Transition 2005: World Economic Update Special Edition - The Administration’s Economic In-Box

Speaker: Alan S. Blinder, G. S. Rentschler memorial professor of economics, Princeton University

Speaker: R. Glenn Hubbard, dean and Russell L. Carson professor of economics and finance, Columbia Business School

Presider: Daniel K. Tarullo, professor of law, Georgetown University Law Center

Council on Foreign Relations
New York, N.Y.
January 28, 2005

[Note: This is an unedited transcript]

DANIEL TARULLO: Good morning, everyone. Welcome to this special edition of the World Economic Update. We are doing this winter session as part of the Council's Transition 2005 series, transition from Bush I to Bush II. And this is the economic program.

Because we're doing it as part of the transition series, we thought we'd have a somewhat different not format so much as kind of guests and kind of discussion. As you know, we traditionally have economists from financial institutions, and we generally talk about the state of the world economy in sort of snapshot fashion, and try to look out a little bit.

Today we're going to look specifically from the perspective of the administration, the Bush administration, with more of an emphasis on policy. So we're pleased to have with us today two friends of mine— they're always friends of mine, you may have noticed that— [laughter]--two very distinguished academic economists who importantly have both served in very senior positions in the U.S. government. Sitting to my right, your left, is Alan Blinder, professor of economics at Princeton. Alan was a member of the Council of Economic Advisers and then vice chairman of the Fed during the Clinton administration. And on my left, to your right, is Glenn Hubbard, the dean of the Columbia Business School. And, as you all know, Glenn was the chairman of the Council of Economic Advisers for the first few years of Bush I.

In trying to set this up— again, we're going to do it a bit differently, because we are thinking about how the administration is going forward in its last four years in office. And there are two kinds of ways you can look at administration priorities in the second term. First of course are what are the overarching problems with which you need to be concerned and where you're trying to keep your focus, no matter what the policy issue. And, second, one has to pay attention to one's own affirmative legislation priorities, because despite the best intentions of every second term president, you get a lot less done than you think you're going to be able to get done, and in about two years from right now President Bush is going to wake up and find out that he's a lame duck, and he's not going to quite understand what that happened, because the last time he looked he had won an election, and there's still a couple of years to go.

So realistically we're looking in the next two years at his window for significant legislative initiatives. And thus I thought it was a good place to start, although we'll go right down the list of important economic topics, I want to start with what appears to be his legislative priority in the economic area for this second term. And that's of course Social Security. Although the administration has been talking some about taxes, talking some about the Pension Benefit Guarantee Corporation problems, at least by the amount of air time and meeting time that senior administration officials and the president himself are devoting to various issues, Social Security seems to be at the top.

So what I am going to do is begin by asking Glenn whether Social Security should be at the very top of the president's legislative priorities in the economic area, and whether or not it should be what kind of policies he actually should be advocating.

GLENN HUBBARD: Well, I think there are a number of things that ought to be at the top of the agenda, and Social Security is clearly among them. One, I would put his whole set of policies to maintain America's rapid rate of economic growth. Second family, of which Social Security would be among them, is old-age issues and American budget issues. And the third would be America's role in the world.

On Social Security, I think the reason to keep this very near the top is it is a program that is in need of some significant repairs, an economic policy matter as well as a budget matter. Part of the issue here is there are really three different conversations, and they're getting conflated. One conversation is the budget problem of Social Security, the very large unfunded liabilities. That is a discussion that has led to either changes in benefits or changes in taxes. A second conversation is whether we should have personal accounts. It is possible to have those as two very different conversations. I think the president is exactly right that personal accounts are part of a way to build an ownership society. The third discussion is a way to enhance the safety net aspects of Social Security for low-income workers. Those are three different discussions. They're all important. I think they'll all be part of any proposal from the president, but I think all three of those suggest the seriousness of the issue.

TARULLO: OK, Alan, why don't you come in right now on the issue of the relative priority in Social Security.

ALAN BLINDER: I'd like to actually pick up the three points that Glenn made, because I think that's a perfectly fine way to think about it. I think Social Security reform, which would be useful, is by no stretch of the imagination a high priority. It is not contributing to the current fiscal problem. It might not be even contributing to the long-run fiscal problem, though it probably is, and that's why some reform is in order. It is dwarfed by several other things, such as Medicare, Medicaid. Even if you just look at a corner of Medicare, the new prescription drug benefit, from the fiscal point of view is twice the size of the Social Security deficit. The Bush tax cuts are three times the size of the Social Security deficit. So we have a very large fiscal problem on our hands.

In the short term, Social Security is making a positive contribution; that is, it's the reverse of a fiscal problem— it's running a surplus. In the long term, it's a valid point that it is a problem. So that was Glenn's first, in Glenn's triad, starts with the budget problem. So Social Security is a long-run budget problem, but not a large one. Many of you have seem the estimates running from seven-tenths to four-tenths of a percent of GDP in terms of the actuarial deficit. It's not a big one.

Personal accounts, we'll probably come back to that. I mean, I could— I feel a little bit like saying I'm against them— let me count the ways. [Laughter] There are many, many arguments against them. But not to be too poetic this early in the morning.

I would draw a sharp distinction— I think everybody should draw— between personal investment accounts that are, say, add-ons to Social Security, versus carve-outs of Social Security. To me that's a huge difference. All the arguments for ownership, wealth accumulation, et cetera, that are perfectly valid— people sometimes ask the rhetorical question, the anti-privatizers: Are you against personal wealth accumulation? Of course not. So add-on accounts are a whole different thing. And we have them. They're called 401[k]s. And we have a variety of other things as well. That's different from a carve-out.

Finally, I was very glad to hear Glenn speak of— and I would hope the administration would speak more of— of the safety net for low-income workers, because I think, and many people think, that moving to privatization will greatly imperil the safety net for low-income workers. So I wish there were more people in the other party like Glenn that were concerned about that.

