Estimates of Nominal and Real GDP in the U.S. for 2013-Q3

Oh no! The government isn't reporting any economic data!

That's something that might stymie a lesser economist, but we're not going to let a lame government shut down stop us!

That's why today, we're going to do the job that the furloughed employees of the Bureau of Economic Analysis won't be doing this month, unless the partial government shutdown ends really soon and they crank out a rush job. We're going to estimate what the United States' Gross Domestic Product will be for the just completed third quarter of 2013.

After all, we've previously found that it takes maybe as many as 2.5 economists in the private sector to do the same job that it takes 16 government economists to do, so just how hard could it be?

Technically, we're going to forecast it, but then, since it takes the BEA three attempts before they finally get close to a good number, forecast values for GDP are probably just as good as an official government estimated one.

Let's do this visually, so you can get a sense of where we came up with our estimate of GDP for 2013-Q3. Our first chart is one based on math that we have been developing to quantify and visualize the impact of changes in government spending, taxes and the Fed's quantitative easing programs upon the U.S. economy, but which we'll now use to project what nominal GDP will be reported to be for the third quarter of 2013:

Using 2012-Q3's GDP as our base point, our forecasting method has come within 0.02% of the actual figure for nominal GDP that was reported in 2012-Q4, 2013-Q1 and 2013-Q2, or rather, the three quarters preceding the third quarter of 2013. We are projecting a nominal GDP of $16,764.5 billion for the U.S. in 2013-Q3, with the following assumptions that apply since the end of 2012-Q3, which marks our base reference point:

• Net Change in total assets held by Federal Reserve (QE): $927.8 billion


• Net Change in government taxes: $168.9 billion


• Net Change in government spending since 2012-Q3: -$21.0 billion

The first two quantities are pretty locked in at this point and won't likely be subject to future adjustment. The wild card in our forecast is the amount of government spending in the U.S., which consists of spending at the federal government level, as well as at the state and local level, for which we won't likely have a good estimate until late December 2013. Assuming that the BEA's data jocks get back on the job before then.

To get around that limitation, we went over data recorded from 1960 through 2012 to determine that average change in spending for both Federal and State & Local governments from the second quarter of each year to the third quarter to determine our estimate for this year. And you want to know the crazy thing about that? Even though the BEA shut down the computer system that reports historic data as part of their effort to completely flummox lesser economists, we didn't need to use their stinking site to get the historic GDP data on government spending at all.

Speaking of which, that value isn't something that would be impacted at all by the partial U.S. federal government shut down, which didn't begin until 1 October 2013, which is part of the fourth quarter of 2013.

Another factor we need to consider from better, private sector sources of information about the relative health of the U.S. economy is the possible return of organic economic growth, following the year-long microrecession experienced by the private sector of the U.S. economy from July 2012 through July 2013, which may have added a positive contribution to the GDP number. Since those conditions would appear to have resumed somewhat in September 2013 however, we think that contribution will be small, with the actual value likely to be reported to be very close to our forecast nominal GDP number.

As for real GDP, our inertial forecasting methods aren't quite as precise as they would seem to be for nominal GDP. Here, outside of periods where the U.S. economy has turned the corner from expansion to contraction, or vice versa, historical back-testing puts us within 2% of the value the BEA reports about 95% of the time, and within 1% of it almost 75% of the time.

Our second chart shows our projected value for real GDP in 2013-Q3:

Here we anticipate that real, inflation-adjusted GDP in the U.S. will most likely fall in a range between $15,590.7 and $15,910.4 billion in terms of constant 2009 U.S. dollars, with a 95% probability of falling in a range between $15,430.9 and $16,070.2 billion.

By definition, it has a 50% probability of being above the midpoint of our forecast range, $15,709 billion. We think that given the relative increase in government spending from 2013-Q2 to 2013-Q3, combined with the positive contribution of organic economic growth, that real GDP in the third quarter of 2013 will indeed be reported to be above that level.

And there you have it - a simple blog just replaced the topline work of the Bureau of Economic Analysis for the third quarter of 2013 using just a handful of data points. We'd actually rather they be able to doing the job themselves, since the full extent of the data collection and reporting that they do is something that does have real world value, but we can't help but think that there ought to be a private sector alternative available to fully pick up the slack during times like these.

The Power of Quantitative Easing

Now that the BEA has released its massive revision of the United States' Gross Domestic Product, we're going to put our Keynesian-style GDP multiplier tool to the test. Will it still be able to accurately predict what a future quarter's nominal GDP will be for the current U.S. economy based only based only on a previous quarter's GDP and a handful of fiscal and monetary policy GDP input shocks? Or will it fold up like the cheap suits worn by Keynesian-style economists?

To do this analysis, we'll be projecting the future value for nominal GDP from the starting point of the fourth quarter of 2012. This is the final quarter preceding major changes in the U.S. government's policies for taxes and spending, which makes it an ideal zero point in time from which to consider the impact of these shocks to the economy. The table below presents the values we'll be using in this analysis.

