The Economic Outlook

The deep recession that began two years ago appears to have ended in mid-2009. Economic activity picked up during the second half of the year, with real (inflation-adjusted) gross domestic product and industrial production both posting gains. Still, GDP remains roughly 6½ percent below the Congressional Budget Office’s estimate of the output that could be produced if all labor and capital were fully employed (so-called potential output), and the unemployment rate—at 10 percent—is twice what it was two years ago.

■	Economic growth will probably be restrained by the aftermath of the financial and economic turmoil. Experience in the United States and in other countries suggests that recovery from recessions triggered by financial crises and large declines in asset prices tends to be protracted.

■

Although aggressive action on the part of the Federal Reserve and the fiscal stimulus package enacted in early 2009 helped moderate the severity of the recession and shorten its duration, the support coming from those sources is expected to wane. In addition, under the assumption that current laws and policies remain unchanged—an assumption that is reflected in CBO’s forecast—tax rates will increase in 2011, further hampering growth.

■	Household spending is likely to be dampened by slow income growth, lost wealth, and constraints on households’ ability to borrow. Investment spending will be slowed by the large number of vacant homes and offices.

In CBO’s forecast, real GDP increases by 2.1 percent between the fourth quarter of 2009 and the fourth quarter of 2010 and by 2.4 percent in 2011 (see Table 2-1). Given CBO’s estimate of growth in potential output, those GDP growth rates will narrow the difference between actual output and potential output (the output gap) only slightly. Growth in real GDP will accelerate after 2011, spurred by stronger business investment and residential construction. From 2012 through 2014, real GDP will increase by an average of 4.4 percent per year, CBO projects, which would close the output gap completely by the end of 2014 (see Figure 2-1).

Even though output began to grow during the second half of 2009, the unemployment rate continued to rise, reaching 10.1 percent in October and finishing the year at 10.0 percent (see Figure 2-2). Since the beginning of this recession, payroll employment has fallen by more than 7 million, reflecting both the rise in unemployment and a drop in labor force participation; payroll employment has not yet begun to increase again. Although new claims for unemployment insurance have fallen substantially since early 2009, they remain well above prerecession levels. Moreover, hiring rates are still very low, and they show only faint signs of recovery.

Sources: Congressional Budget Office; Department of Commerce, Bureau of Economic Analysis; Department of Labor, Bureau of Labor Statistics; Federal Reserve.

Notes: Economic projections for each year from 2009 to 2020 appear in Appendix E.

Sources: Congressional Budget Office; Department of Commerce, Bureau of Economic Analysis.

Notes: Real gross domestic product is GDP adjusted for inflation. Potential GDP is CBO’s estimate of the output the economy would produce if its resources—capital and labor—were fully employed.

This pattern of labor market activity is typical of recent recessions, in which the unemployment rate continued to rise for more than a year after real GDP began to grow. Hiring usually lags behind output during the initial stages of a recovery because firms tend to increase output first by boosting productivity and by raising the number of hours that existing employees work; adding employees tends to occur later. Moreover, the unemployment rate often rises for a few quarters after employment begins to recover, because the perception of improved job prospects encourages workers who had dropped out of the labor force during the recession to reenter the labor force. CBO expects that the unemployment rate will average slightly above 10 percent in the first half of 2010 and then turn downward in the second half of the year. As the economy expands further, the rate of unemployment is projected to continue declining until, in 2016, it reaches 5 percent; that figure is equal to CBO’s estimate of the natural rate of unemployment (which reflects, in part, the difficulty of making immediate matches between job seekers and jobs).¹ In CBO’s forecast, the persistently elevated level of unemployment depresses labor income in 2010. Beyond 2010, CBO expects labor income to grow more rapidly than GDP (as conditions in labor markets improve) and, by 2020, to approach the share of GDP that prevailed, on average, between 1979 and 2008.

Reflecting the large amount of slack in the economy, inflation will decrease further from its already low level in 2009, CBO forecasts. The core price index for personal consumption expenditures (that is, the PCE price index excluding the prices of food and energy) will rise by about 1 percent (on a fourth-quarter-over-fourth-quarter basis) in 2010 and 0.9 percent in 2011.² Overall inflation is also expected to remain quiescent; the PCE price index rises by 1.4 percent in 2010 and 1.1 percent in 2011 in CBO’s forecast. The consumer price index for all urban consumers (CPI-U), a measure more closely related to the budget than is the PCE price index, rises by 1.6 percent and 1.1 percent in those years. Over the following three years, inflation, as measured by any of those indexes, is projected to average 1.5 percent or less.

Short-term interest rates will remain at very low levels through the middle of next year and then rise slowly as the recovery progresses, in CBO’s estimation. As part of its aggressive easing of monetary policy in response to the financial crisis, the Federal Reserve reduced the target federal funds rate—the overnight interest rate at which depository institutions borrow and lend monetary reserves—to near zero in late 2008 and held it at that level throughout 2009. If inflation stays low and the recovery is gradual, as CBO anticipates, then the Federal Reserve is likely to keep its target interest rate low for some time. As economic activity strengthens more noticeably by the end of 2011, CBO expects that the Federal Reserve will begin raising the federal funds rate rapidly. Interest rates on short-term federal borrowing generally follow the funds rate closely. In CBO’s forecast, the yield on the 3-month Treasury bill averages 0.2 percent in 2010 and 0.7 percent in 2011. By late 2014, when the economy strengthens further, the yield will rise to 4 percent, CBO projects. Based on that path for short-term rates, CBO assumes that the rate on 10-year Treasury notes will rise gradually from an average of 3.6 percent in 2010 to 4.9 percent in 2014.

CBO expects that output will reach its potential level by 2014. For the following five years, CBO projects growth in GDP averaging 2.4 percent, the same rate as that of potential output. The unemployment rate is projected to average 5 percent between 2015 and 2020, and consumer price inflation as measured by the PCE price index will average 1.7 percent during that period. From 2015 through 2020, the interest rates on three-month Treasury bills and 10-year Treasury notes will average 4.6 percent and 5.5 percent, respectively.

Sources: Congressional Budget Office; Department of Labor, Bureau of Labor Statistics.

CBO’s current economic projections are similar to its previous projections, which were issued in August 2009. In this forecast, real growth is expected to be slightly faster during the first half of 2010 but slightly slower during the rest of 2010 and in 2011. (For the 2010–2020 period as a whole, the projection for real growth is almost unchanged.) The rate of unemployment is expected to be somewhat higher, on average, reflecting an upward revision to the estimate of the natural rate of unemployment. Interest rates remain low for longer than in the previous forecast. The projection for inflation is somewhat higher than it was last August. The lower interest rates and higher inflation (the latter through its effect on the projection of federal receipts) are the primary reasons for the improved budget outlook. Altogether, the changes in economic projections reduce the federal deficit by an estimated $626 billion over the 2010–2019 period (see Appendix B for more details).

