5 Key Economic Predictions from CBO’s Crystal Ball
Policy + Politics

5 Key Economic Predictions from CBO’s Crystal Ball

iStockphoto/Vallarie Enriquez

The economy is perking up, the deficit is taking a nose dive and consumer optimism is on the rise.

Meanwhile, state and local governments are deciding how to spend revenue surpluses, consumer spending and home buying may be surging. And businesses will finally start opening their wallets and investing more heavily in expansion.

Related: Grim Deficit Outlook in New CBO Report

Or so says the Congressional Budget Office, the non-partisan budget analyst and economic soothsayer that released its latest 10-year economic and budget forecast on Tuesday. The formidable 175-page analysis prepared by the staff and advisers to CBO Director Doug Elmendorf offers the agency’s best guess of the contours of the economy and the likely ups and downs of the federal deficit and debt. In a sense, it is the world according to the CBO.

On the positive side, the CBO cut its projected federal deficit for 2014 by $46 billion dollars, to $514 billion, or about three percent of the U.S. gross domestic product. The agency said it expected the deficit to fall to $478 billion, or 2.6 percent of GDP, in 2015. Deficits are expected to stay below the 40-year average for the next three years.

The bad news is that over the longer term, deficits start growing again, and CBO now believes that growth will be faster than previously anticipated – driving up the accumulated national debt in the process. CBO estimates that federal debt held by the public that currently tops $17 trillion will equal 74 percent of GDP at the end of this year and 79 percent in 2024.

Related: CBO Future Shock: Economy Will Struggle for 7 Years

The consequences for the overall economy largely mirror that good news-bad news motif.

Just as the CBO forecasts the economy will grow at a “solid pace” in 2014 and for several years thereafter before hitting a wall, the agency sees relatively good news on the horizon for the  business sector, households and consumers, home buyers and state and local governments before things start to go south again.

William G. Gale, senior fellow in economic studies at the Brookings Institution, said he was treating CBO’s short-term good news with a healthy dose of skepticism.

Related: Obamacare Will Insure Fewer People, Cost More Jobs: CBO

“It’s good that things are not getting worse in the next couple of years,” Gale said in an interview yesterday. “But relative to what we wanted to do in terms of fiscal policy and [debt] sustainability . . . we’re starting from a position that is not a good one.”

Gale insists that whatever economic progress the CBO and others can point to must be tempered by a debt-to-Gross Domestic Product ratio of 74 percent, or more than twice what it was a decade ago during the Bush administration.  

Even taking into account the adverse impact of the Great Recession on the economy and budget, Gale argues 74 percent is a pretty high number to be starting from. “It’s great that things are not going to hell in a hand basket really fast, but this notion that’s floating around that, ‘Mission accomplished, we’ve solved all our fiscal problems,’ I think is very misleading.”

Here are some of the highlights of CBO’s findings, mostly in the agency’s words: 

State and Local Governments:  Purchases of goods and services by state and local governments will grow faster in the next few years than in the recent past, as the revenues of those governments pick up because of the strengthening  of the economy and increases in the prices of houses and financial assets.

Related: Gov. Jerry Brown Uses Surplus to Prevent Bankruptcies   

Such purchases by state and local governments fell from the end of 2009 to the middle of 2013 because a weak economy depressed tax revenues and raised benefit payments. The economic boost from increasing purchases by state and local government will more than offset the drag from rising tax revenues.

The Household Sector:  There will be solid household growth in spending on consumer goods and services and residential investment over the next few years. That outlook reflects CBO’s expectation that disposable personal income will grow at a moderate pace, households’ net worth and consumers’ confidence will continue to improve, and conditions for borrowing by consumers and homebuyers will ease.

CBO projects real consumer spending will grow by nearly 3 percent per year, on average, through 2016 and by slightly less in 2017.  Real residential investment will grow by 17 percent per year in 2014 and 2015, driven mostly by a rebound in starts of new housing units, and more slowly thereafter. 

Income, Net Worth, and Consumers’ Confidence: Disposable personal income will increase by 3 percent this year and at a similar pace during the next few years. Disposable income fell sharply in early 2013 after payroll tax rates and some  income tax rates rose, but it grew at an annual rate of more than 3 percent for the rest of the year. 

Gains in employment and in hourly wages are expected to boost income in 2014 and subsequent years. Moreover, households’ net worth relative to disposable personal income has grown rapidly for the past year and a half as substantial increases in equity and house prices have outpaced gains in disposable income.

Related: 8 Things That Will Get Cheaper in 2014

Still, consumer confidence remains well below pre-recession levels, consistent with the generally soft growth in consumer spending since the Great Recession.   

The Business Sector:  Investment in business will rise rapidly over the next four years, after a disappointing performance in 2013.

Real business fixed investment – that is, purchases of equipment, structures and

Intellectual property products – grew by just 2.1 percent in 2013.

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However, according to the agency’s projections, the need to replace depreciating capital and expand productive capacity in line with rising demand will boost the growth of such investment to an average annual rate of 7 percent over the 2014–2017 period.

Net fixed investment by businesses -- which equals gross investment minus depreciation -- fell sharply during the 2007–2009 recession and remains low relative to potential GDP by historical standards.

CBO claims that shortfall is due primarily to the low rate of utilization of business capital during the recession and weak recovery, as firms did not need to make full use of their existing capital in light of weak demand for their products. However, the surprising sluggishness of investment last year makes clear that other factors are at work as well.

International Trade:  Real net exports (exports minus imports, after adjustments for inflation) will decrease this year and next before rebounding after 2016.

That projected decline in 2014 and 2015 largely reflects CBO’s expectation that growth in the United States will outpace average growth among the nation’s leading trading partners during those years, causing the demand for imports to the United States to rise faster than the demand for U.S. exports.

However, the decline in net exports in the next two years will be moderated by a projected increase in U.S. production of crude oil, which will decrease the growth rate of petroleum product imports. 

After remaining steady in 2016, net exports will rise in 2017, primarily because of a gradual decline in the exchange value of the dollar.

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