Changes in Fiscal or Monetary Policy Drivers Since 2012-Q4
Fiscal or Monetary Policy Driver	Total Through 2013-Q1	Total Through 2013-Q2
Change in Expected Tax Collections	+$56.3 billion	+$112.6 billion
Change in Government Spending	-$26.6 billion	-$29.1 billion
Amount of Quantitative Easing	+$295.0 billion	+$572.0 billion

Now it's time to do the math! We've entered the data that applies through the first quarter of 2013 into the tool below, which you'll need to change to the values that apply for 2013-Q2 to project the value of GDP for that quarter.

But before you go any farther, if you're reading this article on a site that republishes our RSS news feed, please click here to access a working version of this tool at our site, where it will also be properly formatted (we're looking at you, feedly - we speak CSS, you should too!...)

GDP and "Input Shocks"
Input Data	Values
Nominal GDP for the Previous Period [billions]
Change in Expected Federal Government Tax Collections [billions]
Change in Federal, State & Local Government Spending [billions]
Federal Reserve Net Quantitative Easing [billions]
Fiscal Policy Multipliers (Estimated Range)
Government Spending (0.6-0.7)*
Government Taxes (-3.0)
Quantitative Easing (0.8-1.0)

* If unemployment rate ≥ 7.5%. Multiplier is 0.5 if unemployment rate < 7.5% (may apply after 2013-Q2).

Individual Effects of Fiscal and Monetary Policies Upon GDP
Calculated Results	Values
Effect of Change in Government Spending on GDP [billions]
Effect of Change in Government Taxes on GDP [billions]
Effect of Change in Monetary Policy on GDP [billions]
Combined Effects of Fiscal and Monetary Policies Upon GDP
Combined Effects on GDP [billions]
Estimated GDP for Next Period [billions]

What we find is that with the data for 2013-Q1, for the Keynesian-style GDP multipliers that apply for fiscal and monetary policy, our tool would predict that nominal GDP would be $16,530.4 billion. That compares with the $16,535.3 billion actually recorded by the BEA for the nation's GDP in the first quarter of 2013, which means that our tool would appear to have underpredicted GDP in 2013-Q1 by $4.9 billion, an error of 0.03%.

After substituting in the data for 2013-Q2, with the exact same GDP multipliers, our tool predicts that nominal GDP would be $16,637.0 billion. The BEA's first estimate of GDP for the second quarter of 2013 is actually $16,633.4 billion, as our tool appears to have overpredicted GDP in 2013-Q2 by $4.4 billion, also an error that rounds to 0.03%.

The BEA will not finalize its estimate of GDP for 2013-Q2 until September 2013, so the actual difference between our tool's projection and the official figure will be subject to change until then. Regardless, from the data we do have, it appears that our tool can predict future nominal GDP levels for the current economy with a surprising degree of accuracy.

Update 14 September 2013: It occurs to us that a picture might be worth 1000 words here. Here's a chart illustrating how the puzzle pieces fit together, based upon the BEA's second estimate of GDP for 2013-Q2 (the third estimate will come out near the end of September 2013):

It is pretty clear from these results that if not for the Fed's quantitative easing programs, the U.S. economy would have contracted in recession during these quarters. You can consider the impact to what the U.S.' GDP would be by zeroing out this value in our tool above.

These results also demonstrate that monetary policy can remain highly effective even if basic interest rates are at or near the zero level. We'll discuss the mechanisms by which we think the Fed's quantitative easing programs affect the nation's economy in an upcoming post.

In the meantime, you can take advantage of our tool to get a sense of the extent to which the federal government's tax hikes and spending cuts in 2013 are actually affecting the nation's GDP by alternately zeroing out these figures. One thing that you'll find is that over 90% of the negative drag on GDP may be attributed to the tax hikes that took effect in 2013. Less than 10% may be attributed to reductions in government spending at all levels in the U.S.

Finally, if you really want to play the "what if" game, try combining government spending cuts with modest tax cuts in our tool above. One may wonder why today's politicians aren't discussing implementing this particular combination of fiscal policies.

About the Numbers in the Tool

GDP and Government Spending: The GDP ($16,420.3 billion) for our starting quarter (2012-Q4) was taken from the BEA's massive revision of GDP from 1929 through the first quarter of 2013, as were the numbers we've indicated for the total change in government spending from that starting quarter (-$26.6 billion for 2013-Q1 and -$29.1 billion for 2013-Q2). Most of the reduction in government spending occurred at the federal government level, with the balance being recorded for state and local governments.

We should also note that total government spending appears to have only fallen by $2.5 billion from 2013-Q1 to 2013-Q2 in the BEA's initial estimate for the more recent quarter, all of which occurred at the federal government level. We anticipate that this number will change as the BEA updates its estimate of government spending for 2013-Q2.

2013's Tax Hikes

The total for the change in the amount of taxes in the U.S. is based on the fiscal cliff tax deal of 3 January 2013, which increased the Social Security payroll tax by 2%, as well as increased the tax rates paid by high income earners and also the tax rates for investments.

Social Security Payroll Tax Hike: Here, we estimated the additional amount that President Obama expects to collect through Social Security's combined employer-employee payroll tax of 12.4% in 2013 (as indicated by Table 2.4 of President Obama's FY2014 budget proposal) compared to what would have been collected under 2012's combined tax rate of 10.4%, arriving at a figure of $108.6 billion for the year, for which we assumed that one-fourth ($27.16 billion) would be collected in the first quarter of 2013.

