FROM THE OFFICE OF PUBLIC AFFAIRS

I. Introduction

Thank you for inviting me to speak with you today. It is a privilege to address this group at the close of the Clinton Administration, and to have the opportunity to review the Administration's fiscal legacy.

One sure indicator of the importance of that legacy is the fact that, in at least four ways, the state of fiscal policy is fundamentally different today than it was eight years ago. I have organized the bulk of my remarks today around those four fundamental changes.

But before reviewing those four changes, let me take you back to the beginning, and recall for you how difficult it was to pass the President's first deficit reduction package in 1993, and how great the skepticism it encountered as to its economic merits. The deficit reduction package passed the House of Representatives on August 5, 1993, by a vote of 218-216, with all Republicans voting against. The next day, the Senate passed the bill, on a vote of 50-50, with Vice President Gore casting the tie-breaking vote, again with not a single Republican vote in support of the package.

Much of the commentary in 1993 was, to say the least, skeptical as to the economic merits of the plan. One member of Congress remarked that "this is really the Dr. Kevorkian plan for our economy." Another said: "This plan will not work. If it was to work, then I'd have to become a Democrat and believe that more taxes and bigger government is the answer."

Leaving aside the false premise as to the fiscal orientation of the Democratic Party today, we do now know the outcome as to the recent performance of the macroeconomy: During the Clinton Administration, we have enjoyed the lowest unemployment rate in 30 years. Inflation declined to the lowest levels since the Kennedy Administration, and has remained moderate this year despite the run-up in energy prices. Productivity growth has averaged 3.0 percent over the last five years - nearly double its average rate over the preceding 20 years. And real wages finally have begun rising across the economic spectrum.

Now there has been a lot of debate in recent years about how to parse out the credit for that macroeconomic performance. To be sure, much of the credit goes to the American people, who have displayed enormous creativity and entrepreneurial energy, and to the development of path-breaking new technology. But as Secretary Summers has noted, the American people were creative and entrepreneurial in 1992 as well, and yet the country could not seem to improve its lackluster economic conditions. I hope it will not surprise you too greatly if I attribute a share of the credit to the strategy of sustained fiscal discipline that was put in place by the President and his economic team.

And notwithstanding the economic outcome, I am not aware of any offer on the part of the member of Congress I quoted earlier to carry out his promise and vote with the Democrats!

Let me now turn to a more specific discussion of four ways in which fiscal policy has been transformed during the Clinton Presidency.

Perhaps the simplest and most obvious way in which the fiscal landscape has been revolutionized is the stunning change in the numbers:

• In FY1992 - the year before the Clinton Administration took office - the unified deficit of the Federal government ran a record $290 billion, or 4.7 percent of GDP. By contrast, in FY2000 - the fiscal year just completed - the Federal government set a different and more enviable record, with a surplus of $237 billion, or 2.4 percent of GDP.
• In 1992, the debt held by the public was nearly 50 percent as large as the GDP, and projected to increase to roughly 65 percent of GDP by the end of FY2000. In fact, the debt now is only 35 percent as large as the GDP, and is projected on prudent assumptions to be eliminated by 2012 - even taking account of the President's spending and tax-cut proposals.

This turnaround in the numbers has brought real benefits to individual Americans:

• The net interest payments of the Federal government in FY2000 alone were $125 billion lower than projected in early 1993. That amounts to more than $1700 for every American family.
• Fiscal consolidation has helped reduce mortgage interest costs: a typical American family with a mortgage of $100,000 might expect to save about $2,000 annually in mortgage costs because of our new path of fiscal discipline. Low mortgage rates in turn have helped to make housing more affordable; the homeownership rate increased from 64.2 percent in 1992 to 67.7 percent in the third quarter of this year.
• The swing in the Federal budget from deficit to surplus has resulted in nearly a doubling of the net national saving rate, making more funds available for private investment. (And incidentally, the improvement in the Federal budget deficit - now a surplus - accounts for all of the improvement in national saving.) Surging investment, especially in equipment incorporating the latest advances in technology, has contributed to a pickup in workers' productivity growth - and ultimately, in their wages.

A second respect in which the fiscal landscape has been transformed has more to do with the institutions of the budget process than with the performance of the budget itself.

• Until the past couple of years, the political debate about the budget focused on allocating unified surpluses - or, to be more precise about it - reducing unified deficits. A few insightful observers understood that balancing the unified budget should not be the ultimate goal, but believed that the more ambitious objective of balancing the on-budget account was so far out of reach that highlighting it as a potential objective might actually undermine our collective resolve rather than solidify it. And they were probably right.
• But in the summer of 1999, buoyed by the progress of the preceding six years, President Clinton was able to shift the terms of the political conversation by putting forward a plan for allocating the projected on-budget surpluses over the succeeding ten years, and for setting aside all of the off-budget surpluses - the Social Security surpluses - for debt reduction.

