[Economic Outlook, Highlights from FY 1994 to FY 2001, FY 2002 Baseline Projections]
[II.  The Turnaround in the Budget and the Economy]
[From the U.S. Government Printing Office, www.gpo.gov]



[[Page 13]]

 
            II.  THE TURNAROUND IN THE BUDGET AND THE ECONOMY

  This section reviews the budgetary and economic performance of the 
Clinton-Gore Administration, comparing conditions now with those when 
President Clinton took office. Over the past eight years, the budget has 
turned from record deficits to record surpluses; the resultant increase 
in national saving supported sharply rising investment, accelerating 
productivity, and the longest economic expansion in history. Moreover, 
the substantial improvement in the budget has set the Federal Government 
on a path to be debt-free by the end of this decade.

The Clinton-Gore Economic Strategy

  President Clinton was elected with the goal of revitalizing the 
economy. When he took office in January 1993, the economy was slowly 
emerging from the 1990-1991 recession, with an unemployment rate of 7.5 
percent. He proposed a three-part economic strategy: fiscal discipline 
to free resources for private investment; increased support for 
investment in our people, including education, health care, and 
research; and engagement in the international economy, to open markets 
abroad to our products and services. In the last eight years, this 
Administration has completed hundreds of agreements that increase our 
access to foreign markets, and has expanded public human and 
infrastructure investment (as documented elsewhere in this volume). 
Furthermore, the Administration's new budget policy was enacted in 1993, 
and it has proven a great success.
  The budget deficit, which had reached a record $290 billion in 1992, 
has steadily fallen, until in 1998 there was a budget surplus for the 
first time in 29 years. The budget is projected to end the current 
fiscal year with a surplus of $256 billion--the fourth year in a row of 
surplus, for the longest period of budget surpluses since the 1920s; and 
by far the longest string of consecutive years of budget improvement in 
our Nation's history.
  The turnaround in the budget supported a remarkable turnaround in the 
economy. Financial markets responded to the shift from deficits to 
surpluses by reducing long-term interest rates. Real interest rates 
(actual market rates minus expected inflation) were about 1.2 percentage 
point lower on average under this Administration than they were during 
the previous 12 years. Lower real interest rates stimulated more 
business investment, leading to rising productivity, higher profits, and 
increased real wages. The average rate of economic growth accelerated to 
4.0 percent per year.
  The investment boom strengthened and prolonged the economic expansion, 
which by February 2000 had become the longest in U.S. history. This 
February, it will complete its tenth year. President Clinton is the 
first two-term President to leave office without enduring a recession. 
The past eight years were an extraordinary combination of low inflation, 
falling unemployment, soaring productivity, rising real wages, and 
declining poverty--which continued into the new millennium.

Budgetary Performance

  Before 1993, 12 years of burgeoning budget deficits had quadrupled the 
amount of Federal debt held by the public--an increase of $2.3 trillion. 
Relative to the size of the economy, the debt almost doubled--rising 
from 26 percent of Gross Domestic Product (GDP) in 1980 to 48 percent in 
1992. The Administration's first priority was to cut the massive deficit 
(and thus slow the rise in Federal debt). To accomplish that, the 
Administration proposed, and the Congress enacted, the Omnibus Budget 
Reconciliation Act (OBRA) of 1993. It was a crucial step toward fiscal 
responsibility. The Administration expected OBRA to reduce the deficit 
significantly; but the actual improvement in the budget far exceeded 
these expectations. To finally eliminate the budget deficit, the 
President

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and the Congress agreed to the bipartisan Balanced Budget Act (BBA), 
enacted in 1997, which set a goal of a balanced budget by 2002. In 1998, 
the budget went into surplus four years ahead of schedule, accelerated 
by stronger-than-projected economic growth.