CBO’s forecast anticipates slower growth in 2010 and 2011 than do the forecasts of the Blue Chip consensus (reflecting the views of about 50 private-sector economists) and the forecasts of most participants in last November’s meeting of the Federal Open Market Committee of the Federal Reserve System (reported as the "central tendency" of their forecasts).³ That difference probably stems, at least in part, from divergent assumptions about fiscal policy. CBO’s current-law forecast reflects the assumption that the tax cuts enacted in 2001 and 2003 will expire as scheduled at the end of 2010 and that the exemption amounts for the alternative minimum tax will fall back this year to the amounts they would have been in the absence of the regular "patches" (temporary adjustments). By contrast, private forecasters and the Federal Reserve probably expect that the Congress will extend some or all of those provisions, and they may expect that other stimulative fiscal measures will be enacted as well. If CBO assumed that all of the expiring tax provisions were extended beyond 2010 and no other stimulative fiscal measures were passed, the agency’s forecast of the level of real GDP at the end of 2011 would be in line with the forecast of the Blue Chip consensus and near the lower end of the central tendency of the Federal Reserve’s forecasts. (However, the greater accumulation of government debt that would result would diminish real GDP in later years.) CBO’s inflation forecast calls for inflation that is roughly in line with that of the Blue Chip consensus in 2010 but significantly lower in 2011, and it is at the lower end of the central tendency of the Federal Reserve’s forecasts for 2010 and 2011.

■

The Congress, the Federal Reserve, the Treasury, and other government agencies instituted a series of substantial and innovative policy actions during the financial crisis and recession. Determining the degree to which those initiatives will support output and employment as they wind down in the next few years is not straightforward.

■	Business-cycle recoveries from recessions caused by financial crises and declines in asset prices (in the United States and abroad) have tended to be muted. However, it is uncertain to what degree this recovery will follow that historical pattern.

■	The outlook for inflation is particularly uncertain in this recovery because of the unusual amount of excess capacity in the economy and because of the unprecedented nature of the actions taken by the Federal Reserve during the financial crisis.

Severe economic downturns often sow the seeds of robust recoveries. During a slump in economic activity, consumers defer purchases, especially for housing and durable goods, and businesses postpone capital spending and try to cut inventories. Once demand in the economy picks up, the disparity between the desired and actual stocks of capital assets and consumer durable goods widens quickly, and spending by consumers and businesses can accelerate rapidly. For example, following the deep recession of 1981 to 1982, during which the output gap exceeded 7 percent, real GDP surged by nearly 8 percent in 1983 and by roughly 6 percent in 1984, led by spending on consumer durable goods, housing, and business investment.

Although CBO expects that the current recovery will be spurred by that dynamic, in all likelihood the recovery will also be dampened by continued financial weakness, a lessening of fiscal and monetary stimulus, a subpar recovery in the housing market, and the likelihood that employment growth will lag output growth, thus holding back the recovery in workers’ incomes.

Conditions in many financial markets improved substantially during the second half of 2009, but continuing problems in the financial sector will slow the pace of the recovery. Improving market conditions have allowed policymakers to begin withdrawing the support provided during the financial crisis; in particular, financial institutions have greatly reduced their reliance on the Federal Reserve’s emergency liquidity facilities. Nevertheless, loan losses continue to mount in the banking sector, and activity remains subdued in the once-vibrant private markets for mortgage- and asset-backed securities—markets that have been a major source of funds for lending in recent years.

The risk of further deterioration in many financial markets has diminished, although it has not disappeared. Improvements are particularly apparent in the money market (in which financial institutions and banks obtain short-term financing), as the perceived riskiness of lending in that market has fallen significantly. Indeed, the cost to banks of borrowing from other banks has fallen sharply from its peak during the crisis to a level that is well below its precrisis average, suggesting that banks’ access to short-term credit is near normal levels. In some cases, businesses’ cost of short-term borrowing in the market for commercial paper has fallen to unprecedented levels. For highly rated businesses, for instance, the interest rate on 3-month commercial paper—which during the crisis had reflected a high risk premium—declined in late 2009 to about 20 basis points, implying that the perceived riskiness of such lending is close to its average level. (Lower-rated borrowers continue to pay higher rates, but those rates have also dropped markedly.)

Conditions for longer-term borrowing and in equity markets have improved as well. By lowering the cost of capital for businesses, those improvements should provide support for renewed investment activity, although firms dependent on bank financing may face greater constraints. Interest rates on corporate debt fell sharply last year, reflecting a reduction in financial markets’ assessment of the risk of such lending. As a consequence, corporations issued $1.3 trillion in new debt securities in 2009—40 percent more than they issued in 2008. Equity prices also have increased—the Standard & Poor’s 500 index climbed by nearly 60 percent from its low in March 2009—as prospects for economic growth in the United States and in the rest of the world improved.

Banks. The financial situation of many banks remains fragile, and their losses on loans continue to mount. The net percentage of loans written off as losses (charged off) by banks through the third quarter of 2009 increased to 2.9 percent (on an annual basis) from 1.5 percent one year earlier. CBO expects losses on bank loans to persist for some time because improvements in loan performance tend to lag those in the overall economy. The magnitude of loan losses has led to a sharp increase in the number of bank failures, and CBO expects more failures over the next few years.

Notes: The figure shows the net percentage of respondents to the Federal Reserve’s October 2009 Senior Loan Officer Opinion Survey on Bank Lending Practices who reported tightening lending standards. Similar movements were reported in the lending standards for other loans and credit cards.

Data on mortgages before the first quarter of 2007 cover all mortgage loans; data after that point cover only prime mortgage loans (those made to creditworthy borrowers and thus with a relatively small risk of default).

The net percentage who reported tightening standards for nonprime mortgages after the first quarter of 2007 has been greater than the percentage so reporting for prime mortgages.

Lending by banks remains weak—loans outstanding at commercial banks decreased by about $500 billion during 2009—reflecting both a lower supply of loans from banks and a lower demand for loans by businesses and consumers. Supply fell because banks became concerned about loan losses and acted to preserve their capital. According to the Federal Reserve’s October 2009 survey of senior loan officers, banks have progressively tightened their lending standards, although the rate of tightening has declined (see Figure 2-3). Demand for loans fell because good investment opportunities were scarce and the ability to service debts declined with income in the recession. Small businesses, for example, report to the National Federation of Independent Business that they see tighter-than-usual credit conditions, but their main concern remains a lack of sales rather than an inability to borrow as much as they wish.

An important and continuing source of exposure for banks is loans they made on commercial real estate. Weak economic conditions are likely to boost losses on those loans and on securities backed by commercial real estate. Of the approximately $3.5 trillion in debt associated with commercial real estate that was outstanding in mid-2009, about $1.7 trillion was held on the books of banks and thrifts, and about 8 percent of those loans were considered delinquent, almost double the level of a year earlier. Defaults on commercial real estate loans seem likely to mount as refinancing for many of the almost $500 billion of loans maturing during 2010 and 2011 may be difficult to obtain.⁴

Securitization Markets. In the past two decades, securitization—the process of bundling loans into asset-backed securities and selling the securities to investors in the open market—has become an important source of funding for many types of consumer and commercial credit and for commercial and residential mortgages. During the recent crisis, unexpected losses on what were highly rated asset-backed securities shook investors’ confidence in those products, and activity in certain segments of the market disappeared entirely. The market for securities backed by commercial real estate was hit particularly hard, and almost no securitization of residential mortgages has occurred in the past two years without the backing of the federal government (see Figure 2-4).

