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Congressional Budget Office April 26, 2018 CBOs 10-Year Economic Forecast and How It Is Produced Congressional Research Service Seminar Robert W. Arnold Chief, Projections Unit, Macroeconomic Analysis Division CBO CBOs Economic

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Congressional Budget Office

Congressional Research Service Seminar

April 26, 2018

Robert W. Arnold Chief, Projections Unit, Macroeconomic Analysis Division

CBO’s 10-Year Economic Forecast and How It Is Produced

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CBO’s Economic Forecast Process

Step 1: Background Analysis

Develop preliminary forecast for exogenous variables (e.g., oil prices)
Review recent data

Step 2: Preliminary Forecast

Use macroeconometric model to develop preliminary forecast
Incorporate preliminary federal tax and spending projections

Step 3: Internal and External Review

Obtain input from CBO’s senior staff and other divisions within the agency
Obtain feedback from CBO’s Panel of Economic Advisers and staff of

Congressional budget committees Step 4: Final Forecast

Incorporate feedback and latest data to produce final forecast
Transmit to CBO’s budget and tax divisions to develop budget projections

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CBO’s Forecasting Models

CBO’s Macroeconometric Model Aggregate Demand Other Variables

Consumer spending
Inflation
Business investment
Interest rates
Residential investment
Labor market variables
Government spending
Unemployment
Net exports
Employment
Wages & compensation

Aggregate Supply

Incomes
Potential output

CBO’s Labor Force Participation Rate Model Exogenous Variables

Population
Energy prices
Foreign growth

Policy Variables

Labor supply elasticities
Marginal tax rates
Other fiscal policies

(Labor force participation rate) (Unemployment gap) CBO’s Forecast Growth Model (Investment, potential labor force, and other variables) (Potential output, hours, productivity, and other variables) CBO’s Budget Projections

Federal outlays
Federal revenues

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CBO’s Current Economic Forecast

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Real potential GDP is CBO’s estimate of the economy’s maximum sustainable output, adjusted to remove the effects of inflation.

Grow th of Real GDP and Real Potential GDP

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The output gap is the difference between the level of GDP and the level of potential GDP.

Output Gap

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Potential labor force productivity is the ratio of real potential GDP to the potential labor force, which is CBO’s estimate of the size of the labor force arising from all sources except fluctuations in the overall demand for goods and services.

Determinants of the Grow th of Real Potential GDP

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The unemployment rate is the number of jobless people who are available for and seeking work, expressed as a percentage of the labor

force. The natural unemployment rate is CBO’s estimate of the rate of unemployment arising from all sources except fluctuations in the
verall demand for goods and services.

Unemployment Rate

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The labor force participation rate is the percentage of people in the civilian noninstitutionalized population who are at least 16 years old and either working or seeking work. The potential labor force participation rate is the rate that CBO estimates to arise from all sources except fluctuations in the overall demand for goods and services

Labor Force Participation Rate

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Values are shown for changes in the price index for personal consumption expenditures.

Consumer Price Inflation

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Interest Rates

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Effects of the 2017 Tax Act

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Effects on Aggregate Supply:

Increased business fixed investment
Increased labor supply
Decreased residential investment

Effects on Aggregate Demand:

Increased consumption
Decreased net exports

Macroeconomic Effects of the Tax Act

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Effects on Real GDP and Real Potential GDP

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Effects on the Output Gap

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Values shown are effects on the price index for personal consumption expenditures.

Effects on Consumer Prices

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Effects on Interest Rates

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Business fixed investment is businesses’ purchases of equipment, nonresidential structures, and intellectual property products. The changes in incentives consist of changes in the user cost of capital, which is the gross pretax return on investment that provides the required return to investors after covering taxes and depreciation, and changes in the benefits of locating business establishments in the United States. Changes in economic activity consist of changes in demand for goods and services and changes in the supply of labor. Crowding out occurs when larger federal deficits reduce the resources available for private investment.

Effects on Business Fixed Investment

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Effects on Residential Investment

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Congressional Budget Office, The Budget and Economic Outlook: 2018 to 2028 (April 2018), www.cbo.gov/publication/53651. Robert W. Arnold, How CBO Produces Its 10-Year Economic Forecast, Working Paper 2018-02 (Congressional Budget Office, February 2018), www.cbo.gov/publication/53537.