Growth Without Bubbles

Speaker:
Christina Romer Council of Economic Advisers
Presider:
Henry R. Kravis Kohlberg Kravis Roberts & Co
Audio
Transcript

This session was part of the Stephen C. Freidheim Symposium on Global Economics: Financial Turbulence and U.S. Power, which was made possible through the generous support of Stephen C. Freidheim.

 

HENRY KRAVIS: I'd like to welcome everybody to the third session of the Council on Foreign Relations symposium, on "Growth without Bubbles." This meeting is being webcast live around the nation and around the world via the Council's public website, www.cfr.org. I'd remind you, please turn off completely any cell phones, BlackBerrys or wireless devices; turn them off completely so we don't have the interference. And I'd also like to remind everyone that this meeting is on the record.

Today we're quite fortunate to have Dr. Christina Romer with us, who's chair of the Council of Economic Advisers. Many of you know, until her nomination, Dr. Romer was the co-director of the Program in Monetary Economics at the National Bureau of Economic Research. She also served as the vice president of the American Economic Association, where she was a member of the executive committee. Prior to that, she taught economics at Berkeley and public affairs and economics at Princeton -- a very good background.

She's an economic historian, specializes in the historical analysis of monetary policy. So I think really appropriate that she's in the job that she's in, and certainly appropriate that she's here today with us. She's known for her research on the causes and the recovery of the Great Depression and the role that fiscal and monetary policy played in the United States economic recovery.

So with that, I'd like to ask Dr. Romer to come up to speak to us, and we'll take some questions afterwards. Thank you. (Applause.)

CHRISTINA ROMER: Well, thank you. It is truly a pleasure and an honor to be here today. And actually, what I want to talk about today I'll call realistic expectations for America's future economic growth.

And sort of to set the stage, what I wanted to point out is, in the past 20 years we have had two periods of extended, robust growth: one from about 1992 to 2000 and the other from 2002 to 2007. And in both cases, aggregate output and employment grew steadily; unemployment flew -- fell to low levels; and inflation was restrained.

Now, to be sure, the two episodes had some important differences. Most notably, real medium -- median household income rose strongly in the 1990s but was largely stagnant in the early 2000s. But actually, a fundamental similarity was that both periods were accompanied by very large runups in asset prices that turned out, in retrospect, to be unjustified, a phenomenon that we commonly refer to as a bubble, for short.

Well, the result was substantial overinvestment in certain sectors of the economy, high-tech in the 1990s, housing in the 2000s.

More importantly, in both cases, the bubbles eventually burst, throwing the economy into a recession, a mild one at the end of the 1990s and, as we all know, an extremely severe one in the current episode.

Well, the subject that I want to talk about today is, how can we achieve the good without the bad? Do we need asset bubbles to get robust growth and low unemployment, or does growth inevitably cause such asset price bubbles? And what can we do to ensure that the next expansion doesn't come with a bubble of its own, planting the seeds of the next recession?

And as the title of my talk suggests, what I'm going to look at is, can -- how or can we create growth without bubbles?

All right. So my first observation is that history gives, I think, a clear answer to whether we can have growth without bubbles. Yes, we can. The history of the United States -- (laughter) -- and other economies -- (chuckles) -- provides numerous examples of periods of sustained growth that were not accompanied by large overvaluations of assets and substantial overinvestment in particular sectors.

So for concreteness, let me focus on one such episode -- that is, the United States in the 1960s. Specifically, I want to consider the U.S. in the -- over roughly the six-year period 1962 to 1967. This period was one of unbroken and robust expansion, with real GDP growing at an average rate of 5 percent a year, the unemployment rate falling from over 6 percent to just under 4 percent.

This growth was reflected in steadily rising real median family income. Nonresidential investment averaged a healthy 11 percent of GDP, and its share was generally rising over the period. We ran trade surpluses, with our net exports averaging close to 1 percent of GDP. The federal budget deficit hovered near 0, and the ratio of our debt to GDP fell from 45 to 33 percent. And the stock market rose at a very calm average rate of about 5 percent a year.

Now of course the 1960s were not perfect economically. The conglomerate mania led to some foolish business acquisitions and to the overvaluations of specific companies. More importantly, monetary and fiscal policymakers expanded too far, especially near the end of the decade, overheating the economy, increasing inflation and sowing the seeds for the eventual end of the expansion.

But none of this changes the fact that this period shows that we can have robust economic growth that is neither fueled by bubbles nor creates major bubbles.

There are many other examples like this. The U.S., from the end of World War II through the 1950s, although not as stable as the period that I've just described, experienced healthy and sustained growth (in/and ?) sensible asset markets. And abroad, Japan, Canada and most of Western Europe had sustained periods of non-bubbly growth from the end of World War II into the 1960s, and in some case beyond.

Moreover, I want to suggest there's a reason that such periods of bubble-free growth are common, and that is that there's a natural equilibrating mechanism that ensures that aggregate demand is adequate without the presence of an asset-price bubble.

If, at prevailing interest rates, the demand for the economy's goods and services, without any boost from bubble-driven investment, fell short of the economy's normal capacity, this would translate into a surplus of funds in credit markets. The demand for loans to finance new investment projects and purchases of durable goods would be less than the supply of funds from savers. But this is just another way of saying that interest rates would be above their equilibrium level. Interest rates would fall, relatively quickly if the Federal Reserve perceived the imbalance and injected additional funds into the market; more slowly if the imbalance was not evident. The fall in interest rates would increase investment and purchases of durable goods, as well as lower the value of the dollar and raise our net exports. The process would stop when demand equaled supply, with the economy operating at normal capacity. This is simply how economies have achieved healthy, bubble-free growth throughout modern history.

All right. Well, even if bubbles aren't necessary to growth, an obvious question is, well, how does an economy prevent asset bubbles from developing? And here I think the crucial insight is that bubbles are not a natural consequence of growth.

Indeed, one of the strengths of a well-functioning market economy is that it gives people strong incentives not to pay inflated prices for assets and not to undertake projects that don't pay off. Even in the presence of a global savings glut, low interest rates and, as some people like to put it, money sloshing around, it's not smart to lend money to people with lousy ideas. The venture capitalists who funded Boo.com, Webvan, Pets.com and the other spectacular failures of the dot-com era, lost bundles of money.

The same is true of the real estate developers in the current episode who built large numbers of homes in distant exurbs that they've never been able to sell. The experience of much of the period in the United States from the 1930s through the 1960s shows that it's possible to have very low interest rates without bubbles developing.

Thus, we can and we should rely on market competition as the first line of defense against bubbles. But here, we've learned very painfully that we can't rely completely on these market forces. We need to make sure that financial markets are transparent, and to work vigorously to combat fraudulent and deceptive practices, so that ordinary Americans, who are not experts in finance, are not taken advantage of.

We need to prevent large financial firms from playing a game of "Heads, we win; tails, you lose" with the taxpayers. We need to have appropriate regulation and oversight, particularly of financial firms that are important to the health of the overall financial system.

That's why the president has committed to working, with Congress, to undertake comprehensive reform of our financial regulatory structure.

The full details of reform will obviously take time and great care to flesh out, because it's crucial that we get this reform right. But one element will clearly be central to the issue of preventing bubbles.

Current proposals call for the creation of a systemic regulator, which will be charged with ensuring that all financial institutions -- whose combination of size, leverage, interconnectedness pose a threat to financial stability -- are subject to conservative prudential requirements.

The systemic regulator will also enhance monitoring of systemic threats, from activities in financial markets, including identifying and curtailing practices that can create or exacerbate asset-price bubbles.

More generally going forward, policy makers will need to be alert to questionable practices, conflicts of interest and the possibility of developing bubbles, rather than just having blind faith in the wisdom of financial markets.

The current episode has also taught us that cleaning up, after a popped bubble, is much harder than we might have previously thought. For this reason, policymakers may need to consider asset-price movements as one of a number of indicators, of current and prospective economic conditions that may warrant policy actions.

All right. So the essence of my argument thus far is that the goal of growth without bubbles is achievable and realistic. But concretely what will such growth look like? If growth is not driven by a boom in houses that turn out to have no buyers, or a boom in high-tech investments that turn out to have little use, what will it be driven by?

Well, let me start by talking about the long run. At some point, our current recession will end. And our economy will be operating at its normal level of capacity again. What will provide the demand for goods and services in that situation?

And to address this question, it's helpful to recall the first and, I would guess, in many cases, the only equation that many of us met, in our study of economics. And that is that the economy's total output of goods and services is equal to consumption plus investment plus net exports plus government purchases of goods and services. And I'll even go a little bit further. And I want to separate the investment piece into housing investment and non-housing investment.

All right. Well, looking at things in terms of this five-way breakdown, it seems pretty clear that two pieces will be providing a smaller portion of demand, in the future, than they did in recent years.

The first is housing. Housing investment, as a share of GDP, reached its post-Korean War high in 2005. And it averaged more than 30 -- more than 5.5 percent over the period, 2002 to 2006.

We were building about 30 percent more housing units a year, in the expansion in the 2000s, than in that of the 1990s.

So a return of housing share in GDP to close to the postwar average of 4-1/2 to 5 percent certainly seems likely.

The second piece of that decomposition that will be providing a smaller portion of demand in the future is almost surely consumption. When housing and stock prices were rising rapidly, households could accumulate wealth without saving out of their income. As a result, the personal savings rate was close to zero. Once the economy has recovered, that's neither likely nor desirable. The saving rate has already risen to 4.2 percent, and it's likely to rise further as incomes recover from the recession and households work to rebuild their wealth.

If the saving rate returned to the postwar average of about 7 percent, with no other changes, consumption's share in GDP would fall from 70 percent, that it averaged from 2002 to 2006, to about 66 percent. This is just a shade below its level during the expansions in the 1990s. All right, so not coming from housing, it's not coming from consumption.

The third component in that decomposition, government purchases of goods and services, I think, is also probably likely to be roughly constant rather than a source of increased demand. And here I need to be a little bit careful and remind you that economists don't treat programs like Social Security or Medicare as government purchases. Those are treated as transfer payments. But the composition, probably, of government purchases will surely change as our military involvement in Iraq and Afghanistan eventually winds down and we invest in education, clean energy and health care. This reorienting of government spending will make our economy more productive and so will raise the path of output going forward, but it's hard to see a big change in overall government purchases as a share of GDP, and it's hard to see any substantial change in the role that those purchases will play in generating demand.

All right, so this leaves us with two components of output to make up the shortfall from declining housing investment and consumption: net exports and business investment. And I think both are likely in the future to contribute to fulfilling the shortfall. As we all know -- let's start with net exports. As we all know, we've been running large trade deficits, not just for the past few years but for the past few decades. The average ratio of net exports to GDP in the 2000s expansion was a remarkable minus-5 percent. Such large trade deficits are simply not sustainable in the long run. They are the flip side of our high budget deficits and low personal saving. And they mean that the United States has been borrowing ever- increasing amounts from abroad. This clearly can't continue indefinitely.

At the same time, we should not expect or want to be running trade surpluses any time soon. The dynamism and technological leadership of the U.S. economy make it an attractive place to invest. Thus, even as the budget deficit falls and personal saving rises, it's still reasonable to expect investment to exceed saving, which necessarily implies a current account deficit.

In addition, recent research shows that Americans have consistently earned higher rates of return on their investments abroad than foreigners have earned on their investments here. Given the safety and soundness of the U.S. assets, not to mention Americans' famous willingness to take risks, this is not surprising. But it implies that some trade deficit is sustainable, even in the long run.

Now the last component, non-housing business investment, I think, is likely to be central to filling any shortfall in demand in the long run. During the expansions of the 2000s, the share of non-housing business investment in GDP averaged close to a full percentage point lower than its postwar average. Raising this component share back to and indeed above its historical average, I'd suggest, is not the daunting task that some might suggest.

Some of the increased investment should be encouraged by lower real interest rates. As I described before, healthy economies have a natural equilibrating mechanism. If consumers want to save more, interest rates tend to fall. This lowers the cost of borrowing. It lowers the opportunity cost of doing investment out of retained earning.

Firms with innovative ideas or products in high demand will have every incentive to invest and expand. Figuring out what those investments should be is the fundamental job of the private sector.

The strength of a well-functioning market system is that policymakers don't need to predict what the profitable investments will be in advance. We leave it to the small firms and the big corporations to figure out what products consumers want and what investments will therefore generate the highest returns.

But some of the polices that we are putting in place today may help to sow the seeds for particular areas of robust investment in the future. The American Recovery and Reinvestment Act included unprecedented natural -- national investment in developing renewable energy and in -- and building a smarter electricity grid.

This public investment may help to pave the way for a wave of private energy investment in -- by reducing uncertainty and providing some useful demonstrations.

Likewise, the president's proposal to establish a market-based system to limit greenhouse gas emissions, if it's enacted, will also provide incentives for private investment in clean domestic energy.

Likewise, the public investments in education and in research and development included in the recovery act, and in the president's budget that was just passed, are another policy that could ultimately stimulate private investment.

I think it's no coincidence that an extended period of high investment and bubble-free growth occurred in the decades following the GI Bill. That unprecedented investment in human capital formation left American industry with a magnificently trained workforce, and the country with a bounty of potential inventors and innovators. From these flowed the ideas and the incentives for rapid investment in the 1950s and 1960s.

President Obama's announced commitment to science education, basic research and expanded access to college for all Americans should unleash the same forces in the 21st century.

Whatever the particular form that the investments take, prudent government encouragement, together with lower interest rates and the dynamism of American capitalism, should continue to generate ample demand and growth in the future.

All right. Well, even if I've convinced you that growth without bubbles is possible in the long run, we still have to face the next few years. As we are all too well aware, the U.S. economy is in the throes of a terrible recession. We learned last Friday that the unemployment rate had risen to 8.9 percent in April, and that employment is now 5.7 million lower than it was in December of 2007.

Another crucial fact is that, to return an economy this sick back to health, it's not enough to merely stop falling and start growing again. We know from previous recessions that the unemployment rate continues to rise as long as real GDP growth is below its normal rate of about 2-1/2 percent per year. To bring the unemployment rate down quickly, we need a period of truly robust growth, perhaps of 4 percent per year or higher.

Well, given what I've just said about the likely conservatism of consumers over the long haul, without another bubble to invest in, is there any hope for the healthy rebound in demand and growth? And here again, the answer is yes. Now, one key source of the short-run boost in demand is already happening, and it's coming from the government. I mentioned in -- earlier that over the long run, government spending is not likely to be substantially larger, but it is unquestionably going to be larger in the near term.

The American Recovery and Reinvestment Act provides $787 billion of aggregate-demand stimulus, with the vast majority of it hitting the economy in the next two years. This extra stimulus is exactly what the economy needs to stop falling and start growing robustly. At a time when private investment and consumption is depressed, it's sound policy to expand government investment. It puts people back to work and increases the public capital stock, and so improves our productivity in the future.

In this context, I'd also like to point out that other actions we are taking are also likely to provide an important boost. The Federal Reserve's program of purchasing the debt of the government-sponsored enterprises, the GSEs, Freddie Mac and Fannie Mae, together with the Treasury's actions to increase the government support for these institutions, have brought mortgage rates to historic lows.

This, together with eased equity requirements for homeowners whose property values have fallen, has set off a wave of refinancing. Lower mortgage rates are sort of like a tax cut. They put money in consumers' pockets, and they increase demand.

Likewise, our joint program with the Federal Reserve to restart the securitized lending market is also starting to pay dividends. The TALF program had a much better week last week, announcing requests for loans to buy asset-backed securities of some $10-1/2 billion. Likewise, thanks to reduced fees and larger guarantees, the Small Business Administration -- their loan programs have had a resurgence in transactions.

Developments such as these, which increase lending, are crucial to allowing credit-constrained households and firms to start spending again. Secretary Geithner's often fond of saying there's probably more stimulus in getting financial markets lending again than in direct fiscal stimulus.

Now, while government actions will provide an important source of demand in the next few years, there's another factor that could also get us a temporary surge in spending, and that's investment rebound and pent-up demand.

During a recession, households cut back on their purchases of houses and durable goods, and firms cut back on investment of all kinds. The cutbacks are far more than proportional to the fall in income. Further, the depressed spending during the recession pushes the stocks of investment goods and consumer durables to low levels. Restoring them to normal requires a period when purchases have to not just return to normal, but are unusually high.