CBO expects that the Federal Reserve will use monetary policy to continue to support the nascent recovery until it perceives that the risks of significantly higher inflation outweigh the risks that the economy will fall back into recession. That calculation will probably suggest a lessening of monetary stimulus beginning next year.

Source: Congressional Budget Office based on data through 2008 from Inside Mortgage Finance, The 2009 Mortgage Market Statistical Annual, vol. 2, The Secondary Market (Bethesda, Md.: Inside Mortgage Finance Publications, 2009).

During the recession, the Federal Reserve turned to nontraditional means to provide monetary stimulus. It lowered its target for the federal funds rate to nearly zero to stimulate economic activity, but because of the magnitude of the disruptions to the financial system, it also saw a need for additional actions.⁵ To put downward pressure on medium-term interest rates (those on securities with terms to maturity of between 2 years and 10 years) in the mortgage and debt markets, the Federal Reserve purchased a large amount of mortgage-backed securities and other medium- and long-term debt in the open market. It also created a number of emergency facilities, most of which have now largely wound down, to restore liquidity and confidence in the markets, and it provided financing to several "systemically important institutions." As a consequence, the Federal Reserve’s asset holdings at the end of last year were more than twice as large as they were before the financial crisis. Although the effects of those nontraditional policy actions are hard to quantify, CBO believes that they have provided a significant amount of stimulus—mitigating the impact of the financial crisis on the broader economy and moderating the depth of the recession.

Those nontraditional policy actions have complicated the outlook for monetary policy, however. CBO expects that, beginning next year, the Federal Reserve will seek to withdraw the monetary stimulus in a way that supports the recovery yet avoids creating inflationary pressures. (That outlook is based in part on the expectations of financial market participants and in part on CBO’s forecast for economic growth.) Before the financial crisis, if the Federal Reserve had wanted to remove monetary stimulus, it would have done so by raising the federal funds rate. Now, however, to remove stimulus, the Federal Reserve can undertake different combinations of raising the federal funds rate and reducing its holdings of assets. Because the Federal Reserve has not faced that choice before, it is difficult for it and for outside forecasters to accurately project the interplay between traditional and nontraditional policy tools during the coming years. In CBO’s forecast, the Federal Reserve keeps its target rate very low through the middle of 2011 and begins to raise that rate only as clear signs of improving economic activity and labor market conditions emerge.

Many economists worry that inflation could increase if monetary stimulus provided by the Federal Reserve is not removed in a timely manner. One particular concern is that the Federal Reserve may be constrained from decreasing its holdings of mortgage-related assets while the housing market remains fragile. However, there is also a risk that the Federal Reserve will sell assets or raise the funds rate too quickly, in which case the economic recovery may be even more muted than CBO anticipates.

Federal fiscal policy supported economic activity in 2009, both through the effects of legislation (especially the American Recovery and Reinvestment Act) and through the effects of the automatic fiscal stabilizers—automatic changes in federal revenues and outlays caused by the ups

and downs of business cycles.6 Fiscal policy will boost output and employment to an even greater extent in 2010, according to CBO’s estimates, but its impact will decline in subsequent years. In addition, increases in tax rates scheduled in current law will begin to restrain economic activity in 2011.

CBO expects that the direct and indirect economic effects of ARRA will peak in the first half of 2010 and then diminish, adding to demand by progressively smaller amounts in the second half of 2010 and there-after. ARRA authorized direct purchases of goods and services by the federal government, transfers to states and local governments (for spending on infrastructure and other purposes), payments to individuals, and temporary tax reductions for individuals and businesses. CBO has estimated that the legislation raised real GDP by 1.3 percent to 3.5 percent during the second half of 2009 (relative to what it would have been without the stimulus). CBO projects that ARRA will increase real GDP by 1.5 percent to 4.5 percent during the first half of 2010, 1.2 percent to 3.8 percent in the second half of 2010, 0.6 percent to 2.0 percent in 2011, and by lesser amounts in subsequent years.⁷ Consequently, although it will still add to the level of GDP, ARRA’s contribution to growth will turn negative during the latter part of 2010.

The fiscal policy response to recessions includes not only discretionary actions such as ARRA, but also the federal budget’s automatic tendency to moderate recessions as a result of the structure of federal tax and spending programs. The federal tax system and social safety-net programs automatically dampen swings in economic activity by decreasing tax payments to the government and increasing benefit payments to households when economic activity slows (and by having the opposite effect when economic activity quickens).⁸ That automatic stabilizing effect is quite timely because it does not require legislative action. The automatic stabilizers increased the federal deficit by about one-third percent of GDP in fiscal year 2008 and 2 percent in 2009, and they will add roughly 2½ percent in both 2010 and 2011, in CBO’s estimation. As the economic recovery strengthens and output moves closer to its potential level, support from the automatic stabilizers will wane.

Despite the budgetary impacts of ARRA and the automatic stabilizers, both of which increase the deficit in 2010 relative to 2009, CBO estimates that the federal deficit will drop from 9.9 percent of GDP in fiscal year 2009 to 9.2 percent this year. Rather than stemming from fiscal restraint in the usual sense, however, the reduction results from reduced outlays for the Troubled Asset Relief Program, Fannie Mae, and Freddie Mac (see Chapter 3). Without the large swings in estimated outlays for those activities, whose effects on output and employment are quite difficult to measure, the federal deficit would increase rather than decrease in fiscal year 2010.

Under current law, fiscal policy will be less stimulative in 2011. Growth in 2011 will be reduced by the expiration of the tax cuts provided in the Economic Growth and Tax Relief Reconciliation Act of 2001 and the Jobs and Growth Tax Relief Reconciliation Act of 2003 and by the expiration of the temporary relief from the alternative minimum tax. Because AMT relief ceased at the end of 2009, tax rates and liabilities will be higher in 2010. However, CBO anticipates that the impact of higher taxes under the AMT on economic behavior and growth will largely be delayed until 2011, when most of the added taxes will be paid if no further relief is enacted.⁹ CBO estimates that, taken together, those tax changes will reduce growth only slightly between the fourth quarters of 2009 and 2010, reduce growth by 1.4 percentage points in 2011, and increase growth by 0.6 percent in 2012.

Sources: Congressional Budget Office; Department of Commerce, Bureau of the Census.