Obamacare Taxes: We also took into account the tax increases that went into effect on investment income and upon high income earners as part of the Patient Protection and Affordable Care Act, which are expected to total $36 billion in 2013, one-fourth ($9 billion) of which we assumed was incurred in the first quarter.

Fiscal Cliff Income and Investment Tax Hikes: The remaining portion of tax increases taking effect were a direct outcome of the increases in the top income tax rates and upon investment income mandated as part of the fiscal cliff tax deal at the beginning of 2013, where a static analysis indicates that the $80.6 billion more in taxes will be collected in 2013, one-fourth ($20.15 billion) of which might be applied to the first quarter of the year.

Combined, these values total up to a tax bill for Americans that's $225.2 billion higher for Americans in 2013 than in 2012, which works out to be approximately $56.3 billion higher for just 2013-Q1. To come up with the cumulative total of expected changes in tax collections from 2012-Q4 through 2013-Q2, we simply multiplied this quarterly change by a factor of 2.

About the Multipliers

We featured a discussion of the fiscal multipliers for government spending and tax policies in our previous discussion of Spain's disastrous economic choices of 2012. At present, we're simply assuming that the fiscal multiplier for the Fed's quantitative easing programs is 1.0, in the absence of data that might contradict that figure. As yet, there really isn't any data to contradict this estimate.

Quantitative Easing

Our estimates of the cumulative amount of quantitative easing being provided by the Federal Reserve through the first and second quarters of 2013 were determined by finding the change in the total assets held by the Fed with respect to their holdings at the end of 2012. That worked out to be $295.0 billion through 2013-Q1 and $572.0 billion through 2013-Q2.

Data Sources

Board of Governors of the Federal Reserve System. All Federal Reserve Banks - Total Assets, Eliminations from Consolidation. [Text Document]. Accessed 11 August 2013.

Cloyne, James. What Are the Effects of Tax Changes in the United Kingdom? New Evidence from a Narrative Evaluation. [PDF Document]. CESIFO Working Paper No. 3433. April 2011.

Owyang, Michael T., Ramey, Valerie A. and Zubairy, Sarah. Are Government Spending Multipliers Greater During Periods of Slack? Evidence from 20th Century Historical Data. [PDF Document]. Federal Reserve Bank of St. Louis. Economic Research Division. Working Paper 2013-004A. January 2013.

Romer, Christina D. and Romer, David H. The Macroeconomic Effects of Tax Changes: Estimates Based on a New Measure of Fiscal Shocks. [PDF Document]. March 2007.

U.S. Bureau of Economic Analysis. National Income and Product Accounts, Gross Domestic Product: Second Quarter 2013 (Advance Estimate), Comprehensive Revision: 1929 through First Quarter 2013. [Text Document]. 31 July 2013.

Forecasting 2013-Q2's GDP

Now that the BEA has released its massive revision of GDP data going back to 1929, it's now worth our time and trouble to forecast where real GDP for 2013-Q2 will be finalized.

To do that, we'll be taking the data that the BEA has reported for the three most recent quarters for which it has finalized its estimates of the U.S.' real gross domestic product and applying our "modified limo" technique for forecasting the nation's GDP for the second quarter of 2013. While the BEA has already put forward an initial estimate of real GDP in 2013-Q2 of $15,648.7 billion in terms of chained 2009 U.S. dollars, that's really just their first estimate for the figure. What we're really looking to forecast is the value that will be recorded in the BEA's third estimate, which won't be reported sometime late in August 2013.

Since our modified limo method only incorporates finalized data in its formulation, and not initial estimates, the value of the first estimate that the BEA has already reported will neither affect nor alter our forecast value. If we had known how the BEA was going to revise GDP to incorporate the relatively intangible elements of the economy such as research and development activities in the private sector, we could have obtained the results we'll present today over a month ago, long before the BEA published its first estimate for real GDP in the second quarter of 2013.

That's because our modified limo forecasting technique is really an inertia-based method for projecting what real GDP will be in the future, which is based upon the very recent performance of the economy. It is most accurate when the economy is growing at a steady rate, at least, as measured over two-quarter long periods of time, and even provides insight in those cases when it is off target, as that indicates a situation where the economy is turning a corner, so to speak, either positively toward expansion or negatively toward contraction.

Let's do some math, shall we? We've entered the data for the three most recent quarters for which the BEA has revised its data at least three times already (2012-Q3, 2012-Q4 and 2013-Q1):

Previous Quarters Inflation-Adjusted GDP Data
Input Data	Values
Three Quarters Ago (Billions of Chained U.S. Dollars)
Two Quarters Ago (Billions of Chained U.S. Dollars)
Most Recent Quarter (Billions of Chained U.S. Dollars)

Next Quarter's Inflation-Adjusted GDP Estimate
Calculated Results	Values
Modified Limo Estimate (Billions of Chained U.S. Dollars)

From that data, we find that the midpoint for our forecast range for real GDP in 2013-Q2 is $15,609.0 billion in terms of chained 2009 U.S. dollars, which is nearly $40 billion, or 0.25%, below the BEA's first estimate for the quarter, as the early indication that the U.S. economy performed slightly better in 2013-Q2 than a simple inertial trajectory would project.