  Deficit Reduction Was Augmented by its Favorable Economic Effects: The 
cumulative results of OBRA and the BBA were a stunning turnaround. The 
Administration originally projected that OBRA would reduce the deficit 
by a cumulative $505 billion from 1994 through 1998. In fact, the total 
deficit reduction over this period was more than twice as large--$1.2 
trillion (and $3.3 trillion from 1993 through 2001) as long-term fiscal 
discipline proved its value by accelerating economic growth (see Chart 
II-1). As financial markets saw that the risk of exploding future 
deficits and Federal borrowing would truly decline, they brought market 
interest rates down--reducing the deficit directly, but more 
importantly, reducing the cost of capital to businesses, and stimulating 
investment and growth.

                                     


  Government Debt Was Reduced: When the Government runs a deficit, it 
borrows from the public and accumulates debt. The huge deficits incurred 
to pay for World War II pushed the publicly held Federal debt to a peak 
of 109 percent of GDP in 1946. For many years thereafter, the economy 
grew faster than the debt; and the ratio of the debt to the GDP 
gradually fell to a low of around 25 percent in the mid-1970s. The 
exploding deficits of the 1980s reversed this trend, and sent the debt 
back up--until it peaked at almost 50 percent of GDP in 1993. Had the 
Clinton-Gore Administration done nothing, both OMB and the Congressional 
Budget Office (CBO) had projected that publicly held Federal debt would 
have approached $7 trillion (or 75 percent of GDP) by 2002, and would 
have risen even further thereafter. Instead, the Administration's 
deficit reduction policy cut the ratio of debt to GDP immediately; and 
the budget surpluses

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since 1998 have actually reduced the dollar amount of debt, and driven 
the debt to GDP ratio down even faster. The ratio of publicly held debt 
to GDP in 2000 was 30 percentage points lower than was projected as of 
1993, based on the policies before the Administration's budget plan.
  Moreover, the pay-down in debt in the past three years ($363 billion) 
and the expected amount this year ($237 billion) combine to a $600 
billion debt reduction--the largest four-year debt pay-down ever. As 
Chart II-2 shows, this substantial reduction and the prospect of 
continuing surpluses have put the debt held by the public on a 
trajectory that can eliminate the Federal Government's debtor status by 
the end of this decade.

                                     


  There Are Now Unified, Social Security, and On-Budget Surpluses: The 
unified budget has been the most common framework for tallying the 
Federal Government's deficits and surpluses. The unified budget counts 
all Government receipts and spending (including Social Security 
contributions and benefits). This is the appropriate budget concept to 
evaluate how the Federal Government's activities affect the economy; 
obviously, for that purpose, it is essential to leave nothing out. The 
improvement in this overall budget surplus is shown in Chart II-1, and 
its effect on bringing down debt held by the public is shown in Chart 
II-2. Also, each of the major components of the unified budget is in 
surplus: the off-budget surplus--the excess of Social Security receipts 
over benefit payments, and the relatively small amount of transfers to 
or from the United States Postal Service--has increased from $45 billion 
to $158 billion between 1993 and 2001; and the on-budget balance--the 
rest of the unified budget--has swung from a $300 billion deficit to a 
$98 billion surplus (see Chart II-3). The Medicare surplus (which this 
Administration has proposed to move off-budget to protect that vital 
program's Trust Fund) has grown as well--from $4 billion in 1993 (and 
small