Both business and residential investment fell to extraordinarily low levels during the recession in response to the previous overbuilding of the housing stock and the falloff in demand for goods and services. Problems in the financial sector also contributed to the weakness in investment by raising the cost and reducing the availability of credit to firms and households. Private investment—comprising residential construction; businesses’ purchases of equipment, software, and structures; and the change in businesses’ inventories—declined by an estimated 24 percent during 2009, matching the largest drop previously recorded during the post–World War II period. In CBO’s view, investment will begin to rebound this year as the demand for goods and services picks up and the excess stock of residential housing is whittled down. Nevertheless, the magnitude of that excess stock and the ongoing problems in financial markets, especially in the market for mortgages on commercial real estate, are likely to retard the pace of the recovery in the near term.

Housing. Home builders began construction on 550,000 residential housing units during 2009, well below the estimated 1.5 million units that would be necessary to keep up with the growth of the population and the replacement of obsolete units. That unusually low rate of housing starts primarily reflects the unusually high rate of vacancies among housing units (see Figure 2-5). CBO estimates that there were roughly 2.5 million excess vacant housing units, on average, during the second half of 2009.¹⁰ That number has been fairly steady during the past two years despite very low levels of construction because the recession and a sharp rise in mortgage foreclosures have reduced the number of people and families able to maintain independent households.

Because it will take time to absorb the stock of excess vacant units and because of the continuing problems in mortgage markets, CBO expects that the recovery in residential investment will be tepid during 2010 and will contribute less to overall growth thereafter than it has during recoveries following past deep recessions. The difficulty of obtaining credit for commercial real estate is expected to inhibit the recovery of multifamily housing.

Business Fixed Investment. The rate of net business fixed investment—measured as total investment minus depreciation—dropped below 1 percent of GDP during the second half of 2009 (see Figure 2-6). At that rate, businesses’ spending on plant and equipment was barely sufficient to cover their replacement needs. For that reason, any future growth in demand will probably generate stronger investment within a few quarters. CBO expects that real business fixed investment will begin to grow modestly during 2010, but net investment will remain quite low by historical standards. Investment in producers’ durable equipment and software will lead the recovery; such spending began growing (in real terms) during the second half of 2009, and CBO anticipates that it will rise more rapidly than overall business fixed investment through 2012. Investment in nonresidential structures is expected to lag behind investment in equipment and software because spending for construction requires longer lead times to plan and execute. In addition, problems in the financial sector have hit commercial real estate especially hard, and leading indicators of commercial construction suggest further weakness in that sector during 2010. Nevertheless, CBO expects that overall investment in nonresidential structures will begin to recover during 2011 and then grow more vigorously thereafter.

Sources: Congressional Budget Office; Department of Commerce, Bureau of Economic Analysis.

Notes: Business fixed investment (nonresidential structures and producers’ durable equipment and software) is shown net of depreciation.

Inventory Investment. The drop in sales during the recession caused businesses’ inventories to rise sharply relative to their sales, and businesses responded by cutting production (see Figure 2-7). Typically, it takes about a year for firms to fully adjust their inventories to a large change in demand, so the sharp drop in demand in late 2008 and early 2009 caused businesses to trim real inventories at a record pace during the first three quarters of 2009. By late 2009, the inventory-to-sales ratio had nearly returned to its prerecession level, and the pace of the inventory drawdown slowed considerably—so it appears that the adjustment process is nearly complete. With inventories back in line, firms could increase their production to more closely match their sales. That increase in production probably added more than 2 percentage points to the annual growth of real GDP in the fourth quarter of 2009. CBO estimates that investment in inventories will turn positive in 2010, further contributing to GDP growth, but by less than it did in the fourth quarter of 2009. The need for businesses to maintain inventories consistent with growing sales will most likely lead to modest growth in inventories during the second half of 2010 and beyond.

Real consumer spending grew modestly last year, and CBO expects that its growth will remain subdued this year and next. Such spending declined steeply during the first part of the recession, bottomed out in mid-2009, and began a tepid recovery in the second half of last year, when it rose at an average annual rate of about 2½ percent. Federal fiscal policy, including the effects of ARRA and the temporary "Cash for Clunkers" program, contributed to that recovery. Over the next few years, the growth in consumer spending is likely to be restrained by slow growth in wages and salaries, the declining impact of ARRA, tax increases in 2011, weak gains in households’

Sources: Congressional Budget Office; Department of Commerce, Bureau of the Census.

Notes: Data are for the summed inventories and sales of manufacturers, retailers, and merchant wholesalers.

Real wage and salary income, the largest component of consumer income, declined during the recession at the fastest rate since the recession of 1973–1975. It is likely to recover only slowly, further restraining consumer spending. CBO expects that the continued high rate of unemployment will limit the growth of wage rates for the next few years, and the slow recovery will hold down the growth of employment.

In addition, fiscal stimulus will provide less support to consumer spending in the second half of this year, and the tax increases scheduled for 2011 will dampen spending. Although CBO expects that ARRA will continue to boost consumer spending (and other sources of aggregate demand) during 2010 and 2011, the magnitude of the boost will diminish. Moreover, under current law, federal personal income tax payments will increase sharply in 2011, primarily from the expiration of the tax cuts enacted in EGTRRA and JGTRRA and the expiration of the temporary relief from the alternative minimum tax. CBO expects personal income taxes to increase from $946 billion in fiscal year 2010 to nearly $1.3 trillion in 2011. As a consequence, after-tax income, which is likely to grow only slowly this year, will decline as taxes rise in 2011.

Small gains in households’ wealth are also likely to limit consumer spending in the next few years. During the housing boom, when house prices were rising rapidly, many homeowners borrowed against their rising home equity to fund their spending. Housing equity has dropped with the fall in house prices, and CBO anticipates that weakness in house prices will persist through early 2012. Furthermore, the higher credit standards that have been required to obtain home mortgages in the past few years are likely to restrain borrowing by those homeowners with equity in their homes. Recently, rising stock prices have boosted consumers’ wealth, but stock prices remain about 28 percent below what they were at the stock market peak in October 2007.

Higher standards for borrowing also are likely to rein in consumer spending in the near term. Banks began raising their standards on consumer loans in late 2007, after delinquencies on those loans had begun to move up, and they have continued to tighten them ever since. Given the prospect of continued losses on their consumer loans and other loans, banks are likely to keep their standards for loans to consumers relatively high in the near term.