The result of these forces is that when the economy begins to recover, investment and the purchase of durable goods grow rapidly, strengthening the recovery and further fueling growth in those sectors. The result is really a virtuous circle that yields a period of rapid growth.

To understand this process, let's consider the case of inventories. In recent months, firms have been reducing their inventories in response to falling sales, rather than increasing them slightly as they normally do. As a result, total production in the economy has been falling much more than sales. Just having inventory accumulation return to zero or a small positive number would raise GDP growth sharply. But during the recovery period, firms will want to do more than that. Inventories are now substantially lower than they were a year ago. When sales turn around, as they surely will, firms will want to rebuild their inventories, leading to a period when production is growing considerably faster than sales.

You know, the process is similar for other types of investment in durable goods. Investment other than housing and inventories, which was not exceptionally high during the expansion, has plunged. A return to just normal would raise growth substantially. And at some point, firms will want to have unusually high investment, as they replace the equipment that they did not replace during the recession and make the new investments that they had postponed.

The housing sector is so depressed at the moment that a rise in housing starts just to the level of the 1990s expansion would represent almost a tripling from current levels. And even if consumption is lower in the long run because of increased saving, it's possible that we will have a period of unusually high expenditure, as consumers buy some of the cars, appliances and other durables that they haven't bought for the last 18 months.

Now, to be realistic, historical evidence suggests that recessions accompanied by financial crises tend to be more severe, and their recoveries more protracted. For this reason, policymakers would clearly need to monitor the economy closely, to see if the increase in government spending and the recovery of investment and the desire to rebuild stocks is generating sufficient demand.

But what I want to leave you with today is a sense that there is certainly a path by which the economy could generate the rapid growth necessary to not just stop the rise in unemployment, but to bring it down to normal levels, at a reasonable pace, without resorting to the bubble-based demand of the past.

All right. Well, where does all of this leave us? Well, I guess, I'd have to say, cautiously hopeful about where the economy is headed. I think the goal of long-run economic growth, without asset- price bubbles, is not only achievable but something we should expect, if we put in place a sound regulatory framework, and if policymakers remain vigilant.

The goal of a robust recovery is achievable, even if consumers want to save more, because of the short-run contribution of government spending and the natural forces of inventory rebound and pent-up demand. We do not need bubbles to pull the economy back or to keep it at normal.

I want to close by pointing out one implication of the discussion that I've not stressed so far. Bubble-free growth is not only feasible and not only more stable and sustainable than bubble-fed growth. It's also better for the distribution of income and for long- run growth.

In a bubble, the people who get in early make bundles. And the people who get in late lose their shirts. And on both the up and the down side, some of our brightest minds make small fortunes arranging the deals, rather than pursuing potentially more sociably valuable careers, in fields such as science, medicine and education.

Avoiding the bubbles means we avoid some of this waste of talent. More importantly in a bubble-free economy, more of our output will take the form of things that raise productivity, rather than investment goods that turn out to be worthless or consumption goods.

Our saving will be higher, so that domestic investment will be financed more out of domestic savings, with the result that the fraction of our output that is ours, to keep, will be greater than before. And the reorientation of production to investments in the people, products and energy of the future means that we'll be able to produce more, with less pollution, in the years to come.

For this reason, the frequent claim of the president and his economic team that the economy will not merely come through this crisis but come through it even stronger than before is not just a slogan. It's both a realistic and attainable goal.

Thank you. (Applause.)

KRAVIS: Thank you very much, Dr. Romer. I hope you're right about all of this. (Laughter.)

ROMER: I hope so too because I just went on record saying that now. (Laughter.)

KRAVIS: We all do. There's no question about it.

But if you look at the IMF projections, on a global basis, for this year and next year, and you know you have a global growth this year of maybe 0.5 percent or something like that, for the year, which is down from a recent projection, as you know.

And they also had the U.S. contracting by about 2 percent for the year and going up somewhat -- a slow recovery for next year.

The Obama administration, on the other hand, has a growth rate of about 3-1/2 percent for next year, which is -- obviously I, again, hope they're right, hope you're right. What happens if they're wrong? What does the Obama administration have to do to kick-start the economy so that we can start jobs growing again?

ROMER: All right. Well, there -- it's an excellent question. I think there are a couple of things to say. One is, of course, all forecasts have large margins of error. That's something that we all have to acknowledge. And though I'm on record, I'm perfectly aware I could turn out to be wrong.

But I think the important thing is to think about, certainly, what's likely. And that's really what I was trying to do in the talk, is to say, you know, even if you're realistic about how much more consumers might save, and all of the -- what's happening in the international community, you notice I certainly didn't talk about in the short run we wouldn't expect exports to be a major source of U.S. growth, just simply because the world economy is certainly still very sick.

But I think there is a reasonable path where we could absolutely see the kind of growth that we are forecasting. But you point, though -- and there's another reason, I think, why we think that, and I very much tried to give that as well, which is, we think we're taking the right policies, that the fiscal stimulus, the work we're trying to do to bring the financial markets back -- we think all of that's going to absolutely do the job.

But absolutely we've got to be watching this thing like a hawk, because we could be wrong. We need to absolutely make sure that we're seeing what we expect, which is the job losses to gradually get smaller, to -- GDP losses to get smaller, and finally turn positive; likewise, to finally start adding jobs. But it's going to be a monitoring, right? We've given what we think is a huge dose of medicine to the economy. The right thing is to give it some time to work.

But if, come the late summer and next fall, we're not seeing -- well, we don't move from sort of, you know, the glimmers of spring to, you know, the start of summer, that's when you say, maybe we need to -- are we doing enough for financial markets? Are we doing enough on the fiscal side? Are we doing enough in our housing programs? All of those things.

We're -- it's going to be a -- very much a wait and see, a careful monitoring. You know, the president's always said he'll do whatever it takes. And that's what we're in, is the phase of seeing if what we've done is enough.

KRAVIS: I mean, clearly we have to be patient. You know, the medicine has only been applied, and it's going to take some times -- to take hold.

But the troubling part with that is if they end up having to take a second dose or a third dose of this. And we're -- the administration just yesterday, or day before, increased the budget deficit to $1.8-plus trillion for this year and 1.26 (trillion dollars) for next year.

You take a Goldman Sachs estimate, and they're saying -- could average a trillion dollars over the next 10 years, per year.

Obviously this is not sustainable. We can't -- you know, we'll be broke as a country, and particularly with all of the plans that the administration has, that Congress has, with health care being at the top of that priority, where something has to be done.

But then we have the projected Medicare/Social security deficits that are looming, and whether you call them -- whether they are transfer payments or they're not, they're -- they've got to paid for, you know, somewhere, somehow.

What will the administration do? I mean, how are we going to take care of all of this if we have to just keep putting money in?

ROMER: Well, I think there are a couple of things. One is, you know, the budget deficit in the short run -- fundamentally, what we all know is, it's being driven to a huge extent by what's happening in the economy. So at some level, the actions that you take to get your economy back are good budget policies, just simply because there's nothing as bad for your budget as an economy in free fall.

The second thing is, any of the spending that you do, like even a $787 billion stimulus package that I admit is enormous and sounds enormous, things that are a one-time or a two-time expenditure are not what blows a hole in your deficit. It is the expenditures going off into infinity, like what we see projected with Medicare and things like that, that are really the things that affect the budget in the long run.

I think that's fundamentally why the president has said health care reform is actually a top priority. So rather than thinking of it as a budget buster, what he has absolutely said is, it's the thing we have to fix to get our budget under control in the long haul. And he actually, I remember, at the health care summit was just -- you know, he said to all you advocates of universal coverage, let me tell you, job number one -- we got to get cost growth under control, because that's the only way this works. It's the thing you have to do first to save us from going off to budget hell. And if you want to expand coverage, it's even more important, because you've got more people then that may be getting government assistance.

So you know, I am actually working very hard now in the health- care reform process, and one of the things that the Council of Economic Advisers has been doing is sort of looking at the economic impact. And I've really been struck by -- if you can do what Peter Orszag likes to do, with the careful hand gesture, bend the curve of how fast health-care costs are going up, by doing fundamental reforms, that can have just an amazingly large effect on the economy. It is such a big part of our economy. It's a big part that is projected to grow astronomically. Getting that under control has important effects not just for the budget but for efficiency, but for labor supply, for all sorts of things that just really make it just fundamental.

KRAVIS: Over time, however, it's going to take money to get to that point, and so we're going to continue to build these deficits. This isn't going to be something that's going to happen overnight, unfortunately.

ROMER: No, that's -- that's true. And certainly, one of the things that we are very cognizant of is how important it is, as we go through this process, to never lose sight of how genuinely crucial it is to get those costs under control. And as you point out, the faster, the better.

We do know that -- we just had a meeting yesterday with a lot of, you know -- and a remarkable meeting -- a lot of the private-sector interest groups in the health-care field coming in and saying, "We think we can cut cost growth by 1-1/2 percent per year." And so, if they're ready to try, so are we.

KRAVIS: That -- that would be good. (Laughter.) For sure.

ROMER: And effective, is what you meant to say.

KRAVIS: That would be good. (Laughter.)

So let's assume we get through this, and Ben Bernanke now decides that we've got to start putting the brakes on, okay? We've got to start tightening credit. But we don't have the growth yet. We see, yes, we're through the downturn; the stimulus is maybe taking some hold; but unfortunately, for whatever reasons, particularly outside of the United States, particularly because of China and some of the Asian countries, commodity prices start spiking up, and we now are back into a inflationary period. Fine line to walk. What are your thoughts?

ROMER: All right, well, so, the first thing is, it's very awkward, as someone who's spent my life commenting on what the Federal Reserve does as a monetary economist -- it's kind of the one thing I'm not supposed to do any more.

As a member of the administration, we certainly value the independence of the Federal Reserve. I think that the important -- (laughter) -- no, I'm serious. (Laughs, laughter.) That wasn't supposed to be funny. (Laughter.)

The key thing, though, is, you have to ask yourself -- well, what you describe as a fine line, you know, if we're not growing, it seems to me the chances that we would have inflation spike up and the Federal Reserve would say we need to clamp down is pretty unlikely, right?

You told the story where maybe there's some international thing, but I think that's -- that's not very likely, right? The thing I have certainly been worried about is not inflation, but deflation. When you have an economy as depressed as we have now, I think that is the much -- you know, the much bigger worry.

And so my anticipation is that the Fed is going to be looking at the same numbers we are, and saying we need to keep helping this economy. They certainly have shown, you know, an incredible flexibility and, you know, enthusiasm for doing what it takes to try to get lending going again, trying to hold our financial system going again.

So I don't anticipate them being in the difficult situation that you've described. What they will do if they do, that's for them to say.

KRAVIS: Great. All right, at this time, let me open it up to questions from the members and our guests. Let me remind you, please wait for a microphone.

There are people who will give a microphone to you. Speak directly into the microphone. State your name and affiliation. And please limit yourself to one question. Try to be as concise as you can, so happy to take some questions.

Yes. The woman right there, please.

(Cross talk, laughter.)

QUESTIONER: Quick question, I promise.

How do you avoid the policy mistakes that happened, in 1931 to '33 and again in '37 or so, as you deal with the significant financial crisis, given the problems of dealing with Congress?

ROMER: All right. Boy, coming back to my world, right, economic history.

So '31 to '33, that one strikes me as easier, right, so I think, as I gather, one of the things that came up, in the morning session. But what is true is, you know, the shocks that hit the U.S. economy in 1929, even 1930, you know, were big but were not enormous.

I often say, I think, the shocks that hit our economy this past year-and-a-half are probably about the same size, if not bigger. And I think what your getting at is very much what turned the Great Depression from, you know, pretty ordinary, maybe a severe recession, to the Great Depression was actually a number of policy mistakes.

It's the Fed saying, we're having financial panics, not our problem, right? And that's, you know, certainly letting the money supply contract tremendously. We know in contrast to what we did, right, we had a major tax increase in 1932.

I'm sure you probably talked this morning about the Smoot-Hawley Tariff and putting on trade barriers. So just the confluence of policy mistakes, in this one short period, is really quite striking.

At some level, I want to say, we've already avoided them. Part of what I find so thrilling, about the current situation, is the degree we've already mentioned the Federal Reserve.

You know, I think, it's no surprise that Ben Bernanke is a specialist in the Great Depression, because you saw the Federal Reserve do the most, you know, wide-ranging number of activities, to try to deal with the financial crisis last fall. If no one's buying commercial paper, let's set up a facility. If no one's buying securitized lending, let's set up a facility, right?

It's really been, I think, amazing. And likewise we haven't had a major tax cut. We had a $787-billion stimulus plan. So I think we're doing very well on learning from the 1930s and not recreating the mistakes of '31 and '32.

The '37 one is one that I've been thinking about, because really what happens in 1937 is, you're recovering. You're actually recovering very strongly. And then what happens is sort of, we know, sort of by accident, we had a big fiscal expansion in 1936. We paid a big bonus to veterans. And then it disappears in '37.

So that's a big fiscal contraction. The Federal Reserve starts, I think, to get nervous about inflation too early and kind of says, well, we might have inflation someday, so let's do some things, to get in a position where we could tighten, not understanding what they did was just tighten incredibly.

So we have, certainly, a very big both monetary and fiscal contraction in 1937. And that is what set us back for the recession of '38.

We're -- this is going to be -- as I've described, I don't anticipate the Fed doing what the 1937 Fed did. We do face the same situation of, we have this big fiscal stimulus in 2009 and 2010, and a lot of it disappears in 2011. And so just by its nature, there's a big fiscal contraction. And so that's certainly something that I have been thinking about and watching.

I think the path through it, we would hope, would be the private sector, right? If the things I was describing really are -- you know, are strong -- the pent-up demand, the rebound in inventories, if we get business investment going again -- you can certainly see a path through this where that sector comes back strongly, we keep interest rates low; you can imagine that certainly we can navigate through this. But it is something we're going to have to be -- we're going to have to be aware of.

There -- well, I think sometimes, you know, there was so much talk about, let's make sure that all the money in the fiscal stimulus package gets out in two years; a little bit of me was saying, you know, if it had a little tail going into 2011, that's not the worst situation. And that's -- I think that is one benefit of kind of where we ended up.

But it's my favorite question, so. (Laughter.)

KRAVIS: Yes.

QUESTIONER: Bob Lifton. You know, if you postulate net exports increasing, you postulate net investment in business in a highly competitive environment in which we live, with China, India and the like, and the past history, which reflected the fact that we couldn't even keep up any net exports of any kind, and that the bubble really was a replacement for our business, what do you see as the business model of America going forward that would allow us to accomplish what you're talking about, ex-cheerleading and optimistic hope? (Laughter.)

ROMER: I actually think I had a serious plan! (Laughter.) So I -- so one of the things that I describe -- I mean, so first, I think I have more faith in American ingenuity than you do. So I actually -- I actually think American corporations do a fantastic job of figuring out what products people want and finding the investment opportunities. So I think that is certainly going to be an important -- certainly an important part, going through this.

I think the -- you know, it's not a -- you know, the president talks a lot about renewable energy. And it's not just -- it's not just, again, a slogan or a phrase. If you think about where we are and where we need to get -- in terms of, we know that we are on a path to warming up our entire globe, we know that we are importing huge amounts of oil from abroad -- it's a -- I think, very likely the path that we are on is going to be a fundamental realignment towards renewable energy, other kinds of domestic energy. And that's going to require a lot of investment.

And so a big part, I think, of what the president was doing, both in his budget and in the recovery package, is laying the groundwork for that. You need the smart grid if you're going to actually use wind and you're going to use solar. You're going to need to start building a lot of your -- the -- of different kinds of machines to harness that kind of energy.

I also think the president's focus on education, as I mentioned -- I think that one of the things that has very much struck us is that an economy is more productive if it has more educated workers, if it has the right kind of training, if it has investment in people. And I think that is going to be something that will put us in a -- on a competitive edge, make us able to compete and grow along those dimensions.

KRAVIS: Yes, in the front, please?

QUESTIONER: If we put ourselves -- Letitia DeChatayeux (ph), Iseman Capital. If we put ourselves a year forward, and the 3.5 percent doesn't materialize, what will have happened? And also, in the meantime, what are the leading indicators that you would -- that will tell you at what point do you say now we're on a path to sustainable recovery? What are those indicators?

