REPORTCARD2000.COM
The
following is an analysis of The Economic Outlook section of the January 2001
CBO Budget and Economic Outlook.
The text in *RED are comments included by
the website host.
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The Budget and Economic Outlook:
Fiscal Years 2002-2011 |
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Chapter Two
The Economic Outlook
The growth of economic activity--as
measured by real (inflation-adjusted) gross domestic product--is likely to slow
from its rapid pace of recent years to about 2½ percent this calendar
year and 3½ percent next year (see Table
2-1 and Figure
2-1). Spending by consumers and investment by businesses slowed late last
year in response to higher interest rates in 1999 and early 2000 * CBO assumption that interest rates were the cause and
lower expectations about future business conditions (reflected in last year's
drop in stock prices * CBO is now assuming why the
stock market went down and tightening of standards and terms for
borrowing by businesses). Although in early January the Federal Reserve Board
responded to the slowdown in growth by lowering the federal funds interest
rate, spending by consumers and businesses is likely to remain weak this year. However, lower interest rates will
set the stage for spending to grow more quickly next year.
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Table 2-1. |
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Estimated |
Forecast |
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Projected Annual Average |
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2001 |
2002 |
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2003-2006 |
2007-2011 |
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Nominal GDP (Billions of dollars) |
9,974 |
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10,446 |
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11,029 |
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13,439 |
a |
17,132 |
b |
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Nominal GDP (Percentage change) |
7.3 |
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4.7 |
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5.6 |
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5.1 |
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5.0 |
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Real GDP (Percentage change) |
5.1 |
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2.4 |
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3.4 |
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3.1 |
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3.1 |
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GDP Price Index (Percentage change) |
2.1 |
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2.3 |
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2.1 |
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1.9 |
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1.9 |
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Consumer Price Indexc (Percentage change) |
3.4 |
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2.8 |
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2.8 |
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2.6 |
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2.5 |
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Unemployment Rate (Percent) |
4.0 |
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4.4 |
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4.5 |
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4.7 |
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5.2 |
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Three-Month Treasury Bill Rate (Percent) |
5.8 |
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4.8 |
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4.9 |
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4.9 |
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4.9 |
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Ten-Year Treasury Note Rate (Percent) |
6.0 |
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4.9 |
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5.3 |
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5.6 |
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5.8 |
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Tax Bases (Percentage of GDP) |
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Corporate profitsd |
9.4 |
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8.9 |
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8.5 |
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8.2 |
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8.0 |
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Wages and salaries |
47.8 |
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48.2 |
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48.2 |
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48.2 |
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48.0 |
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SOURCES: Congressional Budget Office; Department of Commerce, Bureau of Economic Analysis; Department of Labor, Bureau of Labor Statistics; Federal Reserve Board. |
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NOTES: Percentage changes are year over year. |
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Annual economic projections for calendar years 2001 through 2011 appear in Appendix E. |
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a. Level of GDP in 2006. |
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b. Level of GDP in 2011. |
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c. The consumer price index for all urban consumers. |
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d. Corporate profits are book profits. |
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The rate of inflation, as measured by the growth of the consumer price index
(CPI), is expected to decline from 3.4 percent in 2000 to around 2.8 percent in
2001. That projected decrease reflects the Congressional Budget Office's view
that oil prices will fall somewhat from last year's level, although underlying
inflationary pressures from the tight labor market will remain. * CBO is assuming a tight labor market is inflationary.
Significant uncertainty surrounds that
short-term forecast. For various reasons, economic conditions in the next two
years could be much worse or better than CBO anticipates: * CBO is now
stating economic forecasting is difficult, in spite of previous statements
cited above.
- The primary negative risk is that the current slowdown might turn into a recession. Although forecasters widely anticipated that economic activity would slow, the deceleration has been surprisingly rapid. * Not only is the economy slowing, it is slowing at a surprisingly rapid rate. Reports of rising loan losses at commercial banks and defaults on high-risk bonds, combined with the drop in stock prices, have heightened fears that financial markets might severely reduce the supply of credit and capital and choke off the economic expansion. In addition, consumers have become less optimistic about the future, in part because of the decline in the stock market. The possibility of further slowing is heightened by the weakness evident in recent economic data, such as those showing slower growth of retail sales and employment. Although those developments must be watched carefully, they do not as yet constitute a strong reason to expect a recession. * CBO summarizes by stating a recession should not be expected. The CBO makes no statement about the duration of the slowdown.
- In the other direction, the economy might continue to grow rapidly without an increase in inflation, rather than slowing as CBO forecasts. In recent years, the unexpected endurance of the expansion has continually surprised analysts and has proved to be the most significant source of error in their economic forecasts. * CBO has been surprised by recent years expansions. This statement is an indicator of the CBO lack of understanding of the economic conditions.
- Another source of risk to CBO's short-term forecast is that inflation might rise. Productivity growth--which has been rapid and kept production costs low--could slow more than generally anticipated, and businesses could pass the resulting cost increases on to customers in the form of higher prices. In that case, rising inflation would be coupled with slowing growth. Alternatively, inflation might start to rise because of continued rapid growth of GDP and increasing wage pressures from the labor market, which has been unusually tight. Or the dollar could fall from its current high level, leading the prices of imported goods to rise and temporarily boosting inflation. Whatever the cause, any further rise in inflation increases the possibility that the Federal Reserve will raise short-term interest rates, with the attendant risk of a recession next year. * The CBO cites more possibilities. A further indication of the uncertainty surrounding the economic forecasts.
Those risks are less important for the economic outlook over the next 10 years as a whole. CBO anticipates that growth of real GDP will average about 3 percent over the 2001-2011 period. CPI inflation is projected to average 2.6 percent during that period, reflecting CBO's assumption about what level of inflation would be consistent with Federal Reserve policy. Given the projection of continued stable inflation, interest rates are expected to remain at levels similar to those seen in the second half of the 1990s (see Figure 2-1).
The major uncertainty in those medium-term economic projections is the
growth rate of potential GDP (defined as the highest level of output that could
persist without spurring higher inflation). CBO has
raised its projections of both potential and actual GDP over the past few years
in response to the investment boom of the late 1990s * CBO has now clearly stated the potential and actual GDP
have been raised as a result of the investment boom in the late 1990s. In other words, the investment boom is
anticipated to result in sustainable GDP growth. A significant assumption ,
evidence of the economy's faster growth of productivity, and changes in the
data used to calculate GDP. That rise parallels changes made by private-sector
forecasters and the Clinton Administration (see Table
2-2). Their and CBO's upward revisions were mostly driven by the increasing belief that acceleration in the
growth of information technology--which was a major force behind the investment
boom of the late 1990s--will continue to stimulate investment over the next
decade * CBO is assuming the IT investment
boom in the late 1990’s is going to continue. Another major assumption.
However, economists are uncertain about the degree to which information
technology will continue to support economic growth over the next 10 years.
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Table 2-2. |
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Average Annual Growth Rate of Real GDP (Percent) |
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Date Projection |
Period Covered |
CBO |
Blue Chip |
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2001 |
2001-2010 |
3.0 |
3.3 |
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3.1 |
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2000b |
2000-2009 |
2.8 |
2.7 |
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2.8 |
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1999b |
1999-2008 |
2.3 |
2.4 |
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2.3 |
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1998 |
1998-2007 |
2.2 |
2.3 |
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2.3 |
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1997 |
1997-2006 |
2.1 |
2.3 |
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2.3 |
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SOURCES: Congressional Budget Office; Aspen Publishers, Inc., Blue Chip Economic Indicators; Office of Management and Budget. |
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a. CBO and Clinton Administration projections were published in January and completed in November or December of the previous year. Blue Chip publishes long-term projections twice a year, in March and October; the projections shown here are those published in October of the previous year. |
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b. About 0.3 percentage points of the change between these projections stemmed from a benchmark revision to gross domestic product during 1999 that, for the first time, included software in GDP. |
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The Growth of the Economy's Potential to Produce
The performance of the
That confluence of events stemmed primarily from an unexpected increase in
the growth of the economy's underlying ability to produce goods and services.