International trade reduced the severity of the recession and will slightly dampen the speed of the recovery this year. Real net exports (exports minus imports) improved during the recession, increasing from about -$560 billion at the beginning of the recession to about -$350 billion by mid-2009, extending an improvement that began in 2006. Because imports fell by more than exports, total demand for domestic production fell less than did demand by U.S. consumers and businesses. The improvement in net exports resulted in part from relatively faster growth among the United States’ trading partners than in the United States for several years before the recession. It also resulted from the long-standing decline in the exchange value of the U.S. dollar, which improved the competitiveness of U.S. goods and services in world markets. The real value of the dollar fell by more than 20 percent in terms of the currencies of U.S. trading partners between 2002 and 2008, lowering the prices of U.S. goods in international markets (see Figure 2-8).¹¹

CBO expects net exports to fall slightly this year. The main reason is that the recession in the United States was less severe and the subsequent recovery will be stronger than in many other countries to which the United States exports goods and services. Specifically, real GDP in the Euro zone, the United Kingdom, Japan, and some emerging economies fell much more sharply than it did in the United States, and recoveries in many advanced foreign economies are expected to be more sluggish than the recovery in the United States this year.¹² Another reason that net exports are likely to fall slightly in 2010 is the effects of the temporary rise in the value of the dollar in

Notes: The index is a weighted average of the foreign exchange values of the U.S. dollar against the currencies of a large group of major U.S. trading partners, adjusted for inflation. The index weights, which change over time, are derived from U.S. export shares and from U.S. and foreign import shares.

late 2008 and early 2009, when international investors increased their purchases of U.S. assets during the most turbulent period of the financial crisis. CBO expects that net exports will increase next year as growth in foreign economies begins to outpace that in the United States and as the value of the dollar continues its long-term downward trend.

The recent recession was marked by extremely weak demand for labor. Payroll employment fell by 6.4 million between December 2007, when the recession started, and June 2009—the date at which most forecasters believe the recession ended—and by an additional 0.8 million during the second half of 2009.¹³ That cumulative decline of 5.2 percent is the largest drop in employment in percentage terms since the period between September 1948 and October 1949. It also pushed the unemployment rate to more than 10 percent (nearly matching its peak since World War II), despite a considerable falloff in labor force participation (see Figure 2-9). Although employment has usually rebounded briskly following deep recessions, in this instance CBO envisions a slow recovery in employment and other measures of labor market performance. In particular, under current law, the unemployment rate is expected to remain at or above 10 percent throughout 2010 and above 9 percent through 2011.

Several factors are important to that outlook.14 First and most important, output is expected to grow fairly slowly in this recovery. Following the two previous severe recessions in the postwar period, output rebounded particularly rapidly, as did employment. Real GDP grew by 6.2 percent in the four quarters following the 1973–1975 recession and by 7.7 percent in the same period following the 1981–1982 recession. In both instances, all of the jobs lost during the recession were regained within four quarters. In contrast, GDP rose modestly and employment remained much weaker following the two most recent recessions. Employment changed little during the four quarters following the 1990–1991 recession, when real GDP rose by 2.6 percent. And employment fell by more than 1 million in the six quarters following the 2001 recession, when real GDP grew at an average annual rate of 2.1 percent.

Second, average weekly hours worked in private industries fell sharply during the recession to a level well below their long-term downward trend (see Figure 2-10). Restoring existing employees’ hours is one way that employers can increase labor input without having to bear the fixed costs of hiring new workers. Although average weekly hours increased in late 2009, they remain below the long-term trend, suggesting that many firms will increase workers’ hours before hiring on a large scale.

Sources: Congressional Budget Office; Department of Labor, Bureau of Labor Statistics.

in past recoveries. Recessions often accelerate the demise or shrinkage of less efficient and less profitable firms, especially those in declining industries and sectors. Thus, the share of unemployed workers whose previous job was permanently lost (or whose temporary job ended) tends to rise during recessions; the rise has been especially pronounced during the past two years (see Figure 2-11). At the same time, workers on temporary layoff represented a smaller percentage of the unemployed in this past recession than they did in earlier ones.

As a result of the surge in losses of permanent jobs (or completion of temporary jobs) during the recession, subsequent gains in employment will probably rely more than usual on the creation of new jobs, possibly in new firms that are located in different places and require workers with different skills than those needed in the jobs that have disappeared. For workers who have lost jobs because of a permanent layoff, the process of acquiring new skills can take time. (In contrast, it is easier for workers who have been laid off temporarily to return to their jobs because the employers already know the workers and the workers already have the right skills and are familiar with the work practices at the job.) For workers who own their homes and need to move to different geographic regions to find new jobs, the sharp declines in house prices during this recession, combined with the high loan-to-value ratios on many mortgages before the downturn, will hinder relocation: With a significant share of homeowners now owing more on their mortgages than their houses are worth, many people may not be able to sell their houses for enough money to enable them to relocate to new areas.

Although those factors suggest that the pace of job recovery is likely to be slow overall, two indicators have hinted that hiring conditions may improve to some extent in the near future. Employment in the category of temporary help services, a leading indicator for the labor market, experienced large gains in late 2009. In addition, during the second half of 2009, businesses achieved greater output by boosting productivity rather than by adding workers. Such surges in productivity are typical during the late stages of a recession or early months of a recovery, but in the past they have not lasted more than a few quarters.

Sources: Congressional Budget Office; Department of Labor, Bureau of Labor Statistics.

Notes: The category of "All Unemployed Persons" includes people who have lost jobs as well as individuals who have quit their job, who are seeking a first job, or who are aiming to return to the labor force after some period of absence.

CBO estimates that the core rate of consumer price inflation, which excludes prices for food and energy, will edge lower over the next few quarters and remain very low—at close to 1 percent—for a few years, gradually increasing as the economy approaches full employment (see Figure 2-12). The principal factor behind that forecast is the large amount of excess productive capacity in the economy, including unemployed workers, vacant houses, and unused business equipment and structures. Excess capacity inhibits firms from raising prices, employees from bargaining for higher wages, and landlords from raising rents. As excess capacity diminishes, the inflation rate will inch up slowly, CBO projects.

Historically, inflation has slowed during periods in which the economy has excess capacity—that is, during recessions and early in recoveries. The short-term relationship between excess capacity and changes in inflation has varied over the years, but an extremely high level of excess capacity (including a high unemployment rate) has always been associated with a slowing in the core rate of inflation.¹⁵ In keeping with that historical pattern, the annual rate of increase in the core PCE price index, which was running at about 2½ percent before the recent recession, has since fallen to about 1¼ percent. A major contributor to the slowdown in core inflation has been the rapid decline in rent inflation, which appears to be related to high vacancy rates, a sign of excess housing capacity (see Figure 2-13). CBO’s inflation forecast incorporates a smaller effect of excess capacity on inflation than has been true, on average, in the past: Given the already low rate of inflation, further declines in inflation would mean that more wage earners and firms would have to accept nominal declines in wages and prices, and resistance to such cuts may be strong.

CBO expects that prices of imports, commodities, and food will tend to push up inflation slightly in the next few years, but not by enough to fully counteract the downward pressure from unused resources. Import prices for nonpetroleum goods and services fell by about 6 percent during the year ending in the third quarter of 2009, which probably lowered consumer price inflation. Such prices are likely to increase in the next two years as foreign economies recover and as the value of the dollar weakens further. However, evidence suggests that changes in nonpetroleum import prices have a limited effect on consumer price inflation in the United States.

Sources: Congressional Budget Office; Department of Commerce, Bureau of Economic Analysis.

Notes: The overall inflation measure is the price index for personal consumption expenditures. The core rate excludes prices for food and energy.

