White House Economist Keith Hennessey Answers Your Questions

Keith Hennessey

Last week, we solicited your questions for Keith Hennessey, the outgoing White House chief economic adviser and director of the National Economic Council.
In his answers below, Hennessey explains (among other things) what he thinks are some of the “most absurd economic assumptions” by Washington politicians; where, exactly, the first few hundred billion dollars of the TARP money has gone; and why he had “the coolest job ever.” Thanks to all of you for the good questions and to Hennessey for his candid and thorough answers.

How much of a president’s economic policy is influenced by external factors such as Congress, party pressures, etc.?

I can only speak to this presidency. External factors have a huge impact on what you can get done. An economist (I’m not one) might say that we maximize policy benefits subject to constraint, and there are a lot of problems that are severely overconstrained in multiple dimensions. Since much of economic policy is determined by law, rather than executive action, the biggest constraint is “How many votes can you get for that?” There are countless brilliant ideas out there that can’t get 51 or 60 votes in the Senate. That makes them interesting, but less relevant.
I’ve found that party pressures generally are a subset of vote counting. You usually start looking for votes in support of the president’s policy with members who generally agree with the president’s basic policy outlook, and then you expand from there.

What are some of the most absurd economic assumptions Washington politicians are guilty of making, and that you’ve had to “advise” against in your position?

That’s a fantastic question, and it gets at a nefarious tactic by some advocates: they try to skew the “baseline” assumptions to make their proposed policy changes look more reasonable. Four particularly egregious ones come to mind. They’re somewhat technical:
1. Within the past year, the Congressional Budget Office has revised its projections of wage growth in Social Security upward, making the Social Security problem look smaller. These new projections are out of line, and closer to the faulty 1983 assumptions than they are to the trustees’ assumptions or recent experience.
2. The Medicare actuaries have long assumed that per-capita health care spending will somehow magically slow down in the future, without explaining why or how that will happen. This understates the long-term fiscal challenge of Medicare and Medicaid.
3. Since the end of World War II, federal taxes have remained basically flat, at just above 18 percent of G.D.P. The Congressional Budget Office changed its assumptions recently, so that it now assumes that Congress will allow massive Alternative Minimum Tax increases to go into effect (when Congress never has allowed this in the past), and that federal taxes as a share of the economy will continue to grow far beyond historic norms. This assumption is absurd, and it makes it easier for advocates to justify tax increases.
4. The Congressional Budget Act assumes that a new temporary entitlement spending program will continue forever, and therefore that extending the program does not need to be offset with spending cuts or tax increases. That same law assumes that a temporary reduction in taxes will go away, and therefore that extending the tax relief must be offset by tax increases or spending cuts. The law therefore biases policy toward long-term spending increases and against keeping taxes low.

Why do presidents (Clinton and Bush, to be exact) change/rotate their chief economic advisers every two to three years?

It’s good to bring in fresh blood so the advice doesn’t get stale, and part of it comes from the advisers’ side; these jobs take a toll, especially on those with families. It’s easy to see why people burn out in a couple of years.

What does America have to do to have a budget surplus next year?

The Congressional Budget Office is now projecting a $1.2 trillion deficit for 2009.
In theory, you could radically cut spending and/or raise taxes. There is no practical likelihood that this could be turned immediately into a surplus without running the risk of placing a further wrenching burden on the nongovernment economy. In addition, with a macroeconomy in recession, you don’t want contractionary fiscal policy immediately.
Current and near-term deficits are now big enough to be a serious concern, but even more dangerous is the projected growth in future long-run deficits, which is driven by certain increases in entitlement spending (Social Security, Medicare, and Medicaid, to be specific). If Congress would address these long-run spending trends, we’d have a much brighter future.

What do you think of dramatically increasing the gas tax (say, maybe $2 to $3 a gallon), and offsetting that increase with a reduction in income tax so that net taxes to the government stay the same. Do you think this is an appropriate way to manage the traffic and environmental issues caused by American drivers?

