| US Forecast: January 31, 2001 |
| Forecast Period 2001:1--2005:4 (20 quarters) Data The forecast is based on the national income and product accounts (NIPA) data that were released on January 31, 2001. The Latest Version of the US Model For purposes of this forecast the US model has been reestimated through 2000:4. These estimates are presented in the "Chapter 5 tables" at the end of The US Model Workbook. The rest of the specification of the model is in Appendix A at the end of this workbook. A complete discussion of the November 3, 1998, version of the US model is in Macroeconometric Modeling, which is the main reference for this site. Since the November 3, 1998, version the NIPA data have been completely revised, and the revised data have been used. A few specification changes were made in the process of updating the model using the revised data. These changes are listed in the last section of this memo. No changes were made to the current version (January 31, 2001) from the previous version (October 30, 2000). Assumptions Behind the Forecast The following table gives the growth rates that were assumed for the current forecast for the key exogenous variables in the model along with the actual growth rates between 1993:3 and 2000:4.
Growth Rates (annual rates)
Current
Forecast Actual
Assumptions 2000:4-1993.3
TRGH 8.0 4.0
COG 2.0 0.5
JG 0.0 -1.4
TRGS 8.0 6.2
TRSH 7.0 6.3
COS 3.0 5.8
JS 1.0 1.6
EX 5.0 7.9
PIM 2.0 -0.3
The first six variables are the main government policy variables in the model aside from tax rates. All tax rates were assumed to remain unchanged for the current forecast. No assumption about monetary policy is needed for the forecast because monetary policy is endogenous. Monetary policy is determined by equation 30, an estimated interest rate reaction function or rule. The Results The current forecasts for real growth (at an annual rate) for the four quarters of 2001 are 0.8, 0.7, 1.1, and 1.4 percent respectively. This is an overall growth rate for the year of 1.0 percent. A year ago (January 29, 2000) the model was forecasting a growth rate for 2001 of 2.1 percent. Nine months ago (April 28, 2000) the forecast for 2001 was 1.8 percent; six months ago (July 31, 2000) it was 1.9 percent; and three months ago (October 30, 2000) it was 2.6 percent. The lower forecast now is partly due to the fall in the stock market in the fourth quarter of 2000. Household wealth fell in the fourth quarter by about $2 trillion (at a quarterly rate), and this has a negative effect on household expenditures in 2001 and beyond. The current prediction is thus for slow growth in 2001, but not negative growth. The unemployment rate rises to 4.6 percent by the end of 2001. Inflation as measured by the growth of the GDP deflator (GDPD) rises. It is predicted to be about 3 percent in 2001. The Fed is predicted (through the interest rate rule) to lower the bill rate (RS) slightly to 5.6 percent by the end of 2001, which is in response to the higher unemployment rate. The fall in the bill rate is small because inflation is higher, which, other things being equal, has a positive effect on the bill rate. The Fed is facing both a higher unemployment rate and a higher inflation rate, which have opposite effects on its behavior. The household saving rate (variable SRZ in the model) is slightly below zero throughout the forecast period. The federal government budget surplus (SGP) is forecast to be between $280.2 and $351.5 billion throughout the forecast period. The U.S. current account deficit (variable -SR in the model) is forecast to be extremely large throughout the period (about $450 billion on average). Corporate profits (PIEF) are essentially flat in 2001. For the two years beyond 2001 the growth rate is about 2 percent, the unemployment rate is about 5 percent, and inflation is about 2.5 percent. There are two main uncertainties regarding the current forecast. The first concerns inflation. The unemployment rate enters linearly in the price equation (equation 10), but at some point one would expect to see large (i.e., nonlinear) price increases in response to a low unemployment rate. Unfortunately, there are not enough observations at low unemployment rates for the data to estimate this nonlinearity, and so there are no nonlinear effects in the model. It could thus be that inflation will be even worse in the future than the model is predicting if the economy is in this nonlinear zone and is about to feel the effects. The second main uncertainty concerns the stock market. There is a stock price equation in the model (equation 25, explaining CG), but it cannot pick up booms and crashes. The equation is predicting that stock prices will grow modestly in the future. If, on the other hand, the stock market crashes, the effect on the economy through the wealth effect could be substantial. If you want to see this, you can run an experiment in which you crash the stock market (see Chapter 7 of The US Model Workbook for how to do this). You will see that a large sustained crash leads to a recession even if you assume that the Fed substantially lowers the interest rate in response to the crash. In other words, the model has the property that the Fed does not have the power to prevent a recession if there is a large