The growth of labor productivity accelerated from a trend rate of 1.5 percent a
year during the 1974-1995 period to 2.9 percent (see Figure
2-2). An important factor behind that recent surge was the acceleration of
investment in information technology (IT), which appears likely to continue to
contribute to the underlying growth rate of the economy in the years ahead. * The IT boom is again cited to contribute to the underlying
growth rate of the economy for years ahead. Therefore, a reduction in IT investment will
result in the CBO assumption being invalid.
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Other important developments also played a role in the economy's outstanding
performance over the past five years. Changes in corporate behavior,
particularly increased efforts to reduce costs (which were facilitated by the
IT revolution), appear to have helped raise the sustainable growth rate of
productivity. * CBO states this “appears”
to have contributed to the rate of productivity. The components of productivity are
critical to the understanding of what constitutes a change in
productivity. Weakness in
many foreign economies, coinciding with a period when inflationary pressures in
the
The Information Technology Boom
Recent progress in information technology has contributed to the increase in
productivity growth in various ways. The most visible and clearly quantified
way involves the manufacturing of IT equipment itself. The rate of technical
change in that sector is reflected in the quality-adjusted price index for
computers and related equipment. That index has been declining for many years
because of ongoing improvements in productivity, but it fell more rapidly between
1995 and 1999 (see Figure
2-3). Although some of that faster decline stemmed from temporary market
developments, CBO anticipates continued rapid productivity gains in the
production of IT equipment. * CBO anticipates productivity gains in the production of IT
equipment.
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Besides those gains, information technology has helped businesses lower their costs of production. Significant cost savings from IT investments are hard to quantify precisely, but numerous anecdotes suggest that savings are greatest in business operations that involve intensive handling, disseminating, or archiving of information or that require constant monitoring of data--operations such as purchasing, delivery, and inventory management.
The unusually large declines in IT prices, combined with the clear benefits
of IT investment, resulted in a surge in such investment by businesses. Indeed,
the investment boom of the late 1990s was led by higher spending on new
software and computing and communications equipment (see Figure
2-4).
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* Graph shows the significance
of the IT investment in the late 1990’s. Did the investment continue as assumed
by the CBO?
Changes in Corporate Management and Culture
Advances in information technology, coupled with increased globalization, have created a more competitive environment for businesses, causing them to significantly change the way they behave. In particular, increased competition has forced firms to sharpen their focus on controlling production costs. Rather than try to pass on higher costs to consumers or improve their profits by raising prices, companies appear more ready and willing to reduce costs by embracing new technology quickly, undertaking large investments, and making changes in their organizational structures that increase efficiency. Although businesses have always tried to lower costs, the IT revolution appears to have given them both the additional means and the need to focus more attention on cost-cutting innovations.
Weakness in the Rest of the World
Weakness in other countries in the second half of the 1990s helped the
In addition, the combination of a strong dollar and excess capacity abroad
held down prices of imports and overall inflation through 1999. Prices of
imported goods (excluding petroleum and computers) fell by an average of 2.3
percent per year between 1996 and 1999 after increasing by an average of 3.0
percent per year in the previous 10 years (see Figure
2-5). Lower import prices reduce overall inflation in two ways: directly
through the share of imported goods and services in the price indexes used to
measure inflation, and indirectly through increased foreign competition that
limits the ability of
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The weakness in world economic activity also reduced prices for commodities (such as grains, metals, and crude oil). Petroleum prices eased for most of the second half of the 1990s before starting their run-up in 1999.
Improvement in the Federal Budget
Another factor that contributed to the favorable economic performance of the
past five years was the improvement in the federal budget, which added to
national saving, making more funds available for private investment. The budget
moved from a $164 billion deficit in 1995 to a $236 billion surplus in 2000. Part of that improvement stemmed from policy changes
that increased revenues in the 1990s and restrained spending when surpluses
emerged. But the bulk of the improvement occurred because economic developments
spurred phenomenal growth in revenues. *
CBO states the bulk of the improvement in economic developments spurred
phenomenal growth in revenues. The
CBO states part of the improvement stemmed from policy changes.
CBO's Medium-Term Projections
CBO projects that real GDP will grow at an average rate of 3.0 percent in
the medium term (defined as the 2001-2011 period). That rate is significantly
higher than the 2.7 percent that CBO projected last July.(1)
The faster growth rate results from a change in CBO's method of calculating the
contribution of capital to growth, an upward revision in the official data on
investment for the past three years, and higher projected levels of investment.
Inflation in the CPI is projected to average 2.6 percent, and the unemployment
rate is expected to average 4.8 percent. * Based on
the significant increase in investment in the past three years, the CBO
increased the projected increase in the GDP. Obviously, a decline in investments in
the following years will invalidate the assumption.
Growth of Potential GDP
Potential GDP--the highest level of output that the
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Table 2-3. |
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Average Annual Growth Since 1951 |
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Projected Average Annual |
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1951- |
1974- |
1982- |
1996- |
Total, |
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2001- |
2006- |
Total, |
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Overall Economy |
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Potential Output (GDP) |
3.9 |
3.2 |
2.9 |
3.4 |
3.4 |
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3.5 |
3.2 |
3.3 |
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Potential Labor Force |
1.6 |
2.5 |
1.4 |
1.2 |
1.7 |
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1.1 |
1.0 |
1.0 |
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Potential Labor Force Productivitya |
2.2 |
0.7 |
1.4 |
2.2 |
1.8 |
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2.4 |
2.2 |
2.3 |
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Nonfarm Business Sector |
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Potential Output |
4.0 |
3.6 |
3.1 |
4.0 |
3.7 |
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4.1 |
3.6 |
3.8 |
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Potential Hours Worked |
1.3 |
2.2 |
1.6 |
1.4 |
1.5 |
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1.2 |
1.0 |
1.1 |
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Capital Input |
3.7 |
4.3 |
3.1 |
5.0 |
3.8 |
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5.8 |
4.8 |
5.2 |
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Potential Total Factor Productivity |
2.0 |
0.8 |
1.1 |
1.5 |
1.5 |
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1.5 |
1.5 |
1.5 |
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Potential TFP Excluding Adjustments |
2.0 |
0.8 |
1.1 |
1.1 |
1.4 |
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1.1 |
1.1 |
1.1 |
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TFP Adjustments |
0 |
0 |
0 |
0.4 |
0 |
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0.4 |
0.4 |
0.4 |
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Computer quality |
0 |
0 |
0 |
0.2 |
0 |
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0.2 |
0.2 |
0.2 |
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Price measurement |
0 |
0 |
0 |
0.1 |
0 |
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0.2 |
0.2 |
0.2 |
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Temporary adjustmentb |
0 |
0 |
0 |
0.1 |
0 |
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0 |
0 |
0 |
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Contributions to Growth of Potential Output (Percentage points) |
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Potential hours worked |
0.9 |
1.5 |
1.1 |
1.0 |
1.1 |
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0.9 |
0.7 |
0.8 |
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Capital input |
1.1 |
1.3 |
0.9 |
1.5 |
1.1 |
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1.7 |
1.4 |
1.6 |
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Potential TFP |
2.0 |
0.8 |
1.1 |
1.5 |
1.5 |
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1.5 |
1.5 |
1.5 |
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Total Contributions |
4.0 |
3.6 |
3.1 |
4.0 |
3.7 |
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4.1 |
3.6 |
3.8 |
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Memorandum: |
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Potential Labor Productivityc |
2.7 |
1.4 |
1.5 |
2.6 |
2.2 |
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2.8 |
2.6 |
2.7 |
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SOURCE: Congressional Budget Office. |
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NOTE: CBO assumes that the growth rate of potential total factor productivity changed after the business-cycle peaks of 1973 and 1981 and again after 1995. |
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a. Potential GDP divided by the potential labor force. |
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b. The temporary adjustment raises the growth of potential TFP during the 1996-2000 period to help make the estimate of potential GDP more compatible with the observed weakness of inflation. That adjustment is considered transitory, in the sense that although it has a permanent effect on the estimated level of potential TFP, its effect on the growth rate of TFP is temporary. |
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c. Estimated trend in the ratio of output to hours worked in the nonfarm business sector. |
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By CBO's estimate, the annual growth rate of potential GDP increased from 2.9 percent between 1982 and 1995, on average, to about 3.4 percent between 1996 and 2000. Much of that acceleration can be attributed to an increase in the growth of the capital input (a measure of the flow of services provided by the stock of capital). * CBO states much of the increase in the growth rate of the GDP is the result of growth in the capital. The contribution of the capital input to the overall growth of potential output in the nonfarm business sector rose to 1.5 percent in the 1996-2000 period from 0.9 percent in the 1982-1995 period.
