[Analytical Perspectives]
[Economic and Accounting Analyses]
[1. Economic Assumptions]
[From the U.S. Government Publishing Office, www.gpo.gov]
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ECONOMIC ASSUMPTIONS
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1. ECONOMIC ASSUMPTIONS
Introduction
The prudent fiscal and monetary policies pursued during this
Administration have fostered the healthiest economy in over a
generation. Judged by the yardsticks of growth, jobs, unemployment,
inflation, interest rates and the stock market, 1997 was a banner year.
Real Gross Domestic Product (GDP) expanded by nearly 4 percent, the
Nation's payrolls increased by 3.2 million jobs, and the unemployment
rate fell to the lowest level in 24 years. Despite robust growth,
inflation edged down; the rise in the Consumer Price Index excluding the
volatile food and energy components last year was the smallest since
1965. The combination of low inflation and low unemployment pulled the
``Misery Index''--the sum of the inflation and unemployment rates--to
its lowest level in three decades.
Households and businesses have prospered in this environment. Wages
and salaries after adjustment for inflation have increased faster than
at any time in the past two decades. And thanks to unusually strong
productivity growth for this stage of an expansion, profits also have
grown at a healthy pace. The share of profits in GDP climbed to over 10
percent last year, the highest it has been since 1968.
Financial markets have responded to these favorable developments by
bidding up the prices of bonds and equities. Long-term interest rates,
which move in the opposite direction from bond prices, fell one-half
percentage point last year. At year's end, the yield on the 30-year
Treasury bond was below 6 percent, the lowest level in four years. In
early January, the rate fell another one-quarter percentage point to the
lowest level since this maturity was first regularly issued in 1977.
The Dow Jones Industrial Average rose 23 percent during 1997, which
followed a 68 percent gain during 1995-96. Since the end of 1994, the
Dow average has doubled, making this the best three-year performance in
the postwar period and the second best in the 101-year history of the
Dow. The broader market indexes, the S&P 500 and the NASDAQ composite
index, also doubled during these three years.
These outstanding financial and nonfinancial achievements--fostered by
sound fiscal and monetary policies--have further boosted business and
consumer confidence. Businesses last year spent heavily on capacity-
expanding new plant and equipment; investment rose at a double-digit
pace after adjustment for inflation. Consumer optimism soared. According
to the University of Michigan Consumer Sentiment Index, optimism reached
the highest level since the survey began in the early 1950s. Overseas
investors also have expressed their confidence in the U.S. economy. With
many financial markets around the world in turmoil, foreign investors
increasingly turned to the safe haven provided by U.S. financial
markets.
The fundamental forces affecting the economy and prospective fiscal
and monetary policies point to continued healthy economic conditions in
the coming years. The budget is projected to reach balance in 1999--the
first time that has occurred in three decades--and to remain in balance
during the remainder of the 10-year planning horizon. A stronger dollar
is likely to keep inflation low. While some may have thought that real
growth in the recent past was too fast, in the future these concerns may
well be eased by developments in Asia. Against this background, monetary
policy should be able to accommodate continued economic growth with low
inflation.
The Administration projects real growth in the next few years to be
around 2.0 percent per year, before rising to 2.4 percent in 2002-2007.
The unemployment rate, which at current low levels may run the risk of
igniting inflation, is projected to edge up slightly to a rate that the
Administration conservatively estimates to be consistent with stable
inflation. Nonetheless, millions of new jobs are expected to be created.
Short-term interest rates are projected to decline and long-term rates
are expected to remain relatively low as private and public credit
demands ease and as expectations of continued low inflation are
incorporated into bond yields. Beyond 1999, the Administration's
economic projections represent expected trends rather than a definite
cyclical pattern.
Private forecasters have a similarly favorable view of the economic
outlook. The January Blue Chip consensus forecast, an average of 50
private forecasts, projected real growth, unemployment and inflation at
rates nearly identical to those used in this budget. The projected
interest rates were somewhat higher than in the budget assumptions. The
similarity to the private sector forecasts is an indication that the
Administration's assumptions are a reasonable, prudent basis for
projecting the budget.
The expansion that began in April 1991 has just completed 82
consecutive months of growth, exceeding 17 of the 20 expansions of this
century. By December of this year, the expansion will become the second
longest U.S. expansion of all time and the longest peacetime expansion.
If it continues through February 2000, this expansion will set a new
longevity record, outlasting the current record of 106 months of
uninterrupted growth in the 1960s. According to the Blue Chip survey,
most private-sector forecasters now expect this to happen.
This chapter begins with a review of recent developments and then
discusses two statistical issues: the
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growing statistical discrepancy (the difference between the aggregate
measures of output and income) and recent methodological improvements in
the calculation of the Consumer Price Index. The chapter then presents
the Administration's economic projections, followed by a comparison with
the Congressional Budget Office's projections. The following sections
present the impact of changes in economic assumptions since last year on
the projected fiscal balance and the structural deficit. The chapter
concludes with estimates of the sensitivity of the budget to changes in
economic assumptions.
Fiscal and Monetary Policy
When this Administration took office, its first priority was to
reverse the 12-year trend of large, uncontrolled fiscal deficits. The
Administration proposed, and Congress passed, the landmark Omnibus
Budget Reconciliation Act of 1993 (OBRA) which set the budget deficit on
a downward path. After having reached a postwar record of $290 billion
in 1992--a huge 4.7 percent of GDP--the deficit has declined each year,
falling to just $22 billion in 1997--just 0.3 percent of GDP. The last
time the deficit share of GDP was this low was in 1970.
The deficit reductions following OBRA have far exceeded predictions
made at the time of its passage. OBRA was projected to reduce pre-Act
deficits by $505 billion over the five years 1994-98. Over the five
years 1993-97, the cumulative deficit reduction has been $811 billion.
In other words, OBRA and subsequent developments have enabled the
Treasury to issue $811 billion less debt than would have been required
under previous law. By 1998, the cumulative deficit reduction from 1994
through 1998 is estimated to be $1.1 trillion, more than double the
original estimate.
While OBRA fundamentally altered the course of fiscal policy towards
lower deficits, it was not projected to eliminate the deficit. In the
absence of further action, deficits were expected to begin to climb once
again. To prevent this and bring the budget into surplus, last summer
the Administration negotiated the Balanced Budget Agreement with the
Congress. This budget proposes to achieve a surplus in 1999--three years
earlier than originally projected. The last budget surplus was in 1969.
OBRA and the Balanced Budget Agreement together are expected to reduce
the deficit by a cumulative total of $3.3 trillion over 1993-2002
compared with the pre-OBRA baseline.
The economy has outperformed most forecasters' expectations in recent
years and, at the same time, deficits have been much lower than
projected. This is more than a coincidence. Lower deficits contribute to
a healthy, sustainable expansion by reducing interest rates and boosting
interest-sensitive spending in the economy. Rapid growth of business
capital spending expands industrial capacity and boosts productivity
growth. The extra capacity, in turn, prevents shortages and bottlenecks
that might otherwise emerge.
