[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
Economic growth decelerated suddenly and sharply last year; by the
end of the year, the record-long expansion was on the verge of stalling.
The economy hardly expanded in the fourth quarter, and signs of weakness
in the first months of this year were widespread. The stock market has
plummeted, consumer and business confidence has dropped sharply,
industrial production and capacity utilization rates have declined, and
job growth has slackened. The unemployment rate, although low by
historical standards, has begun to climb.
Despite the sudden weakness, most forecasters, including the
Administration, anticipate that an economic recovery will begin later
this year. Forward-looking indicators have begun to strengthen recently,
pointing to faster growth in the coming months. Monetary policy has
shifted to stimulating demand. The Federal Reserve reduced the Federal
funds rate twice in January, and it made another cut in March.
Fiscal policy is poised to support a recovery. The Administration
proposes to reduce individual income taxes, which will provide near-term
fiscal stimulus and long-term economic incentives to encourage work and
saving. Beyond the next year or two, the long-term outlook has never
been brighter. There is accumulating evidence that the underlying
productivity trend has improved markedly. This is welcome news for
American workers and business. Enhanced productivity growth enables real
wages to grow faster, profits to expand, and the stock market to rise.
In the long run, productivity growth is the key to maintaining a strong
economy and rising living standards.
This chapter begins with a review of recent developments and then
presents the Administration's economic assumptions, followed by a
comparison with projections of the Congressional Budget Office and the
consensus of private sector forecasters. The following section
decomposes the surplus into its cyclical and structural components. The
chapter concludes with estimates of the sensitivity of the budget to
changes in economic assumptions.
Recent Developments
Financial Markets: Beginning in 1999 and lasting through May 2000, the
Federal Reserve tightened monetary policy to reduce the risk of higher
inflation in a rapidly expanding economy. However, the ensuing
deceleration of demand, the falloff in profits, and financial strains
were unexpectedly sharp. As a result, the threat of higher inflation
diminished while the risk that the expansion might end soon rose. In
response to this shift in the balance of risks, the Federal Reserve
eased monetary policy by cutting the Federal funds by a total of one
percentage point in January and by another one-half percentage point in
March to 5.0 percent. Judging by the futures market, investors expect
additional cuts in the funds rate of one-half percentage point by the
summer.
The credit markets responded promptly to the monetary easing. In the
Treasury market, the yield on 3-month bills fell by 1.5 percentage
points from the end of 2000 to late March, bringing the rate down to 4.3
percent. The decline in the yield on the 10-year Treasury note was less
pronounced, from 5.1 percent to 4.8 percent. Together these changes
restored an upward sloping yield curve, which in the past has often
signaled faster economic growth ahead. In response to the shift in
monetary policy, bond yields fell this year while new issuance rose
significantly. The renewed access to capital enables firms to cope with
the financial pressures from weaker sales and profits.
The easing of monetary policy and lower interest rates, however, did
not succeed in arresting the fall in the stock market. As of late March,
the S&P 500 and the broad-based Wilshire 5000 were down almost 15
percent since the end of last year, bringing the total decline from
their peaks in March 2000 to over 25 percent. The technology-laden
NASDAQ was hit even harder--off about 20 percent through late March, and
about 60 percent from its year-earlier peak.
Economic Activity: Economic growth decelerated significantly last
year, sliding from a robust 5.2 percent annual rate of increase during
the first half of the year to only a 1.1 percent advance in the fourth
quarter. The decline in the growth rate reflected the effects of falling
stock prices and rising interest rates. The deceleration was most
pronounced in the sectors that are especially responsive to changes in
financial market conditions: residential investment, business capital
spending, and consumer durable goods purchases.
Residential investment contracted in the third and fourth
quarters, the first back-to-back declines in four years.
Homebuilding was adversely affected by the rise in mortgage
rates during 1999 and the first half of 2000. By May, the rate
on 30-year mortgages reached 8.5 percent, the highest level in
over five years. Since then, however, the mortgage rate has
fallen to 7.0 percent, the lowest rate in three years, and
there were signs of a pickup in the housing markets as the new
year began.
