Teleconference Press Briefing by Dr. Katherine Baicker and Dr. Matthew Slaughter on the 2006 Economic Report of the President

Via Teleconference

3:42 P.M. EST

DR. SLAUGHTER: Hi, this is Matt Slaughter, from the CEA.

DR. BAICKER: And I'm Kate Baicker.

DR. SLAUGHTER: And we welcome everybody to this conference call on the release of the 2006 Economic Report of the President. We apologize for the logistical snafus earlier today for everyone.

Kate and I thought we would take a few minutes and open just by offering a brief overview statement of the ERP, and then turn it to -- we welcome your questions after that.

So here at CEA we are very pleased to announce the release of the Economic Report of the President and the Annual Report of the Council of Economic Advisors for 2006. This report reviews the state of the economy and the economic outlook, and also discusses a number of economic policy issues of continuing importance. Across its 11 chapters, the report highlights how economics can inform the design of better public policy and reviews administration initiatives.

And I should say at the outset, too, former Chairman Ben Bernanke helped participate in the formulation of the broad themes of this report but, in particular, did not participate in the formulation of the administration's economic forecast, which is at the outset of this report.

The American economy enters 2006 with continued strength and flexibility. Two thousand five saw a fourth consecutive year of expansion for the U.S. economy with real GDP growing at 3.5 percent for the year. The administration forecast for 2006 foresees continued strong performance for the United States on many dimensions. This forecast, which is detailed at the start of the report, projects real GDP growth of 3.4 percent. Payroll employment growth during 2006 is projected to average 176,000 jobs per month, a pace projected to keep the unemployment rate at a low 5 percent. And CPI inflation is forecast to fall to 2.4 percent.

DR. BAICKER: The continued competitiveness of the U.S. economy depends on the strength of its workforce. Promoting a flexible and skilled labor force will ensure that the United States remains a competitive leader in this rapidly changing world economy. Even if living standards rise, Americans are increasingly concerned about rising health care costs. Promoting a stronger role for consumers can help create a health care system that is more affordable, transparent and efficient. This can be accomplished by strengthening health savings accounts and by ensuring that patients and their doctors have the information that they need to get the health care that is best for them.

This report provides an analytical backdrop for the President's agenda, which includes restraining government spending, making tax relief permanent, making health care more affordable and accessible, creating an economic environment that encourages innovation and entrepreneurship, and reducing America's dependence on foreign oil by diversifying our energy supply. These policies will help maintain the economy's momentum, foster job creation and ensure that America remains a leader in the global economy.

On that note, we're happy to take your questions.

Q: Hi Kate, Hi Matt. In the section on the capital accounts surplus you put a lot of emphasis on the factors in the foreign countries that are generating these large inflows of capital to the U.S., and you sort of cite a lot of the positive things about the U.S. attract this capital. But I see very little attention given to either our budget deficit or the level of the dollar, which a lot of private economists say have to play a role in any sort of, like, correction of this imbalance. Could you explain that, why you have given so little attention to those factors?

DR. SLAUGHTER: I think there's attention given to a wide range of factors in that chapter's discussion of the global imbalances, where we try to provide the global perspective by talking about what are the sources of imbalances between savings and investment, not just in the United States, but in many of the large current account surplus countries that the U.S. on net is borrowing from. So in particular, this discussion of economic conditions and policies in Japan, in Germany, in China and Russia, which are four of the biggest net lenders to the United States.

In terms of the market-based and policy-based adjustments going forward that might reduce the size of the U.S. current account deficit, you're definitely right that on the U.S. side, focusing on the different sources of savings in the United States is one of the key areas where changes in the future could materialize. So we know that private savings by firms has been quite high in recent years, so it's likely that any net increase in national savings for the United States would either come from households or from the government sector. And so in the government sector that would be a reduction in the fiscal deficits that we see at the federal level, where again the pass through, as the chapter discusses from that to the current account, is far less than dollar for dollar, and then on the private side, thinking about different incentives to possibly raise the long-standing decline in savings rates by American households.

Q: I didn't see the report, and I'm just wondering what your forecast is for interest rates, because I was talking to the realtors today, they see a 6.9 percent mortgage rate by the end of the year for a 30-year mortgage. Do you see rates going that high?

DR. SLAUGHTER: The interest rate forecast that -- thanks for that question, by the way. The interest rate forecasts that we have are largely taken from market forecasts. There's a time when the administration -- when we finished formulating the forecast, which was based on data as of mid-November of last year.

