The State of the U.S. Economy

Real Audio of Briefing

        MR. BALLARD: Good afternoon, and welcome to the Department of State's Washington Foreign Press Center. My name is David Ballard. I am the acting director of the Washington Center this week. And I am delighted to be able to present for you today Dr. Glenn Hubbard, who is the chairman of the White House Council of Economic Advisers. He'll be around to talk to you about any number of economic and financial questions and concerns that you're interested in, or that your readers and listeners and viewers in your countries are interested in. And I think it's fair to say that the American economy has certainly been the subject of a lot of newsworthy attention in recent weeks and months, and Dr. Hubbard is just the kind of guy for those of you who can't get enough of his stuff. And I include myself in that category. So I think we are very lucky to have someone of his caliber with us today to discuss these issues.

       I would also like to make note of the fact that in the audience today, and some of them were able to fit in -- I think some of them are watching from outside -- we have 15 Department of State employees who are going out to various embassies around the world as press attaches or press officers or public affairs officers, and you will be able to identify them by both their sunny demeanor and their little name tags which have on them the name of the city to which they are going to be assigned or currently working in. So those of you who represent media from some of those countries might take the opportunity to say hello to them and meet them and tell them about your experience here in Washington, and prepare them for their experience in the field.

       But, without any further comments, I'd like to turn the mike over to Dr. Hubbard. I know he's got a lot to say, and you'll have a lot of interest in hearing his answers to your questions. Thanks.

       MR. HUBBARD: I thought it was the economists who have the sunny disposition. I am glad to know I'm not the only person here in late August, so I thank all of you for being here.

       I just wanted to say a few things about the outlook for the economy, the U.S. economy, mainly have a conversation with you.

       Just a bit of history at the beginning, if I might. We know after the recent data revisions that came from the Bureau of the Census that the U.S. experienced a three-quarter recession. We have now had three quarters of positive GDP growth from the recession. The mechanics of the recovery are worth talking about, because this was not a typical recession for the United States. Typical postwar recessions largely have had to do with inflationary problems leading to a monetary policy response. That was not at all the character of this recession. Much of the recession was driven by a downturn in business investment. I think it's fair to say the economy as a whole had gotten a bit overoptimistic about the profitability or productivity of certain new technologies. And investment-oriented recessions take a while to unwind, because one has to work through the capital that has been invested. I think much of that capital overhang, if you will, has been worked through outside the telecommunications sector.

       But as the recovery gains hold, this consumer sector, which has obviously sustained the recovery, is going to have to be joined by greater business investment. And I think the administration's outlook continues to be a recovery in business investment toward the end of this year. We have seen an upturn already in equipment and software investment spending, but non-residential structures is still not performing well at all.

       Indeed, I would say the key question -- not just for the U.S. recovery, but for the world economy and world markets -- really is the timing of that investment recovery in the United States. I think that uncertainty has cast a pall around the world.

       Having said all that about the risk in an investment recovery, I think the possibility of a so-called double-dip recession for the United States is really remote. If by that people mean multiple quarters of negative GDP growth, it would take a whole set of very severe disturbances to do that to the U.S. economy. And let me just give you an illustration of why I believe that to be the case. One of the key risks obviously now in the economy's recovery are recent equity price declines in the United States. And you know there's something called a wealth effect, an effect on consumer spending and business spending when wealth is destroyed, much as we have seen in the decline in stock market prices in the United States.

       To make a long story short, if you took the recent few months -- recent lag of equity price declines, and assume that's a permanent change -- that amount is just taken out of wealth forever -- after about four quarters the economy would grow more slowly by between a half and a full percentage point. Now, that's a noticeable effect. Now, keep in mind I just gave you the worst possible case -- I assumed a permanent hit to equity prices -- but it's by no means anywhere near the size needed to push the economy into recession. So while there are risks out there, I think the risk of recession is remote.

       I wanted to spend though a couple of minutes with you, if I might, on something that you don't see as much in the daily news, but I would argue is more important -- and, more important, it's in the top of the president's mind -- and that's the need to restore an emphasis on long-term economic growth. If you looked at the 1980s and 1990s, there's a general period of a very long boom in the U.S. -- there was a small recession in between, but generally a long boom -- one of the key lessons of the long boom was the need to focus on innovation, opportunities for taking productive risks in the economy. One of the events that has happened in recent months around the world is an increase in the equity risk premium, by which I mean a decline in equity prices -- not just in the United States, but in almost all the industrial world -- and an increase in the price of safe assets, like government bonds. People point to things like corporate governance in the U.S., but this is a global phenomenon. It is very important that public policy, especially in the United States, but elsewhere as well, focus on the need to promote productive long-term risk-taking. In the U.S. we have seen this first of all in the president's original tax cut, which promotes entrepreneurship; more recently, the signing of the Sarbanes-Oxley bill will provide a great deal of support for a pro-risk-taking environment in corporate governance; and of course the landmark passage of trade promotion authority is a key piece of legislation for long-term growth.