Potential GDP accelerated more in the past five years, however, than can be
explained simply by additional capital. * CBO is
stating the rise in potential GDP is not entirely explained by the increase in
capital. The remaining
increase is assumed to be an increase in total factor productivity (TFP).(2)
CBO estimates that the underlying trend for TFP (known as potential TFP) in the
nonfarm business sector grew at an average rate of 1.5 percent for the past
five years, up from its average of 1.1 percent growth for the 1982-1995 period.
The growth of actual TFP escalated further in the past year and a half, but
that surge is projected to be reversed as the economy reverts to its potential
level, and thus the surge has virtually no effect on potential TFP (see Figure
2-6).
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Although much of the increase in the growth of potential GDP in the second
half of the 1990s is carried forward in CBO's projections * CBO is basing the projected GDP on the GDP growth in the
second half of the 1990s, the growth of potential GDP is slower between
2006 and 2011 than in the past five years. That slowing is primarily caused by
slower growth in total hours worked, reflecting a corresponding reduction in
the growth of the working-age population, and the stabilization of the overall
rate of labor force participation.(3) * CBO is
assuming there will be a reduction in the growth of the working-age population
because of the aging baby-boom generation.
The Increase in the Capital Input. The recent
investment boom raised the growth of the capital input to about a 5.0 percent
pace in the past five years from 3.1 percent in the previous 15 years, adding
significantly to the growth of potential GDP. That increase
resulted not only from greater capital investment but also from an increase in
the share of investment devoted to information technology. A dollar's worth of
IT investment contributes more to output per year than other types of
investment; IT equipment has a shorter service life than other types of
capital, on average, so to be profitable, its contribution to production per
year of service life must be higher (see Box
2-1). The shift in the composition of investment toward IT capital raises
the growth rate of the capital input. It also implies, of course, that the capital stock depreciates faster and that a greater
share of earnings in the future will be devoted to replacing depreciated
equipment.
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The Congressional Budget Office uses a neoclassical growth model to project the level of real gross domestic product 10 years ahead. The model tries to explain the historical trends in the growth of real GDP by estimating the contributions of two factors of production, labor and capital, and a residual called total factor productivity (TFP). CBO estimates the underlying trend in real GDP (called potential GDP) by estimating trend lines through the historical pattern of ups and downs in labor hours and TFP. CBO bases its estimate of the capital input on the actual capital stock. That modeling approach is useful for estimating the contribution each factor makes to the growth of potential GDP, but measuring the inputs is often difficult. The measurement of the capital input has been a particular problem in recent years. The difficulty stems from the heterogeneity of capital goods--different types of capital have different levels of productivity. For example, an electric utility turbine has a long service life. Therefore, its rate of depreciation is low, and the part of its value that it contributes to output each year--the capital input--is also low. In contrast, a computer depreciates quickly, having a very short service life. Computers must be productive enough to pay for that high rate of depreciation and thus must provide a large capital input relative to their cost. If they did not, buying computers would ultimately undermine businesses' profitability. In fact, the primary uncertainty now about the contribution of capital to the growth of potential GDP concerns computers. Estimates of computers' contribution to output vary over time and differ among analysts. Indeed, the latest estimates of capital input from the Bureau of Labor Statistics (BLS) and some private forecasters show faster growth during the late 1990s than CBO's estimate from July 2000 did, largely because those analysts place a heavier weight on computers when they construct their measures of capital input. Because recent data and revisions to older data lend further support to the weighting schemes used by those other forecasters, CBO has raised its estimate of the contribution of the computer capital stock to output. The change aligns CBO's estimate with those of BLS and private forecasters. The revisions to older data plus the greater weight on computers raised the growth of the capital input by about 1.2 percentage points over 10 years. That revision caused an offsetting change in CBO's estimate of TFP over history. It did not significantly alter the trend in TFP, however, so potential TFP was almost unaffected. The net result is an upward revision of 0.3 percentage points to the projection for growth of potential GDP. |
The Rise in the Growth of Potential TFP. Two quantifiable and long-lasting factors appear to explain most of the 0.4 percentage-point increase in the growth rate of potential total factor productivity during the 1996-2000 period.
- About 0.2 percentage points of the increase can be traced to productivity gains in the production of IT equipment (the line labeled "computer quality" in Table 2-3). CBO assumes that their contribution to the trend growth of TFP will continue for the next 10 years.
- Another 0.1 percentage point of the increase stems from a definitional change in the way prices were measured for some of the categories of GDP in the 1990s. The Bureau of Economic Analysis (BEA) adopted price indexes for hospital services and for physicians' services from the Bureau of Labor Statistics' producer price index to use in its GDP data starting in 1993 and 1994, respectively. The changes created a discontinuity in the growth rates for those series, as the new price indexes showed much slower rates of increase than the old indexes. Those and other, smaller changes to price indexes that the BEA was not able to carry back in benchmark revisions of the GDP data resulted in a slight discontinuity in the measures of real GDP and productivity between the 1996-2000 period and earlier years. The effect of the new measurement method on real growth is carried forward in CBO's calculations of potential GDP.
In CBO's medium-term projections, the growth rate of potential total factor productivity through 2011 matches that of the 1996-2000 period (see Table 2-3).
Growth of Real GDP
CBO's projection of actual GDP growth is slightly lower than its projection
of potential GDP growth because CBO assumes that the economy is still operating
at an unsustainably high rate of resource use, despite the slowdown at the end
of 2000. As a result, GDP is projected to grow at a 3.0 percent rate, on
average, even as potential GDP grows at a 3.3 percent rate. The slower growth
of GDP brings its projected level down to that of potential GDP during the
medium term (see Figure
2-7).
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By its construction, that projection allows for the likelihood that a recession will occur sometime in the next 10 years. It also incorporates the probability of above-trend growth. As long as the economy is not buffeted by external shocks to prices (such as occurred in 1974 and 1979), gross domestic product is expected to be above its estimated potential during booms and below its estimated potential during recessions. On average over the business cycle, GDP should be equal to potential GDP.
Inflation and Unemployment
Inflation averages 2.6 percent in the medium term as measured by the change in the consumer price index and 2.0 percent as measured by the change in the GDP price index (a summary of the prices of all goods and services that make up GDP). CBO's projections for inflation reflect an assumption about the rate of inflation consistent with Federal Reserve policy.
