WASHINGTON, Jan 25 (Reuters) - The following is the full text of Federal
Reserve Chairman Alan Greenspan's testimony issued Thursday on
"Evolving Fiscal Challenges" before the Senate Budget Committee:
"I am pleased to appear here today to discuss some of the important issues
surrounding the outlook for the federal budget and the attendant
implications for the formulation of fiscal policy. In doing so, I want to
emphasize that I speak for myself and not necessarily for the Federal
Reserve.
The challenges you face both in shaping a budget for the coming year and
in designing a longer-run strategy for fiscal policy were brought into
sharp focus by the release last week of the Clinton Administration's
final budget projections, which showed further upward revisions of
on-budget surpluses for the next decade. The Congressional Budget Office
also is expected to again raise its projections when it issues its report
next week.
The key factor driving the cumulative upward revisions in the budget
picture in recent years has been the extraordinary pickup in the growth
of labor productivity experienced in this country since the mid-1990s.
Between the early 1970s and 1995, output per hour in the nonfarm business
sector rose about 1-1/2 percent per year, on average. Since 1995,
however, productivity growth has accelerated markedly, about doubling the
earlier pace, even after taking account of the impetus from cyclical
forces. Though hardly definitive, the apparent sustained strength in
measured productivity in the face of a pronounced slowing in the growth
of aggregate demand during the second half of last year was an important
test of the extent of the improvement in structural productivity. These
most recent indications have added to the accumulating evidence that the
apparent increases in the growth of output per hour are more than
transitory.
It is these observations that appear to be causing economists, including
those who contributed to the OMB and the CBO budget projections, to raise
their forecasts of the economy's long-term growth rates and budget
surpluses. This increased optimism receives support from the
forward-looking indicators of technical innovation and structural
productivity growth, which have shown few signs of weakening despite the
marked curtailment in recent months of capital investment plans for
equipment and software.
To be sure, these impressive upward revisions to the growth of structural
productivity and economic potential are based on inferences drawn from
economic relationships that are different from anything we have
considered in recent decades. The resulting budget projections,
therefore, are necessarily subject to a relatively wide range of error.
Reflecting the uncertainties of forecasting well into the future, neither
the OMB nor the CBO projects productivity to continue to improve at the
stepped-up pace of the past few years. Both expect productivity growth
rates through the next decade to average roughly 2-1/4 to 2-1/2 percent
per year--far above the average pace from the early 1970s to the
mid-1990s, but still below that of the past five years.
Had the innovations of recent decades, especially in information
technologies, not come to fruition, productivity growth during the past
five to seven years, arguably, would have continued to languish at the
rate of the preceding twenty years. The sharp increase in prospective
long-term rates of return on high-tech investments would not have emerged
as it did in the early 1990s, and the associated surge in stock prices
would surely have been largely absent. The accompanying wealth effect, so
evidently critical to the growth of economic activity since the mid
1990s, would never have materialized.
In contrast, the experience of the past five to seven years has been
truly without recent precedent. The doubling of the growth rate of output
per hour has caused individuals' real taxable income to grow nearly 2-1/2
times as fast as it did over the preceding ten years and resulted in the
substantial surplus of receipts over outlays that we are now
experiencing. Not only did taxable income rise with the faster growth of
GDP, but the associated large increase in asset prices and capital gains
created additional tax liabilities not directly related to income from
current production.
The most recent projections from the OMB indicate that, if current
policies remain in place, the total unified surplus will reach $800
billion in fiscal year 2011, including an on-budget surplus of $500
billion. The CBO reportedly will be showing even larger surpluses.
Moreover, the admittedly quite uncertain long-term budget exercises
released by the CBO last October maintain an implicit on-budget surplus
under baseline assumptions well past 2030 despite the budgetary pressures
from the aging of the baby-boom generation, especially on the major
health programs.
The most recent projections, granted their tentativeness, nonetheless
make clear that the highly desirable goal of paying off the federal debt
is in reach before the end of the decade. This is in marked contrast to
the perspective of a year ago when the elimination of the debt did not
appear likely until the next decade.
But continuing to run surpluses beyond the point at which we reach zero
or near-zero federal debt brings to center stage the critical longer-term
fiscal policy issue of whether the federal government should accumulate
large quantities of private (more technically nonfederal) assets. At zero
debt, the continuing unified budget surpluses currently projected imply a
major accumulation of private assets by the federal government. This
development should factor materially into the policies you and the
Administration choose to pursue.
I believe, as I have noted in the past, that the federal government
should eschew private asset accumulation because it would be
exceptionally difficult to insulate the government's investment decisions
from political pressures. Thus, over time, having the federal government
hold significant amounts of private assets would risk sub-optimal
performance by our capital markets, diminished economic efficiency, and
lower overall standards of living than would be achieved otherwise.
