JEFFREY BROWN: Just three months ago, Fed Chairman Ben Bernanke said he thought it was premature to serve up a new round of measures to stimulate the economy. But times have clearly changed, and today he weighed in positively on a notion that is now very much in play in Congress and being discussed as well at the White House.
Is another stimulus plan needed? And if so, what should be in it? We ask that of two who testified at a congressional hearing today after Bernanke spoke.
Martin Baily served as chairman of the Council of Economic Advisers during the Clinton administration. He’s now a senior fellow at the Brookings Institution.
William Beach is the director of the Center for Data Analysis at the Heritage Foundation in Washington.
Welcome to both of you.
Martin Baily, what’s the argument for a new stimulus package? And what would it be aimed at achieving?
MARTIN BAILY, Brookings Institution: Well, I was very pleased that Bernanke supported that. The economy is looking pretty ugly at the moment. I would expect that we’re going to report a negative third quarter. The fourth quarter looks like it could be substantially down. And then probably a continuing recession into the first half of 2009.
So we need to try to sort of reverse that. Initially, the financial crisis didn’t seem to be having that much ill effect on the overall economy, jobs and production, but now it is. And we need to do something to reverse that. And I think a stimulus package is definitely needed.
JEFFREY BROWN: Do you agree with that as a starting point?
WILLIAM BEACH, Heritage Foundation: I think the problems of the financial sector are beginning to spread throughout the economy. We’ve had such a long period of time when credit was tightening. Every day, we would get more news of tighter credit.
And ultimately that affects people where they work, their payrolls, vendors in businesses, and then it goes out into the consuming public, because they can’t get the credit necessary.
Now, the stimulus package is actually premised on the notion that that contagion, that disease, has already gone out into the general economy and that the general economy cannot absorb that and recover on its own. I think that’s an open question.
But Congress is ready to act. And when Congress is ready to act, I think they’ll act. So, yes, I testified this morning that something needs to be done. I testified on the tax side, others on the spending side. And my guess is that Congress will do something.
Getting credit into the market
JEFFREY BROWN: All right, now, Ben Bernanke was not specific about measures mostly today. But one thing he said -- and we ran it in our news summary -- he said, if Congress proceeds with a fiscal package, it should consider including measures to help improve access to credit by consumers, home-buyers, businesses, and other borrowers.
What might that entail? What kind of measures do that?
MARTIN BAILY: Well, I think he was talking about loan guarantees, probably stuff to work out mortgages. As you know, it's been very difficult to settle some of these mortgages and keep people in their houses where it's possible or deal with the foreclosure where that's not possible.
He also talked, I think, about Fannie Mae and Freddie Mac and the need there to make mortgages more available to homeowners, which I support. So he's looking again to support the measures that he's done to increase liquidity in the economy, to lower interest rates, and make credit more available.
JEFFREY BROWN: There were signs today that the credit crunch was easing a bit.
WILLIAM BEACH: Right.
JEFFREY BROWN: So his notion, though, is that there is still much more to be done and that government can help do it?
WILLIAM BEACH: Well, and it concerns me a little bit. I don't dispute the notion that something needs to be done on the credit side as it deals with the mortgage borrower him or herself. Congress has already passed legislation to that end.
I worry a little bit about putting Congress back in the driver's seat on this whole mortgage issue. You know, I have -- my narrative is that Congress was, in some respects, powerfully responsible for the situation that we find ourselves in.
But I think what the chairman was actually saying is this: Be very prudent on what you do, but make sure you do nothing that tightens credit, that when you act that the objective be to ease credit a bit.
Ask Fannie Mae to be a little more liberal. When you're dealing with consumer credit, err on the side of looseness, at least for a while.
But, again, my worry is that they'll err and produce other problems. We have to watch that very closely. And I think the members understand that, too.
Rebates and tax breaks fuel debate
JEFFREY BROWN: Well, the first stimulus package back in February involved tax rebates. Now, is that a good idea still? And what other measures would you like to see now?
MARTIN BAILY: Well, I would like to see tax rebates again. And I think you could get them out there quickly. And I think that's part of the essence that we have to do this fairly quickly, because the economy is deteriorating right now.
JEFFREY BROWN: When you say quickly, how quickly?
MARTIN BAILY: Well, I think if they passed it when they come back after the election, if they passed that legislation, the IRS could use the same list that it used for the previous tax rebates, and we could probably get them out in time for Christmas or soon after that. So I think that would be very helpful.
Now, in Congress, the members of Congress want to do something a little bit different this time. And they're talking about maybe increasing benefits, or not the level of benefits, the duration of benefits for unemployment insurance and giving some money to states to spend on infrastructure.
Now, the drawback of spending on infrastructure is that it will come too slowly. So you'll spend the money, but it won't actually reach the economy until we've already recovered or else it's, you know, 2010 or something.