CBO assumes that the current unemployment rate, although it has been accompanied by only a slight increase in the inflation rate, is too low to be sustained for a long period without causing inflation to rise. The recent surge in productivity growth appears to have temporarily lowered the rate of unemployment that is compatible with stable inflation, primarily because it may take several years for the process of setting wages to adjust to a sudden change in productivity growth. * CBO states it may take several years for wages to adjust to a sudden change in productivity growth. Consequently, it is likely that the growth rate of labor costs will eventually catch up to the increase in productivity growth, putting downward pressure on profits and upward pressure on inflation. That inflationary pressure is likely to occur even if the growth of labor productivity remains fairly high. CBO's projections assume that an unemployment rate averaging close to 5 percent is compatible with the projection for CPI inflation.
Interest Rates
CBO projects interest rates by adding the projection for CPI inflation to a projection
for inflation-adjusted interest rates. The real rate on three-month Treasury
bills averages 2.4 percent during the last years of CBO's projection period,
and the real rate on 10-year Treasury notes averages 3.3 percent (see Figure
2-8). The real 10-year rate is about the same as its average of the past
four decades; the real three-month rate is slightly higher. Both are also close
to their ranges during the stable inflation years of the 1960s but lower than
their averages of the early 1980s. Real rates should be lower, on average, for
two reasons: because of mounting federal surpluses and because the inflation
stability that has occurred since the mid-1980s is likely to have lowered the
additional return that investors require for uncertainty in inflation. Combined
with projected rates of CPI inflation, those real rates imply nominal interest
rates of 4.9 percent for three-month Treasury bills and 5.8 percent for 10-year
Treasury notes.
|
Taxable Income
CBO's projections for the federal budget
are closely connected to its projections of economic activity and components of
national income. Because different components are taxed at different rates, and
some are not taxed at all, the distribution of income among its components is
an important part of CBO's economic projections. Wage and
salary disbursements and corporate profits are particularly important because
they produce the most tax revenues *
CBO states wage and salary and corporate profits are particularly important
because they produce the most tax revenue.
Therefore, to understand the tax revenue surge in the late 1990s the tax
consequences associated with the investment surge on wages and salaries and
corporate profits must be understood. As a share of GDP, those two
categories combined have risen sharply, from 54.0 percent in 1994 to 57.2
percent in 2000. In CBO's projections, however, their share declines to 56
percent (see Figure
2-9).
|
CBO expects the sum of those high-tax categories of income to grow more slowly than GDP during the next 10 years because depreciation will be higher, reflecting the high investment rates of the recent past. The boom in business investment during the past five years has led to a rapid increase in the size of the nation's capital stock * CBO states there has been a rapid increase in the size of the nation’s capital stock. Consequently, firms will be able to deduct growing amounts for depreciation from their taxable earnings * The CBO does not detail the tax consequences associated with failed company losses. CBO projects that such deductions for depreciation will rise from 7.8 percent of GDP in 2000 to 9.1 percent in 2008 and will remain at that percentage through 2011 (see Figure 2-9).
Comparison with CBO's July 2000 Projections
The current medium-term economic projections have more favorable
implications for the budget outlook than did CBO's previous projections,
published last July. The current projections indicate higher federal revenues
because the growth of real GDP is significantly higher, the growth of the GDP
price index is slightly higher, and the high-tax categories of income together
make up a greater share of GDP (see Table
2-4). Other changes, such as a higher projected unemployment rate and lower
projected interest rates in the short term, have relatively small effects on
the outlook for the budget.
|
Table 2-4. |
|||||||||||||
|
|
|
|
Estimated |
|
Forecast |
|
Projected Annual Average |
||||||
|
|
|
|
|
2001 |
2002 |
|
2003-2006 |
|
2007-2010 |
|
|||
|
|
|||||||||||||
|
Nominal GDP (Billions of dollars) |
|
||||||||||||
|
|
January 2001 |
9,974 |
|
|
10,446 |
11,029 |
|
13,439 |
a |
16,308 |
b |
||
|
|
July 2000 |
9,907 |
|
|
10,433 |
10,940 |
|
13,077 |
a |
15,675 |
b |
||
|
|
|||||||||||||
|
Nominal GDP (Percentage change) |
|
||||||||||||
|
|
January 2001 |
7.3 |
|
|
4.7 |
5.6 |
|
5.1 |
|
5.0 |
|
||
|
|
July 2000 |
7.0 |
|
|
5.3 |
4.9 |
|
4.6 |
|
4.6 |
|
||
|
|
|||||||||||||
|
Real GDP (Percentage change) |
|
||||||||||||
|
|
January 2001 |
5.1 |
|
|
2.4 |
3.4 |
|
3.1 |
|
3.0 |
|
||
|
|
July 2000 |
4.9 |
|
|
3.1 |
2.7 |
|
2.6 |
|
2.8 |
|
||
|
|
|||||||||||||
|
GDP Price Index (Percentage change) |
|
||||||||||||
|
|
January 2001 |
2.1 |
|
|
2.3 |
2.1 |
|
1.9 |
|
1.9 |
|
||
|
|
July 2000 |
2.1 |
|
|
2.1 |
2.1 |
|
1.9 |
|
1.8 |
|
||
|
|
|||||||||||||
|
Consumer Price Indexc (Percentage change) |
|
||||||||||||
|
|
January 2001 |
3.4 |
|
|
2.8 |
2.8 |
|
2.6 |
|
2.5 |
|
||
|
|
July 2000 |
3.1 |
|
|
2.7 |
2.9 |
|
2.6 |
|
2.5 |
|
||
|
|
|||||||||||||
|
Unemployment Rate (Percent) |
|
||||||||||||
|
|
January 2001 |
4.0 |
|
|
4.4 |
4.5 |
|
4.7 |
|
5.1 |
|
||
|
|
July 2000 |
3.8 |
|
|
3.7 |
4.1 |
|
4.7 |
|
5.2 |
|
||
|
|
|||||||||||||
|
Three-Month Treasury Bill Rate (Percent) |
|
||||||||||||
|
|
January 2001 |
5.8 |
|
|
4.8 |
4.9 |
|
4.9 |
|
4.9 |
|
||
|
|
July 2000 |
5.9 |
|
|
6.7 |
5.5 |
|
4.8 |
|
4.8 |
|
||
|
|
|||||||||||||
|
Ten-Year Treasury Note Rate (Percent) |
|
||||||||||||
|
|
January 2001 |
6.0 |
|
|
4.9 |
5.3 |
|
5.6 |
|
5.8 |
|
||
|
|
July 2000 |
6.5 |
|
|
6.8 |
6.3 |
|
5.7 |
|
5.7 |
|
||
|
|
|||||||||||||
|
Tax Bases (Percentage of GDP) |
|
||||||||||||
|
|
Corporate profitsd |
|
|||||||||||
|
|
|
January 2001 |
9.4 |
|
|
8.9 |
8.5 |
|
8.2 |
|
8.0 |
|
|
|
|
|
July 2000 |
9.2 |
|
|
8.4 |
7.7 |
|
7.3 |
|
7.0 |
|
|
|
|
Wages and salaries |
|
|||||||||||
|
|
|
January 2001 |
47.8 |
|
|
48.2 |
48.2 |
|
48.2 |
|
48.0 |
|
|
|
|
|
July 2000 |
48.1 |
|
|
48.5 |
48.8 |
|
48.6 |
|
48.3 |
|
|
|
|
|
||||||||||||
|
SOURCES: Congressional Budget Office; Department of Commerce, Bureau of Economic Analysis; Department of Labor, Bureau of Labor Statistics; Federal Reserve Board. |
|
||||||||||||
|
NOTE: Percentage changes are year over year. |
|
||||||||||||
|
a. Level of GDP in 2006. |
|
||||||||||||
|
b. Level of GDP in 2010. |
|
||||||||||||
|
c. The consumer price index for all urban consumers. |
|
||||||||||||
|
d. Corporate profits are book profits. |
|
||||||||||||
|
|
|
||||||||||||
Growth of Real GDP. CBO has raised its projections for the growth of both GDP and potential GDP since last July. In the current projections, potential output grows at an average rate of 3.3 percent through 2011, compared with last July's projection of 3.1 percent. As noted earlier, that increase reflects a change in the method that CBO uses to calculate the economy's stock of productive capital, an upward revision to the official data on investment for the past three years, and higher projected levels of investment. Those changes raised the estimated growth of the capital input during the recent past as well as in CBO's projections--where growth of the capital input now averages 5.2 percent through 2011, up from 3.9 percent in last July's projections.