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deficits from 1995 through 1997) to $27 billion in 2001.
  A crucial part of the Clinton-Gore Administration's policy has been to 
save and protect the Social Security surpluses. The larger balances in 
the Social Security Trust Funds, and the interest that they earn, can 
finance Social Security benefits further into the future. Balances are 
currently invested in Federal securities--the most secure asset 
available. If Trust Fund assets were to be partly invested in private 
market instruments--such as stocks and bonds, rather than Federal debt--
then the return earned by the Trust Fund could be somewhat higher, on 
average, over long periods. However, though the allocation of gross 
Federal debt between debt in the Trust Funds and debt held by the public 
would change, the total amount of gross debt would not change. The 
buildup of assets in the Trust Funds will correspond to a real increase 
in national wealth, and enhance the Government's ability to pay future 
benefits, only if it is saved by reducing the publicly held debt. This 
can be ensured if the Social Security surplus is protected by keeping 
the non-Social Security budget (approximately equal to the ``on-
budget'') at least in balance. The consistent swing of the on-budget 
from deficit into surplus in this Administration has done just that.
  As is clear from Chart II-3, the shift from unified budget deficit to 
surplus was mainly due to the elimination of the on-budget deficit. But 
whichever framework is used, the Federal Government's fiscal position 
since President Clinton took office has improved dramatically.

                                     


  Government's Claim on the Economy Was Reduced while Prosperity Spurred 
Receipts: Federal spending reached the highest share of the economy 
since World War II in the 1980s; it was still 22.2 percent of GDP in 
1992. The defense buildup in the early 1980s, higher Federal interest 
payments

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because of increased debt and high interest rates, and large cost 
increases in Federal health programs overwhelmed all deficit-cutting 
efforts. This spending share turned down under President Clinton--even 
while the Administration increased Government investments in education, 
health care, the environment, and other priorities. In the last eight 
years, the ratio of Federal spending to GDP has steadily declined; in 
2000 it was down to 18.2 percent, the lowest since the 1960s. At the 
same time, a healthy economy plus a strong stock market raised Federal 
tax receipts. Though tax burdens on most families have declined, the 
share of Federal receipts in GDP rose from 18.5 percent in 1995 to 20.6 
percent in 2000--because of the rapid growth of incomes. Some of this 
increase may prove temporary; the Treasury Department estimates that 
receipts will decline to about 19.7 percent of GDP over the course of 
this decade--again, with no increase in tax rates (see Chart II-4).

                                     


  The United States Has Become a World Leader in Budgetary Performance: 
In the 1980s, world opinion often faulted the United States for its 
large budget deficits, which were believed to have raised worldwide 
interest rates and hampered economic growth. The Clinton-Gore 
Administration's fiscal policy changed this criticism to praise, as the 
United States became a leader among the G-7 countries. In 2001, the 
United States is projected to have the largest budget surplus as a share 
of its economy (see Chart II-5). This outstanding performance came not 
from higher tax rates, but from spending restraint. Though the United 
States supports the world's largest defense establishment, it still has 
the G-7's lowest public spending and taxes as percentages of GDP. 

                                     


Economic Performance

  Government does not make the economy grow; the private sector is the 
engine of economic growth. The American people have

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always been entrepreneurial and productive. However, the economy can 
grow faster and more consistently when budget policy, and monetary 
policy, are sound. Good budgetary policy is as important as monetary 
policy to such a successful outcome. And in fact, though the Federal 
Reserve has played a crucial role in this economic expansion, monetary 
policy was able to do its job better and more easily because of the 
sound fiscal policy of this Administration, as Fed members have 
acknowledged. Fiscal discipline, along with investment in our people and 
opening markets abroad--the other key elements of the Clinton economic 
strategy--has paid clear dividends in the economic performance of the 
1990s.

  Work Effort in the U.S. Economy Is at an All-Time High: Under the 
Clinton-Gore Administration, the share of the adult population that is 
employed has reached the highest point in U.S. history (see Chart II-6). 
The economic expansion, gaining strength as a result of greater 
confidence, lower interest rates, more investment, and accelerating 
productivity, created a veritable explosion of good job opportunities. 
Continuing investment in education at all levels improved the skills of 
new entrants into the labor force. Welfare reform and expansions of the 
Earned Income Tax Credit have increased labor force participation.

