Update to the budget and economic outlook

September 9, 2008

CBO released the annual summer update to the Budget and Economic Outlook for Fiscal Years 2008 to 2018 today. (Today's report updates the Budget and Economic Outlook published in January 2008.)

Today's report makes it challenging to avoid playing the dismal economist, which I generally dislike doing. The budget deficit has risen substantially over the past year. And according to CBO's updated economic forecast, the economy is likely to experience at least several more months of weakness. (Whether this period will ultimately be designated a recession or not is still uncertain, but the increase in the unemployment rate and the pace of economic growth are similar to conditions during previous periods of mild recession.) Finally, the Treasury and Federal Housing Finance Agency have announced significant steps regarding Fannie Mae and Freddie Mac, which carry important implications for how the operations of those entities should be reflected in the federal budget. The estimates presented in the report CBO released today do not reflect the specific details of those actions.

Some more details from today's report include:

Budget projections

  • CBO estimates that the deficit for 2008 will be $407 billion, substantially higher than last year's $161 billion. As a share of the economy, the deficit is projected to rise to 2.9 percent of GDP this year, up from 1.2 percent of GDP in 2007. That 1.7 percentage point increase as a share of GDP is roughly evenly split between a 0.9 percentage point decline in revenue relative to GDP (reflecting the impact of lower corporate tax revenue and the rebates enacted as part of stimulus legislation this year) and a 0.8 percentage point increase in spending relative to GDP.
  • Since March, the bottom line in CBO's baseline over the next ten years has worsened by an average of nearly $260 billion per year. Some of that deterioration is due to the weakened economy, near-term inflation, and other economic variables; those factors increased projected deficits (or decreased projected surpluses) by about $85 billion a year. However, the larger component of the changes results from extrapolating into future years the supplemental appropriations enacted in June (in accordance with the rules governing the baseline).
  • Over the longer term, the fiscal outlook continues to depend mostly on the future course of health care costs as well as on the effects of a growing elderly population. CBO estimates that federal spending on Medicare and Medicaid will grow to 6 percent of the GDP in 2018 and 12 percent of the GDP by 2050.

Economic projections

  • An unusual amount of turbulence has roiled the U.S. economy this year, weakening the near-term outlook since CBO's previous forecast.
  • Specifically, CBO forecasts that GDP will grow by about 1.5 percent in real terms in calendar year 2008 and 1.1 percent in calendar year 2009.
  • Inflation (as measured by change in the CPI-U) is projected to remain high and average 4.7 percent for 2008 but moderate in 2009, falling to an average of 3.1 percent.
  • CBO's projections beyond the two year horizon indicate real growth averaging 2.8 percent and CPI-U inflation averaging 2.2 percent.

Fannie Mae and Freddie Mac

  • Significant government actions regarding Fannie Mae and Freddie Mac occured as this report went to press. The actions were taken to reduce the risk of a systemic shock to the financial system and to stabilize the mortgage markets.
  • In a letterissued on the topic in July, CBO noted that "a strong argument can be made that if the Treasury used the proposed authority, the GSEs operations should be incorporated directly into the federal budget." CBO concluded that the proposal at that time, especially to the extent it would result in any government acquisition of an equity stake in the GSEs, raised a significant budgetary question. Currently, data on the GSEs are reported along with federal budget information each year, but the activity of those entities is not encompassed within the budget. As CBO noted at the time, "That treatment could change if the federal governments financial stake or control changes in a significant way."
  • Given the steps announced by the Treasury Department and the Federal Housing Finance Agency on September 7, it is CBO's view that the operations of Fannie Mae and Freddie Mac should be directly incorporated into the federal budget. The GSEs' revenue would be treated as federal revenue and their expenditures as federal outlays, with appropriate adjustments for the manner in which credit transactions (like a mortgage guarantee) are reflected in the federal budget.