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Economy in Brief

Odd Couple: "A Genuine Economic Boom" & Bigger Budget Deficits
by Joseph G. Carson ([email protected])  August 20, 2018

At a cabinet meeting last week, White House economic advisor Mr. Larry Kudlow described the economy's performance in 2018 as a "genuine economic boom." Yet, Mr. Kudlow failed to mention that this "economic boom" is being accompanied by a substantial increase in the federal budget deficit.

In fact, a recent report from the Office and Management & Budget (OMB) shows that US borrowing will increase twice as fast as the acceleration in economic output. This unusual dynamic suggests that the current strong run in the economy is neither "genuine" nor sustainable for long as increased borrowing of the federal government is financing it.

In the past year, Congress has approved two major fiscal initiatives; the $1.5 trillion tax reduction plan passed at the end of 2017 and the $300 billion increase in spending for defense and non-defense discretionary programs in February. Perspective on how these new fiscal initiatives may influence the economy growth rate and impact the federal budget over time can be gleaned from the mid-session budget report issued on July 19 by the White House's Office of Management and Budget.

According to the new report, OMB believes that the reduction in business and individual taxes and the increased in federal spending will directly and indirectly boost the economy's performance in the short and longer run, as they are projecting 3% real GDP and 5% nominal GDP growth for the next several years, or about 100 basis points faster than the growth rates of the past several years.

Yet, at the same time, OMB is also projecting big increases in the federal deficit for several years. According to OMB, the federal deficit for fiscal year 2018, which ends on September 30, will total $890 billion. In 2017, OMB had estimated the fiscal 2018 deficit to be $440 billion, or less than half the revised estimate. The same is true for fiscal years 2019 and 2020---OMB now projects deficits of $1.127 trillion and $1.148 trillion, up substantially from its prior estimates of $488 billion and $456 billion respectively.

So let's examine the potential tradeoff between faster GDP growth and the change in the budget deficit. According to OMB figures, an acceleration of 100 basis points in the economy's growth rate with a level of nominal GDP of over $20 trillion will generate roughly $200 to $250 billion in additional economic output per year. Yet, at the same time the federal deficit will run $400 to $500 billion more per year. In other words, OMB is saying that the federal government will need to borrow roughly $2 more for every $1 increase in nominal GDP output over the next several years.

In the end, there is nothing unique or special about the recent improvement in US economy's performance in light of the scale of fiscal stimulus that has been enacted. Yet, what is surprising is how much of an increase in the federal deficit has been and will be required to a get the marginal improvement in the economy's nominal output that OMB is projecting. It is debatable how long the US can continue to borrow at projected rates without some adverse affects on its credit ratings. Furthermore, OMB new projections indicate that US economy does not generate enough federal revenue to stabilize the budget deficit even in good times, so what can we expect in bad times? Stay tuned.

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