We find the following probabilities for where GDP will be finalized for the quarter:

• There is a 68.2% probability that real GDP will fall between $15,437.8 and $15,754.3 billion.


• There is a 95.0% probability that real GDP will fall between $15,292.3 and $15,925.6 billion.


• There is a 99.6% probability that real GDP will fall between $15,133.9 and $16,084.0 billion.

And of course, there is a 50% probability that it will be finalized at a value above our midpoint forecast value of $15,609.0 billion. And actually better than that, as the BEA's first estimate for the quarter indicates it is above that value.

The chart below visualizes our forecast, and gives the first hint of what 2013-Q3 might look like, if 2013-Q2's GDP is finalized at its currently estimated value of $15,648.7 billion:

Although the early data favors real GDP being recorded above our forecast midpoint value, that's really not saying very much, as the overall level of economic growth suggests that the U.S. economy is experiencing recessionary conditions, and has been since the third quarter of 2012, as confirmed by our GDP growth rate temperature gauges shown at the top of this post!

But then, while that may be a surprise to people who believed the BEA's pre-revision estimates of GDP through 2013-Q1, which didn't indicate much potential of recession, it's old news to our readers, who know that we have other, more reliable methods than the federal government has for telling when the pace of economic growth has become too cold.

On the Mark with 2013-1Q GDP!

Nearly three months ago, just after the BEA released its third estimate of GDP for the fourth quarter of 2012, we gave the following odds in forecasting where GDP in the first quarter of 2013 would be recorded:

Using our modified-limo forecasting method, we would anticipate that real GDP in 2013-Q1 has the following odds of falling in the indicated ranges (all values are given in terms of constant 2005 U.S. dollars):

• A 68% likelihood of falling between $13,581.8 billion and $13,867.2 billion.


• A 95% likelihood of falling between $13,439.1 billion and $14,009.9 billion.


• A 99% likelihood of falling between $13,296.4 billion and $14,152.5 billion.

The midpoint of our target ranges is $13,724.5 billion. We note for reference that this would correspond to an annualized real growth rate of 1.7%. [We forecast GDP - not GDP growth rates, which are very susceptible to big swings with just small changes in actual GDP.]

We did one other thing as well in our forecast - we took the over, which means that we expected that GDP would be recorded to be above our midpoint value of $13,724.5 billion.

So how did we do?

Would you believe that we just about completely nailed it?

The BEA reports that real GDP in 2013-Q1 came in at $13,725.7 billion, just 0.01% above the midpoint of our forecast range!

Not too shabby, especially because all we did was assume that GDP would grow at the same rate it averaged over the two preceding quarters!

Speaking of which, in now looking forward to where GDP will be recorded in 2013-Q2, well, we'll present our visual results, but we're not going to discuss them in detail, because they'll all be different by the time the data is actually reported!

The reason why is because the BEA is on the verge of a major revision for current and historic data, which will be released on 31 July 2013. That revision will re-base all the seasonally-and-inflation-adjusted values of real GDP to be in terms of constant 2009 U.S. dollars, instead of the 2005 U.S. dollars that the BEA has been reporting over the last several years. (Our chart above shows the data in terms of constant 2005 U.S. dollars).

So we're going to hold off on officially forecasting where real GDP in 2013-Q2 will end up until we have the BEA's revised numbers. Because we'll have enough work later dealing with all the changes that will be part of the BEA's upcoming data revision!

Wrecking the Greek Economy

Today, we're going to demonstrate how the demands of the International Monetary Fund (IMF), the European Commission (EC) and the European Central Bank (ECB) combined together into a troika to wreck the economy of Greece in 2010.

Specifically, we're going to show how the austerity measures they demanded and obtained as a condition of their bailout of the Greek government directly sent Greece's economy into a tailspin.

Let's set the stage. Here is the Guardian's timeline of the major events leading up to the bailout in mid-2010 as they were known at that time. It's definitely worth reviewing to get a sense of the crisis that led to such incredibly poor decisions.

Let's focus now on those austerity measures demanded by the Troika as a requirement to bail out the Greek government from its fiscal crisis. In July 2010, Greece's government reported what that would entail in terms of permanent spending cuts and permanent revenue increases.

Specifically, Greek Prime Minister George Papandreou's government committed to cut €6.915 billion [$9.187 billion U.S. dollars] in the government's planned spending for 2010, while also seeming to commit to permanently increasing the nation's tax collections by €9.950 billion [$13.218 billion USD] in that year.

We say "seeming" because a number of measures mentioned in the report were not enacted, while other amounts were reported as full-year values, where in reality, they were applied for just a fraction of the year. After subtracting the values for the non-enacted measures from the total and adjusting for the actual partial-year data, we find that the Greek government actually increased its intended tax collections in 2010 by €5.971 billion [$7.932 billion USD].

