| US Forecast: April 28, 2011 |
| Forecast Period 2011:2--2020:4 (39 quarters) Data The forecast is based on the national income and product accounts (NIPA) data that were released on April 28, 2011. The Latest Version of the US Model For purposes of this forecast the US model has been reestimated through 2011:1. These estimates and the complete specification of the model are presented in Appendix A: The US Model: April 28, 2011, which is an update of Appendix A in Fair (2004). Beginning with the forecast dated October 31, 2005, a few specification changes have been made to the model from the version in Fair (2004). These are explained in Changes to the US Model Since 2004. Baseline Assumptions Behind the Forecast The policy assumptions behind the forecast are in two parts. The first part ignores the stimulus bill. It produces what will be called "baseline" assumptions. The second part then adds the stimulus measures to the baseline assumptions. Consider first the baseline assumptions. They are as follows. The table below gives the growth rates that were assumed for the key exogenous variables in the model along with the actual growth rates between 1989:4 and 2007:4 (before the stimulus measures in 2008 and 2009).
Growth Rates (annual rates)
Baseline
Forecast Actual
Assumptions 2007:4-1989:4
TRGHQ 3.0 3.9
COG 3.0 2.4
JG 1.0 -0.7
TRGSQ 3.0 5.2
TRSHQ 4.0 5.6
COS 1.5 3.7
JS 1.0 1.5
EX 7.0 6.0
PIM 1.5 1.2
The first seven variables are the main government policy variables in the model aside from tax rates. TRGHQ is real federal government transfer payments to households, COG is real federal government purchases of goods, JG is federal government civilian employment, TRGSQ is real federal government transfer payments to state and local governments, TRSHQ is real state and local government transfer payments to households, COS is real state and local government purchases of goods, JS is state and local government employment, EX is real exports, and PIM is the import price deflator. All tax rates for the baseline forecast were taken to remain unchanged from their 2011:1 values. The values for COG were generated off of a base value of $547.2 billion in 2011:1. This base value is $15.1 billion lower that the actual value in 2011:1. This difference is my estimate of the effect of the stimulus bill on COG in 2011:1. The values for TRGHQ were generated off of a base value of $1499.5 billioni in 2011:1. This base value is $82.6 billion lower than the actual value in 2011:1. This difference is my estimate of the effect of the stimulus bill on TRGHQ in 2011:1. The above assumptions for state and local governments result in roughly balanced budgets over time in the forecast. For the federal government everything is business as usual---no stimulus, etc. Again, this is for the baseline assumptions. No assumption is needed about monetary policy for the forecast because monetary policy is endogenous. Monetary policy is determined by equation 30, an estimated interest rate reaction function or rule. Stimulus Assumptions Behind the Forecast The Congressional Budget Office (CBO) issued a report on March 2, 2009, which analyzed the stimulus bill ("American Recovery and Reinvestment Act of 2009," Public Law 111-5). The numbers that I have used for the present forecast are based (roughly) on the numbers in this report.The stimulus bill has tax cuts, transfer payment increases, and increases in government purchases of goods and services. Some of the transfers are to state and local governments and some are directly to households. In the model it makes no difference whether the federal government makes transfer payments directly to households (variable TRGHQ) or makes them to state and local governments (variable TRGSQ) if the state and local governments in turn pass on the transfer payments to households (variable TRSHQ). To keep matters simple in the present forecast, all transfer payment increases are put into TRGHQ. Again, it would not matter if instead TRGSQ was increased and then TRSHQ increased by the same amount. In addition, tax cuts are taken to be increases in TRGHQ rather than decreases in the personal income tax rate D1G. Most of the tax cuts do not involve cutting tax rates, and so it seems better to put them in TRGHQ. All increases in purchases of goods and services are put in COG, federal government purchases of goods. Therefore, only two variables are changed for the stimulus measures, TRGHQ and COG. Consistent with this treatment, in the actual data for 2009:2, $154.0 billion was moved from THG to TRGH. Similarly, in the actual data for 2009:3, $247.0 billion was moved from THG to TRGH; in the actual data for 2009:4, $245.0 billion was moved from THG to TRGH; in the actual data for 2010:1, $228.0 billion was moved from THG to TRGH; in the actual data for 2010:2, $241 billion was moved from THG to TRGH, in the actual data for 2010:3, $249 billion was moved from THG to TRGH, in the actual data for 2010:4, $10 billion was moved from THG to TRGH, and in the actual data for 2011:1, $48 billion was moved from THG to TRGH. These eight values are my estimates of how much the stimulus bill affected THG in the eight quarters. The timing of expenditures is a major issue in trying to capture the effects of any stimulus package. I have roughly followed the CBO timing for the present experiment. I have assumed that TRGHQ is $93.6 billion larger in fiscal 2011, $10.4 billion larger in fiscal 2012, and $10.0 billion larger (at an annual rate) in 2012:4. I have roughly spread these increases evenly within the four quarters of the fiscal year. (Remember that TRGHQ is in real terms, so these estimates are in 2005 dollars.) For government spending on goods (COG) I have assumed it to be $28.8 billion larger is fiscal 2011, $21.6 billion larger in fiscal 2012, and $14.4 billion larger at an annual rate in 2012:4. (Remember that COG is also in real terms.) The following table lists the additions by quarter that were made to TRGHQ and COG from their baseline values. The changes are at annual rates.