                                     


  Between January 1993 and December 2000, the unemployment rate fell 
from 7.3 percent to 4.0 percent--the lowest it has been since the end of 
the 1960s. The economy created more than 22 million jobs, of which 92 
percent were in the private sector, while Federal Government employment 
shrank. The net increase in jobs was larger under President Clinton than 
under the two previous Administrations combined. The healthy private 
labor market helped to make welfare reform a success by providing people 
leaving the welfare rolls with productive opportunities.

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  Real wages have risen under this Administration; the increase has been 
especially noticeable since 1995. Over the last five years, real hourly 
earnings have increased at an average annual rate of 1.3 percent per 
year. Over the preceding 20 years, hourly earnings had been falling at 
an average annual rate of 0.4 percent per year.

  Administration Budget Policy Promoted National Saving: To get more 
capital, the economy needs more saving. For the economy as a whole, what 
matters is national saving--the sum of household saving, corporate 
retained earnings, and the Government surplus. Household saving is 
important, but it is only one component of national saving. A business 
that seeks to raise investment capital by floating a bond or selling a 
share of stock does not care, or even know, whether the funds come 
ultimately from households, other businesses, or government. National 
saving declined under the two preceding Administrations, but increased 
under President Clinton (see Chart II-7). This is a critical piece of 
evidence that the economic expansion of the 1990s is fundamentally 
different from that of the 1980s.

                                     


  Furthermore, as is shown in Chart II-7, the entirety of the 
improvement in national saving came from the reduction of the Federal 
budget deficit. (The Federal Government's budget improved by more than 
the total increase in national saving; State and local governments as a 
group run roughly balanced budgets in every year, and hence did not 
contribute significantly to the budget improvement.) The overwhelming 
contribution of budget policy toward eliminating the 1998 budget deficit 
came from the Clinton-Gore Administration's initial budget plan. The BBA 
of 1997 and the economic growth generated by the Administration's fiscal 
discipline finished the job.
    

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  National saving went down in the 1980s, and up in the 1990s. National 
saving went up because Federal budget policy produced surpluses. And the 
Federal budget improvement began with the policy actions taken by the 
Administration in 1993.

  Lower Interest Rates Enhanced Investment: The point of the 
Administration's policy of increasing national saving was to reduce 
Government's drain on investable funds, to bring down interest rates 
while increasing the funds available for private investment. This is a 
matter of supply and demand; with a larger supply of investable funds 
because of increased Government saving, the price of the funds--the 
interest rate--would be expected to go down. With the enactment of the 
President's program, interest rates fell; and even though unemployment 
has steadily declined since, interest rates have remained at or below 
the levels of the preceding recession.
  With lower interest rates, businesses enjoyed a lower cost of capital 
for investment--a lower cost to take savings and convert it into capital 
for use in production. Given that national saving generally declined 
from 1980 to 1992, and increased from 1993 to the present, it might be 
expected that investment would be stronger under the current 
Administration than it was in the preceding 12 years; and again, that is 
what the record shows. The share of GDP devoted to business investment 
over the 1980s either declined slightly or was flat depending on the 
precise measure chosen. However, investment soared during the Clinton-
Gore Administration (see Chart II-8).

                                     


  The ratio of real business equipment investment to real GDP reached 
12.4 percent in the third quarter of 2000. Since the beginning of 1993, 
inflation-adjusted investment in equipment and software has grown at an 
annual rate of 13.0 percent, more than 2\3/4\ times the rate of 1981-
1992. The

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investment boom under President Clinton is the longest and strongest 
since World War II. The private sector has done the investing, but the 
Administration's policy of balanced budgets and fiscal responsibility 
clearly helped to bring interest rates down; and that helped to create 
the environment in which businesses could more confidently take business 
risks.

