
fast-approaching retirement of the baby-boom generation will be
met with similar determination and effectiveness.
Footnotes
1. Under current law, faster productivity growth would not
affect individuals who are already retired because their
benefits are indexed by the consumer price index (CPI).
However, it would raise initial benefits for future retirees
through its effect on real wages over time. In the end,
productivity would have to rise about 3-1/2 percent per year,
about 2 percentage points per year faster than the trustees'
current intermediate assumption, to eliminate the Social
Security imbalance over seventy-five years; productivity growth
would have to be even more rapid to achieve balance in
perpetuity.
2. In particular, the chained CPI captures more fully than does
the official CPI the way that consumers alter the mix of their
expenditures in response to changes in relative prices."//
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