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Press Briefing by Edward Lazear, Chairman, Council of Economic Advisers on the Economic Report of the President

February 11, 2008

James S. Brady Press Briefing Room

3:00 P.M. EST

MR. FRATTO: Good afternoon, everyone, thanks for coming. We have Ed Lazear, Chairman of the Council of Economic Advisers, is going to talk about the release of the Economic Report of the President. Ed will have an opening and then be happy to take your questions. Thanks.

CHAIRMAN LAZEAR: Thank you. The President has just signed the Economic Report of the President for 2008. The Economic Report of the President is a detailed summary of the economic issues and policies that face our nation today. Although not every topic worthy of consideration can be covered in one volume, we believe that those covered in this report are among the most important.

The report begins with a summary of the macroeconomic situation. Economic growth over the four quarters of 2007 was 2.5 percent, slightly below that of the previous year but still solid, given conditions in housing and credit markets. Going forward, most forecasters expect the first half of 2008 to have slow, but positive, growth, followed by a pick-up in the latter half of the year. The stimulus package just passed by Congress that will be signed by the President shortly should help ensure against risks in the economy.

This year's most significant economic events revolved around housing and credit markets. An apparent under-pricing of risk was revealed first in mortgage markets, and later in a variety of credit markets. The President was quick to respond to these issues by focusing on borrowers through programs like FHA Secure, suspension of the tax liability on mortgage write-downs, and HOPE NOW programs. Additionally, the Federal Reserve acted to pump liquidity into the market. Some credit markets have become more stable since the acute tightening that occurred in the summer.

One very positive development this year was increases in exports that has occurred. Net exports shifted from reducing GDP growth to being a significant contributor in 2007. In large part, this resulted from growth in the economies of our trading partners, from our own productivity growth and from changes in the terms of trade. We remain committed to open trade, which has beneficial overall effects on the economy.

At the same time, we are cognizant that not all Americans benefit to the same extent from open trade policies. The President continues to support programs and reforms in programs like Trade Adjustment Assistance that help those whose jobs are displaced as a result of trade.

Health care has been an important focus of the President. The President's plan for standard deduction would remove the disadvantage felt by consumers who buy their health care outside their employers. It would allow consumers to benefit from cost saving in the plan that they choose and in the amount of medical treatment that they purchase. It would help provide coverage for several million uninsured and it would encourage competition that will drive costs down. Government-paid Medicare costs are a significant threat to fiscal stability and the President's plan is a step in the direction of bringing these costs down.

This year's report provides a number of observations on taxes. First, the ratio of tax revenue to GDP in 2007 was 18.8 percent, which is above the 40-year historic average of 18.3 percent. Second, failing to extend the President's tax cuts will have adverse consequences for the economy. Low taxes are important for creating an environment conducive to continued economic growth. Equally significant is that allowing the tax cuts to expire will result in 116 million Americans facing tax increases of an average of about $1,800. Finally, the tax cuts help move to a more efficient tax system with respect to saving and business investment.

Our infrastructure is an important factor in economic growth. One chapter explores the current state of our roads, bridges, railways, telecommunications and aviation systems, and explores policies in these important areas.

Alternative energy is also a major thrust of the President's policies. The 20-in-10 legislation that he proposed in last year's State of the Union was passed by Congress. This legislation will move us in the direction of energy security, and also will help reduce the growth of greenhouse gas emissions. The President believes that technology is an important part of the solution, and the United States is a leader in producing new technologies.

Finally, this year's Economic Report of the President contains a chapter on economic statistics. Economic statistics are also part of our infrastructure. They guide policy and private market decisions, as well, and we have an obligation to make sure that they are accurate and as informative as possible. It's important to maintain the continuity in economic statistics and to make sure that they remain relevant in a changing economy, by keeping pace with new sectors and new technologies.

This report contains the usual statistical tables that have come to be a staple for policy makers, researchers and businesses. We hope you find this year's report informative. Thank you, and I welcome your questions.

Q: The chapter on exports notes that that's one of the bright spots in the economy. It identifies one of the causes of the increase in exports as the change in terms of trade, or, in other words, the weakness of the U.S. dollar relative to where it was before. Secretary Paulson frequently comments on how a strong dollars in the U.S. interest. How do you reconcile the benefits of a strong and a weak dollar at the same time?

