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3 Major Economic Predictions From CBO's New Report 3 Major Economic Predictions From CBO's New Report

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Congress

3 Major Economic Predictions From CBO's New Report

The economy isn't expected to reach its potential until 2017. (AP Photo/Richard Drew)(AP Photo/Richard Drew)

photo of Niraj Chokshi
February 5, 2013

The American economy is about halfway through a lost decade of economic potential, according to the nonpartisan Congressional Budget Office's latest projections.

The nation's economic output won't reach its potential level until 2017, nearly a decade after the recession started in December 2007, according to the 10-year outlook CBO released on Tuesday afternoon.

 

Spending cuts slated for March 1 and new upper-income tax hikes will hold back growth this year, but those same policies will help right the nation's economic ship in the medium- to long-term.

"The policies that would restrain growth today ... would ultimately be beneficial once the economy returned to its sustainable level of unemployment and output,” CBO Director Douglas Elmendorf said on Tuesday.

Here are three key charts from CBO's report on America's economic future:

1. A Brief Slowdown, Then a Growth Spurt

Economic growth is expected to weaken this year, thanks in large part to broad spending cuts, known as sequestration, scheduled for March 1. Those cuts were initially slated to take effect at the beginning of the calendar year, but were delayed as part of the Jan. 2 fiscal-cliff deal. President Obama on Monday said now is not the time for such drastic budget cuts and urged a postponement of the sequester.

"While it’s critical for us to cut wasteful spending, we can’t just cut our way to prosperity," he said. "Deep, indiscriminate cuts to things like education and training, energy and national security will cost us jobs and they will slow down our recovery. It’s not the right thing to do for the economy; it’s not the right thing for folks who are out there still looking for work.”

In addition to the cuts, recent tax hikes will hold back growth. Under the fiscal-cliff deal, lawmakers did not extend certain tax cuts—notably the 2 percentage point cut to the payroll tax and upper-income tax cuts—which will "constrain the growth of consumer spending," according to CBO. "That slowdown," CBO wrote, "... will restrain overall growth in output and employment this year."

If lawmakers canceled the spending cuts and unwound the tax hikes, the nation would see economic growth of about 2.65 percent this year. With those policies in place, the economy is expected to grow 1.4 percent.

Regardless, the economy should bounce back next year. "The growth of real GDP"—economic output—"will pick up considerably beginning in 2014, CBO projects, after economic activity adjusts to this year’s fiscal tightening." Next year's growth is expected to be driven by improvements to household income, household wealth, and the credit markets. CBO projects growth of 3.4 percent in 2014 and 3.6 percent annually from 2015 through 2018. Growth is expected to slow, however, in the second half of the decade.

2. Unemployment Will Drop Quickly, Then Stabilize

The pickup in economic growth after this year is expected to drive down joblessness, too. CBO projects that an unemployment rate of 8 percent in the final quarter of 2013 will drop to 6.8 percent by the fourth quarter of 2015. By the end of 2018 it should reach 5.5 percent. Some unemployment is expected even in a healthy economy thanks to natural turnover as workers seek out new, better opportunities. The country’s so-called "natural" unemployment rate was about 5 percent before the recession, though economists argue that the benchmark may be changing.

3. Debt

The chart below shows U.S. debt as a percentage of economic output, a key measure of the health of the economy—and one of the metrics used to calculate the United States' credit rating. For a healthy economy, the debt-to-GDP ratio should rise only in tough economic times, according to the experts at the Center on Budget and Policy Priorities. "While no one knows what 'too high' means for the United States, a debt ratio that rises in both good times and bad will become increasingly problematic," CBPP's Richard Kogan wrote in January. "The critical goal now is to stabilize the debt in the coming decade."

CBO expects debt to reach 76 percent of GDP by year's end—its highest level since 1950. The level could drop over the next few years, but it is expected to rise again in the second half of the decade.

Economists differ on what qualifies as an acceptable debt-to-GDP ratio. The European Union and the International Monetary Fund have settled on 60 percent, though that is arbitrary, Kogan writes. Harvard professors Kenneth Rogoff and Carmen Reinhart, who studied eight centuries of financial crises, say debt becomes a problem when it constitutes more than 90 percent of GDP.

BONUS: The Long-Term Unemployed

This isn't a predictive chart, but it is worth noting. One of the more pernicious effects of recent economic turmoil is the growth of the long-term unemployed—the share of job-seekers who have been unemployed for longer than 26 weeks. The recent growth in the share of the long-term unemployed is expected to affect growth in the second half of the next decade, CBO reports:

"Persistent long-term unemployment will lead some workers to leave the workforce earlier than they would have otherwise and will erode the skills of other workers, making it harder for them to find work in the coming years."

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