Correcting CBO and touting some fiscal oxygen

June 22nd, 2015 at 6:21 am

I wanted to weigh in briefly on this little dust up re some recent CBO analysis. My colleague Richard Kogan pointed out that while the CBO’s recent long-term budget analysis was as sound as ever, the opening sentence was very wrong:

“The Congressional Budget Office’s (CBO) new report on the budget picture opens by saying, “The long-term outlook for the federal budget has worsened dramatically over the past several years,” blaming the Great Recession and the steps taken to address it. But CBO’s own data, in that very report, show that’s not the case. The CBO data that allow an apples-to-apples comparison of its new projections with its earlier ones from before the recession show that the long-term budget picture has improved significantly, not worsened.”

Paul Krugman amplified this message last week.

Probably the easiest way to see Richard’s point, though it’s not as accurate as the figure he shows (i.e., it’s not CBOs work; it’s our own, but it amounts to the same thing), is to look the evolution of CBPP’s long term projects as in the first figure here (shown below). There we show the 2040 debt projected to be around 100% of GDP by 2040 vs. over 200% from our projection a few years back.


One reason for that improvement—not the only one, but a big one—is the decline in government spending on health care, due in large part to the fact that the growth of health care costs has slowed significantly in recent years, which is in turn partially due to health care delivery efficiencies enforced by the ACA.

The figure below, from another new CBO release, shows the persistent decline in their estimates of budget impact of the ACAs premium subsidies, driven both by the decline in costs and reductions in their guesstimates of how many people will purchase coverage through the exchanges (assuming the federal gov’t led exchanges in 34 states survive the SCOTUS).


Source: CBO

Since our strongest fiscal pressures are coming from the combination of aging demographics and rising health costs, this development is creating some much needed fiscal oxygen. From our long-term analysis: “in January 2010 we projected that Medicare and Medicaid together would cost 11.1 percent of GDP in 2040, but we now project that Medicare, Medicaid including the [ACA] expansion, CHIP, and the new marketplace subsidies will together cost 7.7 percent of GDP, or about 30 percent lower than the previous estimate.”

Now, let’s not get too carried away here. First, as Krugman says, long-term budget projections are a uniquely boring sub-genre of science fiction. Second, the path you see in our long-term projection is not sustainable. You still want to be a CDSH and while fiscal rectitude doesn’t imply balanced budgets, austerity, or the reckless cuts of sequestration, it does require debt rising more slowly than GDP in a strong economy. The analysis also implies that the costs of repealing the ACA or for that matter, landing the wrong way on King v. Burwell, will suck a lot of that oxygen out of the fiscal room.

The bottom line is that in part due to a more favorable health cost trajectory than we expected, we have some time to build on this progress. Or, we can mindlessly squabble about whether or not to keep the lights on.

Three reasons why polls are increasingly wrong

June 21st, 2015 at 12:58 pm

I found this to be an important bit of analysis from this AMs NYT. It’s a piece on three reasons why polling is increasingly failing to accurately predict electoral outcomes: the growth of cell phones, lower response rates, and greater difficulty predicting who are the likely voters (i.e., getting turnout wrong).

For reasons explained in the piece (related to an FCC ruling), it’s a lot more expensive to poll by cellphone and polling firms have been trying to make up the loss by cutting corners in sampling and interviewing.

For reasons that may also have to do with technology, response rates have fallen to the point where pollsters cannot count on ending up with a random sample. That in turn makes it hard for them to guess the probability that different types of people are in the sample, which implies greater guesswork to weight the sample up to be nationally representative.

Finally, you can ask people if they plan to vote, but that answer has long been known to have an upward bias. Apparently, it’s getting worse. I’ve thought for awhile that one reason polls seemed to be getting less reliable was due to the problem of accurately modeling turnout, and it turns out that’s true.

I was taught back in econ grad school that economists should work off of what people do, not what they say. (Unfortunately, there are too many economists who believe their models more than the evidence, but that’s a different problem.) So I’ve always taken poll results with a grain of salt. One doesn’t want to push that too far–when a Nate-Silver-style meta-analysis of many polls points in the same direction, I’d still give that some weight.

But for the most part, we should all add a few more grains of salt to the equation until the pollsters can straighten some of this out.

What’s up with the markdowns?