After adjusting for inflation, investment in new plant and
equipment contracted slightly in the fourth quarter, a marked
drop-off from the double-digit gains that prevailed since
1995. Even demand for high-technology hardware and software,
which had soared in recent years, slackened in
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the final quarter, growing at about one-third the pace of the
first half of the year. Weakening capital spending reflected
lackluster demand, growing excess capacity, and a rising cost
of capital because of higher interest rates and falling equity
values.
Real consumer spending on durable goods fell in the fourth
quarter, led by an unexpected drop in motor vehicle purchases,
which, in turn, contributed to a buildup of unwanted
inventories on dealers' lots and sizeable cutbacks in
production in the first quarter. The drop in durable goods
spending restrained the total growth of consumer spending in
the fourth quarter to a 2.8 percent annual rate, the smallest
advance in over three years. The slackening of consumer
spending was influenced by falling equity wealth--a reversal
from the prior five years when exceptional stock market gains
boosted wealth and fueled consumer spending. From its peak in
March 2000 to the end of the year, the decline in the stock
market cut $3 trillion off the $18 trillion in market
capitalization of U.S. equities.
The foreign sector also restrained GDP growth in the fourth quarter,
trimming about one-half percentage point off the growth rate. Imports of
goods and services declined modestly at the end of the year, which
bolstered growth slightly, but this was more than offset by a decline in
exports, in part because of weakening demand in our trading partners.
The economic news so far in 2001 has been mixed. On the downside,
surveys of consumers' attitudes revealed a further loss of confidence,
with especially heightened concerns about the future. The stock market,
which is an indicator of investors' confidence, fell as well.
On the upside, the Nation's total payrolls continued to expand in
January and February, despite large job losses in manufacturing
industries. The unemployment rate ticked up from 4.0 percent to 4.2
percent in January and held there in February. This is still a very low
rate, two percentage points below the average rate over the previous
thirty years.
Based on information for the first two months of the year, consumer
spending after adjustment for inflation appears to have continued to
expand in the first quarter at a moderate pace. Sales of motor vehicles,
however, recovered sharply, which helped reduce the excess inventories
that built up at the end of last year.
In the housing market, starts, permits, existing home sales and
refinancing all increased at the start of the year in response to the
fall in mortgage rates during the second half of 2000. There were also
signs that business investment was holding up. In January, nondefense
capital goods orders and unfilled orders, excluding the volatile
aircraft sector, rose sharply.
Inflation: Price inflation accelerated last year, primarily because of
a jump in crude oil prices, which rippled through to higher energy
prices. The price of West Texas Intermediate crude oil doubled during
1999 and rose by another third during the first 11 months of 2000. On a
year-over-year basis, the total Consumer Price Index (CPI) rose 3.4
percent in 2000, up from 2.2 percent in 1999. Since November, oil prices
have fallen sharply, which can be expected to slow the growth of overall
inflation this year. Excluding the volatile food and energy components,
the acceleration in core CPI inflation last year was much less
pronounced than the rise in the total. The core CPI rose just 2.4
percent during 2000, which is not much more than the 2.1 percent rise in
1999.
The GDP chain-weighted price index, a broad gauge of inflation
covering all the goods and services produced in the United States, rose
just 2.1 percent in 2000 measured on a year-over-year basis. Although
higher than the 1.5 percent advance in 1999, it is still a remarkably
low rate of inflation. Looking at the prices paid by consumers,
businesses, and governments, and excluding the food and energy
components, inflation was only 1.8 percent in 2000, not much different
than the 1.5 percent of 1999.
Historically low unemployment last year contributed to strong growth
of labor compensation, including benefits as well as cash wages.
Nonetheless, core price inflation rose very little because of continued
robust productivity growth, which provided an offset to the upward price
pressures from rising labor costs.