Lower interest rates also raise equity prices, which reduces the cost
of capital to business and increases household wealth and optimism. The
added impetus to business and consumer spending creates new jobs and
business opportunities. The result is more production, more income, more
jobs, more Federal revenues, and a smaller deficit--a virtuous circle of
prosperity. That has been the experience of the past five years, and it
will be the likely consequence of policies that achieve budget
surpluses, and reduce Government debt.
In this expansion, monetary policy shifted when necessary to prevent
inflation from picking up, and shifted again to prevent the expansion
from stalling when that seemed needed. In 1994 and early 1995, monetary
policy tightened when rapid growth raised the possibility that
inflationary pressures were about to build. During 1995 and early 1996,
monetary policy eased because the expansion appeared to be slowing
unduly and the risk of higher inflation had lessened. Since January
1996, monetary policy has remained steady. The sole adjustment was in
March 1997 when the federal funds rate target was raised one-quarter
percentage point to its current level of 5\1/2\ percent.
Stable monetary policy for the past two years has kept the 3-month
Treasury bill rate in a narrow range around 5 percent. Long-term
interest rates have fluctuated in response to the outlook for inflation
and the deficit. When economic growth accelerated during the first four
months of 1997, the yield on the 30-year Treasury bond edged up 50 basis
points to 7.1 percent. During the remainder of the year, however, the
rate fell over 100 basis points in response to low inflation, the
agreement to balance the budget, the unexpectedly low 1997 budget
deficit, and international developments. By early 1998, the yield had
fallen to 5.7 percent.
Recent Developments
Real Growth: The economy expanded an estimated 3.7 percent over the
four quarters of 1997, up from 2.8 percent the prior year. As in 1996,
the fastest growing sector was business fixed investment. During the
first three quarters of 1997, business spending for new plant and
equipment rose at a 13 percent annual rate after adjustment for
inflation, led by an 18 percent advance in equipment spending. The
biggest gains continued to be for information processing and related
equipment, but businesses invested heavily in other forms of equipment
and in structures as well.
This exceptionally strong business capital spending has boosted
productivity and expanded industrial capacity to meet current and future
demands. Manufacturing capacity rose by more than 5 percent in each of
the past three years. The last time capacity grew this rapidly was in
the late 1960s. The extra capacity has helped keep inflation low by
easing the bottlenecks that might otherwise have developed. In the
fourth quarter of 1997, the manufacturing operating rate was near its
long-term average, even though labor markets were much tighter than
usual.
Growth last year was also supported by robust household spending. Low
unemployment, rising real incomes,
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and large capital gains have provided households with the resources and
willingness to spend heavily, especially on discretionary purchases.
Overall consumer spending after adjustment for inflation rose at a 4
percent annual rate during the first three quarters of the year;
spending on durable goods soared at a 9 percent pace.
The same factors spurring consumption, along with relatively low
mortgage rates, pushed new home sales during the first 11 months of 1997
to their highest level since 1978. Buoyant sales and low inventories of
unsold homes have provided a strong incentive for builders to start new
construction. Housing starts remained at high levels last year, and
residential investment, after adjustment for inflation, increased at
nearly a 5 percent annual rate during the first three quarters of the
year.
Government purchases, on balance, made only a small contribution to
GDP growth last year. Federal government spending in GDP after
adjustment for inflation was about unchanged over the first three
quarters. State and local spending rose at only a 2 percent rate during
this period, despite the healthy fiscal surpluses that have resulted
from sharply rising incomes and profits.
The foreign sector was the primary restraint on growth last year,
trimming real GDP growth by nearly 1 percentage point during the first
three quarters of the year. Although exports expanded rapidly, import
growth was even stronger. The widening of the net export deficit
reflected the relatively faster growth of domestic demand in the United
States than in our trading partners, and also the rise in the dollar.
Last year, the dollar gained 12 percent on a trade-weighted basis on top
of a 4 percent rise during 1996.
Labor Markets: The performance of the labor market last year far
exceeded most predictions. At the start of the year, most forecasters
had expected the unemployment rate to rise slightly during 1997.
Instead, the unemployment rate fell 0.6 percentage point to 4.7 percent
by December 1997. November's rate was 4.6 percent. This is the lowest
two consecutive months since March/April 1970. When this Administration
took office, the unemployment rate was 7.3 percent. All demographic
groups have benefited from the decline. Thirty-eight states had
unemployment rates of 5.0 percent or less at the end of last year; only
five had rates above 6.0 percent.
The Nation's payrolls expanded by 3.2 million jobs last year, the
biggest gain since 1994. Since the Administration took office in January
1993, 14.3 million jobs have been created. Job growth was widespread
across industries last year. The service sector accounted for most of
the new jobs, but manufacturing industries increased their payrolls by
over 200,000 jobs. State and local government payrolls also expanded,
while Federal government employment continued to contract. The abundance
of employment opportunities pushed the employment/population ratio up to
64.1 percent by year-end, the highest level on record.
Inflation: Despite rapid growth and the unusually low unemployment
rate last year, inflation not only remained low, it actually declined.
The broadest measure of inflation, the GDP chain-weighted price index,
rose at just a 1.9 percent annual rate during the first three quarters
of 1997, 0.4 percentage point less than during the four quarters of
1996. The last time aggregate inflation was this low was in 1964. The
Consumer Price Index (CPI) and the CPI excluding food and energy also
increased less in 1997 than in 1996. The core CPI excluding food and
energy rose just 2.2 percent last year, the slowest rise since 1965. The
total CPI rose even less, 1.7 percent, because of falling energy prices.
The favorable inflation performance was the result of several factors.
The rise in the dollar has reduced the costs of imported materials and
intensified price competition from imports. Non-oil import prices have
fallen nearly every month in the past two years. Although the pace of
wages and salaries picked up, overall compensation costs were restrained
by continued low health-care inflation. Finally, robust investment in
new plant and equipment has contributed to unusually strong productivity
growth for this stage of an expansion, restraining inflation by
offsetting gains in labor compensation. Unit labor costs have risen very
slowly during the first three quarters of 1997.
The absence of inflation pressures has implications for the estimate
of the level of unemployment that is consistent with stable inflation.
This threshold has been called the NAIRU, or ``nonaccelerating inflation
rate of unemployment.'' Economists have been lowering their estimates of
NAIRU in recent years in keeping with the accumulating experience that
lower unemployment has not led to higher inflation, even after taking
into account the influence of temporary factors. The economic
projections for this Budget assume that NAIRU is 5.4 percent. That is
0.1 percentage point less than estimated in the 1998 Budget assumptions
and 0.3 percentage point less than in the 1997 Budget.
By the end of 1997, the unemployment rate was about three-quarter
percentage point below the current estimate of NAIRU. In the absence of
special factors, if unemployment remains below NAIRU, inflation would
eventually creep up. The Administration forecast for real growth over
the next three years, however, is moderate enough to imply that
unemployment will return to 5.4 percent.