CHAIRMAN LAZEAR: Well, as you probably know, we are not -- the only people who speak about the dollar per se are the President and the Secretary of Treasury, and I really can't comment on our dollar policy. I can certainly comment on the factual issue that you raised, which is the notion that terms of trade have changed over time. And if we look back at the exchange rates in 2001 and compare them to exchange rates today, they are different. And what that implies, of course, is that American goods have become cheaper and that imported goods have become more expensive over time. That's just a fact. That's not a policy statement, that's the reality.

In addition to that, there have been other factors that we think are equally important in driving export growth, and that would be primarily the growth in our -- the economies of our trading partners. That's an extremely important factor. To a first approximation, a 1 percent growth in the economy of a trading partner translates into a 1 percent growth in their demand for our goods and services, as well. And so when our trading partners are growing, that's good for our economy.

The third factor that I would talk about just in this same context is that one of the nice things that's happened over the past few years is that productivity growth has been quite strong. When productivity growth is strong, it means that American goods become cheaper, and even at a given exchange rate, our goods become more competitive as a result. And that's been another factor that's driven our export growth.

Q: In the report you say that the period of somewhat slower than normal growth that began in 2007 is likely to continue into 2008. Is the White House's forecast of 2.7 percent growth for '08 still viable, and why or why not, at this stage?

CHAIRMAN LAZEAR: Well, we only do our forecasts twice a year, so we really only have two formal forecast point -- we have the mid-session review and the annual forecast. The last forecast was done in November. So the 2.7 percent that you're referring to comes from November. Obviously there have been new data since that point that might alter our forecast that you'll see coming next time. I don't want to foreshadow that or tell you where it's going to be because, obviously, we don't know where we'll be at that point and we'll have new data even between now and the time at which we issue that forecast.

But if we look at the forecast of professional forecasters -- those not in the government, but outside government -- those numbers have come down to some extent, but most of those outside forecasters are still predicting positive growth, albeit slower than the growth that we've seen over the past couple of years.

Q: So you see no reason to dispute those figures?

CHAIRMAN LAZEAR: Which figures?

Q: The private sector forecast.

CHAIRMAN LAZEAR: Well, again, what I would say is that there are a variety of outside figures. Forecasts have a significant range to them. Some are quite high -- in fact, I saw one that was extremely high for the third and fourth quarter of this year. That's possible, but that creates a lot of variance to these sorts of things. And again, I wouldn't want to pick one or the other and place too much weight on any one of them.

But I think the bulk of the forecasts, again, are predicting strong -- sorry, positive growth and stronger growth in the second half of the year. I think that's the general consensus right now.

Q: Having said that, do you think we're going to go into a recession or are in a recession right now?

CHAIRMAN LAZEAR: The answer is, I don't think we are in a recession right now, and we are not forecasting a recession. We are forecasting slower growth. There's no denying that the growth that we had in the fourth quarter of last year was significantly lower than the growth that we had in the third quarter. Now I just remind you that we had similar growth rates in the first quarter of last year, and those similar growth rates were followed by two very strong quarters. So these things are somewhat volatile.

I am not suggesting that we expect that in this quarter we'll see the same kind of growth that we saw, say, in the third quarter of last year -- we've had some issues, obviously, in terms of credit tightening, in terms of the housing markets. And that's the reason why the President was very active in pushing through the stimulus package, which we're very pleased about. I think we got that in record time. We think that's insurance against risks on lower economic growth, and we think that will help a good bit. We think it should help immediately, because businesses will build those expectations into their plans, and we expect that will help the economy even in the very near term.

Q: Two questions. One on the labor -- page 38. You talk about long-term unemployment up and median duration up as well. Can you talk a little bit about why these continue to trend up for a number of years, and whether it's reflective of the kinds of jobs that have been created, or something else is at play?

