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112th CONGRESS
2d Session

}

SENATE

{

REPORT

112-253

THE 2012 JOINT ECONOMIC REPORT
_______
REPORT
OF THE

JOINT ECONOMIC COMMITTEE
CONGRESS OF THE UNITED STATES
ON THE

2012 ECONOMIC REPORT
OF THE PRESIDENT

DECEMBER 18 (legislative day, DECEMBER 17), 2012.—Ordered to be printed

U.S. GOVERNMENT PRINTING OFFICE
WASHINGTON: 2012

JOINT ECONOMIC COMMITTEE
[Created pursuant to Sec. 5 (a) of Public Law 304, 79th Congress]
SENATE
Robert P. Casey, Jr., Pennsylvania,
Chairman
Jeff Bingaman, New Mexico
Amy Klobuchar, Minnesota
Jim Webb, Virginia
Mark R. Warner, Virginia
Bernard Sanders, Vermont
Jim DeMint, South Carolina
Dan Coats, Indiana
Mike Lee, Utah
Pat Toomey, Pennsylvania

HOUSE OF REPRESENTATIVES
Kevin Brady, Texas, Vice Chairman
Michael C. Burgess, M.D., Texas
John Campbell, California
Sean P. Duffy, Wisconsin
Justin Amash, Michigan
Mick Mulvaney, South Carolina
Maurice D. Hinchey, New York
Carolyn B. Maloney, New York
Loretta Sanchez, California
Elijah E. Cummings, Maryland

WILLIAM E. HANSEN, Executive Director
ROBERT O’QUINN, Republican Staff Director

ii

LETTER OF TRANSMITTAL
__________________

December 18, 2012
HON. HARRY REID
Majority Leader, U.S. Senate
Washington, DC
DEAR MR. LEADER:
Pursuant to the requirements of the Employment Act of 1946, as
amended, I hereby transmit the 2012 Joint Economic Report. The
analyses and conclusions of this Report are to assist the several
Committees of the Congress and its Members as they deal with
economic issues and legislation pertaining thereto.
Sincerely,

Robert P. Casey, Jr.
Chairman

iii

CONTENTS

CHAIRMAN’S VIEW ...................................................................... 1
Recent U.S. Macroeconomic Performance and Policy ............ 3
Conclusion .............................................................................. 21

VICE CHAIRMAN’S VIEW ........................................................... 27
Overview ................................................................................ 27
Supplemental Commentary on Particular Sections of the 2012
Economic Report of the President .......................................... 36

v

112th CONGRESS
2d Session

}

SENATE

{

REPORT

112-253

THE 2012 JOINT ECONOMIC REPORT

_____________
DECEMBER 18 (legislative day, DECEMBER 17), 2012. – Ordered to be printed

________________
MR. CASEY, from the Joint Economic Committee,
submitted the following

REPORT
Report of the Joint Economic Committee on the 2012 Economic Report of the
President

CHAIRMAN’S VIEW
The following report examines the state of the economy as 2012
ends and focuses on economic highlights and certain challenges
that lay ahead. During 2012, the economy continued to grow at a
modest rate, the labor market continued to heal and inflation
remained low.
Most economists are projecting moderate growth in 2013.
However, if Congress is unable to avert the so-called “fiscal

2
cliff,” and over half a trillion dollars in spending cuts and
revenue increases are triggered, the economy will likely return to
recession in the early part of next year.
The labor market continued to recover in 2012. Over the first 11
months of the year, about 1.7 million jobs were added to nonfarm
payrolls. While the economy has now recorded 33 consecutive
months of private-sector job gains, considerable slack persists in
the labor market. Almost three-and-a-half years after the Great
Recession ended, the economy has recovered just under 60
percent of the private-sector positions lost during and in the wake
of the Great Recession. The unemployment rate declined 0.8
percentage point during the first 11 months of the year, reaching
7.7 percent in November. The recent improvements in the labor
market are welcome developments, but the persistent slack
indicates the need for both monetary and fiscal policy to boost
economic growth over the near term even as fiscal policy turns to
a sustainable track over the longer term.
Inflation remained modest in 2012. Consumer prices (excluding
food and energy which are historically volatile) rose about 2
percent over the past 12 months. That is within the Federal
Reserve’s target range for inflation. Wage growth remained
modest.
The Federal Reserve continues to pursue an expansionary
monetary policy, using a variety of tools to keep long-term
interest rates at historically low levels. By contrast, without
congressional action, fiscal policy is slated to contract
significantly in 2013. As of this writing, Congress has not
reached an agreement to avoid the $1.2 trillion in automatic
spending cuts scheduled to occur between 2013 and 2021 and a
range of tax increases set to take effect on January 1, 2013. It is
clear that any agreement to avert the fiscal cliff will need to
include policies that strengthen growth in the near term while
also putting the economy on a sustainable fiscal path over the
longer term.

3
RECENT U.S. MACROECONOMIC PERFORMANCE AND POLICY

Recent U.S. Macroeconomic Performance
Overall Economic Growth. The U.S. economy grew 2.0 percent
over the course of last year and, on average, it has maintained
that modest pace over the first three quarters of this year. As was
the case last year, the U.S. economy has grown at a more
subdued pace this year than forecasters had expected at the start
of the year. 1 Economic growth over the past several quarters has
been uneven, with real (inflation-adjusted) gross domestic
product (GDP) growing at an annual rate of 2.0 percent in the
first quarter of this year, 1.3 percent in the second quarter and 2.7
percent in the third quarter (see Figure 1). 2
Figure 1
U.S. Economic Growth
Percent change in real (inflation-adjusted) gross domestic product, annual rates
6

4.1

4.0
4

2.3
2

1.7

2.2

2.6

2.7

2.5

2.4

1.4

1.3

2.0
1.3

1.3

0.1
0

-0.3
-2

-4

-1.8
-3.7
-5.3

-6

-8

-8.9
-10

Source: U.S. Department of Commerce, Bureau of Economic Analysis.
Note: The darker bars indicate the recent recession as determined by the National Bureau of Economic Research (NBER).

Forecasters expect that the economy will have grown by just less
than 2 percent over the course of 2012. 3 Moreover, in order for
the economy to grow in 2013, Congress must act to avert the
fiscal cliff and implement policies that will encourage economic
growth and job creation over the near term.

4
The larger context for U.S. economic activity has been one of
weakening economic conditions worldwide. While the pace of
recent U.S. economic growth has been modest, it has tended to
surpass the growth rates posted in other advanced economies. 4
Moreover, weakening conditions in the advanced economies
have tempered growth in large emerging economies that tend to
rely on advanced nations as export markets. 5
Unemployment and Employment. Although the pace of overall
economic activity has not picked up appreciably over the first
three quarters of the year, the unemployment rate has declined
somewhat since the end of last year. In November, the
unemployment rate averaged 7.7 percent of the civilian labor
force, down from 8.5 percent in December 2012. While the
proportion of the population with a job has increased 0.2
percentage point to 58.7 percent so far in 2012, the fraction of the
population that is either working or actively searching for work
has declined by 0.4 percentage point to 63.6 percent (see Figure
2). The relatively low rate of labor force participation reflects a
combination of demographic factors (such as the retirement of
the baby boomer generation) that are not sensitive to changes in
short-term macroeconomic policies as well as cyclical factors
that can be mitigated by growth-enhancing policies.

5
Figure 2
Employment and Labor Force Participation Rates
Percent of civilian noninstitutional population, 16 years and older, monthly through
November 2012
70

65

60

55

50
1948

1953

1958

1963

Recession

1968

1973

1978

1983

Employment

1988

1993

1998

2003

2008

Labor force participation

Source: Chairman's staff of the Joint Economic Committee based on data from the U.S. Department of Labor, Bureau of
Labor Statistics.
Note: Shaded regions mark periods of recession as determined by the National Bureau of Economic Research (NBER).

Through the first 11 months of the year, nonfarm payroll
employment has grown at an average rate of 151,000 jobs per
month, little changed from last year’s average monthly pace (see
Figure 3). Private-sector job growth has been a bit stronger,
averaging 154,000 jobs per month so far this year, down from
175,000 jobs per month, on average, last year. As has been the
case for the last several years, public-sector employment
remained weak this year. However, in contrast with the
experience of recent years, the weakness in public employment
in 2012 primarily reflected contracting federal payrolls.

6
Figure 3
Nonfarm Payroll Employment
Change in thousands, monthly through November 2012
600

400

200

0

-200

-400

-600

-800

-1000
2008-Jan

2008-Jul

2009-Jan

2009-Jul

2010-Jan

2010-Jul

2011-Jan

2011-Jul

2012-Jan

2012-Jul

Source: U.S. Department of Labor, Bureau of Labor Statistics.
Note: The darker bars indicate the recent recession as determined by the National Bureau of Economic Research (NBER).

On balance, private-sector payrolls expanded by 1.697 million
jobs over the first 11 months of the year. Since February 2010
when nonfarm employment stopped declining, private nonfarm
payrolls have increased by 5.117 million jobs, regaining about 58
percent of the 8.833 million jobs lost between December 2007
and February 2010 (see Figure 4). A disproportionately high
share of the private-sector job loss during the recession was
borne by goods-producing industries (especially construction and
manufacturing) and the employment recovery for goods
producers still has some way to go. The payrolls of private
service providers, on the other hand, had nearly fully recovered
to pre-recession levels by November.

7
Figure 4
Private Nonfarm Payroll Employment by Sector
Sector (November 2012 employment as
percent of December 2007 level):

Change in thousands of jobs
-8,833
5,117

-4,307

Private goods-producing (83%)

635
-1,961

Construction (74%)

-15
-2,281

Manufacturing (87%)

492
-65

Mining and logging (113%)

158

-4,526
4,482
-2,177
1,010
-290
-101
-564

Private service-providing (100%)
Trade, transportation and utilities (96%)
Information (87%)
Financial activities (94%)

105
-1,509
1,512
839
1,059
-626
817
-199
80

December 2007 to February 2010

Private nonfarm establishments (97%)

Professional and business services (100%)
Education and health services (110%)
Leisure and hospitality (101%)
Other private services (98%)

February 2010 to November 2012

Source: Chairman's staff of the Joint Economic Committee based on data from the U.S. Department of Labor, Bureau of Labor Statistics.

