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Evaluating CBO's Record of Economic Forecasts July 1999

Evaluating the forecasting record of the Congressional Budget Office requires compiling the basic historical and forecast data for growth in real output, inflation in the consumer price index, interest rates, and taxable income (see Tables A-1 through A-9). Although each of those series has an important influence on budget projections, an accurate forecast of the two-year average growth in real output is the most critical economic factor in accurately estimating the deficit or surplus for the upcoming budget year. Two-year average forecasts published in early 1998 and 1999 could not be included in this evaluation because historical values for 1999 and 2000 are, of course, not yet available. The data were therefore compiled using forecasts published early in the years 1976 through 1997.
 

Selection of Historical Data

Which historical data to use for the evaluation was dictated by the availability of actual data and the nature of the individual forecasts examined. Although CBO, the Administration, and Blue Chip all published the same measure for real output growth, selecting a historical series was difficult because of periodic benchmark revisions in the actual data.⁽¹⁾ By comparison, not all of the forecasters published the same measures for CPI inflation and interest rates, but the selection of historical data for those series was clear-cut.

Growth in Nominal and Real Output

Historical two-year averages of growth in real output were developed from calendar year averages of the quarterly chain-type annual-weighted indexes of real gross national product and real gross domestic product published by the Bureau of Economic Analysis (BEA). The fact that several real GNP and GDP series were discontinued because of periodic benchmark revisions meant that they were unsuitable historical series. For example, during the 1976-1985 period, the three forecasters published estimates for a measure of growth in real GNP that was based on 1972 prices, which was the measure published by BEA at the time. In late 1985, however, BEA discontinued the 1972-dollar series and began to publish GNP on a 1982-dollar basis. As a result, an official series of values for GNP growth in 1972 dollars is not available for the years after 1984, and actual two-year average growth rates are not available to compare with the forecasts made in early 1984 and 1985.

From 1986 to 1991, forecasters published estimates of growth in real GNP based on 1982 prices. BEA revised the benchmark again in the second half of 1991; it discontinued the 1982-dollar GNP and began to publish GNP on a 1987-dollar basis.⁽²⁾ Consequently, the historical annual series for 1982-dollar GNP is available only through 1990, and actual two-year average growth rates are not available for the forecasts made in early 1990 and 1991. The forecasters then published estimates of growth in real GDP on a 1987-dollar basis until 1995, when BEA made another switch, late in the year, to a chain-weighted measure of GDP. Therefore, the historical annual series for 1987-dollar GDP ends with the 1994 annual value, and actual two-year average growth rates are not available for the forecasts made in early 1994 and 1995.

By periodically updating the series to reflect more recent prices, BEA's benchmark revisions yield a measure of real output that is more relevant for analyzing contemporary movements in real growth. But the process makes it difficult to evaluate forecasts of real growth produced over a period of years for series that are subsequently discontinued. The difficulties presented by periodic revisions of the data are avoided here by using one of BEA's alternative measures of real GNP and GDP, the chain-type annual-weighted index.⁽³⁾

CPI Inflation

Two-year averages of inflation in the consumer price index were calculated from calendar year averages of monthly data published by the Bureau of Labor Statistics. Before 1978, the bureau published only one consumer price index series, now known as the CPI-W (the price index for urban wage earners and clerical workers). In January 1978, however, it began to publish a second, broader consumer price index series, the CPI-U (the price index for all urban consumers). CBO's comparison of forecasts used both series.

Until 1992, the Administration published its forecasts for the CPI-W, the measure used to index most of the federal government's expenditures for entitlement programs. By contrast, for all but four of its forecasts since 1979 (1986 through 1989), CBO based its inflation forecast on the CPI-U, a more widely cited measure of inflation and the one now used to index federal income tax brackets. The Blue Chip consensus has always published its forecast of the CPI-U. Although both the CPI-U and CPI-W may be forecast with the same relative ease, and annual fluctuations in the two series are virtually indistinguishable, they differ in some years. For that reason, CBO used historical data for both series to evaluate the alternative forecast records.

