CBO Sees Up to 0.6% GNP Headwind Due to Deficit Spending Cutbacks

Econintersect:  The Congressional Budget Office (CBO) believes the austerity measures of the debt ceiling legislation will result in an economic headwind of up to 0.6% of Gross National Product (GNP).

CBO estimated the short-term and longer-term effects of reducing the primary deficit (the budget deficit excluding net interest) by $100 billion in 2012 and by amounts increasing gradually to $300 billion by 2021. CBO estimated that the illustrative plan would decrease real (inflation-adjusted) gross national product (GNP) in 2012, 2013, and 2014 by amounts ranging from roughly 0.1 percent to 0.6 percent depending on the year and the assumptions used.

Likely, the reason the CBO used GNP instead of Gross Domestic Product (GDP) is the uncertainty of how the cutbacks would effect imports.  GNP ignores where consumed goods or services are produced, while GDP measures only consumption of locally produced goods and services.    Global GDP equals global  GNP.

The CBO also described the longer view silver lining in the cutbacks.

Therefore, the federal government’s budgetary policies affect potential output primarily by affecting the amount of national saving and the incentives for individuals and businesses to work, save, and invest. The nation’s capital stock depends both on public saving (the surpluses, if any, of state and local governments and the federal government) and on private saving (by households and businesses). A federal deficit represents a reduction in public saving and, therefore, in national saving. An overall decline in national saving reduces the capital stock owned by U.S. citizens over time through a decrease in domestic investment, an increase in net borrowing from abroad, or both.

Taking those effects into account, CBO estimated that the illustrative policy of deficit reduction described above would increase output and income in the longer run by boosting national saving and investment. At the turn of the decade, from 2019 through 2021, GNP would increase by roughly 0.5 percent to 1.4 percent, CBO estimated, again depending on the year and the assumptions used.

The CBO stated the selection of the budget items which should be cut is important.

Even among types of federal spending that contribute to potential output, the effects of different policies can vary greatly. For example, spending for basic research and education may affect output only after a number of years, but once those investments begin to boost output, they may pay off over more years than would the average investment in physical capital (in economic terms, they may have a low rate of depreciation). Moreover, even within a specific program, how those funds are allocated also matters a great deal. Although some specific government investments in a particular category may be as productive as private investment, other projects probably fall short of that benchmark.

source: CBO