ROMER: Okay, so both -- both wonderful questions, sort of -- your first one is, what could go wrong, right? So, how do we end up being wrong? I think if we start with the first question, which is, what if the rest of the world deteriorates more, right? We know -- we sort of feel that we've taken actions that we think are going to be helpful, but what if the IMF is right and things are worse, or even the IMF doesn't get how far the rest of the world goes down? We know that can certainly be a drag on us. The other thing I think that could go wrong is the financial sector.

So again, we -- you know, the way I like to think of it, you know, I tend to think of sort of the fiscal -- the fiscal stimulus and the financial rescue are kind of designed to be reinforcing; that I think by getting people employed again, that tends to push up asset prices, that tends to make people default less, that tends to be good for your banking and financial system. Getting your financial system going again is good for lending and good for demand and good for putting people back to work. So if it all goes, again, as we anticipate, those things will reinforce each other.

But if, God forbid, something goes on so that we don't get the resurgence in lending, if we do have, you know, those credit spreads spike up again, I think that would be something that would set us back. So if I had to say, well, what are the risks, how could 2010 turn out less good than we anticipate, that would be, you know, the things that I'd be worried about.

What do we look at? I mean -- I mean, we look at all the conventional indicators. I mean, we're both doing a mixture of -- certainly, we're watching the financial sector, to make sure that we are seeing the healing that we think needs to be there. You know, I have to confess to having been surprised by how well the housing sector is doing. I mean, here's kind of the center of the downturn, and yet we're starting to see some measures of prices go up, we're starting to see building starts again. You know, that I find very encouraging.

I've been watching consumers a lot, so certainly -- you know, tonight I'll get the retail sales data, and that's going to be something -- you know, in my previous life, you know, I'd read the newspaper like everyone else. Now I live for -- you know, what's the data that's coming in tonight? And the surprising part is, the president does, too. It's like, "Is today the employment report?" "Yes, it is!" You know, it's just like -- it's just this is the -- you know, it's such an incredible issue. It's something that we are watching just unbelievably.

In terms of one of the things -- you know, again, we are so interested in the labor market. That certainly has been what the president, you know, has very much -- this is about jobs, it's about putting people back to work.

So I do a lot of, every Thursday, the new -- the initial claims for unemployment insurance, because that's really about the fastest data we get. And it actually has some pretty good predictive powers. So that I find myself again every week -- is it down a little bit? That would be a good sign that eventually we'll see the turn.

KRAVIS: All right.

Yes.

QUESTIONER: Thank you. (Inaudible.)

Dr. Romer, the picture that you just drew, chasing the holy grail of bubble-less growth and fundamentally reorganizing our economy and our business enterprise; you talked about a vigilant regulator, a regulatory framework, described some allocation of resources. And you used the word proper distribution of income.

Is it a fundamental shift away? Would you say that the American economic history has been characterized by bubble-based growth, which seemed to be at the heart of the innovation, and you've had your debacles from time to time?

Thank you. Sorry, the question was a long one.

ROMER: No. I think, in fact, what I would say is, in fact, the way I started, which is, bubble-free growth, I think, is typically the norm. So one of the things -- in some ways, what's been strange are the last two decades, where we had these two sort of bubble-fed -- these two bubble-fed expansions, or at least things that turned into bubbles.

If you really say the period from, you know, World War II through, you know, probably the 1990s, what you certainly had are a number of periods where we had good growth, like the 1960s, without a bubble developing, or the 1950s, without a bubble developing. So I would actually -- what I tried to describe is normally, you know, as even Alan Greenspan said, normally we'd expect market forces to kind of keep things under control.

What we've been describing is, to the degree that that doesn't seem to be enough, trying to put in place sensible, new regulatory framework to kind of help it along. And that is certainly what, I think, is a reasonable approach that, I think, can put us back to what I think is the norm, which is growth without bubbles.

KRAVIS: Yes. Right in the front row.

QUESTIONER: (Inaudible.)

My belief is that because of the crisis, the demographics of the U.S. have been severely altered. The two pillars of American wealth, which are retirement savings and house equity, have been hurt a lot. That will keep people in the workforce longer, leaving less room for more people to come into the workforce.

That's my working thesis. I would ask you to say if you agree with that or not.

ROMER: That's an interesting question. Certainly the way I've been focusing on it is, I agree that the fall in wealth that we've seen, I think -- the numbers are something -- we've lost, you know, sort of -- household wealth has fallen some 13 trillion, I mean, just a huge decline.

I think of it as affecting our saving behavior, so that we're going to tend to consume less and try to recoup our wealth. You want to put in another feature, which is maybe we'll work longer. And that could be something. I don't know. That will be an interesting thing, to see how it plays out.

I think the part I wouldn't necessarily -- certainly wouldn't agree with is that necessarily that's going to -- I think in your model, there's a fixed number of jobs. And so if people work longer, there's not space for the new people coming in. And my sense and maybe it goes back to my faith in the dynamism of the U.S. economy.

What is see is that typically when labor supply increases, which is what you would be describing, the economy expands. Right? So that's -- you know, that would tend to put downward pressure on wages. That's a signal to firms: "Gee, maybe we should build a new factory, or we should set up a new thing."

And so what I would anticipate is, if that does happen, rather than this clogging, it would be another factor of getting -- I guess we'd call it extensive growth, rather than intensive growth. But I think that is the most likely thing I'd expect to happen in that case.

KRAVIS: Yes, all the way in the back, standing.

QUESTIONER: Nick Platt, Asia Society. The theme of this conference has been financial turbulence and U.S. power, and I'd like to know what your take is on the answer to this question. What has been the impact of the financial turbulence and economic dislocation on U.S. power, in your opinion?

ROMER: I have to say I think that's a question outside my area of expertise.

What I will -- I mean, I think the important thing is -- let me talk it from the economist side, because that's the part I feel I have the better handle on.

You know, unquestionably we have, as I've said, faced an enormous shock. And that is certainly -- and unfortunately is something that has -- it's a shock that, as the president said, was felt through much of the world.

The positive side of it is, I think we have dealt with it. Right? So I don't know what it's going to do ultimately to our standing or all of that. But as a country I think there's something, I think, fundamentally admirable and empowering about facing a crisis and stepping up and doing what it takes to deal with it.

And I think the history of the last several months has been actually facing what was a very bad situation and working with Congress, the Federal Reserve doing its part, sort of putting in place what I firmly believe are the polices that are going to get us out of here. And I can't help but think that we come out stronger, if not as an international power, certainly as a people, for having faced this and dealt with it.

QUESTIONER: Following up on that, as you look around the world -- I know your focus is obviously the U.S., but we can't help but look how the rest of the world is growing or contracting. How do you see Europe in particular in -- at this point in time, and their financial institutions, their economy? Will they lag? Will they help us out of this? How do you see it?

ROMER: Certainly the conventional view, I think, is that they've been kind of six months behind us, right? So six months behind us going down and I think to the degree we're seeing glimmers of hope, it's sort of more here than in Europe.

You know, if I were to say where's the -- you know, certainly what seems to be true is a lot of the Asian countries -- certainly China, maybe even Japan -- seen more of a turn there, and so in terms of where the help might be coming from, I think probably we might look there more quickly than to Europe.

But I think it's much like what I was describing with, you know, if the financial sector heals, that works better with the real -- sector and they both come up together, is certainly true of all the countries of the world. The more that we can all start expanding, that's going to feed back from one to another. So, certainly any signs of life anywhere are, I think, great not just for that particular country but for everybody else.

KRAVIS: Okay. Yes, right -- you, yes.

QUESTIONER: Peter Kenen, Princeton University, and a former colleague of yours.

ROMER: Absolutely.

QUESTIONER: This is not the kind of question you would expect from me, knowing my professional interests. I'm wondering whether the council has given much attention to the stimulus that might be afforded by reform of health care, including, for example, the mechanization of and transformation of health care records, issues of this kind, new medical facilities and consolidation in the health care industry.

ROMER: I was counting on an international question from you, but anyway -- but thank you. I love that question, for several reasons.

One, certainly if you look at the American Recovery and Reinvestment Act, one of the main places where we put a lot of money was in health IT, a lot of those -- you know, sort of trying to jump- start that kind of investment, even some into research. And it's absolutely the case that, you know, when -- and again, it comes back to, well, where do you think the growth is going to be in the future? I mentioned energy, I mentioned the effects of education, but surely as an aging population, that's going to be something that -- you know, health care is a sector we'd expect to expand.

And you're right, if we have -- you know, the more we have reform that generates a different kind of technological progress or that requires investments to actually make it work, that's going to be -- going to be good.

Another thing that I've seen on the -- just thinking about sort of the short-run macroeconomic effects, you can't help but realize it would act like a positive supply shot. When people tell stories about the 1990s, why were they so terrific, why do we have low inflation and these very low rates of unemployment, the kind of conventional story is the move to managed care got us a one-time kind of drop in health care costs or a slowing of health care costs, and that acted just like if oil prices had come down or some other piece of the economy had gotten cheaper.

And so, you know, we've actually been doing some computer modeling that if we really can rein in health care costs, you can have a period of that same sort of beneficial supply shock, besides all the other benefits, like greater efficiency and not having your budget fall apart, so that's going to be good for capital formation. I think the idea that transforming health care is not just something you do because we've got millions of uninsured Americans or because the budget is falling apart, but simply because it's smart for the economy, is something that -- that is a point that needs to be made.

So, thank you.

KRAVIS: We'll take one last question, as we're running out of -- out of time.

Yes, right here.

QUESTIONER: Peter Alderman. My question is if you -- many of the folks in this room have made their wealth over the past 20 years by generating or benefitting from outsized returns, and the paradigm you have -- (laughter) -- the paradigm --

ROMER: Going to need to start making things. (Laughter.) No, anyway, go ahead.

QUESTIONER: The paradigm you have talked about really, in my mind, presupposes much lower rates of return. And how are we going to achieve that paradigm, change behavior, change investment patterns so capital will be employed at returns that are 5, 6, 7 percent, instead of sitting on the sidelines, waiting for the higher returns, or seeking out riskier investments that may not be as productive for the economy as a whole?

ROMER: Well, I think there are a couple of things. One is to say, sort of, what was different in the past? Why did we not -- I mean, we did a tremendous amount of investment, you know, in the '50s, in the '60s, in even the '80s, right, without sort of bubbles and outsized returns. So whether it needs to be a change in, you know, just attitudes and culture, or whether -- you know, I think I probably go back to the -- I think, you know, I have a lot of faith that American capitalists will learn, and that if we are successful and sort of keeping bubbles under control and not going back to that sort of bubble-driven thing, I think they'll pretty quickly say, "We -- we, you know, should be investing in sensible places and in the products that people want."

And I think that that is a model that -- we're not talking about anyone not earning lots of money, right? This is going to be a -- you know, if you think about it, an economy that redirects towards investment, right? That's an economy that's going to be growing quickly. That's going to be terrific for overall rates of return and for sort of the productivity of the economy.

So I think it's a very plausible -- a plausible scenario. But it may, you know, require a period of adjustment, or people learning, but I think that's what we're good at.

KRAVIS: Dr. Romer, thank you very much. This was terrific. (Applause.)

ROMER: Thank you.

KRAVIS: Thank you.

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This session was part of the Stephen C. Freidheim Symposium on Global Economics: Financial Turbulence and U.S. Power, which was made possible through the generous support of Stephen C. Freidheim.

 

HENRY KRAVIS: I'd like to welcome everybody to the third session of the Council on Foreign Relations symposium, on "Growth without Bubbles." This meeting is being webcast live around the nation and around the world via the Council's public website, www.cfr.org. I'd remind you, please turn off completely any cell phones, BlackBerrys or wireless devices; turn them off completely so we don't have the interference. And I'd also like to remind everyone that this meeting is on the record.

Today we're quite fortunate to have Dr. Christina Romer with us, who's chair of the Council of Economic Advisers. Many of you know, until her nomination, Dr. Romer was the co-director of the Program in Monetary Economics at the National Bureau of Economic Research. She also served as the vice president of the American Economic Association, where she was a member of the executive committee. Prior to that, she taught economics at Berkeley and public affairs and economics at Princeton -- a very good background.

She's an economic historian, specializes in the historical analysis of monetary policy. So I think really appropriate that she's in the job that she's in, and certainly appropriate that she's here today with us. She's known for her research on the causes and the recovery of the Great Depression and the role that fiscal and monetary policy played in the United States economic recovery.

So with that, I'd like to ask Dr. Romer to come up to speak to us, and we'll take some questions afterwards. Thank you. (Applause.)

CHRISTINA ROMER: Well, thank you. It is truly a pleasure and an honor to be here today. And actually, what I want to talk about today I'll call realistic expectations for America's future economic growth.

And sort of to set the stage, what I wanted to point out is, in the past 20 years we have had two periods of extended, robust growth: one from about 1992 to 2000 and the other from 2002 to 2007. And in both cases, aggregate output and employment grew steadily; unemployment flew -- fell to low levels; and inflation was restrained.

Now, to be sure, the two episodes had some important differences. Most notably, real medium -- median household income rose strongly in the 1990s but was largely stagnant in the early 2000s. But actually, a fundamental similarity was that both periods were accompanied by very large runups in asset prices that turned out, in retrospect, to be unjustified, a phenomenon that we commonly refer to as a bubble, for short.

Well, the result was substantial overinvestment in certain sectors of the economy, high-tech in the 1990s, housing in the 2000s.

More importantly, in both cases, the bubbles eventually burst, throwing the economy into a recession, a mild one at the end of the 1990s and, as we all know, an extremely severe one in the current episode.

Well, the subject that I want to talk about today is, how can we achieve the good without the bad? Do we need asset bubbles to get robust growth and low unemployment, or does growth inevitably cause such asset price bubbles? And what can we do to ensure that the next expansion doesn't come with a bubble of its own, planting the seeds of the next recession?

And as the title of my talk suggests, what I'm going to look at is, can -- how or can we create growth without bubbles?

All right. So my first observation is that history gives, I think, a clear answer to whether we can have growth without bubbles. Yes, we can. The history of the United States -- (laughter) -- and other economies -- (chuckles) -- provides numerous examples of periods of sustained growth that were not accompanied by large overvaluations of assets and substantial overinvestment in particular sectors.

So for concreteness, let me focus on one such episode -- that is, the United States in the 1960s. Specifically, I want to consider the U.S. in the -- over roughly the six-year period 1962 to 1967. This period was one of unbroken and robust expansion, with real GDP growing at an average rate of 5 percent a year, the unemployment rate falling from over 6 percent to just under 4 percent.

This growth was reflected in steadily rising real median family income. Nonresidential investment averaged a healthy 11 percent of GDP, and its share was generally rising over the period. We ran trade surpluses, with our net exports averaging close to 1 percent of GDP. The federal budget deficit hovered near 0, and the ratio of our debt to GDP fell from 45 to 33 percent. And the stock market rose at a very calm average rate of about 5 percent a year.

Now of course the 1960s were not perfect economically. The conglomerate mania led to some foolish business acquisitions and to the overvaluations of specific companies. More importantly, monetary and fiscal policymakers expanded too far, especially near the end of the decade, overheating the economy, increasing inflation and sowing the seeds for the eventual end of the expansion.

But none of this changes the fact that this period shows that we can have robust economic growth that is neither fueled by bubbles nor creates major bubbles.

There are many other examples like this. The U.S., from the end of World War II through the 1950s, although not as stable as the period that I've just described, experienced healthy and sustained growth (in/and ?) sensible asset markets. And abroad, Japan, Canada and most of Western Europe had sustained periods of non-bubbly growth from the end of World War II into the 1960s, and in some case beyond.

Moreover, I want to suggest there's a reason that such periods of bubble-free growth are common, and that is that there's a natural equilibrating mechanism that ensures that aggregate demand is adequate without the presence of an asset-price bubble.

If, at prevailing interest rates, the demand for the economy's goods and services, without any boost from bubble-driven investment, fell short of the economy's normal capacity, this would translate into a surplus of funds in credit markets. The demand for loans to finance new investment projects and purchases of durable goods would be less than the supply of funds from savers. But this is just another way of saying that interest rates would be above their equilibrium level. Interest rates would fall, relatively quickly if the Federal Reserve perceived the imbalance and injected additional funds into the market; more slowly if the imbalance was not evident. The fall in interest rates would increase investment and purchases of durable goods, as well as lower the value of the dollar and raise our net exports. The process would stop when demand equaled supply, with the economy operating at normal capacity. This is simply how economies have achieved healthy, bubble-free growth throughout modern history.

