That would put the budget deficit at 1.6 percent of projected GDP for 1996, down from 2.3 percent during 1995. A fiscal drag equal to 0.7 percent of GDP would be significant and has not yet been factored into the forecasts of most analysts. While the Federal Reserve could offset such fiscal drag with additional interest rate cuts of around 75 basis points, such cuts may, however, be delayed both by the continued furor over the budget and by an absence of numbers. The Greenspan Fed is a cautious institution that likes to operate with as much economic information as possible. In the absence of full information, there will be a strong bias toward caution that may delay an easing even if it turns out by midyear to have been advisable and necessary to maintain economic momentum.
Analysts even seem to be willing to concede a continued slowdown in the first quarter.
But thereafter they expect a sharp pickup of economic activity, even given the likelihood of weaker investment spending driven by the significant inventory accumulation that will probably result from the demand growth slowdown during the fourth and first quarters. The consumer and net exports will have to drive the recovery. Serious questions arise if inventory adjustments require slower employment growth and thereby result in slower income growth. Meanwhile, weak Canadian, Japanese, and European growth will limit any positive contribution from net exports. So will the 6-8 percent appreciation of the dollar.