Prices for many commodities (especially petroleum, metals, and some agricultural goods) have bounced back from their lows early in 2009, so overall inflation is likely to be slightly higher than core inflation this year. Petroleum prices rose from $39 per barrel in February 2009 to near $80 per barrel in mid-January (for West Texas intermediate crude oil), and energy analysts expect that prices will continue to rise this year. Natural gas prices did not increase during 2009, but analysts anticipate that those prices, too, will climb this year.

Prices for food to be consumed at home fell by almost 3 percent over the 12 months ending in December 2009, the greatest 12-month rate of decline since 1959, but food prices are expected to resume a more normal rate of increase this year. Prices for food commodities (such as corn, soybeans, wheat, and rice), which had increased sharply between 2006 and mid-2008, subsequently fell. The extraordinary drop in consumer food prices in 2009 largely reflects that decline in commodity prices. Prices of foodstuffs have stopped falling in recent months, however, and CBO expects that consumer food prices will average 1.5 percent growth over the next few years.

Forecasting inflation is always difficult, but the unprecedented amount of excess capacity in the economy and the extraordinary nature of the Federal Reserve’s monetary policy actions during the financial crisis have made it even more difficult than usual. Some analysts maintain that even nominal wage and price levels are susceptible to the downward pressures of excess capacity. Those analysts expect that inflation will be lower than in CBO’s forecast for the next few years; indeed, some analysts even anticipate a period of deflation. In contrast, many other analysts are concerned that it will be difficult for the Federal Reserve to avoid higher inflation, particularly two or three years from now. They fear that the Federal Reserve may be unable to trim its holdings of mortgage-backed securities and other long-term securities sufficiently rapidly.

CBO does not try to project business-cycle fluctuations in the economy beyond the short term (in this case, beyond 2014) but instead identifies and projects trends in the factors that underlie potential output, including growth in the labor force, the rate of capital accumulation, and the growth of productivity. During the first half of the 10-year projection period, real GDP is expected to grow rapidly enough to close the substantial gap that existed in 2009 between it and potential GDP. Then, during the remainder of the projection period, real GDP is projected to grow at about the same rate as potential GDP. That approach does not preclude the possibility of recession in the latter years of the projection period; instead, it assumes that the likelihood of booms or recessions in the future is about the same as it was in the past.

Sources: Congressional Budget Office; Department of Commerce, Bureau of the Census; Department of Labor, Bureau of Labor Statistics.

Note: The rental vacancy rate (right scale) is a quarterly measure and is plotted through the fourth quarter of 2009. The rental rates from the consumer price index for all urban consumers (left scale) are monthly measures and are plotted through December 2009.

On that basis, CBO projects that real GDP will grow at an average annual rate of 2.4 percent during the 2015–2020 period, which matches the growth rate that is projected for potential output during those years. The unemployment rate will average 5 percent between 2015 and 2020, which is equal to CBO’s estimate of the natural rate of unemployment.

Inflation as measured by the PCE price index will average 1.7 percent annually during the latter years of the decade; core PCE prices are also projected to grow at an average annual rate of 1.7 percent. The interest rate on three-month Treasury bills will average 4.6 percent between 2015 and 2020, and the rate on 10-year Treasury notes will average 5.5 percent.

CBO expects output to converge to the economy’s potential output by the end of 2014. Between now and 2014, potential output will grow at an average annual rate of 2.1 percent, CBO projects, well below the average growth rate of 3.4 percent during the past 60 years (see Table 2-2). During the 2015–2020 period, the average annual growth rate of potential output will pick up to 2.4 percent, still well below the historical average. In CBO’s judgment, potential growth during the coming decade will be held down relative to historical experience by slower growth in three key components: potential hours worked, capital services, and total factor productivity (TFP). During the first five years of the projection period, potential growth is further depressed by a very slow pace of capital accumulation resulting from the plunge of business investment during the recession and its expected gradual recovery. In the second half of the 10-year period, the pace of capital accumulation picks up in response to the recovery in business investment, but it remains below the pace of previous decades.

Potential hours worked in the nonfarm business sector, which accounts for about three-fourths of the economy, are projected to grow at an average annual rate of 0.5 percent from 2015 through 2020, significantly below the long-term historical average of 1.4 percent. That slower growth in hours worked reflects a correspondingly slower growth in the potential labor force, which averages 0.6 percent annually—considerably lower than its historical annual average, which CBO estimates at 1.6 percent from 1950 through 2009. Population growth is expected to be slower during the next 10 years than it was during the previous 60 years, and the labor force participation rate—the percentage of people ages 16 and over who are employed or seeking work—is expected to decline during the next decade (see Figure 2-9 on page 35). That rate has been falling since 2000, but it had been increasing during most of the prior 50 years, boosting the growth of the labor force relative to the population.

Growth in capital services (the services provided by the capital stock) will average 2.1 percent during the 2010–2014 period and 3.5 percent between 2015 and 2020, in CBO’s estimation. Those rates of growth are considerably lower than the average rate of 4 percent witnessed from 1950 through 2009. In the near term, growth in capital services is expected to be held back by very low rates of capital accumulation caused by the falloff in business investment related to the recession. During the second half of the projection period, the pace of capital accumulation is faster, but it is still below average because some private investment will be displaced by increased federal debt and because the slower projected growth in the labor force means that smaller increases in the stock of plant and equipment will be required to outfit the workforce with the same amount of capital per person.

The growth of potential total factor productivity—a measure of the combined productivity of labor and capital—will average 1.3 percent annually from 2015 to 2020, CBO projects. That projected rate is slightly below its average during the past 60 years but slightly above its average rate of growth since the major slowdown in productivity growth that occurred in the early 1970s.

Recessions typically have little effect on potential output beyond the direct effect of lower investment on capital accumulation, and that effect tends to diminish in the long run when investment recovers to normal levels. (The resulting time pattern of growth in capital services is reflected in CBO’s projection.) Other effects of recessions on potential output are possible, including those associated with declines in spending for research and development caused by falloffs in business revenues, but for most recessions they have been small.

Note: TFP = total factor productivity; GDP = gross domestic product; * = between -0.05 percent and zero.

Some analysts have raised concerns about persistent negative effects of the recent recession because of its unique characteristics, including the degree of disruption to financial markets and the labor market. The movement of workers across regions and industries may be more difficult in the wake of this recession than in the past because more workers appear to have been laid off permanently rather than temporarily and therefore may need to acquire new skills and move into new industries to find jobs. Moreover, the real estate slump may hinder workers’ ability to relocate to new jobs because they cannot sell their houses at prices sufficient to allow them to move. And finally, empirical studies have found that business-cycle recoveries from recessions induced by financial crises are generally slower than recoveries from recessions caused by other factors. For example, if financial inter-mediation is hobbled for several years because of the crisis, then the process of allocating resources will be hampered as well, which could slow the growth of potential output. To reflect the possibility that such mechanisms will be operating in coming years, CBO has trimmed the growth rate of potential TFP by 0.1 percentage point for the next five years. Consequently, the level of potential TFP in 2015 and beyond is 0.5 percent lower than it otherwise would be.