With the unemployment rate near 4 percent for the last two years and
only a small step-up in the core rate of inflation, the economy appeared
capable of maintaining stable inflation at a lower level of unemployment
than previously envisaged. In light of this experience, the Budget
assumes that NAIRU (the ``nonaccelerating inflation rate of
unemployment'') is 4.6 percent in the long run. That is identical to the
rate implied by the consensus of private sector forecasters. By
contrast, two years ago the consensus implied a NAIRU just above 5
percent.
Productivity: Productivity growth during the past five years has
averaged 2.9 percent per year, double the rate that prevailed from 1974
through 1995. Increased capital investment and general improvements in
business efficiency were responsible for the step up. The maintenance of
this strong productivity growth, even as the expansion has aged and
unemployment has declined to very low levels, provides evidence that the
improvement is likely to be ongoing.
Economic Projections
The Administration's economic projections, summarized in Table 1-1,
assume the adoption of the policies proposed in the Budget: tax relief
for American workers and their families, the maximum feasible reduction
in Federal debt, Federal spending restraint, and the preservation of the
Social Security surplus for Social Security. Enactment of this
comprehensive program will provide both a needed near-term stimulus to
the economy and promote an economic climate that fosters long-term
growth. The Federal Reserve is assumed to continue
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Table 1-1. ECONOMIC ASSUMPTIONS \1\
(Calendar years; dollar amounts in billions)
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Projections
Actual -----------------------------------------------------------------------------------------------------------
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
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Gross Domestic Product (GDP):
Levels, dollar amounts in billions:
Current dollars........................................................ 9,299 9,974 10,434 11,004 11,596 12,217 12,866 13,550 14,269 15,023 15,817 16,649 17,524
Real, chained (1996) dollars........................................... 8,876 9,325 9,551 9,867 10,184 10,509 10,840 11,180 11,532 11,894 12,264 12,642 13,031
Chained price index (1996 = 100), annual average....................... 104.8 107.0 109.2 111.5 113.8 116.2 118.7 121.2 123.7 126.3 128.9 131.7 134.4
Percent change, fourth quarter over fourth quarter:
Current dollars........................................................ 6.5 6.2 4.8 5.5 5.3 5.3 5.3 5.3 5.3 5.3 5.3 5.3 5.2
Real, chained (1996) dollars........................................... 5.0 3.7 2.6 3.3 3.2 3.2 3.1 3.1 3.1 3.1 3.1 3.1 3.1
Chained price index (1996 = 100)....................................... 1.6 2.3 2.1 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 7.3 4.6 5.5 5.4 5.4 5.3 5.3 5.3 5.3 5.3 5.3 5.3
Real, chained (1996) dollars........................................... 4.2 5.1 2.4 3.3 3.2 3.2 3.1 3.1 3.1 3.1 3.1 3.1 3.1
Chained price index (1996 = 100)....................................... 1.5 2.1 2.1 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........................................... 823 935 951 983 1,030 1,080 1,137 1,173 1,222 1,256 1,291 1,332 1,402
Wages and salaries..................................................... 4,470 4,766 5,016 5,312 5,620 5,930 6,256 6,590 6,927 7,272 7,641 8,035 8,448
Other taxable income \2\............................................... 2,141 2,285 2,348 2,431 2,505 2,590 2,677 2,770 2,872 2,979 3,092 3,206 3,324
Consumer Price Index (all urban): \3\
Level (1982-84 = 100), annual average.................................. 166.7 172.3 176.9 181.4 186.1 190.8 195.6 200.4 205.5 210.6 215.9 221.3 226.8
Percent change, fourth quarter over fourth quarter..................... 2.6 3.4 2.5 2.6 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5
Percent change, year over year......................................... 2.2 3.4 2.7 2.6 2.6 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5
Unemployment rate, civilian, percent:
Fourth quarter level................................................... 4.1 4.0 4.6 4.6 4.5 4.5 4.5 4.5 4.5 4.6 4.6 4.6 4.6
Annual average......................................................... 4.2 4.0 4.4 4.6 4.5 4.5 4.5 4.5 4.5 4.6 4.6 4.6 4.6
Federal pay raises, January, percent:
Military \4\........................................................... 3.6 4.8 3.7 4.6 3.9 3.9 3.9 3.9 3.9 3.9 3.9 3.9 3.9
Civilian \5\........................................................... 3.6 4.8 3.7 3.6 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 \6\.............................................. 4.7 5.8 5.3 5.6 5.6 5.6 5.3 5.0 5.0 5.0 5.0 5.0 5.0
10-year Treasury notes................................................. 5.6 6.0 5.4 5.6 5.7 5.7 5.7 5.7 5.7 5.7 5.7 5.7 5.7
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\1\ Based on information available as of January 20, 2001.