So going forward, for example, we have 10-year interest rate forecast for 2006 at 5 percent, and then gradually increasing in the coming years, such that by 2011 we'd have 10-year Treasury note interest rate forecast at 5.6 percent.

Q: I had a question about China. I wonder if you could clarify your view on whether China is moving quickly enough toward currency flexibility or whether, you know, you think their economy could handle a more -- whether the pace that they're on now, this sort of gradual pace, is an appropriate one or whether you think they could move more quickly?

DR. SLAUGHTER: Thank you for that, Brendan. The chapter, again, on current account balances talks about policy reforms in China and emphasizes that when you think about the broad set of policy reforms that China probably needs to facilitate current account adjustment, but also just economic development there. Currency reform is one dimension of that reform. They have a broader set of financial market reforms that are probably needed going forward to prevent deeper and more liquid capital markets for firms and for households.

So for example, one of the things that has been driving the current account surplus that China has had in recent years has been that the rate of national savings has increased and outpaced the rate of increase of investment by firms in China. And a big component of that has been household savings. There's a large amount of precautionary savings that happens among Chinese households to save for purchases of the households of durable goods, and also to finance spending on health care expenditures. So those are a couple of examples in which a deepening of capital markets in China, on many dimensions, is going to facilitate a broader, more balanced set of demand growth going forward, where private demand by households, in particular, plays a more prominent role.

Now, again, coming back to the particulars of exchange rate policy, the administration has been engaging Chinese officials for many months now on the need to have currency reform be one broader component of financial market reform in that country.

Q: I want to ask a question, a little bit off point, on your energy chapter and the President's declaration that the nation is addicted to oil. It didn't have much talk on cellulose to ethanol. Current ethanol production is a drop in the bucket to our consumption. Do you make assumptions on whether there's going to be a concerted effort -- either conservation, higher CAFE standards? It didn't seem to give a whole lot of attention to where that might be going over the shorter -- if I read it right, you see ethanol and oil sands as the only non-conventional oil that might survive at a lower price structure. Can you shed some light?

DR. SLAUGHTER: Sure. So the energy chapter, I think presents a broad perspective on energy markets, where one of the key themes throughout the energy chapter is talking about how we have very different energy markets in the United States, in terms of petroleum-based products, natural gas, electricity generation. And there's differences across those markets in terms of the different underlying technologies and sources of supply, the nature of demand, and what are the market intermediaries that transmit and kind of match suppliers with demanders.

So to take one example, again, with the broad goals of energy policy for the United States to try to have energy available at prices that are relatively affordable, but also stable, a big difference that's highlighted in the chapter, for example, between petroleum markets and natural gas markets is that natural gas markets are much less tradable across boarders, so of the total national consumption in the United States of natural gas, only about 15 percent is imported, in contrast to our petroleum, of which about two-thirds is imported.

The chapter then talks about how also, at different points, consistent with the President's recent discussions and policy initiatives on energy, that broadening the diversification of the sources of supply of energy going forward, policy probably has a role there, to the extent that there are some early-stage technologies that probably have a need for government support, to the extent that the public returns, the social returns from those early stage investments are probably better -- probably higher than the private returns. And so there's a role for government support for the diversification of energy supplies on that broad front.

Q: Another question which isn't really in the Economic Report of the President, but I'd just like to ask you a little bit about some fiscal policy issues. Can you tell me to what extent you think a tax cut can pay for itself, like if you cut taxes a dollar, how much of that dollar will you get back in revenue? Do you think you can get a full dollar back, or more than a dollar?

DR. BAICKER: Hi, this is Kate Baicker. Thanks for the question. Certainly, the effect of different tax cuts on revenues and on economic growth depends on the particulars of the tax cut -- how it affects the tax base, what the rates are, the relationship between that tax structure and other taxes that already exist in the economy.

The broader point that dynamic analysis of different tax programs would yield different pictures of which ones are most cost effective and what the different revenue yields are is one that's well taken. And the Treasury will be implementing dynamic analysis by the mid-session review.

Now the difference between dynamic analysis and dynamic scoring, just to be clear, is that dynamic analysis takes account of the effect of tax changes or spending changes on GDP and the macro-economic performance. Dynamic scoring then goes one step further and incorporates those changes into revenue forecasts. So the first step is dynamic analysis, figuring out how different policies would affect the growth of the economy, an that's a really important first step, because it yields a more complete picture of what any given policy would do, and allows policy-makers to make a more informed decision.

Q: The White House has said that the 2003 tax cuts have generated more revenues than they cost. What is the evidence of that?