And then the section on housing, you talk about FHA and HUD, and how HUD -- the HUD loans dropped so precipitously, to 40,000, I think; that corresponded with that huge jump in private label issuance and mortgage-backed securities, et cetera. Realistically -- and it advocates price -- risk-based pricing. Wasn't the whole private-label market risk-based pricing to begin with? And what would be different now under risk-based pricing for HUD? Do you think that the private-label is going to go away and that's going to replace it?

CHAIRMAN LAZEAR: Okay, good. Two good questions. Let me just scribble down -- they're quite detailed, let me make sure I get the first one here.

On the first -- on the second one, let me go to that first, about HUD. We think that FHA reform is important and will be useful for a variety of reasons. If you look at places like California right now, the FHA business in California is essentially shut down, and the reason for that is obvious: Houses in California are much more expensive than they are in the nation as a whole, and so what happens is that these limitations on FHA's ability to insure those loans has differential impacts in certain regions of the country. So making FHA loans be a bit more sensitive to local conditions we think is a good idea.

We also think it's a good idea to allow the insurance rates to reflect the relative risks associated with different kinds of loans. That seems to make sense. That's what private markets do, and to the extent that FHA is competing with private markets, we think that a system that mimics at least to some extent what we see out there is probably something that will enhance efficiency, and that's why we think that will be a good step, as well. So we think these FHA reforms can actually be quite helpful in terms of moving the market in the right direction.

On your first question, in terms of the labor market and duration of unemployment -- right now, unemployment duration, if we look at long-term unemployment, it's about where it was in the mid-'90s. So in terms of the proportion of individuals who are facing long-term unemployment, it's about the same as it was in the mid-'90s, and actually lower than throughout most of the past few years.

That said, long-term unemployment is always a major concern. It's one of our most serious concerns because you always worry about individuals who remain chronically unemployed. That's a big problem. Obviously if you're unemployed for a week or two, you get a new job, and you get a new job at approximately the same wage rate or sometimes a higher wage rate, that's less of a concern. So that's something that we always monitor, and we're certainly keeping our eye on those numbers right now.

Q: Any explanation for it as to why -- why it's trending up?

CHAIRMAN LAZEAR: Well, again, I would say it hasn't really -- this particular number that I'm talking about has not trended up. It's basically where it was in the mid-'90s, so I don't see a particular trend in that number at all. Now, there are differences in the labor market. As we see a move to services, one of the things that we know has changed over time is that the -- both the labor market and the economy as a whole has become less cyclically-sensitive, simply because those sectors tend to be less cyclically-sensitive. So you do see some changes over time, but those are long-term trends, rather than something that you'll notice in any one year or even eight-year period; it tends to be something that happens over 20 or 30 years.

Q: I know you're not forecasting a recession, but a lot of Americans look at the fourth quarter figures, they look at the stock market, they look at the shrinkage in the job figures in the fourth quarter, and they say, well, I'm worried about it. Are they wrong to be worried about it?

CHAIRMAN LAZEAR: Well, we look at those numbers too, and that was the motivation, of course, behind the stimulus package, because of the concerns out there -- and it wasn't just the public's concerns, it was our concern that there are some factors that suggest some potential weakness in the economy. We were worried about lower growth, and as a result of that, we decided that it was the right time to act.

We believe that the stimulus package that was voted on last week will be quite effective in ensuring against these downside risks, and we think that they will keep the economy from slipping into lower levels of growth. And again I think that our forecasts are realistic, they're consistent with what you're seeing out on the street, as well. I think this is -- we're moving in the right direction.

I should also mention, by the way, that the Federal Reserve has also acted to change their monetary policy stature over the last few weeks, and in a pretty aggressive way, and that will also contribute, we think, to the economic picture.

Q: Are you saying that you were -- that they were right to be concerned about that, but those two steps -- the Fed, and what you have done -- should take care of those concerns?

CHAIRMAN LAZEAR: Well, again, I don't want to make a normative statement about whether the Fed is right or wrong; the Fed is independent, and they make their own decisions. It is a factual matter that they cut rates pretty aggressively over the past month. Simply if you look at it compared to historic rate cuts, that's a fact; it is a big rate cut. We believe that, coupled with the stimulus, will have an effect on the economy.