  The Benefits of Faster Productivity Growth: Economists believe that 
strong investment pays a double dividend. First, it increases the size 
of the productive base of the economy; with more factories and machines, 
output can expand. But second, to the extent that new factories and 
machines are more efficient than the ones they replace, then 
productivity (the amount of output that we get from each hour of work) 
will rise. Under President Clinton, productivity growth has broken from 
the trend line that had prevailed since the early 1970s (see Chart II-
9).
  Enhanced productivity growth is important for many reasons; but 
perhaps most pertinent today, it makes an economic expansion more 
durable. Economic cycles usually end because inflation breaks out, which 
can occur when investment falls and productivity growth slows--as it did 
at the end of the 1970s, and the end of the 1980s. Continued strong 
investment has helped the current business expansion to continue for so 
long with low inflation. Productivity growth has increased, not 
declined, as this expansion has matured. Thanks to accelerated 
productivity growth due partly to increased capital intensity, the 
current expansion has lasted for almost 10 years; in February 2000, it 
became the longest expansion in U.S. history (the data go back to the 
mid-1800s), and each passing month sets a new record.

                                     


  Increasing productivity is also important because it is the only route 
to sustained real-wage and living-standard growth. In the 1970s, U.S. 
productivity growth slowed

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sharply. The average annual growth of output per hour in the nonfarm 
business sector fell from 2.8 percent (from 1949 through 1973) to 1.4 
percent (from 1974 through 1990). When productivity grows at 2.8 percent 
per year, living standards double every quarter-century; but when 
productivity grows at only 1.4 percent per year, incomes grow by less 
than half. Over a generation, many workers can find themselves falling 
behind their parents, as well as their own expectations.
  From the 1970s through the early 1990s, productivity growth stalled at 
the new slower rate. Since the mid-1990s, however, nonfarm business 
output per hour has grown at an average of 3.0 percent per year--
slightly higher than the rate before the 1970s' slowdown (the break in 
the trend is shown in Chart II-9). Some of the speedup could be due to 
temporary factors; but the persistence of the higher growth rate for 
five years suggests that somewhat faster growth may be sustained. This 
is welcome news, not only for businesses seeking to hold down costs, but 
also for typical workers and their families, who once again see real 
improvements in their earnings.

  The Misery Index Is Near a 30-Year Low: The success of budget and 
monetary policies shows also in the low unemployment and inflation under 
this Administration. The Misery Index--the sum of the annual 
unemployment rate and the core Consumer Price Index (CPI) inflation 
rate--was lower than at any time since the 1960s (see Chart II-10).

                                     


  In 2000, the unemployment rate has averaged 4.0 percent--the lowest 
yearly average since 1969--while inflation has averaged just 2.7 percent 
(as measured by the core CPI, excluding volatile food and energy 
prices). The inflation rate crept up this year after its 34-year low in 
1999, but remains near its average since 1995. This is the fifth year in 
a row of core inflation under three

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 percent--the best five-year record since the 1960s.
  The turnaround in economic performance under President Clinton--faster 
economic growth, falling unemployment, and lower inflation--happened in 
the private sector; but it was aided by the Administration's budget 
policy and the Federal Reserve's monetary policy. The past eight years 
demonstrate that fiscal discipline and a matching monetary policy can 
generate more work, saving, and investment than an easy budget policy 
that ignores deficits and debt.

The Economic Outlook

  The Clinton-Gore Administration has developed a final economic 
forecast, continuing its conservative, prudent approach (See Table II-
1). No economic forecaster is accurate all the time, but the 
Administration believes that it makes more sense to plan for middle-of-
the-road conditions, so that any budget errors are likely to be in the 
``right'' direction, rather than to make long-term commitments for the 
best-case forecast, only to see spiraling uncontrolled deficits and 
debt. Previous Administrations more often overestimated economic 
performance; such mistakes are dangerous, because they can encourage 
policymakers to avoid hard and essential choices. One of the 
Administration's most important early decisions was to adopt a realistic 
economic forecast, and this philosophy has served the Nation well.

