|US Forecast: October 30, 2011|
2011:4--2020:4 (37 quarters)
The forecast is based on the national income and product accounts (NIPA) data that were released on October 27, 2011.
The Latest Version of the US Model
For purposes of this forecast the US model has been reestimated through 2011:3. These estimates and the complete specification of the model are presented in Appendix A: The US Model: October 30, 2011, which is an update of Appendix A in Fair (2004).
Beginning with the forecast dated October 31, 2005, some specification changes have been made to the US model from the version in Fair (2004). These are explained in Changes to the US Model Since 2004.
Unless otherwise noted, the flow variables in the model are presented in this memo and on the site at quarterly rates. This is a change from previous versions, where the flow variables were presented at annual rates. To convert quarterly rates to annual rates, just multiply by four.
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. The baseline assumptions 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 beginning in 2008).
Growth Rates (annual rates) Baseline Forecast Actual Assumptions 2007:4-1989:4 TRGHQ 4.0 3.9 COG 3.0 2.4 JG 1.0 -0.7 TRGSQ 2.0 5.2 TRSHQ 8.0 5.6 COS 1.0 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 assumptions were taken to remain unchanged from their 2011:3 values.
The values for COG were generated off of a base value of $161.35 billion in 2011:3. This base value is $7.1 billion lower that the actual value in 2011:3. This difference is my estimate of the effect of the stimulus bill on COG in 2011:3. The values for TRGHQ were generated off of a base value of $377.29 billioni in 2011:3. This base value is $23.4 billion lower than the actual value in 2011:3. This difference is my estimate of the effect of the stimulus bill on TRGHQ in 2011:3.
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 ForecastThe 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 putting all the tax cuts in TRGHQ for the forecast, the actual data on personal income taxes and transfer payments in the NIPA between 2009:3 and 2011:3 were adjusted to reflect my estimates of the effects of the stimulus bill. The specific adjustments are presented in Table A.5 in Appendix A: The US Model: October 30, 2011.
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 $10.4 billion larger in fiscal 2012 and $2.5 billion larger in 2012:4. I have spread the increase for fiscal 2012 evenly over 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 $21.6 billion larger in fiscal 2012 and $3.6 billion larger 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.
TRGHQ COG 2011:4 2.6 5.5 2012:1 2.6 5.4 2012:2 2.6 5.4 2012:3 2.6 5.3 2012:4 2.5 3.6
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 2011:4 it was lowered to reflect this change. Then from 2012:1 on it was raised back to its 2010:4 value. No other tax rates were changed. The aggregate federal government tax rates in the model, D1G, D2G, D3G, and D5G were taken to be equal to their 2011:3 values. Implicit in this treatment is the assumption that the Bush tax cuts remain in place throughout the forecast horizon.
Federal government spending on the bailout is variable CTGB in the model. This spending began in 2008:4. Since 2010:3 the values of CTGB have been small, and for the forecast the future values of CTGB have been taken to be zero.
No Adjustments for the Debt Ceiling BillNo attempt was made to account for proposed future fiscal policy changes that are in the debt ceiling bill and are currently being considered by the super committee. Most of any spending cuts or tax increases are not likely to begin until 2014, and as of now (October 30, 2011) it is unclear what will be done. The present forecast is thus a forecast conditional on no future spending cuts and tax increases. It is a base forecast from which experiments can be run regarding spending cuts and tax increases.
Forecasts of selected variables are presented in the following: Forecasts of selected variables---html, Forecasts of selected variables---pdf file. 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 3.9 percent in 2011:3, at about 3.5 percent in the first half of 2012, and at about 4.5 percent in the second half of 2012. (All growth rates in this memo are at annual rates.) The unemployment rate falls to 8.1 percent by the end of 2012. The jobs variable, JF, shows jobs rising by 3.0 million between 2011:4 and 2012:4, an average of 200 thousand per month.
Inflation: Inflation as measured by the growth of the GDP deflator (GDPD) rises to 3.4 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 1.1 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 about a trillion dollars at an annual rate for the first four years and then to rise thereafter. It rises to $1.5 trillion by 2020. The federal government debt, variable -AG, is $21.7 trillion at the end of 2020, which is 76.8 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 an annual rate of $276.4 billion in 2011:3 to $1.108 trillion in 2020:4 as a result of the increasing debt and rising interest rates. At the end of 2020 the ratio of INTG to GDP (variable INTGZGDP) is 3.9 percent.
U.S. Current Account: The deficit in the U.S. current account, variable -SR, gradually falls through 2013 and then gradually rises after that.
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 grows fairly well in the near future. By the end of 2012 the unemployment rate is down to 8.1 percent, and by the end of 2013 it is down to 6.9 percent. This is probably more optimistic than the current consensus view about the future course of the economy. However, the strong growth forecast is not surprising given the model. Monetary and fiscal policy are expansionary, and physical stocks that were drawn down during the recession are predicted to be built up. Without any bad shocks assumed, it is thus not surprising that the model predicts a fairly strong recovery. Also, as mentioned above, no government spending cuts or tax increases are assumed for the forecast. 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. One can use the US model to analyize the effects of asset price shocks, but the shocks themselves cannot be predicted. The best one can do in a forecast is to assume some historically average behavior of asset prices, which has been done here.
To examine the effects of asset price shocks, 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 these values. 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.
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. See the discussion in Section 7.2 of The US Model Workbook, October 30, 2011. 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.