The economy has been soft recently. Household spending has advanced more modestly as higher energy prices have pinched real incomes. Yet business investment has stabilised and appears set to recover following the end of the war in Iraq, while rising military expenditures are providing a boost to demand. Growth is expected to rebound sharply by the autumn assuming the conflict is resolved by early summer. Household, business and foreign demand -- the latter buoyed by the drop in the dollar -- are all projected to strengthen markedly in 2004. Inflation should fall back as energy prices reverse and slack persists following several years of growth below potential.

Monetary policy has remained supportive, but interest rates will need to be raised once growth picks up. The proposed tax cuts and further increases in expenditure, not least the jump in defence purchases, will widen the federal government deficit sharply. This will have to be reversed in coming years. While the planned tax rate reductions and reforms to dividend taxation are attractive from an efficiency perspective, these proposed changes should be part of a more revenue-neutral reform package.