Diary

The Fool's Gold Standard of Economic Projections

Enter the Congressional Budget Office (CBO). “Everyone” agrees they are the “gold standard” of economic projections. What if their mathematics and statistical arguments are sound? What if their academic credentials are impeccable? But what if they still get it wrong?  What if they are not so good at predictions? What if their estimate of a nine or ten trillion dollar deficit over the next decade or so is off by a factor of two, or three or (gasp) five? Just ask Debbie Downer.

 

Politicians and pundit of all stripes have blamed the recent debacle in the financial markets on un-named greedy bankers who risked the entire world financial system just so they could buy a better penthouse in Manhattan. Yet today we have politicians relying on number crunchers whose methods they don’t understand, using assumptions that no rational person would accept. Is that not a risk? If they are wrong, America can look forward to decades of economic instability, while half the world can just starve.

 

The problem is that NOBODY this side of Heaven can reliably predict next year’s economy, let alone ten years from now. “But it’s the best we can do”, I hear them whine. Well, no. It is easy to do better. How do I know that? Heh heh, I am a REAL expert. But I’ll violate the expert code of silence just enough to tell you how I know that. Actually, all I really know is that I have no idea what the economy will do between now and 2020, and I sure don’t know how much new legislation will exacerbate the problem.

 

The CBO methodology is actually quite simple. It has to be. It is prescribed by law! They make some assumptions about inflation, interest rates, and GDP. Then they assume that nothing will be done by Congress to mess up these assumptions. Then they use spreadsheets and digital computers and blackberries to calculate numbers to 76 decimal places when no more than 70 can be justified. (That is a joke for the mathematical elite among you.) Then they release a single number as the ten year deficit projection. They are the gold standard, if by gold you mean fool’s gold. You do not need an advanced degree to understand that hidden in those assumptions and calculations are numbers whose actual values could be way off. Many of those numbers are not even possible to ever know accurately, even after the fact.

 

So what can we do? We can examine the impact of various economic and legislative scenarios on the deficit projections. We just can’t predict which scenario will come true. The deficit ultimately depends on two numbers: the average (compounded) growth in revenue and the average growth in expenditures. So I did what any self-respecting geek would do. I cranked up a spreadsheet and made a table showing all the possible ten year deficits that could arise from average growth rates of revenues and expenditures between 1% and 10%.  I can’t say for sure that this range is adequate but it seems a reasonable first step. The best scenario is 10% average growth in revenues combined with 1% growth in spending. That gives no deficit and no surplus. Every other combination produces a deficit. So forget about balancing the budget.  The most optimistic scenario I can imagine really occurring is revenue growth of 3% and spending growth of 5%. That computes to a deficit of $25 trillion. Slightly more pessimistically, revenue growth of only 1% combined with spending growth of 8% slithers in at $37 trillion. Either scenario bankrupts America