The president has consistently opposed a gas tax increase (and, in fact, has blocked or vetoed every bill that contained a net tax increase). The idea you described, sometimes called a “net zero gas tax,” is analytically interesting. Lots of economists like it because it addresses externalities caused by using gasoline (emissions and national security costs) and traffic (although imperfectly).
In Congress this net zero gas tax idea is almost never discussed, because the legislative reality is that gas taxes have historically always been linked to increased highway spending, for which members have an almost insatiable appetite. It will be interesting to see if someone tries to break this tax-and-spend linkage in the upcoming stimulus debate.

How much policy influence did you have?

That’s a question better directed to others than to me. My job has two roles: honest broker and adviser. It’s exciting and rewarding to be able to give the president your personal recommendations, but as the head of the White House National Economic Council, I spent most of my time wearing my honest broker hat.
In that role, my job has been to be an unbiased moderator and coordinator among the president’s various advisers. For a policy question such as whether to provide loans to the U.S. auto manufacturers, I had to coordinate actions and advice among the following presidential advisers: Commerce Secretary Gutierrez, who was the president’s point man in interacting with the firms; Energy Secretary Sam Bodman and Treasury Secretary Hank Paulson, who controlled the two possible pots of money that could be loaned; Transportation Secretary Mary Peters; Budget Director Jim Nussle; White House Environmental Adviser Jim Connaughton; the president’s Chief Economist Eddie Lazear, and several senior White House advisers.
The N.E.C. director and his team develop policy options for the president, ensure rigorous analysis, resolve or at least clarify conflicting views among the president’s advisers, write policy memos and presentation slides, and structure the decision-making process. I have had little to no formal authority to make decisions, but I managed and helped manage the process that led to those decisions and their implementation. In practice, that means I chair lots of meetings and conference calls.
I’ve worked for the president for more than six years in a coordination role, so I’ve been fortunate to be able to contribute to a wide range of policies over time. It’s always a team effort.
Ultimately, it’s the president who makes all the big calls, and I think most people would be surprised at how many decisions are elevated to him. It’s a tremendous feeling to have your recommendation accepted and then pushed as the president’s policy.

Why does ethanol warrant such heavy government support when all indications are that it is an inefficient fuel substitute?

There’s a debate about the efficiency of ethanol-based fuel vs. gasoline, so make sure you check that your data source is reliable. Corn-based ethanol has significant support from many members from corn-producing states, so there’s a legislative reality element to it, and having early presidential caucuses in Iowa tends to have an effect on presidential candidates’ positions.
The U.S. and world economies depend heavily on oil and gasoline for transportation, and this dependency creates economic vulnerabilities. If supply is tight and there’s a supply shock, the lack of affordable close substitutes to oil and gasoline sends the price at the pump skyrocketing. The president recommended, and Congress passed, a significant increase in the amount of mandated renewable fuels that must be blended with gasoline into the fuel at your pump. He did this because he thinks that the national security externality caused by dependence on oil and gasoline is significant. In addition, the president has advocated and enacted policies to jump start the technological acceleration of alternative fuels such as cellulosic ethanol. The pressure for ethanol subsidies and tariffs on imported ethanol comes from the Congress.

Did Bush express a fondness for any particular economists’ theories?

We spent our time with him on practical applications to real-world problems, and the president would generally rely on his Council of Economic Advisers chairman to advise him on which theories are most applicable to any particular problem. In terms of his policy philosophy, he’s obviously been a low-tax, open-trade, and investment president. And I can’t count how many times the president emphasized that economic growth comes from individuals and firms making goods and services outside of Washington, and not from government policies.

Was there a conscious attempt by the Bush administration to pursue a weaker dollar to shrink the trade deficit?

Sorry, but I don’t talk about the dollar. Only the president and the Treasury secretary do, in order to make sure we don’t send mixed messages to currency markets.

Have you ever read Freakonomics?

