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The Implications of the Fiscal Cliff and the Prospects for Reaching an Agreement

Speakers: Martin S. Feldstein, George F. Baker Professor of Economics, Harvard University; President Emeritus of the National Bureau of Economic Research; Former Chair, Council of Economic Advisers, and Alan S. Blinder, Professor of Economics and Public Affairs, Princeton University; Former Vice Chairman, Federal Reserve
Presider: Gideon Rose, Editor, Foreign Affairs Magazine
January 4, 2013

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GIDEON ROSE: Hi, everybody. Gideon Rose here, editor of Foreign Affairs. And I just want to thank you all for coming to what should be a really interesting call.

We have with us two spectacular guests to discuss with us the fiscal cliff and all subscript and related issues: Martin Feldstein, who is the George Baker professor of economics at Harvard University, president emeritus of the National Bureau of Economic Research and who was, of course, the chairman of Council on Economic Advisers for Ronald Reagan; Alan Blinder is on the Princeton faculty, where he has been for -- since 1971. He has also served as a member of President Clinton's Council on Economic Advisers and then was vice chairman of the Board of Governors of the Fed. He's also the author of the brand new book coming out, "After the Music Stopped: The Financial Crisis, the Response and the Work Ahead," which is really excellent; I just read it, and I recommend it to all of you.

As I see it, there are three sets of issues here. There is the short-term politics of the fiscal cliff deal, which we're all watching play out with morbid fascination. Then there is the what you might call the short-term economics of the fiscal cliff, which is the tax-and-spending changes that would happen in January and any change that might happen to them as part of a deal. And then there is the long-term crisis of American fiscal and social welfare policy and spending policy, in which, even after the cliff is passed, there are obviously major problems down the road. And so, you know, you might get over the cliff only to face a giant chasm afterwards. But the question is, I think, how those things are tied together.

And I guess I would open it up, Marty, by asking you to -- the journalist Jonathan Chait at New York Magazine has been saying for a while now that the only way to get to the long-term questions or even the real short-term economic questions is to get past the short-term politics, and that can only happen by going over the cliff itself so that the question becomes, can you make a deal that's positive rather than proactively negative, you know? So once the cliff happens, then you can give tax cuts rather than cutting taxes -- rather than raising them, you can give spending back rather than forcing cutting spending. So I guess my question to you is, now that it looks like things are breaking down, is it so awful that we go over this cliff at least for a little bit in January? Marty Feldstein.

MARTIN FELDSTEIN: Well, it would add greatly to the uncertainty of the outlook for next year. Businesses would be loath to make investments or hiring decisions until it all got clarified. So I think that's a serious risk.

But as I said in the piece in Foreign Affairs, I can understand why the president might adopt that strategy. Let us go over the fiscal cliff and then introduce legislation to reduce taxes for everybody except the top couple of percent and dare the Republicans to vote against such a piece of legislation that would reduce taxes for 98 percent of the voters. So I could see how that could come to pass, but I don't think that the Republicans would fall into that trap. After all, they control the legislation that gets to the floor of the House, so they will never have to vote on that bill in the House.

ROSE: So -- well -- you say the Republicans won't fall into that trap. Do you see the Republicans being unified enough now to do anything at all except respond to whatever happens elsewhere?

FELDSTEIN: I don't know how the Republicans are going to come up with a proposal that they think the president would be willing to go with. I think the Republicans have made it clear that they're prepared to do a substantial amount of revenue over the next 10 years, but not by raising tax rates but rather by broadening the tax base, by tax reform which would avoid the adverse effects of high marginal tax rates and would have the favorable effect of improving the incentives that you get by reducing some of the tax expenditures.

But they would only go for that if there was a sense that the White House was prepared to meet them with comparable amounts of spending reductions.

ROSE: OK. Alan Blinder, your take on all of this?

BLINDER: Well, I think that -- like Marty, I'm not an expert on short-term politics, but it seems to me that the position that some of the over-the-cliff advocates take about saying -- the difficult spot the Republicans will be in on January 3rd isn't so very different than the spot they're going to be on on December 28th, and that to me says they ought to settle this thing. Whether they will or not is anybody's -- is anybody's guess.

The other -- the other thing that your question conjures up is the glib assurances I've heard from so many people that, you know, let's just go over the cliff and by January 3rd it's all taken care of and there's no harm done. Now, if I was sure that that was the case, that, you know, what they couldn't manage to do on December 28th they can suddenly manage to do on January 3rd -- exactly the same thing, by the way, just in another guise -- if I was confident in that, I would say, you know, sure, go over the cliff. Three days is not going to do any harm.

But I'm not at all confident in that. What we've seen is a certain level of obstreperousness in this, an unwillingness to engage, a tremendous amount of partisanship, and I just don't have an confidence this gets settled in three days, and if it lasts three weeks, I'm pretty sure we get a recession out of it. Even if --

ROSE: You think a recession -- even in just three weeks you get a recession?

