The U.S. Economy to 2012: Signs of Growth: Based on the Assumptions Used in Developing Economic Projections, Real GDP Is Expected to Grow during the Next Decade, While Productivity Remains Strong and Inflation Remains Stable
Su, Betty W., Monthly Labor Review
Every 2 years, the Bureau of Labor Statistics prepares a set of projected U.S. economic factors that form the basis for the employment projections program. This article presents the projections of U.S. economic factors that underlie the 2002-12 employment projections. This set of aggregate economic projections presents some unique challenges. After the boom of the 1990s, the U.S. economy suffered a number of serious setbacks, including: the bursting of the technology bubble; the September 11, 2001, terrorist attacks; significant losses of stock market wealth; a stagnant job market; corporate accounting scandals; and uncertainties related to the war in Iraq.
Although the economy has had difficulty shaking off a stubborn slowdown, recent statistical data suggest that we are now poised for a more sustained recovery. During the 2000-02 period, the U.S. economy has experienced low inflation, low interest rates, strong productivity growth, and a healthy housing market. Also, both government monetary and fiscal policies have been focused on stimulating economic growth. Under the assumptions used by the Bureau in developing these projections, gross domestic product (GDP) is expected to reach $12.6 trillion in chained 1996 dollars by 2012, an increase of $3.2 trillion during the 2002-12 decade. (Also see box on page 25.) (1) This translates to an average annual rate of growth for real GDP of 3.0 percent over the period, 0.2 percentage point lower than the historical rate of 3.2 percent from 1992 to 2002. A slower growth of civilian household employment, from 1.3 percent a year during the 1992-2002 period to 1.2 percent from 2002 to 2012, is expected to result in an increase of 17.3 million employees over the latter period, still greater than the increase of 15.8 million employees over the preceding 10-year period, from 1992 to 2002. The employment projection is accompanied by an expected unemployment rate of 5.2 percent in 2012, 0.6 percentage point lower than that in 2002.
Reflecting increased globalization of the U.S. economy, foreign sectors are expected to continue their fast growing trend in the next 10 years. Besides foreign trade, gross private domestic investment also is expected to play a substantial role in the economy over the 2002-12 period. Business spending on high-tech and computer-related equipment is anticipated to lead the rapid growth. On the government side, a projected increase in defense spending reflects the long-term efforts to win the global war on terrorism and protect the American homeland.
This article begins the discussion of economic projections with the macroeconomic model and major underlying assumptions. It then examines more closely the projections of aggregate demand categories of GDP. Lastly, the Bureau's expectations for the growth of incomes, employment, and labor productivity are discussed in turn. The projections are described in the context of trends over the 2002-12 period.
The macroeconomic model
The aggregate economic projections presented in this article have been developed in the context of the macroeconomic model provided by Macroeconomic Advisers, LLC, a St. Louis, MO, based forecasting group. (2) The company's quarterly model comprises 609 variables descriptive of the U.S. economy, of which 169 are exogenous assumptions--that is, variables whose values must be provided to the model in order to calculate a solution for a given period of time. Among the 169 exogenous variables, only a relatively small number of these assumptions significantly affect the long-term projections of the value of cop and its demand makeup, as well as the level of employment necessary to produce that GDP. Those key assumptions are listed in table 1.
In addition, the projections are generally prepared with selected variables, such as the inflation rate, the level of the unemployment rate, the labor productivity growth rate, and the international trade-related issue, which are much more carefully evaluated than the other variables in the model. Setting a preliminary target value for those key variables, helps in defining the parameters around which overall projections are developed.
Monetary policy. Early in 2001, just before the economy officially entered a recession, (3) the Federal Reserve started easing monetary policy and cutting the Federal funds rate. Within a year, the rate was cut a total of 11 times, from 6.50 percent to 1.75 percent. In the following year, the rate fell further, to 1.25 percent in November, in response to the economic shocks accompanying the 9/11 attacks and the war with Iraq. Increasingly worded that U.S. economic growth was close to stalling, the Federal Reserve cut the funds rate again in late June 2003 to a 45-year low of 1.00 percent to help revive the economy and help prevent the economically dangerous threat of deflation. (4)
Generally, the monetary sector in the econometric model is designed to determine the money supply with a long-term steady growth. The BLS projection assumes that once growth recovers towards "trend," the Federal Reserve will reverse course and undertake monetary tightening that will push the funds rate up. By 2012, the Federal funds rate is assumed to rise to 5.33 percent, a rate close to its historical average. Bond yields will generally move parallel to the funds rate over the projection interval, but run somewhat higher. The yield on the 10-year Treasury note is expected to reach 6.25 percent in 2012. (See table 1.)
