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THE ECONOMIC AND BUDGET OUTLOOK:
AN UPDATE
 
 
August 1986
 
 
NOTES

Unless otherwise indicated, all years referred to in this report are calendar years.

Unemployment rates throughout the report are calculated on the basis of the civilian labor force.

Details in the text and tables of this report may not add to totals because of rounding.

The Balanced Budget and Emergency Deficit Control Act of 1985 is also referred to in this volume more briefly as the Balanced Budget Act.
 
 
PREFACE

This volume is one of a series of reports on the state of the economy and the budget issued periodically by the Congressional Budget Office (CBO). In accordance with CBO's mandate to provide objective analysis, the report contains no recommendations.

Chapter I of this report was prepared by the Fiscal Analysis Division under the direction of William J. Beeman and Jacob S. Dreyer, with the assistance of Robert A. Dennis, Victoria S. Farrell, Douglas R. Hamilton, George R. Iden, Stephen A. Parker, John F. Peterson, Martin A. Regalia, Frederick C. Ribe, Frank S. Russek, Jr., Matthew A. Salomon, John R. Sturrock, Stephan S. Thurman, Suzanne Cooper, Lucia S. Foster, Eng Meng Tan, and Bragi Valgeirsson.

Chapter II was prepared by CBO's Budget Analysis Division, under the direction of James L. Blum and Paul Van de Water with the assistance of Kathy A. Ruffing, and by the Tax Analysis Division under the direction of Rosemary D. Marcuss and Kathleen M. O'Connell. Important contributions were also made by Valerie Amerkhail, David Bashore, Paul Christy, Andrew Haughwout, Neil Fisher, Richard Krop, Jeffrey Miller, and Linda Radey.

Paul L. Houts supervised the editing and production of this report, assisted by Nancy H. Brooks. Major portions were edited by Francis S. Pierce, Patricia H. Johnston, and Sherry Snyder. Debra M. Blagburn coordinated the preparation of the report. The authors owe special thanks to Dorothy J. Kornegay, Earnestine Miles, L. Rae Roy, and Linda Brockman, who typed the many drafts.
 

Rudolph G. Penner
Director
August 1986
 
 

CONTENTS
 

SUMMARY

CHAPTER I - THE ECONOMIC OUTLOOK

CHAPTER II - THE BUDGET OUTLOOK

 
SUMMARY TABLE 1.  RECENT ECONOMIC INDICATORS
SUMMARY TABLE 2.  THE CBO FORECAST FOR 1986 AND 1987
SUMMARY TABLE 3.  BUDGET PROJECTIONS, DEFICIT TARGETS, AND UNDERLYING ECONOMIC ASSUMPTIONS
TABLE I-1.  THE CBO FORECAST FOR 1986 AND 1987
TABLE I-2.  MEDIUM-TERM ECONOMIC PROJECTIONS FOR CALENDAR YEARS 1988-1991
TABLE I-3.  MEDIUM-TERM ECONOMIC PROJECTIONS FOR FISCAL YEARS 1988-1991
TABLE I-4.  RECENT MEASURES OF AGGREGATE ECONOMIC ACTIVITY
TABLE I-5.  INFLATION
TABLE I-6.  SELECTED HOUSING DATA
TABLE I-7.  GOVERNMENT PURCHASES OF GOODS AND SERVICES
TABLE I-8.  CURRENT INDICATORS OF BUSINESS FIXED INVESTMENT AND SURVEYS OF CAPITAL SPENDING PLANS FOR 1986
TABLE I-9.  AGGREGATE MEASURES OF FISCAL POLICY
TABLE I-10.  GROWTH RATES OF CREDIT MARKET DEBT, NONFINANCIAL SECTORS
TABLE I-11.  SELECTED MONETARY POLICY MEASURES
TABLE II-l.  THE OUTLOOK FOR FISCAL YEARS 1986 AND 1987
TABLE II-2.  DIFFERENCES BETWEEN CBO BASELINE, BASE FOR SEQUESTRATION, AND BUDGET RESOLUTION
TABLE II-3.  UPDATED CBO BASELINE PROJECTIONS FOR FISCAL YEARS 1986-1991
TABLE II-4.  ON-BUDGET AND OFF-BUDGET SPENDING AND REVENUES
TABLE II-5.  CHANGES FROM CBO FEBRUARY BASELINE PROJECTIONS
TABLE II-6.  POLICY CHANGES IN THE 1987 BUDGET RESOLUTION AS ESTIMATED BY CBO
TABLE II-7.  CBO REESTIMATES OF THE BUDGET RESOLUTION
TABLE II-8.  PROJECTIONS OF BASELINE REVENUES AND EXPENDITURES ON A NATIONAL INCOME AND PRODUCT ACCOUNTS BASIS
TABLE II-9.  RELATIONSHIP OF THE BUDGET TO THE FEDERAL SECTOR OF THE NATIONAL INCOME AND PRODUCT ACCOUNTS
 