I listened to it as an audiobook. I’ve debated with a friend whether that allows me to say “I read it.” I particularly enjoyed the parts about Realtors and baby names. We actually put a lot of effort into making the home-purchase/Realtor interactions more transparent, with something called the Real Estate Settlement Procedures Act. The Realtors fought us hard in Congress and blocked some of the best parts of that proposal, but we got some of it done late last year, through executive action under current law.

Given that you’ve also worked for Senator Lott, how versed would you say the average Senator or White House staffer is on macroeconomics?

On the White House staff, the president looks to C.E.A. Chairman Eddie Lazear for data and advice on the macroeconomy. Last week, for instance, Eddie sent the president the weekly claims numbers on unemployment insurance and some analysis explaining it.
After eight years, the president and his White House staff are extremely well versed on the macroeconomy, and we have had a running dialogue that is updated by new data and analysis. My experience on the Hill was that members of Congress focus much more on the federal budget than they do on the U.S. economy. In addition, members of Congress specialize, so there are a handful who are experts, and then there are many others who look to those thought leaders for advice and guidance.

Doesn’t any kind of stimulus from the government run the risk of reducing people’s faith in both the government and the currency when both are less effective than politicians predict? If so, why are they seen as having very few negative effects?

I have found that people’s faith in the government tends to be influenced much more by highly visible symbols of outrageous policy (the Bridge to Nowhere) or bad behavior (selling Senate seats) than by quantitatively larger but harder to understand policy problems, like the difficulty of demonstrating that certain government spending programs are ineffective at achieving their stated goals. This is in part because it’s easier for the press to explain corruption or show an example to make a broader point than it is for them to explain and communicate why economists have different estimates of the spendout rates for infrastructure spending.

Does the N.E.C. create its own economic models?

We create policy models and analytical tools and we design policies, but we don’t develop our own macro models. The N.E.C. is principally a policy coordination team, and so we look to others inside and outside the government to do most of the modeling. The Council of Economic Advisers has its own macro model, and we ask them lots of questions and get them to run scenarios using that model: “What would happen to employment and G.D.P. growth if we did ________?”

How often do you get to meet with the president?

As often as he needs me. Sorry, I’m not comfortable talking about that level of detail regarding our internal processes.

What made you want to work on policy?

For more than six years, I’ve been allowed to spend my day helping my boss try to make the world a better place — that’s incredibly rewarding. The policies of our government can have a significant impact on people’s lives, for better or worse. I’ve been able to help the president cut taxes, eliminate the bans on offshore drilling for oil and natural gas, create Health Savings Accounts, deal with a port strike and a mad cow disease outbreak, and create the do-not-call list. And I’ve been able to help him advance policies that I think and hope will serve as models for future reforms, including fixing Social Security to be permanently sustainable (with younger workers having the option to save some of their own payroll taxes in a personal account), and replacing the current-law tax treatment of health insurance with a more rational one that gets the incentives right. I am incredibly fortunate to have had what for me is the coolest job ever.
I also like solving hard problems, and I found that policy problems involving people with differing views and priorities are even more challenging that math proofs.

Where did the first $350 billion in TARP money go?

Two hundred and fifty billion of it has gone, and is going, to recapitalize banks, big and small, as we said it would (although in a different way).
About $65 billion went to prevent Citigroup and A.I.G. from failing in ways that our team feared would have had severe systemic financial consequences. Nineteen billion went out as loans to General Motors, Chrysler, and their finance companies. And $20 billion is budgeted for a program scheduled to be rolled out in late February to provide some liquidity to certain securitization markets, to keep money flowing for credit cards, auto loans, small business loans, and student loans. That’s $354 billion, of which about $251 billion had actually gone out the door as of Sunday January 11.
Don’t forget that each of these is a loan or an investment, structured so that the recipient is required to pay the taxpayer back. We’re taking a risk with these funds, in that the investments are uncertain and we know that some of them won’t be paid back in full (but we don’t know which ones). The point is that the long-term cost to the taxpayer will be significantly less than the initial taxpayer outlay.