All right. Well, even if bubbles aren't necessary to growth, an obvious question is, well, how does an economy prevent asset bubbles from developing? And here I think the crucial insight is that bubbles are not a natural consequence of growth.

Indeed, one of the strengths of a well-functioning market economy is that it gives people strong incentives not to pay inflated prices for assets and not to undertake projects that don't pay off. Even in the presence of a global savings glut, low interest rates and, as some people like to put it, money sloshing around, it's not smart to lend money to people with lousy ideas. The venture capitalists who funded Boo.com, Webvan, Pets.com and the other spectacular failures of the dot-com era, lost bundles of money.

The same is true of the real estate developers in the current episode who built large numbers of homes in distant exurbs that they've never been able to sell. The experience of much of the period in the United States from the 1930s through the 1960s shows that it's possible to have very low interest rates without bubbles developing.

Thus, we can and we should rely on market competition as the first line of defense against bubbles. But here, we've learned very painfully that we can't rely completely on these market forces. We need to make sure that financial markets are transparent, and to work vigorously to combat fraudulent and deceptive practices, so that ordinary Americans, who are not experts in finance, are not taken advantage of.

We need to prevent large financial firms from playing a game of "Heads, we win; tails, you lose" with the taxpayers. We need to have appropriate regulation and oversight, particularly of financial firms that are important to the health of the overall financial system.

That's why the president has committed to working, with Congress, to undertake comprehensive reform of our financial regulatory structure.

The full details of reform will obviously take time and great care to flesh out, because it's crucial that we get this reform right. But one element will clearly be central to the issue of preventing bubbles.

Current proposals call for the creation of a systemic regulator, which will be charged with ensuring that all financial institutions -- whose combination of size, leverage, interconnectedness pose a threat to financial stability -- are subject to conservative prudential requirements.

The systemic regulator will also enhance monitoring of systemic threats, from activities in financial markets, including identifying and curtailing practices that can create or exacerbate asset-price bubbles.

More generally going forward, policy makers will need to be alert to questionable practices, conflicts of interest and the possibility of developing bubbles, rather than just having blind faith in the wisdom of financial markets.

The current episode has also taught us that cleaning up, after a popped bubble, is much harder than we might have previously thought. For this reason, policymakers may need to consider asset-price movements as one of a number of indicators, of current and prospective economic conditions that may warrant policy actions.

All right. So the essence of my argument thus far is that the goal of growth without bubbles is achievable and realistic. But concretely what will such growth look like? If growth is not driven by a boom in houses that turn out to have no buyers, or a boom in high-tech investments that turn out to have little use, what will it be driven by?

Well, let me start by talking about the long run. At some point, our current recession will end. And our economy will be operating at its normal level of capacity again. What will provide the demand for goods and services in that situation?

And to address this question, it's helpful to recall the first and, I would guess, in many cases, the only equation that many of us met, in our study of economics. And that is that the economy's total output of goods and services is equal to consumption plus investment plus net exports plus government purchases of goods and services. And I'll even go a little bit further. And I want to separate the investment piece into housing investment and non-housing investment.

All right. Well, looking at things in terms of this five-way breakdown, it seems pretty clear that two pieces will be providing a smaller portion of demand, in the future, than they did in recent years.

The first is housing. Housing investment, as a share of GDP, reached its post-Korean War high in 2005. And it averaged more than 30 -- more than 5.5 percent over the period, 2002 to 2006.

We were building about 30 percent more housing units a year, in the expansion in the 2000s, than in that of the 1990s.

So a return of housing share in GDP to close to the postwar average of 4-1/2 to 5 percent certainly seems likely.

The second piece of that decomposition that will be providing a smaller portion of demand in the future is almost surely consumption. When housing and stock prices were rising rapidly, households could accumulate wealth without saving out of their income. As a result, the personal savings rate was close to zero. Once the economy has recovered, that's neither likely nor desirable. The saving rate has already risen to 4.2 percent, and it's likely to rise further as incomes recover from the recession and households work to rebuild their wealth.

If the saving rate returned to the postwar average of about 7 percent, with no other changes, consumption's share in GDP would fall from 70 percent, that it averaged from 2002 to 2006, to about 66 percent. This is just a shade below its level during the expansions in the 1990s. All right, so not coming from housing, it's not coming from consumption.

The third component in that decomposition, government purchases of goods and services, I think, is also probably likely to be roughly constant rather than a source of increased demand. And here I need to be a little bit careful and remind you that economists don't treat programs like Social Security or Medicare as government purchases. Those are treated as transfer payments. But the composition, probably, of government purchases will surely change as our military involvement in Iraq and Afghanistan eventually winds down and we invest in education, clean energy and health care. This reorienting of government spending will make our economy more productive and so will raise the path of output going forward, but it's hard to see a big change in overall government purchases as a share of GDP, and it's hard to see any substantial change in the role that those purchases will play in generating demand.

All right, so this leaves us with two components of output to make up the shortfall from declining housing investment and consumption: net exports and business investment. And I think both are likely in the future to contribute to fulfilling the shortfall. As we all know -- let's start with net exports. As we all know, we've been running large trade deficits, not just for the past few years but for the past few decades. The average ratio of net exports to GDP in the 2000s expansion was a remarkable minus-5 percent. Such large trade deficits are simply not sustainable in the long run. They are the flip side of our high budget deficits and low personal saving. And they mean that the United States has been borrowing ever- increasing amounts from abroad. This clearly can't continue indefinitely.

At the same time, we should not expect or want to be running trade surpluses any time soon. The dynamism and technological leadership of the U.S. economy make it an attractive place to invest. Thus, even as the budget deficit falls and personal saving rises, it's still reasonable to expect investment to exceed saving, which necessarily implies a current account deficit.

In addition, recent research shows that Americans have consistently earned higher rates of return on their investments abroad than foreigners have earned on their investments here. Given the safety and soundness of the U.S. assets, not to mention Americans' famous willingness to take risks, this is not surprising. But it implies that some trade deficit is sustainable, even in the long run.

Now the last component, non-housing business investment, I think, is likely to be central to filling any shortfall in demand in the long run. During the expansions of the 2000s, the share of non-housing business investment in GDP averaged close to a full percentage point lower than its postwar average. Raising this component share back to and indeed above its historical average, I'd suggest, is not the daunting task that some might suggest.

Some of the increased investment should be encouraged by lower real interest rates. As I described before, healthy economies have a natural equilibrating mechanism. If consumers want to save more, interest rates tend to fall. This lowers the cost of borrowing. It lowers the opportunity cost of doing investment out of retained earning.

Firms with innovative ideas or products in high demand will have every incentive to invest and expand. Figuring out what those investments should be is the fundamental job of the private sector.

The strength of a well-functioning market system is that policymakers don't need to predict what the profitable investments will be in advance. We leave it to the small firms and the big corporations to figure out what products consumers want and what investments will therefore generate the highest returns.

But some of the polices that we are putting in place today may help to sow the seeds for particular areas of robust investment in the future. The American Recovery and Reinvestment Act included unprecedented natural -- national investment in developing renewable energy and in -- and building a smarter electricity grid.

This public investment may help to pave the way for a wave of private energy investment in -- by reducing uncertainty and providing some useful demonstrations.

Likewise, the president's proposal to establish a market-based system to limit greenhouse gas emissions, if it's enacted, will also provide incentives for private investment in clean domestic energy.

Likewise, the public investments in education and in research and development included in the recovery act, and in the president's budget that was just passed, are another policy that could ultimately stimulate private investment.

I think it's no coincidence that an extended period of high investment and bubble-free growth occurred in the decades following the GI Bill. That unprecedented investment in human capital formation left American industry with a magnificently trained workforce, and the country with a bounty of potential inventors and innovators. From these flowed the ideas and the incentives for rapid investment in the 1950s and 1960s.

President Obama's announced commitment to science education, basic research and expanded access to college for all Americans should unleash the same forces in the 21st century.

Whatever the particular form that the investments take, prudent government encouragement, together with lower interest rates and the dynamism of American capitalism, should continue to generate ample demand and growth in the future.

All right. Well, even if I've convinced you that growth without bubbles is possible in the long run, we still have to face the next few years. As we are all too well aware, the U.S. economy is in the throes of a terrible recession. We learned last Friday that the unemployment rate had risen to 8.9 percent in April, and that employment is now 5.7 million lower than it was in December of 2007.

Another crucial fact is that, to return an economy this sick back to health, it's not enough to merely stop falling and start growing again. We know from previous recessions that the unemployment rate continues to rise as long as real GDP growth is below its normal rate of about 2-1/2 percent per year. To bring the unemployment rate down quickly, we need a period of truly robust growth, perhaps of 4 percent per year or higher.

Well, given what I've just said about the likely conservatism of consumers over the long haul, without another bubble to invest in, is there any hope for the healthy rebound in demand and growth? And here again, the answer is yes. Now, one key source of the short-run boost in demand is already happening, and it's coming from the government. I mentioned in -- earlier that over the long run, government spending is not likely to be substantially larger, but it is unquestionably going to be larger in the near term.

The American Recovery and Reinvestment Act provides $787 billion of aggregate-demand stimulus, with the vast majority of it hitting the economy in the next two years. This extra stimulus is exactly what the economy needs to stop falling and start growing robustly. At a time when private investment and consumption is depressed, it's sound policy to expand government investment. It puts people back to work and increases the public capital stock, and so improves our productivity in the future.

In this context, I'd also like to point out that other actions we are taking are also likely to provide an important boost. The Federal Reserve's program of purchasing the debt of the government-sponsored enterprises, the GSEs, Freddie Mac and Fannie Mae, together with the Treasury's actions to increase the government support for these institutions, have brought mortgage rates to historic lows.

This, together with eased equity requirements for homeowners whose property values have fallen, has set off a wave of refinancing. Lower mortgage rates are sort of like a tax cut. They put money in consumers' pockets, and they increase demand.

Likewise, our joint program with the Federal Reserve to restart the securitized lending market is also starting to pay dividends. The TALF program had a much better week last week, announcing requests for loans to buy asset-backed securities of some $10-1/2 billion. Likewise, thanks to reduced fees and larger guarantees, the Small Business Administration -- their loan programs have had a resurgence in transactions.

Developments such as these, which increase lending, are crucial to allowing credit-constrained households and firms to start spending again. Secretary Geithner's often fond of saying there's probably more stimulus in getting financial markets lending again than in direct fiscal stimulus.

Now, while government actions will provide an important source of demand in the next few years, there's another factor that could also get us a temporary surge in spending, and that's investment rebound and pent-up demand.

During a recession, households cut back on their purchases of houses and durable goods, and firms cut back on investment of all kinds. The cutbacks are far more than proportional to the fall in income. Further, the depressed spending during the recession pushes the stocks of investment goods and consumer durables to low levels. Restoring them to normal requires a period when purchases have to not just return to normal, but are unusually high.

The result of these forces is that when the economy begins to recover, investment and the purchase of durable goods grow rapidly, strengthening the recovery and further fueling growth in those sectors. The result is really a virtuous circle that yields a period of rapid growth.

To understand this process, let's consider the case of inventories. In recent months, firms have been reducing their inventories in response to falling sales, rather than increasing them slightly as they normally do. As a result, total production in the economy has been falling much more than sales. Just having inventory accumulation return to zero or a small positive number would raise GDP growth sharply. But during the recovery period, firms will want to do more than that. Inventories are now substantially lower than they were a year ago. When sales turn around, as they surely will, firms will want to rebuild their inventories, leading to a period when production is growing considerably faster than sales.

You know, the process is similar for other types of investment in durable goods. Investment other than housing and inventories, which was not exceptionally high during the expansion, has plunged. A return to just normal would raise growth substantially. And at some point, firms will want to have unusually high investment, as they replace the equipment that they did not replace during the recession and make the new investments that they had postponed.

The housing sector is so depressed at the moment that a rise in housing starts just to the level of the 1990s expansion would represent almost a tripling from current levels. And even if consumption is lower in the long run because of increased saving, it's possible that we will have a period of unusually high expenditure, as consumers buy some of the cars, appliances and other durables that they haven't bought for the last 18 months.

Now, to be realistic, historical evidence suggests that recessions accompanied by financial crises tend to be more severe, and their recoveries more protracted. For this reason, policymakers would clearly need to monitor the economy closely, to see if the increase in government spending and the recovery of investment and the desire to rebuild stocks is generating sufficient demand.

But what I want to leave you with today is a sense that there is certainly a path by which the economy could generate the rapid growth necessary to not just stop the rise in unemployment, but to bring it down to normal levels, at a reasonable pace, without resorting to the bubble-based demand of the past.

All right. Well, where does all of this leave us? Well, I guess, I'd have to say, cautiously hopeful about where the economy is headed. I think the goal of long-run economic growth, without asset- price bubbles, is not only achievable but something we should expect, if we put in place a sound regulatory framework, and if policymakers remain vigilant.

The goal of a robust recovery is achievable, even if consumers want to save more, because of the short-run contribution of government spending and the natural forces of inventory rebound and pent-up demand. We do not need bubbles to pull the economy back or to keep it at normal.

I want to close by pointing out one implication of the discussion that I've not stressed so far. Bubble-free growth is not only feasible and not only more stable and sustainable than bubble-fed growth. It's also better for the distribution of income and for long- run growth.

In a bubble, the people who get in early make bundles. And the people who get in late lose their shirts. And on both the up and the down side, some of our brightest minds make small fortunes arranging the deals, rather than pursuing potentially more sociably valuable careers, in fields such as science, medicine and education.

Avoiding the bubbles means we avoid some of this waste of talent. More importantly in a bubble-free economy, more of our output will take the form of things that raise productivity, rather than investment goods that turn out to be worthless or consumption goods.

Our saving will be higher, so that domestic investment will be financed more out of domestic savings, with the result that the fraction of our output that is ours, to keep, will be greater than before. And the reorientation of production to investments in the people, products and energy of the future means that we'll be able to produce more, with less pollution, in the years to come.

For this reason, the frequent claim of the president and his economic team that the economy will not merely come through this crisis but come through it even stronger than before is not just a slogan. It's both a realistic and attainable goal.

Thank you. (Applause.)

KRAVIS: Thank you very much, Dr. Romer. I hope you're right about all of this. (Laughter.)

ROMER: I hope so too because I just went on record saying that now. (Laughter.)

KRAVIS: We all do. There's no question about it.

But if you look at the IMF projections, on a global basis, for this year and next year, and you know you have a global growth this year of maybe 0.5 percent or something like that, for the year, which is down from a recent projection, as you know.

And they also had the U.S. contracting by about 2 percent for the year and going up somewhat -- a slow recovery for next year.

The Obama administration, on the other hand, has a growth rate of about 3-1/2 percent for next year, which is -- obviously I, again, hope they're right, hope you're right. What happens if they're wrong? What does the Obama administration have to do to kick-start the economy so that we can start jobs growing again?

ROMER: All right. Well, there -- it's an excellent question. I think there are a couple of things to say. One is, of course, all forecasts have large margins of error. That's something that we all have to acknowledge. And though I'm on record, I'm perfectly aware I could turn out to be wrong.

But I think the important thing is to think about, certainly, what's likely. And that's really what I was trying to do in the talk, is to say, you know, even if you're realistic about how much more consumers might save, and all of the -- what's happening in the international community, you notice I certainly didn't talk about in the short run we wouldn't expect exports to be a major source of U.S. growth, just simply because the world economy is certainly still very sick.

But I think there is a reasonable path where we could absolutely see the kind of growth that we are forecasting. But you point, though -- and there's another reason, I think, why we think that, and I very much tried to give that as well, which is, we think we're taking the right policies, that the fiscal stimulus, the work we're trying to do to bring the financial markets back -- we think all of that's going to absolutely do the job.

But absolutely we've got to be watching this thing like a hawk, because we could be wrong. We need to absolutely make sure that we're seeing what we expect, which is the job losses to gradually get smaller, to -- GDP losses to get smaller, and finally turn positive; likewise, to finally start adding jobs. But it's going to be a monitoring, right? We've given what we think is a huge dose of medicine to the economy. The right thing is to give it some time to work.

But if, come the late summer and next fall, we're not seeing -- well, we don't move from sort of, you know, the glimmers of spring to, you know, the start of summer, that's when you say, maybe we need to -- are we doing enough for financial markets? Are we doing enough on the fiscal side? Are we doing enough in our housing programs? All of those things.

