April 29, 2009
On Monday I participated in two panels at the Milken Institutes Global Conference in Los Angeles. I was honored to be invited, and I enjoyed the spirited and insightful discussions. You can view my slides and a webcast.
The first panel addressed the topic U.S. Overview: When Will Growth Resume? My comments stressed four points:
- Even if economic growth resumes later this year, as a large majority of forecasters expects, the unemployment rate is likely to remain high for several years. According to CBOs March forecast, real GDP will begin to grow again in the second half of the year and will expand at a brisk 4 percent pace in both 2010 and 2011. However, under our projections, the shortfall of actual GDP relative to its potential (that is, the output gap) will be so large by the end of this yearroughly 8 percent of GDPthat even this rapid growth rate will leave a measurable output gap through 2012. The implication for economic policy is that actions to narrow that gap and bring the economy back to full employment more quickly are likely to receive serious consideration in the next few years. (Read alonger discussion of our economic forecast.)
- The persistence of high unemployment in CBOs forecast does not stem from a failure of fiscal stimulus. We believe that last years tax rebates had a measurable impact on the economy, and that this years stimulus legislation will have a significant impact as well. CBO had expected that about 40 percent of last years tax rebates would be spent. Although some economists have argued that the lack of a jump in consumption last year contradicts that expectation, we and other analysts think the data are quite consistent with it. For example, see this illustration of actual consumption and disposable income (that is, income after taxes) compared with an estimate of what consumption and
The Effect of Rebates on Disposable Income and Consumption (Monthly)
Source: Congressional Budget Office; Department of Commerce, Bureau of Economic Analysis. (April 27, 2009)
spending from this years stimulus package has just begun. Once the spending and tax effects kick in, CBO expects that the package will boost GDP a little more than dollar-for-dollar of reduced tax collections and increased outlaysin other words, that the overall multiplier will be a little larger than 1. Nevertheless, as large as the stimulus package is, the contraction in underlying demand is far larger, so the stimulus will offset only part of the contraction.
- The U.S. financial system is hardly out of the woods. Despite the hundreds of billions of dollars of losses recognized by U.S. financial institutions in the past few years, most experts believe that hundreds of billions of dollars of further losses on mortgage-related assets and other assets will ultimately be incurred. Unless the economy and real estate markets rebound more quickly than most forecasters predict, these further losses will be a drag on new lending for some time. And international evidence on financial crises suggests that the crimp in lending caused by past losses can impede economic recovery for years. Therefore, despite the vigorous and creative actions already taken by the Federal Reserve and Treasury, further actions are likely to be needed to return the economy to sustained growth. (See my testimony from January on options for dealing with the financial crisis.)
- The outlook for the federal budget over the next decade is grim. To be sure, economic recovery and the waning of countercyclical tax, spending, and financial policies will cause the budget deficit to diminish sharply from its record-setting level this year if tax and spending policies set by current law are maintained. In fact, CBOs baseline projection, which follows current law, shows the deficit in the later part of the decade running just below 2 percent of GDPa level that crowds out some private capital but allows debt to fall over time relative to GDP. However, current law would lead to a significant increase in tax revenue relative to GDP (as the 2001-2003 tax cuts expire and as more households become subject to the Alternative Minimum Tax) and a significant decrease in defense and non-defense discretionary spending relative to GDP (because the baseline assumes that these categories just keep pace with inflation). If these components of the budget were instead maintained at their historical relationship to GDP, then the continued surge in spending on Medicare and Medicaid under current law would push the budget deficit to unsustainable levels. (More discussion of this topic appeared in the blog last week.)