Q: Congress is planning to advance a second stimulus package in a few weeks. First of all, given the timing, would you even agree that it would be a stimulus package? And whether or not it has a stimulative effect, is the administration willing to consider additional measures?

CHAIRMAN LAZEAR: We think the proposal that we put out a few weeks ago, and it was acted on last week, is the right thing to do. We think 1 percent of GDP is about the right number -- it's slightly higher than 1 percent, but we think that's an effective stimulus. We think it will have the desired effect. And that was the policy that we thought was appropriate. We still think that policy is appropriate and we'll stick with that.

Q: When you pass that stimulus package, aren't you pretty much handcuffing the Fed in terms of how low they can lower interest rates?

CHAIRMAN LAZEAR: Again, I don't want to comment on what the Fed can or cannot do. I'm not even sure I follow your -- follow the logic of your question. I'm sorry.

Q: Well, if you're stimulating the economy and you're pumping more money into --

CHAIRMAN LAZEAR: I think I know where you're going. Okay. I'm sorry. I think you're question is whether we have to worry about inflation, and I'm not sure if that's the question -- but that's a question that I would pose and I'm certainly willing to talk about. (Laughter.)

Currently, inflation rates are in the moderate range, and there are a variety of indexes that people look at, but in the low 2s if you look at, say, the PCE deflator, which tends to be the number that the Fed looks at. That is still within the range where I believe that both the government, the fiscal policy and monetary policy still have sufficient flexibility.

We're not talking about handcuffing either of the various -- the two policy instruments for dealing with that. Obviously, we always worry about inflation. Obviously the Fed always worries about inflation; that's one of their two mandates, and so they're not going to ignore that. But right now, things seem to be okay.

Now, again, I would not argue that all prices have been stable. We know that energy prices, in particular, and food prices have also gone up at a pretty significant rate. And that's a concern for a couple of reasons: One is, it's a concern just for the macro economy, as you point out; but it's also a concern because those are two components of consumption that tend to affect the poor disproportionately. They tend to consume a relatively larger share on food, and a relatively larger share on energy. So that's always a concern when those prices go up.

And we think some of the policies that we've put into place will help address that, in particular, the energy policies that we're talking about will get to some of these energy cost issues at least over the longer haul. One could always argue we should have started them 10 years ago, 15 years ago, things would be cheaper now. I wish we had. We haven't. But it's better now than not doing it at all.

Q: Ten years ago, when people talked about unemployment going down below 6 percent, they were very worried about inflation, and it caused a sense of panic. Now, at 5 percent inflation, we're worried that we're in recession -- 5 percent unemployment -- worried about that we might be in recession. What has changed fundamentally in the economy that has put us in this position?

CHAIRMAN LAZEAR: Well, again, I would argue that the 4.9 percent unemployment that we have right now still reflects a relatively tight labor market. Obviously last month's labor market numbers were not as strong as we've seen for the past -- actually, for the past four years or so. And that's something that we're going to keep watching. But at an unemployment rate of 4.9 percent, we still see tightness in the labor market.

I think that the concerns that the economy has, that people looking at the economy have, are concerns that we share, as well, which is we know that the housing market has been negative, and it's been negative for a couple of years now. We also know that we face some tightness in credit markets, and that those credit markets are working their way through a variety of issues, one of which is the under-pricing of risk. I think that, in retrospect, it's pretty clear that people had the wrong notion of what was the appropriate risk premium. And those things take some time. As the structure adjusts, it's going to take some time to work through that.

So I believe that that may be a source of concern. It was certainly a source of concern for us, and it was one of the reasons why we favored being aggressive, taking the steps right now to enact the stimulus package. But again, with the stimulus package, I think that ensures us against some of these downside risks, and I think the economy will continue to grow.

Q: I guess what I'm trying to figure out, what has changed in the economy that we no longer worry that a low unemployment rate, like 6 percent, will cause a burst in inflation and excessive tightness in the economy? Now we're looking at 5 percent unemployment and we think, gosh, we may be in recession. What fundamental shift has taken place in the economy in 10 years?