Short of an extraordinarily rapid and highly undesirable short-term
dissipation of unified surpluses or a transferring of assets to
individual privatized accounts, it appears difficult to avoid at least
some accumulation of private assets by the government.
Private asset accumulation may be forced upon us well short of reaching
zero debt. Obviously, savings bonds and state and local government series
bonds are not readily redeemable before maturity. But the more important
issue is the potentially rising cost of retiring marketable Treasury
debt. While shorter-term marketable securities could be allowed to run
off as they mature, longer-term issues would have to be retired before
maturity through debt buybacks. The magnitudes are large: As of January
1, for example, there was in excess of three quarters of a trillion
dollars in outstanding nonmarketable securities, such as savings bonds
and state and local series issues, and marketable securities (excluding
those held by the Federal Reserve) that do not mature and could not be
called before 2011. Some holders of long-term Treasury securities may be
reluctant to give them up, especially those who highly value the
risk-free status of those issues. Inducing such holders, including
foreign holders, to willingly offer to sell their securities prior to
maturity could require paying premiums that far exceed any realistic
value of retiring the debt before maturity.
Decisions about what type of private assets to acquire and to which
federal accounts they should be directed must be made well before the
policy is actually implemented, which could occur in as little as five to
seven years from now. These choices have important implications for the
balance of saving and, hence, investment in our economy. For example,
transferring government saving to individual private accounts as a means
of avoiding the accumulation of private assets in the government accounts
could significantly affect how social security will be funded in the
future.
Short of some privatization, it would be preferable in my judgment to
allocate the required private assets to the social security trust funds,
rather than to on-budget accounts. To be sure, such trust fund
investments are subject to the same concerns about political pressures as
on-budget investments would be. The expectation that the retirement of
the baby-boom generation will eventually require a drawdown of these fund
balances does, however, provide some mitigation of these concerns.
Returning to the broader picture, I continue to believe, as I have
testified previously, that all else being equal, a declining level of
federal debt is desirable because it holds down long-term real interest
rates, thereby lowering the cost of capital and elevating private
investment. The rapid capital deepening that has occurred in the U.S.
economy in recent years is a testament to these benefits. But the
sequence of upward revisions to the budget surplus projections for
several years now has reshaped the choices and opportunities before us.
Indeed, in almost any creditable baseline scenario, short of a major and
prolonged economic contraction, the full benefits of debt reduction are
now achieved before the end of this decade--a prospect that did not seem
likely only a year or even six months ago.
The most recent data significantly raise the probability that sufficient
resources will be available to undertake both debt reduction and
surplus-lowering policy initiatives. Accordingly, the tradeoff faced
earlier appears no longer an issue. The emerging key fiscal policy need
is to address the implications of maintaining surpluses beyond the point
at which publicly held debt is effectively eliminated.
The time has come, in my judgement, to consider a budgetary strategy that
is consistent with a preemptive smoothing of the glide path to zero
federal debt or, more realistically, to the level of federal debt that is
an effective irreducible minimum. Certainly, we should make sure that
social security surpluses are large enough to meet our long-term needs
and seriously consider explicit mechanisms that will help ensure that
outcome. Special care must be taken not to conclude that wraps on fiscal
discipline are no longer necessary. At the same time, we must avoid a
situation in which we come upon the level of irreducible debt so abruptly
that the only alternative to the accumulation of private assets would be
a sharp reduction in taxes and/or an increase in expenditures, because
these actions might occur at a time when sizable economic stimulus would
be inappropriate. In other words, budget policy should strive to limit
potential disruptions by making the on-budget surplus economically
inconsequential when the debt is effectively paid off.
In general, as I have testified previously, if long-term fiscal stability
is the criterion, it is far better, in my judgment, that the surpluses be
lowered by tax reductions than by spending increases. The flurry of
increases in outlays that occurred near the conclusion of last fall's
budget deliberations is troubling because it makes the previous year's
lack of discipline less likely to have been an aberration.
To be sure, with the burgeoning federal surpluses, fiscal policy has not
yet been unduly compromised by such actions. But history illustrates the
difficulty of keeping spending in check, especially in programs that are
open-ended commitments, which too often have led to much larger outlays
than initially envisioned. It is important to recognize that government
expenditures are claims against real resources and that, while those
claims may be unlimited, our capacity to meet them is ultimately
constrained by the growth in productivity. Moreover, the greater the
drain of resources from the private sector, arguably, the lower the
growth potential of the economy. In contrast to most spending programs,
tax reductions have downside limits. They cannot be open-ended.