We're going to use those numbers in our tool below, along with the GDP value recorded by the World Bank for Greece in 2009, and also our standard GDP multipliers for government spending cuts and tax increases to see just how close we can get to what actually happened with Greece's GDP in 2010 (we'll also zero out the quantitative easing option, since that's not a consideration in this case). All values are presented in terms of U.S. dollars:

GDP and "Input Shocks"
Input Data	Values
Nominal GDP for the Previous Period [billions]
Change in Expected Federal Government Tax Collections [billions]
Change in Federal, State & Local Government Spending [billions]
European Central Bank Net Quantitative Easing [billions]
Fiscal Policy Multipliers (Estimated Range)
Government Spending (0.6-0.7)*
Government Taxes (-3.0)
Quantitative Easing (0.8-1.0)

* If unemployment rate ≥ 7.5%. Multiplier is 0.5 if unemployment rate < 7.5%.

Individual Effects of Fiscal and Monetary Policies Upon GDP
Calculated Results	Values
Effect of Change in Government Spending on GDP [billions]
Effect of Change in Government Taxes on GDP [billions]
Effect of Change in Monetary Policy on GDP [billions]
Combined Effects of Fiscal and Monetary Policies Upon GDP
Combined Effects on GDP [billions]
Estimated GDP for Next Period [billions]

If you're reading this article on a site that republishes our RSS news feed, click here to access a working version of this tool!

What we find is that virtually all of the decline in Greece's GDP is attributable to the spending cuts and tax hikes demanded by the Troika and enacted by the Greek government, as Greece's GDP fell from $321.016 billion USD [€241.638 billion] in 2009 to $292.305 billion USD [€220.025 billion] in 2010, as our tool is off by just 0.2% from that figure. Of these, the government's spending cuts contributed just 19% of the decline in Greece's GDP, while its tax hikes contributed the remaining 81% of the GDP decline from 2009 to 2010.

The collapse of Greece's GDP was such that the nation was unable to meaningfully close its budget gap, which ensured that the nation's fiscal troubles would be a prolonged experience.

What this chart tells us is that the Greek government only collected about as much revenue in 2010 as it would have without any tax hikes given the size of its GDP for the year. What our math earlier in this post demonstrates is that its GDP would have been much higher if not for its tax increases. (Go ahead! Try it in our tool above!)

On a side note, see if you can tell from our chart above when the next time was that the Greek government implemented additional tax hikes....

Barry Eichengreen describes what might have been for Greece:

The critical policy mistakes were those committed at the outset of the crisis. It was already clear in the first half of 2010, when Greece lost access to financial markets, that the public debt was unsustainable. The country’s sovereign debt should have been restructured without delay.

Had Greece quickly written down its debt burden by two-thirds, it would have been able to shed its crushing debt overhang. It could have used a portion of the interest savings to recapitalize the banks. It could have cut taxes, rather than raising them. It could have jump-started investment and gotten its economy moving again, if not in a matter of months, then, with luck, in no more than a year.

In its official post-mortem on the crisis, the International Monetary Fund now agrees that debt restructuring should have been undertaken earlier. But this was not its view at the time. Under the leadership of Dominique Strauss-Kahn, the Fund was in thrall to the French and German governments, which adamantly opposed debt relief.

Without the benefit of any beneficial monetary policy to offset the disastrous effects of the "balanced approach" demanded by the Troika for its fiscal policies, the wrecking of Greece's economy was ensured.

There are many lessons to be learned here. So far, it only appears that the IMF alone among all the leaders of the world's nations has learned any of them. But then, they still don't appear to have learned the most important lesson that taxes should not be hiked during a recession.

Would it be too much to ask for a fresh slate of more competent leadership all around the world?

References

Hellenic Republic Ministry of Finance. The Economic Adjustment Programme for Greece. [PDF Document]. July 2010.

World Bank. Data: GDP (Current US$). [Online Database]. Accessed 11 June 2013.

X-Rates. Exchange Rage Average (US Dollar, Euro) - 2010. [Online Database]. Accessed 11 June 2013.

Owyang, Michael T., Ramey, Valerie A. and Zubairy, Sarah. Are Government Spending Multipliers Greater During Periods of Slack? Evidence from 20th Century Historical Data. [PDF Document]. Federal Reserve Bank of St. Louis. Economic Research Division. Working Paper 2013-004A. January 2013.

Romer, Christina D. and Romer, David H. The Macroeconomic Effects of Tax Changes: Estimates Based on a New Measure of Fiscal Shocks. [PDF Document]. March 2007.

The Drag of Fiscal Policy on the U.S. Economy

Brian Lucking and Daniel Wilson of the Federal Reserve Bank of San Francisco have made news with their 3 June 2013 Economic Letter, in which they point the finger at a new source of drag on the U.S. economy: the U.S. federal government's fiscal policies, and President Obama's tax hikes in particular (emphasis ours):

While our estimates show that fiscal policy has held back the recovery slightly to date, the effect over the next three years looks much bigger. The CBO projects that the federal deficit as a share of GDP will drop 1.4 percentage points per year over the next three years. This projection would ease slightly to 1.2 percentage points per year if sequestration spending cuts were reversed. By contrast, our calculation of the historical-norm deficit decline through 2015 is 0.4 percentage point per year based on the CBO’s output gap projections. This implies that the excess drag from the rapidly shrinking deficit would reduce real GDP growth annually by between 0.8 and 1.0 percentage point, depending on whether sequestration is reversed. Thus, with or without sequestration, fiscal policy is expected to be a much greater drag on economic growth over the next three years than it has been so far.