As measured by the PCE price index, inflation in CBO’s forecast averages 1.7 percent per year between 2015 and 2020. CBO expects that monetary policy will determine the path of inflation during that period and that the Federal Reserve will choose to maintain the rate of PCE inflation near the top of its apparent target range. As measured by the change in the consumer price index, inflation is projected to average 1.9 percent between 2015 and 2020 (reflecting the different methods used to calculate that index).

CBO projects that unemployment will average 5 percent from 2015 to 2020, equal to CBO’s estimate of the natural rate of unemployment. That estimate has been revised upward from 4.8 percent since last August, on the basis of both econometric evidence and an analysis of the recent trends in labor markets.

CBO’s outlook for interest rates in the latter years of the decade reflects its projections for inflation and for inflation-adjusted interest rates. The rate on 3-month Treasury bills is projected to average 4.6 percent, and the rate on 10-year Treasury notes, 5.5 percent.

Projections of federal tax revenues are based on projections of various categories of income—primarily wages and salaries, domestic corporate profits, proprietors’ income, and interest and dividend income—as measured in the national income and product accounts compiled by the Bureau of Economic Analysis. Because the sum of all domestic income is approximately equal to nominal GDP, future levels of income in those categories can be decomposed into future levels and shares of nominal GDP.

The growth of nominal GDP reflects both the growth of real GDP and the rise in prices of goods and services produced in the United States (measured by the GDP price index). In 2010, in CBO’s forecast, the GDP price index rises more slowly than the PCE price index because the rebound in energy prices that is under way affects the PCE price index much more than it does the GDP price index. After 2012, the two measures follow a similar track. Reflecting the growth of real GDP, nominal GDP rises relatively modestly in 2010 and 2011, averaging just over 3 percent. Nominal GDP averages about 6 percent growth over the following two years before converging to a trend growth rate of about 4 percent in the last years of the projection period.

Labor’s share of GDP, which fell during the recession to its lowest value since World War II, will increase over the next 10 years to its average over the past 30 years, CBO projects.¹⁶ In CBO’s forecast, the elevated level of unemployment depresses labor income in 2010. Beyond 2010, CBO expects labor income to grow more rapidly than GDP (as conditions in labor markets improve) and, by 2020, to approach its average share of GDP between 1979 and 2008.

In previous forecasts, CBO had assumed that the labor share of income would return to its average for the entire post–World War II period; that longer-term average is about ½ percentage point above the average since 1979. The change in CBO’s view reflects the fact that labor income as a share of GDP has stayed relatively low during most of the past three decades. Accordingly, a return to the longer-term historical average during the next 10 years would require a very rapid change from recent experience, and the weakness in labor market data suggest that such a rebound has become increasingly less likely.

Domestic corporate economic profits, another important category of income for revenue projections, have rebounded since the beginning of 2009 after a precipitous fall, and they are likely to continue to grow robustly in the near term. Domestic profits fell to 6 percent of GDP early in 2009, but CBO’s forecast shows them rising to nearly 9 percent of GDP by mid-2010. (Economic profits differ from book profits—those reported by corporations—because they remove the effects of tax law on the timing of depreciation and inventory valuation.) Domestic profits are those that arise from corporate operations in the United States. CBO projects that domestic corporate economic profits as a share of GDP will start to fall during 2013, as higher interest rates and the recovery in borrowing by businesses increases interest payments by businesses.

CBO’s economic outlook has not changed substantially since the agency prepared its previous forecast in August 2009. However, two of the changes—faster growth in nominal GDP and lower interest rates—contribute to an improved budget outlook. The forecasts for wages and salaries and for corporate profits (categories of income that are important for projecting revenues) were revised upward for much of the next decade.

The faster projected growth in nominal GDP stems from faster growth in the GDP price index rather than faster growth in real GDP, which is about the same as that projected in the August forecast for the 2010–2019 period as a whole (see Table 2-3). The average rate of increase in the GDP price index for the 2010–2019 period is about 0.2 percentage points faster in this projection than in the August 2009 projection, largely because of upward revisions to the projected increases in the prices of investment and consumption goods.

The projection of inflation (measured by growth in the PCE price index) was revised upward by between 0.3 percent and 0.4 percent over the next three years, in part because import prices are expected to increase more rapidly than CBO last projected, and also because excess capacity seems to be having a somewhat more modest impact on inflation than was previously thought. Inflation remains slightly higher (about 0.1 percentage point after 2015) in the remainder of the projection period than CBO projected in August. The CPI projection was generally revised less than the PCE price index, and it was virtually unchanged after 2015 (because it weights the components of consumption differently).

As a result of projecting a slightly lower growth rate of real GDP and a higher unemployment rate during the early stage of the recovery, CBO now expects interest rates to remain low for longer than it did last August. In CBO’s forecast, short-term rates are lower than previously forecast by 0.3 percentage points in 2010 and 1 percentage point between 2011 and 2014. Long-term rates are also lower in the same period, though by a smaller margin. Participants in financial markets have also lowered their forecasts of short-term interest rates through 2010. For the latter years of the projection period, interest rates are similar to the rates in CBO’s previous forecast.

The share of wages and salaries in GDP is lower throughout the projection period in this forecast than in the previous one, and the domestic corporate profit share is higher in the near term but lower in the latter years. Those changes are partly driven by revisions to historical data and partly by changes in methodology prompted by recent experience.

In July 2009, the Bureau of Economic Analysis published revisions to the national income and product accounts; those revisions indicated that wages and salaries were lower relative to GDP during the past 10 years than previously thought. The lower share in the recent data, combined with the likelihood of a more protracted period of high unemployment and low growth in wage rates, led CBO to forecast a lower share for wage and salary income in the near term. In addition, the downward revision for the past 10 years added to the evidence that the wage and salary share will not quickly return to its average since 1950. Therefore, in the latter years of the projection period, the wage and salary share is also somewhat lower than CBO forecast last August.

In contrast to the wage and salary revisions, the revisions to the corporate profit share of GDP in recent history were upward, and the current forecast indicates that profits will grow more quickly this year than was previously estimated. Therefore, the domestic corporate profit share of GDP is higher, on average, for the next five years in this forecast than in the forecast from last August. In the latter years of the projection period, however, the profit share falls below the amount forecast in August in response to an upward revision to projected interest payments by businesses.¹⁷

Sources: Congressional Budget Office; Department of Commerce, Bureau of Economic Analysis; Department of Labor, Bureau of Labor Statistics; Federal Reserve.