Statistical Issues
The U.S. statistical agencies endeavor to produce accurate measures of
the economy's performance. Nonetheless, in recent years serious concerns
have been raised about possible mismeasurement, especially of real GDP
growth and of inflation.
Real Growth: In a perfect statistical world, the value of output would
equal the value of income generated in its production, that is, GDP
would match Gross Domestic Income (GDI). However, because the series are
based on different source data, each with its own gaps
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and inconsistencies, the two measures are hardly ever identical. What is
particularly unusual now is the wide and growing difference between
product and income measures.
This ``statistical discrepancy,'' defined as aggregate output minus
aggregate income, was -$103 billion in the third quarter of 1997--a
nearly record-setting 1.3 percent of nominal GDP. By comparison, in the
first quarter of 1995, the statistical discrepancy was nearly zero, and
two years earlier, in the first quarter of 1993, it was $71 billion. A
swing of this magnitude means that during the past four and a half
years, the annual average real growth rate measured from the familiar
output side has been about 0.5 percentage point less than the growth
rate measured from the income side. During the first three quarters of
last year, real GDP rose at a 3.8 percent annual rate but real Gross
Domestic Income at a 4.5 percent pace. In the third quarter of 1997, the
divergence widened further. Real GDP growth was at a 3.1 percent annual
rate, but real GDI surged at a 4.5 percent rate.
The absence of a single, clear picture of the economy's actual growth
performance is a cause for concern. It is difficult to know if growth is
accelerating or decelerating; if actual growth is above or below the
economy's potential growth rate; or even what the economy's potential
growth rate is.
Any estimate of potential growth depends on an estimate of trend
productivity growth, which itself depends on recent data on actual
growth. When there is a growing divergence between product and income
measures, there is a comparable divergence in estimates of the
productivity trend. For example, measured from the last cyclical peak to
the third quarter of 1997, labor productivity growth has increased at a
1.1 percent annual rate according to the official productivity
statistics which measure output growth from the product side. Labor
productivity growth measured from the income side, however, has risen at
a 1.5 percent annual rate.
It is unclear whether the product or the income side provides the more
accurate measure of growth. The Bureau of Economic Analysis recognizes
the shortcomings of both measures but believes that GDP is a more
reliable measure of output than GDI (see The Survey of Current Business,
August 1997, page 19). Other experts believe that GDI, or some figure
between the two measures, may be more accurate.
There is circumstantial evidence to suggest that growth may be faster
than shown by the traditional GDP measure. The recent combination of low
inflation and a rising profits share suggests that productivity growth
is stronger than reported from the output side. Moreover, the unexpected
strength of Treasury receipts in the last two years suggests that the
output measure, and even the income measure, may be too low. While some
of the higher receipts are from capital gains generated by the booming
stock market, which are excluded from the national income accounts, this
source does not fully account for the surge.
The uncertainty surrounding actual growth and its trend makes it more
difficult to determine appropriate monetary policy. From a budgetary
perspective, estimates of receipts and expenditures have a larger degree
of uncertainty because they are dependent on the forecast for growth. As
shown in Table 1-6, ``Sensitivity of the Budget to Economic
Assumptions,'' errors in forecasting real GDP growth can have a
significant effect on the budget balance.
Inflation: Accurate measurement of inflation has become increasingly
important in recent years, even as inflation has been brought under
control. Eliminating biases of even a few tenths of a percentage point a
year can have important meaning relative to a goal of price stability
when inflation is low, while it may have less significance when
inflation is higher.
In recent years, serious questions have been raised about the
magnitude of bias in the Consumer Price Index. In December 1996, the
Advisory Commission to Study the Consumer Price Index, appointed by the
Senate Finance Committee, reported that the index overstated the actual
cost of living by 1.1 percentage points per year. The Bureau of Labor
Statistics (BLS), however, believes that the empirically demonstrated
bias is significantly less.
The BLS has instituted a number of methodological changes in recent
years to improve the accuracy of the Consumer Price Index, and has
announced several more changes that will be put in place this year and
next. Taken together, these changes are estimated to result in a 0.7
percentage point slower annual rise in the CPI by 1999. The changes
instituted from 1995-1997 are estimated to have slowed the growth of the
CPI by 0.3 percentage point per year; the forthcoming changes are
expected to trim another 0.4 percentage point per year. Because the CPI
is used to deflate some nominal spending components of GDP, a slower
rise in the CPI translates into a faster rise in real GDP. By 1999,
measured real GDP growth and, therefore, productivity growth, is likely
to be boosted by 0.2 percentage point per year as a consequence of the
cumulative improvements to the CPI since 1995.
Two methodological improvements have been instituted beginning with
the release of the CPI for January 1998: an updating of the expenditure
weights, and a better technique for estimating quality improvements for
computers. Together, the two changes are expected to slow CPI growth by
0.2 percentage point per year.
This year, the BLS updated the expenditure weights used in the CPI
from a 1982-84 basis to 1993-95, using Consumer Expenditure Survey data.
At the same time, BLS introduced a more accurate geographic sample based
on the 1990 decennial census, and redefined the groupings of items. In
the future, BLS expects to introduce updated expenditure weights more
frequently than in the past, when there were approximately 10 years
between updates.
For computers and peripheral equipment, the BLS has now begun to use a
hedonic regression procedure to distinguish price from quality changes.
The esti
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mated value of an improvement obtained from this regression procedure is
deducted from the observed price change for the product. For example, if
the CPI sample of computer prices shows no change in the retail price of
a new computer, but it is 20 percent better than the prior model as
measured by the hedonic procedure, the CPI will report a corresponding
drop in price for this model. A similar procedure has been adopted for
estimating computer prices in the Producer Price Index and in the
National Income and Product Accounts. It is especially important to
measure accurately, and on a timely basis, the extraordinary leaps in
computer power that must be a part of a meaningful measure of computer
prices.
For 1999, BLS has announced that it will select items to be sampled on
a product rather than a geographical basis. This switch will allow more
frequent sampling of categories with rapidly changing product lines,
such as consumer electronics.
A very important change next year will be the replacement of the
current fixed-weighted Laspeyres formula by a geometric mean formula for
combining individual price quotations at the lower level of aggregation
in the CPI. Under certain assumptions, a CPI calculated using geometric
means more closely approximates a cost-of-living index. Unlike the
current fixed- weighted aggregation, the geometric mean formula allows
for shifts in consumer spending patterns in response to changes in
relative prices within categories of goods and services.
Since last April, the BLS has been publishing an experimental CPI each
month that uses geometric means for all lower level aggregation and has
provided a historical series beginning with December 1990. If a
geometric mean is used for all lower level aggregation, BLS estimates
that the growth in the CPI would be slowed by about one-quarter
percentage point per year. Partial adoption would result in a lesser
impact. BLS is expected to announce shortly which categories will be
shifted to geometric means next year and the likely impact on the growth
of the CPI.
