[Analytical Perspectives]
[Economic and Accounting Analyses]
[1. Economic Assumptions]
[From the U.S. Government Publishing Office, www.gpo.gov]
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ECONOMIC AND ACCOUNTING ANALYSES
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1. ECONOMIC ASSUMPTIONS
Introduction
The prudent macroeconomic policies pursued since 1993 have fostered
the healthiest economy in over a generation. Budget surpluses have
replaced soaring deficits. During this Administration, fiscal policy has
been augmenting national saving, private investment, productivity, and
economic growth, rather than restraining them. Monetary policy has
helped reduce inflation while supporting economic growth, and minimizing
the domestic effect of international financial dislocations.
These sound policies have contributed to another year of outstanding
economic achievement--and hold the promise of more successes to come.
Real Gross Domestic Product (GDP) rose 4.2 percent during 1999, the
fourth consecutive year that growth has been four percent or more. The
last time growth was this strong for so long was in the mid-1960s.
Strong and sustained growth has created abundant job opportunities and
raised real wages. The Nation's payrolls expanded by 2.7 million jobs
last year, bringing the total number of jobs created during this
Administration to 20.4 million. The unemployment rate during the last
three months of the year fell to 4.1 percent of the labor force, the
lowest level since January 1970, and 3.2 percentage points lower than
the rate in January 1993.
Despite robust growth and very low unemployment, inflation has
remained low. The Consumer Price Index excluding the volatile food and
energy components rose only 1.9 percent last year, the smallest increase
since 1965. The combination of low inflation and low unemployment pulled
the ``Misery Index,'' defined as the sum of the inflation and
unemployment rates, to the lowest level since 1965.
Households, businesses and investors have prospered in this
environment. Wage growth has outpaced inflation during each of the last
four years, reversing a two-decade decline in real earnings. In 1998,
the poverty rate fell to the lowest level since 1980. Although the
poverty rate for 1999 will not be known until later this year, another
decline is likely in light of the economy's strong job gains and
declining unemployment. The healthy economy boosted consumer optimism
last year to the highest level on record.
Businesses' confidence in the future is evident in a willingness to
invest heavily in new, capacity-enhancing plant, equipment and software.
During the past seven years, equipment and software spending has risen
at a double-digit pace, spurred by purchases of high-tech capital. Rapid
growth of investment has helped return labor productivity growth to
rates not seen since before the first oil crisis in 1973. Rapid
productivity growth has enabled firms to achieve healthy increases in
profits, and to raise real wages while still holding the line on prices.
Forward-looking financial markets have responded to these
developments. The bull market in equities that began in 1994 continued
in 1999. These past five years have recorded the largest percentage
gains in stock prices in the postwar period. From December 31, 1994 to
December 31, 1999, the Dow Jones Industrial Average rose 200 percent;
the S&P 500 gained 220 percent; and the technology-laden NASDAQ soared
441 percent. During January, the Dow and the NASDAQ edged into record
territory and the S&P 500 remained close to its record high.
Short- and long-term interest rates rose during 1999 in response to
the increased demand for credit that accompanied strong private-sector
growth and the Federal Reserve's tightening of monetary policy. Even so,
long-term interest rates during 1998 and 1999 were still lower than in
any year during the prior three decades. The real long-term interest
rate (the nominal rate minus expected inflation), an important
determinant of investment decisions, was also lower in these two years
than in any other two-year period since 1980. As 2000 began, financial
and nonfinancial market indicators were signaling that the economic
outlook remains healthy.
The economy has outperformed the consensus forecast during the past
seven years, and the Administration believes that it can continue to do
so if sound fiscal policies are maintained. However, for purposes of
budget planning, the Administration continues to choose projections that
are close to the consensus of private forecasters. The Administration
assumes that the economy will grow between 2.5 and 3.0 percent yearly
through 2010, while unemployment, inflation and interest rates are
projected to remain relatively low.
Even with the moderation in growth, the economy is expected to
generate millions of new jobs. The unemployment rate, which by
mainstream estimates is below the level consistent with stable
inflation, is projected to edge up slightly until mid-2003. Thereafter,
it is projected to average a relatively low 5.2 percent, the middle of
the range that the Administration estimates is consistent with stable
inflation in the long run. The Consumer Price Index (CPI), which rose
2.7 percent during 1999 because of rapidly rising energy prices, is
projected to slow slightly in the next two years and then increase 2.6
percent per year on average through 2010. Short- and long-term interest
rates are expected to remain in the neighborhood of the levels reached
at the end of 1999.
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As of December, this business cycle expansion had lasted 105 months
since the trough in March 1991. If the expansion continues through
February, as seems highly likely, it will exceed the previous longevity
record of 106 months set by the Vietnam War expansion of the 1960s. If
macroeconomic policies continue to foster high investment without
engendering inflationary pressures, there is every reason to believe
that this expansion will continue for many more years.
This chapter begins with a review of recent developments, and then
discusses two statistical issues: the recent methodological improvements
in the calculation of the Consumer Price Index, which slowed its rise;
and the October comprehensive revisions to the National Income and
Product Accounts, which incorporated computer software as a component of
investment, among other changes. 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 budget surplus, and the cyclical and structural components
of the surplus. The chapter concludes with estimates of the sensitivity
of the budget to changes in economic assumptions.
Recent Developments
The outstanding performance of the economy is due to a combination of
several factors. First, macroeconomic policies have promoted strong
growth with low inflation. Second, thanks in part to robust investment
and new, high-tech means of communicating and doing business, labor
productivity growth in the last four years has approached 3 percent per
year--double the rate that prevailed during the prior two decades, and
comparable to the high rates achieved during the first three decades
following World War II. Third, inflation has been restrained by
recession in much of the world and by the rising exchange value of the
dollar. These forces together--plus intensified competition, including
competition from foreign producers--have kept down commodity prices and
prevented U.S. producers from raising prices. Finally, the labor market
appears to have changed in ways that now permit the unemployment rate to
fall to lower levels without triggering faster inflation.
Fiscal Policy: In 1992, the deficit reached a postwar record of $290
billion, representing 4.7 percent of GDP--and the prospects were for
growing deficits for the foreseeable future. When this Administration
took office in January 1993, it vowed to restore fiscal discipline. That
goal has been amply achieved. By 1998, the budget moved into surplus for
the first time since 1969; and in 1999 it recorded an even larger
surplus of $124 billion. That is the largest surplus ever, and, at 1.4
percent of GDP, it is the largest as a share of the overall economy
since 1951. This fiscal year, the surplus is projected to rise to $167
billion, or 1.7 percent of GDP. The dramatic shift from huge deficits to
surpluses in the last seven years is unprecedented since the
demobilization just after World War II.
The historic improvement in the Nation's fiscal position during this
Administration is due in large measure to two landmark pieces of
legislation, the Omnibus Budget Reconciliation Act of 1993 (OBRA) and
the Balanced Budget Act of 1997 (BBA). OBRA enacted budget proposals
that the Administration made soon after it came into office, and set
budget deficits on a downward path. The deficit reductions following
OBRA have far exceeded the predictions made at the time of its passage.
OBRA was projected to reduce deficits by $505 billion over 1994-1998.