CBO estimates that the unemployment rate will be higher between 2010 and 2014 than it estimated last August, in part because of the forecast for slower growth of real GDP and slightly higher growth in productivity in the near term, but also because the dislocations in labor markets caused by the recession now appear to be more pervasive than previously estimated. CBO has also revised upward its estimate of the natural rate of unemployment for the 2015–2020 period, from

4.8 percent to 5.0 percent. That revision was based partly on econometric evidence and partly on an analysis of the recent trends in labor markets, especially the increase in the number of displaced workers and the growth in the number of workers unemployed for more than 27 weeks. Other factors, including shifts of employment between industries and regions generated by the recession and the difficulty that some workers may face in relocating because they cannot sell their houses, have probably boosted the unemployment rate recently and are likely to slow the rate of recovery in the labor market, but they are not expected to play a major role in the medium term.

The changes between the two forecasts have lowered projected deficits for every year of the 10-year period (see Appendix B, Table B-1). The lower interest rates reduced projected interest payments on the debt, and the faster growth in nominal GDP raised the projections of the incomes that underlie the revenue projections. Those effects were partly offset by higher projections of noninterest outlays—an increase that stemmed from higher inflation rates in the near term and higher unemployment rates throughout the projection period. On balance, changes in the economic outlook since August have caused the annual deficit projections to average about $45 billion lower for 2010 to 2014, and about $80 billion lower from 2015 to 2019.

Comparison of CBO and Blue Chip Consensus Economic Forecasts for Calendar Years 2009 to 2011

Sources: Congressional Budget Office; Aspen Publishers, Blue Chip Economic Indicators (January 10, 2010).

Notes: The Blue Chip consensus is the average of about 50 forecasts by private-sector economists.

CBO’s forecast envisions a weaker recovery from the recession over the next two years than the current Blue Chip consensus of private forecasters or the central tendency of the forecasts from last November’s meeting of the members of the Federal Reserve’s Federal Open Market Committee (see Tables 2-4 and 2-5). CBO’s forecast for inflation, while lower than that of the Blue Chip consensus, is similar to that of the Federal Reserve. Consistent with its outlook for slower real growth and lower inflation, CBO expects a slightly higher rate of unemployment than the other forecasters and lower interest rates than does the Blue Chip consensus. (The Federal Reserve does not publish a forecast of interest rates.)

Notes: The range of estimates from the Federal Reserve reflects all views of the members of the Federal Open Market Committee. The central tendency reflects the most common views of the committee’s members.

The difference in the forecasts probably stems, at least in part, from differences in assumptions about fiscal policy. Although it is uncertain what private forecasters are assuming for fiscal policy during this year or next, most probably assume that the Congress will not allow all of the tax cuts enacted in 2001 and 2003 to expire as scheduled. Furthermore, they probably assume that lawmakers will extend some or all of the AMT relief enacted in previous years in 2010 and beyond, and some forecasters may expect that additional fiscal stimulus will occur this year. In contrast, CBO is required in its baseline projections to assume that current laws and policies remain unchanged. CBO estimates that the scheduled changes to tax law will dampen growth in 2011. If CBO assumed that all of the expiring tax provisions were extended beyond 2011 but no other stimulative fiscal measures were passed, the agency’s forecast of the level of real GDP at the end of 2011 would be in line with the forecast of the Blue Chip consensus and near the lower end of the central tendency of the Federal Reserve’s forecasts.

CBO anticipates a much lower average rate of inflation (based on the CPI-U) for 2010 and 2011 than the Blue Chip consensus, but CBO’s forecast is near the lower end of the central tendency of the forecasts reported by the Federal Reserve. CBO’s projection for CPI-U inflation beyond 2011 also appears to be lower than that of most private forecasters. The recent Blue Chip consensus forecast extends only through 2011, but other information (from surveys of forecasters and the implied inflation rates that can be derived from comparing yields on inflation-protected Treasury securities and yields on traditional securities) indicates expectations of an average CPI-U inflation rate of 2 percent to 2½ percent for 2010 to 2014 and approximately 3 percent for the following five years. In CBO’s forecast, by contrast, the CPI-U grows at an average rate of 1.5 percent through 2014 and 1.9 percent, on average, for 2015 to 2020.

Interest rates in CBO’s forecast are below those of the Blue Chip consensus for 2010 and substantially lower in 2011. The difference is probably attributable to the weaker growth and lower inflation in CBO’s outlook. Weak growth and low inflation would encourage the Federal Reserve to keep short-term interest rates lower than it would otherwise, which would also affect long-term interest rates.

Analysts often gauge the Federal Reserve’s preferred level of the federal funds rate on the basis of models of its past responses to inflation and recessions. Such models are now widely termed "Taylor rules." Most Taylor-rule specifications indicate that, if it were possible, the Federal Reserve’s target federal funds rate would have been well below zero during the recession and would remain below zero currently.

Growth was also boosted by legislation other than ARRA, including the extension of unemployment insurance benefits, credits for first-time home buyers (which were extended once by ARRA and again by the Worker, Homeownership, and Business Assistance Act of 2009), and the Car Allowance Rebate System (the CARS program), often referred to as "Cash for Clunkers."

Similar but smaller automatic changes occur in state and local revenues and spending. In contrast with automatic stabilizers at the federal level, those at the state and local levels are largely offset by discretionary actions used to comply with balanced-budget rules. Those actions include reductions in state and local spending and increases in tax rates and various fees.

See Chapter 4 for further discussion of the revenue effects of the expiration of AMT relief.

Excess vacant units are measured as the difference between the actual number of vacant units—including units for sale or for rent, second homes, and units held off the market for various reasons—and an estimate of the number that would be vacant under normal market conditions. Vacant units are thought to better reflect the excess supply of housing than the total inventory of units for sale because occupied units for sale are part of both the supply of and the demand for housing.

Since the middle of 2006, the price index for exports of non-agricultural goods has fallen by 3 percent relative to the price of imports of nonpetroleum goods; in comparison, in the previous 10 years, from 1996 to 2006, export prices rose faster than import prices.

Some emerging economies have performed much better than the U.S. economy over the past year. In particular, in China, India, and Indonesia, real GDP growth slowed in 2009, but those countries never went into recession and are likely to post strong growth over the next few years. Other Asian economies that were in recession during 2008 and early 2009 have rebounded sharply, in part because of the continued strength of the Chinese economy. However, the United States does not send a large proportion of its exports to countries with such strong growth.

Those figures are based on current official data and do not take into account the benchmark revisions scheduled for early February 2010. In its preliminary benchmark announcement, the Bureau of Labor Statistics indicated that the March 2009 employment level would probably be revised downward by about 800,000. Estimates of employment growth since then may also be revised.

CBO’s measure of labor income consists of the total compensation that employers pay their employees and 65 percent of proprietors’ income (a commonly used estimate of the proportion of proprietors’ income that represents compensation for the labor effort they put into the enterprise). Total compensation is the sum of wages and salaries and supplemental benefits, including employers’ payments for health and other insurance premiums, their contributions to pension funds, and their share of payroll taxes for Social Security and Medicare.

A closer approximation to the tax base that incorporates estimates of depreciation allowable under tax law—known as domestic book profits—follows a similar path to that of domestic economic profits. However, in the latter years of the projection period, its share of GDP does not fall appreciably below the share in the projection from last August.