\2\ Rent, interest, dividend and proprietor's components of personal income.
\3\ Seasonally adjusted CPI for all urban consumers.
\4\ 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.
to pursue monetary policies that support economic activity while keeping
inflation under control.
The economic assumptions are conservative and are close to those of
the Congressional Budget Office and mainstream private sector
forecasters. The key assumption for the average real GDP growth over the
next 10 years is even slightly below the private sector consensus. The
economy may perform even better than assumed here. Nonetheless, for the
purpose of planning fiscal policy, it is appropriate to base the Budget
on prudent assumptions that do not over-estimate available resources.
Real GDP, Potential GDP and Unemployment: Real GDP, which rose 5.0
percent in 2000 on a calendar-year basis, is projected to increase 2.4
percent this year. Economic activity is expected to gain momentum during
the year as the easing of monetary policy stimulates interest-sensitive
sectors. The restraint on production and GDP growth from the buildup of
excess inventories evident early in the year is likely to diminish as
inventories are brought in line with sales.
Economic activity is expected to increase 3.3 percent during 2002.
Faster economic growth over the next year and a half will add to the
pace of job creation, household incomes, and corporate profits, which in
turn will improve consumer confidence and equity markets. With actual
GDP growth below the Nation's potential GDP growth during much of this
year, the unemployment rate is projected to creep up to 4.6 percent by
the fourth quarter. During 2002, the unemployment rate is projected to
remain at that relatively low level.
Beyond 2002, real GDP growth is projected to moderate gradually to a
3.1 percent annual rate of increase beginning in 2005. Average GDP
growth over the next ten years is expected to be close to potential
growth, which would maintain the unemployment rate on a plateau of
around 4.6 percent. Potential GDP growth depends largely on the growth
of the labor force and the trend growth of labor productivity. The labor
force is projected to increase 1.0 percent per year on average over the
ten years 2002 to 2011.
Nonfarm business sector productivity is projected to grow 3.0 percent
in calendar year 2001, 2.6 percent in 2002-2003, slowing to a 2.2
percent average annual increase from 2004 through 2011. Over the next
ten years, productivity growth is assumed to average 2.3
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percent yearly, close to the very long-run average for the U.S. economy.
This is well above the 1.4 percent average rate during 1974-1995,
although it is a deceleration from the 2.9 percent average rate of the
past five years. The assumption that productivity growth will taper off
somewhat from its recent trend is a conservative one, appropriate for
prudent budget planning.
Inflation: The rate of inflation, measured by either the CPI or the
GDP chain-weighted price index, is expected to slow this year as energy
prices fall from the high levels at the end of last year. The CPI is
projected to rise 2.7 percent in 2001 on a calendar year basis and slow
to 2.5 percent yearly beginning in 2004. The GDP measure of inflation is
forecast to increase 2.1 percent each year. The CPI tends to increase
faster than the GDP chain-weighted price index in part because sharply
falling computer prices, which are expected to continue, exert less of
an impact on the CPI than on the GDP inflation measure.