DR. BAICKER: I would defer to the Treasury for specifics on revenue estimators of different proposals. And thinking about the different implications for economic growth of those policies is something that they've put as a high priority. I would leave it at that.

Q: I was somewhat intrigued by your chapter on taxes and -- you know, taxes and international comparison. Are you saying in there that you -- that there is a need to reduce corporate tax burdens in the United States in order to bring them back into -- back on a par or on par with our major competitors?

And I was perplexed about one thing, I was kind of startled, actually. Your charts -- you had two charts in that section. And just eyeballing it, it certainly looks to me like the corporate tax burden in the United States is actually below the OECD average. And even the -- there's a chart about rates -- seems to be U.S. rates, maybe average rates, corporate rates, are below average. This is actually different from the line that I have often heard from many corners that say, our tax rates are too high.

DR. BAICKER: So the broader point that the U.S. tax system looks very different from that of other OECD countries is, indeed, true. And we rely much more heavily on a personal income tax than other nations do as a fraction of our revenue sources.

The other key point that the chapter makes about the corporate income tax is that distortions induced by having different rates of taxation on different forms of investment and on different sources for that investment leads to distortions in the economy that are very costly. Corporations spend a lot of energy finding the highest value investment under the current tax system, which induces lots of distortions between retained earnings and earnings abroad versus domestic earnings and different forms of investment and reducing those distortions by a better integration of the tax system would yield economic gain.

Q: So are you -- two questions. One, are you saying -- is the report saying that we need to reduce the corporate tax burden? And, two, am I missing something when I look at those charts that show the tax burden of the share of GDP being lower in the United States than many countries? I don't have it in front of me, but the rate chart, also, put us below the OECD average.

DR. BAICKER: Indeed, our overall tax burden is lower than many of our OECD counterparts. And the more specific question that you asked about the corporate income tax rate, the chapter and our discussion doesn't particularly favor one particular raft of tax reform proposals. While they're thinking about comprehensive tax reform, some of the important factors to consider are the distortions induced by differences within the tax code of the treatment of different kinds of income, and highlights the fact that double taxation of dividend and capital gains earnings does, indeed, reduce investment and, thus, economic growth in the future. So those are important components of any comprehensive tax reform.

DR. SLAUGHTER: And just to build on it, if I could. One of the themes that's talked about in the context of corporate taxation I the chapter is, in recent decades, we've seen many countries around the world reduce their corporate tax rates and also change policies to make more liberal flows of capital in and out of those countries. And so with increased capital mobility across borders, when we think about what are the -- the constellation of policies that attract mobile capital to the United States as opposed to other countries, over time, the relevance of tax differentials, like any other policy differentials, is probably growing.

Q: I was curious, in your report on the low savings rate, if you had seen any real economic consequences from that yet? And, secondly, the fact that the savings rate keeps declining and going into negative territory, can that at all be seen as evidence that the dividend and capital gains tax cuts haven't worked as hoped to boost investment and eventually long-term growth?

DR. BAICKER: One of the main concerns with the savings rate in the U.S. is the preparedness of the U.S. population for retirement, especially as the population ages and as the leading edge of the baby boom generation nears retirement age. One of the points that the chapter you're referring to, I believe, makes is that, in fact, the savings of the current cohort, or the current generation of people preparing for retirement looks very similar to the personal savings of past generations, so that, in fact, they are no less prepared for retirement in terms of personal savings.

Now, that doesn't mean that there are no risks to retirement security. Social Security plays an important role in maintaining the income of people who are in retirement and ensuring that that system is stable and financially solvent for generations to come will have a big effect on their preparedness for retirement, as well.

The second threat to their retirement security is defined benefit pension plans and the potential insolvency of a lot of plans. It's important that those promises made to future retirees by corporations are, in fact, kept. And so the administration supports reform of the PBGC rules for evaluating whether plans are actually saving enough for the future benefits of their retirees and ensuring that that component of retirement security is intact, as well.

Q: What about the fact that we have a negative savings rate, or a very low one? I mean, isn't that at all evidence that the dividend and capital gains tax cuts are not producing that supply-side effect that was hoped?

DR. SLAUGHTER: I think that the chapter on savings rates and retirement preparedness offers some analysis to look at this decline in the personal household savings rate. And as the chapter talks about again, this has been going on since around the early 1980s. So this is kind of a long-term secular feature of the U.S. economy.

One of the forces that seems to lie behind the decline in personal savings rates is rising wealth for household. So part of the analysis talks about how, with rising household wealth, thanks to appreciation of equity prices and real estate prices, in particular, over the past 10, 20 years, that has been a force that's been raising the net worth of American households. And many households, all else equal, then, given the rise in their wealth, don't put as much of their current income into savings flows as they used to.