The actual total deficit reduction during those years was more than
twice that--$1.2 trillion. In other words, OBRA and subsequent
developments enabled the Treasury to issue $1.2 trillion less debt than
would have been required under previous estimates.
While OBRA fundamentally altered the course of fiscal policy towards
lower deficits, it was not projected to eliminate the deficit; without
further action, deficits were expected to begin to climb once again. To
prevent this and bring the budget into unified surplus, the
Administration negotiated the Balanced Budget Act with the Congress in
the summer of 1997. The BBA was not expected to produce surpluses until
2002, but like OBRA, the results of pursuing a policy of fiscal
discipline far exceeded expectations. The budget moved into surplus in
1998, four years ahead of schedule, and achieved an even larger surplus
in 1999. OBRA 1993 and BBA 1997, together with subsequent developments,
are estimated to have improved the unified budget balance compared with
the pre-OBRA baseline by a cumulative total of $6.7 trillion over 1993-
2005.
The better-than-expected budget results in recent years have
contributed to the better-than-expected economic performance. Lower
deficits and bigger surpluses helped promote a healthy, sustainable
expansion by reducing the cost of capital, through both downward
pressure on interest rates and higher prices for corporate equities. A
lower cost of capital stimulated business capital spending, which
expanded industrial capacity, boosted productivity growth, and
restrained inflation. Rising equity prices also increased household
wealth, optimism, and spending. The added impetus to consumer spending
created new jobs and business opportunities. The faster-growing economy,
in turn, boosted incomes and profits, which fed back into an even
healthier budget.
Though the benefits of fiscal discipline have been widely recognized,
the surprise in recent years has been the magnitude of the positive
impact on the economy. Growth of production, jobs, incomes, and capital
gains have all exceeded expectations. The outstanding economic
performance during this Administration is proof positive of the lasting
benefits of prudent fiscal policies.
Monetary Policy: During this expansion, the Federal Reserve tightened
policy when inflation threatened to pick up, but eased when the
expansion risked stalling out. In 1994 and early 1995, the monetary
authority
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raised interest rates when rapid growth threatened to cause inflationary
pressures. During 1995 and early 1996, however, the Federal Reserve
reduced interest rates, because the expansion appeared to be slowing
while higher inflation no longer threatened. From January 1996 until the
fall of 1998, monetary policy remained essentially unchanged; the sole
adjustment was a one-quarter percentage point increase in the federal
funds rate target in March 1997 to 5\1/2\ percent.
During the second half of 1998, however, financial turmoil abroad
threatened to spread to the United States. In addition, a large, highly
leveraged U.S. hedge fund, which had borrowed heavily from major
commercial and investment banks, nearly failed. In this environment,
normal credit channels to even the most credit-worthy private businesses
were disrupted. In response to these serious challenges to the financial
system and the economy, the Federal Reserve quickly shifted policy by
cutting the Federal funds rate by one-quarter percentage point on three
occasions in just seven weeks--the swiftest easing since 1991, when the
economy was just emerging from recession. By early 1999, those actions
had restored normal credit flows and risk spreads among credit market
instruments and returned the stock market to its upward trajectory.
With the return of financial market stability and amidst an
environment of strong growth and falling unemployment, the Federal
Reserve raised the Federal funds rate by one-quarter percentage point on
three separate occasions during 1999, returning the rate to the 5\1/2\
percent level that prevailed before the 1998 international financial
dislocation.
Real Growth: The economy expanded at a 3.7 percent annual rate over
the first three quarters of 1999, and rose at an even faster 5.8 percent
pace during the fourth quarter. Over the four quarters of the year, real
GDP increased 4.2 percent, the fourth year in a row of robust growth
exceeding 4.0 percent.
The fastest growing sector last year was again business spending on
new equipment and software, which rose 11.0 percent during 1999. The
biggest gains continued to be for information processing and software,
with added impetus from the need to upgrade systems to be Y2K compliant.
Investment in new structures, in contrast, edged down during 1999.
The exceptionally strong growth of spending for new equipment and
software in recent years raised trend productivity growth. This helped
to keep inflation in check by permitting firms to grant real wage
increases without putting upward pressure on prices. The increase in
productive capacity resulting from robust capital spending also eased
the supply bottlenecks and strains that normally would accompany tight
labor markets. In the fourth quarter of 1999, the manufacturing
operating rate was below its long-term average, even though the
unemployment rate was unusually low. Overall industrial capacity rose by
more than 4 percent in each of the past six years--the fastest sustained
increase in capacity in three decades.
The consumer sector, which accounts for two-thirds of GDP, made a
significant contribution to last year's rapid growth, as it did in the
previous two years. Consumer spending after adjustment for inflation
rose 5.4 percent over the four quarters of 1999, the largest increase in
a quarter century. Thanks to low unemployment, rising real incomes,
extraordinary capital gains from the booming stock market and record
levels of consumer confidence, households have the resources and
willingness to spend heavily, especially on discretionary, big-ticket
purchases. For example, sales of cars, minivans and other light-weight
trucks reached nearly 17 million units last year, a new record.
In 1999, growth of consumer spending again outpaced even the strong
growth of disposable personal income, pulling down the saving rate to
2.4 percent, the lowest level in the postwar period. Because of the
enormous increase in household wealth created by the soaring stock
market, households felt confident enough to boost spending by reducing
saving out of current income.
Partly because of rising wealth, households took on considerably more
debt. As a consequence, household debt service payments as a percent of
disposable personal income rose from 11.7 percent at the end of 1992 to
13.4 percent in the third quarter of 1999. However, the ratio of debt
service to income was still \3/4\ percentage point below its prior peak,
suggesting that the household sector on average was not overextended,
especially considering the rapid rise in household equity wealth.
The same factors spurring consumption pushed new and existing home
sales during 1999 to their highest level since record-keeping began. The
homeownership rate reached a record 66.8 percent last year. Buoyant
sales and low inventories of unsold homes provided a strong incentive
for new construction. Housing starts, which were already at a high level
in 1998, increased further last year to the highest level since the mid-
1980s. Residential investment, after adjustment for inflation, increased
during the first half of the year but edged down during the second half,
reflecting the peak in housing starts early in the year.
As a result of the healthier fiscal position of all levels of
government, spending by the government sector rose more rapidly than it
has in recent years. State and local consumption spending after
adjustment for inflation rose 4.6 percent last year, while Federal
Government spending increased 5.3 percent.
The foreign sector was the primary restraint on GDP growth in 1999, as
during the prior two years. Although the economic recovery of our
trading partners boosted our exports, this positive contribution to GDP
growth was more than offset by the very rapid rise of imports that
accompanied the exceptionally strong growth of U.S. domestic demand.
Over the year, exports of goods and services after adjustment for
inflation rose 4.0 percent, while imports soared 13.1 percent. As a
result, the net export balance widened considerably, and restrained real
GDP growth by an average of 1.2 percentage points per quarter--a larger
drag on growth than
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during the two previous years when recessions abroad dramatically
curtailed U.S. exports. The trade-weighted value for the dollar, which
had risen strongly in recent years, was little changed, on average,
during 1999. However, the dollar depreciated 7 percent against the
Japanese yen, while it appreciated 15 percent against the newly launched
Euro.