Economic Projections
The economy's strong performance last year and the continuation of the
virtuous circle of prosperity made possible by sound fiscal and monetary
policies raises the possibility that actual economic developments may
even be better than the assumptions--as has been the case in recent
years. Nonetheless, it is prudent to base budget estimates on a
conservative set of economic assumptions close to the consensus of
private sector forecasts.
Virtuous Circle of Prosperity: The economic assumptions summarized in
Table 1-1 are predicated on the adoption of the policies proposed in
this budget. The swing in the fiscal position from deficit to surplus is
expected to support a continuation of the favorable economic performance
of recent years. The shift from Federal Government dissaving to saving
would pull interest rates down, stimulating private sector investment in
new plant and equipment. The economy is likely to continue to grow,
although at a more moderate pace than during 1997. While job
opportunities are expected to remain plentiful, the unemployment rate is
likely to rise gradually to a level consistent with stable inflation.
New job creation would boost incomes and consumer spending and keep
confidence at a high level. Continued low inflation would enable
monetary policy to support economic growth. Growth, in turn, would
further improve the budget balance.
Real GDP, Potential GDP and Unemployment: Over the next three years,
real GDP is expected to rise 2.0 percent per year. This shift to more
moderate growth recognizes that by conservative, mainstream assumptions,
growth has exceeded the pace that can be maintained on a sustained
basis, which could eventually result in upward pressures on inflation. A
slowdown has been expected for this reason. Also, the financial
dislocations in Asia could contribute to this slowing of U.S. growth.
From 2001-2007, growth is expected to average a slightly faster 2.4
percent per year--the Administration's estimate of the economy's
potential growth rate. Real GDP growth in 2008 is projected to slow to
2.3 percent to reflect the beginning of the years of slower growth of
the workforce as the baby-boomers begin to retire.
The net export component of GDP is expected to restrain real growth by
about 1 percentage point during 1998, as our export growth is curtailed
by slower growth in Asia and the appreciation of the dollar. Thereafter,
as the effects of the crisis abroad wane, export growth is likely to
pick up slightly. Beginning with 1999, the foreign sector is not
expected to make a large contribution, positive or negative, to overall
growth.
As has been the case throughout this expansion, during the next six
years business fixed investment is expected to be the fastest growing
component of GDP. Although residential investment is also expected to
benefit from low mortgage rates, the high level of housing starts in
recent years and underlying demographic trends may tend to reduce
growth. Consumer spending, especially on durable goods, is also likely
to moderate from the rapid pace of 1997. The fundamental factors
supporting consumer spending are likely to remain favorable, although
not quite to the same extent as during 1997. The government component of
GDP will hardly grow through 2003. A decline in Federal consumption and
gross investment is projected to be offset by moderate growth in State
and local spending.
Continued strong growth of business fixed investment and the output-
increasing effects of methodological improvements to the CPI noted above
are expected to raise the measured trend of productivity growth during
the next six years to 1.3 percent per year. By comparison, during the
seven years following the last business cycle peak in the third quarter
of 1990, productivity growth averaged 1.1 percent per year, as measured
from the GDP side of the accounts.
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Table 1-1. ECONOMIC ASSUMPTIONS \1\
(Calendar years; dollar amounts in billions)
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Projections
Actual --------------------------------------------------------------
1996 1997 1998 1999 2000 2001 2002 2003
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Gross Domestic Product (GDP):
Levels, dollar amounts in billions:
Current dollars............................................................. 7,636 8,080 8,430 8,772 9,142 9,547 9,993 10,454
Real, chained (1992) dollars................................................ 6,928 7,187 7,357 7,503 7,652 7,820 8,008 8,199
Chained price index (1992 = 100), annual average............................ 110.2 112.5 114.6 116.9 119.5 122.1 124.8 127.5
Percent change, fourth quarter over fourth quarter:
Current dollars............................................................. 5.6 5.5 4.0 4.1 4.3 4.6 4.6 4.6
Real, chained (1992) dollars................................................ 3.2 3.6 2.0 2.0 2.0 2.3 2.4 2.4
Chained price index (1992 = 100)............................................ 2.3 1.9 2.0 2.1 2.2 2.2 2.2 2.2
Percent change, year over year:
Current dollars............................................................. 5.1 5.8 4.3 4.1 4.2 4.4 4.7 4.6
Real, chained (1992) dollars................................................ 2.8 3.7 2.4 2.0 2.0 2.2 2.4 2.4
Chained price index (1992 = 100)............................................ 2.3 2.0 1.9 2.0 2.2 2.2 2.2 2.2
Incomes, billions of current dollars:
Corporate profits before tax................................................ 677 729 754 768 790 805 830 851
Wages and salaries.......................................................... 3,633 3,868 4,057 4,237 4,424 4,623 4,840 5,068
Other taxable income \2\.................................................... 1,693 1,786 1,859 1,915 1,975 2,046 2,128 2,213
Consumer Price Index (all urban): \3\
Level (1982-84 = 100), annual average....................................... 157.0 160.7 164.1 167.7 171.5 175.5 179.5 183.6
Percent change, fourth quarter over fourth quarter.......................... 3.2 2.0 2.2 2.2 2.3 2.3 2.3 2.3
Percent change, year over year.............................................. 2.9 2.4 2.1 2.2 2.3 2.3 2.3 2.3
Unemployment rate, civilian, percent:
Fourth quarter level........................................................ 5.3 4.8 5.0 5.2 5.4 5.4 5.4 5.4
Annual average.............................................................. 5.4 5.0 4.9 5.1 5.3 5.4 5.4 5.4
Federal pay raises, January, percent:
Military \4\................................................................ 2.6 3.0 2.8 3.1 3.0 3.0 3.0 3.0
Civilian \5\................................................................ 2.4 3.0 2.8 3.1 3.0 3.0 3.0 3.0
Interest rates, percent:
91-day Treasury bills \6\................................................... 5.0 5.0 5.0 4.9 4.8 4.7 4.7 4.7
10-year Treasury notes...................................................... 6.4 6.4 5.9 5.8 5.8 5.7 5.7 5.7
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\1\ Based on information available as of early December 1997.
\2\ Rent, interest, dividend and proprietor's components of personal income.
\3\ Seasonally adjusted CPI for all urban consumers. Two versions of the CPI are now published. The index shown here is that currently used, as required
by law, in calculating automatic adjustments to individual income tax brackets. Projections reflect scheduled changes in methodology.
\4\ Beginning with the 1999 increase, percentages apply to basic pay only; adjustments for housing and subsistence allowances will be determined by the
Secretary of Defense.
\5\ Overall average increase, including locality pay adjustments.
\6\ Average rate (bank discount basis) on new issues within period.