       Having said that, there is more that needs to be done. The president has said on many occasions that it is very important that the U.S. keep an environment of spending restraint. It's arithmetic, but it's worth pointing out, that today's spending is just today's taxes or tomorrow's taxes, and ultimately a tax on our economy's performance. Spending restraint is important. It is also important in the president's view to pursue a climate of ownership-friendly policies. You've heard the president talk a lot about the need to shore up private pensions. The president has talked about a variety of pro-growth initiatives that are on his mind. All of these are in the framework of an ownership-friendly society. And, finally, it is important to continue the discussion -- as is being done in many quarters in the government -- of fundamental tax reform.

       Outside the United States the economic outlook I think is not as bright as it is here over the next couple of years, with the exception of emerging Asia. The Japanese economy of course remains in significant difficulty, owing to familiar problems of deflation and financial sector misallocation -- the nonperforming loan problem. The euro zone should grow modestly over the next year or two, but is still held back by structural impediments.

       So, with those as opening remarks, I would really love to take any questions or comments that you have, and have as much of a conversation as you'd like. Yes, sir?

       Q Alan Biesty (ph) from the Financial Times. Dr. Hubbard, some of the suggestions that have out of the White House in recent days that you suggested again today, seem aimed to increasing savings and possibly investment in the economy. Can you explain why at a time when the American consumer is basically the only thing keeping the economy going, encouraging them to save rather than to spend, is a good way of coping with the sort of macroeconomic downturn that we are seeing at the moment?

       MR. HUBBARD: Well, if I might, I guess I'd dispute the premise of the question. I think most of the ideas that have been talked about recently, including some of the ones the president mentioned after the Waco conference, are ideas that would promote long-term risk taking; for example, eliminating the double taxation of dividends, changes in the tax law and capital loss treatment. There's a whole lost of things the president had mentioned. I view those as very pro- investment policies.

       I think the pro-savings policies can also help restore consumer balance sheets. And in the long run the level of consumption can actually be higher with these policies, because they permit greater income growth. So I see these as very much pro-recovery as well as pro-long-term growth policies.

       Yes, sir?

       Q Jose Lopez of NOTIMEX. What impact on the U.S. economy could you expect in the event of an attack against Iraq?

       MR. HUBBARD: Well, of course I don't want to speculate on the likelihood of an attack on Iraq, but I think we have got some benchmarks -- for example, the Gulf War episode -- where we know there are at least two principal economic channels. One is the price of oil itself. In the Gulf War you had a temporary spike in the price of oil that acted like a tax increase in the U.S. economy. There was also an effect on confidence; that is, until the strategy for the successful prosecution of that war was clear, household and business confidence took a hit. Both of those I think are fairly general lessons for any intervention in the Middle East.

       Yes, sir?

       Q Okay, Hiro Shuzu (ph), Nikkei newspaper. Last week the Federal Reserve changed their policy bias towards economic weakness. It seems to me that there might be some contradiction between your view and the Federal Reserve view. How do you respond to that? That's my first question.

       My next question is some economists say that there is a kind of similarity between the U.S. economy and Japanese economy after a bubble burst. How do you evaluate on these similarities and the differences?

       MR. HUBBARD: Well, let me take the questions in the order you asked them. On the Fed versus the administration view, I don't really see much difference. I think in fact the HOMC's view is pretty much the same risks having to do with investment that I outlined, and have been outlining. So I think we are pretty much the same there. Most of the discussion of long-term fundamentals, I think there's pretty broad agreement between the Fed and the administration. So I think their emphasis on the investment weakness really is the key risk in the economy now, and it is clearly one in which there's substantial downside risks.

       On the issue of the U.S. versus Japan, I think there's as many important difference as there are similarities. I think while it is true that there were asset price declines, it is important to remember that the Japanese asset price run-up was not so much based on fundamental advances in technology, but on speculation in some unproductive sectors of the economy -- notably real estate, unimproved land -- for a variety of reasons. In the U.S., while there was clearly froth and speculation at the last stage of the bull market, we are left with a set of technologies, innovations, processes, that are still likely to have very large positive effects for the economy.

