Cato Policy Analysis No. 25 June 30, 1983

Policy Analysis

Forecasting The Economy:
Do Presidents Get It Right?

by Randolph H. Boehm

Randolph H. Boehm is an editor at University Publications of America.

Executive Summary

0The growing significance of federal budget politics in the American political dialogue cannot be dismissed. The sums involved are fairly described as staggering and will likely have a major impact on the performance of the American economy. Consequently, budget policies have become a topic of considerable concern. Supply-side economists commanded national attention when they questioned the revenue (tax-raising) policies of the federal government, which they say pose a serious threat to economic prosperity. Many of their critics, in turn, point to potentially disastrous effects of federal deficits running into the hundreds of billions of dollars. Special interest groups with a major stake in some aspect of government outlays voice vigorous opinions on the alleged shift in federal priorities from social services to defense with some of the partisans warning of dire consequences should the shift continue and others of dire consequences should it be checked.

The Reagan administration has helped force budget politics to the top of the American political agenda with its stated determination to check a number of fiscal trends which have been gaining momentum for at least a decade. Less appreciated, perhaps, but no less significant than the new administration in focusing attention on the federal budget is the cumbersome congressional budget process itself. It ensures that budget politics consume an inordinately large portion of each congressional session to the inevitable exclusion of many other issues.

One important aspect of the federal budget that is frequently overlooked, however, is the reliability of forecasts of major budget components such as the deficit, outlays and receipts, Gross National Product (GNP), unemployment, and inflation. In examining previous forecasts on these economic variables in federal budgets between 1971 and 1982, it is evident that the forecasters' records have been very poor, that many indicators such as GNP and unemployment are seriously deficient as mirrors of economic reality, and that the uncritical acceptance of aggregate budget figures by the mass media, policymakers, and citizens alike is wholly unwarranted.

Aside, perhaps, from compiling the historical tables in order to monitor the results of previous economic forecasts used in the budget, much of the following analysis is not original. Academic economists as well as economists in the federal agencies who compile the data making up each of the aggregates under discussion regularly point to their deficiencies. Most opine that these deficiencies can be overcome in time with more complete statistical information and greater conceptual refinement. Others are not sure that it will ever be possible to make the aggregates accurately reflect economic reality.

As an academic pursuit, the efforts to quantify data and make predictions may be unexceptionable. Serious errors in academic pursuits often prove beneficial so far as they serve to educate. But such errors obtruding upon public policymaking or codified in law have pernicious effects far beyond their educational value. More attention needs to be focused on the limitations of these various budget components and of efforts to forecast changes in them.

Policymakers' attitudes toward these concepts, however, seem to reflect a trend that is moving in just the opposite direction. President Reagan recently proposed "triggering" stand-by income tax increases on a ratio between two of the aggregates under discussion here -- the deficit and the GNP. The Humphrey-Hawkins full employment bill of the last decade proposed the unemployment rate as a "trigger" for wideranging public works projects. Other instances of this sort could be noted. In addressing this trend of relying upon aggregate economic statistics, a recent study by the Government Accounting Office discusses GNP figures:

The accounts help Federal policymakers pursue the goals of the Employment Act of 1946 -- full employment, price stability, and economic growth. Federal economists use the accounts for short term fiscal, monetary, and wage-price policy analysis, for managing the nation's employment and anti-inflation goals, and analyzing long-term demands for skilled labor and financing for capital formation. Major users include the Council of Economic Advisers, the Federal Reserve Board, the Office of Management and Budget, and the Departments of Treasury and Commerce....

Although the analytical uses of the accounts are primary, additional uses are being made. The Trade Act of 1974 (P.L. 93-618) specifies the use of annual GNP estimates in determining limitations on preferential treatment extended to countries exporting goods to the United States. The GNP price deflator is used as a component in the inflation adjustment factor in the Natural Gas Policy Act of 1978 (P.L. 95-621) and the Crude Oil Windfall Profits Tax Act of 1980 (P.L. 96-223) for determining the ceiling price on certain types of natural gas and the windfall profits on crude oil, respectively....

Proposed legislation in the 96th Congress would have further extended the use of GNP beyond that of an analytic tool and could have generated concern about what it represents and how well it does so. Federal spending would have been affected by the definition and accuracy of GNP.

One proposed amendment to the Employment Act of 1946, H.R. 2314, would have limited Federal outlays in the President's Budget to equal the Council of Economic Advisers' estimated Federal receipts. The receipts would have been based on real economic growth using real GNP estimates as part of the formula for the calculation.

Another proposed bill, H.R. 4610, would have limited Federal outlays to a specific percentage of GNP for the last complete calendar year occurring before the beginning of the fiscal year. Fiscal year 1982 spending, for instance, would have been limited to 23% of calendar year 1980 GNP.

Lastly, H.R. 7112 proposed an antirecession assistance program for aid to State and local governments to be triggered by two consecutive quarterly declines in real GNP and real wages and salaries. Allocation of funds to States and local governments were to be based in part on the aggregate real wages and salaries component.[1]

An equally long recitation might also be made for policy uses of other aggregates like the unemployment rate or the Consumer Price Index (CPI). Clearly, the tendency to accept official economic projections at face value cuts across party and ideological lines. It is common in the executive bureaucracy and is becoming more so within Congress. The honest disclaimers from government agencies that compile the data and from economists who have studied the concepts are lost in the rush, or perhaps it comes closer to the truth to suggest they are ignored under pressure to seize upon "official" statistical data on the economic forces policymakers hope to affect.

A common belief, which may blunt the concern over the limitations of making forecasts from economic aggregates, is that forecasting is a scientific procedure which is slowly but surely undergoing refinements which make its measurements and projections more exact. Such scientific exactitude, however, must exhibit two criteria: 1) a high probability of accurate projections and 2) concepts that are themselves clear and objectively meaningful. By way of assessing the "scientific" status of budget forecasts, therefore, we will assess each of the selected components on the basis of the accuracy of past projections and the clarity and meaning of the concepts themselves.

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