crash. You can examine the tables of this forecast memo for the details, or you can print out the forecast values from the base data set for the model. Although the model is used to forecast through 2005:4, you should not put much confidence on the results beyond about 2002. Forecast error bands are fairly large for predictions this far ahead. Possible Experiments to Run The present forecast is a good base from which to make alternative fiscal-policy assumptions, depending on what you think Congress might do in light of the rosy government budget picture. The most interesting experiments at the moment are various tax-cut plans. Remember that the current forecast assumes that there are no changes in tax rates in the future. This is thus a simple base from which alternative tax rates can be cut. As a historical footnote, the model has consistently been more optimistic about the size of future federal government deficits than have most others, especially regarding future tax revenues, and the recent data suggest that the model has been right. The CBO and others have now moved in the optimistic direction. You may want to compare the current CBO forecasts with those from the model. My sense is that the model has conveyed useful information in the past about the deficit that was not in the CBO forecasts at the time. You may also want to drop the interest rate reaction function (equation 30) and put in your own assumptions about Fed behavior. For example, do you think the Fed will lower interest rates more than the model predicts it will in response to what is happening in the economy? Given the above discussion about nonlinearities and inflation, you may want to experiment with the price equation (equation 10). Will inflation be higher than predicted because of the low unemployment rates? Related to the inflation question, the current forecast is based on the assumption that the price of imports (PIM) grows at a rate of 2 percent per year throughout the forecast period. A strong dollar helps keep PIM down, but oil price increases push it up. It may be that the assumption of 2 percent is too optimistic, and you may want to experiment with higher values. This will, of course, make inflation even worse in the future. Finally, as discussed above, you may want to crash the stock market. Changes to the US Model since November 3, 1998 The following is a list of the changes that have been made to the US model from the November 3, 1998, version.
Some of the above changes have lessened the reliance of the model on peak to peak interpolations. Variables Z, JJS, and the output gap variable have been replaced by UR. This means that the variables JJ, JJP, JJS, YS, and Z are no longer needed in the model. UR and JHMIN are now the only two capacity-like variables in the model. JJP had been created by peak to peak interpolations of JJ. This change also eliminates equations 95-98. In addition, the excess capital variable is no longer used in equation 12, and this means that variables EXKK and MUH are no longer needed in the model. MUH had been created by peak to peak interpolations of Y/KK. This change eliminates equation 93. All these variables and equations have been retained in the software, but they play no role in the solution of the model. The different treatment of INTF and INTG means that three variables have been dropped from the model---BF, BG, and TI---and two have been added---DINTF and DINTG. See Model Versions and References for more discussion of the model versions. |
| US Forecast Tables: January 31, 2001 |
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Table F1: Forecasts of Selected Variables--Real GDP
and Components
Table F1 (continued)--Prices and Wages Table F1 (continued)--Money and Interest Rates Table F1 (continued)--Employment and Labor Force Table F1 (continued)--Other Endogenous Table F1 (continued)--Selected Exogenous Table F2: Forecasts of the Federal Government Budget Table F3: Forecasts of the State and Local Government Budget Table F4: Forecasts of Savings Flows NIPA Table 1.1 NIPA Table 1.2 NIPA Table 3.2 NIPA Table 3.3 NIPA Table 7.1 |
| Table F1: Forecasts of Selected Variables |
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| Table F1 (continued) |
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| Table F1 (continued) |
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| Table F1 (continued) |
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| Table F1 (continued) |
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| Table F1 (continued) |
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| Table F2: Forecasts of the Federal Government Budget |
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| Table F3: Forecasts of the State and Local Government Budget |
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| Table F4 Forecasts of Savings Flows |
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| NIPA Table 1.1 |
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| NIPA Table 1.2 |
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| NIPA Table 3.2 |
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| NIPA Table 3.3 |
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| NIPA Table 7.1 |
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