The Budget and Economic Outlook

January 7, 2009

This morning CBO released the Budget and Economic Outlook: Fiscal Years 2009-2019. This volume is one of a series of reports on the state of the budget and the economy that the Congressional Budget Office (CBO) issues each year. Because economic and budgetary circumstances have changed significantly in recent months, this reportwas preparedand released several weeks earlier than usual to aid the new Congress in its deliberations.

The sharp downturn in housing markets across the country, which undermined the solvency of major financial institutions and severely disrupted the functioning of financial markets, has led the United States into a recession that will probably be the longest and the deepest since World War II. CBO anticipates that the recessionwhich began about a year agowill last well into 2009. That would make it the longest recession since World War II. Underthe standard assumption CBO uses for its estimates---namely,that current laws and policies regarding federal spending and taxation remain the same---we forecast the following:

  • A marked contraction in the U.S. economy in calendar year 2009, with real (inflation-adjusted) gross domestic product (GDP) falling by 2.2 percent, a steep decline from a historical perspective.
  • A slow recovery in 2010, with real GDP growing by only 1.5 percent.
  • An unemployment rate that will exceed 9 percent early in 2010; the unemployment rate has been that high only twice in the past 50 years (in 1975, for one month,and in 1982-1983).
  • A continued decline in inflation, both because energy prices have been falling and because inflation excluding energy and food pricesthe core ratetends to ease during and immediately after a recession; for 2009, CBO anticipates that inflation, as measured by the consumer price index for all urban consumers (CPI-U), will be only 0.1 percent.
  • A drop in the national average price of a home, as measured by the Federal Housing Finance Agencys purchase-only index, of an additional 14 percent between the third quarter of 2008 and the second quarter of 2010; the imbalance between the supply of and demand for housing persists, as reflected in unusually high vacancy rates and a low volume of housing starts.
  • A decrease of more than 1 percent in real consumption in 2009, followed by moderate growth in 2010; the rise in unemployment, the loss of wealth, and tight consumer credit will continue to restrain consumption although lower commodity prices will ease those effects somewhat.
  • A financial system that remains strained, although some credit markets have started to improve; it is too early to determine whether the governments actions to date have been sufficient to put the system on a path to recovery.

The major slowdown in economic activity and the policy responses to the turmoil in the housing and financial markets have significantly affected the federal budget. As a share of the economy, the deficit for this year is anticipated to be the largest recorded since World War II. Under the rules governing CBOs budget projectionsthat is, an assumption that federal laws and policies regarding spending and taxation remain unchangedthe agencys baseline reflects these key points:

  • CBO projects that the deficit this year will total $1.2 trillion, or 8.3 percent of GDP. Enactment of an economic stimulus package would add to that deficit. In CBOs baseline, the deficit for 2010 falls to 4.9 percent of GDP, still high by historical standards.
  • CBO expects federal revenues to decline by $166 billion, or 6.6 percent, from the amount in 2008. The combination of the recession and sharp drops in the value of assetsmost significantly in publicly traded stockis expected to lead to sizable declines in receipts, especially from individual and corporate income taxes.
  • According to CBOs estimates, outlays this year will include more than $180 billion to reflect the present value of the net cost of transactions under the Troubled Asset Relief Program (TARP), which was created in the fall of 2008. (Broadly speaking, that cost is the purchase price minus the present value, adjusted for market risk, of any estimated future earnings from holding purchased assets and the proceeds from the eventual sale of them.) The TARP has the authority to enter into agreements to purchase assets totaling up to $700 billion outstanding at any one time, but the net cost over time will be much less than that amount.
  • The deficit for 2009 also incorporates CBOs estimate of the cost to the federal government of the recent takeover of Fannie Mae and Freddie Mac. Because those entities were created and chartered by the government, are responsible for implementing certain government policies, and are currently under the direct control of the federal government, CBO has concluded that their operations should be reflected in the federal budget. Recognizing that cost in 2009 adds about $240 billion (in discounted present-value terms) to the deficit this year, but that is not a measure of the amount of cash we expect the government to have to put in to those entities this year; that amount is only $18 billion. Note that the Administration may not treat Fannie Mae and Freddie Mac this way in its budget presentation. For comparison purposes, if those two entities were treated as being separate from the federal budget, CBO's estimate of the deficit this year would be $966 billion---stil the highest, as a percent of GDP, since shortly after World War II.
  • Economic factors have also boosted spending on programs such as those providing unemployment compensation and nutrition assistance as well as those with cost-of-living adjustments. (Such adjustments for 2009 are large because most of them are based on the growth in the consumer price index over the four quarters ending in the third quarter of 2008.)