Speech
EXECUTIVE OFFICE OF THE PRESIDENT
OFFICE OF MANAGEMENT AND BUDGET
WASHINGTON D.C. 20503
WWW.OMB.GOV
EMBARGOED UNTIL 11:15 a.m., Tuesday, November 3, 2009
Contact: OMB Communications, 202-395-7254
OMB Director Focuses on ‘Rescue, Recovery, and
Reining in the Deficit’ at NYU
NEW YORK, N.Y.—Today, Office of Management and Budget Director Peter R. Orszag delivered a speech at New York University entitled "Rescue, Recovery, and Reining in the Deficit." Director Orszag’s appearance is sponsored by New York University and the Robert F. Wagner Graduate School of Public Service at NYU. His prepared remarks are below.
Thank you for that kind introduction; thank you, President Sexton, for the invitation to come speak here today, and thank you all for your warm welcome.
As the budget director, let me say that it’s a particular honor to be speaking here at the university founded by Albert Gallatin – not only because he was a distinguished diplomat and public servant…although he was…but also because he did something very few have been able to do, then or since: manage our nation’s finances from deficit to surplus.
Perhaps that’s why Gallatin has a statue in his honor in front of the Treasury Department whereas Alexander Hamilton’s statue is relegated to the south side. Many tourists seem puzzled why Gallatin has the place of honor along Pennsylvania Avenue.
I think I have finally come upon the real answer: Hamilton went to Columbia.
In reviewing the challenges that Hamilton, Gallatin, and their colleagues faced, it’s striking how they grappled with many of the same issues that we face today: from the state of our budget to how much to spend on higher education, infrastructure, and our military.
And just by looking at the end-result of their plans – from the Louisiana Purchase to this great university – it’s clear that in making decisions about these consequential issues, these leaders were looking to the generations of Americans to come.
This is the responsibility that each subsequent generation of Americans must live up to – to build upon the legacy we have inherited and create an economy that is strong, vibrant, and able to sustain our nation long into the future.
All of us are keenly aware of the immediate struggles we face because of the current economic downturn. I’m sure many of your families are facing excruciating choices that, even a few years ago, would have been unimaginable.
But what may be less appreciated is the long-term impact of this crisis – on our economy, on our fiscal situation, and on our future.
So, as we move from rescuing the economy to rebuilding it, it’s essential that we keep these long-term effects in mind – because only by addressing them can we succeed in building a new foundation for stable economic growth.
I want to say a few words about this – and then I’d be happy to take your questions.
Let me start by reviewing where we have been.
Almost a year ago, in the fourth quarter of 2008, real GDP was declining at a rate of more than 6 percent per year. In that quarter alone, household net worth fell by almost $5 trillion, dropping at a rate of 30 percent a year.
In terms of employment, the fourth quarter saw a loss of 1.7 million jobs—the largest quarterly decline since the end of World War II and a number only to be exceeded by the next quarter when 2.1 million jobs were lost.
This slowdown in economic activity created a pair of trillion-dollar deficits. One was the budget deficit, which had ballooned to $1.3 trillion for last year even before President Obama first walked into the Oval Office. The other was the deficit between what the economy could produce and what it was producing. This so-called output gap amounted to about 7 percent of the economy.
To a degree that we had not experienced in more than half a century, we needed to bring the economy back from the brink.
The first step was to restore confidence in the financial system.
We initiated several programs to stabilize the nation’s financial institutions.
I am happy to report that the sense of crisis in our financial markets seems to have passed, and we now are therefore reshaping our efforts to target assistance to the twin challenges of helping responsible families keep their homes and giving small businesses get easier access to credit.
Beyond boosting confidence and stabilizing financial markets, the second step was to bolster macroeconomic demand – jumpstarting economic activity and breaking a potentially vicious recessionary cycle.
In light of the massive GDP gap that we faced, the Administration worked with Congress to enact the Recovery Act just 28 days after taking office. That’s much more rapid and bold action than "the inside lag" economists typically attribute to government policymakers.
Over the past eight months, the Recovery Act has made a difference. Estimates suggest that the bill added three to four percentage points to economic activity in the third quarter.
Last week, we learned that the third quarter real GDP growth was 3.5 percent. In other words, effectively all the growth in real GDP during the third quarter could be attributable – either directly or indirectly – to the Recovery Act.
To economists, these statistics may provide a small measure of optimism. But let’s be clear: these numbers are cold comfort to the millions of Americans who remain out of work.