Potential GDP growth of 2.4 percent during the projection horizon can
be decomposed into the trend growth of productivity, 1.3 percent per
year, plus the growth of the labor force, estimated at 1.1 percent
annually. The Administration's labor force projection assumes that the
population of working age will grow 1.0 percent per year and that the
labor force participation rate will edge up 0.1 percent per year.
Both the labor force and participation rate assumptions are lower than
recent experience. The participation rate has risen 0.4 percent per year
since 1994, as falling unemployment and rapidly expanding job
opportunities have strongly induced job-seeking. But with the labor
force participation rate and employment/population ratio at post-World
War II highs, it is prudent to project a slower rise in the coming
years. In addition, the female participation rate, which had risen
sharply during much of the postwar period, grew much slower during the
1990s, and this trend is assumed to continue.
The real GDP growth projection of 2.0 percent through 2000 is
consistent with a gradual rise in the unemployment rate to 5.4 percent.
Unemployment is then projected to remain on a plateau at that level from
2001 onward, when real GDP growth averages the Administration's estimate
of the economy's potential growth rate.
Inflation: With unemployment expected to be slightly below NAIRU
during the next three years, inflation is projected to creep up by about
one-quarter percentage point by 2000. The CPI is projected to increase
2.3 percent in that year and the subsequent years of the forecast
horizon; the GDP chain-weighted price index is projected to increase 2.2
percent in 2000 and beyond. The relatively small 0.1 percentage point
difference between the two inflation measures is narrower than in the
past because of recent and forthcoming methodological improvements to
both indexes.
Despite the relatively tight labor market in the next few years,
inflation is projected to remain low, partly because of two temporary
factors. The rise in the dollar is expected to hold down import prices
and intensify price competition from imported goods and services. In
addition, wide profit margins provide a cushion that will enable firms
to absorb cost increases without having to pass them on fully into
higher prices.
[[Page 9]]
Moreover, as discussed above, the methodological improvements to the
CPI will offset some of the rise that might otherwise occur. By 1999,
the improvements instituted this year and next will trim about 0.4
percentage point off of the annual rise in the CPI. These same
improvements are likely to restrain the rise in the GDP chain weighted
price index by about 0.1 percentage point per year.
Interest Rates: The assumptions, which were finalized in early
December, project a gradual decline in short- and long-term interest
rates consistent with the improved fiscal balance and low inflation. By
2001 the 91-day Treasury bill rate is expected to be 30 basis points
lower than the fourth quarter 1997 average; the yield on the 10-year
Treasury bond is projected to be 20 basis points lower.
The sharp drop in long-term rates in early 1998 has already driven
long-term rates below the levels anticipated in the economic
assumptions. Recent developments, including the improved budget outlook,
may have caused market participants to lower their expectations for
inflation and credit demands. The turmoil in Asian markets may have
fostered further portfolio adjustments into the safe haven of U.S.
bonds. In light of these developments, it is possible that long-term
rates will be lower on average than those in the economic assumptions.
Financial markets, however, can be quite volatile; the recent drop in
long rates could prove to be temporary.
Incomes: The moderating of real growth during the projection horizon
is expected to shift the distribution of national income slightly,
augmenting the share going to labor while trimming the unusually high
profits share in GDP. On balance, total taxable income is projected to
decline gradually as a share of GDP.
Between 1997 and 2003, aggregate wages and salaries are projected to
rise 31 percent in nominal terms and 15 percent after adjustment for
inflation. Corresponding to the rise in the wage share, corporate
profits before tax are projected to rise just 16 percent in nominal
terms from 1997 to 2003, a markedly slower pace than in recent years. By
2003, taxable profits as a share of GDP are projected to be about 1
percentage point lower than the 30-year high reached during 1997. The
favorable impact of lower interest rates on the debt service payments of
the corporate sector helps to cushion the impact on profits of the
expected shift of income back toward wages.
Lower interest rates will pull down the share of personal interest
income in GDP because the household sector is a net lender in the
economy. Little change is expected in the shares of other components of
taxable income (dividends, rents and proprietors' income).
Comparison with CBO
The Congressional Budget Office (CBO) develops economic projections
used by Congress in formulating its budget policy. In the executive
branch, the analogous function is performed jointly by the Treasury, the
Council of Economic Advisers (CEA), and the Office of Management and
Budget (OMB). These two sets of economic projections can be compared
with one another, but differences in their preparation should be borne
in mind:
The Administration's projections always assume that the
President's policy proposals in the budget will be adopted in
full. In contrast, CBO normally assumes that current law will
continue unchanged; thus, it makes a ``pre-policy'' or
baseline projection, while the Administration's projections
are ``post-policy.''
The two sets of projections are often prepared at different
times. The Administration's projections must be prepared
months ahead of the release of the budget. Differences in the
Administration's and CBO's near-term forecasts, therefore, can
be due to the availability of more recent data to CBO; a
direct comparison with the CBO near-term projections is not
always meaningful. Timing differences are much less likely to
play an important role in any differences in outyear
projections, however.
Table 1-2 presents a summary comparison of the current CBO and
Administration projections.
Real GDP: The projections of real GDP growth are quite
similar. The Administration projects that real GDP will grow
at an average annual rate of 2.2 percent from 1998 through
2003; CBO projects a 2.1 percent rate.
Inflation: Both the Administration and CBO expect inflation
to continue at a slow, steady rate over the next several
years. For the chain-weighted GDP price index, CBO assumes
that inflation will average 2.3 percent a year over the 1998-
2003 period while the Administration projects a 2.1 percent
average for that span; CBO expects the annual rate of change
in the CPI to average 0.4 percentage point higher than the
Administration forecast over the same period.
Unemployment: CBO projects unemployment to rise from its
fourth quarter average of 4.7 percent to 5.9 percent by 2003,
slightly above its estimate of the NAIRU. The Administration
believes unemployment will average its estimate of the NAIRU,
5.4 percent, during 2001 to 2003.
Interest rates: Both the Administration and CBO expect a
similar decline to a level of 4.7 percent by the year 2001 for
the 91-day bill rate. The Administration, however, projects a
slightly greater (0.2 percentage point) decline in long-term
rates than does CBO.
Income distribution: Both CBO and the Administration project
a decline in the profits share of GDP, although both also
expect a shift of income from personal interest income to
corporate profits. In part because the Administration assumes
a slightly larger decline in long-term interest rates than
does CBO, it projects less of a decline in the profits share.