CHAIRMAN LAZEAR: Well, I don't know whether a fundamental shift has taken place in the economy. Again, I don't think we want to be complacent about even a low unemployment rate. Obviously, anytime people are unemployed we worry about that. And that was the reason that I gave the answer before, particularly about long duration unemployment, which is a particular concern if it gets out of hand. Right now it is not and, as you point out, 4.9 percent unemployment is low. That's not a major concern either in terms of the macro economy, but obviously we always get concerned when any Americans find it difficult to find work. And that may be the source of the concern, but, you know, again it's something that we always pay attention to.

Q: Do you still think that the official forecast for unemployment this year is going to turn out about correct and -- by the end of the year, given that there does seem to be additional slowing that's happening, at least in the first half of this year?

And second question related to that is, as you know, one of the big arguments on the stimulus package was whether to extend unemployment benefits. If it were the case, if we have a really slow couple of quarters here and we have an uptick in longer-term unemployment, would you say that the arguments have improved in favor of offering an additional 13 weeks?

CHAIRMAN LAZEAR: In answer to your first question about whether the forecast is right or not -- I mean, the forecast was somewhere around 5 percent, somewhere around high 4s, and that's about where we are right now. Whether we remain there, of course, is something that we'll have to see how that plays out over the next couple of months.

But, again, you know, I hate to keep referring to the stimulus package, but I think that the stimulus package, coupled with the Fed rate cuts, are significant in terms of their effect on the economy, and we estimate that the stimulus will have the effect of increasing jobs by about a half a million above the number that would have been the case in the absence of that. So that's a pretty significant number, and that would have a pretty significant effect on the unemployment rate.

So it is certainly consistent and by no means unreasonable that we would have numbers that are consistent with our forecast from November. Again, you know, we will update our forecast at the usual time, and keep you posted on how that looks, but, again, no reason that we would think that we would be way off.

On the second question about extended unemployment benefits, extension of unemployment benefits has never occurred when the unemployment rate was below 5.7 percent. And usually, if you look at the historical record, it's somewhat closer to 7 percent. So it would be unprecedented to extend unemployment benefits at a time when the unemployment rate is 4.9 percent.

That also is true given that the duration of long-term unemployment is still relatively low. And again, as I had mentioned earlier, kind of middle level of 1990s is about the same. So it would be -- it would really be unprecedented to go that route at this point.

Q: Can I maybe jump back into his question. I think what he was asking is what has changed in the economy -- if I'm not wrong, the answer is our perception of what maximum unemployment without an inflationary effect would be. And the 7 percent figure you just listed, would that suggest that maybe we're in a time where it would necessitate the extended unemployment because our perception of maximum employment has also shifted?

And then the question I really wanted to ask: Where do you -- the home price, as an economist who happens to be the CEA head, how far do the home prices still have to drop -- 6.5 percent on the Shiller Index -- aren't we putting a floor -- with the stimulus package, by getting -- raising loan limits, aren't we at risk of putting a floor on prices that haven't reset completely?

CHAIRMAN LAZEAR: Okay, you guys are giving me two questions at a time here, so you're making me write everything down, make sure I remember this.

First, with respect to unemployment rate, what you're referring to I guess is the so-called NAIRU, Natural Rate of Unemployment Without Inflation, non-accelerating inflation rates of unemployment. Many people think those have dropped. Again, that depends on the models that you estimate. There are very sophisticated models behind these kinds of indexes. And some might argue that that rate has dropped. But again, even if we go with the most aggressive notion of what is a high unemployment rate, 5.7 percent, we're still quite a ways from that right now. So 4.9 percent -- I think by anybody's measure, 4.9 percent is still low unemployment. Remember, that's well below the average that we've had over -- the historical average; it's below the average for the '90s, the '80s and the '70s, each taken separately.

So we're still at low rates of unemployment. And again, that doesn't mean that we're not worried about people who are unemployed. We surely are; we always worry about people who are unemployed. That's one thing. It's another thing to institute a policy -- a significant policy change that would extend unemployment benefits beyond the normal level.