We're -- it's going to be a -- very much a wait and see, a careful monitoring. You know, the president's always said he'll do whatever it takes. And that's what we're in, is the phase of seeing if what we've done is enough.

KRAVIS: I mean, clearly we have to be patient. You know, the medicine has only been applied, and it's going to take some times -- to take hold.

But the troubling part with that is if they end up having to take a second dose or a third dose of this. And we're -- the administration just yesterday, or day before, increased the budget deficit to $1.8-plus trillion for this year and 1.26 (trillion dollars) for next year.

You take a Goldman Sachs estimate, and they're saying -- could average a trillion dollars over the next 10 years, per year.

Obviously this is not sustainable. We can't -- you know, we'll be broke as a country, and particularly with all of the plans that the administration has, that Congress has, with health care being at the top of that priority, where something has to be done.

But then we have the projected Medicare/Social security deficits that are looming, and whether you call them -- whether they are transfer payments or they're not, they're -- they've got to paid for, you know, somewhere, somehow.

What will the administration do? I mean, how are we going to take care of all of this if we have to just keep putting money in?

ROMER: Well, I think there are a couple of things. One is, you know, the budget deficit in the short run -- fundamentally, what we all know is, it's being driven to a huge extent by what's happening in the economy. So at some level, the actions that you take to get your economy back are good budget policies, just simply because there's nothing as bad for your budget as an economy in free fall.

The second thing is, any of the spending that you do, like even a $787 billion stimulus package that I admit is enormous and sounds enormous, things that are a one-time or a two-time expenditure are not what blows a hole in your deficit. It is the expenditures going off into infinity, like what we see projected with Medicare and things like that, that are really the things that affect the budget in the long run.

I think that's fundamentally why the president has said health care reform is actually a top priority. So rather than thinking of it as a budget buster, what he has absolutely said is, it's the thing we have to fix to get our budget under control in the long haul. And he actually, I remember, at the health care summit was just -- you know, he said to all you advocates of universal coverage, let me tell you, job number one -- we got to get cost growth under control, because that's the only way this works. It's the thing you have to do first to save us from going off to budget hell. And if you want to expand coverage, it's even more important, because you've got more people then that may be getting government assistance.

So you know, I am actually working very hard now in the health- care reform process, and one of the things that the Council of Economic Advisers has been doing is sort of looking at the economic impact. And I've really been struck by -- if you can do what Peter Orszag likes to do, with the careful hand gesture, bend the curve of how fast health-care costs are going up, by doing fundamental reforms, that can have just an amazingly large effect on the economy. It is such a big part of our economy. It's a big part that is projected to grow astronomically. Getting that under control has important effects not just for the budget but for efficiency, but for labor supply, for all sorts of things that just really make it just fundamental.

KRAVIS: Over time, however, it's going to take money to get to that point, and so we're going to continue to build these deficits. This isn't going to be something that's going to happen overnight, unfortunately.

ROMER: No, that's -- that's true. And certainly, one of the things that we are very cognizant of is how important it is, as we go through this process, to never lose sight of how genuinely crucial it is to get those costs under control. And as you point out, the faster, the better.

We do know that -- we just had a meeting yesterday with a lot of, you know -- and a remarkable meeting -- a lot of the private-sector interest groups in the health-care field coming in and saying, "We think we can cut cost growth by 1-1/2 percent per year." And so, if they're ready to try, so are we.

KRAVIS: That -- that would be good. (Laughter.) For sure.

ROMER: And effective, is what you meant to say.

KRAVIS: That would be good. (Laughter.)

So let's assume we get through this, and Ben Bernanke now decides that we've got to start putting the brakes on, okay? We've got to start tightening credit. But we don't have the growth yet. We see, yes, we're through the downturn; the stimulus is maybe taking some hold; but unfortunately, for whatever reasons, particularly outside of the United States, particularly because of China and some of the Asian countries, commodity prices start spiking up, and we now are back into a inflationary period. Fine line to walk. What are your thoughts?

ROMER: All right, well, so, the first thing is, it's very awkward, as someone who's spent my life commenting on what the Federal Reserve does as a monetary economist -- it's kind of the one thing I'm not supposed to do any more.

As a member of the administration, we certainly value the independence of the Federal Reserve. I think that the important -- (laughter) -- no, I'm serious. (Laughs, laughter.) That wasn't supposed to be funny. (Laughter.)

The key thing, though, is, you have to ask yourself -- well, what you describe as a fine line, you know, if we're not growing, it seems to me the chances that we would have inflation spike up and the Federal Reserve would say we need to clamp down is pretty unlikely, right?

You told the story where maybe there's some international thing, but I think that's -- that's not very likely, right? The thing I have certainly been worried about is not inflation, but deflation. When you have an economy as depressed as we have now, I think that is the much -- you know, the much bigger worry.

And so my anticipation is that the Fed is going to be looking at the same numbers we are, and saying we need to keep helping this economy. They certainly have shown, you know, an incredible flexibility and, you know, enthusiasm for doing what it takes to try to get lending going again, trying to hold our financial system going again.

So I don't anticipate them being in the difficult situation that you've described. What they will do if they do, that's for them to say.

KRAVIS: Great. All right, at this time, let me open it up to questions from the members and our guests. Let me remind you, please wait for a microphone.

There are people who will give a microphone to you. Speak directly into the microphone. State your name and affiliation. And please limit yourself to one question. Try to be as concise as you can, so happy to take some questions.

Yes. The woman right there, please.

(Cross talk, laughter.)

QUESTIONER: Quick question, I promise.

How do you avoid the policy mistakes that happened, in 1931 to '33 and again in '37 or so, as you deal with the significant financial crisis, given the problems of dealing with Congress?

ROMER: All right. Boy, coming back to my world, right, economic history.

So '31 to '33, that one strikes me as easier, right, so I think, as I gather, one of the things that came up, in the morning session. But what is true is, you know, the shocks that hit the U.S. economy in 1929, even 1930, you know, were big but were not enormous.

I often say, I think, the shocks that hit our economy this past year-and-a-half are probably about the same size, if not bigger. And I think what your getting at is very much what turned the Great Depression from, you know, pretty ordinary, maybe a severe recession, to the Great Depression was actually a number of policy mistakes.

It's the Fed saying, we're having financial panics, not our problem, right? And that's, you know, certainly letting the money supply contract tremendously. We know in contrast to what we did, right, we had a major tax increase in 1932.

I'm sure you probably talked this morning about the Smoot-Hawley Tariff and putting on trade barriers. So just the confluence of policy mistakes, in this one short period, is really quite striking.

At some level, I want to say, we've already avoided them. Part of what I find so thrilling, about the current situation, is the degree we've already mentioned the Federal Reserve.

You know, I think, it's no surprise that Ben Bernanke is a specialist in the Great Depression, because you saw the Federal Reserve do the most, you know, wide-ranging number of activities, to try to deal with the financial crisis last fall. If no one's buying commercial paper, let's set up a facility. If no one's buying securitized lending, let's set up a facility, right?

It's really been, I think, amazing. And likewise we haven't had a major tax cut. We had a $787-billion stimulus plan. So I think we're doing very well on learning from the 1930s and not recreating the mistakes of '31 and '32.

The '37 one is one that I've been thinking about, because really what happens in 1937 is, you're recovering. You're actually recovering very strongly. And then what happens is sort of, we know, sort of by accident, we had a big fiscal expansion in 1936. We paid a big bonus to veterans. And then it disappears in '37.

So that's a big fiscal contraction. The Federal Reserve starts, I think, to get nervous about inflation too early and kind of says, well, we might have inflation someday, so let's do some things, to get in a position where we could tighten, not understanding what they did was just tighten incredibly.

So we have, certainly, a very big both monetary and fiscal contraction in 1937. And that is what set us back for the recession of '38.

We're -- this is going to be -- as I've described, I don't anticipate the Fed doing what the 1937 Fed did. We do face the same situation of, we have this big fiscal stimulus in 2009 and 2010, and a lot of it disappears in 2011. And so just by its nature, there's a big fiscal contraction. And so that's certainly something that I have been thinking about and watching.

I think the path through it, we would hope, would be the private sector, right? If the things I was describing really are -- you know, are strong -- the pent-up demand, the rebound in inventories, if we get business investment going again -- you can certainly see a path through this where that sector comes back strongly, we keep interest rates low; you can imagine that certainly we can navigate through this. But it is something we're going to have to be -- we're going to have to be aware of.

There -- well, I think sometimes, you know, there was so much talk about, let's make sure that all the money in the fiscal stimulus package gets out in two years; a little bit of me was saying, you know, if it had a little tail going into 2011, that's not the worst situation. And that's -- I think that is one benefit of kind of where we ended up.

But it's my favorite question, so. (Laughter.)

KRAVIS: Yes.

QUESTIONER: Bob Lifton. You know, if you postulate net exports increasing, you postulate net investment in business in a highly competitive environment in which we live, with China, India and the like, and the past history, which reflected the fact that we couldn't even keep up any net exports of any kind, and that the bubble really was a replacement for our business, what do you see as the business model of America going forward that would allow us to accomplish what you're talking about, ex-cheerleading and optimistic hope? (Laughter.)

ROMER: I actually think I had a serious plan! (Laughter.) So I -- so one of the things that I describe -- I mean, so first, I think I have more faith in American ingenuity than you do. So I actually -- I actually think American corporations do a fantastic job of figuring out what products people want and finding the investment opportunities. So I think that is certainly going to be an important -- certainly an important part, going through this.

I think the -- you know, it's not a -- you know, the president talks a lot about renewable energy. And it's not just -- it's not just, again, a slogan or a phrase. If you think about where we are and where we need to get -- in terms of, we know that we are on a path to warming up our entire globe, we know that we are importing huge amounts of oil from abroad -- it's a -- I think, very likely the path that we are on is going to be a fundamental realignment towards renewable energy, other kinds of domestic energy. And that's going to require a lot of investment.

And so a big part, I think, of what the president was doing, both in his budget and in the recovery package, is laying the groundwork for that. You need the smart grid if you're going to actually use wind and you're going to use solar. You're going to need to start building a lot of your -- the -- of different kinds of machines to harness that kind of energy.

I also think the president's focus on education, as I mentioned -- I think that one of the things that has very much struck us is that an economy is more productive if it has more educated workers, if it has the right kind of training, if it has investment in people. And I think that is going to be something that will put us in a -- on a competitive edge, make us able to compete and grow along those dimensions.

KRAVIS: Yes, in the front, please?

QUESTIONER: If we put ourselves -- Letitia DeChatayeux (ph), Iseman Capital. If we put ourselves a year forward, and the 3.5 percent doesn't materialize, what will have happened? And also, in the meantime, what are the leading indicators that you would -- that will tell you at what point do you say now we're on a path to sustainable recovery? What are those indicators?

ROMER: Okay, so both -- both wonderful questions, sort of -- your first one is, what could go wrong, right? So, how do we end up being wrong? I think if we start with the first question, which is, what if the rest of the world deteriorates more, right? We know -- we sort of feel that we've taken actions that we think are going to be helpful, but what if the IMF is right and things are worse, or even the IMF doesn't get how far the rest of the world goes down? We know that can certainly be a drag on us. The other thing I think that could go wrong is the financial sector.

So again, we -- you know, the way I like to think of it, you know, I tend to think of sort of the fiscal -- the fiscal stimulus and the financial rescue are kind of designed to be reinforcing; that I think by getting people employed again, that tends to push up asset prices, that tends to make people default less, that tends to be good for your banking and financial system. Getting your financial system going again is good for lending and good for demand and good for putting people back to work. So if it all goes, again, as we anticipate, those things will reinforce each other.

But if, God forbid, something goes on so that we don't get the resurgence in lending, if we do have, you know, those credit spreads spike up again, I think that would be something that would set us back. So if I had to say, well, what are the risks, how could 2010 turn out less good than we anticipate, that would be, you know, the things that I'd be worried about.

What do we look at? I mean -- I mean, we look at all the conventional indicators. I mean, we're both doing a mixture of -- certainly, we're watching the financial sector, to make sure that we are seeing the healing that we think needs to be there. You know, I have to confess to having been surprised by how well the housing sector is doing. I mean, here's kind of the center of the downturn, and yet we're starting to see some measures of prices go up, we're starting to see building starts again. You know, that I find very encouraging.

I've been watching consumers a lot, so certainly -- you know, tonight I'll get the retail sales data, and that's going to be something -- you know, in my previous life, you know, I'd read the newspaper like everyone else. Now I live for -- you know, what's the data that's coming in tonight? And the surprising part is, the president does, too. It's like, "Is today the employment report?" "Yes, it is!" You know, it's just like -- it's just this is the -- you know, it's such an incredible issue. It's something that we are watching just unbelievably.

In terms of one of the things -- you know, again, we are so interested in the labor market. That certainly has been what the president, you know, has very much -- this is about jobs, it's about putting people back to work.

So I do a lot of, every Thursday, the new -- the initial claims for unemployment insurance, because that's really about the fastest data we get. And it actually has some pretty good predictive powers. So that I find myself again every week -- is it down a little bit? That would be a good sign that eventually we'll see the turn.

KRAVIS: All right.

Yes.

QUESTIONER: Thank you. (Inaudible.)

Dr. Romer, the picture that you just drew, chasing the holy grail of bubble-less growth and fundamentally reorganizing our economy and our business enterprise; you talked about a vigilant regulator, a regulatory framework, described some allocation of resources. And you used the word proper distribution of income.

Is it a fundamental shift away? Would you say that the American economic history has been characterized by bubble-based growth, which seemed to be at the heart of the innovation, and you've had your debacles from time to time?

Thank you. Sorry, the question was a long one.

ROMER: No. I think, in fact, what I would say is, in fact, the way I started, which is, bubble-free growth, I think, is typically the norm. So one of the things -- in some ways, what's been strange are the last two decades, where we had these two sort of bubble-fed -- these two bubble-fed expansions, or at least things that turned into bubbles.

If you really say the period from, you know, World War II through, you know, probably the 1990s, what you certainly had are a number of periods where we had good growth, like the 1960s, without a bubble developing, or the 1950s, without a bubble developing. So I would actually -- what I tried to describe is normally, you know, as even Alan Greenspan said, normally we'd expect market forces to kind of keep things under control.

What we've been describing is, to the degree that that doesn't seem to be enough, trying to put in place sensible, new regulatory framework to kind of help it along. And that is certainly what, I think, is a reasonable approach that, I think, can put us back to what I think is the norm, which is growth without bubbles.

KRAVIS: Yes. Right in the front row.

QUESTIONER: (Inaudible.)

My belief is that because of the crisis, the demographics of the U.S. have been severely altered. The two pillars of American wealth, which are retirement savings and house equity, have been hurt a lot. That will keep people in the workforce longer, leaving less room for more people to come into the workforce.

That's my working thesis. I would ask you to say if you agree with that or not.

ROMER: That's an interesting question. Certainly the way I've been focusing on it is, I agree that the fall in wealth that we've seen, I think -- the numbers are something -- we've lost, you know, sort of -- household wealth has fallen some 13 trillion, I mean, just a huge decline.

I think of it as affecting our saving behavior, so that we're going to tend to consume less and try to recoup our wealth. You want to put in another feature, which is maybe we'll work longer. And that could be something. I don't know. That will be an interesting thing, to see how it plays out.

I think the part I wouldn't necessarily -- certainly wouldn't agree with is that necessarily that's going to -- I think in your model, there's a fixed number of jobs. And so if people work longer, there's not space for the new people coming in. And my sense and maybe it goes back to my faith in the dynamism of the U.S. economy.

What is see is that typically when labor supply increases, which is what you would be describing, the economy expands. Right? So that's -- you know, that would tend to put downward pressure on wages. That's a signal to firms: "Gee, maybe we should build a new factory, or we should set up a new thing."

And so what I would anticipate is, if that does happen, rather than this clogging, it would be another factor of getting -- I guess we'd call it extensive growth, rather than intensive growth. But I think that is the most likely thing I'd expect to happen in that case.

KRAVIS: Yes, all the way in the back, standing.

QUESTIONER: Nick Platt, Asia Society. The theme of this conference has been financial turbulence and U.S. power, and I'd like to know what your take is on the answer to this question. What has been the impact of the financial turbulence and economic dislocation on U.S. power, in your opinion?

ROMER: I have to say I think that's a question outside my area of expertise.