Since July, CBO has not changed its estimate of the gap between actual and potential GDP in 2000. Consequently, the growth of real GDP between 2000 and 2011, like that of potential GDP, is also higher than in the July projections, averaging 3.0 percent now compared with 2.7 percent then.
Other Significant Changes. Two other changes to CBO's economic outlook since last July that have particular importance for the budget projections are increases in the projected growth of the GDP price index and in the high-tax income categories as a share of GDP.
The new projection for the GDP price index raises projected surpluses slightly. The GDP price index is now expected to grow at an average rate of 2.0 percent through 2010, compared with 1.9 percent last July. That change raises revenue projections because it tends to raise the projected level of taxable income. Outlay projections, however, depend primarily on the growth of the CPI, which has changed little from the July projection.
The fact that more highly taxed categories of income make up a greater share of GDP * With wages and salaries making up a higher percentage of GDP the tax revenue grew because wages and salaries are more highly taxed. How does wages and salaries percentage of GDP in 2000 compare to recent history? in the current economic outlook than last July also leads to a more favorable budget projection. The combined share of wage and salary disbursements and corporate profits is 56 percent of GDP in 2010 in the current projection compared with 55.1 percent in 2010 last July. Their share is higher in the current projection largely because CBO has lowered its projections of the growth of fringe benefits and businesses' interest payments as a percentage of GDP. (Fringe benefits are expected to grow faster than in the past but slower than projected last July.) Since fringe benefits are not taxed and businesses can deduct their interest payments from earnings when determining corporate tax liability, the reduction in the projections of those categories results in higher taxable income relative to GDP.
Comparison with the
The final economic projections of the Clinton Administration expect stronger
growth this year than CBO's current projections do but virtually the same
growth for the medium term (see Table
2-5). The Bush Administration is preparing its own economic forecast.
|
Table 2-5. |
||||||||||||
|
|
|
|
Estimated |
|
Forecast |
|
Projected Annual Average |
|||||
|
|
|
|
2000 |
|
2001 |
2002 |
|
2003-2006 |
|
2007-2011 |
|
|
|
|
||||||||||||
|
Nominal GDP (Billions of dollars) |
|
|||||||||||
|
|
CBO |
9,974 |
|
|
10,446 |
11,029 |
|
13,439 |
a |
17,132 |
b |
|
|
|
Administration |
9,991 |
|
|
10,536 |
11,099 |
|
13,676 |
a |
17,536 |
b |
|
|
|
||||||||||||
|
Nominal GDP (Percentage change) |
|
|||||||||||
|
|
CBO |
7.3 |
|
|
4.7 |
5.6 |
|
5.1 |
|
5.0 |
|
|
|
|
Administration |
7.4 |
|
|
5.5 |
5.3 |
|
5.4 |
|
5.1 |
|
|
|
|
||||||||||||
|
Real GDP (Percentage change) |
|
|||||||||||
|
|
CBO |
5.1 |
|
|
2.4 |
3.4 |
|
3.1 |
|
3.1 |
|
|
|
|
Administration |
5.2 |
|
|
3.3 |
3.2 |
|
3.2 |
|
2.9 |
|
|
|
|
||||||||||||
|
GDP Price Index (Percentage change) |
|
|||||||||||
|
|
CBO |
2.1 |
|
|
2.3 |
2.1 |
|
1.9 |
|
1.9 |
|
|
|
|
Administration |
2.2 |
|
|
2.0 |
2.1 |
|
2.1 |
|
2.1 |
|
|
|
|
||||||||||||
|
Consumer Price Indexc (Percentage change) |
|
|||||||||||
|
|
CBO |
3.4 |
|
|
2.8 |
2.8 |
|
2.6 |
|
2.5 |
|
|
|
|
Administration |
3.4 |
|
|
2.7 |
2.6 |
|
2.7 |
|
2.7 |
|
|
|
|
||||||||||||
|
Unemployment Rate (Percent) |
|
|||||||||||
|
|
CBO |
4.0 |
|
|
4.4 |
4.5 |
|
4.7 |
|
5.2 |
|
|
|
|
Administration |
4.0 |
|
|
4.1 |
4.4 |
|
4.8 |
|
5.1 |
|
|
|
|
||||||||||||
|
Three-Month Treasury Bill Rate (Percent) |
|
|||||||||||
|
|
CBO |
5.8 |
|
|
4.8 |
4.9 |
|
4.9 |
|
4.9 |
|
|
|
|
Administration |
5.9 |
|
|
6.0 |
5.7 |
|
5.3 |
|
5.3 |
|
|
|
|
||||||||||||
|
Ten-Year Treasury Note Rate (Percent) |
|
|||||||||||
|
|
CBO |
6.0 |
|
|
4.9 |
5.3 |
|
5.6 |
|
5.8 |
|
|
|
|
Administration |
6.1 |
|
|
5.8 |
5.8 |
|
5.8 |
|
5.8 |
|
|
|
|
||||||||||||
|
Tax Bases (Percentage of GDP) |
|
|||||||||||
|
|
Corporate profitsd |
|
||||||||||
|
|
|
CBO |
9.4 |
|
|
8.9 |
8.5 |
|
8.2 |
|
8.0 |
|
|
|
|
Administration |
9.4 |
|
|
8.8 |
8.4 |
|
8.0 |
|
7.5 |
|
|
|
Wages and salaries |
|
||||||||||
|
|
|
CBO |
47.8 |
|
|
48.2 |
48.2 |
|
48.2 |
|
48.0 |
|
|
|
|
Administration |
47.7 |
|
|
47.7 |
47.8 |
|
48.0 |
|
48.1 |
|
|
|
||||||||||||
|
SOURCES: Congressional Budget Office; Office of Management and Budget; Department of Commerce, Bureau of Economic Analysis; Federal Reserve Board; Department of Labor, Bureau of Labor Statistics. |
||||||||||||
|
NOTE: Percentage changes are year over year. |
||||||||||||
|
a. Level of GDP in 2006. |
||||||||||||
|
b. Level of GDP in 2011. |
||||||||||||
|
c. The consumer price index for all urban consumers. |
||||||||||||
|
d. Corporate profits are book profits. |
||||||||||||
|
|
||||||||||||
The
For the entire 2001-2011 period, the Administration's projection of real GDP
growth averages only slightly more than CBO's projection. The difference stems
from higher assumed growth of the labor force * In
spite of the aging baby boom population, the Clinton Administration projected a
higher growth rate than the CBO in the labor force. What did the CBO project versus the
Social Security Department’s projection? , not of labor
productivity. Short-term interest rates are higher as well in the
Administration's medium-term projections, but all other aspects of the economic
outlook are similar to CBO's projections.