Surprisingly, despite all the attention federal spending cuts and sequestration have received, our calculations suggest they are not the main contributors to this projected drag. The excess fiscal drag on the horizon comes almost entirely from rising taxes. Specifically, we calculate that nine-tenths of that projected 1 percentage point excess fiscal drag comes from tax revenue rising faster than normal as a share of the economy. As Panel B shows, at the end of 2012, taxes as a share of GDP were below both their historical norm in relation to the business cycle and their long-run average of about 18%. However, over the next three years, they are projected to rise much faster than our estimate of the usual cyclical pattern would indicate. The CBO points to several factors underlying this “super-cyclical” rise, including higher income tax rates for high-income households, the recent expiration of temporary Social Security payroll tax cuts, and new taxes associated with the Obama Administration’s health-care legislation.

The timing of this particular economic letter from the Fed is cool, because we just did the analysis of the impact of the spending cuts and tax increases upon the U.S. economy in the first quarter of 2013. In that analysis, we found that the Fed's recent adjustments to its quantitative easing programs were working to offset the negative effects of those fiscal policies, which would appear to be the only reason the U.S. economy grew in 2013-Q1.

But more importantly, we also quantified the impact of both the spending cuts and the tax increases upon the nation's GDP. Our tool below focuses just on those components and estimates their relative share of negative impact:

GDP and Fiscal Policy "Input Shocks"
Input Data	Values
Nominal GDP for the Previous Period [billions]
Change in Expected Federal Government Tax Collections [billions]
Change in Federal, State & Local Government Spending [billions]
Fiscal Policy Multipliers (Estimated Range)
Government Spending (0.6-0.7)*
Government Taxes (-3.0)

* If unemployment rate ≥ 7.5%. Multiplier is 0.5 if unemployment rate < 7.5%.

Effects of Changes in Fiscal Policies Upon GDP
Calculated Results	Values
Effect of Change in Government Spending on GDP [billions]
Effect of Change in Government Taxes on GDP [billions]
Combined Effects on GDP [billions]
Percentage Impact of Fiscal Policies Upon GDP
Percentage of Drag on GDP Due to Spending Cuts
Percentage of Drag on GDP Due to Tax Hikes

If you're reading this article on a site that republishes our RSS news feed, click here to access a working version of this tool!

Overall, for the first quarter of 2013, we find that the combination of government spending cuts and tax increases would reduce the United States' GDP by $184.5 billion from the previous quarter, which means the drag of the changes in the U.S.' fiscal policies upon the nation is roughly 1.2% of its GDP, which is close to what the Fed predicts with its model.

Of that fiscal drag on the United States' GDP, 8.5% may be attributed to the effect of government spending cuts at all levels in the U.S. - federal state and local. The remaining 91.5% of that decline is directly attributable to the tax hikes that went into effect in 2013, including the Social Security payroll tax hike, the various Obamacare tax hikes and President Obama's desired tax hikes upon high income earners and investments that were part of the fiscal cliff tax deal at the beginning of the year, all of which applied at the federal government level.

We therefore find that the actual results of the negative effects of the changes in U.S. federal government's fiscal policies are turning out to be pretty much right in line with what the Federal Reserve has predicted using its model.

Previously on Political Calculations

• Input Shocks, GDP, Multipliers and QE

Update 29 June 2013: Reduced the default value for government spending cuts in the tool above from -26.0 billion to -24.2 billion, per the BEA's third estimate of GDP for the first quarter of 2013. We calculate the overall reduction in GDP due to the fiscal drag from tax hikes (92%) and government spending cuts (8%) taking effect in the first quarter of 2013 is 1.1%, which closely agrees with the Fed's prediction.

Like Waiting for a Train That Will Never Come

How good is the President at predicting how much money the U.S. government will collect in revenue from year to year?

The answer to that question matters because when a U.S. President submits a budget proposal to the U.S. Congress, they are effectively putting the credibility of their economic programs on the line. If their revenue projections repeatedly fall short of what the government actually collects from year to year, it is an indication that either they are not in tune with the changing health of the U.S. economy or that their programs are not capable of promoting the kind of economic performance needed to generate the kind of revenue figures they anticipate. And quite possibly, both.

Let's take a closer look at the recent performance of U.S. Presidents. Our chart shows the amount of revenue forecast by President George W. Bush (dashed lines) and President Barack Obama (solid lines) for each of the U.S. government's fiscal years from 2004 through 2014 (FY2004 through FY2014).

In the chart above, the U.S. President's forecast for a given fiscal year is typically made in February of the previous year. For example, President Bush's budget proposal for FY2009 was released with its projection of the U.S. government's revenues through FY2013 in February 2008, nearly 8 months ahead of when the U.S. federal government's 2009 fiscal year began on 1 October 2008.