TRGHQ COG
2011:2 93.6 28.8
2011:3 93.6 28.4
2011:4 10.4 22.0
2012:1 10.4 21.6
2012:2 10.4 21.6
2012:3 10.4 21.2
2012:4 10.0 14.4
The tax bill that was passed at the end of 2010 lowered the employee payroll tax rate from 6.2 to 4.2 percent for 2011. This is roughly a one-third drop. The employee payroll tax rate in the model is variable D4G, and for the remaining three quarters of 2011 it was lowered by about a third from its 2010:4 value. Then from 2012:1 on it was raised back to its 2010:4 value. No changes from previous forecasts were needed to account for the extension of the Bush tax cuts because it was always assumed that the tax cuts would be extended. Regarding federal government spending on the bailout, this spending is in variable CTGB, capital transfers from the federal government to financial business. (This variable is in nominal terms.) Values of CTGB are the government's estimate of the eventual cost to the federal government of the bailout activity. The value for 2008:4 is $270.5 billion, the value for 2009:1 is $219.3 billion, the value for 2009:2 is $129.9 billion, the value for 2009:3 is $37.3 billion, the value for 2009:4 is $69.0 billion, the value for 2010:1 is $55.4 billion, the value for 2010:2 is $53.5 billion, the value for 2010:3 is $4.4 billion, the value for 2010:4 is $6.0 billion, and the value for 2011:1 is $58.7 billion (all at annual rates). For the forecast all future values of CTGB were taken to be zero. The Forecast Selected forecast results are present in Tables F1 through F4. If you want more detail, click "Solve current version" after "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. Real GDP Growth and the Unemployment Rate: The forecast has real GDP growing at 4.3 percent in 2011:2, 5.0 percent in 2011:3, and 4.7 percent in 2011:4. The growth rate is around 3.7 percent in 2012. (All growth rates in this memo are at annual rates.) The unemployment rate falls to 8.0 percent by the end of 2011 and to 7.1 percent by the end of 2012. The jobs variable, JF, shows jobs rising by 5.6 million between 2011:1 and 2012:4. Inflation: Inflation as measured by the growth of the GDP deflator (GDPD) rises to 3.5 percent by the end of 2011 and to 4.0 percent by the end of 2012. Monetary Policy: The estimated interest rate rule (equation 30) is predicting that the three month bill rate (RS) will begin gradually rising. It is 2.0 percent at the end of 2012. Federal Government Budget: The nominal federal government budget deficit on a NIPA basis, variable -SGP, is predicted to be between about $1.2 and $1.5 trillion for the next five years. It rises to $1.8 trillion by 2020. (Again, all values are at annual rates.) The federal government debt, variable -AG, is $23.2 trillion at the end of 2020, which is 81.6 percent of nominal GDP (variable AGZGDP in the model). This is up from 35.4 percent in 2007:1. Interest payments of the federal government, variable INTG, rise from $284.7 billion in 2011:1 to $1.300 trillion in 2020:4 as a result of the increasing debt and rising interest rates. U.S. Current Account: The deficit in the U.S. current account, variable -SR, gradually falls over the period. Comments on the Forecast and Possible Experiments to Run The main message from the current forecast is that if there are no bad shocks, the economy comes out of the recession slowly but steadily. By the end of 2012 the unemployment rate is down to 7.1 percent. This is a fairly good picture, although the inflation forecasts are higher than most people currently expect. This message is probably not surprising. Monetary and fiscal policy are expansionary, and physical stocks that were drawn down during the recession are being built up. In addition, the stock market is doing well, and there is a non trivial wealth effect in the model. Without any bad shocks assumed, it is not surprising that the model is predicting a reasonably good economy. The assumption of no bad shocks, which is used for the forecast, means that stock prices, housing prices, and import prices grow at historically normal rates. There are no negative wealth shocks through falling stock prices and housing prices and no positive price shocks through rapidly rising import prices (due, say, to a depreciating dollar and/or rising dollar oil prices). Asset prices like stock prices, housing prices, exchange rates, and oil prices are essentially unpredictable. Experiments can be run using the model in which stock prices (variable CG), housing prices (variable PSI14), and import prices (variable PIM) are changed. This allows one to examine the sensitivity of the forecast to changes in asset prices. It may be, for example, that the growing federal government debt triggers a large depreciation of the dollar and possible fall in U.S. equity prices, and this can be analyzed by changing CG and PIM. I have done some experiments like this in a recent paper, Possible Macroeconomic Consequences of Large Future Federal Government Deficits. Even though the current forecast looks encouraging for the economy, there is clearly a non trivial probability that bad shocks occur in response to the federal government debt situation. While shocks can't be predicted, the consequences of bad shocks can be analyzed. To review, oil price shocks and exchange rate shocks are handled through changes in PIM. Housing price changes are handled through changes in PSI14. Changes in PSI14 change PKH relative to PD and thus change housing wealth, PIH*KH. This affects consumption through the wealth variable AA (equation 89 and equations 1, 2, and 3). Regarding the stock market, each change in the S&P 500 index of 10 points is a change in CG, the capital gains variable in the model, of about $100 billion. If you think that the S&P index will fall, say, 100 points, you should drop the equation for CG and change CG by about -$1,000 billion at a quarterly rate (-$4,000 billion at an annual rate). See the discussion in Section 7.2 of The US Model Workbook. This will have a negative effect on real output growth because of a negative wealth effect. Regarding the stimulus measures, the key variables are TRGHQ and COG. The key personal income tax rate is D1G. The employee payroll tax rate is D4G. The bailout variable is CTGB. |
| 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 1.1.5 |
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| NIPA Table 1.1.6 |
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| Old NIPA Table 3.2 |
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| Old NIPA Table 3.3 |
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| NIPA Table 1.1.4 |
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