Interest Rates

Two-year averages of nominal short- and long-term interest rates were developed from calendar year averages of monthly data published by the Board of Governors of the Federal Reserve System.

The forecasts of short-term interest rates were compared using historical values for two measures of the interest rate on three-month Treasury bills: the new-issue rate and the secondary-market rate. The Administration forecasts the new-issue rate, which corresponds to the price of three-month bills auctioned by the Treasury Department--that is, it reflects the interest actually paid on that debt. CBO forecasts the secondary-market rate, which corresponds to the price of the three-month bills traded outside the Treasury auctions. Because such transactions occur continually in markets that involve many more traders than do Treasury auctions, the secondary-market rate provides an updated evaluation of the short-term federal debt by the wider financial community. Blue Chip has alternated between those two rates; it published the new-issue rate from 1982 to 1985, switched to the secondary-market rate during the 1986-1991 period, and then returned to the new-issue rate in 1992. Clearly, there is no reason to expect the two rates to differ persistently; indeed, the differences between their calendar year averages are minuscule.

CBO likewise compared the various forecasts of long-term interest rates using historical values for two measures of long-term rates: the 10-year Treasury note rate and Moody's Aaa corporate bond rate. A comparison of forecasts is not possible before 1984 because not all of the forecasters published projections of long-term interest rates before that year. For forecasts made in early 1984 and 1985, CBO projected the Aaa corporate bond rate. Beginning with its early 1986 forecast, however, CBO switched to the 10-year Treasury note rate. The Administration has always published its projection for the 10-year Treasury note rate, but Blue Chip has published the Aaa corporate bond rate.

CBO calculated separate historical values for real short-term interest rates using the nominal short-term interest rate and inflation rate appropriate for each forecaster. In each case, the two-year average nominal interest rate was discounted by the two-year average rate of inflation. The resulting real short-term interest rates were very similar. Because there is no agreed-upon method for calculating real long-term interest rates, they were not included in the evaluation.

Taxable Income

Through its direct influence on the projection for federal revenues, the forecast for taxable income plays a critical role in determining the accuracy of the deficit projection. The income measure examined here--wage and salary distributions plus the book value of corporate profits--combines the two sources of income to which tax receipts are most sensitive. Because the effective rates of tax on wages (including payroll and income taxes) and corporate profits are nearly the same and because those tax rates exceed the rate at which other income sources (such as interest income) are taxed, it is appropriate to consider wages and profits together.

Although the level of taxable income is the factor that most directly affects federal revenues, historical estimates of the levels of income are subject to substantial statistical revision. As a result, using the levels of taxable income would distort the forecast comparison. Instead, the forecasts are presented here as changes in taxable income as a share of total income; the historical revisions, carried forward consistently to projections, should not affect projections of revenues. Moreover, the shares formulation is closer to the concept that macroeconomists consider when they construct their forecasts.
 

Sources of Forecast Data

With the exception of the measures of taxable income, the evaluation used calendar year forecasts and projections--which CBO has published early each year since 1976--timed to coincide with the publication of the Administration's budget proposals. The Administration's forecasts were taken from its budget in all but one case; the forecast made in early 1981 came from the Reagan Administration's revisions of President Carter's last budget. The corresponding CBO forecast was taken from CBO's published analysis of President Reagan's budget proposals. That forecast did not include the economic effects of the new Administration's fiscal policy proposals.⁽⁴⁾

The average two-year forecasts of the Blue Chip consensus survey, which are published monthly, were taken from those published in the same month as CBO's forecasts. Because the Blue Chip consensus did not begin publishing its two-year forecasts until the middle of 1981, the first consensus forecast available for this comparison was published in early 1982. Average five-year projections, however, are published by Blue Chip only two or three times a year. All but one of its five-year projections used in this evaluation were published in March; the 1980-1984 projection was published in May.

Since 1985, the Congressional Budget Office has regularly included projections of economic profits and wage and salary disbursements in The Economic and Budget Outlook. Because book profits more closely reflect the corporate profits tax base than do economic profits, forecasts of book profits were extracted from CBO's unpublished forecast files. Unpublished CBO forecasts are used for both profits and wages for the 1980-1984 period.