Interest Rates: The 91-day Treasury bill rate is projected to rise
during 2001, leveling off at 5.6 percent during 2002-2004, then
gradually decline to 5.0 percent in 2006 and thereafter. The yield on
the 10-year Treasury note is assumed to rise to 5.7 percent in 2003 and
remain at that level through 2011. The projected decline in the short-
term rate after 2004 would restore an upward sloping yield curve, which
is normal during periods of expansion.
Incomes: The share of total taxable income in nominal GDP is projected
to decline gradually, mainly because capital consumption is expected to
claim a larger proportion of GDP. The investment boom of recent years
and the projected rising share of investment in GDP imply a rapid growth
of depreciation, a component of business expenses. As the share of
depreciation in GDP rises, the share of corporate profits is projected
to decline. The share of wages and salaries in GDP is projected to be
relatively stable over the projection horizon.
Comparison with CBO and Private-Sector Forecasts
The Congressional Budget Office (CBO) and many private-sector
forecasters also make 10-year projections. The CBO projection is used by
Congress in formulating budget policy. In the executive branch, this
function is performed jointly by the Treasury, the Council of Economic
Advisers, and the Office of Management and Budget. The private sector
forecasts are often used by businesses for long-term planning. Table 1-2
compares the Budget assumptions with projections by the CBO and the Blue
Chip consensus, an average of about 50 private forecasts
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
Table 1-2. COMPARISON OF ECONOMIC ASSUMPTIONS
(Calendar years; percent)
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Projections
---------------------------------------------------------------------------------------- Average,
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2002-11
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Real GDP (chain-weighted): \1\
CBO January........................................ 2.4 3.4 3.3 3.0 3.0 3.0 3.0 3.0 3.0 3.1 3.1 3.1
Blue Chip Consensus March.......................... 1.9 3.4 3.5 3.4 3.4 3.4 3.3 3.3 3.3 3.3 3.3 3.4
2002 Budget........................................ 2.4 3.3 3.2 3.2 3.1 3.1 3.1 3.1 3.1 3.1 3.1 3.2
Chain-weighted GDP Price Index: \1\
CBO January........................................ 2.3 2.1 2.0 1.9 1.9 1.9 1.9 1.9 1.9 1.9 1.9 1.9
Blue Chip Consensus March.......................... 2.1 2.0 2.1 2.1 2.1 2.2 2.2 2.2 2.2 2.2 2.2 2.2
2002 Budget........................................ 2.1 2.1 2.1 2.1 2.1 2.1 2.1 2.1 2.1 2.1 2.1 2.1
Consumer Price Index (all-urban): \1\
CBO January........................................ 2.8 2.8 2.7 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.6
Blue Chip Consensus March.......................... 2.8 2.4 2.6 2.6 2.5 2.6 2.6 2.6 2.6 2.6 2.6 2.6
2002 Budget........................................ 2.7 2.6 2.6 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5
Unemployment rate: \2\
CBO January........................................ 4.4 4.5 4.5 4.7 4.8 4.9 5.0 5.1 5.2 5.2 5.2 4.9
Blue Chip Consensus March.......................... 4.5 4.6 4.6 4.6 4.6 4.6 4.6 4.6 4.6 4.6 4.6 4.6
2002 Budget........................................ 4.4 4.6 4.5 4.5 4.5 4.5 4.5 4.6 4.6 4.6 4.6 4.6
Interest rates: \2\
91-day Treasury bills:
CBO January...................................... 4.8 4.9 5.0 4.9 4.9 4.9 4.9 4.9 4.9 4.9 4.9 4.9
Blue Chip Consensus March........................ 4.6 4.8 5.2 5.3 5.3 5.2 5.2 5.2 5.2 5.2 5.2 5.2
2002 Budget...................................... 5.3 5.6 5.6 5.6 5.3 5.0 5.0 5.0 5.0 5.0 5.0 5.2
10-year Treasury notes:
CBO January...................................... 4.9 5.3 5.5 5.6 5.7 5.8 5.8 5.8 5.8 5.8 5.8 5.7
Blue Chip Consensus March........................ 5.1 5.4 5.7 5.7 5.7 5.7 5.7 5.7 5.7 5.7 5.7 5.7
2002 Budget...................................... 5.4 5.6 5.7 5.7 5.7 5.7 5.7 5.7 5.7 5.7 5.7 5.7
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Sources: Congressional Budget Office; Aspen Publishers, Inc., Blue Chip Economic Indicators
\1\ Year over year percent change.