BLINDER: Yeah, because you get it started. I mean -- you know, an economy is not like a car, where you have a gas pedal and a brake pedal and it just stops and starts like that. Once you start sliding downhill, once confidence is shattered, as Marty was just saying -- you know, you can right the ship, it's not like we just go straight down from that, but it takes a while to right the ship. And you know, I wrote in The Wall Street Journal earlier this month, the sort of eerie parallel, to my mind, between what happened in 1980 with credit controls, where it was done for political reasons -- in that case -- in that case, the issue was anti-inflation rather than anti-deficit -- and a lot of people thought, well, it'll only be in there for a short period of time and they won't really do very much harm. Well, they did a lot of harm. The economy just fell off the table.

ROSE: But wouldn't -- couldn't it -- wouldn't it -- OK, let me -- I'll push back on this a little bit. If what you're saying is true, then the markets will recognize that and start exacting a price before it actually happens, since markets can see the things going down the road. So -- and that, presumably, is the mechanism which would force a deal, which is that if the Republicans in the House who won't do any kind of tax increases at all -- I know what they -- their preference is what Marty suggested, but if that's not available, then the question is, OK, what else are they going to do? And they've just indicated with the lack of ability to pass Plan B that they won't even go with the tax cuts above, you know, --

BLINDER: It was just the millionaires and up.

ROSE: Right. Well, but so, if they say, OK, fine, we're going to go over the cliff, won't the markets start to react --

BLINDER: Oh, yeah.

ROSE: -- and then create pressure for a deal that -- and isn't that what's going to change, in effect, in early January from late December?

BLINDER: Sure --

FELDSTEIN: One of the things that protects the market from that kind of reaction is the Fed's policy. The Fed has made it clear that they're going to buy a trillion dollars' worth of long-term securities this year and that they're going to keep the short-term interest rates extremely low. When you put all that together and you say, well, therefore, bond interest rates are not going to rise and the stock market is going to be helped by people who say, well, I've got to put my money someplace; I get nothing -- I get negative real rates on long-term Treasurys, so I'm not prepared to abandon the stock market even with the risk of the cliff.

BLINDER: Well, we're guessing here. My guess would be on the opposite side of -- I mean, we're on the same side of the issue: We need to settle this. But on this particular one, my guess or my fear -- and they're the same -- is that the markets take this very badly, that you can sort of see in market pricing right now that the market's putting a very low weight on the notion that we actually go over the cliff or that we go over for more than three days or something like that. They're pretty relaxed about it, both the bond market and the stock market.

I think this would really kick the chair out from under the market's current belief. And when you kick chairs out from market beliefs, bad things often happen.

So to your question, Gideon, yeah, I think it does (start ?). The markets react first, and then the economy reacts second. And it's the second one -- (chuckles) -- that worries me much more than the first, frankly.

ROSE: But why wouldn't what happened happen like -- why wouldn't this play out like the fall of 2008 with the bailout bill?

BLINDER: Like the TARP?

ROSE: Yeah.

BLINDER: Well, you can hope for that. I'm -- I worry that it takes longer. I mean, look at -- look at what just failed in the House of Representatives. Hardly anybody's taxes were going to be touched, only over a million dollars in annual -- I guess that's AGI, whatever the million (dollar) cutoff was. And Boehner couldn't even get it through his own caucus and pulled it. I just -- this concerns me about getting this over quickly.

ROSE: OK, so aside from hand-wringing, do either of you brilliant economists and observers have anything -- any concrete suggestions to add for how we move forward right now?

FELDSTEIN: Well, sure, I do. And I wrote about it in your fine publication. And that is that instead of talking about raising tax rates, we put a limit, a broad cap on all tax expenditures, all except for charitable contributions. And you could raise a substantial amount of revenue that way, as much as the president has called for over the next 10 years, without having to push up individual tax rates.

ROSE: Alan, what's your suggestion?

BLINDER: Look, I'm happy with that. I think there are lots -- my main concern is we don't go over the cliff.

To Marty's suggestion, I'm pretty happy with that. Here's what I think is difficult about it. First of all, the details will be very complicated and are not going to get settled between now and New Year's Day. So what you need is a kind of -- at best, you're going to get a hortatory pledge to do something like that. Then when they come down to the -- now, that may be enough to get us over the cliff, which would be a good thing.

When they come down to the nitty-gritties, the -- Marty uses the term quite correctly, "tax expenditures." The Romney plan was using the term "itemized deductions" -- let's say in both cases excluding charity, although Romney hadn't said that. There's a big difference between the two, with Marty's tax expenditures, appropriately so, I believe, much more encompassing. There are a lot of things in the tax code that come before you even get to the definition of adjusted gross income, not the least of which is capital gains preferences.

And so just take that example. You can easily see this whole hortatory agreement, if we get one, stumbling over that, with the Democrats wanting to put that into the pot and the Republicans insistent that it stays out of the pot.