       The sense of which there is a similarity is that public policy has to be very careful in traveling over this terrain, because it isn't a typical recession and isn't a typical recovery.

       Yes, sir?

       Q Lambros Papantoniou, Elettheros Typos, Greek daily, Athens. How do you assess the Sarbanes bill -- you mentioned it -- since he's a Democrat senator? In the meantime, what would be the final impact on the U.S. economy, and more specifically on the big corporations and companies?

       MR. HUBBARD: Well, the president signed it, so it's certainly something that enjoys the administration's support. And I think the important reason to sign the Sarbanes-Oxley bill was to get very clear corporate governance standards. The president had really been arguing since January for two pillars that I think the Sarbanes bill got at. One was a pillar of information disclosure, and a second was a pillar of accountability -- be it accountability from CEOs to shareholders or accountability of auditors, boards and so on. Those are addressed Sarbanes-Oxley bill. I think that it will help clear up some of the short-term uncertainty that was surrounding whether or not frankly investors could or should believe numbers they seeing from corporate America. I think that will be a very positive effect.

       The longer-term effects of things like the next public accounting board we will have to see as institutions evolve. But I think we are off to a very good start.

       Q Do you think that somehow it's going to stabilize to the big companies including the airlines?

       MR. HUBBARD: Do I think Sarbanes-Oxley will stabilize the airlines? I think the trouble in the airline industry has very little to do with corporate governance and a lot to do with problems in business models, and I think many of the airlines realize that and are trying to change their business models. So I think Sarbanes-Oxley is not going to be the medicine needed for the airlines.

       Yes, ma'am?

       Q (Off mike.) Deborah Luetterek (ph) with Reuters Television. I kind of had a follow-up to the question about Iraq. How do you as an economic policymaker prepare for a potential military action with the U.S. against Iraq? You talked about oil prices, confidence. What would worry you? What do you do? And what do you see as the impact on the global economy?

       MR. HUBBARD: Well, as I said, the key short-term macroeconomic impacts from any turmoil in the Middle East, whether it's the Iraqi invasion and should it happen or any turmoil, come from price of oil effects, which there are pretty good rules of thumb for, and confidence effects. In the long term I guess the question would be what do you think the industrial organization of the world oil market looks like in a future world, and that of course is the subject of great speculation -- but I won't speculate here.

       Q (Off mike) -- global economy?

       MR. HUBBARD: Well, higher oil prices of course are a tax on the global economy, not just the United States, and could be expected to retard economic growth. Again, the lesson from the Gulf War though is that the price increases tend to be relatively transitory. In general price changes in the world oil market have more to do with the world economy and the state of the world economy.

       Yes, sir?

       Q (Off mike) -- from the Journal of Asia Economics. I have a question on exchange rates. In your expectation, the (nominal ?) value of the U.S. dollar with respect to major currencies such as the euro and the Japanese yen will continue to depreciate or appreciate? Thank you.

       MR. HUBBARD: Well, I only talk about the dollar to my wife and Secretary O'Neill, and my wife tries to listen to me, or pretends to listen to me. So I am not going to speculate on foreign exchange movements, simply except to give the usual economics mantra that exchange rates are just prices, and they are pricing fundamentals in economies.

       Yes, ma'am?

       Q Atsuko -- (inaudible) -- newspaper. My question is about price index. Now the airlines recently started discounted travel fares and the auto dealers are offering 0 percent financing, and -- (inaudible) -- Producer Price Index declined 0.2 percent from June, and 1.1 percent down from 12 months ago. And is there any risk of deflation coming, if -- especially if there will be job cuts (here of late ?)?

       MR. HUBBARD: Well, I think that there's very little risk of general price deflation in the United States. And I think that one of the things the Federal Reserve has emphasized over and over over the years is its concern for low modest inflation in the United States, and i would certainly guess as an economist the Fed would be very vigilant against deflation. So that's not one of the key risks that I would worry about for the U.S.

       Yes, ma'am?

       Q (Inaudible) -- TV reporter from Mongolia. I have two general questions. Can you -- (inaudible) -- the United States economic situation after the last September 11th? The second question is we know that the world economy depends on the American economy -- how do you see today the future of -- the American economic future?