We note this particular revenue projection because it turned out to be considerably far off the target. Prior to 2008, President Bush's budget proposals had a high degree of credibility, as the federal government's revenues frequently came in at levels slightly higher than the President had forecast.

But in February 2008, President Bush's revenue projections for FY2009 and beyond failed to anticipate the financial system crisis that would take hold during the year, nor did it anticipate the record spike in oil prices that would subsequently lead to near collapse of the U.S. auto industry by the end of the year. Note the permanent fall in the number of Americans employed by the U.S. automotive industry in the following graph (shown in orange on the scale on the right hand side of the chart):

Source: U.S. Department of Labor

Consequently, in missing the deteriorating health of the U.S. economy during 2008, President Bush's economic agenda quickly lost its credibility during that year, even though it would have appeared to have been successful in the preceding years.

Meanwhile, President Obama's track record of revenue forecasts indicate that his administration has never had a good handle on accurately assessing the health of the U.S. economy, nor has his economic initiatives been successful in stimulating the kind of economic activity needed to meet his revenue projections.

We can see this outcome in our chart above by comparing President Obama's revenue forecasts with the heavy black line in our chart above indicating the U.S. government's actual revenue collections. Here, we find that President Obama's forecast revenues are almost always far more optimistic than the actual outcome. Much as President Obama's unemployment rate forecasts have been.

Source: U.S. House of Representatives Ways and Means Committee

We can also see President Obama's forecast economic recovery following the 2008-2009 recession progressively get dragged out longer and longer with each year's forecast in our chart. Here, it appears that President Obama has taken a simple straight-line projection of President Bush's revenue projections from the FY2007 budget proposal as his idea of how much revenue the federal government would collect if the U.S. economy were to fully recover from the recession. This straight-line projection then sets the bar for determining how effective President Obama's economic growth programs have been by his own selected standard.

We should note that President Obama has set the bar at a very high level, as the revenue forecasts for President Bush's FY2007 budget proposal was issued in February 2006, just after the peak of the first U.S. housing bubble, in which government revenues were elevated over what they would be in more typical circumstances.

Still, it is clear that this is the standard that President Obama has selected to assess his own economic performance in office. With that being the case, it is also clear that President Obama's economic programs as presented in his annual budget proposals have repeatedly fallen far short of meeting their anticipated performance targets.

alt="Real GDP vs Climbing Limo and Modified Limo Forecasts, Ending 2013-Q1" style="display: block; width: 600px; margin: 10px auto;" />

We therefore find that President Obama's economic agenda has never had much credibility, especially when measured against the President's chosen measure of success. Which is perhaps why each of his most recent budget proposals have been dead on arrival on Capitol Hill, as no U.S. Congress has acted to pass any of President Obama's proposed budget measures since 2009, whether the national legislature was fully controlled by the President's own political party, as in 2010, or not.

And that is perhaps the best indication that waiting for President Obama's economic recovery is a lot like waiting for a train that will never come.

The lyrics to the Matchbox 20 song by that name are here. They would seem to fit the political situation with President Obama's economic agenda fairly well.

A Preliminary Forecast for 2013-Q2's GDP

As expected, the first estimate of GDP for the first quarter of 2013 came in above the midpoint of our target forecast range, with the Bureau of Economic Analysis reporting that the aggregage national income of the United States was $13,750.1 billion in terms of constant 2005 U.S. dollars.

The midpoint of our official target range for GDP in 2013-Q1 was $13,724.5 billion in terms of constant 2005 U.S. dollars, about 0.19% below the BEA's initial estimate.

So where might we reasonably project GDP for the current quarter (2013-Q2) to be when it is first reported three months from now?

The chart below shows what our inertia-based "modified limo" forecasting technique anticipates it will be:

alt="Real GDP vs Climbing Limo and Modified Limo Forecasts, Ending 2013-Q1" style="display: block; width: 600px; margin: 10px auto;" />

Using the initial estimate for real GDP in 2013Q1, we can provide the following preliminary odds for 2013Q2 - all GDP figures are given in terms of constant 2005 U.S. dollars:

• There is a 50% probability that U.S. GDP will be greater than $13,799.3 billion. There is likewise a 50% probability that GDP will be less than $13,799.3 billion.


• There is a 68.2% probability that it will be somewhere between $13,581.8 billion and $13,867.2 billion.


• There is a 95.0% probability that it will be somewhere between $13,439.1 billion and $14,009.9 billion.


• There is a 99.8% probability that it will be somewhere between $13,296.4 billion and $14,152.5 billion.

The BEA will revise GDP for 2013-Q1 twice more before setting it aside and revisiting it in a bigger scale revision. Our official estimate for GDP in 2013-Q2 will be based on its third estimate, which will be released near the end of June 2013.

Taking the Over for GDP in 2013Q1

A little over three months ago, we predicted that GDP for the U.S. in the fourth quarter of 2012 would be finally recorded below a value of $13,726.5 billion in terms of constant 2005 U.S. dollars, which represents the midpoint of our target range. Now that the U.S. Bureau of Economic Analysis has released its third and for now final estimate of real GDP in 2012-Q4, it's time to find out just how far off target we were!

