The CBO budget estimates were announced on Friday and the number are much worse than the projections of the Obama Administration. The current year baseline budget deficit projections will come in worse by $400 billion and will total 11.9% of GDP for total of $1.7 trillion. The deficit will be $1.1 trillion or 7.9% of GDP next year and then will close to 2% of GDP through 2019. This assumes that we will be out of the recession by the fourth quarter 2009 and have positive growth in nominal GDP of 3.8% in 2010.
However, the number actually get much worse when the CBO estimates the President's budget. There is an extra $4.8 trillion in spending between now and 2019. The impact on deficit to GDP will be an increase of 2% so that the projection for 2009 will be deficit to GDP of 13.1% and 9.6% of GDP in 2010.
The impact on overall debt to GDP ill be 56.8% for 2009 and will rise to 82.4% as of 2019. The baseline debt held by the public will be 54.8% in 2009 to 56.1% in 2019. This is against the total debt held by the public to GDP of 40.8% in 2008.
Crowding out is real and will be worse than expected. If the US was a small open economy, a debt held by the public to GDP of over 50% would place it in a warning zone. Now many European countries have high public debt to GDP, so we cannot immediately assume dire consequences. These projections will rival the post WWII period where interest rates were held down by the Fed-Treasury Accord. We expect that the Fed will have to monetize debt in order to keep this debt under control and avoiding crowding out, but then we will have higher expected inflation.
Rates will have to go higher over the long-run, but we will get to pick our poison. Higher expected inflation or higher real rates. Nevertheless, with the output gap being over 7% of GDP, there is little to suggest higher overall inflation. We still think that the focus will have to be on asset inflation in the shorter-run which will suggest false rallies.
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