FELDSTEIN: But if you said, we've got to do something quickly, then what I would do, and what I talked about in that Foreign Affairs piece -- what I would do would be all deductions other than charitable deductions plus municipal bond interest and high-value health insurance payments by employers, a number that's going to be on everybody's W-2 by next year. So that would be easy to do, and it wouldn't be like saying, well, how shall we change the deduction for mortgages, and how will that relate to the deduction for state and local taxes. It would be an across-the-board single number. And that would avoid all of the endless hassle over specifics.

And of course, all we need is a plan like that that can serve if Congress doesn't come up with something better over the next six months. So it would be putting in place a fallback plan immediately, but with the understanding that Congress of course can write other legislation, can decide how they want to change other aspects of the tax code.

ROSE: One last thing before I turn it over to our loud and vibrant crowd of excellent commentators who want to ask questions of their own. My question to you guys would be this: One of the things that the White House may be thinking is that it has for a variety of reasons maximum leverage in the very near future and that it wants to settle not just this immediate crisis, but also avoid future crises -- for example, the debt limit period crises. Because you hear Republicans, a lot of Republicans, actually saying, look, let's get past this immediate thing so we can live to fight another day, which we intend to do.

So is there going to be, as part of whatever deal happens right now, a deal to prevent future fights over the debt limit for at least a couple of years?

BLINDER: My assessment is no. I'm sure the White House would like that; I'd like it -- I mean, most of us economists think there shouldn't be a national debt ceiling at all. We have a budget and the budget implies how much debt you're going to rise, and we should fight every year over the budget, That's perfectly appropriate. But we shouldn't have a potentially contradictory law saying, even though the budget was going to go to X -- sorry, even though the budget deficit was -- sorry. Even though the national debt under the budget would go to X, we're going to put a ceiling below X. Two contradictory laws. That's the system we have now. So I'd like to get rid of it, as Tim Geithner said.

But I don't believe for a minute -- now, the White House is not confiding in me, so this is a purely external view -- but I don't believe for a minute that they think they're going to get that, and I think they see that as a bargaining chip that they can give away sometime late in the game.

ROSE: Marty, what's your take on that?

FELDSTEIN: I agree. I don't think the Republicans, who are, after all, in the minority in the Senate and don't have the White House, want to give up that important piece of leverage.

ROSE: OK. With that, let's open it up to questions.

OPERATOR: (Gives queueing instructions.)

Our first question comes from Sudeep Reddy from Wall Street Journal.

QUESTIONER: Yes, I have two questions. The first is, what do you think the Fed would do if we're over the cliff for more than a few weeks? They do have a meeting in late January.

And second is a much broader issue: What do you think of the long-term consequences of these fights in Washington? And I'm not talking about straight fiscal policy but more on the sentiment about how people view their government. Do you think there are any meaningful implications, and how do you think of those?

FELDSTEIN: Well, I think there's very little the Fed can do. When Ben Bernanke spoke to the Economic Club of New York a couple of weeks ago, I was one of the two formal questioners. Alan was the other one, as it happened. And I asked him, and he basically said, that's just too big a hit to the economy for us to be able to offset it. So I think the Fed is doing everything that they can now to try to stimulate the economy. I don't see them doing anything to -- anything different if we actually go over the cliff.

BLINDER: Let me add one thing. I basically have the same attitude as Marty with a couple of nuances of difference. First of all, I think that they might well accelerate their QE purchases. LSAPs, they call them -- large-scale asset purchases. They made clear that that -- the current number, which if you add up the two pieces is 85 billion (dollars) a month, is not write in stone, and they maintain the flexibility to go up or down on that depending on how the economy does. So this would be a reason to go up and start purchasing more.

The reason I still mostly agree with Marty is I don't think that's going to make a huge difference in the macroeconomic picture and the main story is that the Fed just doesn't have anything like the kind of weaponry that would be needed to offset a 4 percent of GDP fiscal contraction. I mean, not even close to that. And that's what Bernanke correctly said.

The other thing that I would add that Marty didn't mention is that to the extent that going off the fiscal cliff really rattles the financial markets and starts causing major disruptions -- you know, think of this as, like, as mini-Lehman two scenario -- it's hard to imagine it's actually like Lehman, but something on the road in that direction -- then I think the Fed can bring back some of these emergency measures -- they won't be exactly the same things -- that we saw in 2008 and into 2009 should that be necessary.

FELDSTEIN: But the problems are totally different from if we go over the cliff, would be totally different from the dissolutional financial markets that we had in '08 and '09 -- banks not lending to each other, unconvinced about the value of their own balance sheet, let alone that of potential counterparties. So those were the things that the Fed rightly had to deal with back then and did. But that wouldn't be the problem here. It would be that individuals and businesses would sees a sharp reduction in their after-tax income. The sequester would be cutting government spending, defense and nondefense, and that would involve bunches of layoffs. So those are things that the 2008-2009 policies really couldn't deal with.

BLINDER: Yeah. They would be different. I just -- my point is that to the extent that this kicks off a financial panic -- you could think of it as a flight from risk and an opening of risk spreads and things like that -- it's possible the Fed will come in and try to do something about that.