Labor Markets: At the start of the year, most forecasters had
expected growth to slow significantly and the unemployment rate to rise.
Instead, the economy continued to expanded at a rapid pace, pulling the
unemployment rate down from 4.3 percent at the end of 1998 to 4.1
percent during the last three months of 1999. When the Administration
took office, the unemployment rate was 7.3 percent. In December, forty-
five States had unemployment rates of 5.0 percent or less; rates in the
other five were between 5.1 and 6.1 percent. Significantly, all
demographic groups have participated in the improved labor market. The
unemployment rates for Hispanics and Blacks during 1999 were the lowest
on record.
The Nation's payrolls expanded by a sizeable 2.7 million jobs last
year. As in 1998, employment did not increase in all industries; mining
and manufacturing, which are especially vulnerable to adverse
developments in international trade, lost jobs. However, a greater
number of jobs were created in the private service sector, construction,
and State and local government. The abundance of employment
opportunities last year kept the labor force participation rate at the
record-high level set in 1997 and 1998, and pulled up the employment/
population ratio to the highest level ever.
Inflation: Despite continued rapid economic growth and the low
unemployment rate, inflation remained low last year, and the ``core''
rate even slowed. The core CPI, which excludes the volatile food and
energy components, rose just 1.9 percent over the 12 months of 1999,
down from 2.4 percent during 1998. Last year's rise in the core rate was
the smallest since 1965. However, because of a sharp rise in energy
prices, driven to a considerable extent by international economic
recovery, the total CPI rose 2.7 percent last year--up from 1.6 percent
during 1998, when energy prices fell substantially.
The broader GDP chain-weighted price index rose just 1.6 percent
during 1999, not much higher than the 1.1 percent during the four
quarters of 1998. This is the smallest two-year rise in overall prices
since 1962-63. The favorable inflation performance was the result of
intense competition, including from imports; very small increases in
unit labor costs because of robust productivity growth; and perhaps
structural changes in the link between unemployment and inflation.
Last year, however, import and export prices exerted less of a
restraint on inflation than in prior years. Because of the overall
stability of the dollar last year, import prices other than petroleum
were about unchanged during 1999; by contrast, import prices had been
falling for several years in response to the dollar's rise. Moreover,
the price of imported petroleum products doubled last year as a result
of a recovery in world demand and a cutback in OPEC production. On the
other side of the ledger, prices of exported goods (a component of the
GDP price index) were about unchanged during 1999, after having fallen
in 1998; the dollar's stability enabled U.S. firms to avoid having to
cut prices to remain competitive.
Real wages grew again in 1999; but even with the low unemployment,
hourly earnings and the broader measures of compensation rose slightly
less during 1999 than in the prior year. Robust investment in new
equipment contributed to unusually strong productivity growth for this
stage of an expansion, helping to restrain inflation by offsetting the
nominal rise in labor compensation. Unit labor costs rose at only a 1.8
percent annual rate during the first three quarters of 1998, down from
2.1 percent during 1999.
The absence of any signs of a buildup of inflationary pressures
despite low and falling unemployment and rapid growth 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 of lower unemployment without higher inflation,
even after taking into account the influence of temporary factors. The
economic projections for this Budget assume that NAIRU is in a range
centered on 5.2 percent in the long run. That is the same rate as in the
Mid-Session Review published last June, but 0.1 percentage point less
than estimated in the 2000 Budget assumptions, and 0.5 percentage point
less than in the 1997 Budget. Most private forecasters have also reduced
their estimates of NAIRU in recent years.
By the end of 1999, the unemployment rate was well below the current
mainstream estimate of the long run NAIRU. The Administration's forecast
for real growth over the next three years implies that unemployment will
return to 5.2 percent by the middle of 2003.
Statistical Issues
Statistical agencies must constantly improve their measurement tools
to keep up with rapid structural changes in the U.S. economy. Last year,
the Bureau of Labor Statistics (BLS) implemented the latest in a series
of planned improvements to the Consumer Price Index; and the Bureau of
Economic Analysis (BEA) made significant methodological and statistical
changes to the National Income and Product Accounts. On balance, these
changes revised real GDP growth and labor productivity growth
significantly upward in recent years.
Inflation: The CPI is not just another statistic. Perhaps more than
any other statistic, it actually affects the incomes of governments,
businesses and households via statutory and contractual cost-of-living
adjustments.
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As such, recent improvements in measurement of the CPI--which, on
balance, have slowed its increase--have significant impacts throughout
the economy. Because the CPI is used to deflate some nominal spending
components of GDP as well as household incomes, compensation, and wages,
a slower rise in the CPI translates directly into a faster measured real
growth of such key indicators as GDP, productivity, household incomes
and wages.
In recent years, considerable attention has been given to estimating
the magnitude of the bias in the CPI and how best to reduce it. In
December 1996, the Advisory Commission to Study the Consumer Price
Index, appointed by the Senate Finance Committee, issued its
recommendations on this subject.
Beginning in 1995, the Bureau of Labor Statistics instituted a number
of important methodological improvements to the CPI. Taken together,
these changes are estimated to result in about a 0.6 percentage point
slower annual increase in the index in 1999 and every year thereafter
compared with the methodologies and market basket used in 1994. The most
recent significant change, instituted beginning with the January 1999
CPI release, replaced the fixed-weighted Laspeyres formula, which had
been used to aggregate lower level components of the CPI, with a
geometric mean formula for most such aggregates. A CPI calculated using
geometric means more closely approximates a cost-of-living index. Unlike
the fixed-weighted aggregation, the geometric mean formula assumes
consumer spending patterns shift in response to changes in relative
prices within categories of goods and services.
Also in 1999, BLS instituted new rotation procedures in its sampling
of retail outlets where it selects items for price collection. The new
procedures focus on expenditure categories rather than geographic areas,
thereby enabling the CPI to incorporate price information on new, high-
tech consumer products in a more timely fashion.
The next scheduled improvement will be an updating of the consumption
expenditure weights used in the CPI effective with the release of the
CPI for January of 2002, when weights based on spending patterns in
1999-2000 will replace the current 1993-95 market-basket weights. The
BLS has announced that it will update expenditure weights every two
years thereafter. It is expected that the shift to biennial updates of
the weights will have little impact on measured inflation.
For the Federal Government, slower increases in the CPI mean that
outlays for programs with cost-of-living adjustments tied to this index
or its components--such as Social Security, Supplemental Security Income
(SSI), retirement payments for railroad and Federal employees, and Food
Stamps--will rise at a slower pace, more in keeping with true inflation,
than they would have without these improvements. In addition, slower
growth of the CPI will raise the growth of tax receipts because personal
income tax brackets, the size of the personal exemptions, and
eligibility thresholds for the Earned Income Tax Credit (EITC) are
indexed to the CPI. Thus, the methodological improvements made in recent
years act on both the outlays and receipts sides of the budget to
increase the budget surpluses.
For the National Income and Product Accounts, the Bureau of Economic
Analysis follows the convention that changes in concepts and methods of
estimation are incorporated into the historical series whenever
possible. In contrast, the Bureau of Labor Statistics (BLS) follows the
convention that the historical CPI series is never revised. The
reasoning is that the public is probably better served by having an
unchanged CPI series for convenient use in contract escalation clauses
rather than one that is revised historically and might trigger claims
for payment adjustments with every revision.
