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Government spending and economic growth, V [ClearOnMoney]
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Government spending and economic growth, V

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Commentary

Government spending and economic growth, V

22 Aug 2012 by Jim Fickett.

The Congressional Budget Office projects a recession if Congress does not do something about the “fiscal cliff”. This projection may very well be right, but no real evidence is presented by the CBO to support it.

The main conclusion of this series was already clear in the fourth post – namely, that there is precious little evidence for a close connection between government spending and economic growth. There may well be a connection, or there may not be, but the economics profession has failed to make a clear case for one.

This series of posts was sparked by an argument over the value of stimulus – a positive spending shock. But of course any connection can also work for negative shocks, and there is a large negative shock threatening, namely the so-called “fiscal cliff” which current law entails as of the end of 2012.

Today there were many headlines trumpeting that the Congressional Budget Office projects a recession if the fiscal cliff is not softened (e.g. Congressional Budget Office warns recession looming if Congress doesn't act on "fiscal cliff").

On what is this projection based?

The actual CBO report, at 75 pages, gives many details about what they think the outcome will be, including government outlays to four significant digits ten years out, but gives no hint on how the projections are actually calculated.

A quick google search brings up a related older CBO document, How CBO Analyzed the Macroeconomic Effects of the President's Budget, from July 2003. Here they do explain their methodology:

Description of the Models

This section provides a summary description of the models that CBO used in its analysis: the textbook growth model, the life-cycle model, the infinite-horizon model, and the two macroeconometric models. …

The Life-Cycle Model

The life-cycle model is a general-equilibrium growth model. It incorporates simulated households that make decisions about how much to work and save in order to make themselves as well off as possible over their lifetime. Those simulated households differ in their ages, working ability (measured by hourly wages), accumulated savings, and earnings histories (which determine their Social Security benefits). A household is assumed to consist of a married couple with some children. …

Each household chooses its optimal consumption, labor supply (working hours), and savings, taking a series of current and future factor prices (such as the interest rate and wage rate) and policy variables (such as marginal income tax rates) as givens. Households in the model can foresee those future factor prices and policy variables because they are assumed to know all future government policies as well as the current distribution of households does and because there are no aggregate shocks in the model.

[emphasis added]

Gee, totally rational households that know the future. How realistic!

At least in today's report the CBO admits,

The path of recovery has so far been difficult to predict, and outcomes in coming years will no doubt hold surprises as well.

It really is astonishing that public policy debates assume macroeconomic projections have some value, but there is no evidence presented that this is the case, and no discussion of past track record. What exactly is the difference between this any any of the powerful priesthoods of “less advanced” societies in the past?