CBO projects a slightly higher wage and salary share of GDP
than does the Ad
[[Page 10]]
Table 1-2. COMPARISON OF ECONOMIC ASSUMPTIONS
(Calendar years; percent)
----------------------------------------------------------------------------------------------------------------
Projections
-----------------------------------------------------
1998 1999 2000 2001 2002 2003
----------------------------------------------------------------------------------------------------------------
Real GDP (chain-weighted): \1\
CBO January............................................. 2.3 1.9 1.9 2.0 2.2 2.3
1999 Budget............................................. 2.0 2.0 2.0 2.3 2.4 2.4
Chain-weighted GDP Price Index: \1\
CBO January............................................. 2.1 2.2 2.4 2.5 2.4 2.5
1999 Budget............................................. 2.0 2.1 2.2 2.2 2.2 2.2
Consumer Price Index (all-urban): \1\
CBO January............................................. 2.4 2.5 2.7 2.8 2.8 2.8
1999 Budget............................................. 2.2 2.2 2.3 2.3 2.3 2.3
Unemployment rate: \2\
CBO January............................................. 4.8 5.1 5.4 5.6 5.8 5.9
1999 Budget............................................. 4.9 5.1 5.3 5.4 5.4 5.4
Interest rates: \2\
91-day Treasury bills:
CBO January........................................... 5.3 5.2 4.8 4.7 4.7 4.7
1999 Budget........................................... 5.0 4.9 4.8 4.7 4.7 4.7
10-year Treasury notes:
CBO January........................................... 6.0 6.1 6.0 5.9 5.9 5.9
1999 Budget........................................... 5.9 5.8 5.8 5.7 5.7 5.7
Taxable income \3\ (share of GDP):
CBO January............................................. 79.0 78.3 77.7 77.3 77.0 76.7
1999 Budget............................................. 79.1 78.9 78.6 78.3 78.0 77.8
----------------------------------------------------------------------------------------------------------------
\1\ Percent change, fourth quarter over fourth quarter.
\2\ Annual averages, percent.
\3\ Taxable personal income plus corporate profits before tax.
ministration. Overall, CBO's taxable income share of GDP
declines from 79.1 percent for 1997 to 76.7 percent for 2003;
the Administration's assumptions also show a decline, but only
to 77.8 percent for 2003. Both forecasts thus recognize that
the 1997 share is historically high, in large measure
reflecting the discrepancy in recent GDP and GDI growth rates
discussed earlier in this Chapter.
CBO has a good economic forecasting record. During much of the 1980s,
its forecasts were more accurate than those of the Administrations then
in office. The record over the last five years, however, has been more
mixed. Since it took office in 1993, this Administration has placed high
priority on careful and prudent economic forecasts. Economic performance
in the last four years has been better than assumed by the
Administration, while exceeding CBO's assumptions by an even wider
margin. The Administration's cautious approach to forecasting is one of
the reasons that actual deficits have consistently come in below
expectations since 1993.
The differences in economic assumptions between the Administration and
CBO have been small--smaller than they were under previous
Administrations, and well within the usual range of error in such
projections. CBO's assumptions and those used in this Budget are
unusually close, and both are similar to private sector forecasts such
as the Blue Chip consensus. However, even small differences in economic
assumptions can yield sizable differences in budget projections when
extended over a long planning horizon. Given the positive economic
outlook in the United States--steady growth, robust job creation, and
low inflation and interest rates with none of the excesses that
foreshadow an economic downturn--there are sound reasons for believing
that the Administration's projection is likely to be close to the actual
outcome.
Impact of Changes in the Economic Assumptions
The economic assumptions underlying this budget are similar to those
of last year. Both budgets anticipated that achieving a balanced budget
would result in a significant decline in interest rates that would serve
to extend the economic expansion at a moderate pace, while helping to
maintain low, steady rates of inflation and unemployment. A shift to a
balanced budget and the ensuing lower interest rates were also expected
to shift income from interest to profits. This would have favorable
effects on budget receipts and the deficit, because profits are on
average taxed more heavily than interest income.
The changes in the economic assumptions since last year's budget have
been relatively modest, as Table 1-3 shows. The differences are
primarily the result of more favorable economic experience in 1997 than
was anticipated. Economic growth was stronger than expected in 1997,
while inflation and unemployment were lower. Because of this favorable
experience, the projected annual averages for the unemployment and
inflation rates have been reduced slightly. At the same time, interest
rates are again assumed to decline in this
[[Page 11]]
Table 1-3. COMPARISON OF ECONOMIC ASSUMPTIONS IN THE 1998 AND 1999 BUDGETS
(Calendar years; dollar amounts in billions)
----------------------------------------------------------------------------------------------------------------
1997 1998 1999 2000 2001 2002 2003
----------------------------------------------------------------------------------------------------------------
Nominal GDP:
1998 Budget assumptions \1\.................... 8,005 8,379 8,786 9,226 9,686 10,167 10,674
1999 Budget assumptions........................ 8,080 8,430 8,772 9,142 9,547 9,993 10,454
Real GDP (percent change): \2\
1998 Budget assumptions........................ 2.0 2.0 2.3 2.3 2.3 2.3 2.3
1999 Budget assumptions........................ 3.6 2.0 2.0 2.0 2.3 2.4 2.4
GDP price index (percent change): \2\
1998 Budget assumptions........................ 2.5 2.6 2.6 2.6 2.6 2.6 2.6
1999 Budget assumptions........................ 1.9 2.0 2.1 2.2 2.2 2.2 2.2
Consumer Price Index (percent change): \2\
1998 Budget assumptions........................ 2.6 2.7 2.7 2.7 2.7 2.7 2.7
1999 Budget assumptions........................ 2.4 2.1 2.2 2.3 2.3 2.3 2.3
Civilian unemployment rate (percent): \3\
1998 Budget assumptions........................ 5.3 5.5 5.5 5.5 5.5 5.5 5.5
1999 Budget assumptions........................ 5.0 4.9 5.1 5.3 5.4 5.4 5.4
91-day Treasury bill rate (percent): \3\
1998 Budget assumptions........................ 5.0 4.7 4.4 4.2 4.0 4.0 4.0
1999 Budget assumptions........................ 5.0 5.0 4.9 4.8 4.7 4.7 4.7
10-year Treasury note rate (percent): \3\
1998 Budget assumptions........................ 6.1 5.9 5.5 5.3 5.1 5.1 5.1
1999 Budget assumptions........................ 6.4 5.9 5.8 5.8 5.7 5.7 5.7
----------------------------------------------------------------------------------------------------------------
\1\ Adjusted for July 1997 NIPA revisions.
\2\ Fourth quarter-to-fourth quarter.
\3\ Calendar year average.
budget, but the decline is smaller in percentage points, in part because
the deficit has already fallen much faster than expected.
The net effects on the budget of these modifications in the economic
outlook are shown in Table 1-4. The largest effects come from higher
receipts during 1998-2002 due to higher projected levels of taxable
incomes. In all years through 2003, there are higher outlays for
interest due to the smaller expected decline in interest rates, offset
by lower outlays for cost-of-living adjustments to Federal programs due
to lower rates of inflation. A more favorable economic outlook since
last year improves the budget balance by $38 billion for 1998 and by $15
billion in 2003.