\2\ Annual averages, percent.
[[Page 7]]
a ``pre-policy'' projection. The private sector forecasts are based on
an appraisal of ``the most-likely policy outcome,'' which would vary
considerably among forecasters. Despite these differences in policy
assumptions, the three sets of projections are currently quite close for
almost all the key economic assumptions.
For real GDP growth, the Blue Chip consensus is slightly lower than
the public-sector forecasts in 2001. The private forecasts, made in
early-March, were influenced in part by the weaker recent data. For
2002, all three sets of forecasts anticipate a rebound of growth. Over
the ten years 2002-2011, the Blue Chip consensus averages 3.4 percent
GDP growth, two-tenths of a percentage point faster than the 3.2 percent
in the Administration's conservative assumptions.
The Administration's inflation projection is very similar to that of
the Blue Chip consensus. CBO's GDP inflation projection is slightly
below the Administration's assumptions in most years. The
Administration's unemployment rate is nearly identical to the Blue
Chip's, while the CBO's rate is well above either of the other two
forecasts.
The Administration's projection of the yield on the 10-year Treasury
note is identical in most years to that of the Blue Chip consensus, and
is close to that of CBO. The Administration's short-term interest rate
projection is somewhat higher than that of the Blue Chip consensus over
the next few years. Beyond 2005, the three short-term interest
projections are quite close.
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 intensely employed, and outlays for unemployment-sensitive
programs (such as unemployment compensation and food stamps) are lower.
As a result, the surplus is larger than it would be if unemployment were
at the sustainable long-run average. The portion of the surplus that can
be traced to this factor is called the cyclical component. The balance,
the portion that would remain with the unemployment rate at its long-run
value, is called the structural surplus (or structural deficit).
The structural balance 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.
For this reason, changes in the structural balance give a better picture
of the impact of budget policy on the economy than does the unadjusted
budget balance.
During 1992-1996, when the actual unemployment rate was above the 5.2
percent estimate of NAIRU, the cyclical component was negative: the
unadjusted deficit was larger than the structural deficit. From 1997 to
2000, the consensus of private sector forecasters gradually reduced
NAIRU to 4.6 percent. Nonetheless, the actual unemployment rate was
below NAIRU, resulting in a positive cyclical component. By 2000, the
actual surplus of $236 billion was $72 billion larger than the
structural surplus.
In the early 1990s, large swings in net outlays for deposit insurance
(the S&L bailouts) had substantial impacts on deficits, but had little
concurrent impact on economic performance. It therefore became customary
to remove deposit insurance outlays as well as the cyclical component of
the surplus or deficit from the actual surplus or deficit to compute the
adjusted structural balance. This is shown in Table 1-3.
Two significant points are illustrated by this table. First, of the
$527 billion swing in the actual budget balance between 1992 and 2000
(from a $290 billion deficit to a $236 billion surplus), only 35 percent
($182 billion) resulted from cyclical improvement in the economy. The
rest of the reduction stemmed from policy actions and an unusually
strong rise in individual income tax receipts as a percentage of GDP.
Second, in 2002 and thereafter, the cyclical component of the surplus is
small because the projected unemployment rate is close to the assumed
NAIRU of 4.6 percent. Deposit insurance net outlays are also projected
to be very small in the coming years. Therefore, the adjusted structural
surplus and the unadjusted surplus are nearly identical during the
forecast horizon.
