By Drew Pierson

WASHINGTON (MNI) – If the “fiscal cliff” occurs at the beginning of
2013, the roughly $500 billion in ensuing deficit reduction would be the
largest such cut as a share of GDP since 1969, Congressional Budget
Office Director Doug Elmendorf said Wednesday.

“We think economic growth is being held back by the anticipation of
this fiscal tightening,” Elmendorf said during a press briefing.

Such an immediate contraction in federal spending would likely
trigger a recession, Elmendorf said. The CBO projects a real GDP of 2.1%
this year, but 0.5% contraction in 2013 if that fiscal cliff occurs.

Elmendorf spoke to reporters after the release of his
organization’s updated Budget and Economic Outlook, which anticipates
future economic and budgetary growth in the coming decade.

For financial markets, although CBO anticipates a recession would
likely trigger further stimulative action by the Federal Reserve, it
would also cause the U.S. to lose its ability to borrow at affordable
rates, Elmendorf said.

Elmendorf noted the CBO had already predicted higher interest rates
on Treasury securities than today’s low rates, and said continued
weakness and uncertainty in both domestic and international markets were
keeping rates at their present low levels.

The CBO currently predicts interest on 10-year Treasury notes to
rise to 5% by the end of the decade.

“Between the situation in the U.S. economy and the situation in
foreign economies, it’s not too surprising rates are low,” Elmendorf
said.

When asked about recent Office of Management and Budget projections
that discussed the possibility of significant upside risk to the
economic recovery, Elmendorf said there were certain factors he could
see that would lead to such a recovery.

For example, the large number of vacant homes in America, coupled
with low mortgage rates and depressed construction activity could point
to a sudden surge in the housing market.

“It’s not at all impossible for homebuilding to come back stronger
than we think,” Elmendorf said.

Elmendorf also said a stronger-than-anticipated rebound in business
confidence could occur.

“Businesses are sitting on a lot of liquid assets — cash, people
say — and if they felt more optimistic about the economic path … that
could also jumpstart a favorable feedback loop,” he said.

However, Elmendorf discussed downside risks as well, chief among
them uncertainty about the “fiscal cliff.” CBO anticipates 2 million
fewer jobs to be created by the end of next year if no changes to policy
are made compared to an alternative scenario where all of the Bush-era
tax cuts are extended and no planned sequestration takes effect, among
other changes.

Additional downside risks to the economy in CBO’s projections
include continuing cuts in U.S. public sector funding and employment, as
well as tensions in the eurozone.

“In an economy growing such a slow rate … large shocks can matter
a lot,” Elmendorf said.

Elmendorf said the CBO purposely steered its projections toward
consensus, and that significant deviations were possible. Elmendorf
noted several factors continued to surprise CBO analysts, including the
aforementioned lower-than-expected Treasury rates, as well as that, “We
are a little surprised at how weak tax revenues are.”

Elmendorf noted that even if the United States were to experience
high growth throughout the next decade, deficits would still remain
extremely high without changes to current law.

“At some point we will need to adopt policies that require people
to pay significantly more taxes, accept substantially less in government
benefits, or both,” Elmendorf said.

The White House issued a statement after the CBO release, calling
for Congress to act at once on extending the parts of the Bush-era tax
cuts and other provisions to avoid shocking the economy:

“Republicans in Washington should do the right thing and pass a
bill that extends tax cuts for 98% of Americans and 97% of small
businesses. There’s no reason to wait.”

Elmendorf noted his office was not tasked with making policy
recommendations for Congress, and thus would not do so. But he said
action sooner rather than later would have a magnified economic effect
because of the increase in confidence it would give businesses and
consumers.

The next CBO economic outlook will be released in January. After
next year, CBO projects average real GDP to run at 4.1% from 2014-2017,
falling to 2.5% per year until 2022 — assuming no changes to current
law are made.

“We don’t entirely understand what’s going on with the economy; we
wouldn’t claim otherwise,” Elmendorf said.

** MNI Washington Bureau: 202-371-2121 **

[TOPICS: M$U$$$,MGU$$$,MFU$$$,MCU$$$,M$$CR$]