Economy to resume growth this year

NEW YORK (CNNMoney.com) -- The economy will start growing in the second half of 2009, but it will be several years before the positive effects of a turnaround will be felt, the Congressional Budget Office said Thursday.

"Even if the economy returns to positive growth this year, the loss in output, income and employment during the recession and the next few years will be huge," said Douglas Elmendorf, director of the CBO, in testimony before the House Budget Committee.

The CBO is updating its economic forecasts and will release new estimates in August. Elmendorf expects the new numbers will be less optimistic than the estimates the agency released in March.

"CBO's forecast in August is likely to show even larger shortfalls in output over the next few years," he said.

The agency is expecting that the unemployment rate will continue to rise into the second half of next year and will peak at 10.5%. In March, CBO forecast unemployment would peak in the first half of next year at 9.5%.

The $787 billion economic stimulus package enacted in February is helping to boost GDP this year and, to a lesser extent, will do so in 2010 as well. Thereafter, economic growth will be hindered if private demand does not pick up, he told lawmakers.

And even if private demand picks up, "it still takes a long time to catch up with the weak growth last year and this year," Elmendorf said.

Elmendorf was asked to lay out what he saw as potential risks going forward. "The number of sandpits we see ahead would scare a good golfer," he said.

Among them is the exposure of small- and medium-sized banks to the fortunes of commercial real estate.

"The fundamentals in the market are very weak," Elmendorf said. He said current price declines of between 35% and 45% exceed those of the early 1990s, when commercial property collapsed. Meanwhile, delinquency rates are up.

With estimates of commercial real estate losses totaling more than $200 billion, that could exceed the revenue small and mid-size banks take in, thereby reducing their capital.

This week, Standard & Poor's lowered its ratings outlook to negative for the United Kingdom, in great part due to its growing debt levels.

House Budget Committee Ranking Member Paul Ryan, R-Wisc., asked Elmendorf to assess whether the United States is likely to suffer the same fate.

The U.S. government and others around the world flood the debt markets with government issues. That, in turn, can cause interest rates to rise as investors start to demand greater reward for the risk they're taking.

"Certainly in the next several years, there's likely to be significant upward pressure on interest rates," Elmendorf said. But any increase "is likely to be delayed until the economy comes out of its [downturn]."

CBO projects that, under the current congressional budget resolution for fiscal year 2010, the debt held by the public could rise to more than 60% of GDP over the next 5 years. Under the president's budget proposals, it could rise more than 80% over the next 10 years.

"This is a grim outlook for the federal budget," Elmendorf said. "At some point investors may decide the United States is not the safest haven. [But there's great] uncertainty when sentiment will turn." If it does, it could turn more quickly than expected, he noted.