What I will -- I mean, I think the important thing is -- let me talk it from the economist side, because that's the part I feel I have the better handle on.

You know, unquestionably we have, as I've said, faced an enormous shock. And that is certainly -- and unfortunately is something that has -- it's a shock that, as the president said, was felt through much of the world.

The positive side of it is, I think we have dealt with it. Right? So I don't know what it's going to do ultimately to our standing or all of that. But as a country I think there's something, I think, fundamentally admirable and empowering about facing a crisis and stepping up and doing what it takes to deal with it.

And I think the history of the last several months has been actually facing what was a very bad situation and working with Congress, the Federal Reserve doing its part, sort of putting in place what I firmly believe are the polices that are going to get us out of here. And I can't help but think that we come out stronger, if not as an international power, certainly as a people, for having faced this and dealt with it.

QUESTIONER: Following up on that, as you look around the world -- I know your focus is obviously the U.S., but we can't help but look how the rest of the world is growing or contracting. How do you see Europe in particular in -- at this point in time, and their financial institutions, their economy? Will they lag? Will they help us out of this? How do you see it?

ROMER: Certainly the conventional view, I think, is that they've been kind of six months behind us, right? So six months behind us going down and I think to the degree we're seeing glimmers of hope, it's sort of more here than in Europe.

You know, if I were to say where's the -- you know, certainly what seems to be true is a lot of the Asian countries -- certainly China, maybe even Japan -- seen more of a turn there, and so in terms of where the help might be coming from, I think probably we might look there more quickly than to Europe.

But I think it's much like what I was describing with, you know, if the financial sector heals, that works better with the real -- sector and they both come up together, is certainly true of all the countries of the world. The more that we can all start expanding, that's going to feed back from one to another. So, certainly any signs of life anywhere are, I think, great not just for that particular country but for everybody else.

KRAVIS: Okay. Yes, right -- you, yes.

QUESTIONER: Peter Kenen, Princeton University, and a former colleague of yours.

ROMER: Absolutely.

QUESTIONER: This is not the kind of question you would expect from me, knowing my professional interests. I'm wondering whether the council has given much attention to the stimulus that might be afforded by reform of health care, including, for example, the mechanization of and transformation of health care records, issues of this kind, new medical facilities and consolidation in the health care industry.

ROMER: I was counting on an international question from you, but anyway -- but thank you. I love that question, for several reasons.

One, certainly if you look at the American Recovery and Reinvestment Act, one of the main places where we put a lot of money was in health IT, a lot of those -- you know, sort of trying to jump- start that kind of investment, even some into research. And it's absolutely the case that, you know, when -- and again, it comes back to, well, where do you think the growth is going to be in the future? I mentioned energy, I mentioned the effects of education, but surely as an aging population, that's going to be something that -- you know, health care is a sector we'd expect to expand.

And you're right, if we have -- you know, the more we have reform that generates a different kind of technological progress or that requires investments to actually make it work, that's going to be -- going to be good.

Another thing that I've seen on the -- just thinking about sort of the short-run macroeconomic effects, you can't help but realize it would act like a positive supply shot. When people tell stories about the 1990s, why were they so terrific, why do we have low inflation and these very low rates of unemployment, the kind of conventional story is the move to managed care got us a one-time kind of drop in health care costs or a slowing of health care costs, and that acted just like if oil prices had come down or some other piece of the economy had gotten cheaper.

And so, you know, we've actually been doing some computer modeling that if we really can rein in health care costs, you can have a period of that same sort of beneficial supply shock, besides all the other benefits, like greater efficiency and not having your budget fall apart, so that's going to be good for capital formation. I think the idea that transforming health care is not just something you do because we've got millions of uninsured Americans or because the budget is falling apart, but simply because it's smart for the economy, is something that -- that is a point that needs to be made.

So, thank you.

KRAVIS: We'll take one last question, as we're running out of -- out of time.

Yes, right here.

QUESTIONER: Peter Alderman. My question is if you -- many of the folks in this room have made their wealth over the past 20 years by generating or benefitting from outsized returns, and the paradigm you have -- (laughter) -- the paradigm --

ROMER: Going to need to start making things. (Laughter.) No, anyway, go ahead.

QUESTIONER: The paradigm you have talked about really, in my mind, presupposes much lower rates of return. And how are we going to achieve that paradigm, change behavior, change investment patterns so capital will be employed at returns that are 5, 6, 7 percent, instead of sitting on the sidelines, waiting for the higher returns, or seeking out riskier investments that may not be as productive for the economy as a whole?

ROMER: Well, I think there are a couple of things. One is to say, sort of, what was different in the past? Why did we not -- I mean, we did a tremendous amount of investment, you know, in the '50s, in the '60s, in even the '80s, right, without sort of bubbles and outsized returns. So whether it needs to be a change in, you know, just attitudes and culture, or whether -- you know, I think I probably go back to the -- I think, you know, I have a lot of faith that American capitalists will learn, and that if we are successful and sort of keeping bubbles under control and not going back to that sort of bubble-driven thing, I think they'll pretty quickly say, "We -- we, you know, should be investing in sensible places and in the products that people want."

And I think that that is a model that -- we're not talking about anyone not earning lots of money, right? This is going to be a -- you know, if you think about it, an economy that redirects towards investment, right? That's an economy that's going to be growing quickly. That's going to be terrific for overall rates of return and for sort of the productivity of the economy.

So I think it's a very plausible -- a plausible scenario. But it may, you know, require a period of adjustment, or people learning, but I think that's what we're good at.

KRAVIS: Dr. Romer, thank you very much. This was terrific. (Applause.)

ROMER: Thank you.

KRAVIS: Thank you.

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This session was part of the Stephen C. Freidheim Symposium on Global Economics: Financial Turbulence and U.S. Power, which was made possible through the generous support of Stephen C. Freidheim.

 

HENRY KRAVIS: I'd like to welcome everybody to the third session of the Council on Foreign Relations symposium, on "Growth without Bubbles." This meeting is being webcast live around the nation and around the world via the Council's public website, www.cfr.org. I'd remind you, please turn off completely any cell phones, BlackBerrys or wireless devices; turn them off completely so we don't have the interference. And I'd also like to remind everyone that this meeting is on the record.

Today we're quite fortunate to have Dr. Christina Romer with us, who's chair of the Council of Economic Advisers. Many of you know, until her nomination, Dr. Romer was the co-director of the Program in Monetary Economics at the National Bureau of Economic Research. She also served as the vice president of the American Economic Association, where she was a member of the executive committee. Prior to that, she taught economics at Berkeley and public affairs and economics at Princeton -- a very good background.

She's an economic historian, specializes in the historical analysis of monetary policy. So I think really appropriate that she's in the job that she's in, and certainly appropriate that she's here today with us. She's known for her research on the causes and the recovery of the Great Depression and the role that fiscal and monetary policy played in the United States economic recovery.

So with that, I'd like to ask Dr. Romer to come up to speak to us, and we'll take some questions afterwards. Thank you. (Applause.)

CHRISTINA ROMER: Well, thank you. It is truly a pleasure and an honor to be here today. And actually, what I want to talk about today I'll call realistic expectations for America's future economic growth.

And sort of to set the stage, what I wanted to point out is, in the past 20 years we have had two periods of extended, robust growth: one from about 1992 to 2000 and the other from 2002 to 2007. And in both cases, aggregate output and employment grew steadily; unemployment flew -- fell to low levels; and inflation was restrained.

Now, to be sure, the two episodes had some important differences. Most notably, real medium -- median household income rose strongly in the 1990s but was largely stagnant in the early 2000s. But actually, a fundamental similarity was that both periods were accompanied by very large runups in asset prices that turned out, in retrospect, to be unjustified, a phenomenon that we commonly refer to as a bubble, for short.

Well, the result was substantial overinvestment in certain sectors of the economy, high-tech in the 1990s, housing in the 2000s.

More importantly, in both cases, the bubbles eventually burst, throwing the economy into a recession, a mild one at the end of the 1990s and, as we all know, an extremely severe one in the current episode.

Well, the subject that I want to talk about today is, how can we achieve the good without the bad? Do we need asset bubbles to get robust growth and low unemployment, or does growth inevitably cause such asset price bubbles? And what can we do to ensure that the next expansion doesn't come with a bubble of its own, planting the seeds of the next recession?

And as the title of my talk suggests, what I'm going to look at is, can -- how or can we create growth without bubbles?

All right. So my first observation is that history gives, I think, a clear answer to whether we can have growth without bubbles. Yes, we can. The history of the United States -- (laughter) -- and other economies -- (chuckles) -- provides numerous examples of periods of sustained growth that were not accompanied by large overvaluations of assets and substantial overinvestment in particular sectors.

So for concreteness, let me focus on one such episode -- that is, the United States in the 1960s. Specifically, I want to consider the U.S. in the -- over roughly the six-year period 1962 to 1967. This period was one of unbroken and robust expansion, with real GDP growing at an average rate of 5 percent a year, the unemployment rate falling from over 6 percent to just under 4 percent.

This growth was reflected in steadily rising real median family income. Nonresidential investment averaged a healthy 11 percent of GDP, and its share was generally rising over the period. We ran trade surpluses, with our net exports averaging close to 1 percent of GDP. The federal budget deficit hovered near 0, and the ratio of our debt to GDP fell from 45 to 33 percent. And the stock market rose at a very calm average rate of about 5 percent a year.

Now of course the 1960s were not perfect economically. The conglomerate mania led to some foolish business acquisitions and to the overvaluations of specific companies. More importantly, monetary and fiscal policymakers expanded too far, especially near the end of the decade, overheating the economy, increasing inflation and sowing the seeds for the eventual end of the expansion.

But none of this changes the fact that this period shows that we can have robust economic growth that is neither fueled by bubbles nor creates major bubbles.

There are many other examples like this. The U.S., from the end of World War II through the 1950s, although not as stable as the period that I've just described, experienced healthy and sustained growth (in/and ?) sensible asset markets. And abroad, Japan, Canada and most of Western Europe had sustained periods of non-bubbly growth from the end of World War II into the 1960s, and in some case beyond.

Moreover, I want to suggest there's a reason that such periods of bubble-free growth are common, and that is that there's a natural equilibrating mechanism that ensures that aggregate demand is adequate without the presence of an asset-price bubble.

If, at prevailing interest rates, the demand for the economy's goods and services, without any boost from bubble-driven investment, fell short of the economy's normal capacity, this would translate into a surplus of funds in credit markets. The demand for loans to finance new investment projects and purchases of durable goods would be less than the supply of funds from savers. But this is just another way of saying that interest rates would be above their equilibrium level. Interest rates would fall, relatively quickly if the Federal Reserve perceived the imbalance and injected additional funds into the market; more slowly if the imbalance was not evident. The fall in interest rates would increase investment and purchases of durable goods, as well as lower the value of the dollar and raise our net exports. The process would stop when demand equaled supply, with the economy operating at normal capacity. This is simply how economies have achieved healthy, bubble-free growth throughout modern history.

All right. Well, even if bubbles aren't necessary to growth, an obvious question is, well, how does an economy prevent asset bubbles from developing? And here I think the crucial insight is that bubbles are not a natural consequence of growth.

Indeed, one of the strengths of a well-functioning market economy is that it gives people strong incentives not to pay inflated prices for assets and not to undertake projects that don't pay off. Even in the presence of a global savings glut, low interest rates and, as some people like to put it, money sloshing around, it's not smart to lend money to people with lousy ideas. The venture capitalists who funded Boo.com, Webvan, Pets.com and the other spectacular failures of the dot-com era, lost bundles of money.

The same is true of the real estate developers in the current episode who built large numbers of homes in distant exurbs that they've never been able to sell. The experience of much of the period in the United States from the 1930s through the 1960s shows that it's possible to have very low interest rates without bubbles developing.

Thus, we can and we should rely on market competition as the first line of defense against bubbles. But here, we've learned very painfully that we can't rely completely on these market forces. We need to make sure that financial markets are transparent, and to work vigorously to combat fraudulent and deceptive practices, so that ordinary Americans, who are not experts in finance, are not taken advantage of.

We need to prevent large financial firms from playing a game of "Heads, we win; tails, you lose" with the taxpayers. We need to have appropriate regulation and oversight, particularly of financial firms that are important to the health of the overall financial system.

That's why the president has committed to working, with Congress, to undertake comprehensive reform of our financial regulatory structure.

The full details of reform will obviously take time and great care to flesh out, because it's crucial that we get this reform right. But one element will clearly be central to the issue of preventing bubbles.

Current proposals call for the creation of a systemic regulator, which will be charged with ensuring that all financial institutions -- whose combination of size, leverage, interconnectedness pose a threat to financial stability -- are subject to conservative prudential requirements.

The systemic regulator will also enhance monitoring of systemic threats, from activities in financial markets, including identifying and curtailing practices that can create or exacerbate asset-price bubbles.

More generally going forward, policy makers will need to be alert to questionable practices, conflicts of interest and the possibility of developing bubbles, rather than just having blind faith in the wisdom of financial markets.

The current episode has also taught us that cleaning up, after a popped bubble, is much harder than we might have previously thought. For this reason, policymakers may need to consider asset-price movements as one of a number of indicators, of current and prospective economic conditions that may warrant policy actions.

All right. So the essence of my argument thus far is that the goal of growth without bubbles is achievable and realistic. But concretely what will such growth look like? If growth is not driven by a boom in houses that turn out to have no buyers, or a boom in high-tech investments that turn out to have little use, what will it be driven by?

Well, let me start by talking about the long run. At some point, our current recession will end. And our economy will be operating at its normal level of capacity again. What will provide the demand for goods and services in that situation?

And to address this question, it's helpful to recall the first and, I would guess, in many cases, the only equation that many of us met, in our study of economics. And that is that the economy's total output of goods and services is equal to consumption plus investment plus net exports plus government purchases of goods and services. And I'll even go a little bit further. And I want to separate the investment piece into housing investment and non-housing investment.

All right. Well, looking at things in terms of this five-way breakdown, it seems pretty clear that two pieces will be providing a smaller portion of demand, in the future, than they did in recent years.

The first is housing. Housing investment, as a share of GDP, reached its post-Korean War high in 2005. And it averaged more than 30 -- more than 5.5 percent over the period, 2002 to 2006.

We were building about 30 percent more housing units a year, in the expansion in the 2000s, than in that of the 1990s.

So a return of housing share in GDP to close to the postwar average of 4-1/2 to 5 percent certainly seems likely.

The second piece of that decomposition that will be providing a smaller portion of demand in the future is almost surely consumption. When housing and stock prices were rising rapidly, households could accumulate wealth without saving out of their income. As a result, the personal savings rate was close to zero. Once the economy has recovered, that's neither likely nor desirable. The saving rate has already risen to 4.2 percent, and it's likely to rise further as incomes recover from the recession and households work to rebuild their wealth.

If the saving rate returned to the postwar average of about 7 percent, with no other changes, consumption's share in GDP would fall from 70 percent, that it averaged from 2002 to 2006, to about 66 percent. This is just a shade below its level during the expansions in the 1990s. All right, so not coming from housing, it's not coming from consumption.

The third component in that decomposition, government purchases of goods and services, I think, is also probably likely to be roughly constant rather than a source of increased demand. And here I need to be a little bit careful and remind you that economists don't treat programs like Social Security or Medicare as government purchases. Those are treated as transfer payments. But the composition, probably, of government purchases will surely change as our military involvement in Iraq and Afghanistan eventually winds down and we invest in education, clean energy and health care. This reorienting of government spending will make our economy more productive and so will raise the path of output going forward, but it's hard to see a big change in overall government purchases as a share of GDP, and it's hard to see any substantial change in the role that those purchases will play in generating demand.

All right, so this leaves us with two components of output to make up the shortfall from declining housing investment and consumption: net exports and business investment. And I think both are likely in the future to contribute to fulfilling the shortfall. As we all know -- let's start with net exports. As we all know, we've been running large trade deficits, not just for the past few years but for the past few decades. The average ratio of net exports to GDP in the 2000s expansion was a remarkable minus-5 percent. Such large trade deficits are simply not sustainable in the long run. They are the flip side of our high budget deficits and low personal saving. And they mean that the United States has been borrowing ever- increasing amounts from abroad. This clearly can't continue indefinitely.

At the same time, we should not expect or want to be running trade surpluses any time soon. The dynamism and technological leadership of the U.S. economy make it an attractive place to invest. Thus, even as the budget deficit falls and personal saving rises, it's still reasonable to expect investment to exceed saving, which necessarily implies a current account deficit.

