Wednesday, coverage everywhere buzzed with excitement over what’s clearly this time of year’s red-letter event. No, we’re not referring to the Super Bowl, Mardi Gras or even the approach of Valentine’s Day. As it does at this time of year annually, the Congressional Budget Office (CBO) just published its initial economic projections for 2013.
For the record, the CBO is a nonpartisan government body tasked with evaluating the economic effects of both current and proposed government policies. Its major, preplanned works are its annual outlook and the revision to its annual outlook, released midyear. (In addition, the CBO will attempt to assess the economic impact of proposed legislation if requested by members of Congress.) In its reports, a series of different indicators—GDP, unemployment or tax revenue for example—are plotted not only for the year ahead, but stretching out a full decade. (There’s even an appendix that goes far further, projecting debt, deficits and GDP six presidential elections [12 congresses] from now.) A difficult task, to be sure, one unlikely to be completed with much accuracy. Long range forecasting is folly, forever and ever, amen.
But still, many do seem to harp on the projections and take them, in our view, far too literally.
In this year’s release, the CBO projected (under current policy) the budget deficit will fall to $845 billion, but net debt will rise to 77% of GDP … through 2023. For the record, it’s currently about 71%, implying the CBO believes current policy will amount to only a six percentage point increase in net debt over the next decade. (Don’t worry, we’re not taking that forecast to the bank. More on that later.) Don’t think for a moment, though, that this will quell debate or fear over US debt.
Separately, the report also noted nominal GDP is still below nominal potential GDP—and could be for some time to come. Which seems to have spurred a fair amount of worry. Some interpret this as a call for more government action to spur the economy. Yet potential GDP is a rather arbitrary, reversion-to-the-mean driven, linear analysis of what growth could have been if the entire American economy operated at full steam (employment, industrial production, services output, etc.). Said differently, it’s what growth would have been if life didn’t happen. This measure has next to no value for investors, because, put simply, the occasional economic downturn is an unfortunate fact of life. By definition recessions push growth under a linear “potential” figure. Yet when you consider headline GDP figures aren’t perfectly reflective of economic health and vibrancy, and that GDP doesn’t translate directly to market results, you start to realize this is a debater’s tool—not one with much real-world applicability. Yet to the extent it influences the debate over economic policy, it could actually have an effect on the CBO’s long-range net-debt forecasts--highlighting the folly of paying much heed to CBO reports.
The CBO is tasked with an impossible mission, one that’s never likely to be completed with pinpoint (or in many cases, even ballpark) precision. They’re asked to forecast a decade out, but are required by law to use the “current services baseline”—a rule mandating the CBO make its annual forecast based on the presumption current laws, spending and tax policies are the same for the entirety of the forecast period. Forecasts made ten years ago today, despite the “temporary” 2003 tax rates that were among the longest lasting in American history, would still be skewed by this. The likelihood we have the current slate of policies—in full across the board—a decade from now is remote. And that’s only the policy end of the analysis. The CBO still has to layer an economic forecast on that. The results are often misses, like the well-documented 2000 CBO forecast we’d be free of all net debt by 2010. Which, while that’s perhaps the most stark example, is not a lonely inaccuracy. The fact is the CBO’s track record is dotted with them—even ones much closer than a decade out. The CBO’s average margin of error in five-year forecasts is a yawning gap of 2.65% of GDP.
In our view, the CBO’s projections hold very little value for investors, because they’re based on way too many variables subject to massive change. In order to facilitate even producing a forecast, constant assumptions must be made. And who sets those assumptions, you ask? Well, they’re mandated by laws politicians pass. Only a handful of months ago, such CBO assessments of the size of the fiscal cliff led to a great deal of unnecessary nerves. We’re betting many of those who hinged their arguments before on the CBO’s analyses will as quickly dismiss this version’s non-fear-inducing debt analysis. These analyses, fun as they are, should be met with a great deal of skepticism—not skepticism of the selective variety.
So in the end, the CBO’s nonpartisan nature is not in question. But its analyses and projections, underpinned by politician’s presumptions, seem to be mostly fodder for very partisan debate.