Recent Economic Developments
In the last five years of the 1990s, the economy grew much more rapidly than
CBO's estimate of its potential growth. But during the second half of 2000,
economic activity appears to have shifted from above-trend growth to
below-trend growth. (That shift was especially pronounced in the manufacturing
sector; see Box
2-2 for details.) After an extraordinarily rapid increase--6.1
percent--during the previous four quarters, real GDP slowed to 2.2 percent
annual growth in the third quarter of 2000 and appears to have remained at a
subdued pace in the final quarter.
|
Output from the manufacturing sector has grown much more slowly in recent months, and some monthly indicators point toward further slowing and a significant risk of a recession in that sector * CBO is stating there is a risk of a recession in the manufacturing sector. The Congressional Budget Office does not consider the recent weakness to be a strong signal of an overall recession, however. The slowdown may be temporary, and even if the weakness in manufacturing persists, the overall economy may continue to grow. One measure that indicates further slowing in manufacturing is the National Association of Purchasing Managers' (NAPM) index, which dropped sharply in 2000 (see the figure below). Until recent years, the growth of the Federal Reserve's industrial production (IP) index for manufacturing--a measure of manufacturing output adjusted for inflation--would turn negative or be very weak soon after the NAPM index fell below a value of 50. That relationship changed during the second half of the 1990s. IP growth remained above 3 percent even when the NAPM index fell well below 50. The change resulted from the growth in the manufacturing sector's output of information technology, particularly semiconductors. In spite of that change in the relationship between the two indicators, the recent drop in the NAPM index is a strong signal of further slowing in the growth of manufacturing output. A moderate recession in manufacturing would not necessarily imply a recession for the economy as a whole, however. The IP index was flat or fell over a number of four- or five-month periods during the 1980s and 1990s (in 1986, 1993, 1995, and 1998) when the economy was not in recession. Moreover, the output of the manufacturing sector accounts for only about 16 percent of gross domestic product, so continued strength in the output of services can offset weakness in manufacturing. Furthermore, any recession in manufacturing
could be brief. Since firms have developed better inventory information and
control systems over the years, manufacturers may be able to realign output
with demand quickly. In addition, manufacturing output could pick up soon
because the recent easing of interest rates by the Federal Reserve may spur
demand for and production of manufactured goods.
|
Slower growth in spending by consumers and businesses accounts for much of the slowdown in overall growth. That sudden deceleration has raised the chances that the economy could slip into a recession this year * CBO is acknowledging the economy could slip into a recession as early as 2002--although in CBO's view, that possibility is not as likely as the mild slowdown that CBO has forecast for the short term. In any event, such a slowdown has few lasting effects and thus has little impact on the medium-term projections.
The recent slowing in economic activity followed restrictive monetary actions by the Federal Reserve and probably a shift in consumers' and businesses' confidence about future economic activity. The Federal Reserve responded to the earlier rapid growth in aggregate demand by tightening conditions in credit markets, raising its target for the federal funds rate from 4.75 percent in early June 1999 to 6.5 percent by May 2000. In the second half of 2000, credit markets grew more cautious as losses on business loans and bonds mounted * CBO acknowledges there has been mounting losses on business loans and bonds, and they raised lending standards and interest rates, particularly for high-risk borrowers. Stock prices fell with investors' diminished expectations about the future growth of profits, which in turn lowered consumers' wealth and raised businesses' cost of capital.
The Federal Reserve made no further changes to its target for the federal funds rate in the second half of 2000 as growth began decelerating and the rate of inflation eased from its pace in the first half of the year. However, at the end of 2000, the Federal Reserve indicated that the balance of risks in the economy had shifted from rising inflation to economic weakness. In a surprise move, it lowered its target for the federal funds rate by 0.5 percentage points in the first week of January * “In a surprise move,” is this an indication the CBO did not understand the current economic situation.
Consumer Spending and Residential Investment
The Federal Reserve's move reflected in part a sharp slowdown in consumer spending toward the end of last year. After growing at an average annual rate of 5.4 percent from the second quarter of 1999 through the second quarter of 2000, real consumer spending slowed to a still-strong annual growth rate of 4.5 percent in the third quarter of 2000. However, available data on spending confirmed news reports of disappointing holiday sales and indicate that consumer spending on goods slowed further in the fourth quarter.
Some of that slowdown was probably inevitable because spending had grown very rapidly at the end of 1999 and beginning of 2000. Sales of cars and light trucks, for example, rose from an average rate of about 15 million units a year during the 1994-1998 period to an annual rate of 17 million in the second half of 1999 and 18.2 million in the first quarter of 2000--the strongest quarter on record. Sales of those vehicles fell back to an annual rate of 15.3 million by December 2000. Domestic manufacturers have scaled back their production plans to reduce inventories of unsold vehicles.
The slowdown in consumer spending also reflected a weakening in some
fundamental factors that determine such spending, including consumers'
expectations about future business conditions. Before 2000,
a significant share of the strength in consumer spending reflected a rise in
consumers' wealth, much of which resulted from sharp increases in stock prices * If consumer spending is affected by the stock market, a
sharp decline in the stock market will reduce consumer spending (see Figure
2-10). Correspondingly, the decline
in stock prices in 2000 reduced consumers' wealth. In addition,
the growth of employment slowed in 2000, which may have moderated consumers'
expectations about their income growth. Higher interest rates on consumer loans
may also have dampened spending slightly. Rising energy prices may have been
another factor, as well as the early arrival of winter in several parts of the
country (see Box
2-3). Those two factors ran up consumers' heating bills and kept some
shoppers from stores during the crucial holiday season.
|
|
Box 2-3. Prices for crude oil, petroleum products, and natural gas shot up in 2000. The markets for different energy products--especially crude oil and petroleum products--influence one another, but each market is affected by special and independent circumstances. The recent price increases probably will not continue beyond this winter. Developments in oil markets, in fact, point strongly to the prospect of lower prices this year. Crude Oil Ironically, the broad swings in oil prices
seen in recent years stem largely from efforts by the Organization of
Petroleum Exporting Countries (OPEC) to keep prices within a narrow range.
The Asian financial crisis of 1997 and 1998 caused a severe drop in demand
for oil in that region and a collapse of oil prices--to less than $15 per
barrel in mid-1998. The drop in demand prompted OPEC producers to curtail
their output, and the prospect of falling prices led oil companies to pare
down their petroleum inventories. In 1999, however, rebounding Asian demand,
solid economic growth in the As of January, oil production once again
appears to exceed demand, and the easing of oil prices that occurred in the
last quarter of 2000 looks likely to continue. However, events such as
production cutbacks by OPEC, a cold winter, or adverse political developments
in the Petroleum Products Although prices for refined petroleum
products in the Below-average levels of petroleum stocks in
the Natural Gas Because it is difficult in the short run to
substitute between natural gas and petroleum products, the market for natural
gas is largely independent of the world market for crude oil. Nevertheless,
natural gas prices also rose sharply in 2000. The producer price index for
residential natural gas has soared by 30 percent since the spring of 2000
(see the figure
below). The forces that caused that increase had been building for many
years, including low levels of exploration for natural gas and growing demand
for gas by electric utilities and homes--both a response to 15 years of low
prices. During the summer of 2000, record high temperatures and demand for
cooling across the central southern states and problems with electricity
restructuring in In response to the high prices, however, natural gas exploration and development have risen sharply. Thus, some additional supplies should be reaching the market soon. That extra supply should help limit further price increases in the near future and perhaps--as futures markets for natural gas expect--cause prices to decline. Implications for the Economy So far, developments in energy markets
appear unlikely to dampen
|
Investment in housing also slowed in the second half of last year. After
growing at an average annual rate of 2.2 percent in the first half of 2000,
real residential investment fell by 10.6 percent in the third quarter of 2000
and appears to have remained weak through the end of the year. That drop
probably reflected many of the same factors that slowed consumer spending; it
also resulted from a decline in the affordability of housing in the first half
of 2000 that occurred because of rapidly rising housing prices and higher
mortgage rates (see Figure
2-11).
|
Business Fixed Investment
Like consumer spending, spending by businesses on structures, equipment, and software--known as business fixed investment (BFI)--weakened in the second half of 2000 after a strong showing in the first half * Another sign of a weakening economy. The growth of real BFI slowed to an annual rate of 7.7 percent in the third quarter of 2000 after averaging 17.7 percent in the first half of the year. Spending on equipment and software accounted for all of that slowdown in the third quarter, and data on shipments suggest that equipment spending remained subdued in the fourth quarter. Spending on nonresidential construction, however, was strong last year, buoyed in part by a sharp rise in exploration for petroleum and natural gas in response to higher energy prices.