Inflation. Despite having come down this year, unemployment
remains high and considerable slack remains between the level of
goods and services the economy could produce if all resources
were fully utilized and the actual level of production. Not
surprisingly, then, inflation trends have remained relatively low
(see Figure 5). Over the 12 months through November, the core
rate of consumer price inflation, as measured by the consumer
price index excluding food and energy, rose 1.9 percent.

8
Figure 5
Core Inflation in Consumer Prices
15

Twelve-month percent change, monthly through November 2012 (CPI-U)

10

5

0
1960

1965

1970

1975

1980

Core PCE price index

1985

1990

1995

2000

2005

2010

Core CPI-U

Source: U.S. Department of Commerce, Bureau of Economic Analysis and U.S. Department of Labor, Bureau of Labor
Statistics.
Note: Core price indexes of consumer prices exclude the volatile indexes for food and energy prices. The PCE price index is
the price index for personal consumption expenditures in the national income and product accounts. The CPI-U is the
consumer price index for all urban consumers. Data for the PCE price index is available through October 2012. Data for the
CPI-U is available through November 2012.

Wage growth has remained low but relatively stable through the
recovery (see Figure 6). For most of that period, wage growth
was eclipsed by growth in the cost of living, so that real wages
declined. Only in the last two quarters has the growth in overall
consumer prices (i.e., including food and energy) stabilized at
about the same rate as wages.

9
Figure 6
Inflation in Wages and Consumer Prices
Four-quarter percent change
4

2.9

3

2.7

2.5
3

2.4

2.3

2.2
2.1

2

1.5

2

1.5

1.7 1.6

1.6 1.5

1.4

1.5

1.6

1.5

1.5

1.6

1.7
1.5

1.7

1.6 1.7

2012-Q2

2012-Q3

1.5

1
1
0

PCE price index

-1

Wage rate, civilian workers

-0.7
-1
2009-Q3

2009-Q4

2010-Q1

2010-Q2

2010-Q3

2010-Q4

2011-Q1

2011-Q2

2011-Q3

2011-Q4

2012-Q1

Source: Chairman's staff of the Joint Economic Committee based on data from the U.S. Department of Commerce, Bureau of
Economic Analysis and the U.S. Department of Labor, Bureau of Labor Statistics.
Note: The PCE price index is the price index for personal consumption expenditures in the national income and product
accounts. The wage rate is for civilian workers as measured in the employment cost index.

Interest rates. The combination of relatively weak overall
demand, relatively low inflation expectations and, most
importantly, aggressive easing by the Federal Reserve has kept
yields on U.S. Treasury debt at or near record historical lows
across the range of debt maturities (see Figure 7). Moreover, the
demand for Treasury debt has remained relatively strong across
maturities. For example, competitive bids on 10-year Treasury
notes averaged about three times supply over the 11 months of
the year—a healthy margin.

10
Figure 7
Yields on U.S. Treasury Debt
Percent, end of month value through November 2012
20

Ten-year notes, constant maturity
Three-month bills, secondary market
15

10

5

0
1960

1965

1970

1975

1980

1985

1990

1995

2000

2005

2010

Source: Board of Governors of the Federal Reserve System.

Perspectives on the Expansion
This has not been a typical economic expansion. Since the
recovery began in mid-2009, the economy has grown at an
average annual rate of 2.2 percent. That is less than half the pace
of growth typical for U.S. business cycle recoveries at the same
stage (see Figure 8). 6

11
Figure 8
U.S. Recovery Comparison: Real (inflation-adjusted) Gross Domestic Product
Percent change from business cycle trough
20
Median, 8 previous recoveries

18

Current recovery (from 2009-Q2 trough)

16
14
12
10
8
6
4
2
0
0

1

2

3

4

5

6

7

8

9

10

11

12

13

14

Number of Quarters Since the Business Cycle Trough
Source: Chairman's staff of the Joint Economic Committee using data from the U.S. Department of Commerce, Bureau of
Economic Analysis and the National Bureau of Economic Research (NBER).
Note: The median is calculated as the median of growth rates from the business cycle trough dates as determined by the
NBER: 1949-Q4, 1954-Q2, 1961-Q1, 1970-Q4, 1975-Q1, 1982-Q4, 1991-Q1, and 2001-Q4. The recoveries that began in
1958-Q2 and 1980-Q3 were omitted because they ultimately overlapped with subsequent cycle troughs.

The relatively slow pace of the current expansion is somewhat
puzzling. The recession that preceded it was the sharpest and
most protracted U.S. decline since the 1930s and economists
have long noted that relatively deep downturns tend to be
followed by relatively steep recoveries. 7 That this has not been
the case during the current recovery has prompted considerable
economic research. Some researchers have investigated the
degree to which the recoveries from downturns associated with
financial crises tend to be slower than from other cyclical
downturns. 8 Related lines of research have assessed the degree to
which the recent downturn impaired structural forces
contributing to growth and how structural impediments may be
limiting growth during the expansion. 9
It is generally very difficult to distinguish unobserved
movements in cyclical components of growth from structural
components and especially so when the time period of interest is
relatively recent and relatively short. Some recent studies have
concluded that much of the sluggish growth is the result of longterm trends that were unrelated to the recession, such as the

12
demographic changes in the labor force as the baby boomer
generation retires. 10 Even so, cyclical factors remain a significant
force in restraining overall economic growth.
Such cyclical forces can be assessed by comparing what the
economy did produce (actual GDP) with an estimate of what the
economy could have produced if productive resources (i.e., labor
and capital) had been fully utilized with overall inflation stable
and low (potential GDP). The output gap—the difference
between actual and potential GDP—provides a comprehensive
measure of an economy’s productive slack. 11 By mid-2009, the
U.S. output gap had widened to about 7½ percent of real
potential GDP (see Figure 9). Since then, the output gap has
narrowed as the economy has recovered but that narrowing has
been more slowly paced than in previous recoveries from severe
downturns (for example, the back-to-back recessions of the early
1980s and the sharp downturn of 1974). In the third quarter of
this year, the output gap represented a sizeable shortfall of over
$950 billion in current dollar terms. Even if some of the
weakness in product demand growth reflects structural factors,
the extraordinary size and persistence of the output gap serves as
an indication for macroeconomic policymakers that both
monetary and fiscal policies should be promoting aggregate U.S.
demand, at least over the near term. 12

13
Figure 9
U.S. Output Gap
Actual minus potential real GDP as percent of potential GDP, quarterly through 2012-Q3
8

6

4

2

0

-2

-4

-6

-8

-10
1949 1952 1955 1958 1961 1964 1967 1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006 2009 2012

Source: Chairman's staff of the Joint Economic Committee based on data from the U.S. Department of Commerce, Bureau of
Economic Analysis and the Congressional Budget Office, The Budget and Economic Outlook: Fiscal Years 2012 to 2022
(August 2012).
Note: Shaded regions mark periods of recession as determined by the National Bureau of Economic Research (NBER).

Purely as an accounting matter, it is straightforward to identify
those sectors largely responsible for the relatively slow pace of
the recovery from the recession: housing activity, government
purchases of goods and services, and personal consumption
expenditures.
In terms of both direct and indirect impacts, housing activity
contributed most substantially to both the severity of the
recession and the modest pace of the ensuing recovery. The
direct impact of the housing bust channeled through the economy
as a 36.2 percent decline in residential fixed investment from the
overall cyclical peak in 2007-Q3 through the cyclical trough in
2009-Q2. 13 Normally, housing investment grows more rapidly
than other sources of demand in the early phases of a cyclical
recovery, particularly so in the wake of a severe decline.
However, since the start of the current recovery, residential
investment has grown at an average annual rate of only 3.4
percent, well below the 9.0 percent average pace typical for
postwar recoveries at the same stage (see Figure 10). Residential
investment has accelerated so far in 2012, rising at an average

14
annual rate of 14.3 percent over the first three quarters of the
year.
Figure 10
U.S. Recovery Comparison: Real (inflation-adjusted) Housing Investment
Percent change from business cycle trough
40
Median, 8 previous recoveries

35

Current recovery (from 2009-Q2 trough)

30
25
20
15
10
5
0
-5
-10
0

1

2

3

4

5

6

7

8

9

10

11

12

13

14

Number of Quarters Since the Business Cycle Trough
Source: Chairman's staff of the Joint Economic Committee using data from the U.S. Department of Commerce, Bureau of
Economic Analysis and the National Bureau of Economic Research (NBER).
Note: The median is calculated as the median of growth rates from the business cycle trough dates as determined by the
NBER: 1949-Q4, 1954-Q2, 1961-Q1, 1970-Q4, 1975-Q1, 1982-Q4, 1991-Q1, and 2001-Q4. The recoveries that began in
1958-Q2 and 1980-Q3 were omitted because they ultimately overlapped with subsequent cycle troughs.

Government purchases of goods and services have also been
substantially weaker in the current recovery than they were in
previous postwar recoveries. Over the course of the recovery,
government purchases have declined at an average annual rate of
1.1 percent; by contrast, government purchases have typically
grown at an average rate of 1.7 percent over the first 13 quarters
of an expansion (see Figure 11). The recession was particularly
severe on state and local governments and, despite some
improvements in the revenue outlooks for those governments, in
the third quarter of this year purchases remained 6.7 percent
below what they were in the second quarter of 2009; state and
local government purchases of goods and services would
typically have risen 9.3 percent after 13 quarters of recovery.
Federal purchases have also been weaker than in past recoveries:
while in past recoveries at this stage federal purchases have
typically risen at a 2.4 percent annual rate, purchases have only
managed to grow at a 0.5 percent average annual rate during the

15
current recovery. If Congress fails to avert the fiscal contraction
that looms at the start of next year, the government drag on
overall economic growth would be exacerbated significantly.
Figure 11
U.S. Recovery Comparison: Real (inflation-adjusted) Government Purchases
Percent change from business cycle trough
8
Median, 8 previous recoveries
6

Current recovery (from 2009-Q2 trough)

4
2
0
-2
-4
-6
0

1

2

3

4

5

6

7

8

9

10

11

12

13

14

Number of Quarters Since the Business Cycle Trough
Source: Chairman's staff of the Joint Economic Committee using data from the U.S. Department of Commerce, Bureau of
Economic Analysis and the National Bureau of Economic Research (NBER).
Note: The median is calculated as the median of growth rates from the business cycle trough dates as determined by the
NBER: 1949-Q4, 1954-Q2, 1961-Q1, 1970-Q4, 1975-Q1, 1982-Q4, 1991-Q1, and 2001-Q4. The recoveries that began in
1958-Q2 and 1980-Q3 were omitted because they ultimately overlapped with subsequent cycle troughs.