TARULLO: Glenn, let's go back to you, but let me ask you specifically on your triad, as Alan put it, at least as the administration is now thinking about the private accounts, there's not going to be any net effect on savings rate, because in fact they're going to go out and borrow money in order to be able to finance the transition to private accounts. So even if one wants to make Social Security the higher priority, doesn't the merging of private accounts with the fiscal problem actually lead to a contradiction between the aims rather than pursuing them simultaneously?

HUBBARD: Not at all. I think not when you think of them in pieces. The fiscal issues I think can be addressed by just changing the system's indexation formulas. The popular version of this is just moving from wage indexing to price indexing. That alone would more than offset Social Security's actuarial problems, and that will be a large present value increase in savings.

The prefunding through personal accounts, once you've done that, is akin to prepaying the mortgage. So, yes, there's more cash out the door today, but you're also changing the liability tomorrow.

I think the reasons to advocate personal accounts have to do with their role in building individual wealth. And here I guess I'd like to take issue with one thing Alan said. The issue of add-on and carve-out is one of the great red herrings I think of this debate. Let me just put two policies on the table and have you tell me the difference. Suppose that I did a very large present-value change in Social Security's benefit formula and then did a small add-on of a personal account. Another might be that I do a smaller present-value benefit change, and do a carve-out. I could easily come up with examples where the present values of those are the same. I could make the add-on bigger than the carve-out, or vice versa. I think the question is really the pieces: Do you want the personal accounts, and do you want to fix the actuarial adjustment?

It is true that Social Security's actuarial problems are far smaller than Medicare. They aren't trivial. There's several trillion dollars in present-value terms, and I would at least question whether we can do Medicare reform without having done Social Security reform first as a marker.

TARULLO: Alan?

BLINDER: Two points. Glenn's of course correct that you can mix and match pieces so that something is or isn't an add-on or a carve-out. What I mean by that distinction is when I speak about a carve-out I'm speaking about a plan that would significantly reduce the guaranteed Social Security benefit, and presumably replace it by a non-guaranteed benefit coming out of the defined-contribution plan. But the key thing there is a substantial cutback in the guaranteed benefit. That's what I mean by a carve-out.

I want to say something about this much discussed and seemingly technical change in the indexation formula from wage indexing to price indexing. This sounds like one of those details that will surely make the eyes glaze over of 290 million Americans out of the 296 million— probably more. [Laughter] However, it is not a technical detail. The design of Social Security is to maintain rough equality over the generations of the ratio of the retirement benefit to wages, the so-called "replacement rate" of wages. That's the whole idea from the beginning, and that's what it's done more or less with some fluctuations.

If you replace the indexing to wages by indexing to prices, in translating old wages into today's benefits, you will basically cut the benefit ratio relative to wages by about 30 percent per generation, in round numbers. I mean, it's a little in one generation— it's only 30 percent— then in two generations it's 50-something percent, and so on. And eventually Social Security dwindles into insignificance.

That is why, as Glenn correctly said, that one, quote, "little change" by itself is more than enough to wipe out the entire actuarial deficit, because it comes close over a long period of time to wiping out Social Security. [Laughter]

TARULLO: It's 2040 is the date everybody is looking at here.

So, Alan, if— OK, I just want to ask one follow-up question though. If you are disinclined to make the change in the indexing constant, what ought to be the approach to eventually dealing with the Social Security deficit?

BLINDER: I think at least at this point the sensible approach looks to me what I call a "cats-and-dogs" solution. It's a little of this, a little of that. For example, the indexing is not sacred. There are two components of indexing. The one Glenn had made allusion to and that I vehemently disagreed with is the indexing that translates all wages into new wages so to speak for the computation of the benefit. Then there's the indexing to the CPI that once you're retired keeps cost-of-living parity in your pension payment. That could be trimmed a bit. They can take a few points out of that.

I think, despite the protestations of many politicians, some of whom I've been associated with, raising the retirement age not only makes sense, but it's a complete imperative going forward. We're doing it now. We're in the process of moving it up to 67. That doesn't come close to accounting for changes in life expectancy— or what's more germane, the retirement period of the typical American. We ought to remember that— you know where the age 65 started with? Bismarck. Yeah, things have changed since Bismarck's days. [Laughter] So I very much thing that we should be changing that. You can bring more workers, a few more workers, into the system— there are a few other things that are skipping my mind right now— and you can solve it that way.

TARULLO: OK, last comment on Social Security, then we'll move on.

HUBBARD: Just two quick points on that. One, I think Alan is absolutely right that the discussion of indexing isn't a technical discussion— it's a big deal. The real I think the discussion of wage versus price indexing is one that we will have to have as a country, is if we were to imagine economically what we'd like to do with Social Security— at least speaking from probably the administration's perspective— it would be something like a gradual decline in the guaranteed replacement rate that is achieved by a movement from wage indexing to price indexing. If we were to start afresh thinking of Social Security today, I strongly suspect what we would have is a program that had a very substantial guaranteed benefit for low-income people, and a variety of things that narrowed that down for middle- and upper-income people, replacing those with a combination of personal accounts and savings incentives. So I take exactly Alan's take, but I have a very different philosophical answer to it.

I was heartened to hear Alan in describing other ways out to focus on other ways of reducing the size of the system through spending changes. Most of the alternative discussion of Social Security reform does talk about cats and dogs, but they all turn out to be one cat and one dog, namely a family of tax increases. It is not the same thing for our economy to change this problem by slimming down the program on the one hand, or raising taxes on the other. There are very different economic consequences from that, and as a country that's what we'll have to talk about in this debate.

TARULLO: OK. Let's now step back a bit and try to look at the economy a bit more large. And specifically, Glenn, or generally, the related problems of budget deficit, current account deficit, the position of the dollar, the long-term fiscal concern, the savings rate— all the things that you mentioned at the outset being implicated by Social Security, but obviously the magnitude of the issue is substantially larger.