In addition, recent research shows that Americans have consistently earned higher rates of return on their investments abroad than foreigners have earned on their investments here. Given the safety and soundness of the U.S. assets, not to mention Americans' famous willingness to take risks, this is not surprising. But it implies that some trade deficit is sustainable, even in the long run.

Now the last component, non-housing business investment, I think, is likely to be central to filling any shortfall in demand in the long run. During the expansions of the 2000s, the share of non-housing business investment in GDP averaged close to a full percentage point lower than its postwar average. Raising this component share back to and indeed above its historical average, I'd suggest, is not the daunting task that some might suggest.

Some of the increased investment should be encouraged by lower real interest rates. As I described before, healthy economies have a natural equilibrating mechanism. If consumers want to save more, interest rates tend to fall. This lowers the cost of borrowing. It lowers the opportunity cost of doing investment out of retained earning.

Firms with innovative ideas or products in high demand will have every incentive to invest and expand. Figuring out what those investments should be is the fundamental job of the private sector.

The strength of a well-functioning market system is that policymakers don't need to predict what the profitable investments will be in advance. We leave it to the small firms and the big corporations to figure out what products consumers want and what investments will therefore generate the highest returns.

But some of the polices that we are putting in place today may help to sow the seeds for particular areas of robust investment in the future. The American Recovery and Reinvestment Act included unprecedented natural -- national investment in developing renewable energy and in -- and building a smarter electricity grid.

This public investment may help to pave the way for a wave of private energy investment in -- by reducing uncertainty and providing some useful demonstrations.

Likewise, the president's proposal to establish a market-based system to limit greenhouse gas emissions, if it's enacted, will also provide incentives for private investment in clean domestic energy.

Likewise, the public investments in education and in research and development included in the recovery act, and in the president's budget that was just passed, are another policy that could ultimately stimulate private investment.

I think it's no coincidence that an extended period of high investment and bubble-free growth occurred in the decades following the GI Bill. That unprecedented investment in human capital formation left American industry with a magnificently trained workforce, and the country with a bounty of potential inventors and innovators. From these flowed the ideas and the incentives for rapid investment in the 1950s and 1960s.

President Obama's announced commitment to science education, basic research and expanded access to college for all Americans should unleash the same forces in the 21st century.

Whatever the particular form that the investments take, prudent government encouragement, together with lower interest rates and the dynamism of American capitalism, should continue to generate ample demand and growth in the future.

All right. Well, even if I've convinced you that growth without bubbles is possible in the long run, we still have to face the next few years. As we are all too well aware, the U.S. economy is in the throes of a terrible recession. We learned last Friday that the unemployment rate had risen to 8.9 percent in April, and that employment is now 5.7 million lower than it was in December of 2007.

Another crucial fact is that, to return an economy this sick back to health, it's not enough to merely stop falling and start growing again. We know from previous recessions that the unemployment rate continues to rise as long as real GDP growth is below its normal rate of about 2-1/2 percent per year. To bring the unemployment rate down quickly, we need a period of truly robust growth, perhaps of 4 percent per year or higher.

Well, given what I've just said about the likely conservatism of consumers over the long haul, without another bubble to invest in, is there any hope for the healthy rebound in demand and growth? And here again, the answer is yes. Now, one key source of the short-run boost in demand is already happening, and it's coming from the government. I mentioned in -- earlier that over the long run, government spending is not likely to be substantially larger, but it is unquestionably going to be larger in the near term.

The American Recovery and Reinvestment Act provides $787 billion of aggregate-demand stimulus, with the vast majority of it hitting the economy in the next two years. This extra stimulus is exactly what the economy needs to stop falling and start growing robustly. At a time when private investment and consumption is depressed, it's sound policy to expand government investment. It puts people back to work and increases the public capital stock, and so improves our productivity in the future.

In this context, I'd also like to point out that other actions we are taking are also likely to provide an important boost. The Federal Reserve's program of purchasing the debt of the government-sponsored enterprises, the GSEs, Freddie Mac and Fannie Mae, together with the Treasury's actions to increase the government support for these institutions, have brought mortgage rates to historic lows.

This, together with eased equity requirements for homeowners whose property values have fallen, has set off a wave of refinancing. Lower mortgage rates are sort of like a tax cut. They put money in consumers' pockets, and they increase demand.

Likewise, our joint program with the Federal Reserve to restart the securitized lending market is also starting to pay dividends. The TALF program had a much better week last week, announcing requests for loans to buy asset-backed securities of some $10-1/2 billion. Likewise, thanks to reduced fees and larger guarantees, the Small Business Administration -- their loan programs have had a resurgence in transactions.

Developments such as these, which increase lending, are crucial to allowing credit-constrained households and firms to start spending again. Secretary Geithner's often fond of saying there's probably more stimulus in getting financial markets lending again than in direct fiscal stimulus.

Now, while government actions will provide an important source of demand in the next few years, there's another factor that could also get us a temporary surge in spending, and that's investment rebound and pent-up demand.

During a recession, households cut back on their purchases of houses and durable goods, and firms cut back on investment of all kinds. The cutbacks are far more than proportional to the fall in income. Further, the depressed spending during the recession pushes the stocks of investment goods and consumer durables to low levels. Restoring them to normal requires a period when purchases have to not just return to normal, but are unusually high.

The result of these forces is that when the economy begins to recover, investment and the purchase of durable goods grow rapidly, strengthening the recovery and further fueling growth in those sectors. The result is really a virtuous circle that yields a period of rapid growth.

To understand this process, let's consider the case of inventories. In recent months, firms have been reducing their inventories in response to falling sales, rather than increasing them slightly as they normally do. As a result, total production in the economy has been falling much more than sales. Just having inventory accumulation return to zero or a small positive number would raise GDP growth sharply. But during the recovery period, firms will want to do more than that. Inventories are now substantially lower than they were a year ago. When sales turn around, as they surely will, firms will want to rebuild their inventories, leading to a period when production is growing considerably faster than sales.

You know, the process is similar for other types of investment in durable goods. Investment other than housing and inventories, which was not exceptionally high during the expansion, has plunged. A return to just normal would raise growth substantially. And at some point, firms will want to have unusually high investment, as they replace the equipment that they did not replace during the recession and make the new investments that they had postponed.

The housing sector is so depressed at the moment that a rise in housing starts just to the level of the 1990s expansion would represent almost a tripling from current levels. And even if consumption is lower in the long run because of increased saving, it's possible that we will have a period of unusually high expenditure, as consumers buy some of the cars, appliances and other durables that they haven't bought for the last 18 months.

Now, to be realistic, historical evidence suggests that recessions accompanied by financial crises tend to be more severe, and their recoveries more protracted. For this reason, policymakers would clearly need to monitor the economy closely, to see if the increase in government spending and the recovery of investment and the desire to rebuild stocks is generating sufficient demand.

But what I want to leave you with today is a sense that there is certainly a path by which the economy could generate the rapid growth necessary to not just stop the rise in unemployment, but to bring it down to normal levels, at a reasonable pace, without resorting to the bubble-based demand of the past.

All right. Well, where does all of this leave us? Well, I guess, I'd have to say, cautiously hopeful about where the economy is headed. I think the goal of long-run economic growth, without asset- price bubbles, is not only achievable but something we should expect, if we put in place a sound regulatory framework, and if policymakers remain vigilant.

The goal of a robust recovery is achievable, even if consumers want to save more, because of the short-run contribution of government spending and the natural forces of inventory rebound and pent-up demand. We do not need bubbles to pull the economy back or to keep it at normal.

I want to close by pointing out one implication of the discussion that I've not stressed so far. Bubble-free growth is not only feasible and not only more stable and sustainable than bubble-fed growth. It's also better for the distribution of income and for long- run growth.

In a bubble, the people who get in early make bundles. And the people who get in late lose their shirts. And on both the up and the down side, some of our brightest minds make small fortunes arranging the deals, rather than pursuing potentially more sociably valuable careers, in fields such as science, medicine and education.

Avoiding the bubbles means we avoid some of this waste of talent. More importantly in a bubble-free economy, more of our output will take the form of things that raise productivity, rather than investment goods that turn out to be worthless or consumption goods.

Our saving will be higher, so that domestic investment will be financed more out of domestic savings, with the result that the fraction of our output that is ours, to keep, will be greater than before. And the reorientation of production to investments in the people, products and energy of the future means that we'll be able to produce more, with less pollution, in the years to come.

For this reason, the frequent claim of the president and his economic team that the economy will not merely come through this crisis but come through it even stronger than before is not just a slogan. It's both a realistic and attainable goal.

Thank you. (Applause.)

KRAVIS: Thank you very much, Dr. Romer. I hope you're right about all of this. (Laughter.)

ROMER: I hope so too because I just went on record saying that now. (Laughter.)

KRAVIS: We all do. There's no question about it.

But if you look at the IMF projections, on a global basis, for this year and next year, and you know you have a global growth this year of maybe 0.5 percent or something like that, for the year, which is down from a recent projection, as you know.

And they also had the U.S. contracting by about 2 percent for the year and going up somewhat -- a slow recovery for next year.

The Obama administration, on the other hand, has a growth rate of about 3-1/2 percent for next year, which is -- obviously I, again, hope they're right, hope you're right. What happens if they're wrong? What does the Obama administration have to do to kick-start the economy so that we can start jobs growing again?

ROMER: All right. Well, there -- it's an excellent question. I think there are a couple of things to say. One is, of course, all forecasts have large margins of error. That's something that we all have to acknowledge. And though I'm on record, I'm perfectly aware I could turn out to be wrong.

But I think the important thing is to think about, certainly, what's likely. And that's really what I was trying to do in the talk, is to say, you know, even if you're realistic about how much more consumers might save, and all of the -- what's happening in the international community, you notice I certainly didn't talk about in the short run we wouldn't expect exports to be a major source of U.S. growth, just simply because the world economy is certainly still very sick.

But I think there is a reasonable path where we could absolutely see the kind of growth that we are forecasting. But you point, though -- and there's another reason, I think, why we think that, and I very much tried to give that as well, which is, we think we're taking the right policies, that the fiscal stimulus, the work we're trying to do to bring the financial markets back -- we think all of that's going to absolutely do the job.

But absolutely we've got to be watching this thing like a hawk, because we could be wrong. We need to absolutely make sure that we're seeing what we expect, which is the job losses to gradually get smaller, to -- GDP losses to get smaller, and finally turn positive; likewise, to finally start adding jobs. But it's going to be a monitoring, right? We've given what we think is a huge dose of medicine to the economy. The right thing is to give it some time to work.

But if, come the late summer and next fall, we're not seeing -- well, we don't move from sort of, you know, the glimmers of spring to, you know, the start of summer, that's when you say, maybe we need to -- are we doing enough for financial markets? Are we doing enough on the fiscal side? Are we doing enough in our housing programs? All of those things.

We're -- it's going to be a -- very much a wait and see, a careful monitoring. You know, the president's always said he'll do whatever it takes. And that's what we're in, is the phase of seeing if what we've done is enough.

KRAVIS: I mean, clearly we have to be patient. You know, the medicine has only been applied, and it's going to take some times -- to take hold.

But the troubling part with that is if they end up having to take a second dose or a third dose of this. And we're -- the administration just yesterday, or day before, increased the budget deficit to $1.8-plus trillion for this year and 1.26 (trillion dollars) for next year.

You take a Goldman Sachs estimate, and they're saying -- could average a trillion dollars over the next 10 years, per year.

Obviously this is not sustainable. We can't -- you know, we'll be broke as a country, and particularly with all of the plans that the administration has, that Congress has, with health care being at the top of that priority, where something has to be done.

But then we have the projected Medicare/Social security deficits that are looming, and whether you call them -- whether they are transfer payments or they're not, they're -- they've got to paid for, you know, somewhere, somehow.

What will the administration do? I mean, how are we going to take care of all of this if we have to just keep putting money in?

ROMER: Well, I think there are a couple of things. One is, you know, the budget deficit in the short run -- fundamentally, what we all know is, it's being driven to a huge extent by what's happening in the economy. So at some level, the actions that you take to get your economy back are good budget policies, just simply because there's nothing as bad for your budget as an economy in free fall.

The second thing is, any of the spending that you do, like even a $787 billion stimulus package that I admit is enormous and sounds enormous, things that are a one-time or a two-time expenditure are not what blows a hole in your deficit. It is the expenditures going off into infinity, like what we see projected with Medicare and things like that, that are really the things that affect the budget in the long run.

I think that's fundamentally why the president has said health care reform is actually a top priority. So rather than thinking of it as a budget buster, what he has absolutely said is, it's the thing we have to fix to get our budget under control in the long haul. And he actually, I remember, at the health care summit was just -- you know, he said to all you advocates of universal coverage, let me tell you, job number one -- we got to get cost growth under control, because that's the only way this works. It's the thing you have to do first to save us from going off to budget hell. And if you want to expand coverage, it's even more important, because you've got more people then that may be getting government assistance.

So you know, I am actually working very hard now in the health- care reform process, and one of the things that the Council of Economic Advisers has been doing is sort of looking at the economic impact. And I've really been struck by -- if you can do what Peter Orszag likes to do, with the careful hand gesture, bend the curve of how fast health-care costs are going up, by doing fundamental reforms, that can have just an amazingly large effect on the economy. It is such a big part of our economy. It's a big part that is projected to grow astronomically. Getting that under control has important effects not just for the budget but for efficiency, but for labor supply, for all sorts of things that just really make it just fundamental.

KRAVIS: Over time, however, it's going to take money to get to that point, and so we're going to continue to build these deficits. This isn't going to be something that's going to happen overnight, unfortunately.

ROMER: No, that's -- that's true. And certainly, one of the things that we are very cognizant of is how important it is, as we go through this process, to never lose sight of how genuinely crucial it is to get those costs under control. And as you point out, the faster, the better.

We do know that -- we just had a meeting yesterday with a lot of, you know -- and a remarkable meeting -- a lot of the private-sector interest groups in the health-care field coming in and saying, "We think we can cut cost growth by 1-1/2 percent per year." And so, if they're ready to try, so are we.

KRAVIS: That -- that would be good. (Laughter.) For sure.

ROMER: And effective, is what you meant to say.

KRAVIS: That would be good. (Laughter.)

So let's assume we get through this, and Ben Bernanke now decides that we've got to start putting the brakes on, okay? We've got to start tightening credit. But we don't have the growth yet. We see, yes, we're through the downturn; the stimulus is maybe taking some hold; but unfortunately, for whatever reasons, particularly outside of the United States, particularly because of China and some of the Asian countries, commodity prices start spiking up, and we now are back into a inflationary period. Fine line to walk. What are your thoughts?

ROMER: All right, well, so, the first thing is, it's very awkward, as someone who's spent my life commenting on what the Federal Reserve does as a monetary economist -- it's kind of the one thing I'm not supposed to do any more.

As a member of the administration, we certainly value the independence of the Federal Reserve. I think that the important -- (laughter) -- no, I'm serious. (Laughs, laughter.) That wasn't supposed to be funny. (Laughter.)

The key thing, though, is, you have to ask yourself -- well, what you describe as a fine line, you know, if we're not growing, it seems to me the chances that we would have inflation spike up and the Federal Reserve would say we need to clamp down is pretty unlikely, right?

You told the story where maybe there's some international thing, but I think that's -- that's not very likely, right? The thing I have certainly been worried about is not inflation, but deflation. When you have an economy as depressed as we have now, I think that is the much -- you know, the much bigger worry.

And so my anticipation is that the Fed is going to be looking at the same numbers we are, and saying we need to keep helping this economy. They certainly have shown, you know, an incredible flexibility and, you know, enthusiasm for doing what it takes to try to get lending going again, trying to hold our financial system going again.

So I don't anticipate them being in the difficult situation that you've described. What they will do if they do, that's for them to say.

KRAVIS: Great. All right, at this time, let me open it up to questions from the members and our guests. Let me remind you, please wait for a microphone.

There are people who will give a microphone to you. Speak directly into the microphone. State your name and affiliation. And please limit yourself to one question. Try to be as concise as you can, so happy to take some questions.

Yes. The woman right there, please.

(Cross talk, laughter.)

QUESTIONER: Quick question, I promise.

How do you avoid the policy mistakes that happened, in 1931 to '33 and again in '37 or so, as you deal with the significant financial crisis, given the problems of dealing with Congress?