Relatively weak growth in consumption, the largest component
of GDP, has also accounted for some of the slowing in overall
growth during the current expansion. Since the recovery began in
mid-2009, personal consumption expenditures have grown at an
average annual rate of 2.1 percent. That is about half the 4.3
percent average pace typical during previous recoveries at the
same stage. There are two broad factors responsible for the
unusually weak recovery in consumer spending.
First, the severity of the recession’s impacts on employment and
the relatively slow pace of economic growth during the recovery
have tempered growth in the income available to households to
finance purchases. Real labor income (defined as labor
compensation plus two-thirds of proprietors’ income in the
national income and product accounts and deflated by the GDP
price index) grew at an average annual rate of 1.5 percent
between 2009-Q2 and 2012-Q3. That is well below the 4.9

16
percent average annual pace over the first 13 quarters of the
typical postwar recovery (see Figure 12). 14
Figure 12
U.S. Recovery Comparison: Real (inflation-adjusted) Labor Income
Percent change from business cycle trough
18
Median, 8 previous recoveries

16

Current recovery (from 2009-Q2 trough)

14
12
10
8
6
4
2
0
-2

0

1

2

3

4

5

6

7

8

9

10

11

12

13

14

Number of Quarters Since the Business Cycle Trough
Source: Chairman's staff of the Joint Economic Committee using data from the U.S. Department of Commerce, Bureau of
Economic Analysis and the National Bureau of Economic Research (NBER).
Note: Labor income is defined as the sum of wage and salary disbursement, supplements to wages and salaries, and twothirds of proprietors' income. Real labor income equals labor income deflated by the product price index. The median is
calculated as the median of growth rates from the business cycle trough dates as determined by the NBER: 1949-Q4, 1954Q2, 1961-Q1, 1970-Q4, 1975-Q1, 1982-Q4, 1991-Q1, and 2001-Q4. The recoveries that began in 1958-Q2 and 1980-Q3
were omitted because they ultimately overlapped with subsequent cycle troughs.

The second significant factor that has worked to impede growth
in consumer spending has been the decline and slow recovery in
household wealth (see Figure 13). As the housing market
collapsed and equity markets followed, household net worth
plunged to a degree not seen since the 1930s. Declines in the
value of owner-occupied housing were substantial and persisted
essentially to the start of this year. So far this year, home prices
have tended to appreciate, bolstering the value of the housing
stock. Even so, as of the third quarter of this year, household
wealth remains $1.232 trillion below the level that prevailed at
the end of 2007. Continued support from accommodative
monetary policy and growth-enhancing fiscal policy is necessary
to complete the recovery of household wealth.

17
Figure 13
Household Wealth
Net worth of households and nonprofit sector as a percent of disposable personal income,
quarterly through 2012-Q3
700

650

600

550

500

450

400
1952

1955

1958

1961

1964

1967

1970

1973

1976

1979

1982

1985

1988

1991

1994

1997

2000

2003

2006

2009

2012

Source: Board of Governors of the Federal Reserve System and U.S. Department of Commerce, Bureau of Economic
Analysis.
Note: Shaded regions mark periods of recession as determined by the National Bureau of Economic Research (NBER).

Macroeconomic Policy
The sizeable output gap, the still-high unemployment and low
inflation suggest that macroeconomic policy should and could be
expansionary, but current monetary and fiscal policies appear to
be pursuing contrary aims over the near term. The Federal
Reserve continues to apply downward pressure to longer-term
rates, having already lowered short-term interest rates as much as
possible. Ultimately, however, monetary policy is constrained by
the lower zero bound it has reached on short-term interest rates.
Federal fiscal policy, on the other hand, is currently tilted toward
a contractionary stance and could exert a significant drag on
overall economic growth next year if Congress fails to act to
avert lapsing tax breaks, to prevent spending cuts and to keep
growth-enhancing policies in place.
Monetary policy. The Federal Open Market Committee (FOMC),
the body within the Federal Reserve charged with decisionmaking authority over monetary policy, operates under a dual
mandate to maximize employment and maintain price stability
over the long run. In normal times, the FOMC does so by easing

18
monetary conditions (lowering short-term interest rates) when
unemployment is high and inflation low and by tightening
monetary policy (raising short-term interest rates) when
unemployment is low and inflation high. Currently, economic
conditions warrant monetary easing: unemployment is well
above its trend level and inflation is relatively low. Since the end
of 2008, the Federal Reserve has kept short-term interest rates as
low as possible. Since then, the central bank has endeavored,
through unconventional means, to keep longer-term rates low as
well. Those unconventional means have included several rounds
of large-scale asset purchases designed to lower longer-term
yields and improved communication as to future monetary policy
actions. Long-term interest rates are at historically low levels,
partly reflecting the policies of the Federal Reserve.
In 2012, the FOMC further eased its monetary accommodation in
several ways. First, the FOMC took steps to increase the
transparency of monetary policy. 15 Through the year, the
Committee twice signaled that short-term rates could remain low
for a longer period of time than previously anticipated. Then, at
the close of its December meeting, the FOMC shifted from a
calendar-based forward guidance on interest rates to an
outcomes-based guidance. In particular, the Committee
announced its intention to keep its target short-term interest rate
low for at least as long as the unemployment rate remained above
6½ percent, inflation projections did not exceed 2½ percent a
year, and inflationary expectations remained stable. That shift in
the FOMC’s forward guidance considerably enhances the
transparency of monetary policy.
The FOMC also took steps to increase its purchases of longerterm assets. In September, the FOMC decided to purchase
agency mortgage-backed securities (MBS) at a pace of $40
billion per month. In December, the FOMC announced that once
its program to extend the maturity of its Treasury holdings
expired at the end of this year, it would continue to purchase
longer-term Treasury debt at a pace of $45 billion per month.
The Committee expects that its asset purchases will continue

19
until the outlook for the labor market “improves substantially” in
a context of price stability.
Finally, the FOMC plans to continue reinvesting principal
payments from its holdings of agency debt and mortgage-backed
securities in agency MBS. Beginning in January, the FOMC will
resume rolling over its maturing Treasury securities at auction.
Fiscal policy. Under current law, a combination of spending cuts
and tax increases (the so-called “fiscal cliff”) will begin early
next year, and as of this writing, Congress has yet to decide
whether it will avert the fiscal contraction. As a result, the
impacts of fiscal policy on the near-term economic outlook are
still highly uncertain and potentially significant.
The spending cuts include reductions due to lowered
discretionary spending caps from the Budget Control Act of 2011
(amounting to $900 billion from fiscal years 2013 to 2021) as
well as additional across-the-board automatic spending cuts ($1.2
trillion over that same period). Additionally, extended federal
unemployment benefits will expire at the end of 2012, directly
affecting more than 2 million unemployed workers who are
currently receiving federal unemployment benefits. In total, the
spending cuts would amount to $98 billion in fiscal year 2013.
Individual income tax rates are scheduled to increase and certain
tax credits will expire at the end of 2012. Income tax rate
increases include higher marginal tax rates on all existing tax
brackets and higher rates on interest and dividend income and
long-term capital gains. Along with these increases to income tax
rates, the temporary payroll tax reduction, which lowered
employees’ withholding by 2 percentage points, is scheduled to
expire at the end of the year. Taken together, the revenue
increases would amount to $393 billion in fiscal year 2013.
All told, the spending cuts and revenue increases imply a
contractionary shock of $491 billion for fiscal year 2013,
beginning in the early part of calendar year 2013. That is a

20
sizeable shock amounting to 2.9 percent of potential GDP. That
is too large a contractionary impulse for the Federal Reserve,
constrained by the zero lower bound on interest rates, to offset.
Without any Congressional action to avert this contraction, the
economy would likely return to recession in the early part of next
year. The Congressional Budget Office (CBO) estimates that the
combination of tax increases and spending cuts will cause the
economy to contract by 0.5 percentage point over the course of
calendar year 2013 (i.e., measured from the fourth quarter of
2012 to the fourth quarter of 2013). 16 CBO also expects that
failure to act would cause employment to fall and the
unemployment rate to rise by more than one percentage point to
9.1 percent by the end of 2013.
A short-term extension of some tax cuts and spending may be the
only way to avoid another recession. Because of large budget
shortfalls, those short-term extensions should be chosen to have
the greatest level of economic impact for the lowest budgetary
cost.
According to CBO, extending the Bush-era tax cuts to
households making under $250,000 and indexing the income
thresholds of alternative minimum tax for inflation would
increase real GDP by 1.3 percent in the fourth quarter of 2013.
That translates into an increase in GDP of about $0.60 in 2013
for every dollar of budgetary cost. Expanding the tax cut
extension to include taxpayers making over $250,000 per year
would only add an additional one-tenth of a percent to GDP.
Including the cuts for higher-income taxpayers also lowers the
effect on output per dollar of budgetary cost (“bang for the
buck”) because the wealthiest taxpayers are likely to save more
per dollar of tax reduction than lower-income taxpayers, who are
likely to spend a larger portion of each dollar of reduced taxes.
CBO also estimates that extending the payroll tax cut and
extending federal unemployment insurance benefits would have
the largest impacts on growth, on a dollar-for-dollar basis.