Table 1-4. EFFECTS ON THE BUDGET OF CHANGES IN ECONOMIC ASSUMPTIONS SINCE LAST YEAR
(In billions of dollars)
----------------------------------------------------------------------------------------------------------------
1998 1999 2000 2001 2002 2003
----------------------------------------------------------------------------------------------------------------
Budget totals under 1998 Budget economic assumptions and
1999 Budget policies:
Receipts................................................ 1,630.0 1,714.3 1,775.4 1,855.1 1,947.3 2,032.4
Outlays................................................. 1,677.9 1,745.0 1,796.8 1,846.8 1,874.5 1,964.5
-----------------------------------------------------
Deficit (-) or surplus.............................. -47.9 -30.7 -21.4 8.3 72.8 67.8
Changes due to economic assumptions:
Receipts................................................ 27.9 28.4 18.2 7.5 2.0 -4.2
Outlays:
Inflation............................................. -4.4 -8.1 -12.4 -16.8 -20.8 -25.3
Unemployment.......................................... -5.4 -4.2 -2.4 -1.0 -1.0 -1.1
Interest rates........................................ 0.7 3.4 7.3 10.6 12.7 13.7
Interest on changes in borrowing...................... -1.0 -2.8 -4.2 -5.1 -5.8 -6.5
-----------------------------------------------------
Total, outlay decreases (net)....................... -10.1 -11.8 -11.7 -12.4 -14.9 -19.2
-----------------------------------------------------
Increase in surplus or reduction in deficit......... 38.0 40.2 29.9 19.9 17.0 15.0
Budget totals under 1999 Budget economic assumptions and
policies:
Receipts................................................ 1,657.9 1,742.7 1,793.6 1,862.6 1,949.3 2,028.2
Outlays................................................. 1,667.8 1,733.2 1,785.0 1,834.4 1,859.6 1,945.4
-----------------------------------------------------
Deficit (-) or surplus.............................. -10.0 9.5 8.5 28.2 89.7 82.8
----------------------------------------------------------------------------------------------------------------
[[Page 12]]
Structural vs. Cyclical Balance
When the economy is operating above potential as it is currently
estimated to be, receipts are higher than they would be if resources
were less fully employed, and outlays for unemployment-sensitive
programs (such as unemployment compensation and food stamps) are lower.
As a result, the deficit is smaller or the surplus is larger than it
would be if unemployment were at NAIRU. The portion of the surplus or
deficit that can be traced to such factors is called the cyclical
surplus or deficit. The remainder, the portion that would remain with
unemployment at NAIRU (consistent with a 5.4 percent unemployment rate),
is called the structural surplus or deficit.
Changes in the structural balance give a better picture of the impact
of budget policy on the economy than does the unadjusted budget balance.
The level of the structural balance also gives a clearer picture of the
stance of fiscal policy, because this part of the surplus or deficit
will persist even when the economy returns to normal operating levels.
In the early 1990's, large swings in net outlays for deposit insurance
(the S&L bailouts) had substantial impacts on deficits, but had little
concurrent impact on economic performance. It therefore became customary
to remove deposit insurance outlays as well as the cyclical component of
the surplus or deficit from the actual surplus or deficit to compute the
adjusted structural balance. This is shown in Table 1-5.
Because unemployment is projected to be quite close to NAIRU over the
forecast horizon, the cyclical component of the surplus is small. For
the period 1997 through 2000, the unemployment rate is slightly below
the estimated NAIRU of 5.4 percent, resulting in cyclical surpluses.
Deposit insurance net outlays are relatively small and do not change
greatly from year to year. The adjusted structural surplus or deficits
in this budget display much the same pattern of year-to-year changes as
the actual deficits. The most significant point illustrated by this
table is the fact that of the $268 billion reduction in the actual
budget deficit between 1992 and 1997 (from $290 billion to $22 billion),
35 percent ($94 billion) resulted from cyclical improvement in the
economy. The rest of the reduction stemmed primarily from policy
actions--mainly those in the Omnibus Budget Reconciliation Act of 1993,
which reversed a projected continued steep rise in the deficit and set
the stage for the remarkable cyclical improvement that has occurred.
Sensitivity of the Budget to Economic Assumptions
Both receipts and outlays are affected by changes in economic
conditions. This sensitivity seriously complicates budget planning,
because errors in economic assumptions lead to errors in the budget
projections. It is therefore useful to examine the implications of
alternative economic assumptions.
Many of the budgetary effects of changes in economic assumptions are
fairly predictable, and a set of rules of thumb embodying these
relationships can aid in estimating how changes in the economic
assumptions would alter outlays, receipts, and the surplus or deficit.
Economic variables that affect the budget do not usually change
independently of one another. Output and employment tend to move
together in the short run: a higher rate of real GDP growth is generally
associated with a declining rate of unemployment, while weak or negative
growth is usually accompanied by rising unemployment. In the long run,
however, changes in the average rate of growth of real GDP are mainly
due to changes in the rates of growth of productivity and labor supply,
and are not necessarily associated with changes in the average rate of
unemployment. Inflation and interest rates are also closely
interrelated: a higher expected rate of inflation increases interest
rates, while lower expected inflation reduces rates.
Changes in real GDP growth or inflation have a much greater cumulative
effect on the budget over time if they are sustained for several years
than if they last for only one year.
Highlights of the budget effects of the above rules of thumb are shown
in Table 1-6.
If real GDP growth is lower by one percentage point in calendar year
1998 only and the unemployment rate rises by one-half percentage point,
the fiscal 1998 deficit would increase by $9.1 billion; receipts in 1998
would be lower by about $7.5 billion, and outlays would be higher by
about $1.5 billion, primarily for unemployment-sensitive programs. In
1999, the receipts shortfall would grow further to about $16.2 billion,
and outlays would increase by about $5.5 billion relative to the base,
even though the growth rate in calendar 1999 equals the rate originally
assumed. This is because the level of real (and nominal) GDP and taxable
incomes would be permanently lower and unemployment higher.
Table 1-5. ADJUSTED STRUCTURAL BALANCE
(In billions of dollars)
--------------------------------------------------------------------------------------------------------------------------------------------------------
1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003
--------------------------------------------------------------------------------------------------------------------------------------------------------
Unadjusted deficit (-) or surplus.................. -290.4 -255.0 -203.1 -163.9 -107.4 -21.9 -10.0 9.5 8.5 28.2 89.7 82.8
Cyclical component............................... -72.5 -57.2 -27.8 -8.4 -4.2 21.4 30.1 19.6 9.0 ...... ...... ......
----------------------------------------------------------------------------------------------------
Structural deficit (-) or surplus.................. -217.9 -197.8 -175.3 -155.5 -103.2 -43.4 -40.1 -10.0 -0.4 28.2 89.8 82.8
Deposit insurance outlays........................ -2.3 -28.0 -7.6 -17.9 -8.4 -14.4 -4.5 -4.5 -1.9 -1.4 -1.2 -0.3
----------------------------------------------------------------------------------------------------
Adjusted structural deficit (-) or surplus......... -220.3 -225.8 -182.9 -173.4 -111.6 -57.8 -44.6 -14.5 -2.3 26.7 88.6 82.5
--------------------------------------------------------------------------------------------------------------------------------------------------------
[[Page 13]]
The budget effects (including growing interest costs associated with
higher deficits or smaller surpluses) would continue to grow slightly in
later years.