June 19th, 2015 at 11:35 am

The figure below shows a series of forecasts by the Federal Reserve for real GDP growth in 2015, with the first forecast made in March 2013 and the last one made a few days ago. Each bar shows the central range of the forecasts by Fed economists, with the average forecast as a dot in the middle of each range.


Source: Federal Reserve

The punchline, as you see, is that the closer we’ve gotten to the actual outcome for GDP growth this year, the more they’ve marked down their previous guesstimates. Back in early 2013, they thought we’d be cooking along at 3.3%, and if anything, their “north-of-three” forecast became stronger as time went on, as seen by the narrower range around the average.

Then, as reality set in and faster growth turned out not be around the next corner, their forecasts came down a bit. Still, they thought ample growth rates just shy of 3% were awaiting us this year.

Except they weren’t, and the markdowns continued and got bigger, with the most recent one taking their 2015 guesstimate from 2.5% down to 1.9%. As the NYT crisply put it, “In a retreat that has become a ritual for the overly optimistic central bank, officials said in a new round of economic forecasts published Wednesday that they expected the economy to grow this year by 1.8 percent to 2 percent.”

Now, to be clear, this isn’t meant to pick on the Fed forecasters, who are no better or worse than most others. You can see this same pattern in the forecasts of the IMF, the World Bank, CBO, and the National Association of Business Economists.

What’s interesting here are the two questions this raises: 1) what’s driving these markdowns? What’s going on in the economy that top forecasters keep systematically missing, and 2) Why aren’t the forecasts self-correcting? Why do they keep trusting Lucy to hold onto the football?

Re the first question, there are numerous perps that have contributed to the markdown pattern.

–Bad fiscal policy: While we’re not Europe, we too pivoted to deficit reduction too soon. The figure below, from Goldman Sachs researchers, shows the impact of fiscal policy on GDP growth, 2009-15. In 2009, the Recovery Act did some heavy lifting, but it quickly faded (despite President Obama’s efforts to do more) and in 2013, fiscal policy was a big negative on growth and jobs. The fiscal growth impulse has shifted into neutral for now, and I suppose “do no harm” is the most we can expect from the current Congress. But there’s no question that our subpar growth has been a function of unlearning lessons about the need for supportive fiscal policy in weak economies.


Source: Goldman Sachs

–Weak investment: Both public and private investment has been subpar in recent years, with the latter feeding back negatively into productivity growth, as Larry Mishel shows—quite dramatically—here. In terms of our transportation infrastructure, according to the most recent World Economic Forum rankings, the U.S. fell from 7th to 18th in the quality of our roads over the past decade, as our investments in this space have declined by half as a share of GDP since the 1960s. I should note here that the Republican budget resolution calls for a 40% decline in transportation funding.

–Deleveraging and the reverse wealth effect: I’ve written in lots of places how debt bubbles, like those involving mortgages, take a lot longer to work through then equity bubbles. Basically, your shares in Pet Rocks, Inc., get marked to market quickly, while banks holding non-performing loans can “extend-and-pretend” ad nauseam. Interestingly, Chair Yellen has often made this point herself, referring to this dynamic as a persistent and ongoing headwind. To be fair—and this gets a bit into question #2 (why are the models systematically wrong)—no one really knows the timing of how this kind of dynamic plays out in the macroeconomy.

–Inequality and the decline in the compensation share of national income: Economist Joe Stiglitz has argued that the extent of income inequality has also hurt growth in ways the models underweight. If you’re just thinking about averages, you may miss the fact that while average income has gone up, median income has gone up a lot less—this is a symptom of inequality. In the same vein, the share of national income going to paychecks versus profits is around a 50-year low.

The germane factor here re growth is that those with higher propensities to spend the marginal dollar are seeing fewer dollars flow their way, while those who are anything but liquidity constrained—the very wealthy—are bathing in the stuff. As I note below, the housing bubble and its wealth effect offset this dynamic in the 2000s. But not now.

–Congressional dysfunction: IMHO, this is a bigger deal than people think. It’s de rigueur to say stuff like, “well, as long as Congress is tied up in ideological knots, they can’t mess stuff up.” But, in fact, that’s just wrong. First, businesses can’t plan ahead if they don’t know what’s happening with tax issues like bonus depreciation and other such “extenders.” Second, as a colleague who watches both governments and markets pointed out to me, the return on government investments is lower when it’s made at the last minute, without adequate planning. Again, think of highway and mass transit spending. And of course, debt ceilings and shutdowns don’t help, either.