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Table II-1.  Economic Assumptions \1\
                                                                          (Calendar years; dollar amounts in billions)
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                                                      Projections
                                                                              Actual -----------------------------------------------------------------------------------------------------------
                                                                               1999     2000     2001     2002     2003     2004     2005     2006     2007     2008     2009     2010     2011
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Gross Domestic Product (GDP):-------------------------------------------------------------------------------------------------------------------------------------------------------------------
  Levels, dollar amounts in billions:
    Current dollars........................................................    9,299    9,991   10,536   11,099   11,695   12,324   12,986   13,676   14,388   15,122   15,888   16,692   17,536
    Real, chained (1996) dollars...........................................    8,876    9,337    9,645    9,954   10,272   10,601   10,941   11,284   11,627   11,968   12,315   12,672   13,039
    Chained price index (1996 = 100), annual average.......................    104.8    107.0    109.2    111.5    113.8    116.2    118.7    121.2    123.7    126.3    129.0    131.7    134.5
  Percent change, fourth quarter over fourth quarter:
    Current dollars........................................................      6.5      6.7      5.3      5.4      5.4      5.4      5.4      5.3      5.2      5.1      5.1      5.1      5.1
    Real, chained (1996) dollars...........................................      5.0      4.1      3.2      3.2      3.2      3.2      3.2      3.1      3.0      2.9      2.9      2.9      2.9
    Chained price index (1996 = 100).......................................      1.6      2.4      2.0      2.1      2.1      2.1      2.1      2.1      2.1      2.1      2.1      2.1      2.1
  Percent change, year over year:
    Current dollars........................................................      5.8      7.4      5.5      5.3      5.4      5.4      5.4      5.3      5.2      5.1      5.1      5.1      5.1
    Real, chained (1996) dollars...........................................      4.2      5.2      3.3      3.2      3.2      3.2      3.2      3.1      3.0      2.9      2.9      2.9      2.9
    Chained price index (1996 = 100).......................................      1.5      2.2      2.0      2.1      2.1      2.1      2.1      2.1      2.1      2.1      2.1      2.1      2.1

Incomes, billions of current dollars:
    Corporate profits before tax...........................................      823      934      922      934      961      990    1,035    1,080    1,127    1,162    1,196    1,226    1,251
    Wages and salaries.....................................................    4,470    4,767    5,031    5,310    5,608    5,917    6,233    6,566    6,904    7,264    7,637    8,028    8,437
    Other taxable income \2\...............................................    2,141    2,286    2,353    2,422    2,488    2,561    2,649    2,745    2,843    2,943    3,048    3,152    3,263

Consumer Price Index (all urban): \3\
    Level (1982-84 = 100), annual average..................................    166.7    172.3    176.8    181.4    186.2    191.2    196.4    201.7    207.2    212.7    218.5    224.4    230.4
    Percent change, fourth quarter over fourth quarter.....................      2.6      3.4      2.5      2.6      2.7      2.7      2.7      2.7      2.7      2.7      2.7      2.7      2.7
    Percent change, year over year.........................................      2.2      3.4      2.7      2.6      2.7      2.7      2.7      2.7      2.7      2.7      2.7      2.7      2.7

Unemployment rate, civilian, percent:
    Fourth quarter level...................................................      4.1      4.0      4.3      4.6      4.7      4.8      4.9      5.0      5.1      5.1      5.1      5.1      5.1
    Annual average.........................................................      4.2      4.0      4.1      4.4      4.6      4.7      4.8      4.9      5.0      5.1      5.1      5.1      5.1

Federal pay increases, percent:
    Military and civilian \4\..............................................      3.6      4.8      3.7      3.9      3.9      3.9      3.9      3.9      3.9      3.9      3.9      3.9      3.9

Interest rates, percent:
    91-day Treasury bills \5\..............................................      4.7      5.9      6.0      5.7      5.4      5.3      5.3      5.3      5.3      5.3      5.3      5.3      5.3
    10-year Treasury notes.................................................      5.6      6.1      5.8      5.8      5.8      5.8      5.8      5.8      5.8      5.8      5.8      5.8      5.8
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
\1\ Based on information as of mid-November 2000.
\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.
\4\ Beginning with 2002, projected increases in the Employment Cost Index for private industry wages and salaries.
\5\ Average rate (bank discount basis) on new issues within period.


