Weak US growth could swamp $1tn deal on cuts

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Weak economic growth could swamp the first $917 billion of cuts included in the political deal struck to raise the US debt ceiling. Friday's anaemic GDP report casts doubt on the pact's deficit reduction figures. On a simple analysis, if economic growth in 2011-16 falls short of the Congressional Budget Office's 3.25 per cent estimate by 0.5 percentage point, the expected initial cuts disappear completely.

The CBO's growth forecast looks optimistic, even on average, against last week's advance estimate of second-quarter GDP from the Bureau of Economic Analysis, which showed an annualised growth rate of just 0.8 per cent in the first half of 2011. Expansion is returning considerably more slowly than in past economic recoveries, with unemployment remaining higher.

In a sensitivity analysis included with its budget forecasts earlier this year, the CBO calculated that a 0.1 percentage point decrease in the average GDP growth rate would increase the cumulative deficit from 2012 to 2021 by $310 billion.

On that basis an average growth rate of even 2.75 per cent for the next six years -- half a percentage point below the CBO's assumed rate and still high compared with recent readings -- would increase the 10-year deficit by around $930 billion, assuming growth in the remainder of the period meets the CBO's forecasts. That would more than wipe out the estimated initial savings from the debt ceiling deal.

There's more bad news. According to the CBO, a one percentage point increase in average annual inflation over 2012-21 would widen the projected 10-year deficit by $867 billion. However the CBO assumes inflation in personal consumption expenditures of only 1.3 per cent in 2011 and 1.2 per cent in 2012, while last week's GDP report showed PCE inflation running at an annual 3.5 per cent clip in the first half of this year.

Weaker growth could damp inflation and possibly help keep interest rates low, thereby avoiding another change that could make deficits larger. But the CBO's own analysis highlights the sensitivity of the hard-fought deal in Congress to variables largely beyond political control.