[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]
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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.
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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
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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.