Now, why is it possible -- this takes me to the second question that you asked, Sudeep, which is that I do worry about the medium- to long-term consequences, you said of the -- I think you said of the public's view of their government; then I agree -- (chuckles) -- with that -- but also of the market's view of whether we have sane people managing the government -- outside the Federal Reserve, that is. (Chuckles.)

And that -- you know, that's not a good thing, and that's a kind of thing that can lead to a panic. If you think, like, nobody's in charge here, that can lead to the kind of disruptions in financial markets -- first in financial markets; it wouldn't just stay in financial markets, but first in financial markets that I was alluding to.

FELDSTEIN: These people must ask themselves, why doesn't the president -- since things have broken down and we're down to counting the days, why doesn't the president put a specific proposal on the table? I mean, he doesn't like doing that. In general, he hasn't done that. In the health care area, he waited for it to work its way through from the Congress. But there isn't time, and the Congress isn't going to do it. Why doesn't he do it?

BLINDER: Is this a question to me, Marty? (Chuckles.)

FELDSTEIN: No, it's a kind of rhetorical question about the -- following up on your statement that, is anybody in charge, is anybody managing the government's business.

BLINDER: Well, you know, I think he has been. (In fact ?), his opening bid, which, of course, was not going to be where the thing closed, was very specific. I mean, it all added up, and you could (tote the sums ?). And of course, the Republicans were not going to accept that. So he's got the opening bid on the table. And in addition, we now know he'll accept the chained CPI for Social Security and other benefits and a couple of other things that have been made public. So I think there is a fair amount of specifics in the -- in the president's plan.

FELDSTEIN: Yeah, but not nearly enough to be equal to the amount of revenue that he wants to raise. So I think that's where we're stuck.

OPERATOR: Thank you. Our next question comes from Kim Dixon, from Reuters.

QUESTIONER: Hi. Thanks. I wanted to follow up on Mr. Feldstein's ideas about capping deductions. Couple things, do you think there's been an evolution in Republican acceptance of this idea? There seemed -- there seemed to be some indications before the talks broke down this week that Mr. Boehner was going to accept -- (inaudible) -- 28 percent idea. And also, what is after -- you said -- (inaudible) -- doing things quickly, I mean, how likely do you think that is? My understanding is, those are things that the Republicans have already put up on the table on tax reform.

FELDSTEIN: Well, again, I can't speak for the Republicans. I think that if they have to choose between a 2 percent cap, which would not just be focused on the very highest income taxpayers, and a 28 percent limit, which was the president's proposal, I would like to think that the Republicans would favor this broader approach.

QUESTIONER: Why is that approach broader? Why is the 2-percent cap broader than the 28-percent approach? And it --

FELDSTEIN: Of course, the 28-percent -- the 28-percent cap says, if your tax rates -- your marginal tax rate is less than 28 percent or equal to 28 percent, it doesn't affect you at all.

QUESTIONER: Right, right, right.

FELDSTEIN: It only affects folks in the 33 (percent), 35 (percent) and so on, as opposed to a 2-percent cap which says if you're making a hundred thousand dollars and your deductions produce a tax benefit which is greater than $2,000 tax -- a tax benefit, not the deductions themselves -- then you would be limited on that. So it would affect small-dollar amounts from a much larger group. It would also raise much more revenue than the -- than the 28-percent cap.

QUESTIONER: OK. But do you think there's an increasing acceptance on this idea? The Republicans and Democrats always both talk about -- (inaudible) -- to the wealthier taxpayers. I know yours is broader, but just more in general the capping deductions and if you have more acceptance of that idea among Republicans amid, you know, the fiscal cliff.

FELDSTEIN: (Inaudible) -- the truth is, I don't know where they stand on that, and probably they don't know, because the focus until last night was on the Boehner proposal, which involved rate increases.

QUESTIONER: OK. Thank you.

OPERATOR: Thank you. Our next question comes from Derek Mitchell from Mitchell Report.

QUESTIONER: Thanks. I think we may have covered this ground, but let me take a shot at it. And I also ought to say I came in a minute or two late, so perhaps you covered this, but I want to -- I want to ask the questions -- (inaudible) -- you've talked about what the effect on the markets might be and then we really have our sort of two different perspectives about how people might respond. Interested in what seems to me to be the larger question here, which is not an economic one but a political one. And my question is, let's assume that we don't get whatever it is we mean by the word "deal," that we head into the new year unresolved on this question. Is there any way that the rating agencies can disregard that and not be forced to change the credit rating of the United States?

MS. : Yeah.

FELDSTEIN: My opinion on that is very clear. The United States is not going to default on its debt, period. So the -- what I think rating agencies are supposed to tell you when they rate a bond is whether the interest and principal will be paid. And there's certainly nothing here that suggests that the United States government wouldn't be able to pay the interest and principal on its debt. So it's really in a situation that doesn't apply to the U.S. government.

