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Economic Forecasting and Policy Decisions

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For those of you who do not know, CBO stands for “Congressional Budget Office.” Even Slate (not a bastion of conservatism) says the CBO offers the most accurate forecasts: “…the administration’s forecasts were the least accurate and the CBO’s were the most accurate.” That conclusion was based on a 1979-1997 study. Has anything been found to refute that conclusion?

On November 22, 2011, from Politico, we got this headline, “CBO: Stimulus added up to 3.3M jobs”. The picture opening the article was captioned, “The CBO report estimates that 500,000 to 3.3 million jobs were created by the stimulus”. Wow! 500,000 to 3.3 million jobs is a big range. At least we now know what Politico means when it says “up to.” Is this an example of MSM bias? You make the call. On November 26, Blogcritics published the article, “CBO Says Stimulus a Drag on Economy,” and YouAreA_RightWingLiar, in comment #1, also posted Nov 26, wrote, “That is a total lie. The CBO said just the opposite. Damn right-wingers lie,” and citing the same Politico article as proof that I was incorrect!

The CBO issues monthly reports, so again this month, December, it has issued another report, saying that the stimulus was even less effective than previously believed. Before all of you Obama Kool-Aid drinkers have a hissy-fit and stop reading here, let me get to the purpose of this article.

The Politico article specified a high CBO estimate of jobs created to be 3.3 million, unchanged from previous CBO estimates. It also provides a low estimate of 500,000 jobs. Previous CBO low estimates were as high as 1.2 million jobs. So what, you say, they are only estimates. That is precisely my point! They are estimates, but government policy is established and money we don’t have is spent based on those estimates. Again, you say, “So what?Policies and money expenditures have to be based on something.”  The White House provides the methodology the Obama administration used in 2009 to estimate jobs created or saved, and that methodology has not changed!

The CBO, however, does update its models, primarily through updating data derived from what actually happened, rather than relying solely upon unchanged forecasts and unchanged forecasting models. For example, this report, while focusing on capital gains, illustrates how the CBO updates its forecasting models. (bottom of Abstract, page i)

Economic forecasts try to calculate a multiplier, the effect that each dollar spent by whomever, usually the government, will have on the economy and on job creation. Studies attempting to estimate the effects of countercyclical fiscal policy have found an incredibly wide range of multipliers. The CBO estimates a multiplier effect for the stimulus of between 0.5 and 2.5. Recent studies found estimates that government spending could be either harmful or could be more effective than the most optimistic CBO scenario. Researchers found there to be an “Embarrassingly wide range of estimated multipliers,” said Douglas Holtz-Eakin, former CBO director and president of the American Action Forum, “Usually, the CBO is very careful when they apply the range of jobs created because they don’t really know for sure. There’s simply no consensus about the size of multiplier effects in the best of circumstances, and for those that were introduced in the midst of a large financial crisis-induced recession, it’s even more uncertain.”

Edward L. Glaeser, Harvard economics professor, said, “Does that mean that recovery spending was a waste or just that we didn’t do enough of it? Is public spending just crowding out private employment? Or is each public employee spending more on private goods, thereby creating an employment multiplier? We don’t really know.”

We don’t really know.

Yet our future, our children’s future, our grandchildren’s future, and the world’s future are based on the current administration’s forecasts. Glaeser concludes with, “It is a great tragedy that the most important area of economic decision-making is also the area where we will always know the least.”

The stimulus debate might have been quite different if it had been based on the possibility that an $840 billion spending spree would yield only 500,000 jobs! It could have been difficult to argue that the stimulus was worth it if the CBO’s new low-end estimate of jobs “created or saved” was used, instead of the administration’s estimate. Hindsight is always 20/20, so model updating and policy changes, rather than recent rhetoric, are essential.

So what is the ultimate answer? Well, recent history (the current administration’s track record) has shown that it isn’t economic forecasting. Perhaps Adam Smith was correct in 1776 when he published An Inquiry into the Nature and Causes of the Wealth of Nations. Smith coined the term, “invisible hand,” but we will never know if the invisible hand works because policy makers insist upon making forecasts and then making policy decisions based on them.

Interestingly, the CBO has updated its stimulus cost from $787 billion to $840 billion based on Obama’s proposed 2012 budget, and with scoring changes made by the CBO since the enactment of the ARRA.

One final point:  I have provided sources, which I have read, for my statements, unlike many, such as YouAreA_RightWingLiar,  who express opinions and/or do not read the sources cited so you can reach your own conclusions.

But that’s just my opinion. And, no, I did not steal that ending from Dennis Miller!

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