The BLS, however, has recently published a research CPI series (the
CPI-RS) that backcasts the current methods to 1978. (See ``CPI Research
Series Using Current Methods, 1978-98,'' Monthly Labor Review, June
1999, for the series and an explanation of all the methodological
improvements instituted since 1978.) This methodologically consistent
series shows a slower rise in inflation, and therefore a faster rise in
real measures, than the official CPI: during these 21 years, the CPI-RS
increased 4.28 percent per year on average compared with 4.73 percent
for the CPI, a difference of 0.45 percentage point per year.
As discussed below, the National Income and Product Accounts had
already incorporated many of the improvements in methods that have been
made over the years in the CPI. The most recent significant improvement,
the use of a geometric mean formula for combining lower level
aggregates, was incorporated into the October benchmark national
accounts for the period 1977-94; this change was already in the national
accounts for the period since 1994.
National Income and Product Accounts: In October, the BEA released a
comprehensive revision of the National Income and Product Accounts
(NIPA), also referred to as a ``benchmark'' revision. These periodic
revisions differ from the usual annual revisions in that they are much
wider in scope and include definitional, methodological and
classification changes in addition to incorporation of new and revised
source data. The latest comprehensive revision significantly changed the
definition and estimates of nominal and real GDP, investment, and
saving. (For details about the revision, see the August, October and
December, 1999 issues of the Survey of Current Business.)
Real and Nominal GDP: The most significant definitional change was
the recognition of business and government expenditures on computer
software (including the costs of in-house production of software) as
investment, and therefore as a component of GDP and the Nation's capital
stock. Until this revision, BEA had treated software, except that
embedded in other equipment, as if it were an intermediate good, and had
not counted it in GDP until it appeared as part of a final
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product. Intermediate goods do not add directly to GDP; capital goods
do. (The Federal Government investment estimates presented in Chapter 6
of this volume also treat software as investment.)
The rapid growth of spending on software in recent years has made a
significant contribution to the new, upwardly revised estimates of real
GDP growth. Although real GDP growth was raised by 0.4 percentage point
per year on average during 1987-93 and by a similar amount since then,
the sources of the revision differ greatly between the two periods.
During 1987-93, new definitions, notably the inclusion of spending on
computer software as a component of investment, boosted growth by only
0.1 percentage point. The downward revision to inflation estimates,
notably the incorporation of the geometric mean formula to estimate
consumer price inflation, contributed another 0.3 percentage point. New
source data did not make any contribution to the upward revision of real
growth. In contrast, during 1994-98, about 0.2 percentage point of the
upward revision was due to the inclusion of computer software; and
another 0.2 percentage point was due to revised source data. Revisions
to inflation hardly affected the estimate of real GDP growth.
The sources of the upward revision to nominal GDP provide another
perspective on the importance of including software in the definition of
GDP. For calendar year 1998, the benchmark revision in total raised
nominal GDP by $249 billion, or 2.9 percent. Definitional sources,
primarily the new classification of software, added $169 billion (2.0
percentage points). Statistical sources (including new and revised
source data, the incorporation of the more recent input-output accounts,
and preliminary data from the 1997 economic census) accounted for $80
billion (0.9 percentage point).
Saving: By including computer software spending as investment, the
comprehensive revisions boosted measured gross business saving (or
undistributed profits and capital consumption) but increased gross
national saving much more than net national saving. That is because
including software as investment also increases capital consumption
(depreciation) more than undistributed profits. In fact, most of the
gross investment in software, as measured in NIPA, goes to replace the
large amount of software that is annually ``used up'' or depreciated
through technical obsolescence, as reflected in the short service lives.
Therefore, net saving is only a slightly larger share of Net Domestic
Product in recent years than it was in the previous data, and for some
prior years, in which capital consumption increased more as a result of
the revision than did gross saving, the revised net saving rate is
smaller than it was previously. It is only net saving and its
counterpart, net investment, that adds to the Nation's net capital
stock.
In addition to defining software spending as part of GDP, the
comprehensive revisions made other changes in the NIPA definitions.
These did not have a noticeable effect on nominal or real GDP or overall
national saving; they did, however, affect measured saving of government
and households. These definitional changes included:
A shift in the classification of government employee
pensions from the public sector to the private sector, which
increased measured personal saving, and reduced the NIPA
government surplus by an equal amount. (For an explanation of
the differences between the NIPA definition of the Federal
Government surplus and the unified surplus referred to in the
Budget, see Chapter 16 of this volume.)
Estate and gift taxes were reclassified as ``capital
transfers.'' This reduced government saving by reducing
current receipts, and increased personal saving by reducing
personal taxes.
Federal investment grants were also reclassified as
``capital transfers,'' which increased Federal saving by
eliminating a category previously counted as a NIPA Federal
government expenditure. As a counterpart, the reclassification
reduced State and local government revenues and, therefore,
the saving of that sector.
These changes affected the composition of saving, shifting some saving
from the government sector to the household sector. The new methodology
treats government employee pensions the same as private employee
pensions: the contributions to the pension programs are treated as
saving of the household sector; the earnings on pension fund assets are
treated as household income; and the benefits paid by the pension funds
are defined as transfers within the household sector, not part of
government transfer payments. The net effect of these changes is to
raise the NIPA measures of personal saving while lowering the NIPA
government surplus. The previously reported nonoperating surplus of
State and local governments, which was composed in large part of the
difference between pension fund receipts and payments, was nearly
eliminated by this change.
Productivity: The upward revisions to real GDP growth, and in
particular, the even larger revisions to the growth of output in the
Nation's nonfarm business sector, have significantly raised measured
labor productivity growth--especially beginning in 1994, because of the
inclusion of software spending and the revised source data.
The Administration had already raised its projections of real GDP and
productivity growth in last summer's Mid-Session Review. The further
increase in trend growth of GDP and productivity in the 2001 assumptions
presented below reflects the new information in the benchmark revision
that revealed that underlying source data in recent years have been
revised upward.
Productivity growth, which had averaged 1.4 percent per year from 1994
through 1998, was revised up to 1.9 percent per year. During the four
years through the third quarter of 1999, the most recent quarter
available, productivity growth averaged an even faster 2.7 percent per
year. In other words, the recent growth of productivity is double the
pace experienced from 1973 to 1995, and on a par with the rapid rates
that pre
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vailed from the end of World War II until the first oil crisis in 1973.
The growth of productivity would be even faster in recent years if
nonfarm business output were measured from the income side of the
national accounts (using Gross Domestic Income) rather than from the
slower-growing GDP product side. Since the third quarter of 1995, gross
domestic income in real terms has grown 0.4 percentage point per year
faster than the growth of GDP. That is because the statistical
discrepancy--the difference between the product and income sides of the
accounts--has shifted from $3 billion to -$141 billion over these four
years. In principle, the product and income sides of the accounts should
be equal. In practice, this does not occur because the two measures are
estimated from different source data. What is unique about recent years,
however, is the extent of the difference and the magnitude of the swing.
