Is The Economic Forecast Too Optimistic?

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John Maggs of NationalJournal.com asks our Expert Bloggers: Was President Obama's economic forecast, as prepared by Christina Romer for the budget, too rosy? It estimated that the economy would shrink 1.2 percent this year and grow 3.2 percent in 2010, then grow at greater than 4 percent in 2011. Weigh the pros and cons of an optimistic forecast during a bad recession.


Mark Bloomfield, President, American Council for Capital Formation: "Our question of the week:  "Is The Economic Forecast Too Optimistic?" triggers some thoughts I would like to share with my fellow "expert" bloggers."  I'm not sure that the Administration's baseline forecast before -- and I want to stress before -- its policy recommendations was too optimistic. 


Few soothsayers predicted the 6.2 percent drop in GDP in the 4th quarter and the weaker economy we now face.  However, I do worry that their projections of growth this year and next are too optimistic because I fear both the beginning and the nipping in the bud of a recovery from the Administration's policy prescriptions, especially from the anti-growth, short and long term, of trying to restore a 19th century tax code to the 21st century rather than making our tax structure more appropriate for our time, more pro-growth or at least competitive with the rest of the world. 


Finally, what about erring on the side of pessimism or optimism in an economic downturn when the loss of confidence among the general public, investors and business is so great?


It reminds me of a conversation Mrs. Roosevelt had with an admirer, who remarked:  "Please tell Mr. Roosevelt that when he talks to the nation at his fireside chats, it's like he talks to me directly."  President Obama shares this ability to connect directly with the American people at a critical time.  I worry that his ability to maintain the great American middle class's confidence in our mixed free market could be dissipated with what both friends and foes fear is a lack of specificity in the avalanche of new initiatives.  The Washington Post editorially worried about a lack of a singular focus on the economy rather than a broader social and political agenda.   The Wall Street Journal editorialized on the initiatives as anti-growth tax policies.  Several prominent Democratic wise men and women from prior Administrations publicly and privately fear is a lack of fiscal discipline in the long run.


This deep recession will end sooner or later but unless we address the long-term fiscal imbalance, to be blunt, a serious downgrading of the nations credit rating with all of its frightening consequences is not out of the question.  I challenge the goal of the President's budget, a 3 percent deficit after ten years. Shouldn't we aim for a surplus over the course of the business cycle to provide for another chapter in the American dream?


James K. Galbraith, Professor of Economics, University of Texas:The forecasts of the CBO, Federal Reserve and the administration are probably too optimistic, for  technical, psychological and political  reasons.


First, the underlying baseline models incorporate the notion of a natural rate of unemployment. This is an arbitrary  rate to which the economy is assumed to return automatically over time - even if no action is taken. CBO pegs this rate at 4.80 percent and builds a five-year reversion period into its model. There is no foundation in real life for this.  The implicit idea, drawn from textbook theory,  is that real wages will fall to adjust the labor market. In real life this does not happen (real wages have risen inn this slump so far), and  even if it did happen, it  would not quell unemployment.


Second, agencies may be tempted to make their forecasts rosy in order to try to foster confidence among the broader public, and perhaps to avoid a charge of complacency in the face of disaster. It may be better to appear not to see the disaster, than to appear to accept it.  


Third, the White House and OMB may favor rosy scenarios because they reduce projected budget deficits, which eases political problems.


Fourth, mechanical forecasting models built around self-stabilizing assumptions will not generate outcomes outside the range of experience on which they are estimated.  Therefore, in a slump of extreme violence, forecasts will never capture the rate of decline. The starting point for recovery will therefore be lower than forecasts of this type expect.


Fifth, the administration is assuming that its policy of bank bailouts can somehow raise the growth rate of new bank lending.  This is very unlikely to succeed, because it misunderstands the nature of the banking problem. So long as the administration fails to face the realities of the mess in the financial sector, the underlying sources of the credit collapse will not be dealt with. One consequence is that multiplier effects from spending increases and tax cuts may be smaller than expected.


These sources of false optimism tend to corrupt fiscal planning, so that expansion programs in deep slumps are likely to be too small, and designed to terminate too soon.


On the bright side, there is the fact that the automatic stabilizers are large and effective: taxes fall and spending rises in a slump, increasing disposable income and improving household balance sheets. And the expansion package as enacted does a good (though incomplete) job of stemming the state and local budget crises, for the moment.


Putting all of these pieces together, it is reasonable to expect that the economy will eventually stabilize and return to positive growth -- but, crucially, at a lower level of activity and a much higher rate of unemployment (or lower rate of employment) than the official forecasts allow for. And the growth rate may not be sufficient to restore high employment in any reasonable time.


The Levy Economics Institute Strategic Analyses (http://www.levy.org/ ) provide useful guidance here. Contrary to the CBO, Fed and administration, they foresee unemployment above 8 percent indefinitely.


Gary Burtless, Chair in Economic Studies, Brookings Institution: Since I am not an economic forecaster, I have no special advantage in predicting the future course of the economy.  Nonetheless, I have been surprised by the comparative optimism of both the Administration's and the Federal Reserve Board's forecast of economic growth over the next couple of years. 

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Cyra Master

Cyra Master is a W.E.B. Du Bois fellow at the Atlantic. Previously, she was an editor at the nonprofit Center for Law and Social Policy and was a reporter for the New Hampshire Eagle Tribune. She is a graduate of Emerson College.
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