Sensitivity of the Budget to Economic Assumptions
Both receipts and outlays are affected by changes in economic
conditions. This sensitivity 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
Table 1-3. ADJUSTED STRUCTURAL BALANCE
(In billions of dollars)
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1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
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Unadjusted deficit (-) or surplus.. -290.4 -255.1 -203.3 -164.0 -107.5 -22.0 69.2 124.6 236.4 280.7 231.2 242.0 262.1 269.0
Cyclical component............... -109.9 -104.0 -68.7 -29.5 -16.0 5.9 33.5 44.8 72.0 36.3 2.1 6.4 7.6 7.1
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Structural deficit (-) or surplus.. -180.5 -151.1 -134.6 -134.5 -91.5 -27.9 35.7 79.8 164.4 244.4 229.1 235.6 254.5 261.9
Deposit insurance outlays........ -2.3 -28.0 -7.6 -17.9 -8.4 -14.4 -4.4 -5.3 -3.1 -1.0 -0.7 0.1 0.6 1.1
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Adjusted structural deficit (-) or -182.8 -179.1 -142.2 -152.3 -99.9 -42.3 31.3 74.5 161.3 243.4 228.4 235.7 255.1 263.0
surplus...........................
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NOTE: The NAIRU is assumed to be 5.2% through calendar year 1998, 4.9% in 1999, and 4.6% thereafter.
[[Page 8]]
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
force, 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 1-4.
If real GDP growth is lower by one percentage point in calendar year
2001 only and the unemployment rate rises by one-half percentage point
more than in the budget assumptions, the fiscal year 2001 surplus is
estimated to decrease by $11.7 billion; receipts in 2001 would be lower
by $9.6 billion, and outlays would be higher by $2.1 billion, primarily
for unemployment-sensitive programs. In fiscal year 2002, the estimated
receipts shortfall would grow further to $20.9 billion, and outlays
would increase by $7.3 billion relative to the base, even though the
growth rate in calendar 2002 equaled the rate originally assumed. This
is 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 smaller surpluses)
would continue to grow slightly in each successive year.
The budget effects are much larger if the real growth rate is assumed
to be one percentage point less in each year (2001-2011) and the
unemployment rate to rise one-half percentage point in each year. In
this case, the levels of real and nominal GDP would be below the base
case by a growing percentage. The budget balance would be worsened by
$545.0 billion relative to the base case by 2011.
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
$431.9 billion worsening of the budget balance by 2011.
Joint changes in interest rates and inflation have a smaller effect
on the surplus than equal percentage point changes in real GDP growth.
An example is the effect of a one percentage point higher rate of
inflation and one percentage point higher interest rates during calendar
year 2001 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 2001 rise by
$5.5 billion and receipts by $11.0 billion, for a increase of $5.5
billion in the 2001 surplus. In 2002, outlays would be above the base by
$11.4 billion, due in part to lagged cost-of-living adjustments;
receipts would rise $22.4 billion above the base, however, resulting in
an $11.0 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 $57.7 billion to outlays in 2011 and $341.1
billion to receipts, for a net increase in the 2011 surplus of $283.4
billion. This rule-of-thumb now shows a more positive net budget outcome
than was estimated a few years ago, when the interest outlays were
larger because of higher levels of public debt.
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 in part because, when the budget is in surplus and 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.
The outlay effects of a one percentage point increase in interest
rates alone is now relatively small, and changes sign, that is, reduces
outlays after 2006 when increased interest earnings on the Government's
excess balances exceed increased interest payments on the outstanding
debt held by the public. The receipts portion of this rule-of-thumb is
due to the Federal Reserve's deposit of earnings on its securities
portfolio.