Judging from my perspective— but not disinterested— judging by the administration's first budget foray in the second administration, in the second term, we're not seeing a path towards the substantial deficit reduction. How ought the administration to proceed over the next four years in reaching its goal of halving the budget deficit by the time the president's successor is inaugurated?

HUBBARD: Well, I think there are two deficit discussions, and your question is about what I would think is the lesser of the two. One discussion is what's going to be the five-year-out or even eight- or 10-year-out budget forecast. And my concern with the administration's claim that we could halve the deficit in five years is not that we couldn't do it— because we actually can. There's a whole variety of sets of economic growth assumptions and discretionary spending restraint that will get you there. But it's a trivial question, is my issue.

The bigger issue are these longer-term entitlement questions, and they are not a five-year issue— they're a 10-, 20-, 30-year issue. Just to frame it for you, the Congressional Budget Office tells us that if we were to go out another 30 years, we would find Social Security and Medicare consuming about 10 percentage points of GDP more than they consume today. To get a handle on whether that's big or small, the whole federal tax take in GDP today is about 19 percent. So were we not to make any changes in these programs, that is a 50 percent tax increase. Now, that won't happen. But that frames for you how big this long-term problem is, and to me that's what the administration should be talking about, and the Congress of course has to talk about it.

So I don't have any quarrel with the notion that we could significantly bring down the deficit over the next several years. I just don't think that's enough.

TARULLO: So, what I hear you saying is that, to pick up on one of Alan's points, the apparent disinclination to address Medicare and Medicaid spending in the second term, or at least for the foreseeable future, puts a serious constraint, perhaps a disabling constraint, on the administration's capacity to have those long-term effects on the fiscal situation.

HUBBARD: Well, it is true that any long-term fiscal discussion is about Medicare. Social Security is the junior player in that discussion. Although, as I said before, I think addressing it first makes Medicare easier. The reason Medicare is hard is because I don't think you can address the budget issues in Medicare without doing a whole series of health care policy reforms that would also affect the Medicare program. Those are politically a very different subject. If you think Social Security is hard, I think these would be even harder. But I would like to see more discussion of health care in the policy debate.

TARULLO: Alan, how about both sets of issues, both the sort of near-term budget and the longer-term issues?

BLINDER: Yeah, I wouldn't dismiss the near-term budget issues so easily as Glenn. There are macroeconomic consequences of running deficits of the size that we are running and we are likely to continue running; consequences for interest rates, for exchange rates; consequences for the national savings investment balance, which whose flip side is the current accounts, and which is then in turn related to the dollar.

You know, to me it's one of the crying shames of the first Bush administration that it started with such a fabulous initial fiscal position and finished with such a terrible initial for Bush II. Bush II is starting with a terrible initial fiscal position, because of what happened during Bush I. It didn't have to be that way.

As Glenn correctly says, the budget— the real budget tidal wave hits when the baby boomers start retiring. So the year 2010, which used to seem so distant, is not very far from the end of the Bush presidency. A rational government— this the following is not a partisan statement, it doesn't matter whether it's Democrats or Republicans running the government, because neither one is very rational— [laughter]--a rational government would plan to come into that period running a budget surplus, because you know from whatever position you start you're going to run downhill pretty far and pretty fast. That's completely predictable. And so you prepare for it by squirreling away some food for the winter. We haven't done that. We've in fact done the opposite. And I think that's the biggest problem with the current budget policy. And it is an issue for the next five years. That is, we so to speak have got five years to get ready for the budgetary onslaught, and we ought to start doing it.

TARULLO: So, Alan, with broad brush strokes obviously, rather than a line by line, line-item OMB type approach, what should the general orientation of government's budget— let's not put all the onus on the administration— the government budget changes be to start getting us in that better position?

BLINDER: Well, I think the first step would be to realize, as Ronald Reagan and the Congress did in 1982, that we goofed. If I can take you back to ancient history, in 1981, under the leadership of Reagan, Congress passed a gigantic, titanic series of tax cuts to be phased in. They came back the next year and said, Oh, my God, what did we do?--and they repealed almost half of them right there. That was smart. You made a mistake, you realize it, you cut taxes to an extent you couldn't afford, and they came back and repealed half of them. And the great tax-cutter, Ronald Reagan, signed the legislation.

So I think a first step would be pare back some of the tax-cutting, or not let it become permanent. You almost have a natural pare-back, because part of the budget chicanery of the last four years is continually make everything sunrise and sunset. So actually you barely need legislation to do this. A lot of it will go away by itself— probably more of it will go away than you need to go away. So I would start there.

And then of course you go to spending control, which is what the administration is talking about. And Glenn's right. I mean, as you look further out into the future, the larger entitlements bulk relative to everything else.

TARULLO: Glenn, can you address the tax issue for a second, and then with any larger comments you want to make? Is there any realistic way, given all the pressures on entitlements that you alluded to earlier, even with entitlement reform, that you could assure long-term fiscal stability without, as Alan puts it, allowing some of the tax cuts to lapse, or doing something else on the revenue side?

HUBBARD: Well, as a public finance specialist, the way I think of the question is the first question for us as a country and our political leaders is what's the size of government. And so I would start on the spending side and ask what do we want these programs to be. And I think the first discussion is not taxes, it's the entitlements.

When the political process answers that question, we will then have an answer on the tax side. If the political process says, as I hope it will, that these programs need to be a smaller share of government than current law suggests, then I don't see that we have a tax problem. We have a composition of tax problem— that's the tax reform debate. But I don't see an overall problem.

If we answer the question differently ,and we say we're not going to cut these programs as a country, then, yes, we will have to raise taxes, and the arithmetic will give you that.

