Remarks on CBO’s Updated Budget and Economic Projections

Posted by
Doug Elmendorf
August 27, 2014

This morning CBO released An Update to the Budget and Economic Outlook: 2014 to 2024, and as usual, we offered a briefing to the press about our new projections. I began the briefing with the following statement, highlighting various figures from the report (shown in the slides below):


CBO has just released an update to our previous budget and economic projections. I will briefly summarize those projections, beginning with the budget and then turning to the economy.

The Budget Outlook

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. But later in the coming decade, under current law, the gap between spending and revenues would grow again relative to the size of the economy, and federal debt would climb.

To be specific, we estimate that the deficit for this fiscal year will amount to $506 billion, about $170 billion lower than the deficit in 2013. At 2.9 percent of gross domestic product, or GDP, this year’s deficit will be much smaller than those of recent years.

Looking ahead, CBO’s baseline projections show what we think would happen if current laws governing taxes and spending generally remain unchanged. Those baseline projections are designed to serve as a benchmark that policymakers can use when considering possible changes to laws. According to our updated baseline projections, the deficit would remain less than 3 percent of GDP through 2018 but would grow thereafter, reaching nearly 4 percent from 2022 through 2024.

Federal outlays will be boosted in the coming decade by four key factors: the retirement of the baby boom generation, the expansion of federal subsidies for health insurance, increasing health care costs per beneficiary, and rising interest rates on federal debt. Given those factors, and under current law, spending in three key components of the budget would grow faster than the economy. Those components are Social Security; the major health care programs, including Medicare, Medicaid, and subsidies in insurance exchanges; and net interest payments. In contrast, spending in three other broad categories would shrink markedly relative to the size of the economy; that includes so-called mandatory spending other than that for Social Security and health care, and both defense and nondefense discretionary spending. Outlays in those three categories taken together would fall to their lowest percentage of GDP since 1940, the earliest year for which comparable data have been reported.

Of the total projected increase in spending over the next decade, the major health care programs, Social Security, and net interest account for 85 percent, and all other programs account for just 15 percent.

Total outlays would reach about 22 percent of GDP in 2024, a little above their average for the past 40 years. Total revenues would also be above their historical average relative to GDP, but to a smaller extent. Revenues are projected to jump by about 9 percent next year, because of both provisions of law that have recently taken effect, such as the expiration of certain tax provisions, and the ongoing economic expansion. After 2015, we expect that revenues would change little relative to GDP under current law because of various offsetting factors.

Those paths for federal outlays and revenues would push federal debt relative to the size of the economy even higher over time. We expect that federal debt held by the public will reach 74 percent of GDP at the end of this fiscal year—more than twice what it was at the end of 2007 and higher than in any year since 1950. And in our baseline projections, that debt reaches 77 percent of GDP in 2024 and is on an upward trajectory.

Such large and growing federal debt would have serious negative consequences, including:

  • Increasing federal spending for interest payments;
  • 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.

The Economic Outlook

Our budget projections are built on our economic forecast, which anticipates that the economy will grow slowly this year, on balance, and then at a faster but still moderate pace over the next few years. The gap between the nation’s output and its potential, or maximum sustainable, output will narrow to its historical average by the end of 2017, we expect, largely eliminating the underuse of labor that now exists.

Real GDP—that is, GDP adjusted for inflation—grew at an annual rate of only about 1 percent during the first half of this calendar year, but we expect stronger growth in the second half. All told, we estimate that real GDP will increase by 1.5 percent from the fourth quarter of 2013 through the fourth quarter of 2014.

After this year, we anticipate that real GDP growth will pick up to about 3½ percent in 2015 and 2016. In our view, growth will strengthen for three principal reasons:

  • First, in response to increased demand for their products, businesses will increase their investments in new structures and equipment at a faster pace and will continue to expand their workforces.
  • Second, consumer spending will grow more rapidly, spurred by recent gains in household wealth and—with an improving labor market—gains in labor income.
  • And third, fewer vacant housing units, more rapid formation of new households, and further improvement in mortgage markets will lead to larger increases in home building.

The faster growth of output will reduce the amount of underused productive resources—or “slack”—in the economy. We think that a significant amount of slack remains in the labor market today, despite notable improvements in recent quarters, but that it will be largely eliminated during the next few years.

The current slack in the labor market consists of a few main elements:

  • First, the unemployment rate is elevated.
  • Second, the rate of participation in the labor force is well below what we estimate would be achieved if the demand for workers was stronger.
  • And third, the share of part-time workers who would prefer full-time work is significantly higher than it was before the recession.

One important signal that significant slack remains in the labor market is that wages and salaries continue to grow slowly.

To assess the impact of the weakness in the labor market, suppose that, in the second quarter of this year, the unemployment rate had returned to its prerecession level and the labor force participation rate equaled the rate we think could be achieved if more jobs were available. Then, according to our estimates, about 3¾ million more people would have been employed than actually were. But we emphasize in our report that measuring slack is quite difficult, and the current amount of slack could be a good deal larger or smaller than we estimate.

By the end of 2017, we expect that the gap between GDP and potential GDP will have narrowed to its historical average. Between 2018 and 2024, we project that real GDP will grow by an average of 2.2 percent per year—a rate that is notably less than the average growth of output during the 1980s and 1990s. That slower projected pace reflects a number of factors, including the retirement of members of the baby boom generation; a relatively stable labor force participation rate among working-age women after decades of strong increases; and the effects of federal tax and spending policies embodied in current law.

The gradual elimination of slack in the economy will eventually remove the downward pressure on the rate of inflation and on interest rates that has existed in the past several years. We anticipate that the rate of inflation as measured by the price index for personal consumption expenditures will move up during the next several years to the Federal Reserve’s goal of 2 percent. We project that the interest rate on 3-month Treasury bills will remain near zero until the second half of 2015 and then increase substantially, reaching 3.5 percent in 2019 and later years. And we project that the rate on 10-year Treasury notes will continue to increase, reaching 4.7 percent in 2019 and later years.

The Long-Term Outlook

Let me conclude by returning to the budget. Last month CBO extrapolated its previous baseline projections beyond the standard 10-year period, showing that under current law, there would be a substantial imbalance in the federal budget over the long term. By 25 years from now, rising budget deficits would push federal debt held by the public to more than 100 percent of GDP, a level seen only once before in U.S. history, just after World War II. Federal debt in 2024 under CBO’s current baseline is very similar to what we previously projected for that year, so the long-term outlook remains about the same: Under current law, debt would be quite high by historical standards and on an upward path relative to the size of the economy, a trend that would impose substantial costs and could not be sustained indefinitely.