21
Moreover, unemployment benefits reduce poverty among
recipients and their families. In 2011, about 27 percent of
unemployed people receiving benefits would have been
considered poor without their benefits. After counting their
benefits, their poverty rate dropped to 14 percent. In 2011 the
benefits lifted about 2.3 million people out of poverty, onequarter of whom were children living with a family member who
received unemployment insurance benefits. 17

CONCLUSION

While Congress has not yet reached an agreement to avert the
fiscal cliff, there is an emerging consensus on key elements of an
agreement that could earn support among Democrats and
Republicans. There is growing recognition that the wealthiest
Americans should help to bring down the deficit by paying taxes
at higher rates. Both parties agree that triggering $1.2 trillion in
automatic spending cuts would be unwise. Additionally, there is
a widely-shared belief that any fiscal cliff agreement must
protect middle-income Americans from tax increases and include
incentives for businesses to create jobs.
A balanced, bipartisan agreement that includes significant
spending cuts and generates new revenues can help strengthen
consumer and business confidence in the immediate term while
putting our fiscal house in order over the longer term. Such an
agreement will enable the economic recovery to continue.
Sustained economic growth is vital to bringing down the deficit.
As we near the end of 2012, the economy is in stronger shape
than it was a year ago. More Americans are working and fewer
are unemployed. There have been fresh signs of recovery in
housing. And when the fourth quarter ends, GDP will have
grown for 14 consecutive quarters. Yet, too many Americans
have not felt the recovery and many families are still hurting. In
the days ahead, as Congress works to reach agreement on

22
spending cuts and revenue increases, policymakers must
simultaneously promote job creation, achieve meaningful deficit
reduction, and protect middle-income families from tax
increases.
ENDNOTES
1

This report reflects developments in economic data available through midDecember 2012. In particular, the national income and product accounts
were available only through the second estimate for the third quarter by the
Department of Commerce.
2

The sharp deceleration in the second quarter primarily reflected slower
growth in consumer spending on goods (particularly motor vehicles), business
investment in fixed capital, and housing investment. A severe drought in the
Midwest subtracted from overall growth in the second and third quarters.

3

Most forecasters estimate that the economy is decelerating in the fourth
quarter. The Blue Chip consensus average of leading private-sector forecasts
has the economy growing at a 1.2 percent annual rate in the fourth quarter and
1.8 percent over the four quarters from 2011-Q4 to 2012-Q4 (Blue Chip
Economic Indicators, Aspen Publishers, December 10, 2012.)

4

The 17-country eurozone remains mired in recession with the economy
contracting at an average annual rate of 0.3 percent so far this year, following
a contraction of 0.5 percent in the second half of last year. The Japanese
economy has grown at an average annual rate of 0.6 percent over the first
three quarters of this year, with a significant contraction in the third quarter.
The U.K. economy has grown at an average annual rate of only 0.4 percent so
far this year. The Canadian and Australian economies have decelerated
through the year.
5

For example, the Chinese economy has grown at an average annual rate of
7.0 percent over the first three quarters of the year, down from 9.0 percent
over the course of last year. The deceleration in India has been even more
pronounced, with that economy growing at an average pace of only 1.9
percent so far this year (compared with 6.4 percent over the four quarters of
2011). Economic growth in Brazil has been a relatively tepid 1.2 percent on
average over the first three quarters of this year.

6

The “typical” recovery is defined to be the median experience over the first
13 quarters following the eight cyclical troughs in 1949-Q4, 1954-Q2, 1961Q1, 1970-Q4, 1975-Q1, 1982-Q4, 1991-Q1, and 2001-Q4. The National

23

Bureau of Economic Research has designated those quarters as troughs in the
business cycle, when a recession ends and the subsequent recovery begins.
That list omits two cyclical troughs (1958-Q2 and 1980-Q3) which, by the end
of 13 quarters, had already overlapped subsequent cyclical troughs.
7

Classic studies of this association are Milton Friedman, “Monetary Studies
of the National Bureau,” in The National Bureau Enters Its 45th Year, 44th
Annual Report (1964), pp. 7-25 and Milton Friedman, “The ‘Plucking Model’
of Business Fluctuations Revisited,” Economic Inquiry, April 1993, pp. 171177.

8

A substantial portion of the recent research assesses the role of financial
crises in deepening cyclical downturns and protracting the subsequent
recoveries. The results are mixed as they depend on precisely how a financial
crisis is defined for research purposes. For example, see Carmen M. Reinhart
and Kenneth S. Rogoff, This Time is Different: Eight Centuries of Financial
Folly (Princeton: Princeton University Press, 2009); Carmen M. Reinhart and
Kenneth S. Rogoff, “The Aftermath of Financial Crises,” American Economic
Review: Papers & Proceedings 2009, 99:2, pp. 466-472; Carmen M. Reinhart
and Vincent R. Reinhart, “After the Fall,” in Macroeconomic Challenges:
The Decade Ahead, Economic Policy Symposium, Federal Reserve Bank of
Kansas City, August 2010
(http://www.kansascityfed.org/publicat/sympos/2010/2010-08-17reinhart.pdf); Greg Howard, Robert Martin, and Beth Anne Wilson, “Are
Recoveries from Banking and Financial Crises Really So Different?” Board of
Governors of the Federal Reserve System International Finance Discussion
Paper Number 1037, November 2011
(http://www.federalreserve.gov/pubs/ifdp/2011/1037/ifdp1037.pdf); and
Michael D. Bordo and Joseph G. Haubrich, “Deep Recessions, Fast
Recoveries, and Financial Crises: Evidence from the American Record,”
Federal Reserve Bank of Cleveland Working Paper 12-14, June 2012
(http://www.clevelandfed.org/research/workpaper/2012/wp1214.pdf).
9

Congressional Budget Office, An Update to the Budget and Economic
Outlook: Fiscal Years 2012 to 2022, August 2012, pp. 40-41
(http://www.cbo.gov/sites/default/files/cbofiles/attachments/08-22-2012Update_to_Outlook.pdf); David Furceri and Annabelle Mourougane, “The
Effect of Financial Crises on Potential Output: New Empirical Evidence from
OECD Countries,” OECD Economics Department, Working Paper No. 699,
OECD Publishing, May 2009 (http://www.oecd-ilibrary.org/economics/theeffect-of-financial-crises-on-potential-output_224126122024); and
Directorate-General for Economic and Financial Affairs, “Impact of the
Current Economic and Financial Crisis on Potential Output,” Occasional
Paper 49, European Commission, June 2009
(http://ec.europa.eu/economy_finance/publications/publication15479_en.pdf).

24

10

Congressional Budget Office, What Accounts for the Slow Growth of the
Economy After the Recession? November 2012
(http://www.cbo.gov/sites/default/files/cbofiles/attachments/43707SlowRecovery.pdf); and James H. Stock and Mark W. Watson,
“Disentangling the Channels of the 2007-2009 Recession,” National Bureau
of Economic Research, Working Paper 18094, May 2012
(http://www.nber.org/papers/w18094.pdf).
11

The estimates of potential real GDP used here are taken from Congressional
Budget Office, An Update to the Budget and Economic Outlook: Fiscal Years
2012 to 2022, August 2012
(http://www.cbo.gov/sites/default/files/cbofiles/attachments/08-22-2012Update_to_Outlook.pdf). CBO bases its estimate of potential GDP on a gross
up of net service flows from productive labor and capital. CBO’s approach to
measuring potential output is sensitive to secular trends as well as pronounced
cyclical movements in the labor force and the net capital stock. CBO’s
measure of potential output growth slowed somewhat during the recession and
has been decelerating relative to earlier decades.
12

Considerable research has also focused on disentangling structural from
cyclical elements at play in the labor market. While demographic changes and
other structural forces may be tempering employment growth somewhat,
ongoing cyclical weakness is evident and very likely the dominant force at the
moment. For fuller discussions of this point see, for example, Ben Bernanke,
The Economic Recovery and Economic Policy, Board of Governors of the
Federal Reserve System, November 20, 2012
(http://www.federalreserve.gov/newsevents/speech/bernanke20121120a.pdf).
Compelling arguments that cyclical forces continue to dominate labor market
outcomes are provided by Jesse Rothstein, “The Labor Market Four Years
Into the Crisis: Assessing Structural Explanations,” Industrial and Labor
Relations Review, 65:3, March 2012 (draft version available at
http://www.nber.org/papers/w17966.pdf); and Edward P. Lazear and James R.
Spletzer, “The United States Labor Market: Status Quo or a New Normal?”
paper delivered to the 2012 Economic Policy Symposium of the Kansas City
Federal Reserve at Jackson Hole, Wyoming, July 22, 2012
(http://www.kansascityfed.org/publicat/sympos/2012/el-js.pdf).
13

The indirect impacts of the housing bust on overall activity, working
primarily through the wealth channel, are likely to have been even more
significant on balance.
14

In contrast with the lackluster recovery in labor income, during the current
expansion, growth of real capital income (i.e., national income minus labor
income, deflated by the product price index) has more closely matched the

25

typical historical experience. Between 2009-Q3 and 2012-Q3, real capital
income grew at an average annual rate of 5.9 percent, just shy of the median
historical growth of 6.2 percent for cyclical expansions at a comparable stage.
15

This report includes monetary policy developments through the FOMC’s
policy announcement of December 12th
(http://www.federalreserve.gov/newsevents/press/monetary/20121212a.htm).
16

Congressional Budget Office, Economic Effects of Policies Contributing to
Fiscal Tightening in 2013, November 2012
(http://www.cbo.gov/sites/default/files/cbofiles/attachments/11-08-12FiscalTightening.pdf).
17

Gabe, Thomas, and Julie Whittaker, “Antipoverty Effects of Unemployment
Insurance.” Congressional Research Service. October 16, 2012.
(http://www.crs.gov/pages/Reports.aspx?PRODCODE=R41777&Source=sear
ch).