ROMER: All right. Boy, coming back to my world, right, economic history.

So '31 to '33, that one strikes me as easier, right, so I think, as I gather, one of the things that came up, in the morning session. But what is true is, you know, the shocks that hit the U.S. economy in 1929, even 1930, you know, were big but were not enormous.

I often say, I think, the shocks that hit our economy this past year-and-a-half are probably about the same size, if not bigger. And I think what your getting at is very much what turned the Great Depression from, you know, pretty ordinary, maybe a severe recession, to the Great Depression was actually a number of policy mistakes.

It's the Fed saying, we're having financial panics, not our problem, right? And that's, you know, certainly letting the money supply contract tremendously. We know in contrast to what we did, right, we had a major tax increase in 1932.

I'm sure you probably talked this morning about the Smoot-Hawley Tariff and putting on trade barriers. So just the confluence of policy mistakes, in this one short period, is really quite striking.

At some level, I want to say, we've already avoided them. Part of what I find so thrilling, about the current situation, is the degree we've already mentioned the Federal Reserve.

You know, I think, it's no surprise that Ben Bernanke is a specialist in the Great Depression, because you saw the Federal Reserve do the most, you know, wide-ranging number of activities, to try to deal with the financial crisis last fall. If no one's buying commercial paper, let's set up a facility. If no one's buying securitized lending, let's set up a facility, right?

It's really been, I think, amazing. And likewise we haven't had a major tax cut. We had a $787-billion stimulus plan. So I think we're doing very well on learning from the 1930s and not recreating the mistakes of '31 and '32.

The '37 one is one that I've been thinking about, because really what happens in 1937 is, you're recovering. You're actually recovering very strongly. And then what happens is sort of, we know, sort of by accident, we had a big fiscal expansion in 1936. We paid a big bonus to veterans. And then it disappears in '37.

So that's a big fiscal contraction. The Federal Reserve starts, I think, to get nervous about inflation too early and kind of says, well, we might have inflation someday, so let's do some things, to get in a position where we could tighten, not understanding what they did was just tighten incredibly.

So we have, certainly, a very big both monetary and fiscal contraction in 1937. And that is what set us back for the recession of '38.

We're -- this is going to be -- as I've described, I don't anticipate the Fed doing what the 1937 Fed did. We do face the same situation of, we have this big fiscal stimulus in 2009 and 2010, and a lot of it disappears in 2011. And so just by its nature, there's a big fiscal contraction. And so that's certainly something that I have been thinking about and watching.

I think the path through it, we would hope, would be the private sector, right? If the things I was describing really are -- you know, are strong -- the pent-up demand, the rebound in inventories, if we get business investment going again -- you can certainly see a path through this where that sector comes back strongly, we keep interest rates low; you can imagine that certainly we can navigate through this. But it is something we're going to have to be -- we're going to have to be aware of.

There -- well, I think sometimes, you know, there was so much talk about, let's make sure that all the money in the fiscal stimulus package gets out in two years; a little bit of me was saying, you know, if it had a little tail going into 2011, that's not the worst situation. And that's -- I think that is one benefit of kind of where we ended up.

But it's my favorite question, so. (Laughter.)

KRAVIS: Yes.

QUESTIONER: Bob Lifton. You know, if you postulate net exports increasing, you postulate net investment in business in a highly competitive environment in which we live, with China, India and the like, and the past history, which reflected the fact that we couldn't even keep up any net exports of any kind, and that the bubble really was a replacement for our business, what do you see as the business model of America going forward that would allow us to accomplish what you're talking about, ex-cheerleading and optimistic hope? (Laughter.)

ROMER: I actually think I had a serious plan! (Laughter.) So I -- so one of the things that I describe -- I mean, so first, I think I have more faith in American ingenuity than you do. So I actually -- I actually think American corporations do a fantastic job of figuring out what products people want and finding the investment opportunities. So I think that is certainly going to be an important -- certainly an important part, going through this.

I think the -- you know, it's not a -- you know, the president talks a lot about renewable energy. And it's not just -- it's not just, again, a slogan or a phrase. If you think about where we are and where we need to get -- in terms of, we know that we are on a path to warming up our entire globe, we know that we are importing huge amounts of oil from abroad -- it's a -- I think, very likely the path that we are on is going to be a fundamental realignment towards renewable energy, other kinds of domestic energy. And that's going to require a lot of investment.

And so a big part, I think, of what the president was doing, both in his budget and in the recovery package, is laying the groundwork for that. You need the smart grid if you're going to actually use wind and you're going to use solar. You're going to need to start building a lot of your -- the -- of different kinds of machines to harness that kind of energy.

I also think the president's focus on education, as I mentioned -- I think that one of the things that has very much struck us is that an economy is more productive if it has more educated workers, if it has the right kind of training, if it has investment in people. And I think that is going to be something that will put us in a -- on a competitive edge, make us able to compete and grow along those dimensions.

KRAVIS: Yes, in the front, please?

QUESTIONER: If we put ourselves -- Letitia DeChatayeux (ph), Iseman Capital. If we put ourselves a year forward, and the 3.5 percent doesn't materialize, what will have happened? And also, in the meantime, what are the leading indicators that you would -- that will tell you at what point do you say now we're on a path to sustainable recovery? What are those indicators?

ROMER: Okay, so both -- both wonderful questions, sort of -- your first one is, what could go wrong, right? So, how do we end up being wrong? I think if we start with the first question, which is, what if the rest of the world deteriorates more, right? We know -- we sort of feel that we've taken actions that we think are going to be helpful, but what if the IMF is right and things are worse, or even the IMF doesn't get how far the rest of the world goes down? We know that can certainly be a drag on us. The other thing I think that could go wrong is the financial sector.

So again, we -- you know, the way I like to think of it, you know, I tend to think of sort of the fiscal -- the fiscal stimulus and the financial rescue are kind of designed to be reinforcing; that I think by getting people employed again, that tends to push up asset prices, that tends to make people default less, that tends to be good for your banking and financial system. Getting your financial system going again is good for lending and good for demand and good for putting people back to work. So if it all goes, again, as we anticipate, those things will reinforce each other.

But if, God forbid, something goes on so that we don't get the resurgence in lending, if we do have, you know, those credit spreads spike up again, I think that would be something that would set us back. So if I had to say, well, what are the risks, how could 2010 turn out less good than we anticipate, that would be, you know, the things that I'd be worried about.

What do we look at? I mean -- I mean, we look at all the conventional indicators. I mean, we're both doing a mixture of -- certainly, we're watching the financial sector, to make sure that we are seeing the healing that we think needs to be there. You know, I have to confess to having been surprised by how well the housing sector is doing. I mean, here's kind of the center of the downturn, and yet we're starting to see some measures of prices go up, we're starting to see building starts again. You know, that I find very encouraging.

I've been watching consumers a lot, so certainly -- you know, tonight I'll get the retail sales data, and that's going to be something -- you know, in my previous life, you know, I'd read the newspaper like everyone else. Now I live for -- you know, what's the data that's coming in tonight? And the surprising part is, the president does, too. It's like, "Is today the employment report?" "Yes, it is!" You know, it's just like -- it's just this is the -- you know, it's such an incredible issue. It's something that we are watching just unbelievably.

In terms of one of the things -- you know, again, we are so interested in the labor market. That certainly has been what the president, you know, has very much -- this is about jobs, it's about putting people back to work.

So I do a lot of, every Thursday, the new -- the initial claims for unemployment insurance, because that's really about the fastest data we get. And it actually has some pretty good predictive powers. So that I find myself again every week -- is it down a little bit? That would be a good sign that eventually we'll see the turn.

KRAVIS: All right.

Yes.

QUESTIONER: Thank you. (Inaudible.)

Dr. Romer, the picture that you just drew, chasing the holy grail of bubble-less growth and fundamentally reorganizing our economy and our business enterprise; you talked about a vigilant regulator, a regulatory framework, described some allocation of resources. And you used the word proper distribution of income.

Is it a fundamental shift away? Would you say that the American economic history has been characterized by bubble-based growth, which seemed to be at the heart of the innovation, and you've had your debacles from time to time?

Thank you. Sorry, the question was a long one.

ROMER: No. I think, in fact, what I would say is, in fact, the way I started, which is, bubble-free growth, I think, is typically the norm. So one of the things -- in some ways, what's been strange are the last two decades, where we had these two sort of bubble-fed -- these two bubble-fed expansions, or at least things that turned into bubbles.

If you really say the period from, you know, World War II through, you know, probably the 1990s, what you certainly had are a number of periods where we had good growth, like the 1960s, without a bubble developing, or the 1950s, without a bubble developing. So I would actually -- what I tried to describe is normally, you know, as even Alan Greenspan said, normally we'd expect market forces to kind of keep things under control.

What we've been describing is, to the degree that that doesn't seem to be enough, trying to put in place sensible, new regulatory framework to kind of help it along. And that is certainly what, I think, is a reasonable approach that, I think, can put us back to what I think is the norm, which is growth without bubbles.

KRAVIS: Yes. Right in the front row.

QUESTIONER: (Inaudible.)

My belief is that because of the crisis, the demographics of the U.S. have been severely altered. The two pillars of American wealth, which are retirement savings and house equity, have been hurt a lot. That will keep people in the workforce longer, leaving less room for more people to come into the workforce.

That's my working thesis. I would ask you to say if you agree with that or not.

ROMER: That's an interesting question. Certainly the way I've been focusing on it is, I agree that the fall in wealth that we've seen, I think -- the numbers are something -- we've lost, you know, sort of -- household wealth has fallen some 13 trillion, I mean, just a huge decline.

I think of it as affecting our saving behavior, so that we're going to tend to consume less and try to recoup our wealth. You want to put in another feature, which is maybe we'll work longer. And that could be something. I don't know. That will be an interesting thing, to see how it plays out.

I think the part I wouldn't necessarily -- certainly wouldn't agree with is that necessarily that's going to -- I think in your model, there's a fixed number of jobs. And so if people work longer, there's not space for the new people coming in. And my sense and maybe it goes back to my faith in the dynamism of the U.S. economy.

What is see is that typically when labor supply increases, which is what you would be describing, the economy expands. Right? So that's -- you know, that would tend to put downward pressure on wages. That's a signal to firms: "Gee, maybe we should build a new factory, or we should set up a new thing."

And so what I would anticipate is, if that does happen, rather than this clogging, it would be another factor of getting -- I guess we'd call it extensive growth, rather than intensive growth. But I think that is the most likely thing I'd expect to happen in that case.

KRAVIS: Yes, all the way in the back, standing.

QUESTIONER: Nick Platt, Asia Society. The theme of this conference has been financial turbulence and U.S. power, and I'd like to know what your take is on the answer to this question. What has been the impact of the financial turbulence and economic dislocation on U.S. power, in your opinion?

ROMER: I have to say I think that's a question outside my area of expertise.

What I will -- I mean, I think the important thing is -- let me talk it from the economist side, because that's the part I feel I have the better handle on.

You know, unquestionably we have, as I've said, faced an enormous shock. And that is certainly -- and unfortunately is something that has -- it's a shock that, as the president said, was felt through much of the world.

The positive side of it is, I think we have dealt with it. Right? So I don't know what it's going to do ultimately to our standing or all of that. But as a country I think there's something, I think, fundamentally admirable and empowering about facing a crisis and stepping up and doing what it takes to deal with it.

And I think the history of the last several months has been actually facing what was a very bad situation and working with Congress, the Federal Reserve doing its part, sort of putting in place what I firmly believe are the polices that are going to get us out of here. And I can't help but think that we come out stronger, if not as an international power, certainly as a people, for having faced this and dealt with it.

QUESTIONER: Following up on that, as you look around the world -- I know your focus is obviously the U.S., but we can't help but look how the rest of the world is growing or contracting. How do you see Europe in particular in -- at this point in time, and their financial institutions, their economy? Will they lag? Will they help us out of this? How do you see it?

ROMER: Certainly the conventional view, I think, is that they've been kind of six months behind us, right? So six months behind us going down and I think to the degree we're seeing glimmers of hope, it's sort of more here than in Europe.

You know, if I were to say where's the -- you know, certainly what seems to be true is a lot of the Asian countries -- certainly China, maybe even Japan -- seen more of a turn there, and so in terms of where the help might be coming from, I think probably we might look there more quickly than to Europe.

But I think it's much like what I was describing with, you know, if the financial sector heals, that works better with the real -- sector and they both come up together, is certainly true of all the countries of the world. The more that we can all start expanding, that's going to feed back from one to another. So, certainly any signs of life anywhere are, I think, great not just for that particular country but for everybody else.

KRAVIS: Okay. Yes, right -- you, yes.

QUESTIONER: Peter Kenen, Princeton University, and a former colleague of yours.

ROMER: Absolutely.

QUESTIONER: This is not the kind of question you would expect from me, knowing my professional interests. I'm wondering whether the council has given much attention to the stimulus that might be afforded by reform of health care, including, for example, the mechanization of and transformation of health care records, issues of this kind, new medical facilities and consolidation in the health care industry.

ROMER: I was counting on an international question from you, but anyway -- but thank you. I love that question, for several reasons.

One, certainly if you look at the American Recovery and Reinvestment Act, one of the main places where we put a lot of money was in health IT, a lot of those -- you know, sort of trying to jump- start that kind of investment, even some into research. And it's absolutely the case that, you know, when -- and again, it comes back to, well, where do you think the growth is going to be in the future? I mentioned energy, I mentioned the effects of education, but surely as an aging population, that's going to be something that -- you know, health care is a sector we'd expect to expand.

And you're right, if we have -- you know, the more we have reform that generates a different kind of technological progress or that requires investments to actually make it work, that's going to be -- going to be good.

Another thing that I've seen on the -- just thinking about sort of the short-run macroeconomic effects, you can't help but realize it would act like a positive supply shot. When people tell stories about the 1990s, why were they so terrific, why do we have low inflation and these very low rates of unemployment, the kind of conventional story is the move to managed care got us a one-time kind of drop in health care costs or a slowing of health care costs, and that acted just like if oil prices had come down or some other piece of the economy had gotten cheaper.

And so, you know, we've actually been doing some computer modeling that if we really can rein in health care costs, you can have a period of that same sort of beneficial supply shock, besides all the other benefits, like greater efficiency and not having your budget fall apart, so that's going to be good for capital formation. I think the idea that transforming health care is not just something you do because we've got millions of uninsured Americans or because the budget is falling apart, but simply because it's smart for the economy, is something that -- that is a point that needs to be made.

So, thank you.

KRAVIS: We'll take one last question, as we're running out of -- out of time.

Yes, right here.

QUESTIONER: Peter Alderman. My question is if you -- many of the folks in this room have made their wealth over the past 20 years by generating or benefitting from outsized returns, and the paradigm you have -- (laughter) -- the paradigm --

ROMER: Going to need to start making things. (Laughter.) No, anyway, go ahead.

QUESTIONER: The paradigm you have talked about really, in my mind, presupposes much lower rates of return. And how are we going to achieve that paradigm, change behavior, change investment patterns so capital will be employed at returns that are 5, 6, 7 percent, instead of sitting on the sidelines, waiting for the higher returns, or seeking out riskier investments that may not be as productive for the economy as a whole?

ROMER: Well, I think there are a couple of things. One is to say, sort of, what was different in the past? Why did we not -- I mean, we did a tremendous amount of investment, you know, in the '50s, in the '60s, in even the '80s, right, without sort of bubbles and outsized returns. So whether it needs to be a change in, you know, just attitudes and culture, or whether -- you know, I think I probably go back to the -- I think, you know, I have a lot of faith that American capitalists will learn, and that if we are successful and sort of keeping bubbles under control and not going back to that sort of bubble-driven thing, I think they'll pretty quickly say, "We -- we, you know, should be investing in sensible places and in the products that people want."

And I think that that is a model that -- we're not talking about anyone not earning lots of money, right? This is going to be a -- you know, if you think about it, an economy that redirects towards investment, right? That's an economy that's going to be growing quickly. That's going to be terrific for overall rates of return and for sort of the productivity of the economy.

So I think it's a very plausible -- a plausible scenario. But it may, you know, require a period of adjustment, or people learning, but I think that's what we're good at.

KRAVIS: Dr. Romer, thank you very much. This was terrific. (Applause.)

ROMER: Thank you.

KRAVIS: Thank you.

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