Is The Recovery Finally for Real?
Jeff Lemieux
November 3, 2003

Rapid economic growth in the 3rd quarter of 2003 and slightly higher-than-expected revenue collections in recent months probably mean the Congressional Budget Office (CBO) will revise its economic outlook a little higher in January.  CBO's forecast of the federal budget deficit for 2004 could be revised down a bit.  However, with aggregate wages and salaries still growing at a measly 2 percent year-over-year rate, it may be a while longer before the economy returns to anything resembling the 1990s exuberance.

First the good news:  The budget deficit for 2003 turned out to be $374 -- roughly $27 billion less than CBO's previous projection of $401 billion.  Revenues for the fiscal year ended about $13 billion higher than CBO had forecast in its August 2003 baseline.

Second, more good news:  The economy grew at an annual rate of 7.2 percent in the third quarter of 2003, on top of a decent growth rate of 3.3 percent in the second quarter (see Figure 1).  The third quarter growth was considerably higher than most previous projections.  Economic growth seems fairly well balanced, with large gains in consumption and significant new investment (including both business investment and housing).  A lower dollar is starting to boost exports and restrain imports, which aids domestic production.  Unlike the big growth spurt of early 2001, the 3rd quarter jump wasn't the result of quirky inventory changes (although some economists expect a build-up in the 4th quarter).

Figure 1.



Now the inevitable "on the other hands:"  Aggregate wages and salaries are still growing very slowly -- about 2 percent on a year-over-year basis (see Figure 2).  And as we reported a month ago, payroll job growth is still stagnant (although the household survey of employment is looking a little better, see Figure 3 below).

Figure 2.


How can people spend so much when their wages aren't growing and jobs remain scarce?  Tax cuts and ultra-low interest rates.  People seemed to spend this year's tax cut very quickly and are continuing to invest in housing and consumer durables (like cars) to take advantage of low interest rates.  These purchases probably can't outpace income growth for much longer.

For example, total personal income in the economy expanded by $190 billion between January and August of 2003.  Of that, only $70 billion was wages and salaries.  Yet personal consumption expenditures rose by a whopping $310 billion during the same period.  (These numbers are reported at annual rates.)

Meanwhile, tax collections fell by almost $140 billion during the same period (again, measured at an annual rate).  That allowed people to spend more even if their earnings weren't growing. 

By contrast, tax collections spiked in September -- after the latest round of rebates had finished -- and personal consumption fell.

So the preliminary conclusion is:  the good economic and budget news should be tempered by the likelihood that recent infusion of economic stimulus -- tax cuts and low interest rates -- won't be sustained, and that consumer spending may continue to slip back from its recent pace, at least until the labor markets finally pick up.

On balance, the good news makes it likely that CBO will revise its economic projections and its forecast of federal revenues slightly higher in fiscal year 2004. 

How much?  It's very hard to say.  CBO's economic assumptions "lock" in early December.  By that time, we'll have personal income, consumption and retail sales figures for October, plus jobs and employment data through November.  If the monthly figures look strong, then CBO will probably raise its economic forecast for 2004 considerably, and 2004 revenues could be revised upward by as much as $50 billion or more.  If the monthly figures look weaker, as they were in September, then CBO will probably still increase its economic forecast for 2004 a little bit, but the impact on revenues might be smaller.

It's too soon to revise the Centrists.Org long-term budget baseline for these short term wobbles.  The baseline already assumes a decent recovery.  And with the labor market still painfully slow to respond to rapid economic growth, we're not yet sure these latest bits of good news signal that a change in the medium- or longer-term forecast is warranted. 

We'll take another look in December.  By then we'll know whether or not a Medicare drug benefit was enacted (we assume it will be), and if not, whether or not Congress seems poised to try again next year.  We'll also know how the end-of-year appropriations battles played out, and whether or not new tax cuts for manufacturers and (many) others were enacted.

Figure 3.


Links:
Centrists.Org No-BS Long-Term Budget Baseline Homepage
Centrists.Org Preliminary 2003 Budget Deficit:  $374 Billion (October 10, 2003)
Centrists.Org Interpreting the Diverging Employment Statistics (September 29, 2003)
Congressional Budget Office The Budget and Economic Outlook:  An Update (August 2003)