Some of the slowdown in BFI in the second half of last year may have been a rebound from the unusually fast growth of equipment spending in the first half of 2000. But part of the slowdown may prove more lasting if it reflects weaker business confidence and a higher cost of capital. The growth of corporate profits slowed in the second half of last year, and credit and equity markets tempered their willingness to assume risk. An important source of uncertainty in CBO's short-term forecast is the degree to which financial markets will reduce their lending and further weaken investment by businesses.
Financial Markets and Monetary Policy
Financial markets retrenched in the second half of 2000, as expectations about the future growth of corporate earnings declined and concerns about the quality of credit rose. The Standard and Poor's (S&P) 500 stock price index, which summarizes the stock market values of major U.S. corporations, fell at an annual rate of 17 percent between June and December of last year, after growing at an annual rate of almost 15 percent in 1999 and the first half of 2000 * stock market decline began in the second half of 2000. Moreover, the share prices of many high-technology firms collapsed * What is the tax consequences of the collapses on overall tax revenue. On average, the businesses listed by the Nasdaq stock market, which include many well-known high-technology companies, lost about half of their market value between March 2000 and the end of the year. High-technology start-ups lost much of their attractiveness to investors and faced greater difficulty raising funds in capital markets.
Credit markets have also become more cautious in their lending. Commercial banks tightened their standards and terms of lending to businesses last year in the face of rising delinquencies and losses on business loans. As a consequence, the growth of business loans slowed, although to a pace still consistent with continued economic expansion. The spread between the interest rates on top-quality corporate bonds and lower-quality bonds increased last year, indicating that lenders' perception of the risk of default increased. The corporate bond market also pulled back from new issues of risky debt such as high-yield (or junk) bonds in the face of greater defaults; the amount of funds raised in the high-yield market was sharply lower in 2000 than in 1999. Although some of the pullback by banks and the bond market may reflect a better assessment of risk that will enhance the productivity of business investment in the long run, there is always a danger that lenders will over-react and sharply curtail funding to low-risk firms.
Against that backdrop of tighter supply in credit and capital markets and a slowdown in economic activity, the Federal Reserve eased monetary policy early this year. On January 3, it cut the target for the federal funds rate from 6.5 percent to 6 percent. The size and timing of that move surprised financial markets. In contrast to its usual practice, the Federal Reserve had not signaled its intentions to the markets ahead of time. Before the cut, the futures market for federal funds had expected the Federal Reserve to drop its target gradually to 6 percent by the end of March and to 5.5 percent by midyear. After the January cut, the futures market lowered its expectation for the federal funds rate to 5 percent by midyear.
Net Exports
The trade deficit continued to grow in the third quarter of 2000, widening
to a record $389.5 billion, or 3.9 percent of GDP (see Figure
2-12). Preliminary data indicate that it remained large in the fourth
quarter.
|
The uninterrupted rise in the trade deficit since 1997 has resulted mainly
from the gap between economic growth rates in the
The fragility of foreign recoveries and a relatively more favorable investment environment in the United States kept the dollar strong last year, despite the persistence of the trade deficit and a consequent rise in U.S. external indebtedness. The strength of the dollar has continued to keep the prices of U.S. exports high relative to those of imports, constraining U.S. exports and stimulating imports.
Government Spending
Direct government spending for goods and services--by both the federal government and state and local governments--has supported strong growth over the past year. Real federal government spending for goods and services surged back * Government spending began to increase in 1999, during the past two years after a prolonged contraction between 1990 and 1998, and state and local spending, although easing somewhat in recent quarters, has been strong for more than four years.
Labor Markets and Wage and Price Inflation
Labor markets continued to be extremely tight in the second half of 2000
despite the slowdown in growth of GDP; the unemployment rate remained at a
remarkably low 4.0 percent. In line with tight labor markets, labor
compensation--including benefits as well as wages and salaries--grew faster in
2000 than the year before (see Figure
2-13). An important reason for the spurt in benefit costs has been an
acceleration in the cost of medical benefits, which analysts expect to continue
this year.
|
The growth of the broad price indexes used to measure inflation generally
showed little change in the second half of 2000. The core rate of inflation
(the growth rate of the consumer price index excluding food and energy) inched
up slightly, but the growth rate of the overall CPI did not. The difference in
behavior between the two rates reflects a deceleration in the average growth of
the energy component of the CPI. Although economic activity has slowed, the
economy's continued high level of resource use may put more pressure on prices
in the near future.
CBO's Short-Term Forecast
Those various recent economic developments suggest that the slowdown that
many forecasters expected has arrived. CBO anticipates that in 2001 and 2002,
real GDP will grow well below the 4.6 percent rate of the past two years and
below the estimated potential growth rate of GDP discussed earlier. CPI
inflation is expected to fall from 3.4 percent in 2000 to 2.7 percent in 2001,
reflecting CBO's belief that energy prices will remain lower than last autumn's
levels (see Table
2-6). In addition, slower growth of economic activity than in recent years
will probably contribute to lower interest rates. A major risk
to CBO's short-term forecast is that consumers and businesses will curtail
their spending much more than CBO assumes, leading to a recession
this year * CBO is now stating there is a possibility
of a recession as early as 2001. Alternatively, the growth of
consumption and investment could pick up again from its modest rates of late
last year, producing faster economic activity than CBO anticipates.
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Table 2-6. |
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|
|
Estimated |
|
Forecast |
|
|
|
|
|
2001 |
2002 |
|
|
|
|||||
|
Fourth Quarter to Fourth Quarter (Percentage change) |
|||||
|
|
|||||
|
Nominal GDP |
6.1 |
|
5.0 |
5.6 |
|
|
Real GDP |
3.7 |
|
2.6 |
3.4 |
|
|
GDP Price Index |
2.4 |
|
2.3 |
2.1 |
|
|
Consumer Price Indexa |
|
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|
|
Overall |
3.4 |
|
2.7 |
2.8 |
|
|
Excluding food and energy |
2.6 |
|
2.8 |
2.8 |
|
|
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|
Calendar Year Average |
|||||
|
|
|||||
|
Real GDP (Percentage change) |
5.1 |
|
2.4 |
3.4 |
|
|
Unemployment Rate (Percent) |
4.0 |
|
4.4 |
4.5 |
|
|
Three-Month Treasury Bill Rate (Percent) |
5.8 |
|
4.8 |
4.9 |
|
|
Ten-Year Treasury Note Rate (Percent) |
6.0 |
|
4.9 |
5.3 |
|
|
|
|||||
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SOURCES: Congressional Budget Office; Department of Commerce, Bureau of Economic Analysis; Department of Labor, Bureau of Labor Statistics; Federal Reserve Board. |
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a. The consumer price index for all urban consumers. |
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|
|
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The current CBO forecast for growth and inflation in the next two years is
about the same as that of the Blue Chip consensus, an average of
approximately 50 private-sector forecasts (see Table
2-7). Compared with the Blue Chip consensus, CBO's forecast for
growth of real GDP is slightly lower for 2001 and about the same for 2002, and
its forecasts for inflation are slightly higher for both years. CBO's forecasts
for interest rates are noticably lower than those of the Blue Chip
consensus, but that is probably because the latter did not fully reflect the
Federal Reserve's surprise interest rate cut of early January.
