Overview of the Administration Economic Forecast David Griffiths - - PowerPoint PPT Presentation

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

2 (The views in this presentation are those of the author and do not necessarily reflect those of the Treasury Department.)

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)

3 (The views in this presentation are those of the author and do not necessarily reflect those of the Treasury Department.)

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
• f 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.

4

(The views in this presentation are those of the author and do not necessarily represent those of the Treasury Department)

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.

5 (The views in this presentation are those of the author and do not necessarily reflect those of the Treasury Department.)

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

6

(The views in this presentation are those of the author and do not Necessarily represent those of the Treasury Department.)

Forecast Issues

THREE QUESTIONS

• Where are we? (or what is current gap between trend output and actual
• utput?
• 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

7 (The views in this presentation are those of the author and do not necessarily reflect those of the Treasury Department.)

Where are we now? Where are we headed? How fast will we get there?

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10,000 12,000 14,000 16,000 18,000 2006Q4 2009Q4 2012Q4 2015Q4 2018Q4 2021Q4

Trend and actual GDP Budget FY13 forecast

gap

Real GDP (trillion) 2005$

Trend GDP Actual GDP No future cycles Gap closed by about 2019

(The views in this presentation are those of the author and do not necessarily reflect those of the Treasury Department.)

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?

9

The views in this presentation are those of the author and do not necessarily represent those of the Treasury Department.)

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Real Gross Domestic Product

Bil.Chn.2005$ 10 05 00 95 90 85 80 75 70 65 60 55 50 45 40 35 30 Source: Bureau of Econom ic Analysis /H av er Analytics 15000 12500 10000 7500 5000 2500 1250 716 15000 12500 10000 7500 5000 2500 1250 716

(Log scale) Recessions Trend GDP Actual GDP Long term trend GDP growth has been historically stable

(The views in this presentation are those of the author and do not necessarily reflect those of the Treasury Department.)

…but estimates and forecasts of the gap vary considerably

11 (The views in this presentation are those of the author and do not necessarily reflect those of the Treasury Department.)

….one issue is the data can be historically revised

Comprehensive revision to GDP from August 2011

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• 0.7

0.6

• 4.0
• 6.8
• 4.9
• 0.7

1.6 5.0 3.7 1.7 2.6 3.1 1.9 0.0

• 1.8

1.3

• 3.7
• 8.9
• 6.7
• 0.7

1.7 3.8 3.9 3.8 2.5 2.3 0.4 1.3

• 10.0
• 8.0
• 6.0
• 4.0
• 2.0

0.0 2.0 4.0 6.0 081 082 083 084 091 092 093 094 101 102 103 104 111 112 Percent (annualized) year and quarter

revised previous

(The views in this presentation are those of the author and do not necessarily reflect those of the Treasury Department.)

%∆ %∆ %∆ %∆ %∆

GDP = Population +

%∆

Labor Force Participation Rate +

%∆

Employment Rate = (1-unemployment rate)

+ Work Week + Labor Productivity + Technical Adjustments

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…another is different assumptions in the future components of trend

• utput

Estimates of the output gap depend on estimates of trend output.

(The views in this presentation are those of the author and do not necessarily reflect those of the Treasury Department.)

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…another is different assumptions about Fiscal Drag on total spending

In the aggregate, states and localities have posted an operating deficit since the end of 2007. Real federal government spending subtracted 0.5 percentage points from GDP growth in 2012Q1 and 0.6 percentage points from growth in 2011Q4. State and local spending has been a drag

• n growth for the past seven quarters.
• 140
• 120
• 100
• 80
• 60
• 40
• 20

20 40 60 80

00 01 02 03 04 05 06 07 08 09 10 11

State and Local Operating Surplus

SAAR, Bil. $

• 0.1

0.0 0.0

• 0.3
• 0.1

0.1

• 0.2
• 0.4
• 0.5

0.1

• 0.1
• 0.3
• 0.4
• 0.3
• 0.2
• 0.3
• 0.1

0.7 0.4 0.8 0.7

• 0.3

1.1 0.5 0.2 0.2 0.7 0.3

• 0.3
• 0.8

0.2 0.2

• 0.6
• 0.5
• 2.0
• 1.0

0.0 1.0 2.0 08Q1 08Q3 09Q1 09Q3 10Q1 10Q3 11Q1 11Q3 12Q1

Contributions of Real Government Spending to GDP Growth

Percentage Points

State and Local (Dark bars) Federal (Light bars)

(The views in this presentation are those of the author and do not necessarily reflect those of the Treasury Department.)

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

• f 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)

15 (The views in this presentation are those of the author and do not necessarily reflect those of the Treasury Department.)

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Advances in price and unemployment data

• The aggregate price data have become

less informative as measures of slack

• ver time.
• The Phillips Curve, which maps inflation

to the level of the unemployment rate, has flattened out, particularly over the last two decades (the red dots).

• 5
• 4
• 3
• 2
• 1

1 2 3 4 3 4 5 6 7 8 9 10

Inflation less sensitive to unemployment

Change in Inflation Unemployment (t-1)

1962-1993 (blue dots) 1994-2011 (red dots)

2 4 6 8 10 12 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 12

University of Michigan: Median Inflation Expectations Percent, Monthly

Next 5-10 years Next 12 months

(The views in this presentation are those of the author and do not necessarily reflect those of the Treasury Department.)

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…putting it all together, forecast accuracy

Table 3-2 Analytical Perspectives (abridged, pp 25 ) Forecast Errors: Jan 1982 to present REAL GDP ERRORS 6-Year Average Annual real GDP Growth Admin. CBO Blue Chip Mean Error 0.1

• 0.2
• 0.2

Mean Absolute Error 0.8 0.8 0.8 Root Mean Square Error 1.0 1.0 1.0 INFLATION ERRORS 6-Year Average Annual Change in the GDP Price index Mean Error 0.4 0.6 0.8 Mean Absolute Error 0.7 0.9 1.1 Root Mean Square Error 0.9 1.0 1.3

(The views in this presentation are those of the author and do not necessarily reflect those of the Treasury Department.)

Further Information

Fiscal year 2013, Analytical Perspectives, Budget of the U.S. Government Chapter 2, p 9-21. http://www.whitehouse.gov/omb/budget/Analytical_Perspectives

(The views in this presentation are those of the author and do not necessarily represent those of the Treasury Department.)

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