The last entry in the table shows rules of thumb for the added
interest cost associated with changes in the 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 9]]
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 1-4. SENSITIVITY OF THE BUDGET TO ECONOMIC ASSUMPTIONS
(In billions of dollars)
--------------------------------------------------------------------------------------------------------------------------------------------------------
Budget effect 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
--------------------------------------------------------------------------------------------------------------------------------------------------------
Real Growth and Employment
Budgetary effects of 1 percent lower real GDP growth:
For calendar year 2001 only: \1\
Receipts......................................... -9.6 -20.9 -24.8 -26.0 -27.3 -28.5 -29.8 -31.2 -32.7 -34.2 -35.9
Outlays.......................................... 2.1 7.3 8.6 10.8 13.0 15.1 17.5 20.2 23.0 26.2 29.7
--------------------------------------------------------------------------------------------------
Decrease in surplus (-)........................ -11.7 -28.3 -33.3 -36.8 -40.3 -43.6 -47.3 -51.4 -55.8 -60.4 -65.6
Sustained during 2001-2011: \1\
Receipts......................................... -9.6 -30.8 -56.7 -84.8 -115.2 -147.9 -183.0 -220.8 -261.6 -305.0 -353.0
Outlays.......................................... 2.1 9.5 18.5 30.1 43.8 59.6 78.4 101.0 126.6 157.1 192.0
--------------------------------------------------------------------------------------------------
Decrease in surplus (-)........................ -11.7 -40.3 -75.2 -114.9 -159.1 -207.5 -261.4 -321.8 -388.2 -462.1 -545.0
Sustained during 2001-2011, with no change in
unemployment:
Receipts......................................... -9.6 -30.8 -56.7 -84.9 -115.3 -148.0 -183.1 -221.0 -261.9 -305.2 -353.3
Outlays.......................................... 0.2 1.1 3.3 7.1 12.2 18.2 25.9 35.8 47.6 61.9 78.6
--------------------------------------------------------------------------------------------------
Decrease in surplus (-)........................ -9.8 -31.8 -60.1 -92.0 -127.5 -166.1 -209.0 -256.8 -309.5 -367.2 -431.9
Inflation and Interest Rates
Budgetary effects of 1 percentage point higher rate
of:
Inflation and interest rates during calendar year
2001 only:
Receipts......................................... 11.0 22.4 22.1 20.7 21.9 23.1 24.5 25.8 27.1 28.7 30.6
Outlays.......................................... 5.5 11.4 9.8 9.0 8.4 7.2 6.5 6.1 5.6 5.2 4.6
--------------------------------------------------------------------------------------------------
Increase in surplus (+)........................ 5.5 11.0 12.3 11.7 13.4 15.9 18.0 19.7 21.5 23.5 26.0
Inflation and interest rates, sustained during 2001-
2011:
Receipts......................................... 11.0 34.1 58.2 82.4 109.2 138.7 171.4 207.3 247.1 290.9 341.1
Outlays.......................................... 5.3 16.1 23.9 30.8 37.5 42.8 47.4 51.4 54.5 56.7 57.7
--------------------------------------------------------------------------------------------------
Increase in surplus (+)........................ 5.7 17.9 34.3 51.7 71.7 95.9 124.0 155.9 192.7 234.1 283.4
Interest rates only, sustained during 2001-2011:
Receipts......................................... 1.4 3.8 4.8 5.3 5.7 6.1 6.5 7.0 7.4 7.8 8.2
Outlays.......................................... 4.1 9.8 11.6 11.3 10.2 8.3 5.7 2.1 -2.1 -7.1 -13.4
--------------------------------------------------------------------------------------------------
Decrease in surplus (-)........................ -2.7 -6.0 -6.8 -6.0 -4.6 -2.2 0.9 4.8 9.4 14.8 21.6
Inflation only, sustained during 2001-2011:
Receipts......................................... 9.6 30.3 53.4 77.2 103.5 132.6 164.8 200.3 239.7 283.1 332.9
Outlays.......................................... 1.2 6.6 12.8 20.6 29.2 37.4 46.0 55.2 64.5 74.3 84.7
--------------------------------------------------------------------------------------------------
Increase in surplus (+)........................ 8.4 23.7 40.5 56.6 74.4 95.2 118.9 145.1 175.3 208.8 248.2
Interest Cost of Higher Federal Borrowing
Outlay effect of $100 billion reduction in the 2001 2.8 5.9 6.3 6.7 6.9 7.0 7.2 7.6 8.0 8.4 8.9
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.