Far too many workers who would rather be earning a paycheck are forced to accept unemployment, and are worrying about how to pay their mortgage, keep their health insurance, and continue to provide for their families while they try to find another job.
Unfortunately, even as the economy begins to turn around, the employment picture isn’t going to brighten immediately – as the contrast between the recently reported GDP numbers and the unemployment numbers that we are expecting later this week will likely illustrate.
The sad fact is that unemployment lags a general recovery, and as the President has said, the coming months will continue to be difficult ones for American workers.
The typical progression in a recovery is first an increase in productivity; then an increase in hours worked; and finally, the hiring of additional workers by firms.
We are somewhere between the first and second stages of this process.
Productivity surged in the second quarter by more than 6 percent on an annualized basis, and it appears as though it increased at a similar clip in the most recent quarter. Although the month-to-month change in aggregate hours worked has not yet turned consistently positive, its decline has moderated from the depths of last fall and winter.
We have seen this before: as the economy picks up, jobs are ultimately created, and those who are unemployed will go back to work.
Unfortunately, that process takes time – and even when employment starts to pick up again, this is not the end of the story.
A new body of social science literature demonstrates that an economic downturn has a long-term impact on workers and their families.
Consider the effect of what economists call an "exogenous labor shock"—but normal people call a "lay-off"— on the life course not of those laid off…but on their children.
A range of studies have found that having a parent experience unemployment is significantly associated with whether you graduate from high school, whether you go to college, whether you get a job after college, and how much you get paid in that job. And the effect is persistent – with higher high school dropout rates and lower college enrollment rates evident even years later.
Reflecting this, the children of workers who were once laid off have lower average wages as adults -- even decades later than those whose parents never experienced such setbacks.
And even if you or your parent didn’t experience a layoff, the long-term repercussions of a recession are evident.
In other words, the impact extends to those not directly affected by unemployment – by those entering the workforce for the first time…the rising generation of workers. The adverse effect of entering the labor force during an economic downturn imposes a drag on career earnings that goes far beyond the duration of the recession itself.
One recent study, for example, found that graduating during a period of high unemployment leads to depressed initial wages–-roughly 6 percent on average for every one percentage point increase in unemployment. This negative wage effect declines only slowly over time: to 5 percent after five years, 4 percent after 10 years, and 3 percent even 15 years after graduation.
Remember, that’s for each percentage point increase in the unemployment rate. When most of today’s seniors entered NYU, the unemployment rate was about 5 percentage points lower than it is today.
You can do the math.
Another way of looking at it: when one compares the wages earned by the class of 1982 (a peak unemployment year) with the wages of the class of 1988 (a peak employment year) over the first 20 years of a career, the difference – on a net present value basis – averages $100,000.
The evidence thus suggests that the recession hits young people particularly hard, knocking them off course for years to come.
Now, for the students in the audience, if I haven’t totally depressed you – let me highlight one bright spot.
Researchers also have found that so-called "recession graduates" are slightly more likely to go on to college or graduate school than counterparts in a boom year. In fact, the data suggest that community college enrollment has recently surged, pushing the overall college enrollment rate to record levels.
And this is good news because the evidence is clear: the more you learn, the more you earn.
The bottom line is that the Administration and Congress did the right thing in forcefully responding to the current downturn: mitigating the depth and duration of the recession will help to lessen the extent to which its effects reverberate in the years ahead.
The other lesson is that we need to invest in the education and skills of the youngest members of our workforce – making sure that they do not slip off that crucial first rung of the career ladder and are able to quickly climb it as the economy recovers.
That is why the Administration has taken a number of steps to open the doors of college to more Americans.
To make college more affordable, we passed into law the American Opportunity Tax Credit that provides a $4,000 tax credit for college students. And in July, the President announced the American Graduation Initiative that will devote $12 billion over the next decade to support community colleges as well as innovative strategies to help students complete college.
Not only did we increase the size of Pell grants and expand the Perkins loan programs to help lower-income students, but we also have undertaken a potentially more important task: simplifying the dreaded FAFSA – or federal student aid application: A form more complex than a tax return – and a huge obstacle for many worthy students applying for aid and hoping to attend college.
To get a sense of how big a barrier this application is, consider a recent H&R Block randomized experiment in which low- and moderate-income high school seniors were provided a modest amount of help in filling out the forms.
The students who were helped were almost 30 percent more likely to attend college and receive a Pell Grant the next year than a statistically comparable control group.
It’s a stunning result.