       MR. HUBBARD: Well, let me take your questions in order. On the issue of September 11th, I think that we learned a very powerful lesson of how resilient the private economy was. If you were to go back to news accounts shortly after September 11th and assessments of the effect of such a terrible human and economic tragedy on the economy, you would have had very dire predictions compared to what turned out to be true. I think that reflected both the quick bounce- back in the private sector and private markets, and actually very good public policy, particularly at the Federal Reserve, and also very good fiscal policy.

       Some of the not gone effects of September 11th though that still have to be dealt with are things like increased security spending. Increased security spending is something that's needed but is not productive in the economic sense of the term. And so how to do that as the smallest tax possible on the economy is still important. The other is how do you secure financing for, say, large high-profile projects. I live in New York City, and so the question of how do you deal with large commercial real estate projects in the event of terrorism risks is one that's keenly on my mind. And you probably know that the administration is still working to get a terrorism risk insurance bill through the Congress.

       As to the future of the economy, the economy's future really is the productive possibility -- so-called potential GDP growth. In the administration we have in the budget a long-term growth rate for the U.S. economy of 3.1 percent. I think that is, if anything, too modest. I would count myself among the believers that structural productivity growth is probably in the two and a quarter to two and a half percent range, so adding a hour's growth the economy's potential is probably much greater. That is something we won't know for a while, but we conservatively forecast it at 3.1 percent.

       Yes, sir?

       Q (Inaudible) -- Tokyo Broadcasting. I would like to ask you the real estate prices -- recently I heard some economists said at first in the U.S. economy stock market, equity price decline, and next we are undergoing real estate bubble , and it will impact us, U.S. economy. Don't you think so?

       MR. HUBBARD: No.

       Q Why?

       MR. HUBBARD: Okay, why. (Laughter.) Let's -- the thing about the fundamentals of the real estate market, much like you'd think of any other asset market, there's a price being present, discounted value of future cash flows or future rents in the case of real estate. Much of what's driven up real estate prices are changes in current and expected future rents. That's been abetted by two things in cities especially -- one, as Chairman Greenspan has emphasized, immigration to the United States; and also by land-use restrictions. So I think most of the evidence generally for housing prices is not consistent with a bubble. There are regional pockets in the country where housing prices may look a bit high by fundamentals, but as a national matter I don't think that's a problem.

       You've identified of course a key thing for households, because for most households it really is real estate or housing wealth that's the dominant component of their wealth.

       Yes, sir?

       Q Corbett Daley (ph) with AFX News. At the Waco forum Secretary O'Neill came out and said he was surprised at how many people suggested the administration should accelerate the tax cut. And I'm wondering is the administration going to push for an acceleration? And, if so, specifically what would it like to see?

       MR. HUBBARD: Well, I think there are a number of proposals the president is considering, and he has not made any decisions. He listed some of them in his own remarks last Friday. There are strong pro-growth benefits to accelerating the tax rate cuts that were passed into law earlier. There are also very strong benefits for some of the other items the president mentioned. And he really hasn't made up his mind.

       Q (Off mike)?

       MR. HUBBARD: He has not made any decisions on taxes -- whether to do or which to do. I don't want to speculate other than to say he ticked off a very impressive list.

       Anybody -- yes, ma'am?

       Q Crystal LaHuff (ph) with Channel News Asia. With the World Conference on Sustainable Development coming up, the floods in Europe, the brown cloud over Southeast Asia, has the Bush administration been looking at the impact of the environment on long-term growth for the global economy?

       MR. HUBBARD: We have. Some of the things that will be part of the U.S. message will emphasize the need for better environmental policies in developing countries -- in particular policies that have a nexus with health, for example clean water policies and some clean air policies. In general we believe that it is possible to have good environmental policy and good economic growth, and that's the message that Secretary Powell and others will be taking to the WSSD. Yes, ma'am?

       Q What's your read on Latin America right now?

       MR. HUBBARD: A pretty general question. Do you have a particular country in mind?

       Q Okay, then let's go Argentina, Brazil, Venezuela.

       MR. HUBBARD: Okay. Venezuela of course a lot of political concern, political risk. I think that's relatively clear-cut. Argentina is a case in which additional assistance or programs for the International Monetary Fund could not be useful until Argentina completes economic reforms that would make them useful, to wit things like improving the rule of law and investor protection; more responsible fiscal policy between the central government and the provinces. These are well known things and there has been progress, but it really isn't sufficient to make additional assistance actually meaningful for Argentina.