But there is some stuff that's sort of ready to go, some projects that are ready to go. And I think there's some maintenance expenditure that could also be made, filling in some potholes, improving the maintenance of bridges and that kind of thing.
So I support that. I think we should have that as part of the package.
JEFFREY BROWN: These are the kinds of proposals that Democrats in Congress put forward. What do you think of them?
WILLIAM BEACH: Well, we're a little skeptical about rebates. We saw the rebates go out the last time and we got about one quarter of bump up and then the economy went back into its downward track.
I'm much more interested in doing something that's highly effective and quick. And the quickest thing is to signal that tax rates on capital will come down, that investment capital will be more affordable, and that you'll be able to undertake an expansion or any kind of a move in your business where tax rates are important, especially marginal tax rates, rate reduction for business expensing, a rate reduction for corporation income taxes.
Why is that quick to do? The moment it's announced with conviction by the leadership of Congress, then those people in the business community who make the decisions about expanding and increasing activity will begin to act. You don't even have to wait for Congress to pass the legislation.
When they do pass it, of course, it will be priced in and action will take place. That's what we need to do. That's what Democrats and Republicans have always done when they've come together to look at a stimulus package. They've had a very powerful centerpiece in tax policy.
JEFFREY BROWN: What do you think about that as an approach?
MARTIN BAILY: Well, I think this is an important piece of legislation that has to go through. We have to have a stimulus package, in my view. And if we need to do this, well, we do need to do it on a bipartisan basis. So I'd be willing to support tax cuts on that basis for business.
I don't agree with Bill on what the evidence shows in terms of the effectiveness of those tax cuts. And if you talk about capital gains tax cuts, well, I think most people have capital losses right now, not capital gains.
So I don't think that would go quickly into spending, but I know we disagree a little on the evidence.
WILLIAM BEACH: One other thing that we've been talking about is a very -- maybe even a zero capital gains tax on new stock issues for financial institutions. This is very targeted.
The idea would be that, if you did that, then banks could go to the equity markets to raise that capital which they're now going to the Treasury to raise. And it would be easier for them to do that from private sources.
Growth based on capital and jobs
JEFFREY BROWN: What about the other things he mentioned and the congressional Democrats have mentioned, the extension of unemployment benefits, more Medicaid spending, that kind of new spending as a way of stimulating things?
WILLIAM BEACH: Well, when the economy is really slow, as it is right now, a lot of people are going to be hurting, and more are going to be hurting in the future for the next several months. I don't disagree with what Martin is saying about the near-term economic prospects.
But you do those things because people are in need. You don't do them to stimulate the economy.
Medicaid expansion will occur. Food stamps will need to be boosted up. And we'll need probably to have some addition to the unemployment, because people are hurting.
Now, if you want to stimulate the economy, you don't fill family budgets with dollars so that they can pay just the overhead that doesn't create new jobs or create new factories. You have to do effective things on the capital side.
And spending for bridges and for maintenance, again, it doesn't create jobs. It maybe fills in some of the holes there, to use an analogy out of the highway business, but I don't think that those are the things that are well-calculated to get the economy moving at a higher level.
JEFFREY BROWN: But do you think some of those things can have a quick impact?
MARTIN BAILY: Oh, I do think so, yes. And I think it would be good to get money into the hands of low- and middle-income people. I think they will spend it. And there are some projects at the state level that are being held up because of lack of funding.
JEFFREY BROWN: All right, let me just ask you both quickly before we go here, I mean, all this is happening against the backdrop of rising budget deficits. Do we not worry about that at a moment like this?
MARTIN BAILY: No, we do. We're like the drunken sailor that says, "Give me another couple of shots and that'll fix it." This is something that we have to grapple with over the long run, is this rising debt and rising deficits, but don't do it right now. We have to...
JEFFREY BROWN: Don't worry about it right now?
MARTIN BAILY: Well, don't worry too much about it right now. We need to fix this short-term recession. But then we really do have to get to work on the long-run deficit problem.
WILLIAM BEACH: That's something Martin and I do agree on, in that the deficit problem is a very big situation that's facing us.
Just think of the $700 billion rescue as a bucket. I know we're not supposed to call it the bailout, but let's suppose that. The bucket of debt that's coming at us over the next 5, 6, 7, 8, 10 years, from just funding the unfunded liabilities of Social Security and Medicare, would be like adding another 56 buckets to what we're going to have to raise in the debt markets.
If we have mounting deficits now, the holders of our bonds are going to be looking at us and saying, "Are you really able to repay that debt?" And we don't want them to have to ask us that question, because that means they'll downgrade the debt and that's bad for our economy.
JEFFREY BROWN: All right, William Beach, Martin Baily, thank you both very much.
MARTIN BAILY: Thank you.
WILLIAM BEACH: Thank you.