27
VIEWS OF VICE CHAIRMAN KEVIN BRADY, SENATOR DAN
COATS, DR. MICHAEL BURGESS, AND REPRESENTATIVE MICK
MULVANEY

We submit these views without the benefit of reviewing the
contribution of the Chairman and other Democratic members of
the committee:
OVERVIEW
Had the Joint Economic Committee filed this report, responding
to the 2012 Economic Report of the President (ERP), closer to
the date that it was released by the White House—in February
2012—we would have provided a detailed chapter-by-chapter
evaluation of the report. We would have explained that the
submission revealed the Administration’s misplaced faith in
bigger government and attempts to re-engineer the American
economy would lead to substandard economic growth and subpar
job creation.
Instead, since we are filing this report at the close of the 112th
Congress, it is not necessary to express our belief that the
Administration’s policy prescriptions would not work. We have
the benefit of simply looking at the data to understand the scope
of the failure of the Administration’s economic policies.
As Republicans on the Joint Economic Committee have
consistently highlighted, the current economic recovery ranks as
the weakest recovery, lasting longer than a year, since World
War II. We have witnessed unacceptably low economic growth
and sluggish job creation. Apologists for the Administration are
quick to shift blame by noting that the “Great Recession” was the
most severe economic downturn since the Great Depression.
However, Administration apologists conveniently ignore the fact
that historically deep recessions are normally followed by strong
recoveries.

28
Serious concern exists that if the Administration’s economic and
fiscal policies become embedded in the American economy that
historians will look back and refer to the current period as the
beginning of the “Great Stagnation.”
For the American people to prosper, we need to accelerate
significantly the pace of economic growth. Stronger economic
growth will produce faster job creation and will accelerate the
growth in federal tax receipts, ameliorating our huge federal
budget deficits, which have exploded to dangerous levels under
the leadership of the current Administration.
In the following pages, we will review the current economic
recovery in historical context in terms of both economic growth
and job creation in the private sector. Additionally, we will
discuss various aspects of the ERP that illustrate this
Administration’s lack of understanding when it comes to the free
enterprise system.
While we hold little hope that this Administration will suddenly
wake up and realize that its policies are making a bad situation
worse, we would implore the President and his economic team to
abandon their quest for economic equality and focus on the one
thing that can create greater opportunity for everyone– economic
growth.
The Record on Economic Growth
The President and his economic team like to boast that the
economy has expanded for 13 consecutive quarters since the
recession ended in the 2nd quarter 2009. What they do not talk
about is the anemic nature of economic growth over that period.
Since the recession ended, total real gross domestic product
(GDP) has grown a total of 7.4%—or an annualized growth rate
of 2.2%—earning this recovery the dubious distinction of being
worst among the ten post-World War II recoveries lasting more
than one year.

29

The average total growth in real GDP of the other nine recoveries
was 16.8% or an annualized growth rate of 4.9%. In other
words, growth in this recovery has been less than half of average.
The strong Reagan recovery of the 1980s saw real GDP expand
over the comparable period by 19.6%. As the following chart
illustrates, the anemic nature of this recovery equates to a loss of
$1.2 trillion (2005) in real GDP compared to the average of other
recoveries and more than $1.5 trillion compared to the Reagan
recovery.

30
For perspective, the average recovery achieved more in 5
quarters than what the Obama recovery has taken more than three
years to accomplish. The slow rate of growth in this recovery
means that it would take 32 years for real GDP to double
compared to just 15 for an average recovery.
Investment is “Missing in Action”
The Administration’s Keynesian focus on growing demand
continues to be misguided. And blaming reduced spending by
government for the slow recovery is wrong. The missing
component in this recovery is fixed private investment—both
residential and nonresidential.

Personal consumption expenditures (PCE) account for slightly
more than 70% of GDP. Real PCE are higher than at the start of
the recession in the December 2007. And despite recent declines
from its peak during the recession, real government consumption
and investment is higher than the 4th quarter 2007.
Neither residential fixed investment nor nonresidential fixed
investment has recovered to their pre-recession levels.
Residential investment remains roughly 30% lower than at the
beginning of the recession and less than half its peak in the 4th
quarter 2005. However important the housing sector is to the

31
U.S. economy, it is investment by private business in structures,
equipment, and software—fixed nonresidential investment – that
drives private sector job creation. And despite some gains earlier
in the recovery, business investment growth has shown
troublesome signs of weakness in recent quarters.
BEA’s revised estimates of 3rd quarter 2012 GDP represent a
step backward. Fixed nonresidential investment declined at an
annual rate of 2.2% on a real basis during the quarter, it also
declined on a nominal basis at an annualized rate of 1.5%. This
represents the first decline on a real basis since the 1st quarter
2011 and the first nominal decline since the 4th quarter 2009.
On a year-over-year basis, real fixed private nonresidential
investment has only increased by a total of 4.5% in the past four
quarters and remains 7.3% lower than in the 4th quarter 2007.
Policymakers should be concerned by the lethargic growth in
private business investment because private investment drives
job creation.
Changes in private sector payrolls are highly correlated with
changes in real fixed nonresidential investment. The following
chart illustrates the relationship since 1990.

32
It is because of this relationship that policy-makers must insure
that any actions taken to address the “fiscal cliff” do not
adversely affect private business investment.
The substandard pace of job creation in the present recovery can
be traced in large part to the failure of private business
investment to regain its 4th quarter 2007 levels. Faster growth in
private business investment will lead to higher growth in private
sector job creation.
Lack of Growth = Lack of Jobs
The recession that began in the 4th quarter 2007 was the deepest
recession of the post-World War II era in terms of output lost and
the number of job losses experienced in the private sector. From
January 2008, when private sector employment peaked at 115.6
million through February 2010, when private sector employment
bottomed out at 106.8 million, the economy lost 8.8 million
private sector jobs.
Since that time, the economy has regained 5.6 million of those
jobs. The 5.1% increase in private sector payrolls is not
insignificant but it leaves the economy still 3.3 million private
sector jobs in the hole.
As the following chart indicates, if we had experienced an
average recovery in the private sector job market, the economy
would have added 9 million private sector jobs instead of 5.6
million. An average recovery would have regained the January
2008 private sector employment peak. A strong recession like
the Reagan recovery would have added 12.6 million jobs or 3.8
million jobs above the prior peak.

33

The magnitude of failure is illustrated not just by this type of
number, but by the struggles of millions of American families.
And the lack of a solid, or even average, recovery has magnified
the nation’s precarious fiscal position.
The Administration has trumpeted recent declines in the
unemployment rate from its peak 10.0% peak in October 2009 to
the most recent reading of 7.7% for November 2012.
Unfortunately, there is little to cheer about in the recent declines.
The declines have been driven by people dropping out of the
labor force, not by employment growing faster than the
population.
When President Obama first took office in January 2009, the
unemployment rate stood at 7.8%. The percentage of American
adults with jobs or actively seeking work, the labor force
participation rate, was 65.7%. In the most recent employment
report, labor force participation came in 2.1 percentage points
lower at 63.6%. The decline in labor force participation over the
past for years has created the mirage of a steadily improving
unemployment rate. If labor force participation had remained at
the January 2009 level of 65.7%, the unemployment rate would
stand at 10.7%, not 7.7%. At 10.7%, the unemployment rate

34
would be more than double the rate of 5.3% promised when the
massive stimulus legislation was passed in February 2009.

More Growth Means Smaller Deficits
The President could have honored his pledge to cut the deficit in
half in his first term if he had focused on growing incomes and
wealth instead of focusing on how to re-divide the pie.
Prior to the start of the recession, fiscal year 2007, revenues rose
to 18.2% of 3rd quarter GDP. Federal government receipts stood
at roughly $2.6 trillion in fiscal year 2007, the highest on record
and 25% greater than in fiscal year 2000. In the fiscal year just
ended, the Treasury collected $2.4 trillion in revenues or 15.5%
of 3rd quarter GDP.
If the economy had grown by 16.8% as it averaged in the other
post-war recoveries and revenues had returned to the 18.2% of
3rd quarter GDP that they were in fiscal year 2007, the Treasury
would have collected an additional $653 billion in revenue. That

35
would have cut last year’s deficit by more than half. And that’s
before you even begin to take into account the lower spending
that would result from fewer Americans needing public
assistance.
A Reagan-style recovery would have generated even more
revenue. At 18.2% of 3rd quarter GDP, revenues would have
been $722 billion higher and the deficit chopped by two-thirds.
And that’s without raising anyone’s taxes. By focusing on progrowth policies and generating even an average recovery, the
President could have kept his promise to cut the deficit in half.

As policymakers consider how to resolve the so-called “fiscal
cliff”, they should remember the salutatory effects that stronger
economic growth would have on the federal government’s fiscal
position. It should go without saying that policies that inhibit
growth and job creation should be avoided.
Conclusion
Recent gains in private sector payrolls and economic growth are
unacceptably small bordering on stagnation. Acceptance of this

36
lethargic growth in output and job growth would condemn the
United States to a bleak economic future. We find such a course
of action unacceptable and implore the President and members of
his party to abandon their ideological crusade to redefine
America’s greatness as rooted in government. We urge them to
change course and embrace the power of liberty and the free
market system as the best hope to restore rapidly prosperity and
opportunity for all Americans.