It seems that the midpoint for our target range overshot the actual figure of $13,665.4 billion 2005 U.S. dollars by just $61.1 billion, or rather, by 0.45%, which as it turns out, is well within our narrowest target range of $13,581.8 billion to $13,867.2 billion. The overshot in our predicted midpoint value indicates just how sluggishly the U.S. economy performed in 2012-Q4 compared to realistic expectations.

With the GDP data finalized for the time being, we can now project forward to anticipate what real growth the U.S. economy can expect in the first quarter of 2013:

Using our modified-limo forecasting method, we would anticipate that real GDP in 2013-Q1 has the following odds of falling in the indicated ranges (all values are given in terms of constant 2005 U.S. dollars):

• A 68% likelihood of falling between $13,581.8 billion and $13,867.2 billion.


• A 95% likelihood of falling between $13,439.1 billion and $14,009.9 billion.


• A 99% likelihood of falling between $13,296.4 billion and $14,152.5 billion.

The midpoint of our target ranges is $13,724.5 billion. We note for reference that this would correspond to an annualized real growth rate of 1.7%. [We forecast GDP - not GDP growth rates, which are very susceptible to big swings with just small changes in actual GDP.]

We anticipate however that the resolution of the fiscal cliff tax crisis at the beginning of 2013 will have a net positive effect on the U.S. economy in the first quarter of 2013, more than offsetting the negative effects of the higher tax rates that took effect, as the event eliminated an immense source of uncertainty that President Obama had created with respect to the future of U.S. tax rates. With that being the case, we would take the over for GDP in 2013-Q1.

The Upside of the Under

Previously, we took the under in forecasting where the United States' GDP would be recorded in the fourth quarter of 2012, forecasting that the nation's real GDP would be recorded below our mid-range projection of $13,726.5 billion in terms of constant 2005 U.S. dollars.

Taking the under turned out to have been the right call for us to make, as the first estimate for inflation-adjusted GDP came in at $13,647.6 billion in terms of the BEA's chained 2005 U.S. dollars, a difference of roughly 0.6% from the value we have projected will be recorded when the BEA finalizes its estimate of GDP for 2012Q4 at the end of March 2013.

We had given 68.2% odds that 2012-Q4's real GDP would fall between $13,583.8 billion and $13,869.2 billion, as the U.S. economy would appear to be continuing to skirt the edge of what we would describe as a microrecession. That condition becomes more apparent as we consider our two-quarter GDP growth rate temperature gauge, where the growth rate for 2012-Q4 falls just into the "cold" purple zone.

Since we base our GDP forecasts on the two-quarter growth rate of GDP, our forecast was largely immune to the large swings in the U.S. federal government's spending for defense that took place in the second half of 2012, where planned spending had been pulled ahead into the third quarter of 2012 to offset potential cuts in this spending as part of the so-called "fiscal cliff" at the end of 2012 and also to provide a boost to the U.S. economy ahead of the national elections on 6 November 2012. Defense-related spending was then sharply reduced in the fourth quarter of 2012, accounting for much of the lackluster GDP growth rate reported in the quarter.

The other major economic event of the quarter, Hurricane Sandy, would appear to have had a negative, but very small effect upon GDP in the fourth quarter of 2012.

Looking forward, using the first estimate of GDP for 2012-Q4, our "modified limo" forecasting technique anticipates that real GDP in the first quarter of 2013 will come in around $13,697.6 billion in terms of constant 2005 U.S. dollars. A positive move, so that's the upside of the under.

We will update our projections as the BEA adjusts its estimates of GDP for the fourth quarter of 2012. At present, we would expect the BEA's estimate of real GDP for 2012-Q4 to be revised slightly upward by the time of their third revision at the end of March 2013.

Elsewhere on the Web

Jim Hamilton offers his analysis of the fourth quarter's GDP figures and points to other viewpoints.

Taking the Under on 2012Q4 GDP

As we expected, economic growth in the third quarter of 2012 was revised upward twice before being finalized at the end of December 2012, rising from the originally reported annualized growth rate of 2.0% to 3.1% in the BEA's third (and final for now) estimate for that quarter.

We had forecast that real GDP would be recorded at $13,602.8 billion in terms of constant 2005 U.S. dollars, and the BEA's third estimate came in at $13,652.6 billion - a difference of $49.8 billion, or within 0.04% of the BEA's last recorded figure.

We've updated our forecast for where GDP in the fourth quarter of 2012 with that finalized data:

Our inertia-based forecast is overly optimistic and we anticipate that real GDP in 2012-Q4 will be recorded at a level below the $13,726.5 billion in terms of inflation-adjusted, chained 2005 U.S. dollars shown in the chart above, thanks to the combination of our expected major slowdown in economic growth for the quarter and the negative impact of Hurricane Sandy.

We'll close by repeating our comments from 29 October 2012:

In considering the overall strength of economic growth in the United States, our one and two quarter temperature gauges both indicate the economy is currently performing in the "cool" zone, indicating sluggish economic growth. Our less volatile two-quarter GDP growth rate temperature gauge indicates that the U.S. economy is actually trudging along at near-recessionary levels.

We anticipate that this condition will continue through the fourth quarter of 2012 and will worsen going into 2013.

You can't say you weren't warned months ago!