TARULLO: And is it— let me rephrase the question. Is it realistic to think, given that all the pressures on Medicare and Medicaid are upward, and it's only a question of how much upward, is it realistic to think that you can cut those programs enough to take care of, I guess depending on the year, half a trillion or more of deficit that looms out there in the out years?

HUBBARD: I think the answer to that question is a qualified yes. I say qualified, because in health care, as you and I were discussing at breakfast, no one really knows. Small changes in rates of growth change any answer. But I think, yes, it is possible. The question is not whether we're going to pretend that people will spend more or less on health care than current trajectories suggest, but how that's going to be covered. It makes a big difference in an economy whether that's covered in a prefunded privately saved way as opposed to using distorting taxes to do it. The recent Nobel Prizewinner Ed Prescott has suggested very large consequences for the economy of ratifying these entitlement promises with tax increases as opposed to funded accounts.

TARULLO: OK. Alan?

BLINDER: I would say this in terms of the size of government: We now have reduced the tax share of GDP to the lowest since— you'll help me, 1953?--I'm forgetting the year. Around that, around that. Compared to 1953, we have a much bigger— well, we have a bigger government in many respects, but we especially have a much bigger need to take care of the elderly population. For example, in 1953, there was no such thing as Medicare. You fended for yourself. I don't think we want to abolish that. In 1953, the gap— I'll be approximate here, but this is roughly correct— the gap between the average longevity of an American and the average retirement age was a year and a half. A year and a half. Now it's about 14 years. And there are more older people.

In a society that has changed in that way, I think it's entirely rational for the state to be spending a larger share of GDP on support for the elderly, both health and retirement.

Now, maybe it's too much going forward— that may be right, and we need to trim it back. I wouldn't quarrel with that. But the point is it must be higher. On top of that, we've had in recent years a perceived, and I think probably actual, need to raise the share of our GDP that we devote to national defense and homeland security. I think that's correct— not relative to 1953 levels now, but relative to 2000 levels. In an environment like that, where you have these two big needs, and then 27 other things in the budget that are needy— but just those two, it seems to me most unlikely that you can or should want to get away with a declining tax share in GDP. There are bills to pay. So at least constancy in the share of taxes to GDP in an environment like that.

HUBBARD: I think that really conflates two issues. One, as a country I wouldn't be surprised if our share of health care spending in GDP rises. Health care is a superior good— it wouldn't surprise me at all that a rich country might even spend more as a share of GDP than we are currently spending.

My concerns are two. Markets in health care don't work as well as they could. There are a whole series of deliberate policy errors that have made that happen. The question for Medicare, and to some extent Medicaid, is where this takes place. It makes a big difference whether we're doing this more through the private sector or more through the state. I don't think there's much of a question that if were to start today in a room like this and decide we've never had Medicare— we're thinking about how to do it— we would probably have some sort of forced savings scheme where people saved up money in their individual accounts, and then were required to buy health insurance in old age, and we'd probably help low-income people do that. That of course isn't what we do in Medicare. And I think the real issue is not whether or not we're going to ratify some spending level in GDP, but whether this is largely the state or largely the private sector.

TARULLO: Do you want to come back on that one?

BLINDER: Just a very brief word on that. If you look around the world, many— all countries have to grapple with these problems, and the number that have decided that you have to do a lot more through the private sector, and/or do it through forced savings to prefund your health bills is zero.

TARULLO: Let me see if I can isolate a point of agreement now— [laughter]--which is always a bit risky, but --

HUBBARD: We can agree on that. The number is zero. [Laughter]

TARULLO: I'm going to try. And that is the picture I've heard painted from both my physical left and right and the metaphorical left and right— [laughter]--has been that entitlements, national security, both in conventional military spending and newer homeland security spending, entitlements and the growth of entitlements— plus something no one has mentioned, but debt servicing costs— all of which are very hard to get a handle on in the near term— virtually impossible to bring down in the near to medium term— are by far the lion's share of the fiscal difficulties that we face, and thus the inevitable focus on discretionary spending, which is going to emerge from this, is at some level a distraction and misleading. Can we— do we agree on that?

HUBBARD: I think that's right. I mean, that's why I said it's— I don't doubt that we could cut some discretionary spending, but I don't think it's a very interesting question. I'm sure there's fat in the discretionary budget, but that's not the source of a long-term problem.

TARULLO: OK. All right, now I want to— I mentioned it, Alan mentioned it, and let's now address it head on, the current account deficit and the position of the dollar, but again not in kind of a detached analysis but what the administration's posture— concern about, if any, about either of those related factors ought to be, and what if anything they ought to be doing about the two of them in the near term.

HUBBARD: Well, the current account deficit of course gets a great deal of discussion, as it should. But I think here some introspection is useful. You know, we've had now a decade of people saying we will have a necessary collapse. The truth is as an economics profession we don't know what the critical threshold for a country like the United States is for current account deficit relative to GDP. We have lots of empirical evidence on countries that weren't the reserve currency.

At the same time, Herb Stein was clearly right that something that's growing too fast forever will stop.

TARULLO: Three of Herb Stein's aphorisms have occurred to me in the course of the— [laughter]--

HUBBARD: OK, well, that shows we're talking about real issues. So the question is what to do. Well, the current account is— the flip side, as Alan correctly said, is to think about the saving investment balance in the United States. And it seems to me there are a couple of clear directions. One is to gradually raise national saving in the United States. And here I think the emphasis is gradual. You know, think about Saint Augustine's prayer of, Lord make me virtuous, but not today— [laughter]--we don't want all of this adjustment at once, before the rest of the world has made certain adjustments.

But, secondly, I think the administration is right that we have to raise prospects for growth in the major regions of the world outside the United States. So I think both of those discussions need to happen.

TARULLO: Alan?