BLINDER: Let me just say I -- what Marty just said substantively I agree with 100 percent. That said, I believe that the rating agencies will downgrade us. The downgrade from S&P before was -- it was a different issue, but it was basically because of a dysfunctional government unable to make rational decisions, and this would just incredibly reinforce that view. So I would certainly expect a downgrade, even though it wouldn't raise the probability of a default on the debt, as Marty says.

FELDSTEIN: Remember what happened when they did that. Remember what happened when they downgraded.

BLINDER: Yeah, nothing happened.

FELDSTEIN: That's right. The bond market actually said, oh, that's nothing. Interest rates on long-term treasuries actually fell a bit at that point. So I think the markets understand that there's some strange game that the rating agencies are playing, but it bears no relation to what investors care about. Is this bond going to pay me the interest and principal that it is supposed to pay, and the answer to that is yes, it will pay it.

QUESTIONER: I had a second part of that question which presumably you've covered, which is to say that irrespective of the -- whether the -- whether there is an actual financial and economic downfall that results from that, the signals it sends out about the United States generally at a time when Europe is teetering, the Chinese economy is not doing well. I guess my question is, in addition to having our own set of problems, are we -- is this in any complicating the teetering economic picture in Europe and a -- and a questionable one in China?

BLINDER: Yes, it is. I think when you go to Europe now or talk to Europeans and Asians and so on and Latin Americans and you ask them sort of, what's the biggest near-term risk to the world economy, they name the U.S. fiscal cliff. Everybody is thinking about this, and this will do us a tremendous amount of damage.

FELDSTEIN: Because if our economy goes into a recession, especially a serious recession, a deep recession, that's going to hit imports from the rest of the world, and that's what they care about. And of course, to the extent that it messes up financial markets, that has a contagion effect.

QUESTIONER: Thank you.

ROSE: And in the future, only question per questioner from now on.

OPERATOR: Thank you. Our next question comes from Azeem Mian from Geo TV.

QUESTIONER: Yes, my question is just to both of you. If this crisis -- partisan in crisis in the U.S. continues, how is it going to affect the Third World? And --

FELDSTEIN: Sorry, I couldn't hear -- how is it going to affect what?

QUESTIONER: How is it going to affect the countries of the Third World --

FELDSTEIN: Third World, OK.

QUESTIONER: -- those economies and all of the suffering? And second part is, how it is going to affect the American neighbors and the member countries of NAFTA, the North American Free Trade Area (sic) -- means Canada and Mexico. How the immediate neighboring economies are going to get affected, and how the Third World countries are going to get affected?

FELDSTEIN: Well, I think we answered that question in response to Mr. Mitchell's (sp) questions. The rest of the world is going to be adversely affected. Both NAFTA and the Third World would see weaker demand from the United States for their products.

BLINDER: Yeah, and I agree completely with -- also just add -- obviously, you picked NAFTA because the trading relations are thickest with Mexico and Canada, so they will feel the trade part even more strongly than anyone else. The Third World will feel it as well, a little less strongly quantitatively, but they'll -- much less able to withstand shocks. And then, as Marty mentioned in the -- answering the last question, if you have a financial ruction, that spreads all over the whole world.

OPERATOR: Thank you. Our next question comes from Genie Nguyen from Voice of Vietnamese Americans.

QUESTIONER: Thank you. I would like to follow up with the global impacts and more on the security and power of the U.S. and what is the Asian unintended consequences? Like, a war broke out in the Pacific in the East Sea of China where Japan and China is having a conflict now -- how would that affect us altogether? And was that already calculated in the risk of the cliff?

FELDSTEIN: Well, one of the things that happens if we go over the cliff is another very substantial reduction in the defense budget, about $50 billion a year, or about 10 percent reduction in the defense budget. It's not clear exactly how that would affect different tasks of the security forces, but it obviously would weaken our ability to play the role in Asia and elsewhere that we're accustomed to.

BLINDER: I guess all I would -- I guess all I would --

QUESTIONER: But then -- (inaudible) -- on the TPP. And so how would that affect our credibility in the TPP?

BLINDER: What I was going to say is I don't -- you asked this as part of the first part of the question, whether this was playing into the fiscal cliff, you know, sort of domestic politics in the United States. And I think other than the 50 billion (dollars) in defense spending that Marty mentioned, I don't think this is seen -- conceptualized as a security issue.

That said, my view is that it doesn't do a country, especially a big, powerful country like the United States any good to look clownish in the eyes of the world. And we are looking clownish.

OPERATOR: Thank you. Our next question comes from Allan Dodds Frank from The Daily Beast. (Pause.) Mr. Frank, your line is open.

QUESTIONER: Can you hear me? Hi. Is there anything in the next week that would give investors a cause to think they shouldn't be selling?

BLINDER: You know -- (chuckles) -- it's a -- it's a really good question. And my crystal ball is not that exact. But what we've been seeing over the last -- over the last week or so is up days and down days. There are -- you know, last night and into today is a down day. It looks worse. A couple of days before that it was, hmm, this is looking a little better; they may get a deal. And I would expect that over the days between now and December 29th that will continue. There'll be some up days and some down days.