Re the second question—why haven’t the forecasters self-corrected?—it is by definition the case that the models are inadequately capturing the factors above, including any I’ve left off. However, before you trash the forecasting endeavor in general, and you wouldn’t be far off to do so, consider that it’s awfully tricky to build Tea Party obstructionism into an economic model. Also, the impact of inequality on consumption growth is well-established theoretically, but less so empirically, in part due to the wealth effect noted above. Thus, there are complex interactions beyond the scope of current models.

End of the day, my advice is: don’t think of these point estimates as reliable predictions. Instead, think of them as a) what the Fed thinks, which has implications for monetary policy, and b) more importantly, as a clear message that if we want to get to and stay at full employment, we’ll need to reverse the negative practices listed above. That is, we’ll need better fiscal policy, investment in productive infrastructure, less inequality, and functional politics.

Gosh, when you put it that way, it doesn’t sound so hard, right?!

Optimal fiscal policy

June 17th, 2015 at 1:31 pm

I testified in the House Budget Committee this AM and have many excellent war stories to share. But no time to do so now. Until then, please read my testimony, to which I devoted some thought.

Roughly speaking, the position of the majority R’s is that you should always balance the budget for…I just sat with these folks for two long hours and I can’t really finish that sentence.

Partly for moral reasons. One witness blamed “Keynesianism for the decline in beneficial ‘Victorian fiscal morality.’” Another had a macro-model that maintained, contrary to the CBO’s analysis of the R’s budget resolution, that the deep near term cuts would boost, not hurt, growth, because forward-looking households would realize that R spending cuts would eventually lead to greater investment, more tax cuts, and higher incomes in the future, so they’d spend more today to offset the cuts.

One member, touting the folk’ism that since families have to balance their budgets, the Feds should too, took issue with my point that in fact, families borrow long-term all the time for things like college and homes. He asked me if I make more than I spend. I told him I certainly went into debt to pay for college, and he said he did too!

Another R member went on about how much he hated government debt and I had the chance to ask him, “so, why did you guys pass $570 billion in non-offset tax cuts?!” I think he answered, not unreasonably, something like, “well, maybe that’s something we can put on the table.”

And so on.

Here are my bullet points:

  • The idea that the budget should always be in balance actually runs counter to optimal fiscal policy in an advanced, dynamic economy like ours. Instead, smart fiscal policy must be flexible, with deficits temporarily rising in recessions to support the weak economy and coming down in recoveries as the economy strengthens.
  • Elevating the goal of a balanced budget above other fiscal priorities risks doing more harm than good. The failure of European austerity — with those countries choosing fiscal consolidation in the context of weak economies — provides strong evidence to support this claim.
  • In contemplating questions about fiscal policy, we must never forget the core purpose of federal taxing and spending: to provide the American people with the government services and public goods they need, want, and deserve.
  • We must carry out this core purpose in a way that is fiscally responsible. At the same time, any benefits of fiscal consolidation must always be weighed against this essential government function. Are we disinvesting in critical public goods, like transportation or human capital development? Are we adequately pushing back against market failures like cyclical downturns? Are we providing those who’ve aged past their working years with adequate retirement and income security? Are we helping the least advantaged among us to meet their basic needs and to get a foothold on the ladder of upward mobility?
  • The answers to these questions imply that we cannot achieve a sustainable budget, where “sustainability” includes strengthening our economy and achieving broadly shared prosperity, solely by cutting spending. Policymakers, including many on this committee, have understandably raised serious concerns about the reckless cuts engendered by sequestration. The recent Republican budget resolution calls for far deeper spending cuts, which would undermine the essential roles government should play.
  • Some argue that because families and states must balance their annual budgets, the federal government must also do so. These analogies are wrong for two reasons. First, neither families nor states really have to balance their budgets; families borrow for various investments and states don’t have to balance their capital budgets, so the analogy is faulty. Second, the fiscal lesson to take from this framing of the argument is precisely the opposite of the one often drawn: the fact that states must balance their operating budgets actually provides a stronger rationale for the federal government to temporarily expand budget deficits in downturns.
  • Recent Republican budget plans only achieve balance through a) excessive spending cuts that violate the principles articulated above and b) gimmicks that ignore the impact of large tax cuts that are not offset. Implementing these proposed budgets would thus gut valued investments, reduce economic security, and harm prospects for jobs and wages, while doing much less to reduce deficits and debt than proponents claim.