SUPPLEMENTAL COMMENTARY ON PARTICULAR SECTIONS OF
THE 2012 ECONOMIC REPORT OF THE PRESIDENT
Housing
At the time of its February release, the 2012 ERP offered an
overly optimistic and incomplete account of developments in the
U.S. housing market. It overstated the effectiveness of the
Administration’s policy responses to housing market woes. The
implicit assumption of the ERP is that private market actors
alone were responsible for the housing market bubble that lead to
the Great Recession, and that government intervention in the
market is the most efficient and effective method for improving
the anemic housing recovery.
Within that context, the
Administration lauded its policy responses as stabilizing forces in
the housing market during from 2009 to 2011. Yet, it was not
until recently—over 9 months after the 2012 ERP was first
released and nearly four years after the President took office and
first implemented his policies—that signs of a housing market
rebound have manifested.
The singularly pro-government perspective of the Administration
has prevented it from addressing housing market woes
comprehensively and instead focuses the Administration on
government-mandated solutions. The ERP ignores the role the
government policy played in causing the unsustainable rise in
home prices that lead to the housing bubble. Myriad federal tax
and regulatory policies created incentives for investors to invest

37
their capital in housing market-related assets instead of other
alternatives. Moreover, the ERP virtually ignores the largest
players in the housing finance market—the governmentsponsored enterprises Fannie Mae and Freddie Mac. Fannie and
Freddie leveraged their government-granted funding advantages
to both influence the market in the lead up to the bursting bubble,
and to disproportionately contribute to the deterioration in
underwriting standards over time as they pursued increased
market share.
The Administration does correctly recognize the critical
contribution a housing recovery will make to the broader
economic recovery. After all, for most Americans, a home is the
largest single investment they make. Further, homes serve as
collateral through which many entrepreneurs and small business
owners secure financing for new business ventures. The
Administration also correctly recognizes the harmful effect of
negative equity, which resulted from the steep drop in residential
real estate prices. Negative equity has decreased labor mobility
in America and has increased the number of foreclosures in the
market. These foreclosures have, in turn, further lowered home
prices as they are sold off under distressed conditions.
Fortunately, home values across the country have begun to tick
up once again, increasing 1.3 percent in the third quarter of 2012.
However, one-fifth of all homeowners still owe more on their
home than it’s worth. 1 Home prices remain 29.2% below the
peak price level reached over six years ago, resulting in
approximately $6 trillion in lost household wealth.
Although the Administration has correctly identified the
problem, its biases have prevented it from taking decisive action
to ameliorate the disruptions in the housing market. One of the
Administration’s most touted initiatives is called Making Home
Affordable (MHA), which includes the Home Affordable
Gudell, Svenja, “Negative Equity Falls in the Third Quarter, But Fiscal
Cliff Could Derail Momentum,” Zillow Real Estate Research (November
14, 2012).

1

38
Refinance Program (HARP) and the Home Affordable
Modification Program (HAMP). It is difficult to objectively
conclude that MHA has had a material positive effect on the
housing market. According to the Inspector General of TARP,
just 13.4% of the $29.9 billion allocated to MHA under TARP
have been spent by the Administration in the three years since its
programs were first created. 2
Individual MHA programs have also underperformed. At the
time the ERP was released, the Administration noted that
930,000 permanent loan modifications have been achieved
through HAMP (the inspector general of TARP found 762,839
over the same time period). However, the Administration failed
to note that its inflated modification number represents just 19
percent of the loan modifications HAMP was originally projected
to facilitate. The Administration has tacitly admitted the failed
structure of HAMP and other MHA programs by implementing
several program modifications in recent months.
These
modifications focus on creating the proper incentives for private
market actors to cooperate with homeowners in order to facilitate
additional loan modifications and refinancing activity. 3
Actions by the Federal Reserve to support the ailing housing
market echo the lackluster performance of MHA. Through its
first quantitative easing program, the Federal Reserve purchased
over $1 trillion in agency mortgage-backed securities in order to
lower residential real estate mortgage rates. The hope was that
falling rates would spur additional home refinancing activity.
Although the excess liquidity risks the possibility of harmful
future price inflation, the benefits of lower mortgage rates for
ailing homeowners was anticipated to outweigh the possible
downside risks. However, as the Administration admited in the
Inspector General of TARP, Quarterly Report to Congress (October 25,
2012).
3
Massad, Timothy, “Expanding Our Efforts to Help More Homeowners
and Strengthen Hard-Hit Communities.” Making Home Affordable Blog
(January 27, 2012); Editorial, “Obama Housing Plan,” The New York
Times (February 1, 2012).
2

39
2012 ERP, the widespread effect of negative equity “undermines
the effectiveness of monetary policy that aims to lower
borrowing costs to businesses and households and thus
encourage greater economic activity.” 4 Put another way, the
Federal Reserve’s efforts to aid those borrowers have been
largely in vain. The risk-reward calculus the Federal Reserve
made appears to have been wrong, and now the economy faces
the prospect of rising price inflation without much to show for it.
Even despite having attempted this maneuver before with little
benefit and much risk, the Federal Reserve recently announced a
third quantitative easing program that consists of $40 billion a
month in agency mortgage-backed securities purchases for the
foreseeable future. The likely impact of this action is minimal at
best, but the risks of price inflation are even higher than before.
Though the Administration has tried several different commandand-control strategies to revive the economy, it has yet to address
the now defunct government-sponsored enterprises (GSEs)
Fannie Mae and Freddie Mac. The GSEs have cost American
taxpayers $187.5 billion since they were first placed under
government conservatorship in 2008, and may eventually cost
$30 billion more. Further, the Federal Housing Administration
(FHA), which provides government-backed mortgage insurance
for low down payment loans, has recently exhausted its loan loss
reserves and now has a negative economic value of $16.3 billion.
The likelihood that FHA will need to U.S. taxpayer bailout by
drawing funds from the U.S. Treasury is greatly increased. The
final cost to U.S. taxpayers is currently unknown, although one
analysis suggests the FHA’s insolvency is already worse than it
reports, to the tune of another $20 billion. 5
Although the U.S. housing market has begun its long road to
recovery, the market cannot enjoy a truly robust recovery until
private firms reenter the housing finance market. Yet, the
government accounts for “essentially all issuance of mortgaged4
5

ERP at 106.
Pinto, Ed, FHA Watch, American Enterprise Institute (November 2012).

40
backed securities” as of the end of the second quarter of 2012. 6
Rather than tinker on the margin with inefficient and ineffective
government programs, the Administration would do well to
provide a comprehensive solution to our nation’s housing finance
system—one that incentivizes the responsible deployment of
private capital into the market and limits government subsidies
only to those borrowers that truly need assistance.
Eurozone Crisis
On the international front, the Administration’s overarching
economic prejudices are especially evident in the ERP. In
particular, the ERP attributes the Eurozone’s sovereign debt
crisis not to overspending, but rather to slower economic growth.
Further, it then blames some of the near-term economic growth
problems on the fiscal austerity measures needed to bring
countries at risk of default back from that precipice. 7 To be sure,
a poorly focused fiscal austerity package can harm economic
growth in the near term, but the Administration is wrong in
finding fault with well-intended, albeit imperfect, solutions,
while failing to recognize that the sovereign debt crisis is
primarily driven by ill-advised, unsustainable government
spending.
Economic growth would be especially helpful in alleviating the
Eurozone’s sovereign debt crisis, but this would ultimately be a
band-aide on an untreated, festering fiscal wound. As noted in
the 2011 Joint Economic Committee Republican Study, “Spend
Less, Owe Less, Grow the Economy,” a credible fiscal
consolidation, wherein spending cuts are perceived as credible
and sustainable by the private sector, can mitigate the otherwise
harmful near-term economic effects of the spending cuts. Such a
package can actually stimulate the economy because, if a fiscal
austerity package is perceived as credible, the private sector may
respond by making more investments and hiring because the
Federal Housing Finance Agency, Conservator’s Report on the
Enterprises’ Financial Performance (Q2 2012).
7
ERP at 129.
6

41
private sector will anticipate a more favorable business climate
moving forward.
Economic Mobility in America
Notwithstanding the ERP’s assertion that the United States has
had low rates of income mobility for decades—an assertion for
which it is not clear what exact time span is indicated—analysis
from the Treasury indicates that the degree of relative income
mobility over the 1996 to 2005 period is very similar to that of
the prior decade (1987 to 1996). Though increasing income
inequality widened income gaps, this was offset by increased
absolute income mobility so that relative income mobility has
neither increased nor decreased over the past 20 years. 8
Research from economist Scott Winship confirms that claims of
rising inequality are overstated.
Winship found claims
describing that upward mobility fell 10 percentage points
between midcentury and 1980 to be untrue. Using real-world
data, Winship established there was no change over the period—
a finding that is also consistent with previous academic
research. 9
By another data set, the Federal Reserve Bank of Minneapolis
has also demonstrated earnings mobility of U.S. households
using income data from the Panel Study of Income Dynamics
that followed the same households from 2001 to 2007. The
empirical results demonstrate that 44 percent of the lowest
quintile moved up at least one quintile by 2007, and 34 percent in
the highest quintile moved down at least one quintile over the
“Income Mobility in the U.S. from 1996 to 2005,” Report of the
Department of the Treasury, November 13, 2007,
http://www.treasury.gov/resource-center/taxpolicy/Documents/incomemobilitystudy03-08revise.pdf
9
Scott Winship, “Guest Post: Scott Winship on the Obama
Administration’s Questionable Mobility Claims,” National Review Online,
January 17, 2012,
http://www.nationalreview.com/agenda/288306/guest-post-scottwinship-obama-administrations-questionable-mobility-claims-reihan-sal
8

42
same time period. In addition, when taking into account
household size and differing price indexes, median household
income for most household types increased by somewhere
between 44 percent to 62 percent from 1976 to 2006. 10 Median
hourly wages, including fringe benefits, also increased 28 percent
between 1975 and 2005. 11
Economic Inequality
The Administration also takes a very static and narrow view
when addressing income inequality. The data clearly shows that
the highest income earners are not the same people over time, but
a constantly changing set of taxpayers. Hence, the different
reasons for wealth and income inequality call into question the
justification as well as the likely efficacy of government
redistribution efforts.
An updated article from the Federal Reserve Bank of
Minneapolis’ Quarterly Review in February 2011 found that
many low-income households continue to hold substantial
amounts of wealth, and many wealthy households have very little
or negative income. 12 For example, the wealth gap between the
elderly and the young has reached a record high, doubling since
2005 alone. 13

Terry J. Fitzgerald, “Where Has All the Income Gone?” The Region, The
Federal Reserve Bank of Minneapolis, September 1, 2008,
http://www.minneapolisfed.org/pubs/region/08-09/income.pdf
11
Terry J. Fitzgerald, “Has Middle America Stagnated?” The Region, The
Federal Reserve Bank of Minneapolis, September 1, 2007,
http://www.minneapolisfed.org/pubs/region/07-09/wages.pdf
12
Javier Diaz-Gimenez, Andy Glover, and Jose-Victor Rios-Rull, “Facts on
the Distributions of Earnings, Income, and Wealth in the United States:
2007 Update,” Quarterly Review 34, No. 1, The Federal Reserve Bank of
Minneapolis, February 2011: 2-31,
http://www.minneapolisfed.org/research/qr/qr3411.pdf.
13
Chairman Paul Ryan, “A Deeper Look at Income Inequality,” House
Budget Committee, November 17, 2011,
www.budget.house.gov/UploadedFiles/CBOInequality.pdf
10