Now let me get to your second question, house prices. I'm not going to -- obviously, I'm not going to give you market advice on whether to speculate on homes or not. I think most people believe that the housing market declined more than we expected. I would have to say, in honesty, if we looked back a year ago most people who were looking at the housing market would not have forecasted that it would fall as much as it has since then. Whether it will continue to fall I think remains to be seen. It is difficult to believe at some point that it's going to continue to fall, because once you get to lower and lower levels, it's just much tougher for that to take as much off of GDP as it did before. First of all, it becomes a smaller part of GDP, and second, as it gets closer to lower and lower levels, it's harder for it to fall by a significant amount.

So I would say going forward, eventually this has to bottom out. I think most probably would have expected that to have started to happen right now. Last quarter we know housing was a significant drag on GDP growth, and it will continue to be, at least for the first quarter, simply because there are lags. So once you see housing starts down, it takes some time for investment to play out. And so it will be a drag for the first quarter and probably into the second quarter of this year, even if things were to bottom out right now.

Q: Back in March, the great debate was, will this housing crisis spill over into any other sector, and economists were divided, and of course by August we knew it was spilling into the financial sector. Now, if you pick up the papers you're reading about corporate debt market seems to be under pressure. Is your forecast assuming no more spillover, or have you actually taken into effect possible spillover into corporate debt and other marketplaces?

CHAIRMAN LAZEAR: Well, when you say "spillover," I guess I would say that's still a debatable point. The fact that we saw some distress in other credit markets does not necessarily mean that it was a spillover from the housing market. It could have been, but it could also be a reflection of the same underlying phenomenon. I think most market observers believe that most of what we've seen in terms of credit markets reflects the under-pricing of risk that occurred over the past couple of years, that happen to have shown up first in mortgages.

Okay, so it showed up first in subprime. That doesn't mean that subprime necessarily was the cause of what we saw in other markets. It's just a reflection of the same forces perhaps showing up there first. And my guess is that will be something that will be debated by academics for the next 10 years to come.

Is it over? You know, who knows whether it's over. I think the good thing that has happened in credit markets is that many firms have recognized their losses and, in addition to that, they've been able to raise capital. I think that's the most encouraging sign -- that firms have suffered some distress and financial markets, no question about it, but after they've declared those losses they've been able to go out and raise capital and to start again. And that's what's most important, I think, going forward.

Q: I didn't see any mention in the book of the $9 trillion national debt. What level of concern does the Council have about that?

CHAIRMAN LAZEAR: The national debt is always a concern, although we tend to look at the public debt, rather than the national debt. I think the public debt is a number that, at least to my mind as an economist, is more informative, because it's the debt held by the public. The national debt includes inter-governmental transfers, so when one department lends money to another department, that shows up in the national debt. But the public debt is still --

Q: But the money doesn't exist, right?

CHAIRMAN LAZEAR: But the public debt is still a relevant number. And if you look at the number on the public debt, the public debt is about 37 percent of GDP, which is kind of on the average that we've seen historically. It's the number that we tend to look at in terms of whether the deficit is too high or not too high.

When the deficit is below about 2 percent to 2.5 percent of GDP, depends on the growth rate, but when it's about 2 percent to 2.5 percent of GDP, what that tends to mean is that the ratio of the public debt to GDP tends to fall over time. If the deficit gets larger than that, then that tends to drive up the ratio of the public debt to GDP. And obviously, large deficits that tend to drive that public debt up relative to the GDP are a significant concern in the long run.

The thing that I would point to is that certainly not only by historic standards, but also by the standards of other major countries that are in the comparison group -- look at the other G7 countries -- we're still in pretty good shape in terms of our public debt to GDP ratio, because -- I think it's only one country has a slightly lower ratio than we have. And so we're still in relatively good shape.

That said, we are never complacent about the deficit. And that's why the President has laid out his plans to try to cut the deficit to zero by 2012. We believe that we can still do that. We believe that the stimulus, which will obviously increase the deficit for next year, is a one-time shot; it's an investment worth making. It does increase the public debt, national debt as well, no doubt about it. But again, it's a cost that we think is appropriate to bear right now, because of its investment in long-term growth.

MR. FRATTO: Thank you.

END 3:35 P.M. EST

George W. Bush, Press Briefing by Edward Lazear, Chairman, Council of Economic Advisers on the Economic Report of the President Online by Gerhard Peters and John T. Woolley, The American Presidency Project

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