QUESTIONER: And you don't have a judgment on the balance of which way that'll end up?

BLINDER: I don't.

QUESTIONER: Thank you.

OPERATOR: Thank you. (Gives queuing instructions.) Our next question comes from Anita Gallagher from Executive Intelligence.

QUESTIONER: Yes, my question is that what's been discussed is -- reminds me of looking on the floors of the Titanic while it was still above water. And I think that if we look at Greece, we look at the agreements that have been made, the continual reductions in the budget, the draconian situation there, we can't say that Greece has solved it. In fact, you know, they're killing people. Their credit rating hasn't improved. They're doing everything that they are told they have to do. So why not try a different approach? And my suggestion is going over the fiscal cliff. Not going over it equals a tremendous amount of austerity. Either way -- you know, if we go over it, we get it now -- later. So why not go the way of Franklin Roosevelt? Why not go back to Glass-Steagall, which Roosevelt did in the first month after his inauguration? Why not then issue credit to put people back to work, like in the Reconstruction Finance Corporation? Why not start the urgent great infrastructure projects we need, like he did the TVA? You know, we need water projects. Every storm is a disaster to the United States because we don't have storm barriers like Holland and so forth. Why don't we try this? Because it worked, you know, and put us in a position to defeat Hitler. Why not try that?

FELDSTEIN: It really didn't work -- it really didn't work very well. We continued to have very high unemployment rates all through the 1930s. The thing that finally brought the unemployment rate down from nearly 10 percent was World War II, the buildup, the Lend-Lease operations to Britain and then finally the full mobilization. That's what brought the unemployment rate down.

QUESTIONER: That's true, but sir, we could have done that at any point. The problem was the Supreme Court and the political opposition was overcome by the war. But economically, you don't need the war.

BLINDER: (Chuckles.) I'm not sure we're going to debate the -- settle the -- (inaudible) --

QUESTIONER: But what about Glass-Steagall? It's in -- it's in the Congress right now, and it has 90 co-sponsors, H.R. 1489. How about that for a start?

BLINDER: I don't think that Glass-Steagall had anything much to do with the financial crisis that got us into this recession to begin with, and it certainly doesn't have anything to do with the fiscal cliff, avoiding the fiscal cliff.

QUESTIONER: Well, we get a lot of money if we write down a lot of bad debts.

BLINDER: Somebody gets, and somebody loses. (Chuckles.) Look, I'm not against writing down of bad debts, by any means. And I'm not even against some of the things that you mentioned. But I think most of them were more apropos when we were sort of at the bottom of the recession an desperate to get out. The concern now over the cliff is we don't go back there again.

QUESTIONER: Well, I don't -- you know, if we look at the kind of things we're talking about, I don't think we're really out of a recession. And you know, we're looking at terrible cuts. The only -- Obama said, I laid 400 billion (dollars) cuts in Medicare on the table. What does that mean? The only place it could conceivably come from, something that big, is raising the age of eligibility to 67. That's a disaster. You know, people are going to die. And you know, we can, you know, stop bailouts and put government money into creating, you know, real physical wealth and improving the productivity of the United States. This is what we need. Greece hasn't worked. Do you agree with me? It's getting worse.

ROSE: That -- I -- let's get back to -- so you -- can we move on to the next questioner, please?

OPERATOR: (Gives queueing instructions.)

ROSE: Let me take one for -- from the bench here myself. Alan, you wrote a piece years ago for Foreign Affairs, talking about how there were some things that actually should be protected from politics --

BLINDER: Yes.

ROSE: -- and how the Fed -- and you made some nice comment about the Federal Reserve now being one of the few sets of grownups in Washington able to actually provide responsible leadership, and Marty, you seem to sort of agree.

And my question would be, is -- I mean, does this -- is this really sort of a case for why certain kinds of long-term structural decisions should be made by either commissions or by groups or by insulated panels, rather than by pure democratic processes? But if that's the case, how do you ever get political legitimacy behind the tough choices that need to be made?

BLINDER: Right. Right. Let me try to answer that in two ways. I think it's not, actually, Gideon. This is a political confrontation between two parties that are miles apart. The centers of the two parties are miles apart, not to mention the fringes of the two parties, and political disputes like this have to have political decisions.

That said, over the years since I wrote that piece in Foreign Affairs -- by the -- the title of it, as I recall, was "Is Government Too Political?" (Is ?) I'm answering to my own mind, yes -- (laughs) -- more and more strongly over the years.

The tax code is a great example. I mean, I think it would not be a very difficult task to get technicians who were right-leaning and left-leaning, Republicans and Democrats -- so I mean lawyers, accountants and economists, basically -- to agree on a vastly improved tax code to the one that we have now, and then present it to the Congress for decision making. Or I guess I left out one thing. What you would have first is a congressional resolution instructing these technocrats what Congress did or did not want to see in the code. At a broad level -- how redistributive it should be, how it should -- you know, should a tax consumption or income, and et cetera, a few things like that. Let the technicians then generate it and bring it back to Congress for an up or down vote. Congress could vote it down if they didn't like it.

