Overview of the Administration Economic Forecast David Griffiths Department of the Treasury Office of Economic Policy (The views in this presentation are those of the author and do not necessarily reflect those of the Treasury Department.)
Overview • Organization – The Troika Process and Budget Estimates – Basic Assumptions • Forecast issues – Three questions – Underlying issues: forecast assumptions – Long term GDP growth has been historically stable – Components of trend output – Fiscal drag • How have data and models Improved? – Advances in price and unemployment data • Putting it all together: forecast accuracy • Further information (The views in this presentation are those of the author and do not necessarily reflect those of the Treasury Department.) 2
Organization • The Troika is the Council of Economic Advisers (CEA), the Office of Management and Budget (OMB) and the Treasury (Economic Policy ) • The Troika creates the economic assumptions used to forecast federal receipts and outlays for the next ten years • Calendar – Semi-annual forecast – Budget (preparation starts October for Feb release ) – Mid-session review (preparation starts April for July release) (The views in this presentation are those of the author and do not necessarily reflect those of the Treasury Department.) 3
Organization (cont’d) • The model and software used to create the Troika forecast is from Macroeconomic Advisers (MA), a traditional quarterly macro- econometric model of the U.S. • The work is largely done by CEA and consists of repeated iterations of the model software, varying individual equation adjustment factors to achieve the top-line figures. Staff at Treasury and OMB review the CEA work for errors and consistency. (The views in this presentation are those of the author and do not necessarily represent those of the Treasury Department) 4
The Troika Process and Budget Estimates • The Treasury Office of Tax Analysis (OTA) is the key receipts estimator • The Office of Management and Budget and other federal agencies use various parts of the forecast to mainly predict spending. • Key variables include wage and salary growth, personal income growth, inflation, interest rates, the unemployment rate and GDP growth. • The focus of the forecast is on the INCOME side of the National Income and Product Accounts (NIPA). • Variables not available from consensus forecasts (like Blue Chip consensus) play key role in the receipts forecast. Chief among these variables are the shares of national income accruing to taxable and non- taxable components . (The views in this presentation are those of the author and do not necessarily reflect those of the Treasury Department.) 5
Basic Assumptions • Troika forecast is a “current policy” forecast – it assumes the policies proposed in the budget will be passed (tax cuts will be extended for all but high income individuals, indexation of tax brackets, etc.) • CBO economic forecast is a “current law” forecast (expiration of tax cuts, no indexation of tax brackets, etc. ) • Blue Chip consensus based on forecaster expectations – possibly between “current law” and “current policy” • That goes some way in explaining the differences in the forecasts (The views in this presentation are those of the author and do not Necessarily represent those of the Treasury Department.) 6
Forecast Issues THREE QUESTIONS • Where are we? (or what is current gap between trend output and actual output? • Where are we headed? (or how fast can trend output grow over the forecast horizon?) • How fast will we get there? (or how fast will the gap between actual and trend output be closed?) FACTORS TO CONSIDER • Unemployment Rate and Inflation: the forecast is conditioned on the relationships in the variables • Fiscal drag (withdrawal of stimulus spending): many programs are winding down which may temporarily slow spending if the private sector does not fill the gap. • Interest rates: futures markets • Wealth: stock market and house prices impact on consumer spending • Foreign sector: trade weighted foreign GDP growth • Energy/Oil prices: futures market (The views in this presentation are those of the author and do not necessarily reflect those of the Treasury Department.) 7
Where are we now? Where are we headed? How fast will we get there? Real GDP Trend and actual GDP (trillion) 2005$ 18,000 forecast 16,000 No future cycles Trend GDP Gap closed by about 2019 14,000 gap 12,000 Actual GDP 10,000 2006Q4 2009Q4 2012Q4 2015Q4 2018Q4 2021Q4 Budget FY13 (The views in this presentation are those of the author and do not necessarily reflect those of the Treasury Department.) 8