Q: I wanted to ask both of you to address what you believe is the outlook for housing prices in the United States. I didn't see anything specific about house prices in the report going forward. Did you expect them to go up, or go down? What's your expectation for this year, and then the years following?

DR. SLAUGHTER: The rate of home price appreciation in the United States in the past four or five years has been above historical trend. I think most averages that I see are about 9 percent per year rate of home price appreciation. That's likely to slow in the future. And so slowing rates of price appreciation, no one has a crystal ball to understand exactly how or when or in what markets.

But most historically previous home price appreciation run ups in the U.S. economy have evolved by having slower rates of price appreciation in the future that allow incomes of households to, in some sense, catch up with the home price appreciation so that affordability of homes comes back closer to historical levels. And I think that's a likely scenario playing out for the U.S. economy as you move into '06 and future years.

Q: On your table on the supply side components of real GDP growth projecting ahead to 2011, on page 44, you showed a growth rate in productivity declining from the end of 2005 to 2011 for roughly a percentage point from 3.6 to 2.6. And, yet, the rate of economic growth is actually going up, from 2.8 to 3.2, and the difference is accounted for by, I guess, increased hours.

So two questions. Why is the rate of productivity growth going down? What explains it? And I'm a little bit surprised that employment hours are growing as rapidly as they are, in contrast to this previous period from 2001 to 2005. Do you want to elaborate on that a little bit?

DR. SLAUGHTER: Sure, sure. I'd be happy to take both those. First, on the deceleration of productivity growth, one of the -- one of the strong features of the U.S. economy in recent years has been, I think it's fair to say, largely unexpected acceleration of productivity growth and output per worker hour that U.S. economies enjoyed in the past four years.

So we had this productivity acceleration that began around 1995 in the U.S. economy, that's actually in that table there if you're looking, from about 1.5 percent per year to an increase of about a percentage point to about 2.4, 2.5 percent per year. A pleasant economic outcome in recent years has been that has accelerated even further by about another percentage point, to well above 3 percent per year.

The forecast, like other parts of the forecast going forward, is conservative by assuming that the rate of productivity growth will decelerate back to the -- from the high levels that we've had now. I think it's fair to say it would be a pleasant surprise, on many dimensions, if productivity growth of recent years were to continue at the rate that it has been. But the forecast has a deceleration, just to bring it more in line with historical trends.

And on hours dimension, I think in part the logic there was recent years with the slight decline in hours of persons in the overall non-farm business sector was quite atypical, relative to previous decades. And so projecting going forward, again a bit more of a return toward historical norms there.

Q: Is it possible that the aging of the workforce, though, is going to lead you into a slower labor force growth?

DR. SLAUGHTER: It's going to lead to a deceleration, I think, on many counts, of growth of the overall labor force. Again, I think it's fair to say we don't have clarity for sure knowing exactly how that broad demographic trend will feed into particular labor force participation decisions of in or out of the labor force, and also on hours decisions of people, as well.

Q: Again, I'm reading press reports, I didn't get the original copy -- but looking at China's currency, the language seems very diplomatic. It doesn't call for, you know, float your currency, period. It's more liberalization, greater flexibility in your exchange rate. Why are you couching it in such diplomatic terms? Do you believe that a full float isn't in the best interests of China or the U.S.? Or do you think that's the best you can get from China?

DR. SLAUGHTER: Thanks for that. I'll defer to the long-standing precedent to speak on particular currency issues for the administration to the Secretary of the Treasury, and the Treasury Department more generally. Our perspective at CEA, in discussing global imbalances and the role of China, was to take a bit broader perspective, again. And I'll circle back to the theme of, China has had some -- has played a role in accumulating savings that they are lending to the rest of the world, both through a mix of policy decisions -- and you cite their current currency regime -- but also a set of kind of market-based decisions, in particular the savings decisions of households.

And so going forward, as China continues to grow and become more closely integrated into the world economy, a broader engagement of market-based reforms, not just in currency markets, but in a wide range of their financial markets, is probably going to be a helpful development.

Q: And does the report compare -- a better approach. Would we be more competitive if we cut corporate taxes than we would be, say, if China floats its currency to a greater degree? Do you get into that?

DR. SLAUGHTER: I think that one -- in echoing the President's recent discussion of the American competitiveness initiative, the report in many different chapters -- for example, in the international trades chapter, talks about the role of productivity growth as being a strong indicator of the competitive stance of the U.S. economy overall. And so thinking about a broad spectrum of policies across international trade, across tax, with an eye to thinking about what are the different mix of policies that are going to support ongoing productivity growth that American firms and their workers can generate for the U.S. economy.