BLINDER: I agree with everything that Glenn just said. I am not now, nor have I ever been, a catastrophe-monger vis-a-vis the dollar. The dollar has fallen significantly since 2002. I believe it will fall significantly further against euros, say, and several other currencies. I don't believe that will lead to any cataclysmic consequences for the United States.

I was once speaking to an audience much less sophisticated like this, and somebody asked me, Should I be worried about the fall in the dollar? And I said to her, Do you speculate in foreign currencies? She said no. I said, Don't worry about it. [Laughter] If you have a long, and especially leveraged position in the dollar, I would worry about it. [Laughter] But so I don't think that this is going to be a big problem.

TARULLO: OK, I don't think we have anything more on that.

Now, there's another issue which is lurking out there that the administration at least has started to pay a little bit more attention to in the last couple of weeks, and that's the position of the private pension system, the private defined benefit pension system in the United States. And fiscal implications come out here in the Pension Benefit Guarantee Corporation, which is the government agency that ensures most private defined benefit plans. Now, as most of you probably know, only about one in five workers in the United States participate in the defined benefit plan. That's been halved in the last 20 to 25 years. But that's still a significant number, and there are a lot of unfunded liabilities— many it appears in the airline industry, some of which have been off-loaded on the PBGC, some of which the PBGC has taken, to wit the pilots program from United.

The PBGC seems to be present a more immediate problem than either Social Security or Medicare. Right now its liabilities exceed its assets by about 50 percent. It also seems to present the classic case, the classic political economy case of what happens with a big problem like this.

Last year PBGC problems come to the fore, and lots more companies are badly underfunded. And what did Congress and the administration do? They increased the discount rate that can be applied to the assets, meaning that the funds look in better shape than they actually are. And they stretch out the amount of time that underfunded plans have to put additional assets in in order to come up to the funding. The obvious reason for that is to relieve short-term pressures.

Glenn and Alan both— we'll start with Glenn— how much of a problem is the PBGC? Does it need more immediate attention and fairly significant attention? But, secondly, is the PBGC story a cautionary tale about what's going to happen with entitlement programs more generally?

HUBBARD: That's a lot in one question. I would start, first— I mean, to me the biggest pension issue outside Social Security facing the country is how to shore up defined-contribution plans even more, and get greater participation. We can come back to that, because you're more interested in the DB side.

On the PBGC, it strikes me there are a couple of big issues. One is the appropriate pricing. And we have of course seen proposals now for better risk pricing of PBGC insurance. The other is whether the PBGC needs to rethink the way it intervenes. You've correctly identified airlines as a big industry here. The PBGC has taken in some cases a series of short-term actions that just bring the problem back several months hence. I mean, if the goal is to try to get some of these industries back on their feet, current workouts, at least as being done by the PBGC, aren't going to do that. So I think there are really two PBGC issues. One is the pricing; and, two, how do we want to do workouts when we effectively get an entire industry in trouble.

TARULLO: Alan?

BLINDER: First, I guess I'd like to applaud the administration for paying any attention to this issue at all, because it's the kind of thing that you can sweep under the rug, and it's been swept under the rug for a long time. It's obviously not, as Glenn said, properly priced, funded, et cetera. It's really not a viable insurance— if you thought of it as an insurance company, so to speak, it's not a viable insurance company.

My reading of the Congress suggests strongly that, quote, "something will be done," unquote, only when there's no way to avoid it— which is to say when the PBGC is flat broke and Company X— I won't name it, though I have a few candidates in mind— [laughter]--has just unloaded their pension liabilities on the PBGC, and they don't have the dough to fit the bill, to pay the bill, and they'll be at the congressional doorstep. And that's when Congress will do something. That would be my prediction. It would be nice if we could act sooner than that, but I wouldn't be optimistic that we will.

TARULLO: All right, now as our last round-up here before we turn to you, and I want to give a lot of time today for questions— what else should be talking about that we haven't been talking about? What else should the administration be thinking about that we haven't heretofore talked about? Glenn?

HUBBARD: I would say two things, one of which is very big, which is the notion of how— what set of policies we can pursue as a country to keep our long-term rate of economic growth high. The big unsung news in this country is that we have almost a sea change in the shift of our economy's ability to grow. Potential GDP growth right now is about 3.5 percent. Ten years ago if we were having this conversation, very few serious economists would have suggested that that was possible. The issues we've talked about today are part of that discussion, but so are regulation, tort reform, keeping a very intelligent monetary policy. All of these things are there.

The second, especially in an audience like this, is America's role in the world. I think a second Bush administration could and should spend more time on our relationships with the big international financial institutions, and particularly in big regions of the world, how we communicate in China and Latin America, both regions I think we've had missteps, and it would be nice to remediate.

TARULLO: OK. Alan?

BLINDER: I would name a few things. First, something that we haven't talked about, but is actually on the Bush agenda, which is simplifying the tax code. I've been a big proponent of that for a very long time, and I would really like to see it, just speaking as a citizen who does his own taxes, and as an economist, both.

TARULLO: When you say simplify the tax code, you mean keep the basic approach that exists now, but just remove deductions and like rather than— you're not talking about moving to a value-added tax?

BLINDER: No, no. I'm talking more about a 1986-style simplification I would favor.

Secondly, I think the administration is going to have to do some work to avoid the movements towards protectionism and away from free trade. I mean, China-bashing is only one aspect of that. When you have a $600 billion and rising trade deficit, you get some protectionist impulses, and we're going to have large trade deficits for— certainly through the entire second Bush administration, and probably longer than that.

So those are two things I think it's reasonable to actually expect this administration to at least try to do something about.

On my wish list, which I don't think the administration will have the slightest interest in doing anything about, is I think the national government ought to be doing much more than it is— I might say something— but if you say they are doing something, then I'd say much more— to counteract the rising tide of inequality in this country, which is now a 25-year phenomenon more or less. The Bush administration did not cause this. It is not guilty of doing this. The market has done this. But when the security— to my mind, when the market is turning viciously against the working classes, the government ought to be trying to do something to cushion the blow, rather than exacerbate inequality. I don't expect anything in that dimension.

