| US Forecast: April 27, 2001 |
| Forecast Period 2001:2--2005:4 (19 quarters) Data The forecast is based on the national income and product accounts (NIPA) data that were released on April 27, 2001. The Latest Version of the US Model For purposes of this forecast the US model has been reestimated through 2001:1. 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 current version of the US model (April 27, 2001) is in Macroeconometric Modeling, which is the main reference for this site. See Current Versions and References for more details. Previous versions of the US model are discussed in Previous Versions and References. 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 2001:1.
Growth Rates (annual rates)
Current
Forecast Actual
Assumptions 2000:4-1993.3
TRGH 8.0 4.4
COG 3.0 (beg. 2001:3) 0.8
JG 1.0 -1.4
TRGS 8.0 6.5
TRSH 7.0 6.3
COS 3.0 5.7
JS 1.0 1.6
EX 5.0 7.5
PIM 2.0 -0.4
The first seven 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 Selected forecast results are present in the tables that follow this memo. If you want more detail, click in the left menu "US Model," create a data set, and then go immediately to "Examine the results without solving the model." You can then examine any variable in the model. Although the model is used to forecast through 2005:4, you should not put much confidence on the results beyond about 2003. Forecast error bands are fairly large for predictions out a number of years. Real Growth and the Unemployment Rate: The two main features of the forecast are 1) the predicted growth rate for the second quarter of 2001 is a fairly strong 3.4 percent and 2) the growth rates for 2002 and 2003 are not strong (less than 2 percent). The strong growth rate in 2001:2 is due to a large predicted inventory correction. Inventories fell substantially in 2001:1, and the model is predicting that there will be a fairly large correction in 2001:2 (with some correction also in 2001:3). The unemployment rate is flat for 2001:2 and 2001:3, and it then rises gradually to 5.1 percent by the end of 2003. Inflation: Inflation as measured by the growth of the GDP deflator (GDPD) rose a fairly strong 3.4 percent in 2001:1, and the model is predicting that inflation will stay above 3 percent for the rest of 2001. (If you click "Forecast Record" in the left menu, you can see that the model accurately predicted the fairly strong inflation in 2001:1.) This forecast is based on only a modest assumed increase in the price imports of 2 percent per year. Monetary Policy: The Fed lowered the short term interest rate more in 2001:1 than the model predicted. (You can see this by estimating the model in Eviews or the FP program and examining the estimated residuals for equation 30.) The estimated interest rate rule (equation 30) is predicting that the three month bill rate (RS) will stay flat at 4.8 percent in 2001:2 and then rise to 5.6 percent by the end of 2001. This is due in part to the fact that inflation is predicted to remain larger than it has been in the past few years and in part to the fact that the predicted unemployment rate remains low. Other Variables: 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 $263.9 and $339.5 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). Stimulus Needed in 2002 and 2003? If the aim for 2002 and 2003 is to get growth above 2 percent and to prevent the unemployment rate from rising, then the forecast says that more stimulus is needed. One possibility is for the Fed to keep interest rates lower than the model is predicting it will do. You can do this in the model by dropping equation 30 and exogenously lowering RS. The other possibility is for there to be a tax cut or government spending increase. Remember that the current forecast is based on the assumption of no tax cuts and no unusual government spending increases. You can also do this in the model by lowering the relevant tax rates or by increasing the relevant government spending variables. See Chapter 5 of The US Model Workbook for how to do this. The cost of any monetary or fiscal policy stimulus will be somewhat higher inflation. Uncertainties 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. 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, as noted above, 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 keep RS low, contrary to what equation 30 is predicting? 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. |
| US Forecast Tables: April 27, 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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