How Changes in Economic Conditions Might Affect the Federal Budget
Report
CBO has developed “rules of thumb” that show how changes in four key economic variables might affect revenues, outlays, and deficits. An interactive workbook allows users to see the budgetary effects of their own alternative scenarios.
One source of uncertainty in budget projections stems from the fact that the federal budget is highly sensitive to economic conditions, which are difficult to predict. If conditions differed from those in CBO’s economic forecast, budgetary outcomes could diverge from those in the agency’s baseline budget projections.
To show how changes in economic conditions might affect the budget, CBO has analyzed what might happen to the budget if the following key economic variables differed from those in the agency’s current economic forecast:
The growth of productivity and, consequently, the growth of real (inflation-adjusted) gross domestic product (GDP);
Labor force growth and, in turn, real economic growth;
Interest rates; and
Inflation.
CBO created and analyzed four illustrative scenarios to develop “rules of thumb” for those variables. The scenarios are for the following changes from the agency’s current economic forecast, all of which would increase deficits above the amounts in CBO’s baseline budget projections: slower growth of productivity (in this analysis, total factor productivity, which is real output per unit of combined labor and capital services), slower growth of the labor force, higher interest rates, and higher inflation. Those scenarios were chosen for simplicity, but the variables could be higher or lower than they are in CBO’s forecast. The rules of thumb are symmetrical, so if productivity or the labor force increased more quickly than projected, or if interest rates or inflation were lower than projected, deficits would be smaller than they are in the agency’s baseline budget projections.
The rules of thumb can be used to analyze other economic scenarios that differ from CBO’s forecast, although there are a few caveats that must be kept in mind. Among the most important is that each rule shows the effects of differences in a single key variable, but any factor that caused a change in one such variable would probably have additional direct effects on the economy (and thus on the budget). Those broader effects are not incorporated into the rules of thumb.
