Presentation with the Release of the Budget and Economic Outlook

Posted by Doug Elmendorf on
February 4, 2014

This morning we released our annual report on the outlook for the budget and the economy; we also released a companion report that takes a closer look at the slow recovery of the labor market. In a briefing for the press this morning, I delivered the following summary of our analysis (with accompanying slides shown below):


Beginning with the budget, the federal budget deficit has fallen sharply during the past few years, and it is on a path to decline further this year and next year. We estimate that under current law, the deficit will total about $500 billion this year, compared with $1.4 trillion in 2009. At that level, this year’s deficit would equal 3 percent of the nation’s economic output, or GDP—close to the average percentage seen during the past 40 years.

The baseline projections we released today show what we think would happen to federal spending, revenues, and deficits over the next 10 years if current laws generally were unchanged. Under that assumption, the deficit is projected to decrease again in 2015—to about 2½ percent of GDP. After that, however, deficits are projected to start rising—both in dollar terms and relative to the size of the economy—because revenues are expected to grow at roughly the same pace as GDP whereas spending is expected to grow more rapidly than GDP.

Why the more-rapid spending growth? In our baseline, spending is boosted by four factors: the aging of the population, the expansion of federal subsidies for health insurance, rising health care costs per beneficiary, and mounting interest payments on federal debt. With no changes in the applicable laws, spending for Social Security will increase from 4.9 percent of GDP in 2014 to 5.6 percent in 2024. Spending for the major health care programs—a category that includes Medicare, Medicaid, the Children’s Health Insurance Program or CHIP, and subsidies for health insurance purchased through exchanges—will climb even more under current laws. And net interest payments by the federal government are also projected to grow rapidly, mostly because of the return of interest rates to more typical levels.

In sharp contrast, the rest of the federal government’s noninterest spending—for defense, benefit programs other than those I just mentioned, and all other nondefense activities—is projected to drop from 9.4 percent of GDP this year to 7.4 percent in 2024 under current law. That would be the lowest percentage of GDP since at least 1940, which is the earliest year for which comparable data have been reported. Thus, an increasing share of the budget would go toward benefits from a few large programs, and a shrinking share would go toward most of the rest of the government’s functions.

The large budget deficits recorded in recent years have substantially increased federal debt, and the amount of debt relative to the size of the economy is now very high by historical standards. We estimate that federal debt held by the public will equal 74 percent of GDP at the end of this year and, under current law, will reach 79 percent in 2024. Such large and growing federal debt could have serious negative consequences, including restraining economic growth in the long term, giving policymakers less flexibility to respond to unexpected challenges, and eventually increasing the risk of a fiscal crisis (in which investors would demand high interest rates to buy the government’s debt).

Turning to the economy, we expect that, after a frustratingly slow recovery from the severe recession of 2007 to 2009, the economy will grow at a solid pace for the next few years—but will continue to have considerable unused labor and capital resources, or “slack.”

Further growth in housing construction and business investment should raise output and employment, and the resulting increase in income should boost consumer spending. In addition, under current law, the federal government’s tax and spending policies will not restrain economic growth to the extent they did last year, and state and local governments are likely to increase their purchases of goods and services (adjusted for inflation) after having reduced them for several years. As a result, our baseline shows inflation-adjusted GDP expanding more quickly from 2014 to 2017—at an average rate of roughly 3 percent a year—than it did in 2013.

We expect that those increases in output will spur businesses to hire more workers, pushing down the unemployment rate and tending to raise the rate of participation in the labor force, as some discouraged workers return to the labor force in search of jobs. That effect on participation will keep the unemployment rate from falling as much as it would otherwise. We project that the unemployment rate will decline only gradually over the next few years, finally dropping below 6 percent in 2017 and then edging down further after that.

Nevertheless, the labor force participation rate is also projected to decline further in the next few years because, according to our analysis, the increase in participation stemming from improvements in the economy will be more than offset by downward pressure from demographic trends, especially the aging of the baby-boom generation. After 2017, when the demographic trends will still be unfolding but the effects of cyclical conditions will, we expect, have largely waned, the participation rate is projected to decline more rapidly. That is the main reason why, beyond 2017, we project that economic growth will diminish to only a bit more than 2 percent per year—a pace that is well below the average seen over the past several decades.