I think something like that would be a vast improvement over the policy-making apparatus that we have now, but I don't think it gets us anywhere on the fiscal cliff issue.

ROSE: Marty, is there --

FELDSTEIN: You know, in terms of a commission, that's what I thought was going to happen when President Obama appointed the Bowles-Simpson commission: a bipartisan group, broad tasking to deal with the long-term as well as short-term deficit situation; they came back with a pretty detailed report and nothing happened.

BLINDER: No, but the difference -- there was no requirement for up or down vote unlike the Conrad-Gregg proposal, which was voted down.

FELDSTEIN: Well, there was a requirement if they had gotten a majority or a supermajority in the committee, and they failed to get that and so therefore it never went to the congressional vote. So, you know, the one big tax reform that we've had in the last decades was the one that Tip O'Neill and Ronald Reagan agreed to. Now, they didn't just sit down over a beer and work it out; there was staff work on both sides that produced very substantial reductions in tax expenditures at the time, combined with reductions in tax rates so that both sides could say this was a much better tax code. It ended up having no net revenue cost; in fact, it was a static -- it was a revenue-neutral bill. When the incentive effects kicked in, it actually produced more revenue.

So I would say we do have a staff in the Congress, joint tax committee and the budget committees and Ways and Means Committee, and the Congressional Budget Office -- it's not that Congress lacks staff, and the administration has a Treasury Department and they can obviously call on experts to supplement that. So we don't need a -- we don't need an extra governmental process to make these things work.

OPERATOR: Thank you. Our next question is from Ray Han (sp) from JP Morgan.

Mr. Han (sp), your line is open.

QUESTIONER: Hi. Sorry about that. To play devil's advocate, could you speak a little bit on the medium-term CBO projections on growth and unemployment? In 2013 the CBO expects growth to dip to negative-.5 percent, and unemloyment to rise to 9.1 percent. The press seems to love these figures. But from 2014 to 2017, it says growth will average 4.3 percent and unemployment will end up at 7.3 percent, while debt falls from 73 percent to 68 percent, which are not nearly as scary as the short-term effect.

How much credibility can we place on these projections, especially since economists were hopefully -- helplessly often forecasting the eurozone debt crisis?

FELDSTEIN: Well, I think the big problem is we don't know what the policies are that are going to be in place. And as Alan said, and I agree, the Fed isn't going to have much of an impact on this, so it's really a question of what kinds of policies, tax policies and spending policies. And therefore, it's very hard to fault the CBO if it doesn't get it right, because it has to make its predictions conditional on some assumptions about these difficult-to-judge political issues.

So the answer -- if your question is how much confidence should we have in those numbers, I would say very, very little. But that's not a criticism of the CBO. It's saying that they can only make forecasts once it's clear what the political environment is going to be. And usually it doesn't have the kind of uncertainty associated with it that we see today.

BLINDER: I agree with that very much. I think you -- think of there being very large standard error bands around those CBO estimates, which are reasonable central estimates, but we know they'll be wrong. I mean, if you always forecast confidently that we're going to hit in the middle of a probability distribution, you know you're going to be wrong, always.

OPERATOR: (Gives queuing instructions.) Our next question comes from Seth McLaughlin from Washington Post.

QUESTIONER: Yeah, thanks for doing the call. I wanted to piggy-back on that last question and ask you -- the CBO basically has said that if the nation does go off the fiscal cliff, that there would be a sharp, quick recession and it would put the economy on a -- make the economy stronger over the long haul Can you weigh in on that and, you know, whether or not you think that is going to be the case if they do actually do go over the cliff?

FELDSTEIN: I think, you know, again it depends on what happens after we go over the cliff, how quickly it gets remedied, the nature of the remedy. But my sense is that the CBO's estimate for the path in 2013, if we actually go over the cliff and don't remedy it, is much too optimistic. That we have an economy that has struggled to reach 2 percent growth this year, we're going to see weaker exports next year, we're going to see, I think, consumers having a hard time expanding their consumer spending, given that the saving rate is now under 3 1/2 percent.

So for all of those reasons, I think it's a weak economy to begin with, and if you hit it with a negative-4 percent of GDP plus higher tax rates that discourage investment and discourage hiring, you do all of that and we will have a much more serious downturn in 2013 than the Fed -- than the CBO's numbers suggest.

BLINDER: On the downturn, I think it depends -- well, it's kind of obvious it depends on many things, but one of the things it depends on is how much of the cliff we go off. The cliff has many, many pieces, so the off-the-cliff scenario -- there are many off-the=cliff scenarios, and I don't actually recall which one the CBO presumed. So you could easily imagine a worse case than what's in the CBO forecast.

But I'm much more worried about -- I should have answered this in answering the previous gentleman's question. I'm much worried about getting the mechanical, quick snapback, sharp snapback from the recession in an economy which was just limping out of the worst recession since the 1930s, then gets another body blow; sees its government act like a bunch of clowns, as I was saying before; may see borrowing costs go up because of lack of confidence in the -- in the financial markets and so on.