Although there is no perfect measure of productivity and real growth,
the income side perspective provides some reason to believe that
productivity and real growth recently may have been even stronger than
the official series suggest.
Economic Projections
The economy's outstanding performance last year--indeed, over the last
seven years--and the maintenance of sound policies raise the possibility
that future economic developments may continue even better than assumed.
Nonetheless, it is prudent to base budget estimates on a conservative
set of economic assumptions, close to the consensus of private-sector
forecasts.
Table 1-1. ECONOMIC ASSUMPTIONS \1\
(Calendar years; dollar amounts in billions)
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Projections
Actual -----------------------------------------------------------------------------------------------------------
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Gross Domestic Product (GDP):
Levels, dollar amounts in billions:
Current dollars........................................................ 8,760 9,232 9,685 10,156 10,621 11,105 11,644 12,236 12,847 13,477 14,118 14,777 15,471
Real, chained (1996) dollars........................................... 8,516 8,850 9,142 9,393 9,629 9,870 10,146 10,451 10,758 11,064 11,360 11,655 11,958
Chained price index (1996 = 100), annual average....................... 102.9 104.3 105.9 108.1 110.3 112.5 114.8 117.1 119.4 121.8 124.3 126.8 129.4
Percent change, fourth quarter over fourth quarter:
Current dollars........................................................ 5.9 5.2 4.8 4.6 4.6 4.5 5.0 5.1 4.9 4.9 4.7 4.7 4.7
Real, chained (1996) dollars........................................... 4.6 3.8 2.9 2.6 2.5 2.5 3.0 3.0 2.9 2.8 2.6 2.6 2.6
Chained price index (1996 = 100)....................................... 1.1 1.4 1.9 2.0 2.0 2.0 2.0 2.0 2.0 2.0 2.0 2.0 2.0
Percent change, year over year:
Current dollars........................................................ 5.5 5.4 4.9 4.9 4.6 4.6 4.9 5.1 5.0 4.9 4.8 4.7 4.7
Real, chained (1996) dollars........................................... 4.3 3.9 3.3 2.7 2.5 2.5 2.8 3.0 2.9 2.8 2.7 2.6 2.6
Chained price index (1996 = 100)....................................... 1.2 1.4 1.6 2.0 2.0 2.0 2.0 2.0 2.0 2.0 2.0 2.0 2.0
Incomes, billions of current dollars:
Corporate profits before tax........................................... 782 845 842 828 827 824 852 892 933 971 1,001 1,034 1,062
Wages and salaries..................................................... 4,186 4,470 4,711 4,942 5,161 5,388 5,629 5,892 6,176 6,458 6,747 7,039 7,342
Other taxable income \2\............................................... 1,990 2,088 2,161 2,231 2,293 2,356 2,431 2,518 2,609 2,703 2,802 2,904 3,015
Consumer Price Index (all urban): \3\
Level (1982-84 = 100), annual average.................................. 163.1 166.7 171.0 175.1 179.6 184.3 189.1 194.0 199.0 204.2 209.5 215.0 220.6
Percent change, fourth quarter over fourth quarter..................... 1.5 2.7 2.3 2.5 2.6 2.6 2.6 2.6 2.6 2.6 2.6 2.6 2.6
Percent change, year over year......................................... 1.6 2.2 2.6 2.4 2.6 2.6 2.6 2.6 2.6 2.6 2.6 2.6 2.6
Unemployment rate, civilian, percent:
Fourth quarter level................................................... 4.4 4.1 4.3 4.7 5.1 5.2 5.2 5.2 5.2 5.2 5.2 5.2 5.2
Annual average......................................................... 4.5 4.2 4.2 4.5 5.0 5.2 5.2 5.2 5.2 5.2 5.2 5.2 5.2
Federal pay raises, January, percent:
Military \4\........................................................... 2.8 3.6 4.8 3.7 3.7 3.2 3.2 3.2 NA NA NA NA NA
Civilian \5\........................................................... 2.8 3.6 4.8 3.7 3.7 3.2 3.2 3.2 NA NA NA NA NA
Interest rates, percent:
91-day Treasury bills \6\.............................................. 4.8 4.7 5.2 5.2 5.2 5.2 5.2 5.2 5.2 5.2 5.2 5.2 5.2
10-year Treasury notes................................................. 5.3 5.6 6.1 6.1 6.1 6.1 6.1 6.1 6.1 6.1 6.1 6.1 6.1
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
NA = Not Available.
\1\ Based on information available as of late November 1999.
\2\ Rent, interest, dividend and proprietor's components of personal income.
\3\ Seasonally adjusted CPI for all urban consumers.
\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.
The economic assumptions summarized in Table 1-1 are predicated on the
adoption of the policies proposed in this Budget. The maintenance of
unified budget surpluses in the coming years is expected to contribute
to continued favorable economic performance. Growing Federal Government
surpluses reduce real interest rates, stimulate private-sector
investment in new plant
[[Page 10]]
and equipment, boost productivity growth, and thereby raise real incomes
and help keep inflation under control. The Federal Reserve is assumed to
continue to pursue the goal of keeping inflation low while promoting
growth.
The economy is likely to continue to grow during the next few years,
although at a more moderate pace than during 1999. While job
opportunities are expected to remain plentiful, the unemployment rate is
projected to rise gradually to the range that mainstream private-sector
forecasters estimate is consistent with stable inflation. New job
creation will boost incomes and consumer spending, and keep confidence
at a high level. Continued low inflation will support economic growth.
Growth, in turn, will further help the budget balance.
Real GDP, Potential GDP and Unemployment: During 2000, real GDP is
expected to rise 2.9 percent, then average 2.5 percent during the
following three years. This shift to more moderate growth recognizes
that by mainstream assumptions, growth must proceed at a pace below the
Nation's potential GDP growth rate for a while; the unemployment rate
would then rise somewhat, thereby avoiding a build-up of inflationary
pressures. Beginning in 2004, real GDP growth is assumed to match the
growth of potential GDP. Inflation-adjusted potential and actual growth
are projected to moderate from 3.0 percent yearly during 2004-2005 to
2.6 percent during 2008-2010.
As has been the case throughout this expansion, business fixed
investment is again expected to be the fastest-growing component of GDP,
although capital spending is likely to slow from the double-digit pace
of recent years. Consumer spending is also expected to moderate, as the
stimulus from the soaring stock market of the last few years approaches
its full effect. Although residential investment is also expected to
benefit from relatively low mortgage rates and strong demand for second
homes for vacation or retirement, the high level of housing starts in
recent years and underlying demographic trends may tend to reduce future
growth from the pace of the last few years.
The growth of the Federal and State/local government components of GDP
is also projected to moderate from the pace of recent years. The net
export balance is expected to be less of a restraint on growth this year
than during 1998-99, because more moderate growth of domestic demand is
expected to slow the growth of imports. After 2000, the foreign sector
is projected to make a modest, positive contribution to GDP growth in
each year, reflecting the fundamental competitiveness of U.S. business,
and the increased demand for U.S. exports that is likely to accompany a
sustained recovery of activity abroad.
The real GDP growth projection is consistent with a gradual rise in
the unemployment rate to 5.2 percent by mid-2003. The unemployment rate
is then projected to remain at that level on average thereafter, as real
GDP growth returns to the Administration's estimate of the economy's
potential growth rate.