Looking further ahead, I think the big issue for the next generation I'd say of Americans, starting now, but continuing for a generation, is how are we going to cope with off-shoring of various kinds of jobs. We have seen up till now the tip of the tip of the iceberg— that is relative an iceberg, what we now is the snow that fell in New York a couple of days ago compared to an iceberg. There's that much beneath the surface. The electronic age has now— is now making a vast swath of our work force that formerly thought themselves invulnerable to foreign competition vulnerable. Loosely speaking, anything that can be delivered down a wire is now a traded good— not "is now"--is in the process of becoming a tradeable and probably a traded good. I think this requires major rethinking, for example, of our educational system, and a variety of other things. But this is an issue for sufficiently far down the horizon that it's probably outside the purview of most politicians.

TARULLO: Alan, just follow up on that a bit, because many people when talking about outsourcing draw a contrast between the circumstances that we faced in the '70s and '80s and those we face today. To wit, in the '70s and '80s, when there was a huge push of imports, mostly in the manufacturing sector, and lots of traditional reasonably well-paying jobs were being lost, the policy message from people in the government, Republicans and Democrats, outside the government, economists everywhere, was, We need to move up the skills ladder. Our human capital needs to be invested in more. "Move into the service sector" was the implicit and sometimes explicit message. That wonderful phrase that came out of Boston Fed, "Our people are going to need to think for a living and not just work for a living."

Right now the phenomenon you describe worries a lot of people because of the perception that it's not a question of simply being better educated, being a more sophisticated computer programmer or an engineer or someone who reads MRIs, and precisely because that stuff can go over the wires.

BLINDER: Absolutely.

TARULLO: So the paean to education that we all had 15 years ago rings a bit hollow here, doesn't it?

BLINDER: I think that's right. The unusual thing about this recent or coming, if I may call it, an Industrial Revolution— I mean, we had one revolution where we moved people from the farm to the factories, and another, the second, we moved them from the factories to the offices so to speak, into the service sector.

The interesting thing about the third revolution, which is just beginning, is that it cuts across the educational spectrum. It's not just a question that more education is going to help you in this domain. If you think about the jobs that are vulnerable to foreign competition, you have in addition to call centers, which is a very low-end job in the United States though a high-end job in India, you have all the things that you just mentioned— designers, radiologists and so on.

If you think of the jobs that are invulnerable to foreign competition, they also run the spectrum. The janitor that cleans up is not going to fear foreign competition. The doctor— not the radiologist, the doctor who gives you a physical examination— is not going to fear foreign competition. I sometimes wonder, though it will be beyond my tenure as a teacher at Princeton University, where college professors are sitting on this spectrum. [Laughter] I think we're ones that think of --

HUBBARD: Now you raised a real problem. [Laughter]

TARULLO: Spoken like a dean.

BLINDER: Glenn's a lot younger and he's a dean, so he's going to have to be thinking about this. It's not so clear where college teaching goes, but you could— The point is that as you suggest the answer to this is not just moving up the educational spectrum; it's more about where are you going. And I think Americans are going to have— this is what I was alluding to when I said major changes in the American educational system. We need to shunt our young people into the jobs that will be doable in America.

TARULLO: Glenn, why don't you say something about both of those last issues.

HUBBARD: Yeah, I mean I'd like to go back actually to the beginning of what Alan was saying, that he found it unlikely that the administration might be interested in policies to cushion inequality. I think one aspect of this that we will see discussion on, whether the administration pushes it or not, is a way to spend the safety net so that we can support policies for change. I mean, just to take your example of off-shoring, which I think is a smaller problem than you seem to believe— though still a noticeable one— if you take numbers like 300,000 jobs that are bandied about, in 1999, the peak of a boom, the American economy destroyed 33 million jobs. I didn't miss the decimal point there— destroyed 33 million jobs. The good news was it created 35.7 million jobs. This is an incredibly dynamic economy. The goal for policy ought to be to ensure that dynamism, but create a safety net for people who lose. So I share the concern that that's got to happen. Otherwise we'll lose support for the policies that promote change.

It's hard for economists, because you know we can never tell business audiences what the next big thing will be. But I can tell you it has always happened in an economy that is very dynamic like this one.

TARULLO: OK. Now we are going to turn to questions. We didn't touch on energy, we didn't touch on a lot of other things. Anything we talked about and anything— at least if it has to do with economics— that we didn't talk about is fair game here. We've got the mikes on the side. So, when I recognize you, please, A, wait for the mike; B, state your name and affiliate; and, C, please member this is an on-the-record meeting. OK, yes, sir, right here. The mike is coming around.

QUESTIONER: Hi, I'm Richard Whalen [ph], retired editor of Fortune. I didn't hear a word about inflation or deflation. That used to be way up top. It's gone. Keynes told us inflation us a mighty tax gatherer. In a few days, we're going to have an official number for the fiscal '06 deficit, and it's going to be a humdinger. Nobody is talking about the monetary consequences of the United States being forced to buy its own debt as other foreign predators. I think I've got enough of that. We are on the brink, I believe, and so do some computer models that my friends consult, of a return to double-digit inflation within five to seven years. It's a ghastly prospect, but it is one that is completely outside the bounds of complacency, and I wish you would comment on it. Thank you.

TARULLO: Go ahead, Glenn, and then we'll go to the --

HUBBARD: Two points. One, the good news for inflation now and for inflationary expectations is that it's the Federal Reserve at the helm, and the Federal Reserve has had a policy of bringing down inflation to levels that are approximating price stability. And I see no prospect of that changing. And in the bond market, where people are playing with real money, doesn't appear to see any prospect of that changing.