 
SUMMARY FIGURE 1.  1987 DEFICIT PROJECTIONS UNDER DIFFERENT POLICY ASSUMPTIONS
SUMMARY FIGURE 2.  MAJOR ECONOMIC ASSUMPTIONS
SUMMARY FIGURE 3.  BASELINE, BUDGET RESOLUTION, AND TARGET DEFICITS
FIGURE I-1.  ECONOMIC ASSUMPTIONS
FIGURE I-2.  PAYROLL EMPLOYMENT
FIGURE I-3.  CIVILIAN UNEMPLOYMENT RATES
FIGURE I-4.  EMPLOYMENT COST INDEX,WAGES AND SALARIES
FIGURE I-5.  REAL COMPENSATION PER MAN-HOUR
FIGURE I-6.  PRODUCTIVITY AND UNIT LABOR COSTS
FIGURE I-7.  MEASURES OF INFLATION
FIGURE I-8.  EXCHANGE RATE AND IMPORT PRICES
FIGURE I-9.  OIL PRICES AND OIL RIGS IN OPERATION
FIGURE I-10.  REAL BUSINESS FIXED INVESTMENT AND TOTAL INDUSTRY CAPACITY UTILIZATION
FIGURE I-11.  THE EXCHANGE RATE AND RELATIVE INTEREST RATES
FIGURE I-12.  FISCAL AND MONETARY INDICATORS
FIGURE I-13.  RECENT SHORT- AND LONG-TERM INTEREST RATE MOVEMENTS
FIGURE I-14.  COMMON STOCK PRICES (STANDARD AND POOR'S "500")
FIGURE I-15.  MONEY GROWTH AND TARGETS IN 1986
FIGURE I-16.  THREE-MONTH TREASURY BILL RATES
FIGURE II-l.  DEFICIT PROJECTIONS AND TARGETS
 
 
BOXES
 
ASSET SALES AND FEDERAL DEFICIT TARGETS
VELOCITY


 
SUMMARY

Despite the current subdued state of the economy, the Congressional Budget Office (CBO), like most forecasters, projects brisker economic growth by the end of 1986. In the year ahead, employment is forecast to rise steadily and the unemployment rate to decline. Inflation is projected to rise as the effects of the oil price decline gradually dissipate and the effects of rising import prices begin to be felt throughout the domestic price structure. Interest rates are expected to rise modestly, and net exports to improve.

In the meantime, however, the weakness of the economy, reduction in inflation, and more rapid than expected spending for several federal programs have caused a worsening of the short-run budget outlook. CBO estimates that the federal deficit for this fiscal year will reach a record level of $224 billion, up from $212 billion in 1985. While the deficit is projected to decline in 1987, it will still substantially exceed the target of $144 billion established by the Balanced Budget and Emergency Deficit Control Act of 1985 (the Balanced Budget Act). Under CBO's short-run forecast, the baseline deficit projection for 1987 is $184 billion. Under the same economic assumptions but the policy assumptions specified in the Balanced Budget Act, CBO estimates a base deficit of $173 billion. Even under the policies of the Congressional Budget Resolution, the 1987 deficit would still be $161 billion, as shown in Summary Figure 1.

At the time this report goes to press, the near-term economic outlook is particularly uncertain. Indicators of domestic output growth reflect continuing weakness; prospects for a significant increase in capital spending remain mediocre; real consumer spending is unlikely to continue growing at the extremely rapid pace of the second quarter; and the timing and magnitude of any turnaround in net exports are still quite uncertain. Moreover, the projected large cuts in federal spending and the proposed tax reform add another layer of uncertainty to the near-term outlook.

The economy slowed in the second quarter of the year to a meager 1.1 percent growth rate after a relatively strong first quarter when gross national product (GNP) grew at a 3.8 percent rate. Some components of GNP have been quite volatile, making it difficult to ascertain whether the slowdown is likely to be transitory or prolonged.

Although oil imports are likely to continue at high levels, the oil inventory adjustment seems to be largely completed, and auto production schedules for the third quarter call for substantial increases from the levels of the previous quarter. The result could be a snapback leading to a onetime surge in economic growth.

More fundamental reasons for projecting a pickup in the quarters immediately ahead are to be found in economic developments since the beginning of the year. They include a decline in interest rates, lower inflation, the drop in petroleum prices, and further depreciation of the dollar.

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