CBO Report’s Good News Built on Shifting Economic Sands

Contrary to tradition, the Congressional Budget Office (CBO) today released its mid-year assessment of the budget and economic situation.

Traditionally, CBO releases its mid-year assessment after the White House’s Office of Management and Budget (OMB) releases its statutorily required Mid-Session Review (MSR). The law requires the MSR to be produced by July 15 of each year. For example, last year the Administration almost hit the target, releasing the MSR on July 23. However, the Administration has not yet complied with the law for this year, and with August waning the CBO apparently concluded it could wait no longer to perform its duty.

Being late to publication, however, is the least of the Administration’s problems—or the nation’s—according to the CBO report. For example, CBO has lowered its projected 2011 inflation-adjusted economic growth rate from 3.1 percent in CBO’s January report to only 2.3 percent. (The projection is for growth in real gross domestic product from the fourth quarter of 2010 to the fourth quarter of 2011.) This is well below the growth rate needed to reduce the unemployment rate.

Yet even this forecast for 2011 seems extremely optimistic given that the current official estimates for annualized growth in the first and second quarters of this year were a negligible 0.4 and 1.3 percent, respectively. To achieve the projected level of growth for the year, either the Bureau of Economic Analysis will need to revise these slow earlier growth rates upwards significantly or the economy will need to grow at an annualized rate of nearly 3.8 percent in the latter half of the year.

While such an acceleration in growth would be most welcome, it is hard to envision given the recent apparent slowdown in the U.S. economy, stock market jitters, and a slowing of the European economies and a slow-motion sovereign debt meltdown. Moreover, as the CBO points out in Table 2-5, its forecast for growth in 2011 at 2.3 percent is markedly higher than the Blue Chip consensus forecast at 1.6 percent.

While it is often all-too-easy to carp on economic projections in the CBO and OMB budget analyses, the CBO also has another very curious forecast, this for inflation as measured by the Consumer Price Index. The CBO is projecting a very modest 1.3 percent inflation for 2011. Yet on an annualized basis, inflation has run at an average of 4.3 percent over the last eight months. Except for an easing in May and June, on an annualized basis, inflation has exceeded 4.9 percent every month since December 2010.

Again, the CBO forecast is also substantially out of line with the Blue Chip consensus forecast, which at 3.2 percent is about two-and-a-half times higher. Inflation may taper off, but for the CBO forecast to hold, prices would have to decline through the balance at an annualized rate of almost 2 percent. This would be a stunning—indeed, frightening—prospect in light of current economic weakness.

If the economy evolves roughly in line with the CBO forecast, then the balance of the report offers some good news. For example, CBO now projects a deficit for 2011 of $1.284 trillion, which is good news only in comparison to its January deficit projection of $1.480 trillion. At 8.5 percent of the economy, this marks only a slight improvement over the post–World War II record set in 2010 at 8.9 percent. This improvement arises because revenues are now $86 billion higher than CBO projected in January, while outlays are coming in $111 billion lower.

Another spot of good news in the CBO analysis is that projected cumulative deficits have been reduced, assuming the economic forecast holds. In its January analysis, CBO projected a cumulative 2012–2021 baseline deficit of $6.971 trillion. (A baseline projection essentially means excluding the enactment of new policy, and so outlays are projected according to current policy while revenues are projected according to current law.)

CBO now projects a cumulative baseline deficit of $4.687 trillion excluding the projected $1.2 trillion in savings from the Joint Select Committee on Deficit Reduction created by the recently enacted Budget Control Act of 2011.

On balance, the CBO report suggests a near- and medium-term modest improvement on budgetary disaster. One should hope this good news holds, though it comes with a huge caveat that it is based on a remarkably positive economic forecast given recent information.

One should also hope that Congress and the President build on this progress by taking up the opportunity presented by the Joint Special Committee and other opportunities in the course of the coming year to cut deficit spending substantially.