Your question is really about the discussion we did have, which is about long-term fiscal policy. Markets seem to believe in their price-setting that we will make progress on these fiscal discussions.

TARULLO: Alan?

BLINDER: I agree completely. Three quick points. First of all, the Fed will not monetize these deficits. So the Latin American analogy that big deficits lead to hyperinflation just won't happen here. I'm willing to bet a lot of— in fact, I have— I own some long-term bonds. [Laughter]

Secondly, there's a huge amount of inertia in the inflation process. That's why it was so devilishly hard to get it down. But once you've got it down, that works in your favor. It doesn't just pop up so easily.

Thirdly, as Glenn mentioned, just to elaborate, if you open the Wall Street Journal this morning and read the prices of— the yields of nominal bonds and TIPS, the indexed bonds, you see the five- to 10-year expected inflation rate is 2.25 percent, which seems like a reasonable number to me. So as Glenn said, the people that are betting real— I was almost going to say their own money— people that are betting other people's money— [laughter]--on this are betting on low inflation, and I would bet that they're right.

TARULLO: So neither of you saw anything of particular interest in the last set of Fed minutes that got released? No?

All right, next question— or next questions. Way in the back. I often ignore the back. So I'll try not to today.

QUESTIONER: Thank you. Douglas Makepeace from the Sperry Fund Management. Is the savings rate really zero? And does that matter? And is Leon Levy right in that wonderful book, "The Mind of Wall Street," that every one percent up in the savings rate will cut consumption so much that corporate profits will be hit by 10 percent?

TARULLO: Glenn?

HUBBARD: Well, just to take the questions in turn, although I'll have less to say about Leon Levy's observation— in terms of the savings rate, the first thing in an economy is how do you measure the savings rate. And some people think of saving rate as what I save out of this year's current income. Economists would say, Well, that's not quite right, because you have changes in the value of assets that you have. The United States clearly doesn't save enough. But part of what looks anomalous in the data is the fact that sometimes as an economy gets richer people save less.

The bigger economic answer to your question is while the saving rate is important, what a country does with saving is what's ultimate important. China is saving 40 percent of GDP— we don't really know, but that's what the data say. It's almost surely wasting the same amount. And so the question is, you know, what an economy does. And I think we would not trade the combination of American saving rate and American economic performance for a 20 years ago Japanese saving rate and performance or today China.

BLINDER: I think the answer is within the bounds of measurement error, and these things are not measured perfectly. Personal savings is closer to zero. National savings is not. There's a lot of corporate saving. So I mean private— never mind the government— private savings is by no means zero. It's very far from zero.

I'd just like to make one other remark, since I have such a room full of highly influential people here. Economists— and it's not the conventional economists like Glenn and I, it's the behavioral economists— have finally figured out how to raise the personal savings rate. As many of you know, we have tried in the United States every imaginable— well, almost every imaginable tax gimmick to get Americans to save more, and they keep saving less. We've decided to give up on that.

Behavioral economists have noted the following simple thing: change the default option in a 401[k] when somebody goes to work for a company from what it normally is now, which is nonparticipation unless you make an active decision to participate, to participate to the maximum employer match. That's the default. Anybody who doesn't want to do it can just opt out and do whatever they want, including not participating. There is now overwhelming statistical evidence that that will boost personal savings by a very significant amount. So I do that as a commercial. [Laughter] Go tell all your companies to do that.

TARULLO: OK, next question. Yes, right here.

QUESTIONER: Thank you very much. Mahesh Kotecha, Structured Credits International. I was quite surprised that— [inaudible]--

BLINDER: Thank you. [Laughter]

QUESTIONER: Sorry, sorry, you've written articles together I know, and I mix them up. [Laughter] That you took such a benign approach to the dollar. The dollar— I was very early in my career at the New York Fed when Volcker came in and he did what he did to restore the dollar. I wonder if you just think that the Chinese are, and the other Asians, are just going to stick with us and not have us worry too much about higher interest rates here.

BLINDER: Three questions— no, three responses. First of all, what Volcker did in the end of the '70s and into the '80s was not primarily for the dollar but for inflation. He— so pushing interest rates up like that is a classic way that a central bank defends its currency. But what Volcker was concerned with was inflation. He was taking very tough medicine or administering very tough medicine to counter inflation.

When I look for a likely parallel to what's going on now, I look back to '85 to '88, where the dollar fell by an enormous amount over about a three-and-a-half-year period, and the economy grew right through it, markets did pretty well except for that October '87 little detail there. [Laughter] But if you actually look at the three-and-a-half-year period, the stock market did fine, the bond market did fine. This is why I'm not very worried.

On your last point, I believe that China and Japan and the other Asian countries will, as you put it, stick with us for at least awhile longer. And when I say awhile, I don't mean another three weeks— I mean a substantial period longer, but not forever— for a very simple reason. They are not doing this out of charitable impulse toward the United States. They are doing it out of what they perceive to be in their own national interests, and I think by the way correctly perceive. Not everybody agrees with that. But whether it's correct or not is less important than they perceive it to be in the national interests, and that's why they will hang in there.

TARULLO: Right here. Yes, sir?

QUESTIONER: I've Steve Robert of Robert Capital Management. While we've talked a lot today and expressed concern about the government deficit, I notice a real change in the center of gravity of the debate. If we were here in 1996 we would have said that the sort of Clinton-Rubin regime that turned the budget deficit into a huge budget surplus was largely responsible for improvements in the U.S. growth rate, in the availability of capital, in the health and the creation of jobs. It created more money for savings, which boosted productivity, which boosted the growth of our economy and real incomes. So we would have— I think we would have viewed that as the keystone of economic progress. And certainly Al Gore argued that when he was running for president— maybe not strongly enough.

But yet I sense a little glossing over today of this problem. You know, it took, besides Clinton and Rubin, it took Ross Perot and Newt Gingrich, who may not be the two most popular names in this room, but the Contract in America, the return of Congress to Republican hands under the Contract in America, to tackle this problem. What is it going to take to get serious about this problem today?