Q: This is a question about financial services. I haven't had an opportunity to read the chapter in great detail, but you talk about trying to balance between over-regulation and under-regulation in financial services, and you talk about some of the Basel new standards for trying to manage risks. I noticed that one of the Federal Reserve governors gave a speech about this recently and raised the question about how well risk is being managed, some of the commercial real estate concentrations. It doesn't get into derivatives in this particular speech, but you mention that, too.

Is it your sense that -- you've mentioned the benefits of derivatives as perhaps contributing to fewer fluctuations in the financial sector, but are we, in fact, shifting these risks to places where we just don't recognize them as well? Or do you think we've got this under control?

DR. SLAUGHTER: Thanks for that interesting question. The financial services chapter, as you point out, does highlight the important and rising role that the financial services sector plays in the U.S. economy. Financial services by matching innovative ideas and investment opportunities in new technologies would pool the savings -- plays an important role in fostering economic growth. There's substantial evidence for the U.S. economy over time by looking at the history across different U.S. states and evidence across countries of that link between financial development and economic growth.

And, again, there was evidence that by creating new methods of sharing and pooling risk, that development of financial services also supports greater stability in economies.

That said, two of the broad policy challenges in financial services that we highlight in the chapter, one of which is always adequate protection for consumers, the financial services, and the second, as you alluded to, was maintaining sort of a soundness and stability of the overall financial system.

So we talk about particulars there on the latter point of the Basel II Accords, building out from the Basel I Accords, and also talk about another recent example in the United States of the proper regulation for GSEs, for example.

Q: And was it your sense that we have struck that balance with the Basel II Accords, the balance between protection and not stifling the development, the economic gain that you had from sophisticated financial system?

DR. SLAUGHTER: I wouldn't want to speak on behalf of the Federal Reserve and the other regulators of the U.S. financial system. I'd say just in general that the Basel II Accords, their implementation is an ongoing process, and it remains to be seen kind of -- and, again, here I would defer to officials at the Federal Reserve and other organizations -- on the proper way to implement the three pillars that are envisioned in the Basel II Accords in terms of mandatory verus voluntary participation level of disclosure of information in those types of particulars.

Q: What should we be looking for as that goes forward?

DR. SLAUGHTER: Again, I guess I would defer to the guidance provided by the Federal Reserve in particular on their sense on the participation of the financial entities that they're regulating, and their happiness both with participation and the desire to impact on and fostering stability of the overall financial system and minimizing the threat of systemic risks.

Q: So you're actually not prepared to say how well you think we've struck a balance between regulation -- over-regulating on the one hand, and exposing ourselves to too much risk on the other?

DR. SLAUGHTER: The chapter aims to present those broad sets of issues in the context of providing an input for those types of policy questions by emphasizing the benefits of financial innovation with the good goals that are achieved by thinking about the proper financial regulation regimes.

Q: Just to follow up on my colleague's question on assumptions, your immigration chapter didn't talk about levels. Can you talk a little bit about where you see -- I think the Social Security actuaries and a lot of other government agencies are working off those, or 800,000 -- kind of a steady 800,000 -- is that your assumption for immigration? And whether that factors in, in any way to the productivity numbers?

DR. SLAUGHTER: Thank you for that. Our assumptions about labor force growth are built on historical patterns and protections going forth from, in part, from the Census Bureau and data that we have collected over time. I do not think we have any particular assumptions built in about growth in overall population and labor force from natives, as opposed to immigration inflows.

DR. BAICKER: But to build on that, the immigration chapter that you mentioned does, indeed, discuss the important contribution of immigrants to the U.S. economy, in particular, high-skilled immigrants to innovation and science and engineering in the U.S.

Q: The reason I ask is because it's hard to find any reliable estimates, but it seems at a time when the baby boomer retirement picking -- picking up steam and one presumes a smaller workforce, it seems odd that the actuaries keep estimating they have flat 800,000. I'm wondering if you guys have any thoughts on how realistic that is.

DR. BAICKER: Certainly, the economic report of the President doesn't aim to create new estimates of some of these big components of the U.S. economy, rather to build on mainstream estimates of those to discuss different policy options on the table. So there's no divergence from the standard assumptions in here.

Q: Thanks.

DR. BAICKER: Great. We're ready to wrap up.

DR. SLAUGHTER: And we appreciate all the questions from everyone, and thank you very much for participating.

END 4:16 P.M. EST