Potential GDP growth depends largely on the trend growth of labor
productivity in the nonfarm business sector and the growth of the labor
force. Productivity growth is assumed to moderate gradually from the
high rates of recent years. During 2000-2001, productivity is projected
to rise 2.1 percent annually on average, then phase down to 1.8 percent
(which is the average rate experienced during the 1990s after allowance
is made for the procyclical behavior of productivity) from 2007 onwards.
The productivity path in the projection is a conservative estimate that
allows the near-term projection to rely more heavily on recent
experience and the longer-term projection to rely on the productivity
experience over a longer period.
The labor force component of potential GDP growth is assumed to rise
1.2 percent per year through 2007 and then slow to 1.0 percent yearly as
the first of the baby-boomers begin to retire.
Inflation: With the unemployment rate well below mainstream estimates
of the NAIRU, inflation is projected to creep up. The CPI is projected
to increase 2.3 percent during this year, rising to 2.6 percent in 2002
and thereafter. The GDP chain-weighted price index is projected to
increase 1.9 percent during 2000, and 2.0 percent thereafter.
The 0.6 percentage point difference between the CPI and the GDP chain-
weighted price index matches the average difference between these two
inflation measures during the past five years. The CPI tends to increase
relatively faster than the GDP chain-weighted price index in part
because sharply falling computer prices exert less of an impact on the
CPI than on the GDP price measure.
In the 2000 budget, this ``wedge'' between the two measures was
projected to be 0.2 percentage point. The larger wedge assumed in this
projection tends to reduce the Federal budget surplus because Social
Security payments and other indexed programs increase with the faster-
rising CPI, while Federal revenues are expected to increase in step with
the slower-rising GDP chain-weighted price index. In addition, a
relatively faster-rising CPI reduces the rate of growth of Federal
receipts because the CPI is used to index personal income tax brackets,
the size of the personal exemptions, and the eligibility thresholds for
the Earned Income Tax Credit.
Interest Rates: The assumptions, which were based on information as
of late November, project stable short- and long-term interest rates.
The 91-day Treasury bill rate is expected to average 5.2 percent over
the forecast horizon; the yield on the 10-year Treasury bond is
projected to average 6.1 percent. Since the completion of the
assumptions, market rates have edged up somewhat.
Incomes: On balance, the share of total taxable income in nominal GDP
is projected to decline gradually. This is primarily because the
corporate profits share of GDP is expected to fall. That is a
consequence of
[[Page 11]]
the expected rapid growth of depreciation, a component of business
expenses. Robust growth of capital spending, especially on rapidly
depreciating high-tech equipment and software, suggests that
depreciation will account for an increasing share of GDP at the expense
of the corporate profits share. The personal interest income share is
also projected to decline, as interest rates remain relatively low and
as households hold less Federal Government debt because of the projected
unified budget surpluses. The share of labor compensation in GDP is
expected to be little changed.
Comparison with CBO
Table 1-2. COMPARISON OF ECONOMIC ASSUMPTIONS
(Calendar years; percent)
--------------------------------------------------------------------------------------------------------------------------------------------------------
Projections
---------------------------------------------------------------------------------------
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
--------------------------------------------------------------------------------------------------------------------------------------------------------
Real GDP (chain-weighted): \1\
CBO January................................................... 2.9 3.0 2.7 2.6 2.6 2.7 2.7 2.7 2.8 2.9 2.9
2001 Budget................................................... 2.9 2.6 2.5 2.5 3.0 3.0 2.9 2.8 2.6 2.6 2.6
Chain-weighted GDP Price Index: \1\
CBO January................................................... 1.7 1.6 1.7 1.7 1.7 1.7 1.7 1.7 1.7 1.7 1.7
2001 Budget................................................... 1.9 2.0 2.0 2.0 2.0 2.0 2.0 2.0 2.0 2.0 2.0
Consumer Price Index (all-urban): \1\
CBO January................................................... 2.3 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5
2001 Budget................................................... 2.3 2.5 2.6 2.6 2.6 2.6 2.6 2.6 2.6 2.6 2.6
Unemployment rate: \2\
CBO January................................................... 4.1 4.2 4.4 4.7 4.8 5.0 5.0 5.1 5.2 5.2 5.2
2001 Budget................................................... 4.2 4.5 5.0 5.2 5.2 5.2 5.2 5.2 5.2 5.2 5.2
Interest rates: \2\
91-day Treasury bills:
CBO January................................................. 5.4 5.6 5.3 4.9 4.8 4.8 4.8 4.8 4.8 4.8 4.8
2001 Budget................................................. 5.2 5.2 5.2 5.2 5.2 5.2 5.2 5.2 5.2 5.2 5.2
10-year Treasury notes:
CBO January................................................. 6.3 6.4 6.1 5.8 5.7 5.7 5.7 5.7 5.7 5.7 5.7
2001 Budget................................................. 6.1 6.1 6.1 6.1 6.1 6.1 6.1 6.1 6.1 6.1 6.1
Taxable income (share of GDP): \3\
CBO January................................................... 79.9 79.3 78.6 78.0 77.5 77.1 76.8 76.4 76.1 75.8 75.4
2001 Budget................................................... 79.6 78.8 78.0 77.2 76.5 76.0 75.6 75.2 74.7 74.3 73.8
--------------------------------------------------------------------------------------------------------------------------------------------------------
\1\ Percent change, fourth quarter over fourth quarter.
\2\ Annual averages, percent.
\3\ Taxable personal income plus corporate profits before tax.
The Congressional Budget Office (CBO) prepares the economic
projections used by Congress in formulating budget policy. In the
executive branch, this function is performed jointly by the Treasury,
the Council of Economic Advisers (CEA), and the Office of Management and
Budget (OMB). It is natural that the two sets of economic projections be
compared with one another, but there are several important differences,
along with the similarities, that should be kept 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 to hold; thus, it makes
a ``pre-policy'' projection. In recent years, and currently, CBO has
made economic projections based on a fiscal policy similar to the
budget's. An additional source of difference is that CBO and
Administration forecasts are finalized at somewhat different times.
Table 1-2 presents a summary comparison of the Administration and CBO
projections. Briefly, they are very similar for all the major variables
affecting the budget outlook.
Real growth and unemployment: Over the 10-year projection horizon, the
average rates of real GDP growth projected by CBO and the Administration
are quite close. However, CBO projects somewhat faster growth through
2003 than does the Administration, while the Administration assumes
somewhat faster growth than CBO during the following four years. During
the last three years of the projection period, CBO projects a slight
pickup in the growth rate to a faster pace than that projected by the
Administration.
These differences in real growth contribute to the differences in the
unemployment rate paths. While both projections assume that the rate
will gradually rise to, and level off at, 5.2 percent, the
Administration's projection reaches this sustainable level in 2003 while
CBO's projection reaches it in 2008.
Inflation: The Administration and CBO forecast the same moderate
rates of increase for the CPI for 2000 and 2001, and differ by only 0.1
percentage point thereafter, with the Administration higher. Over the
same period, both project low and steady rates of increase
[[Page 12]]
for the GDP price index, with CBO's projection 0.3 percentage point
lower in each year, 2000-2010.