Underlying issues: forecast assumptions • Is potential GDP growth constant (red line)? • How certain is the size of the gap? – Many alternatives • How will data revisions affect estimates of the gap? The views in this presentation are those of the author and do not necessarily represent those of the Treasury Department.) 9
Long term trend GDP growth has been historically stable Real Gross Domestic Product (Log scale) Bil.Chn.2005$ 15000 15000 12500 12500 10000 10000 7500 7500 5000 5000 Trend GDP 2500 2500 Recessions 1250 1250 Actual GDP 716 716 30 35 40 45 50 55 60 65 70 75 80 85 90 95 00 05 10 Source: Bureau of Econom ic Analysis /H av er Analytics (The views in this presentation are those of the author and do not necessarily reflect those of the Treasury Department.) 10
…but estimates and forecasts of the gap vary considerably (The views in this presentation are those of the author and do not necessarily reflect those of the Treasury Department.) 11
….one issue is the data can be historically revised Comprehensive revision to GDP from August 2011 6.0 5.0 3.9 3.8 3.8 3.7 4.0 3.1 2.6 2.5 2.3 1.9 1.7 1.7 1.6 2.0 1.3 1.3 0.6 0.4 0.0 0.0 Percent (annualized) 081 082 083 084 091 092 093 094 101 102 103 104 111 112 -0.7 -0.7 -0.7 -2.0 -1.8 -4.0 -3.7 -4.0 -4.9 -6.0 -6.7 -6.8 -8.0 revised previous -8.9 -10.0 year and quarter (The views in this presentation are those of the author and do not necessarily reflect those of the Treasury Department.) 12
…another is different assumptions in the future components of trend output Estimates of the output gap depend on estimates of trend output. %∆ %∆ %∆ %∆ %∆ %∆ %∆ Labor Force Employment Rate Labor Technical Participation = (1-unemployment Work Week + GDP = Population + Rate + + Productivity + Adjustments rate) (The views in this presentation are those of the author and do not necessarily reflect those of the Treasury Department.) 13
…another is different assumptions about Fiscal Drag on total spending Contributions of Real Government Spending to GDP Growth Percentage Points Real federal government spending 2.0 Federal subtracted 0.5 percentage points from (Light bars) GDP growth in 2012Q1 and 0.6 1.1 1.0 0.8 percentage points from growth in 2011Q4. 0.7 0.7 0.7 0.5 0.4 State and local spending has been a drag 0.3 0.2 0.2 0.2 0.2 0.1 -0.3 0.0 0.1 0.0 on growth for the past seven quarters. 0.0 -0.1 -0.1 -0.1 -0.1 -0.2 -0.2 -0.3 -0.3 -0.3 -0.3 -0.3 -0.4 -0.4 -0.5 -0.5 -0.6 -0.8 -1.0 State and Local (Dark bars) -2.0 State and Local Operating Surplus 08Q1 08Q3 09Q1 09Q3 10Q1 10Q3 11Q1 11Q3 12Q1 SAAR, Bil. $ 80 60 40 In the aggregate, states and localities 20 have posted an operating deficit since 0 -20 the end of 2007. -40 -60 -80 -100 -120 -140 00 01 02 03 04 05 06 07 08 09 10 11 (The views in this presentation are those of the author and do not necessarily reflect those of the Treasury Department.) 14
How have data and models improved? • Technology: – simulation turnaround is almost instantaneous on a PC (Macro Economic Advisers model of the US economy) – Data availability is much better than in the past (Bureau of Economic Analysis website: http://www.bea.gov/) • Advances in modeling (a bit wonk-ish) – Role of expectations, adaptation to energy price shocks (anchored inflation expectations) – Attention to subtle long run and short relationships amongst variables (co-integration) (The views in this presentation are those of the author and do not necessarily reflect those of the Treasury Department.) 15
Advances in price and unemployment data University of Michigan: Median Inflation Expectations Percent, Monthly • The aggregate price data have become 12 less informative as measures of slack 10 over time. 8 • The Phillips Curve, which maps inflation 6 Next 12 months to the level of the unemployment rate, Next 5-10 years 4 has flattened out, particularly over the last two decades (the red dots). 2 0 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 12 Inflation less sensitive to unemployment 4 3 1962-1993 (blue dots) 2 1 Change in Inflation 0 -1 -2 1994-2011 (red dots) -3 -4 (The views in this presentation are those of the author and do not -5 necessarily reflect those of the 3 4 5 6 7 8 9 10 Treasury Department.) 16 Unemployment (t-1)
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