Every Time Someone Uses a CBO Forecast, a Dead Puppy Returns to Life

I can always tell at a glance when someone has made a projection based on Congressional Budget Office forecasts, since they always involve a picture of doom and gloom that suddenly explodes into prosperity a couple of years after the line between "historical" and "projected." Dead puppies are projected to come back to life and resume playing, based on historical trends for the amount of time those puppies spent playing before they died and subsequently became not much fun.

The CBO produces economic forecasts for Congress. There are two assumptions in CBO forecasts that make them useless for anyone else, one of which might make them useless for Congress itself.

The first of these assumptions is that the forecasts are made "under current law," which means that they do not account for any new laws and new spending that Congress might make in the meantime. That's not a problem for Congress since they use CBO forecasts to guess at how much money they might be able to spend, but for the rest of us, the CBO forecast provides us with a forecast for a world in which Congress meets to discuss new ways to spend money, but goes home after they can't think of any.

The second of these assumptions is that GDP will return to trend, in other words that we'll be back to potential GDP within a few years. Exactly what potential GDP is involves a whole lot of guessing and some extrapolating of historical GDP growth, but the basic idea is that if you have a crappy economy, it's not a permanent setback and it'll grow faster later to make up for it. The latest CBO forecast assumes that we'll be all caught up by 2017.

In 2008, they assumed better than average historical growth for the years after 2009. From 2010-2013 we averaged 1.95% GDP growth, well below the average historical growth of 3.4%. They also guessed in 2008 that GDP would grow by 2.8% in 2009, when it ended up shrinking by 2.6%.

In 2009, they assumed that we'd be back to trend by 2014. We're about a trillion dollars short and 2014 is three months away. Some of us might need to work a couple of extra weekends.

The point I'm making with all of this is that the CBO has an established record of being overly optimistic in its assumptions that GDP will return to trend. Potential GDP is a function of many things: physical and human capital, technology, institutions both private and public, regulation, and so on. Changes in regulation, such as mandating insurance for full time employees, can affect potential GDP in a permanent way. Low labor force participation means that human capital goes unused. Bad government can turn a crappy economy from a temporary setback into the new normal. While the CBO does try to account for losses in human capital due to people retiring or sitting idle for an extended period, it does not, to the best of my knowledge, account for costs of regulatory compliance or people getting priced out of the labor market to due minimum wage increases or insurance mandates.

Stop using CBO forecasts. The puppy is dead.