Interest rates: The Administration and CBO have very similar paths for
long- and short-term interest rates. In 2000 and 2001, CBO's rates are
slightly higher; from 2003 onward, CBO's are slightly lower.
Income shares: Although both projections envision a decline in the
total taxable income share of GDP, primarily because of a decline in the
profits share, the CBO total taxable share is higher in every year, and
declines more slowly, than the Administration's share.
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 fundamental
shift in fiscal posture from large unified budget deficits to moderate
unified budget surpluses would result in a significant boost in
investment, which would serve to extend the economic expansion at a
moderate pace while helping to maintain low, steady rates of inflation
and unemployment. The shift to unified budget surpluses and the ensuing
stronger investment were also expected to continue to have favorable
effects on receipts and the budget balance, because of stronger profits,
capital gains, and high taxable incomes.
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 economic performance in 1999 that has, once
again, proven more favorable than was anticipated at the beginning of
last year. Economic growth was stronger than expected in 1999, while
inflation and unemployment were lower. Because of this favorable
performance, the projected annual averages for the unemployment rate and
GDP price index have again been reduced slightly this year--but
conservatively. At the same time, interest rates are assumed in this
budget to remain near their current low levels.
Table 1-3. COMPARISON OF ECONOMIC ASSUMPTIONS IN THE 2000 AND 2001 BUDGETS
(Calendar years; dollar amounts in billions)
----------------------------------------------------------------------------------------------------------------
1999 2000 2001 2002 2003 2004 2005
----------------------------------------------------------------------------------------------------------------
Nominal GDP:
2000 Budget assumptions \1\.................... 9,108 9,495 9,899 10,345 10,823 11,325 11,850
2001 Budget assumptions........................ 9,232 9,685 10,156 10,621 11,105 11,644 12,236
Real GDP (percent change): \2\
2000 Budget assumptions........................ 2.1 2.1 2.1 2.5 2.5 2.5 2.5
2001 Budget assumptions........................ 3.8 2.9 2.6 2.5 2.5 3.0 3.0
GDP price index (percent change): \2\
2000 Budget assumptions........................ 1.9 2.1 2.1 2.1 2.1 2.1 2.1
2001 Budget assumptions........................ 1.4 1.9 2.0 2.0 2.0 2.0 2.0
Consumer Price Index (percent change): \2\
2000 Budget assumptions........................ 2.3 2.3 2.3 2.3 2.3 2.3 2.3
2001 Budget assumptions........................ 2.7 2.3 2.5 2.6 2.6 2.6 2.6
Civilian unemployment rate (percent): \3\
2000 Budget assumptions........................ 4.8 5.0 5.2 5.3 5.3 5.3 5.3
2001 Budget assumptions........................ 4.2 4.2 4.5 5.0 5.2 5.2 5.2
91-day Treasury bill rate (percent): \3\
2000 Budget assumptions........................ 4.2 4.3 4.3 4.4 4.4 4.4 4.4
2001 Budget assumptions........................ 4.7 5.2 5.2 5.2 5.2 5.2 5.2
10-year Treasury note rate (percent): \3\
2000 Budget assumptions........................ 4.9 5.0 5.2 5.3 5.4 5.4 5.4
2001 Budget assumptions........................ 5.6 6.1 6.1 6.1 6.1 6.1 6.1
----------------------------------------------------------------------------------------------------------------
\1\ Adjusted for October 1999 NIPA revisions.
\2\ Fourth quarter-to-fourth quarter.
\3\ Calendar year average.
The net effects on the budget of these modifications in the economic
assumptions are shown in Table 1-4. By far the largest effects come from
higher receipts during 2000-2005 resulting from higher nominal incomes.
In all years through 2005, there are higher outlays for interest due to
the higher interest rates in the 2001 Budget assumptions than in the
2000 Budget assumptions, and, in most years, higher outlays for cost-of-
living adjustments to Federal programs due to higher CPI inflation
assumptions. On net, the changes in economic assumptions since last year
increase unified budget surpluses by $61 billion to $85 billion a year.
Table 1-4. EFFECTS ON THE BUDGET OF CHANGES IN ECONOMIC ASSUMPTIONS SINCE LAST YEAR
(In billions of dollars)
----------------------------------------------------------------------------------------------------------------
2000 2001 2002 2003 2004 2005
----------------------------------------------------------------------------------------------------------------
Budget totals under 2000 Budget economic assumptions and
2001 Budget policies:
Receipts................................................ 1,899.3 1,947.5 2,004.1 2,076.2 2,166.4 2,259.3
Outlays................................................. 1,793.6 1,835.7 1,893.1 1,960.3 2,041.3 2,128.8
-----------------------------------------------------
Unified budget surplus.............................. 105.7 111.8 111.0 116.0 125.1 130.5
Changes due to economic assumptions:
Receipts................................................ 57.0 71.5 77.1 71.3 69.7 81.6
Outlays:
Inflation............................................. -1.8 -0.9 0.3 2.0 3.7 5.8
Unemployment.......................................... -7.8 -7.7 -3.5 -0.7 -0.9 -1.1
Interest rates........................................ 6.9 12.2 13.2 12.5 11.5 9.9
Interest on changes in borrowing...................... -1.4 -4.4 -7.8 -11.2 -14.4 -17.9
-----------------------------------------------------
Total, outlay changes (net)......................... -4.1 -0.7 2.2 2.6 -0.2 -3.4
-----------------------------------------------------
Increase in surplus................................. 61.0 72.2 74.9 68.7 69.9 85.0
Budget totals under 2001 Budget economic assumptions and
policies:
Receipts................................................ 1,956.3 2,019.0 2,081.2 2,147.5 2,236.1 2,340.9
Outlays................................................. 1,789.6 1,835.0 1,895.3 1,962.9 2,041.1 2,125.5
-----------------------------------------------------
Unified budget surplus.............................. 166.7 184.0 185.9 184.6 195.0 215.4
----------------------------------------------------------------------------------------------------------------
Note: The surplus allocation for debt reduction is part of the President's overall budgetary framework to extend
the solvency of Social Security and Medicare, and is shown in Tale S-1 in Part 6 of the 2001 Budget.
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
[[Page 13]]
is larger than it would be if unemployment were at the long-run NAIRU.
The portion of the surplus or deficit that can be traced to this factor
is called the cyclical surplus or deficit. The remainder, the portion
that would remain with unemployment at the long-run NAIRU (consistent
with a 5.2 percent unemployment rate), is called the structural surplus
or deficit.
Table 1-5. ADJUSTED STRUCTURAL BALANCE
(In billions of dollars)
--------------------------------------------------------------------------------------------------------------------------------------------------------
1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
--------------------------------------------------------------------------------------------------------------------------------------------------------
Unadjusted deficit (-) or surplus.. -290.4 -255.0 -203.1 -163.9 -107.4 -21.9 69.2 124.4 166.7 184.0 185.9 184.6 195.0 215.4
Cyclical component............... -106.1 -106.1 -73.0 -30.9 -13.1 16.7 48.3 74.8 74.1 57.9 35.4 15.2 1.7 ......
