Despite Hurricanes Katrina and Rita, the U.S. economy grew by an annual rate of 4.1 percent in the third quarter of 2005. This follows two quarters of slower-than-expected growth, bringing predictions of growth for the year to between 3.6 and 3.7 percent.
Slower economic growth is on the horizon for 2006, according to recent forecasts from three key sources: the Congressional Budget Office (CBO), the Federal Reserve Bank's "Survey of Professional Forecasters," and The Economist. The CBO and Federal Reserve predict an annual growth rate of 3.4 percent in 2006, with The Economist's forecast a bit lower at 3.3 percent.
Reasons for the predicted slowdown include an increasing budget deficit (as a result of tax cuts and increased spending), increasing national debt, and increasing interest rates.
Deficits & Program Cuts
Proposed tax cuts, together with increasing government spending, mainly on the war in Iraq, military operations in Afghanistan, and homeland security, result in an estimated budget deficit of $317 billion for 2005 and a projected $314 billion deficit in 2006.
The current administration is pushing to make earlier tax cuts permanent – while also paring down spending on government programs other than the military. According to the December Presidential Agenda, the proposed budget will "terminate or reduce more than 150 government programs."
The CBO estimates that since 9/11 the Department of Defense (DoD) has spent $197.5 billion on the war on terrorism, including homeland security and activities in Afghanistan, and on Iraqi operations. Future cost estimates based on various scenarios range from $141 billion to $336 billion between 2006 through 2014. The least expensive scenario required a decrease of troop levels in 2005 (which did not happen) and total withdrawal from Iraq by 2009.
Budget deficits add to the existing national debt, expected to reach $8.6 trillion in 2006. CBO reports indicate the fastest-growing spending category in the government's budget in 2005 was interest costs of the public debt.
Pressure on Interest Rates
Funding the national debt in financial markets requires competition for resources with private companies and consumers, which results in higher expected interest rates in 2006. Economic activity will be affected negatively by the higher financing costs borne by companies, as well as higher borrowing costs for consumers in purchasing goods and services. Higher interest rates will also affect the housing market, as the financing costs associated with home purchases increase, putting downward pressure on economic activity in this leading sector.
Monetary Policy an Uncertainty
A key uncertainty for 2006 is the direction monetary policy will take under the newly appointed Chair of the Federal Reserve, Ben Bernanke. Being an expert in monetary policy, Mr. Bernanke is by all accounts a well-qualified replacement for Alan Greenspan, who held the post for more than 18 years.
Mr. Bernanke is expected to continue the current Fed policy of raising interest rates. Interest rate estimates for 2006 from the Survey of Professional Forecasters are substantially higher than CBO estimates: 4.5 percent for the three-month Treasury Bill versus 3.7 percent, and 5.1 percent for the 10-year Treasury Note versus 4.7 percent. This divergence in forecasts may reflect uncertainty about Mr. Bernanke's new style and policies.
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