ECONOMIC AND BUDGET ANALYSES

ECONOMIC AND BUDGET ANALYSES

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2. ECONOMIC ASSUMPTIONS AND OVERVIEW

This chapter presents the economic assumptions that underlie the Administration's 2022 Budget.1 It provides an overview of the recent performance of the American economy, presents the Administration's projections for key macroeconomic variables, compares them to forecasts prepared by other prominent institutions, and discusses the unavoidable uncertainty inherent in providing longterm forecasts.

This chapter proceeds as follows: The first section provides an overview of the recent functioning of the U.S. economy, examining the performance of a broad array of key economic indicators. The second section presents a detailed exposition of the Administration's economic assumptions underlying the 2022 Budget, discussing how key macroeconomic variables are expected to evolve over the years 2021 to 2031. The third section compares the forecast of the Administration with those of the Congressional Budget Office (CBO), the Federal Open Market Committee of the Federal Reserve, and the Blue Chip panel of private-sector forecasters. The fourth section discusses the sensitivity of the Administration's projections of Federal receipts and outlays to alternative paths of macroeconomic variables. The fifth section considers the errors in past Administrations' forecasts, comparing them with the errors in forecasts produced by the CBO and the Blue Chip panel of private professional forecasters. The sixth section uses information on past accuracy of Administration forecasts to provide understanding

1 Economic performance, unless otherwise specified, is discussed in terms of calendar years (January-December). Budget figures are discussed in terms of fiscal years (October-September).

and insight into the uncertainty associated with the Administration's current forecast of the budget balance.

Recent Economic Performance2

The onset of the COVID-19 pandemic was marked by a sharp recession with steep declines across all prominent U.S. economic indicators. Unlike a typical recession, the effects of the recession were most acutely felt by those in the service and retail sectors, where social distancing behavior limited overall spending and activity. The economy plunged in the second quarter of 2020 and has partially rebounded in the quarters since, yet GDP remains below its pre-pandemic peak. Gains continue to be made in labor force participation while employers have added over 1.5 million jobs since the beginning of 2021.

Looking forward, consumers and businesses alike are showing increasing optimism following the passage of the American Rescue Plan Act of 2021 and significant progress in controlling the pandemic. Both the University of Michigan and Conference Board indicators for consumer sentiment and consumer confidence, respectively, have increased substantially over the past few months. Improvements in consumer sentiment signal increased consumer spending heading into the summer months. Businesses are also exhibiting optimism, as seen in the recent high levels of the ISM Purchasing Managers Index, a survey of business activity at manufacturing companies.

Labor Markets--The headline unemployment rate (U3) spiked to 14.8 percent in April 2020 and has gradually declined to 6.1 percent as of April 2021. While the

2 The statistics in this section are based on information available in April 2021.

Chart 2-1. Labor Underutilization: Alternative Measures

Source: Bureau of Economic Analysis, Haver.

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ANALYTICAL PERSPECTIVES

Chart 2-2. Contributions to Percent Change in 2020 Real GDP

Source: Bureau of Economic Analysis, Haver, Office of Management and Budget.

decline in the unemployment rate is a positive sign for the economy, and the Blue Chip panel of professional forecasters projects that the unemployment rate will fall to an average of 4.7 percent during 2022, several important labor market indicators still show signs of weakness.

By looking at alternative measures of labor underutilization (Chart 2-1), we can get a clearer picture of the state of employment. The U5 unemployment rate, which includes those workers who identify as marginally attached to the workforce, is 7.2 percent as of April.3 Including workers who are working part-time for economic reasons (U6), the rate is 10.4 percent. Additionally, not only do millions of Americans remain unemployed--9.8 million as of April, a 72.0 percent increase from February 2020--but the duration of unemployment remains elevat-

3 The BLS defines marginally attached workers as persons who are not in the labor force, want and are available for work, and had looked for a job sometime in the prior 12 months. They are not counted as unemployed because they had not searched for work in the prior 4 weeks.

ed as well. The long-term unemployment rate (U1), which measures the percent of the labor force unemployed for 15 weeks or longer, is 3.3 percent as of April; this is almost three times as high as the pre-pandemic rate of 1.2 percent from February 2020. Moreover, the median duration of unemployment in April was 19.8 weeks, which is the highest this indicator has been since October 2012.

Consumption--Consumption by private households is the largest component of the country's economy, accounting for over two-thirds of output in 2019. Because of its large share of GDP, consumer spending growth is essential to economic growth in the United States. Real personal consumption expenditures (PCE) declined sharply at the onset of the pandemic (6.9 and 33.2 percent at an annual rate in 2020 Q1 and Q2, respectively), and following a large increase in Q3 (41.0 percent), progress has continued (2.3 percent in Q4 and 10.7 percent in 2021 Q1). As of 2021 Q1, real PCE is only 0.2 percent below where it was at the end of 2019.