--------------------------------------------------------------------------------------------------------------------
Structural deficit (-) or surplus.. -184.3 -148.9 -130.1 -133.0 -94.3 -38.6 21.0 49.6 92.6 126.1 150.5 169.5 193.3 215.4
Deposit insurance outlays........ -2.3 -28.0 -7.6 -17.9 -8.4 -14.4 -4.4 -5.3 -1.4 -1.6 -1.3 -1.0 -0.7 0.2
--------------------------------------------------------------------------------------------------------------------
Adjusted structural deficit (-) or -186.6 -176.9 -137.7 -150.9 -102.7 -53.0 16.6 44.3 91.2 124.5 149.2 168.5 192.5 215.7
surplus...........................
--------------------------------------------------------------------------------------------------------------------------------------------------------
Changes in the structural balance give a better picture of the impact
of budget policy on the economy than do changes in 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 achieves permanently
sustainable operating levels.
In the early 1990s, large swings in net outlays for deposit insurance
(savings and loan and bank 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.
For the period 1999 through 2002, the unemployment rate is slightly
below the long-run NAIRU of 5.2 percent, resulting in cyclical
surpluses. Thereafter, unemployment is projected to equal the NAIRU, so
the cyclical component of the surplus vanishes. Deposit insurance net
outlays are now relatively small and do not change greatly from year to
year. Two significant points are illustrated by this table. First, of
the $415 billion swing in the actual budget balance between 1992 and
1999 (from a $290 billion deficit to a $124 billion surplus), 44 percent
($181 billion) resulted from cyclical improvement in the economy. The
rest of the reduction stemmed in major part from policy actions--mainly
those in the Omnibus Budget Reconciliation Act of 1993, which reversed a
projected continued steep rise in the unified budget deficit and set the
stage for the remarkable cyclical improvement that has occurred. Second,
the structural surplus is expected to rise sub
[[Page 14]]
stantially over the projection horizon--in part due to the effects of
the Balanced Budget Act of 1997--even though the cyclical component of
the surplus is projected to vanish by 2005.
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.
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 high rate of real GDP growth is generally
associated with a declining rate of unemployment, while moderate 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
2000 only, and the unemployment rate rises by one-half percentage point,
the fiscal 2000 surplus would decrease by $10.5 billion; receipts in
2000 would be lower by about $8.5 billion, and outlays, primarily for
unemployment-sensitive programs, would be higher by about $2.0 billion.
In fiscal year 2001, the receipts shortfall would grow further to about
$18.3 billion, and outlays would increase by about $6.8 billion relative
to the base, even though the growth rate in calendar 2001 equals the
rate originally assumed. This effect grows because the level of real
(and nominal) GDP and taxable incomes would be permanently lower, and
unemployment higher. 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 (2000-2005) 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 $179.3 billion relative to the base case by 2005.
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
$145.5 billion worsening of the budget balance by 2005.
Joint changes in interest rates and inflation have a smaller effect on
the budget balance 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 2000 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
2000 rise by $5.8 billion and receipts by $9.9 billion, for an increase
of $4.1 billion in the 2000 surplus. In 2001, outlays would be above the
base by $11.9 billion, due in part to lagged cost-of-living adjustments;
receipts would rise $19.8 billion above the base, however, resulting in
a $7.8 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 $50.4 billion to outlays and $117.3 billion to
receipts in 2005, for a net increase in the surplus of $66.9 billion.
The table shows the interest rate and the inflation effects
separately. These separate effects for interest rates and inflation
rates do not sum to the effects for simultaneous changes in both. This
occurs because, when the unified budget is in surplus and some debt is
being retired, the combined effects of two changes in assumptions
affecting debt financing patterns and interest costs may differ from the
sum of the separate effects, depending on assumptions about Treasury's
selection of debt maturities to retire and the interest rates they bear.
In any case, the sensitivity of the budget to interest rate changes has
been greatly reduced since the budget shifted into unified surplus. The
last entry in the table shows rules of thumb for the added interest cost
associated with changes in the unified budget surplus.
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.
[[Page 15]]
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.
Table 1-6. SENSITIVITY OF THE BUDGET TO ECONOMIC ASSUMPTIONS
(In billions of dollars)
----------------------------------------------------------------------------------------------------------------
Budget effect 2000 2001 2002 2003 2004 2005
----------------------------------------------------------------------------------------------------------------
Real Growth and Employment
Budgetary effects of 1 percent lower real GDP
growth:
For calendar year 2000 only: \1\
Receipts........................................ -8.5 -18.3 -21.5 -22.4 -23.3 -24.3
Outlays......................................... 2.0 6.8 7.6 9.4 11.4 13.5
-----------------------------------------------------------
Decrease in surplus (-)....................... -10.5 -25.2 -29.1 -31.7 -34.6 -37.8
Sustained during 2000-2005: \1\
Receipts........................................ -8.5 -27.1 -49.5 -73.2 -98.7 -126.4
Outlays......................................... 2.0 8.9 16.7 26.4 38.5 52.9
-----------------------------------------------------------
Decrease in surplus (-)....................... -10.5 -36.0 -66.1 -99.7 -137.2 -179.3
Sustained during 2000-2005, with no change in
unemployment:
Receipts........................................ -8.5 -27.1 -49.5 -73.2 -98.7 -126.4
Outlays......................................... 0.2 1.2 3.4 7.1 12.3 19.1
-----------------------------------------------------------
Decrease in surplus (-)....................... -8.7 -28.3 -52.9 -80.3 -110.9 -145.5
Inflation and Interest Rates
Budgetary effects of 1 percentage point higher rate
of:
Inflation and interest rates during calendar year
2000 only:
Receipts........................................ 9.9 19.8 19.2 17.6 18.3 19.3
Outlays......................................... 5.8 11.9 9.5 8.3 7.9 7.7
-----------------------------------------------------------
Increase in surplus (+)....................... 4.1 7.8 9.8 9.3 10.4 11.6
Inflation and interest rates, sustained during
2000-2005:
Receipts........................................ 9.9 30.2 50.9 70.8 92.7 117.3
Outlays......................................... 5.8 17.5 26.8 35.3 43.0 50.4
-----------------------------------------------------------
Increase in surplus (+)....................... 4.1 12.7 24.0 35.5 49.6 66.9
Interest rates only, sustained during 2000-2005:
Receipts........................................ 1.4 3.5 4.4 4.8 5.1 5.5
Outlays......................................... 4.7 12.0 15.1 16.5 16.9 16.6
-----------------------------------------------------------
Decrease in surplus (-)....................... -3.4 -8.5 -10.7 -11.7 -11.8 -11.1
Inflation only, sustained during 2000-2005:
Receipts........................................ 8.5 26.7 46.5 66.0 87.6 111.8
Outlays......................................... 1.1 5.7 12.3 19.8 27.8 36.2
-----------------------------------------------------------
Increase in surplus (+)....................... 7.4 21.0 34.2 46.2 59.8 75.6
Interest Cost of Higher Federal Borrowing
Outlay effect of $100 billion reduction in the 2000 2.8 5.7 6.0 6.4 6.7 7.1
unified surplus....................................
----------------------------------------------------------------------------------------------------------------
* $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.