[[Page 25]]

The Near-Term Outlook

  Real GDP Growth: Over the coming 10 years, the Blue Chip panel of 50 
forecasters predicts a trend of real GDP growth averaging around 3.3 
percent for most of the decade. The Administration's forecast for the 
next five years averages 3.2 percent. After 2005, the Administration 
projects growth slowing gradually to 2.9 percent per year in 2009-2011. 
Later this decade, the large baby-boom generation--born in the 20 years 
following World War II--will begin to retire. When that happens, labor 
force growth is likely to slow, pulling down real GDP growth. The 
initial effects of this demographic transition are reflected in the 
Administration's projections of real GDP for 2006-2011. It is not clear 
whether the private forecasters have begun to take account of this 
predictable shift in the labor force.
  It is uncertain how much of the actual acceleration in productivity 
growth since 1995 will be sustained; but since last year's forecast, 
favorable evidence has mounted, and most economists are now more 
sanguine about prospects for productivity growth. Compared with the 2001 
Budget assumptions, the Administration has increased projected potential 
GDP growth, and now projects that labor productivity in the nonfarm 
business sector can increase at an average rate of 2.2 percent per year 
through 2011.

  Unemployment and Inflation: The unemployment rate in December was 4.0 
percent, near the lowest point in three decades. It is projected to rise 
somewhat over the next few years, and to stabilize at an average rate of 
5.1 percent--still well below the 6.7 percent average rate from 1970 
through 1992.
  Inflation was boosted this year by a spike in oil prices; but oil 
futures market prices imply relief in 2001, and so inflation is likely 
to decline. The Administration projects CPI inflation of 2.5 percent in 
2001 (on a fourth quarter to fourth quarter basis), following a 3.4 
percent rate during 2000. CPI inflation is expected to average 2.7 
percent per year for 2002 through 2011--close to the average of 2.5 over 
the past five years. Inflation in the GDP chain-weighted price index is 
projected to average 2.1 percent through 2011. These projections 
maintain the gap that has emerged in recent years between these two 
measures of inflation.
  For several years, real GDP has grown faster than mainstream 
forecasters believed would be sustainable without higher inflation. This 
year's moderate upward revision to the estimate of potential GDP growth 
is consistent with this performance; strong investment in new 
technologies is paying off in higher productivity. However, some of the 
rapid GDP growth of the last eight years came because labor force 
participation was increasing and unemployment was falling. Looking 
ahead, the unemployment rate is likely to rise slightly and labor growth 
is projected to slow, which the Administration believes will moderate 
the pace of GDP growth.

  Interest Rates: Interest rates on Treasury debt fell to extremely low 
levels--short maturities under five percent--during the world financial 
crisis of 1997-1998. Since then, short-term rates--following several 
interest rate hikes by the Federal Reserve during 1999 and 2000--have 
risen to their highest level since 1991; the 91-Day Treasury Bill 
discount rate was 5.7 percent in late December. The yield on 10-year 
Treasury notes also rose in 1999, but it retreated in 2000; in late 
December, it was about \1/2\ percentage point below the short-term rate. 
The Administration projects that the 10-year rate will average near 5.8 
percent--its level of mid-November--throughout the forecast period. 
Meanwhile, the short-term rate is projected to decline gradually to 
around 5.3 percent, which would restore the usual upward-sloping yield 
curve. The outlook is complicated by the ongoing reduction in Federal 
debt, which gradually removes Government bills, notes, and bonds from 
the market.
  Trend Projections: Except in the near term, the projections shown in 
Table II-1 are not a precise year-to-year forecast; instead, they 
reflect the average behavior expected for the economy over the medium 
term. In some years, growth could be faster than assumed; in other 
years, it could be slower. Similarly, inflation, unemployment, and 
interest rates could fluctuate around the projected values. If the 
assumptions hold on average, however, they should provide a prudent 
basis for budgeting. If fiscal and monetary policies remain sound, the 
economy could continue to

[[Page 26]]

outperform these relatively conservative projections, as it has for the 
past several years.