Chart 2-3. Components of Real Personal Consumption Expenditures

Relative to January 2020

Source: Bureau of Economic Analysis, Haver, Office of Management and Budget

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2. Economic Assumptions and Overview

Table 2?1. ECONOMIC ASSUMPTIONS1

(Calendar Years, Dollar Amounts In Billions)

Projections Actual 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 2031

Gross Domestic Product (GDP) Levels, Dollar Amounts in Billions:

Current Dollars Real, Chained (2012) Dollars Chained Price Index (2012=100), Annual Average Percent Change, Fourth Quarter over Fourth Quarter: Current Dollars Real, Chained (2012) Dollars Chained Price Index (2012=100)

21,433 19,092

112

4.0 2.3 1.6

20,933 18,423

114

-1.2 -2.5 1.3

22,411 19,375

116

7.1 5.2 1.8

23,799 20,200

118

5.2 3.2 1.9

24,808 20,652

120

4.0 2.0 2.0

25,778 21,039

123

3.8 1.8 2.0

26,767 21,418

125

3.8 1.8 2.0

27,794 21,803

128

3.8 1.8 2.0

28,860 22,196

130

3.8 1.8 2.0

29,986 22,609

133

3.9 1.9 2.0

31,166 23,039

135

3.9 1.9 2.0

32,414 23,491

138

4.0 2.0 2.0

33,723 23,961

141

4.0 2.0 2.0

Incomes, Billions of Current Dollars Domestic Corporate Profits Employee Compensation Wages and Salaries Nonwage Personal Income

1,745 11,432 9,309 5,413

1,616 11,489 9,369 5,409

1,529 12,247 10,047 5,324

1,725 12,907 10,491 5,522

1,795 13,416 10,918 5,806

1,861 13,909 11,383 6,096

1,880 14,435 11,818 6,436

1,854 15,018 12,296 6,747

1,828 15,642 12,812 7,094

1,825 16,305 13,352 7,371

1,849 17,002 13,930 7,650

1,900 17,730 14,526 7,984

1,955 18,491 15,159 8,265

Consumer Price Index (All Urban)3:

Level (1982-1984 = 100), Annual Average 249 252 258 263 269 275 281 287 294 301 307 314 321

Percent Change, Fourth Quarter over Fourth Quarter 1.9 1.3 2.0 2.1 2.2 2.3 2.3 2.3 2.3 2.3 2.3 2.3 2.3

Unemployment Rate, Civilian, Percent Annual Average 3.7 8.1 5.5 4.1 3.8 3.8 3.8 3.8 3.8 3.8 3.8 3.8 3.8

Interest Rates, Percent

91-Day Treasury Bills2

2.1

0.4

0.1

0.2

0.4

0.8

1.2

1.5

1.6

1.7

1.8

2.1

2.3

10-Year Treasury Notes 2.1 0.9 1.2 1.4 1.7 2.1 2.4 2.6 2.7 2.8 2.8 2.8 2.8

1 Based on information available as of mid-February 2021 2 Average rate, secondary market (bank discount basis) 3 Seasonally Adjusted

A prominent story of the pandemic has been the extent of the economic damage in specific sectors, particularly services. Chart 2-2 illustrates that a decline in the combined consumption of goods and services accounted for 75 percent of the total decline in real GDP for the year as a whole in 2020. Looking at the composition of services consumption, Chart 2-3 shows that several prominent service sectors are still considerably below pre-pandemic levels.

Nonresidential Fixed Investment--Real nonresidential fixed investment declined at an annual rate of 4.0 percent in 2020 (year-over-year). Equipment and intellectual property investment have recovered strongly in recent quarters, although business structures investment remains slow.

The Government Sector--Topline real government expenditures on consumption and investment increased 1.1 percent in 2020 (year-over-year), which includes a 4.3 percent increase in Federal spending partially offset by a 0.8 percent decline in State and Local spending. Within the Federal spending category, nondefense spending rose 5.6 percent while defense spending increased 3.5 percent.

Federal Reserve Policy--The Federal Reserve's response to the COVID-19 pandemic can be grouped into three main categories: lowering the policy rate, stabilizing financial markets, and supporting the flow of credit in the economy.4 First, the Fed's monetary policymaking

4 See the following Fed blog post for a more detailed description of the

body--the Federal Open Market Committee (FOMC)-- quickly lowered the target range for the federal funds rate. The federal funds rate, which serves as the FOMC's policy interest rate, is the rate that banks charge each other for overnight loans. In an effort to forestall negative economic impacts from the pandemic, the FOMC rapidly lowered the federal funds rate from an average of 1.59 in January 2020 to 0.08 by the end of March 2020, and this rate currently sits within the target range of 0 to 0.25 percent as of April 2021. This step helped reduce borrowing costs for households and businesses.

During its March 2021 meeting the FOMC announced it would maintain the target range for the federal funds rate at 0 to 0.25 percent. In its accompanying statement, the Committee repeated that it will not raise the federal funds rate target range "until labor market conditions have reached levels consistent with the Committee's assessments of maximum employment and inflation has risen to 2 percent and is on track to moderately exceed 2 percent for some time."

Second, the Fed took a number of steps to unfreeze key financial markets and to help them run smoothly. In many cases this involved the purchases of securities and assets that were otherwise difficult to sell. These purchases con-

Fed's policy response to the pandemic:

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