43
In fact, a recent study of Census Bureau data explains a majority
of income inequality by household demographics. In 2010 alone,
there were significantly more income earners per household in
the top income quintile of households, at 1.97, than earners per
household in the bottom quintile of households, at 0.43.
Additionally, married-couple households represented a larger
share of the top quintile, at just over 78 percent, relative to
single-parent families or singles. The top quintile had the largest
share of full-time workers (over 77 percent), while 68 percent of
those in the bottom quintile did not work. Family members in
the top income quintile were five times more likely to have a
college degree and 12 times more likely to have finished high
school than those in the bottom quintile.14
Intergenerational Elasticity and the “Great Gatsby Curve”
The ERP also highlights research that suggests that
intergenerational elasticity (IGE) of earnings may have increased
over time, implying that intergenerational mobility has fallen in
the last 30 years. However, use of IGE can be very limiting.
There are also reasons that international comparisons can be
difficult when discussing income inequality. As highlighted by
Jim Manzi, potential reasons for differences in the IGE of
amongst countries could include population size, as countries
with larger populations tend to have greater income variety, and
thus higher IGE. Other variables Manzi mentions include degree
of specialization of a given country and religious
fractionalization. In actuality, real drivers of mobility in
America are far more complicated. 15

Mark J. Perry, “Income Inequality can be explained by household
demographics,” The American, American Enterprise Institute, October 21,
2011, http://blog.american.com/2011/10/income-inequality-can-beexplained-by-household-demographics
15
Jim Manzi, “The Great Gatsby, Moby Dick, and Omitted Variable Bias,”
National Review Online, February 7, 2012,
http://www.nationalreview.com/corner/290053/great-gatsby-mobydick-and-omitted-variable-bias-jim-manzi
14

44
Winship recently argued that the use of the “Great Gatsby
Curve”—which described a positive relationship between IGE
and inequality and which the ERP presents as evidence of a
shrinking middle class—has given the illusion of precision in
attempting to prove that today’s children will encounter less
mobility than their parents. However, not only did Winship find
that Gatsby Curves covered a wide range, between -0.15 to 0.87
for mobility-inequality correlations, but also found that for five
countries where wealth Gini coefficients were comparable, the
correlation was flat, indicating that there is no relationship
between inequality and mobility. 16
A compelling statistic that the report fails to mention in
discussing intergenerational mobility is the absolute mobility that
children have experienced relative to their parents in the United
States. According to a recent study by Pew Charitable Trusts,
more than four out of five Americans have higher absolute
family incomes today than their own parents had approximately
30 years ago, and children born to parents in the bottom quintile
are more likely to surpass their parents’ income than children
from any other quintile as shown in Figure 2. 17
Limitations to Current Measurements of Inequality
The upward bias of the consumer price index (CPI), which is
estimated to add more than one percent annually to official
estimates of the growth of mean and median wages, likely
resulted in an upward bias in the CPI of 38 percent cumulatively
between 1977 and 2006. This can be remedied by using different
Scott Winship, “Guest Post: Scott Winship Offers His Closing Argument
in the Great Gatsby Curve Wonk Fight of 2012,” National Review Online,
January 20, 2012
http://www.nationalreview.com/agenda/288748/guest-post-scottwinship-offers-his-closing-argument-great-gatsby-curve-wonk-fight-201
17
Susan K. Urahn and Erin Currier, et. al., “Pursuing the American Dream:
Economic Mobility Across Generations,” Economic Mobility Project, Pew
Charitable Trusts, July 2, 2012,
http://www.pewtrusts.org/uploadedFiles/wwwpewtrustsorg/Reports/E
conomic_Mobility/Pursuing_American_Dream.pdf
16

45
inflation rates to account for the differences in consumption
patterns between the bottom and upper quintiles. 18
As highlighted in recent analysis from the House Budget
Committee, Christian Broda of the University of Chicago found
that those in the lowest earnings decile have seen a 30 percent
real wage gain from 1979 to 2005 when using a corrected price
index that accounts for the significant decreases in relative prices
for most basic goods that lower income households
disproportionately consume. 19
Regarding the ERP’s highlight of the share of total U.S. income
earned by the top one percent, while one could argue that income
inequality has grown between the 99 percent and the top one
percent, this phenomenon is not unique to the United States; in
fact, there is very little evidence to suggest that this disparity is a
result of the top gaining at the expense of the 99 percent. This is
possible because the economic pie can grow in size that benefits
the top one percent immensely while concurrently advancing the
bottom 99 percent as well. 20
The CBO report from October 2011 that the CEA cites to
demonstrate the changes in income over time also accounts for
after-tax income including transfers for the income category
minimums for each quintile and the top one percent. When
adjusting market income for transfers and federal taxes, the
minimum income threshold (adjusted for household size) for the
top quintile is just $60,557; the top one percent is $252,607 for

James Pethokoukis, “Shining more light on income inequality myths,”
The American, November 1, 2011,
http://blog.american.com/2011/11/shining-more-light-on-incomeinequality-myths/
19
See Endnote 11: Ryan, 2011
20
Scott Winship, “Assessing Income Inequality, Mobility and
Opportunity,” Testimony before the Senate Budget Committee, February
9, 2012,
http://www.brookings.edu/testimony/2012/0209_inequality_mobility_
winship.aspx
18

46
2007, demonstrating that the top one percent is not exclusively
millionaires. 21
In addition, the top one percent of income earners has not seen
their share of the income tax burden decline, and the share of
income that the top one percent earns is approximately the same
as in 2000. While the capital gains tax reductions that took effect
in 1997 and 2003 resulted in lower average tax rates among the
top 400 returns, the share of total income taxes paid by these
returns actually increased. Additionally, more than half of
returns reporting positive income of less than $75,000 in adjusted
gross income had no positive federal income tax liability. 22
As Winship testified before the Senate Budget Committee
investigating this issue, the facts of income inequality and
mobility are nonpartisan, incomplete, and subject to revision:
“But in order to guide policy, facts must be as accurately
understood and conveyed as possible. Doing so is often difficult
not only because the world is complicated, but because new
evidence routinely appears to muddy the picture we previously
managed to discern.” 23
Absolute income has increased as the costs of basic goods
decreased, and there is much more that can be afforded with less
income than in the past. In this sense, the inequality of wellbeing has tremendously declined over the past century, including
over the past two decades. As time has passed, the perceptions
of economic inequality and well‐being have skewed the focus
from addressing the needs of those at the lowest end of the scale
towards the perceived injustice of how much the wealthiest earn.
“Trends in the Distributions of Household Income Between 1979 and
2007,” Congressional Budget Office, October 25, 2011,
http://www.cbo.gov/sites/default/files/cbofiles/attachments/10-25HouseholdIncome.pdf
22
“Debunking the Obama-Buffett Myth on Taxes,” Joint Economic
Committee,
http://jec.senate.gov/republicans/public/index.cfm?p=Studies&Content
Record_id=C0FDA591-B533-44BD-A484-C6A8E06EBC93
23
See Endnote 19: Winship, 2012
21

47
This has derailed the discussion in policy from successful
solutions addressing economic immobility in favor of ensuring
everyone receives a “fair” share. 24 Rather than remain concerned
with “concentrations” of income and wealth among the one
percent, which is a constantly changing set of individuals, it is
important to identify barriers to economic mobility, and ensure
that programs intended to aid the lowest quintile don’t end up
inadvertently pricing the poor out of opportunities for upward
economic mobility.
Safety Net Programs & Moral Hazard
The ERP claims federal safety net programs protect families
against major risks and reduce the likelihood that temporary
economic shocks will cause permanent harm. They claim
increased funding for UI, TANF, Medicaid, and EITC provided
in the 2009 stimulus bill helped stabilize the economy by
supporting aggregate demand, and suggest these programs
prevented millions of American from falling into poverty. 25
Admittedly, government programs provide valuable cash and inkind assistance to millions of Americans. While the short-term
benefits are easy to see, the long-term costs are often hidden.
Safety net programs and taxes that fund them create a moral
hazard and distort economic incentives. The benefits reduce
precautionary savings, undermine personal responsibility, and
weaken the voluntary support of families and communities. The
taxes raise the cost of labor and capital, thereby reducing
investment, employment, and output.

“Economic Inequality and Mobility,” Republican Staff Commentary,
Joint Economic Committee, June 19th, 2012,
http://www.jec.senate.gov/republicans/public/?a=Files.Serve&File_id=8
187f1f2-eb54-4ab2-844c-5b0aafcd87fd. See: “Identifying Economic
Inequality,” Republican Staff Commentary, Joint Economic Committee,
June 18th, 2012,
http://www.jec.senate.gov/republicans/public/?a=Files.Serve&File_id=d
4d8a9a9-042e-43b0-aae6-642fb798732d
25
ERP at 197.
24

48
Temporary government spending can increase short-term
economic growth by stimulating aggregate demand. But these
temporary policies reduce long-term growth by reducing savings
and investment, and diverting workers and resources from more
efficient and sustainable uses.
The unemployment insurance (UI) program provides weekly
cash benefits to covered workers who lose their job through no
fault of their own. While many workers use these benefits to
meet urgent needs, many others use them to delay seeking and
accepting other employment. The Administration admits that
extended UI benefits increase the number of people who claim
they are looking for a job until they’ve collected the maximum
weeks of benefits, whereupon they drop out the labor force. 26
The Administration claims UI benefits help the economy by
boosting aggregate demand. 27
This claim assumes the
unemployed spend, rather than save, all of their benefits. Yet
more than two-thirds of families with an unemployed worker
have another family member who is employed. Thus, many
families likely might spend less than 100 percent of their benefits
because uncertainty about their future job prospects increases the
need for precautionary savings.
Providing cash payments to unemployed workers may boost the
demand for consumer goods, but it also reduces the supply of
labor needed to produce those goods. The net result of more
demand and less supply is higher prices, not real economic
growth.
The Affordable Care Act (aka ObamaCare) & Healthcare
The Administration claims the Affordable Care Act (ACA) will
increase the number of Americans with health insurance and
provide new protections and benefits to those already insured. 28
ERP at 202.
Ibid.
28
ERP at 209.
26
27

49
This claim ignores the impact that the increased demand for
health care services will have on medical price inflation and the
cost of government health programs and insurance exchange
subsidies.
Much of the increase in insurance coverage comes from
expanded Medicaid eligibility, but many doctors refuse to accept
Medicaid patients due to the low reimbursement rates provided
by the States. Having a Medicaid card in no way assures prompt
access to medical care.
Soaring Medicaid costs already threaten to bust many state
budgets. The expanded eligibility provided by the ACA will
only exacerbate this problem, despite the enhanced federal
matching payments.
The Administration claims expanded eligibility for Medicaid and
CHIP improves children’s access to care. 29 This result is largely
due to the crowding-out effect whereby these government
programs reduce private coverage, shifting more of the cost of
health care to the taxpayers.
The ACA has already increased the cost of employer-provided
insurance due to the imposition of various mandated benefits.
The new exchange subsidies will increase costs even more due to
the increased demand for health care. Increased demand will
result in additional medical price inflation which will result in
higher premiums, as well as larger taxpayer subsidies for the
exchanges.
The Administration claims the ACA will benefit seniors on
Medicare by providing new benefits and reduced cost-sharing. 30
But these potential benefits will be offset by the negative effects
of the $500 billion (2012-2021) reduction in provider
reimbursements.