       Elsewhere in the region, Uruguay I think was a very different case. In the case of Uruguay you had a real transmission of events in Argentina to the Uruguayan banking system. Uruguay had long had very significant respect for foreign banks, foreign investors, a better fiscal policy regime. The assistance Uruguay received from the international financial community certainly reflected those commitments; but, almost more important, reflected the fact that the funds would be useful because the better policies were in place.

       Brazil is a complicated case, because you do have responsible policies in much of the economic agenda of Brazil. The fiscal responsibility law in Brazil is much more of a model than in the Argentine case of federal versus provincial relations. Monetary policy has been on a good track in Brazil. Brazil faces domestic political risk, and I think the challenge there is for international financial institutions to assist the Brazilian economy, help the Brazilian economy, which has many of the right policies in place, but being cognizant, frankly, of significant political risk.

       Yes, sir?

       Q (Off mike.) What impact on the U.S. economy could be expected with the full return of Iraq to the oil market, international oil markets?

       MR. HUBBARD: I think that -- I would only be speculating to do that, because there are issues with what the optimal long-term capacity for Iraq would be. As I alluded to earlier, one of the long- term effects of any such interventions in the Middle East would be the changes in capacity, and could well have a salutary effect on world oil prices.

       Anyone else? Yes, sir.

       Q Two very basic questions. One, if you could -- Jose -- (inaudible) -- of Mexico City. Could you please address the economic situation -- the U.S. -- excuse me -- address the economic situation of Mexico vis-a-vis the U.S.? And, second, during the last couple of months there was a lot of talk about problems of confidence in the U.S. economy, because of all these corporate scandals. Do you believe that idea of lack of confidence in the U.S. economy? Is it still there, or it has been solved?

       MR. HUBBARD: Well, to take I think the two basic parts of your question, I think the very strong linkages between the U.S. and the Mexican economy evolve through trade, and there I think we have a pretty good long-term story. I think obviously for the Mexican economy the loss in confidence in particularly business investment in the United States has been quite harmful. And there I'd break confidence down into two parts. If the question is, What are the confidence -- what should one's confidence be in the fundamentals of the economy? -- I think there almost all economists would be on the same page -- you know, the timing may differ, but this is definitely a high confidence situation in terms of economic fundamentals. That's just a wordy way of saying the potential growth number that I gave you, I gave you before. There have, however, been confidence about the numbers themselves, but the corporate statements. And that I think is something that had to be addressed quickly, and was addressed quickly, both by the SEC in its administrative actions on certification, and in the legislation this gentleman had asked about, the Sarbanes-Oxley law. I think that those developments -- the SEC action and Sarbanes-Oxley -- will have positive effects. That is, people's confidence will be heightened. But, frankly, I think it will take some time. I don't think that this is something which confidence restores in the accounts and in governance immediately.

       Yes, sir?

       Q How do you assess the U.S. dollar vis-a-vis the euro of the European Union and the international market?

       MR. HUBBARD: That's an easy question. As I said to this guy, I never talk about exchange rates. When Secretary O'Neill comes to see you, you can ask him, but I'm not allowed to have an opinion.

       Q Okay. (Laughs.)

       MR. HUBBARD: Yes, sir?

       Q (Off mike) -- Sao Paolo, from Brazil. Going back to Latin, the president of Brazil has tried to reduce the political risk meeting with the candidates -- I think it was yesterday -- and the U.S. government supported a $30 billion agreement with Brazil. Why do you think the agreement hasn't worked so far to reduce the pressure on the exchange rates? And also, what do you think of the meeting between President Cardoso and the candidates?

       MR. HUBBARD: Well, I don't like talking about patients on the table, so let me talk more generally about what I think your question is about, about how IFI programs do and don't work. I think anytime you have political risk in the short term, it is going to be very hard to design a program, so I am not quite sure what your benchmark is for success. I think as the political uncertainty becomes dissipated following the meetings that have been had, the program will have a much greater chance of success. I think it's very important to pursue pro-growth policies in Brazil. It shouldn't be up to the IFIs or to the United States to dictate a Brazilian election. That's up to the people of Brazil. I think what the international financial community can say, though, is that certain kinds of policies promote growth, and without those policies any amount of money from the IFIs is not going to restore growth and confidence in Brazil.

       I think growth and confidence in Brazil can be restored. I think the fundamentals are there. And I don't think this was the same kind of situation as Argentina.

       Other? Okay. Great. Thank you.