The budget effects are much larger if the real growth rate is assumed
to be one percentage point less in each year (1998-2003) and the
unemployment rate to rise one-half percentage point in each year. With
these assumptions, the levels of real and nominal GDP would be below the
base case by a growing percentage. The budget balance would be worsened
by $153.3 billion relative to the base case by 2003.
The effects of slower productivity growth are shown in a third
example, where real growth is one percentage point lower per year while
the unemployment rate is unchanged. In this case, the estimated budget
effects mount steadily over the years, but more slowly, resulting in a
$130.2 billion worsening of the budget balance by 2003.
The effects of an abrupt and sustained one percentage point increase
in the level of the unemployment rate (due, say, to a sudden rise in
labor force participation relative to the base case), with no change in
the level or growth rate of real GDP, are shown in a fourth example. In
this case, unemployment-sensitive outlays would increase by amounts
rising from $6.5 billion in 1998 to $12.4 billion in 2003. The effects
on the surplus would be smaller (a $7.9 billion reduction in 2003),
however, because under current law, federal unemployment tax collections
would gradually rise during a period of sustained higher unemployment
rates.
Joint changes in interest rates and inflation have a smaller effect on
the deficit than equal percentage point changes in real GDP growth,
because their effects on receipts and outlays are substantially
offsetting. An example is the effect of a one percentage point higher
rate of inflation and one percentage point higher interest rates during
calendar year 1998 only. In subsequent years, the price level and
nominal GDP would be one percent higher than in the base case, but
interest rates are assumed to return to their base levels. Outlays for
1998 rise by $5.8 billion and receipts by $8.7 billion, for a decrease
of $2.8 billion in the 1998 deficit. In 1999, outlays would be above the
base by $14.2 billion, due in part to lagged cost-of-living adjustments;
receipts would rise $17.6 billion above the base, however, resulting in
a $3.4 billion improvement in the budget balance. In subsequent years,
the amounts added to receipts would continue to be larger than the
additions to outlays.
If the rate of inflation and the level of interest rates are higher by
one percentage point in all years, the price level and nominal GDP would
rise by a cumulatively growing percentage above their base levels. In
this case, the effects on receipts and outlays mount steadily in
successive years, adding $62.6 billion to outlays and $106.5 billion to
receipts in 2003, for a net increase in the surplus of $43.9 billion.
The table also shows the interest rate and the inflation effects
separately, and rules of thumb for the added interest cost associated
with changes in the budget surplus or deficit (increased or reduced
borrowing). The effects of changes in economic assumptions in the
opposite direction are approximately symmetric to those shown in the
table. The impact of a one percentage point lower rate of inflation or
higher real growth would have about the same magnitude as the effects
shown in the table, but with the opposite sign.
These rules of thumb are computed while holding the income share
composition of GDP constant. Because different income components are
subject to different taxes and tax rates, estimates of total receipts
can be affected significantly by changing income shares. However, the
relationships between changes in income shares and changes in growth,
inflation, and interest rates are too complex to be reduced to simple
rules.
[[Page 14]]
Table 1-6. SENSITIVITY OF THE BUDGET TO ECONOMIC ASSUMPTIONS
(In billions of dollars)
----------------------------------------------------------------------------------------------------------------
Budget effect 1998 1999 2000 2001 2002 2003
----------------------------------------------------------------------------------------------------------------
Real Growth and Employment
Budgetary effects of 1 percent lower real GDP
growth:
For calendar year 1998 only: \1\
Receipts........................................ -7.5 -16.2 -18.7 -19.0 -19.5 -20.1
Outlays......................................... 1.5 5.5 6.8 8.2 9.8 11.6
-----------------------------------------------------------
Decrease in surplus (-)....................... -9.1 -21.8 -25.5 -27.2 -29.3 -31.7
Sustained during 1998-2003: \1\
Receipts........................................ -7.5 -24.0 -43.4 -63.6 -85.2 -108.0
Outlays......................................... 1.5 7.1 14.0 22.3 32.6 45.3
-----------------------------------------------------------
Decrease in surplus (-)....................... -9.1 -31.1 -57.4 -86.0 -117.8 -153.3
Sustained during 1998-2003, with no change in
unemployment:
Receipts........................................ -7.5 -24.3 -44.5 -66.1 -89.4 -114.4
Outlays......................................... 0.2 1.1 2.9 5.9 10.1 15.8
-----------------------------------------------------------
Decrease in surplus (-)....................... -7.7 -25.4 -47.4 -71.9 -99.5 -130.2
Budgetary effects of 1 percent higher unemployment
rate:
Sustained during 1998-2003, with no change in real
GDP:
Receipts........................................ * 0.9 2.2 3.2 3.9 4.5
Outlays......................................... 6.5 9.4 10.1 10.7 11.4 12.4
-----------------------------------------------------------
Decrease in surplus (-)....................... -6.5 -8.5 -7.9 -7.5 -7.5 -7.9
Inflation and Interest Rates
Budgetary effects of 1 percentage point higher rate
of:
Inflation and interest rates during calendar year
1998 only:
Receipts........................................ 8.7 17.6 17.5 16.2 17.0 17.9
Outlays......................................... 5.8 14.2 11.9 11.5 11.1 10.5
-----------------------------------------------------------
Increase in surplus (+)....................... 2.8 3.4 5.6 4.7 5.9 7.4
Inflation and interest rates, sustained during
1998-2003:
Receipts........................................ 8.7 26.7 45.4 63.8 84.1 106.5
Outlays......................................... 5.9 20.7 32.8 44.0 53.6 62.6
-----------------------------------------------------------
Increase in surplus (+)....................... 2.8 6.0 12.7 19.8 30.5 43.9
Interest rates only, sustained during 1998-2003:
Receipts........................................ 1.2 2.9 3.7 4.0 4.3 4.6
Outlays......................................... 5.5 16.0 21.7 25.1 27.5 29.1
-----------------------------------------------------------
Decrease in surplus (-)....................... -4.3 -13.0 -17.9 -21.2 -23.2 -24.4
Inflation only, sustained during 1998-2003:
Receipts........................................ 7.5 23.8 41.7 59.8 79.8 101.9
Outlays......................................... 0.4 4.7 11.1 18.9 26.1 33.5
-----------------------------------------------------------
Increase in surplus (+)....................... 7.1 19.0 30.6 41.0 53.7 68.3
Interest Cost of Higher Federal Borrowing
Outlay effect of $100 billion additional borrowing
during 1998........................................ 2.9 5.5 5.6 5.8 6.0 6.3
----------------------------------------------------------------------------------------------------------------
* $50 million or less.
\1\ The unemployment rate is assumed to be 0.5 percentage point higher per 1.0 percent shortfall in the level of
real GDP.