29
30

ERP at 212.
ERP at 219.

50
Medicare already pays significantly less than private insurance.
Further reductions would widen the gap and jeopardize
beneficiaries’ access to care.
Social Security Reform
In the ERP, the Administration claims Social Security is a critical
element of the social safety net, proving a stable source of
retirement income. 31 This claim ignores the fact that without
reform, Social Security will be unable to pay promised benefits
within two decades. The disability program is facing insolvency
within a decade. Yet, the Administration has failed to propose
any solution to this looming crisis.
Energy & Regulation
The ERP advocates for government regulation of the economy
and an active role for the government in innovation, energy, and
infrastructure—with infrastructure including the wireless
broadband network. The contention is that the government can
properly identify and correct market failures. In coming to these
conclusions, the ERP relies heavily on the tool of cost-benefit
analysis, making the suspect claim that regulation does not come
at the cost of prosperity or living standards.
While exuding confidence government’s ability to “improve the
quality of life” through its activism, the ERP never sets forth a
principled framework for federal economic intervention or what
should be the preferred nature and limits of the intervention.
Irony might be found in that the February release date of the ERP
coincided with the publication date of an edition of The
Economist whose cover declares “Over-regulated America.”
This February 18, 2012 issue of The Economist, illuminates the
state of regulation in the United States and the problems
confronting the economy, flowing from federal intervention. The
subtitle of the issue’s lead article declares “The home of laissez31

ERP at 220.

51
faire is being suffocated by excessive and badly written
regulation,” and concludes with the words “regulation may crush
the life out of America’s economy.” Regrettably, based upon the
discussion of regulation in the ERP, it seems that the President’s
Council of Economic Advisers may be completely out of touch
with respect to the effects and tremendous difficulties of the
Administration’s regulations.
Here, the implication from the ERP is that the government is
moving beyond the claim that regulation is needed for the benefit
of the public to presuming that consumers need help making
rational choices about private costs and benefits. For instance,
those who see a role for government regulation of environmental
effects likely would be surprised to learn that the government
does not consider them fully competent to buy a washing
machine. Yet the ERP makes it clear its confidence that the
Administration knows better.
Also surprising is that much of the claimed benefits of regulation
are so-called ‘co-benefits,’ which—when carried to the
extreme—constitute a bait-and-switch. For example, the EPA
has standards for safe emission levels of fine particles, but that
does not stop it from crediting other rules with a so-called cobenefit for reducing fine particle emissions much further. The
EPA claims annual benefits of $90 billion compared with annual
costs of $10 billion for its new mercury emission rule, but the
mercury part of the purported benefit is less than 0.01%. Almost
all of the claimed benefits come from reductions in fine particle
emissions incidental to the rule. 32 The EPA presumably made
the attribution to the more alarming sounding mercury emissions
because it hoped to bolster support for its action. The reliance on
co-benefits has expanded to about 65% of all benefits claimed for
rules considered economically significant in 2010, with another
20% coming from private benefits, according to a former head of

32

Economist, February 28, 2012, p.77.

52
the Office of Information and Regulatory Affairs (OIRA), Susan
Dudley at George Washington University. 33
The ERP describes government energy innovation initiatives
with the same confidence as regulatory interventions. For
instance, DOE’s Advanced Research Projects Agency-Energy
(ARPA-E) is said to focus on transformational energy research
that the private sector by itself is unlikely to support. 34 Yet it
ignores problems with ARPA-E identified by the Government
Accountability Office (GAO); the Department of Energy’s
Inspector General, and the Science, Space, and Technology
committee staff. A significant number of companies have
received private sector investment prior to their ARPA-E award.
It appears that ARPA-E at times is following, not leading, private
venture capital investment for a greater chance to show success.
The ERP also credits the government for the success of hydraulic
fracturing and horizontal drilling techniques that have increased
domestic natural gas and oil production. However, it fails to
mention private oil company use of hydraulic fracturing as early
as the 1940s and the persistent pioneering work of one
company—Mitchell Energy—which developed the technique to
the point that has enabled the remarkable shale gas and oil
production boom. Further, the ERP fails to mention that while
oil production has increased on private land, which is regulated
by the states; it has fallen on public land, which is regulated by
the federal government.
The ERP implies that broadly, there really is no cost to
regulation:
“Even though smart regulations can impose
restrictions on the private sector, … the resulting benefits do not
come at the cost of prosperity or sacrifices in U.S. standards of
living. Over a period of decades, air quality has improved while
the economy has grown.” 35

Ibid. See graph “Moving the Goalposts.”
ERP at 255.
35
ERP at 243.
33
34

53
Unfortunately, the ERP has it reversed. Regulation should be
evaluated against a rising standard of economic growth and
prosperity in its absence. Regarding Clean Air Act Amendments
(CAAAs), Michael Greenstone, MIT economics professor and
director of the Brookings Institute’s Hamilton project, advises:
“The CAAAs are controversial, because reliable evidence on
their costs and benefits is not readily available. For instance,
there is not even a consensus on whether the CAAAs are
responsible for the dramatic improvements in air quality that
have occurred in the last 30 years.” 36
Economic growth and technological progress bring society the
great benefits. Modern plants are much more efficient and
cleaner as a result of advancing technology, and it is
preposterous to assume the state of industry would not progress
but for federal regulation. Moreover, regulation takes place at
the state and local levels as well, and the federal government
cannot simply lay claim to any regulatory induced benefit for
itself.
Further, in the ERP, cost-benefit analysis is no more than an
artificial construct whose value lies in introducing at least some
limited recognition of cost to rulemakings. Considered as a
guide for government to shape entire industries, the
Administration’s cost-benefit analysis is essentially a cover for
discretionary governance. Even within the ERP, it is noted that,
“The prospective benefit-cost analysis that goes into crafting
smart, efficient regulations is necessarily fraught with
uncertainty. 37
Retrospective analyses of benefits and costs are also subject to
uncertainty, because they require evaluation of a counterfactual
scenario in which the rule was not adopted. Identifying that
counterfactual is often difficult, in part, because changes that
“Did the Clean Air Act Cause the Remarkable Decline in Sulfur Dioxide
Concentrations?” Michael Greenstone, Journal of Environmental
Economics and Management, Elsevier, vol. 47(3), pp. 585-611, May 2004.
37
ERP at 238.
36

54
occurred due to the rule are difficult to distinguish from changes
that the industry would have adopted voluntarily. 38
To what then does the premise of the Administration’s regulatory
policy come down? Shockingly is that when the Administration
sees something it does not like, it can declare a “market failure”
and impose requirements that it claims are corrective. Beneath
the veneer of analytically derived net benefit findings, it is easy
to skew the results to show what regulators want. A cost-benefit
analysis can be designed to show large positive net benefits, and
as if the leeway to produce such a showing were not great
enough already, Executive Order 13563 authorizes consideration
of values that are difficult or impossible to quantify, including
equity, human dignity, fairness, and distributive impacts. 39
There is no explanation in the ERP of how cost-benefit analysis
should incorporate such considerations. The Administration and
the various agencies can do this any way they want. Of course,
that is no departure from the variation in the conduct of much of
the rest of the analysis.
The current regulatory philosophy has no limiting conceptual
framework for how to conduct regulation; it sets no boundaries
on what the government can justify. Regulation, therefore, is
neither “smart” nor democratic. Truly smart regulation would
respect the process it regulates and aim to enhance its
functioning. Regulators would take pains to understand what
makes the process work and what can make it work better
without dictating the outcomes. The result would be a minimum
of rules that are well understood and widely accepted. Rules
should be least intrusive, enduring, and give rise to few
exceptions. Regulation then would be more predictable, less
arbitrary, and less prone to capture by special interests. That
means regulating with a light touch, not heavy-handed.

38
39

ERP at 239, footnote 1.
ERP at 235.

55
The regulatory tangle in the United States described by The
Economist is the result of a governance philosophy that believes
in trying to force specific outcomes. That is how we get 2,000plus page laws with thousands of pages of regulations added by
the regulatory agencies.
The ensuing entanglements and
confusion are symptomatic of a central authority overwhelmed
by the complexity of what it is trying to micromanage.
We have been in a similar situation before. In the 1970s and
1980s recognition set in that while one could identify all manner
of imperfections in real world markets, government could not
necessarily correct them and likely made things worse.
Government and the political process are not perfect either.
Much so-called “economic” regulation of airlines, railroads,
trucking, and other industries was undone and the Interstate
Commerce Commission abolished. It is time we gain similar
recognition of the limits of government with respect to “social”
regulation, attempts to improve on individual choices, and
attempts to outdo the market in innovation.

Representative Kevin Brady
Vice Chairman
Senator Dan Coats
Dr. Michael Burgess
Representative Mick Mulvaney