So I'd just -- I'm much more worried -- or I'm much more dubious, not about the 2013 forecast but about the snapback thereafter.

FELDSTEIN: I don't disagree with that. I think we're accustomed to thinking of recessions as relatively short. You know, the average of NBER recessions historically has been 10 months from peak to trough. This last one was 18 months. This time would be even tougher to get a rapid bounce back because monetary policy wouldn't be able to do anything.

BLINDER: Right.

OPERATOR: Thank you. And everyone, there are no further questions in the queue currently.

ROSE: OK. Let me ask one about you guys. Everyone seems to agree -- this is Gideon again -- that as tough as these fiscal cliff negotiations are, they're -- actually are only the tip of the long-term structural iceberg when it comes to major tax reform, when it comes to major entitlements reforms and so forth. What does this really say not just about the immediate ability of Washington to do this? If we can't do this sort of -- how are we going to tackle the fundamental kinds of challenges looming well past the cliff?

FELDSTEIN: Well, that's absolutely right. You know, even if the administration's budget was completely accepted, their forecasts and the CBO's forecasts for the debt ratio a decade from now wouldn't be any lower than it is today. And it would be at a point of inflection, where after that, the forecasts -- the CBO's forecasts are that it would increase even faster.

So we're going to be heading to a hundred percent debt-to-GDP ratio if we don't do some serious reforms of entitlement policies.

BLINDER: I couldn't agree with that more. I always emphasize in discussions of this that we're -- all these plans, Bowles-Simpson and Domenici-Rivlin and gang of this and gang of that -- they're all focused on the next 10 years. Compared to what happens after -- at least in the projections, what happens after -- the first 10 years are a piece of cake. It's really easy. After that, go out 20, 30, 40 years. It becomes a horrifically large problem.

And my other pet peeve is that people keep saying it's an entitlements problem. It's a health care problem, basically. None of the other entitlements are showing this kind of explosive growth on any reasonable projection. That includes Social Security. So it's a health care problem, and we need to find a way -- and we don't have it yet -- to slow down the growth of health care costs in the future, if we're going to really wrap our arms around the very long-term deficit problem that we have.

ROSE: Great. Let me follow that up with one more. I mean, to whippersnappers like myself, this all seems really, really bad. Marty, Alan, you guys have been around the block more times than I have. You've been watching this longer. Is the inability to deal with national problems at this scale by the major parties worse now -- significantly worse now than it was back in the day? I mean, is this just today's version of the kinds of fights we've always been having, or is -- are we seeing something qualitatively different in the functioning and management of the American political economy that really should scare the bejeezus out of us?

FELDSTEIN: The magnitudes are just much worse. You know, we coped with a debt-to-GDP ratio that meandered around 40 percent for a long time. Now suddenly we're looking at something around 75 percent and predicted to head much further up from that. So we just haven't had to deal with something of this magnitude in the past.

BLINDER: I think also the -- and I think, more importantly, the partisanship is much worse. I don't want to say it's worse than ever in American history. You know, we had the antebellum period. We had Jefferson and Hamilton and so on. But for most of the postwar -- post-World War II period, compared to now, the partisanship has been mellow. And it's vicious now.

FELDSTEIN: Well, think about the --

BLINDER: These parties are barely on talking terms with one another.

FELDSTEIN: Yeah.

BLINDER: There's no Tip O'Neill. There's no Bob Dole, et cetera, et cetera. And that, I think, more than the magnitude of the deficit problem, which, as Marty said, is larger -- but I think it's the partisanship that is the bigger hurdle.

FELDSTEIN: I don't disagree with that. I think the situation is very different. When I was in Washington, in the early 1980s, Reagan and O'Neill could sit down and strike the deal that constituted the 1986 Tax Reform Act. And it's hard to imagine Obama sitting down with anybody in the Congress and doing a similar thing.

ROSE: Let me just say on that cheery note that our next issue, the Jan.-Feb. 2013 issue -- which, by the way, sports the new, glorious redesign of Foreign Affairs in print -- has a lead package by Fareed Zakaria and Roger Altman on exactly this subject, where Fareed actually ends up as pessimistic as Marty and Alan are about whether the long-term fiscal and health care and so forth crisis can actually be resolved. And it concludes by saying that, look, we're probably going to be looking at an American future like Japan, which is very depressing.

On that note --

FELDSTEIN: No that is not --

BLINDER: I disagree with that.

FELDSTEIN: That need not be true, because --

BLINDER: Right.

FELDSTEIN: -- we do have a growing population. We have a different kind of business community. So there are many reasons why we are not Japan. But no doubt that's for a different time.

ROSE: (Chuckles.) Well, it's good that we can have some optimism on something.

On that note, thank you all for participating. And we look forward to future engagements with you in print, online and on these kind of events. Thank you very much.

FELDSTEIN: Very good. Bye-bye.

BLINDER: Goodbye.

ROSE: Bye-bye.

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