In addition to these direct efforts, we also helped schools indirectly by providing roughly $140 billion in the Recovery Act in state fiscal relief. This infusion of funds works to counteract not just the revenue lost because of this current downturn, but also the long-running trend of rising costs crowding out state investment in higher education.
The interplay among squeezed budgets, higher college tuition rates, cuts in services, and the effects this has on young people’s earnings, as well as economic growth, is just one manifestation of the long-term effects of fiscal strain.
And that takes me to another consequence of the financial and economic meltdown that we have experienced – and that’s the impact it has had on our fiscal situation.
Just a few weeks ago, the Administration released the year-end statement of the federal government – a final accounting of what we took in and what we spent for fiscal year 2009, which ended in September.
The results were not a surprise, but they were still sobering: the deficit for last fiscal year was $1.4 trillion, or 10 percent of our economy.
Next year’s deficit is expected to be about the same size, and current projections show $9 trillion in deficits over the next 10 years, averaging about 5 percent of GDP.
Deficits of this size are serious – and ultimately unsustainable.
So how did we get here?
Of the $9 trillion in deficits projected over the coming decade, nearly $5 trillion comes as a result of failing to pay in the past for just two policies — the 2001 and 2003 tax cuts and the creation of a Medicare prescription drug benefit.
The cost of the tax cuts will total about $4 trillion over the next decade, including the additional interest on the debt the federal government will have to pay since the tax cuts were deficit financed. The Medicare prescription drug bill will add about another $700 billion to the deficit – bringing us to about $5 trillion total for the cost of just these two policies.
In addition, roughly $3.5 trillion can be attributed to automatic economic stabilizers.
As the economy enters recession, certain spending programs, such as unemployment insurance and food stamps, automatically increase and revenues tend to decline. Although this helps to ameliorate the economic downturn by stimulating demand, it also leads to higher deficits.
Finally, there is the Recovery Act which accounts for just 10 percent of the entire deficit over the next decade.
All told, the entire $9 trillion deficit reflects the failure to pay for policies in the past and the cost of the worst economic downturn since the Great Depression and the steps we had to take to combat it.
Now, assigning blame never solves a problem, but it is important to understand that we didn’t get where we are merely as a result of bad luck.
It was the result of decisions – conscious, but unfortunate – and it will take deliberate action for us to work our way out of this situation.
And it’s critically important that we do just that.
Over the long-term, deficits tend to have some combination of two effects. First, they can raise interest rates and decrease investment, as the federal government goes into the credit markets and competes with private investors for limited capital.
Second, deficits can increase the amount that the United States borrows from abroad, as foreigners step in to finance our consumption.
Either way—whether deficits increase interest rates or borrowing from abroad—the long-term effect is the same: It generates a greater burden on you—our future workers.
If interest rates rise and investment falls, that will make you less productive and reduce your incomes. And, if we borrow more from abroad as a result of our deficits, that means that more of your future incomes will be mortgaged to pay back foreign creditors.
From a quick look through the financial pages, you might think that what I’m saying is belied by the facts.
Even as the deficit reached a record level, interest rates have been very low. So far this year, for example, the nominal interest rate on the Treasury’s 10-year note has averaged roughly 3 percent. If this holds out, this will be the lowest average annual interest rate on the 10-year note since the 1950s.
And in just three years, the current account, or the amount that we borrow from abroad, has fallen in half as a share of the economy—dropping from 6 percent of GDP in 2006 to under 3 percent today.
These seemingly conflicting trends—rising budget deficits but falling interest rates and borrowing from abroad—are a product of the extraordinary economic environment in which we currently find ourselves.
Right now, the federal government, in effect, isn’t really competing with other borrowers for capital.
Among households and non-financial businesses, total borrowing peaked at about 15 percent of GDP in 2006 and has since fallen to -3 percent of GDP as of the second quarter. In other words, people and non-financial businesses went from borrowing an amount equivalent to about one-seventh of our economy to a situation in which currently, on net, they are paying back loans rather than taking new ones.
Among U.S. financial-sector businesses, the shift has been even more substantial. They went from borrowing an amount equivalent to about 10 percent of GDP as of 2006 to paying back about 15 percent of GDP in the second quarter, as the financial crisis has forced these companies to deleverage.
Public sector borrowing has increased dramatically, but by a smaller amount than the decline in private sector borrowing. As a result, total domestic borrowing – public and private – has gone from roughly 30 percent of GDP as of 2006 to roughly zero now.