The Budget Outlook

  The Near-Term Outlook: The Administration projects continuing budget 
surpluses in 2001 and subsequent years. On current-services assumptions, 
the unified surplus is projected at $256 billion in 2001 and $277 
billion in 2002. The on-budget surplus, $86 billion in 2000, is 
projected to be $98 billion in 2001. By 2011, it could reach $479 
billion.

                                     


  These projections are imprecise, and if experience is any guide, they 
could err by large margins. The future is uncertain, and the more 
distant the projection, the greater the uncertainty. Over the history of 
five-year budget projections (first required by the Congressional Budget 
Act of 1974, and thus starting with the 1976 Budget), every 
Administration has made substantial errors. Chart II-11 shows that the 
average forecast error for the deficit/surplus (regardless of sign, 
expressed as a percentage of GDP) of the fiscal year already in progress 
was 0.6 percent of GDP (in today's terms, over $60 billion--not a 
trivial sum for a year already one-fourth over). The average error for 
the coming year was twice as large--1.2 percent (or more than $120 
billion today). Errors grew even larger as the projection was more 
distant, averaging 4.0 percent of GDP (more than $400 billion today) for 
the five-year ahead (the most distant) projections. (The Clinton-Gore 
Administration's errors were only slightly smaller than those of other 
Administrations, though unlike all the others, we have run smaller 
deficits and larger surpluses than we projected.) Such enormous 
uncertainty about budgets just a few years in the future should 
influence policymakers' decisions about expensive, long-term commitments 
on the basis of mere projections--especially now, when the public debt, 
though declining, is still about the same percentage of GDP as in 1985; 
and

[[Page 27]]

when the baby-boom generation is just seven years away from beginning to 
collect Social Security benefits.

  The Long-Term Outlook: Though long-run budget projections are 
inherently uncertain, they can warn of potential problems, which may be 
more easily solved if addressed sooner. In the 1990s, policymakers 
increasingly focused on long-range projections, some looking as far as 
75 years ahead--especially for the budget effects of population aging 
and reforms to Social Security or Medicare.
  Prior to the 1993 Clinton program, the Federal deficit was projected 
to spiral out of control in this decade. The outlook improved after 
OBRA, although deficits continued for a time. Following the passage of 
the BBA in 1997, a unified budget surplus was projected beginning in 
2002, and for about 20 years; even so, the deficit was expected to 
return in the long run.
  Since 1997, the economy and the budget have performed much better than 
projected when the BBA was passed. Projections of publicly held Federal 
debt have steadily declined. Lower interest payments have reinforced the 
improvement of the budget, and have significantly extended the long-run 
surplus projections. Still, the long-term current services baseline is a 
mechanical extrapolation of the budget implications of current law, and 
thus is not intended to reflect likely policy actions. Moreover, the 
range of uncertainty around such projections is very large. Under 
reasonable alternative assumptions, the budget could return to deficit 
within a few years following the retirement of the baby-boomers. The 
underlying demographic pressures are formidable, and if the demographic 
or economic outcomes prove to be less favorable than assumed here, the 
surplus would be threatened. (See Budget of the United States 
Government, Fiscal Year 2001: Analytical Perspectives, chapter 2; and 
Economic Report of the President, January 2001, chapter 2.)
  The favorable long-term budget results in these projections can be 
realized only with prudent policy--choosing continuing reductions in 
outstanding debt, rather than expensive tax cuts or spending increases--
while sustaining private saving, investment, and productivity growth.
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