|
Table 2-7. |
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|
|
|
Estimated |
|
Forecast |
|
|
|
|
|
2001 |
2002 |
|
|
|
|||||
|
Nominal GDP (Percentage change) |
|
||||
|
|
Blue Chip high 10 |
|
|
5.5 |
6.1 |
|
|
Blue Chip consensus |
|
|
4.8 |
5.4 |
|
|
CBO |
7.3 |
|
4.7 |
5.6 |
|
|
Blue Chip low 10 |
|
|
3.9 |
4.8 |
|
|
|||||
|
Real GDP (Percentage change) |
|
||||
|
|
Blue Chip high 10 |
|
|
3.1 |
4.0 |
|
|
Blue Chip consensus |
|
|
2.6 |
3.4 |
|
|
CBO |
5.1 |
|
2.4 |
3.4 |
|
|
Blue Chip low 10 |
|
|
2.0 |
2.8 |
|
|
|||||
|
GDP Price Index (Percentage change) |
|
||||
|
|
Blue Chip high 10 |
|
|
2.5 |
2.4 |
|
|
Blue Chip consensus |
|
|
2.1 |
2.0 |
|
|
CBO |
2.1 |
|
2.3 |
2.1 |
|
|
Blue Chip low 10 |
|
|
1.7 |
1.4 |
|
|
|||||
|
Consumer Price Indexb (Percentage change) |
|
||||
|
|
Blue Chip high 10 |
|
|
3.1 |
3.0 |
|
|
Blue Chip consensus |
|
|
2.6 |
2.5 |
|
|
CBO |
3.4 |
|
2.8 |
2.8 |
|
|
Blue Chip low 10 |
|
|
2.2 |
1.9 |
|
|
|||||
|
Unemployment Rate (Percent) |
|
||||
|
|
Blue Chip high 10 |
|
|
4.6 |
4.9 |
|
|
Blue Chip consensus |
|
|
4.4 |
4.5 |
|
|
CBO |
4.0 |
|
4.4 |
4.5 |
|
|
Blue Chip low 10 |
|
|
4.2 |
4.2 |
|
|
|||||
|
Three-Month Treasury Bill Rate (Percent) |
|
||||
|
|
Blue Chip high 10 |
|
|
5.8 |
5.9 |
|
|
Blue Chip consensus |
|
|
5.4 |
5.4 |
|
|
CBO |
5.8 |
|
4.8 |
4.9 |
|
|
Blue Chip low 10 |
|
|
4.9 |
4.9 |
|
|
|||||
|
Ten-Year Treasury Note Rate (Percent) |
|
||||
|
|
Blue Chip high 10 |
|
|
5.9 |
6.2 |
|
|
Blue Chip consensus |
|
|
5.3 |
5.6 |
|
|
CBO |
6.0 |
|
4.9 |
5.3 |
|
|
Blue Chip low 10 |
|
|
4.9 |
5.1 |
|
|
|||||
|
SOURCES: Congressional Budget Office; Department of Commerce, Bureau of Economic Analysis; Department of Labor, Bureau of Labor Statistics; Federal Reserve Board; Aspen Publishers, Inc., Blue Chip Economic Indicators (January 10, 2001). |
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|
NOTE: The Blue Chip high 10 is the average of the 10 highest Blue Chip forecasts; the Blue Chip consensus is the average of all 50 Blue Chip forecasts; and the Blue Chip low 10 is the average of the 10 lowest Blue Chip forecasts. |
|||||
|
a. CBO's estimate for 2000. |
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|
b. The consumer price index for all urban consumers. |
|||||
|
|
|||||
CBO's current forecast for 2001 is weaker than its previous forecast, published last July (see Table 2-4) * CBO has acknowledged the current forecast is weaker than the previous forecast, a clear indication the downturn had occurred by 2001. The growth rate of real GDP is substantially lower, the unemployment rate is significantly higher, and interest rates are much lower. The forecast for CPI inflation is virtually unchanged, whereas the forecast for inflation in the GDP price index is slightly higher.
Growth of Real GDP
CBO's forecast for the growth of real GDP over the next two years reflects
the view that the factors stimulating overall demand during the second half of
1999 and the first half of 2000 have waned. Investors' expectations of the
growth of corporate profits, which boosted stock prices and encouraged greater
lending for business investment, provided much of that stimulus. Higher stock
prices in turn spurred consumer spending. Favorable rates of return in U.S.
capital markets also encouraged foreigners to invest in the United States,
which further lowered the cost of investment for U.S. businesses. * CBO is
describing the impact a falling stock market has on the overall economy.
Investors' expectations were deflated in the second half of last year, when slower profit growth and rising defaults on business loans and high-yield bonds began to appear. A less bullish stock market will continue to limit the growth of consumers' wealth and thus their spending. A higher cost of equity capital, plus stricter lending standards by banks and bond investors, will dampen investment by keeping the cost of funds higher and their availability less than in recent years. Moreover, because the economic outlook abroad has sagged, the trade deficit is unlikely to improve noticeably over the next two years despite moderate growth in the United States.
A major risk to that forecast is that the growth of spending may slow more than CBO assumes. Consumers may retrench drastically in response to the drop in their stock market wealth and to lower expectations about their future income. Businesses may slash their investment plans if they grow more wary or may be forced to cancel those plans if a shortage of capital and credit occurs. Foreign investors may become disenchanted with the U.S. economy, perhaps because of its growing trade deficit, and move their capital to other countries, thus raising interest rates and further curtailing spending in the United States * CBO is describing the impact the economic activity has on the flow of foreign capital. A greater slowdown in the U.S. economy would also be felt in the rest of the world as the United States imported fewer goods.
Alternatively, since unemployment is low and real wage growth has remained strong, consumption may rebound. If so, manufacturers could quickly sell off excess inventories, employment and investment growth could bounce back, and overall economic growth would be faster than CBO anticipates.
Inflation and Unemployment
CBO expects that a drop in energy prices will slow the rate of consumer price inflation this year to 2.7 percent from 3.4 percent last year (see Table 2-6). However, core CPI inflation will edge upward to 2.8 percent from 2.6 percent last year because the high level of resource use will continue to put upward pressure on the core rate of inflation. The unemployment rate is projected to rise over the next two years, reflecting CBO's view that the growth of GDP will be less than CBO's estimate of the growth of potential GDP.
If the growth of labor productivity slows dramatically from its rapid pace of recent years, inflation may increase by more than CBO anticipates. That recent rapid growth has held down inflation and costs per unit of labor in the face of strong demand for labor and output. A sudden drop in the growth of productivity could increase businesses' costs and the prices of their products. In those circumstances, the Federal Reserve would probably feel compelled to raise interest rates to preempt an increase in inflation, thus slowing the economy even more.
A sudden drop in the exchange value of the U.S. dollar would also lead to higher inflation than CBO expects. The large U.S. current-account deficit and international indebtedness indicate that the dollar eventually needs to fall to help lower that deficit. Although the dollar declined at the end of 2000, it is still strong relative to its average of the 1990s. The fragility of economic recoveries in many countries, however, suggests that the dollar may remain strong for a while longer despite weaker economic activity in the United States.
Interest Rates
CBO believes that interest rates in 2001 and 2002 will, on average, be lower than last year's levels. Slower growth of aggregate demand is likely to continue to contribute to lower interest rates this year. Indeed, financial markets have reduced their expectations of the federal funds rate for the first part of 2001, indicating that they believe that the Federal Reserve will relax monetary policy further this year. However, if inflation picks up more than the markets expect, interest rates will be higher than they anticipate.
1. Congressional Budget Office, The Budget and Economic Outlook: An Update (July 2000).
2. The measure of TFP discussed in this report is an estimate from CBO's growth model. See Congressional Budget Office, CBO's Method for Estimating Potential Output, CBO Memorandum (October 1995).
3. See Congressional Budget Office, The Budget and Economic Outlook: An Update (July 2000), Appendix A.