CBO’s Fiscal Prediction Fails the Smell Test

Washington Post, October 23, 2012. All Rights Reserved.

The Congressional Budget Office predicted back in August that if the country went over the fiscal cliff, the economy would dip into a shallow recession and take about a year to recover. The U.S. economy would shrink about 0.5 percent over the year before bouncing back and growing at a rapid clip of 4.3 percent annually between 2014 and 2017.

However, the Washington Post’s Brad Plumer reports that a new study by the Levy Economics Institute found problems with CBO’s estimate and claims that it is optimistic at best – without providing alternative projections for declining growth next year.

The authors of the report argue that unless one assumes that U.S. households will start borrowing and spending at an unprecedented rate – which is not likely to happen — the CBO’s numbers don’t work. The report notes, “households would have to carry more debt than they did at the height of the housing bubble for the CBO’s optimistic growth rates to come true.”

The Levy Economics Institute maps out three post-cliff scenarios.:

Scenario 1 — There  is an unlikely boom in household borrowing and spending. 
Scenario 2 – The Bush tax cuts are extended and households increase their borrowing and consumption at a more realistic rate. Unemployment stays high.
Scenario 3 – Congress enacts a very modest fiscal stimulus. Unemployment goes down just a bit.

The report also predicts that unemployment will remain unacceptably high for an indefinite period unless Congress and the White House agree to avert a year-end confluence of major tax increases and spending cuts. “Based on our results, we surmise that it would take a much more substantial increase in fiscal stimulus to reduce unemployment to a level that most policymakers would regard as acceptable.”