When the 2010 Budget was released I questioned whether they were using assumptions that were too optimistic. When the 2011 Budget was relaesed I did historic studies on each of the five key assumptions (Growth, Unemployment, Inflation and Short Term and Long Term Interest Rates) and found they couldn't be supported by historical trends. This year, when the 2012 Budget was released, I concentrated on the Inflation assumption. I found it to be dramatically understated making the budget projections meaningless. I wrote the following letter to the White House Chief Economist. I haven't heard back.
Maybe you should write to him too? Include a copy of my letter. And be sure to "CC" it to someone on the list.
Its time to let DC know we are watching as they play games with our future!
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March 16, 2011
Mr. Austan Goolsbee
Chief Economist
White House Council of Economic Advisors
1600 Pennsylvania Ave.
Washington, DC 20500
Re: 2012 Budget Assumptions
Dear Austan Goolsbee,
First I would like to acknowledge that my training and involvement in the study of economics is not at the same level as yours. I understand that you are well respected for your knowledge of economics, holding the Robert P. Gwinn Professor of Economics position at the University of Chicago. It’s with that understanding that I’m asking for your assistance in understanding the latest budget proposals put forward by the White House Office of Budget and Management.
Each year since 2009 I’ve downloaded the Summary Schedules and done a high level review of the assumptions and trends. In 2009 (2010 Budget) I came away with the feeling that the major assumptions in table S-13 were overly optimistic leading me to wonder if the results shown in the budget were achievable. In 2010 (2011 Budget) I analyzed historical data in an attempt to determine if the assumptions in table S-13 could be supported by past trends. I came away concerned that the inflation assumption was understated from what should be expected and that the Net Interest Expense was also significantly understated. I calculated Net Interest Expense could have been understated by as much as $3.8 trillion over the ten years covered in the budget. This year (2012 Budget) I concentrated on the inflation assumption as it is probably the most important driver determining the budget results. I looked at historical data and current year results. (I wrote to the President about my concerns. In case he hasn’t shared my letter with you, I’ve included a copy.)
During my years in preparing and presenting budgets, the first step I took was to get approval of “high level” assumptions so that’s why I started there. In the case of projecting results for 10 years, it would appear the inflation assumption (Consumer Price Index, percent change, year to year) would be the most important of those shown in Table S-13. Not only does it have a large impact on the size of Outlays, Deficits and Debt in the “out years”, but it also helps determine what assumptions are reasonable to use for interest rates.
This year I noticed that each of the three budgets used a maximum inflation assumption of 2.1%. So I wondered how well we had done in the past at keeping inflation at or below that rate. Going to the government website for CPI (inflation) I found since 1965 there had only been 7 years (1986, 1997, 1998, 2001, 2003, 2008 & 2010) at or below 2.1%.) Most of those years were during times of recession. Most non-recession years were significantly higher.
From there I looked at the combined assumptions to see what the trends are. I saw reasonably strong growth, decreasing unemployment and low interest rates. My understanding of economics says that during times of growth and reducing unemployment we typically see an increase in inflationary pressures. I believe that was one of the driving factors that caused the Fed to increase interest rates in 2004 (Fed Fund went from 1.00% to 5.25%).
I also looked to see how we have done so far in fiscal year 2011. What I came away with is we have nearly matched the 1.3% assumption for this year during the first 5 months (Oct ’10 to Feb ’11). If that’s the case, I’m not sure the assumption for 2011 will prove to be a reasonable one.
Finally I modeled the compounded impact of various inflation rate assumptions to see what impact it would have on year 10 projections. As you might expect, the difference between the factor for year 10 using the budget assumptions (average 2.0%) and what I thought would be a more historically appropriate rate (i.e. 3.5%) is very significant. The impact on interest rates would be quite significant too.
I’m hoping I’m missing something, but I’m not sure what it would be. I even checked to see if there was a precedent for the use of the Fed Target Rate as the maximum inflation rate. That wasn’t the case as the maximum inflation assumption in the 2009 budget and 2007 budget were 3.2% and 3.4% respectively. (I didn’t check 2008.)
I hope you can help me answer the following questions:
- Is it appropriate to use the Fed Target rate as the maximum inflation rate assumption in the budget?
- If not, what would you think would be a good set of inflation assumptions to use? (I thought a 3.5% to 4.0% average would be more reasonable.)
- If the inflation rate assumption is understated, doesn’t that mean the interest rate assumptions (especially 91 Day Treasury rate) are also understated?
- What would you think would be good assumptions for interest rates if you believe they are understated?
Again, my lack of advanced economic training may be causing me to miss something, but this looks like such a basic error that it almost appears to have been done on purpose. The combination of these issues results in such a significant understatement of Outlays, Deficits and Debt in out years it allows for the appearance of fiscal restraint when in fact reasonable projections would show a true crisis.
I’ve come to the conclusion that it would make sense to reforecast the budget so we have better numbers to look at and Congress has better numbers to make decisions from. What do you think?
I welcome your feedback.
Sincerely,
Alan R. Davis
Private Citizen
CC: Jacob J. Lew, Director
The Office of Management and Budget
725 17th Street, NW
Washington, DC 20503
Douglas Elmendorf, Director
Congressional Budget Office
Ford House Office Building, 4th Floor
Second and D Streets, SW
Washington, DC 20515-6925
Sen. Kent Conrad
Chairman, Senate Budget Com.
530 Hart SOB
Washington, DC 20510
Rep. Paul Ryan
Chairman, House Budget Com.
1233 Longworth HOB
Washington, DC 20515-4901
Rep. Bob Gibbs
329 Cannon HOB
Washington, DC 20515-3518
Sen. Sherrod Brown
713 Hart SOB
Washington, DC 20510
Sen. Rob Portman
B40D Dirksen SOB
Washington, DC 20510
Rep. Robert Dold
212 Cannon HOB
Washington, DC 20515-1310
Jim Angle
Fox News
400 N Capitol St NW
Washington, DC 20001
Ben S. Bernanke
Chairman, Federal Reserve Board
Board of Governors of the Federal Reserve System
20th Street and Constitution Avenue NW
Washington, DC 20551
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