The practical implication of this change is that the budgetary debate now focuses on how best to use $1.9 trillion in projected on-budget surpluses rather than $4.2 trillion in unified surpluses. The beneficial implications for national saving and the performance of the macroeconomy can hardly be overstated.

The shift in the terms of political debate had an immediate and extremely consequential implication for the interpretation of the Social Security trust fund, which represents a third important change in the fiscal landscape:

• Back when the budget debate focused on the unified surplus or deficit, changes in the level of the Social Security trust fund conveyed little information about the extent to which the Federal government or the nation was preparing for the retirement of the babyboom generation. So long as balancing the unified budget remained the standard for adequate fiscal performance, a larger Social Security surplus would tend to be offset by a larger non-Social Security deficit. Accordingly, an increase in the Social Security trust fund did not imply that the government or nation was better prepared for the demographic changes of the next few decades.
• But now that the budget debate focuses on balancing the on-budget account, changes in the level of the Social Security trust fund do reflect incremental government saving. So long as the on-budget account remains either in balance or in surplus, Social Security surpluses translate dollar for dollar into improvements in the net financial position of the government. Thus, they represent preparation that the Federal government is undertaking on behalf of all of us for the retirement of the babyboom generation.

It is worth digressing here for a moment to address one common misconception about the Social Security trust fund. A number of critics have attacked the "reality" of the trust fund, on the basis that the trust fund holds only "government IOUs." This attack is a red herring.

In point of fact, the macroeconomic reality of the trust fund does not hinge on the assets that it holds, but rather on the issue of whether trust fund accumulations are backed by government saving.

• In the old regime, in which balancing the unified budget was taken to be the standard of adequate fiscal performance, the trust fund did not have great significance from a macroeconomic perspective (even though it is very "real" indeed for other purposes). And the same was true regardless of what assets the trust fund was invested in -- be they gold ingots, corporate shares, or Treasury securities.
• By contrast, in the new regime, in which the fiscal objective is to balance the budget excluding the Social Security surpluses, then the trust fund is fully "real" from a macroeconomic perspective, again without regard to whatever assets the trust fund may be invested in.

The key is whether changes in the level of the trust fund are backed, dollar for dollar, by government saving. If they are, then - for my purposes as a macroeconomist - the trust fund is very real indeed. And this accomplishment - the fact that the Social Security trust fund now has real macroeconomic meaning - is, in my view, one of the most under-rated achievements of the Clinton Administration.

A fourth change in the fiscal landscape is that we now have a much keener appreciation for the near-term implications of out-year fiscal settings.

• In 1992, the notion that a back-loaded deficit reduction package could be stimulative in the near term was still regarded as somewhat controversial. This new theory held that once a deficit-reduction program had been announced, the bond market would look ahead, recognize the future fiscal consolidation and its implication for future short-term interest rates, and bring that back to the present in the form of lower long-term interest rates. Thus, it would be possible to stimulate business investment and other interest-sensitive forms of spending without immediately bearing the contractionary consequences of a tighter overall stance of fiscal policy.
• Today, that view is regarded as conventional wisdom, largely on the basis of the experience of the 1990s. More specifically, over the course of 1993, as the initial deficit reduction package was working its way through the Congress, interest rates in fact did come down, even as the economic recovery was gathering strength, consistent with the theory behind the policy.

I should note that there is nothing special about fiscal consolidations, and that the logic of this lesson applies equally in reverse: a back-loaded fiscal expansion can, in principle, be contractionary in the near term. The main determining factors include the speed with which the fiscal stimulus is phased in, and the degree to which fiscal policy becomes more expansionary in the future relative to the present.

The extent of the fiscal progress of the past eight years is almost difficult to comprehend. Now it is no longer common to worry about the mounting fiscal burden that we are bequeathing to our children. Instead, we can realistically look forward to the day when we will have eliminated the debt held by the public altogether.

But the fiscal agenda is not finished. Let me highlight two items that the Clinton Administration fought for, but was unable to obtain:

• First, the President and Vice President proposed taking Medicare out of the budget, and thus giving the Medicare trust fund the same degree of macroeconomic significance now enjoyed by the Social Security trust fund. Unfortunately, despite some expressions of support for this idea from both sides of the aisle, Congress did not ratify the suggestion. This will be an important next step for the new Administration and the new Congress to take.
• Second, of course, the fundamental goals of Social Security reform and Medicare reform remain unaccomplished. President Clinton put forward a plan that would have extended the solvency of the Social Security trust fund to 2054, and suggested that a bipartisan process be put in motion to close the remainder of the 75-year actuarial imbalance. On the Medicare side, he put forward a detailed proposal for extending the solvency of the trust fund while introducing real competition into the program - competition not only among Medicare HMO plans, but also between those plans and the traditional fee-for-service program.

Unfortunately, Congress failed to respond to the President's leadership on either point. But one of the greatest fiscal legacies of the Clinton Administration is that the resources have been preserved to enact those proposed solutions in the future, should the new Congress and the new President choose to do so. For the sake of the nation's economic future, I hope they will make that choice.