Lately there has been much discussion of cutting taxes to confront the
evident pronounced weakening in recent economic performance. Such tax
initiatives, however, historically have proved difficult to implement in
the time frame in which recessions have developed and ended. For example,
although President Ford proposed in January of 1975 that withholding
rates be reduced, this easiest of tax changes was not implemented until
May, when the recession was officially over and the recovery was
gathering force. Of course, had that recession lingered through the rest
of 1975 and beyond, the tax cuts would certainly have been helpful. In
today's context, where tax reduction appears required in any event over
the next several years to assist in forestalling the accumulation of
private assets, starting that process sooner rather than later likely
would help smooth the transition to longer-term fiscal balance. And
should current economic weakness spread beyond what now appears likely,
having a tax cut in place may, in fact, do noticeable good.
As for tax policy over the longer run, most economists believe that it
should be directed at setting rates at the levels required to meet
spending commitments, while doing so in a manner that minimizes
distortions, increases efficiency, and enhances incentives for saving,
investment, and work.
In recognition of the uncertainties in the economic and budget outlook,
it is important that any long-term tax plan, or spending initiative for
that matter, be phased in. Conceivably, it could include provisions that,
in some way, would limit surplus-reducing actions if specified targets
for the budget surplus and federal debt were not satisfied. Only if the
probability was very low that prospective tax cuts or new outlay
initiatives would send the on-budget accounts into deficit, would
unconditional initiatives appear prudent.
The reason for caution, of course, rests on the tentativeness of our
projections. What if, for example, the forces driving the surge in tax
revenues in recent years begin to dissipate or reverse in ways that we do
not now foresee? Indeed, we still do not have a full understanding of the
exceptional strength in individual income tax receipts during the latter
1990s. To the extent that some of the surprise has been indirectly
associated with the surge in asset values in the 1990s, the softness in
equity prices over the past year has highlighted some of the risks going
forward.
Indeed, the current economic weakness may reveal a less favorable
relationship between tax receipts, income, and asset prices than has been
assumed in recent projections. Until we receive full detail on the
distribution by income of individual tax liabilities for 1999, 2000, and
perhaps 2001, we are making little more than informed guesses of certain
key relationships between income and tax receipts.
To be sure, unless later sources do reveal major changes in tax liability
determination, receipts should be reasonably well-maintained in the near
term, as the effects of earlier gains in asset values continue to feed
through with a lag into tax liabilities. But the longer-run effects of
movements in asset values are much more difficult to assess, and those
uncertainties would intensify should equity prices remain significantly
off their peaks. Of course, the uncertainties in the receipts outlook do
seem less troubling in view of the cushion provided by the recent sizable
upward revisions to the ten-year surplus projections. But the risk of
adverse movements in receipts is still real, and the probability of
dropping back into deficit as a consequence of imprudent fiscal policies
is not negligible.
In the end, the outlook for federal budget surpluses rests fundamentally
on expectations of longer-term trends in productivity, fashioned by
judgments about the technologies that underlie these trends. Economists
have long noted that the diffusion of technology starts slowly,
accelerates, and then slows with maturity. But knowing where we now stand
in that sequence is difficult--if not impossible--in real time. As the
CBO and the OMB acknowledge, they have been cautious in their
interpretation of recent productivity developments and in their
assumptions going forward. That seems appropriate given the uncertainties
that surround even these relatively moderate estimates for productivity
growth. Faced with these uncertainties, it is crucial that we develop
budgetary strategies that deal with any disappointments that could occur.
That said, as I have argued for some time, there is a distinct
possibility that much of the development and diffusion of new
technologies in the current wave of innovation still lies ahead, and we
cannot rule out productivity growth rates greater than is assumed in the
official budget projections. Obviously, if that turns out to be the case,
the existing level of tax rates would have to be reduced to remain
consistent with currently projected budget outlays.
The changes in the budget outlook over the past several years are truly
remarkable. Little more than a decade ago, the Congress established
budget controls that were considered successful because they were
instrumental in squeezing the burgeoning budget deficit to tolerable
dimensions. Nevertheless, despite the sharp curtailment of defense
expenditures under way during those years, few believed that a surplus
was anywhere on the horizon. And the notion that the rapidly mounting
federal debt could be paid off would not have been taken seriously.
But let me end on a cautionary note. With today's euphoria surrounding
the surpluses, it is not difficult to imagine the hard-earned fiscal
restraint developed in recent years rapidly dissipating. We need to
resist those policies that could readily resurrect the deficits of the
past and the fiscal imbalances that followed in their wake."
Thursday, 25 January 2001 15:03:37 |