That’s why interest rates remain low and the amount we borrow from abroad isn’t rising along with budget deficits – because the private sector’s demand for capital has collapsed and, for the time being, the Treasury is the one borrower left standing.
That said, as the economy recovers, other borrowers are going to return to the market as consumer spending and business investment pick up again. When that happens, the federal government’s borrowing to finance its deficits will be competing more directly with private-sector borrowers for capital.
It is at this point that we are likely to observe a rise in interest rates, an increase in borrowing from abroad, or some combination thereof due to the deficits. And it is at that point that deficits will be putting the health of our economy in jeopardy rather than helping to mitigate the most severe economic downturn in more than 50 years – as they are now.
While we are addressing our short-term economic crisis with deficit spending, as we must, we also are taking on the biggest threat to our long-term fiscal future: rising health care costs.
Our fiscal future is so dominated by health care that if we can slow the rate of cost growth by just 15 basis points per year (that is, 0.15 percentage points per year), the savings on Medicare and Medicaid would equal the impact from eliminating Social Security’s entire 75-year shortfall.
Right now, we are further along toward our goal of fiscally responsible health reform than ever before. I believe that in the weeks to come, the President will sign a bill that gives those with health insurance stability and expands coverage, and does so while boosting quality and reducing long-term deficits.
Let me be clear: any bill that the President will sign will not add to the deficit over the next decade and will reduce deficits thereafter.
This will be done through a "belt and suspenders" approach. That is, we are relying on hard, accountable savings – as scored by the independent Congressional Budget Office – to pay for health reform…and we are not banking for that purpose on the potentially much more important cost-savings that will come from transforming the health care delivery system.
In this way, the worst-case scenario is that we have reformed health care and paid for it. But because we’re also taking substantial steps to make health care more efficient over the long term, reform will also undoubtedly help to improve our long-term fiscal standing – even if it is challenging to quantify by precisely how much.
Once health reform is passed, however: the job of getting our nation back on a fiscally sustainable course will not be complete. Our current projections of 4 to 5 percent of GDP in budget deficits in the out-years are well above the fiscally sustainable level of roughly 3 percent.
To bring deficits down to a sustainable range, therefore, will require more action once the economy is into a recovery. We are currently considering a number of proposals to put our country back on firm fiscal footing, and to cut the deficit we inherited in half by the end of the President’s first term.
In the meantime, in addition to health reform, we have taken steps to start changing the culture in Washington – to boost efficiency and make sure that taxpayer dollars are spent wisely.
We have undertaken a reform of federal contracting that will help curtail the number of no-bid contracts and ultimately save an estimated $40 billion a year.
Upon the recommendation of Secretary Gates and the military leadership, we have identified weapons system that were doing little to make our nation safe, that the Pentagon didn’t want, but were costing the treasury billions.
In fact, this year, the President worked with Senator McCain and members from both parties to stop further production of the F-22 fighter jet.
Time and again, the military said that it had enough of these aircraft, but Congress kept funding them. Few thought we could do it, but we succeeded in ending this waste – freeing up valuable resources for the troops in the field.
And, after years of failing to abide by the simple principle that you should pay for what you spend, the Administration has proposed statutory "pay-as-you-go," or, as it’s often called, "PAYGO" legislation. PAYGO would require that any new tax cut or entitlement program be fully paid for—just as we are doing today with health reform.
In the 1990s, PAYGO’s commonsense approach encouraged the tough choices that helped transform large deficits into surpluses – and its absence over the past eight years accounts for the $5 trillion figure that I mentioned earlier.
These are all important steps to reining in waste and creating a government that uses taxpayer dollars more effectively and efficiently. But these steps alone will not fill the shortfall that we face. That is why the President and his economic team are busy working on a range of options as we prepare for the fiscal year 2011 budget to be released in February.
As we look to the future, then, there is much work we need to do today to lay a new, stable foundation for economic growth.
We must give a hand-up to those entering the workforce – enabling them to get the schooling they need so that they can counter the headwind of recession that is hindering their careers.
And as the economy recovers, we must pull together – as a nation – and make the tough decisions to put our country back on a solid fiscal foundation.
None of this will be easy.
After all, it took us years to dig ourselves into the current fiscal hole. And, it will take years for us to get out.
But I – along with the President and the rest of the Administration – all are committed to making our way – responsibly and rapidly – out of this fiscal hole.
That’s what the founder of this university did when he was helping to lead our young nation at the start of the 19th century, and what we must do as we lead the United States at the start of the 21st.
Thank you.
# # #