Three Economists Testify Before Senate Budget Committee

Yesterday morning, Richard Berner of Morgan Stanley, Simon Johnson of MIT, and Joel Naroff of Naroff Economic Advisors testified before the Senate Budget Committee on the state of the economy in the short-term and prospects down the road. All three displayed some concern about the vitality of the economy in the next few years, but they each focused on different aspects: the housing market, financial markets, and consumer spending, respectively.

Berner said that in the short run, the government should take steps improve both the housing situation and the employment situation. He noted that the Home Affordable Modification Program (HAMP) did not have sufficient scope (and has in fact shrunk in recent weeks) to address the foreclosure issue. He suggested both strengthening this program and other housing refinance programs, in addition to attempting to get borrowers to refinance government guaranteed loans. As for employment, he suggested a payroll tax credit (although there is already one in place through the end of this year) and job retraining efforts to mitigate the effects long unemployment has on workers' skills. Also, he said that extending the tax cuts "should reduce uncertainty as well as sustain fiscal stimulus."

Berner also re-affirmed his membership in the Announcement Effect Club when he discussed the positive effects that removing uncertainty would have on the economy.

Mr. Chairman, Ranking Member Gregg, your work as Commissioners on the National Commission on Fiscal Responsibility and Reform is critical. I know you agree that crafting a long-term credible plan to restore fiscal sustainability will ease concerns and uncertainty about future tax hikes and the potential loss of our safety nets.

Johnson focused on the importance of financial crises in the context of fiscal policy. As he notes, the serious deterioration in the medium-term fiscal outlook is mainly due to lower tax revenues from the financial crisis, and the crisis necessitated many actions which added significantly to the debt. He said that the Dodd-Frank bill would not do enough to prevent excessive risk-taking and future financial crises, so we might be in danger for another large jump in debt as a result. As for direct fiscal policy, he brought up the "big three" of new revenue sources: a VAT, carbon tax, and a financial activities tax levied on big banks. On the long-term situation, he said that to get Medicare spending under control, lawmakers should focus more on cutting the cost of health care rather than reducing the amount of health care Medicare pays for, since the latter would simply shift costs around and would be unproductive. Also, during questioning, he said that it was quite possible that there could be a shift away from US bonds (as Treasuries lose their safe haven status) as soon as next year, which underscores the importance of acting--though not actually cutting--now.

Naroff focused somewhat on consumer confidence in the short-run and how it relates to economic performance. He pointed out that there is a cycle between consumer confidence and business confidence, where depressed spending lowers business confidence, which limits their hiring, which hurts consumer confidence further. He added that uncertainty further aggravates this cycle. As for fiscal policy, he offered few specific recommendations, but seemed to be less bullish on demand-side stimulus measures than the other two, saying that "alternatives that produce less initial bang but more long term bucks should be considered....Public capital must be used judiciously and should maximize long term growth potential." Also, he repeated a line that we have said many times: we shouldn't wait until a crisis to deal with our long term debt problem, because then the fiscal adjustment will need to be drastic.

These testimonies came in the first of a series of hearings on the economy by the Budget Committee. This is truly important, because how we deal with both economic weakness and our deficit problems will be critical to the economic future of the U.S.