HUBBARD: Well, if I could start this on the diagnosis, I have called in the past that kind of a story as "Rubinomics," and I think that it's not at all an accurate description of what happened either in policy or the economy. The bulk of what happened in terms of good news for the budget came from two things, one of which politicians, Democrats and Republicans, should get some credit for, which is the budget restraint that happened in the '90s— on the tax side, more the '90 act than the '93 act— but the bulk was just the shift in growth prospects in the American economy. And that was not directed by the White House, Republican or Democrat.

But I think the bigger issue, and the reason I think your question is a great one, is the second part, which is what does it take to get serious. I think it takes to get serious a realization that these long-term entitlement problems are really severe. I'm not sure that what we saw in the '90s was so much people getting serious as the huge winds in the sails from the sea change in economic growth. So it may be harder.

TARULLO: Alan?

BLINDER: I'll beg to differ with that. I think the policies that we put in place at the beginning of the Clinton administration— and which had their antecedents, importantly, in the first Bush administration, did quite a bit, though not everything, to improving the economic prospects for the economy, including raising the productivity growth rate. A fraction, a nontrivial fraction of that, came from what economists call "capital deepening"--more investment. One contributor to that is the greater national savings. It is still true to this day that the surest way to raise the national savings is to reduce government dissaving. We know how to do that, and that's what we did in the '90s.

To the second part of your question, I'm a bit at a loss because I'm sitting here on January 28th, 2005, completely clueless about why the long bond rate is as low a it is today. And my answer to you is that people will start getting serious about this when the bond market vigilantes, decamped in Nevada I guess— [laughter]--come back.

TARULLO: Any vigilantes out there who want— let's see, yeah, Peter.

QUESTIONER: Peter Guinn [ph], Council on Foreign Relations and Princeton University. Alan, I'll argue about the dollar some other time. [Laughter] I want to talk about health care, or raise a question to Glenn about health care.

We talk about Social Security, we talk about the transition problem and the financing of that transition problem. I have some difficulty with the idea that we could move to a prefunded health care system or health care saving, particularly for people in my group who are already on Medicare. But, beyond that, I wonder what's going to happen to insurance rates when we throw a whole medically-dependent or medical-consuming public onto the private sector health insurance system using prefunded accounts to pay for it. I would suspect that we will see a very substantial increase in medical insurance costs.

HUBBARD: Well, this is such a big question. I'll just touch on a few things. We don't really have a private health insurance system and cost-control system that can work as well as it might. Partly this is because we have a tax code that seems hell-bent on discouraging consumer consciousness in health care. We have a whole variety of state-level regulations that make it very difficult for individual and small group insurance markets to survive. And we have competition policy largely asleep at the wheel on health care. So we've done what we can to make sure the markets aren't working well.

I think if the health care markets worked much better, and I think they can, then I think we could make that transition to private insurance. I think what the state would have a role in is two things. One is supplementing the cost of low-income people, and also dealing with the chronically ill. You know, insurance as an economic matter is about catastrophic events— it's not about chronic events. I mean, once something is chronic it's not really an insurable event. And so I think there is a need to think about separating chronic risks from other risks in insurance pools. I think those are some roles for the state. But I would put more faith in private markets, if we enable them to work better.

TARULLO: OK, next question. Right there.

QUESTIONER: Hi, Vincent DeLorenzo, Bank of America. Regarding the long-term guaranteed government benefits discussion, one aspect that I think was absent from this debate was the idea of moral hazard, and the reduction in moral hazard that would come with I guess private or personal accounts, though we haven't agreed on the nomenclature yet. As economists, wouldn't you think that people internalizing responsibility for their future— which is what I think the president is trying to do by the idea of an ownership society— wouldn't you support that?

TARULLO: I've got a feeling Glenn would. [Laughter]

HUBBARD: I have. [Laughter] I think I was there. I'm a big believer in it for the reasons you mention, but the reasons you mention aren't my largest reasons for supporting it. I think there's enormous gain for our society in having every individual part of the personal wealth accumulation process. I think it helps the individuals, it helps the society. I'm all for it.

TARULLO: Alan, moral hazard?

BLINDER: You know, "moral hazard" is one of those nice words which is important in some contexts and unimportant in others. Vis-a-vis retirement that's potentially important— though I'm skeptical that people are such good planners and gamers of the system— as against that I would call to your attention the problem of people who have not successfully planned for their retirements, throwing themselves at the mercy of the state. And in case you think that's a ridiculous proposition, calculations have been made by Gary Burtless at the Brookings Institution showing that had privatization been in effect for years, you know going back so therefore covering the entire careers of people who have recently retired, the retirement benefit of someone who retired in 2000 versus 2003 would have differed by 50 percent. Just imagine the political pressures of the people at the bottom of that, when they had a 50 percent smaller Social Security benefit. So I think there's sort of an inverse moral hazard from the privatization.

On the medical account, Medicare, I just don't see moral hazard as a germane argument for the big-ticket items in the medical care system. It's very germane and we wouldn't want plastic, cosmetic plastic surgery, covered by Medicare. But when you talk about heart attacks, cancer and so on, this is not— people are not getting these things because of moral hazard— except in some limited sense that they didn't live the healthy lifestyle that they should have lived. So I don't think you get much more. You don't get cost savings I don't believe out of greater individual responsibility to any appreciable extent.

TARULLO: OK, thanks. Last question. And here comes the mike.

QUESTIONER: Thank you. Rick Fellman [ph], Corporate Perspectives and Columbia University. I wanted to ask a question about the environment as you see it. Glenn, I think you talked a little bit about the importance of a positive environment, keeping the growth rates at 3.5 percent going forward, because anything you talk about with these problems gets better with growth and gets worse wi