Fiscal policy. The Bureau's 10-year projections incorporate the policy impacts associated with three major tax bills enacted in the past 2-1/2 years. The first tax cuts are the immediate implementation of provisions in the "Economic Growth and Tax Relief Reconciliation Act of 2001" (EGTRRA or Economic Growth Act); the second tax cuts are the provisions of the "Job Creation and Worker Assistance Act of 2002" (JCWAA, or Job Creation Act); and the third are the recently enacted provisions of the "Jobs and Growth Tax Relief Reconciliation Act of 2003" (JGTRRA or Jobs and Tax Relief Act). The fiscal stimulus packages include reduced tax rates for individuals and on capital gains, and increases of expensing limits for certain types of investment. Although some of the provisions in the Jobs and Tax Relief Act are set to expire and return to the provisions set in the Economic Growth Act, and all of the provisions of the Economic Growth Act are scheduled to expire in 2010 and return to prior law, the model assumes that the provisions will be extended through the projection period. (5)
Tax-related assumptions affect Federal Government revenues. The Federal effective marginal personal tax rate increased from 21.3 percent of personal income in 1992 to 22.5 percent by 2002. Reflecting the recently enacted tax cut package, a gradual decrease in this rate is expected to occur over the next decade. In the BLS projections, it is assumed that the effective marginal personal tax rate will drop to 21.4 percent in 2012, noticeably lower than that in 2002. The effective marginal dividends tax rate is expected to drop significantly from 28.0 percent in 2002 to 22.5 percent in 2012, while the capital gains tax rate is anticipated to fall from 18.8 percent in 2002 to 15.0 percent in 2012. The maximum Federal corporate tax rate is assumed to be maintained at 35.0 percent in 2012; the same as in 2002.
Government spending and the budget deficit. Since 2001, Federal defense spending has increased sharply in response to the terrorist attacks of September 11 and the military operations in Afghanistan and Iraq. The acceleration of spending, together with reduced revenues due to the recent economic slowdown and legislation enacted over the past couple of years, has pushed the Federal budget from a surplus of $207 billion in 2000 and $72 billion in 2001 to a deficit of $202 billion in 2002 and an estimated $400 billion in 2003. According to the Department of Defense's current established budget plan for the next 6 years through 2009, it would require funding at higher levels than defense spending has been in any year since 1980. The budget emphasizes strong support for the global war on terrorism, sustaining high quality personnel and forces, and transforming the U.S. defense establishment. (6) On the basis of Defense Department estimates, the Bureau has assumed that, after 2009, defense spending will continue the same trend toward increased levels, growing about 2 percent per year through the rest of the projection period.
In addition, the significant long-term strains on spending will begin to intensify within the next decade as the baby-boom generation begins reaching retirement age. Driving those pressures on the budget will be growth in the largest retirement and health programs. Federal spending on Social Security, Medicare, and Medicaid will consume a growing portion of budgetary resources. BLS assumes that long-term defense spending on consumption and gross investment will continue to rise over the entire projection period. In short, high spending levels accompanying tax reductions will add to fiscal stimulus throughout the entire projections, but will result in budget deficits, reaching an estimated $164 billion in nominal terms in 2012. (A further discussion is presented later in the "Federal Government" section.)
Energy. Among the energy-related assumptions, the most important is the refiners' acquisition price for crude oil, expressed in dollars per barrel. Growing concerns about a U.S. confrontation with Iraq and wider disruptions to Gulf supplies drove U.S. crude oil over $40 per barrel in February 2003, approaching the $41.15 record set during the buildup to the 1991 Gulf War. Although oil prices dropped after the U.S. attacked Iraq, with little disruption to Middle East crude flows, energy prices are still on the high side.
In the aggregate economic model, the level of GDP determines the level of energy demanded by the economy; the price of crude oil determines the level of domestic production, and the residual amount of the energy demand not met by domestic production is, by assumption, met by imports of crude petroleum. This particular assumption is drawn from annual energy projections prepared by the U.S. Department of Energy, which expects the dollar value of a barrel of crude oil to rise from about $23.61 per barrel in 2002 in nominal terms to $30.52 per barrel in 2012. The domestic share of crude-oil production is expected to continue to decline from 54.6 percent of total U.S. demand in 1992 and 39.5 percent in 2002 to 31.2 percent by 2012. (7)
Demographic assumptions. The demographic assumptions are based on the 2000 Census middle-series population projections. These projections estimate the U.S. population to be expanding at an annual rate of 0.9 percent between 2002 and 2012, when the population reaches 315 million. Growth in the older age cohorts will be strong as baby boomers age. The BLS labor force projections are consistent with the Census Bureau population projections and are prepared at detailed levels as well as for the aggregate; the estimates then carry over to the aggregate economic model. (8)
Inflation. After accelerating in the 1970s and early 1980s, inflation has slowed significantly in recent years. Combined with high productivity, relatively cheaper imports, and the absence of commodity shocks, even during a long-lived expansion in the 1990s, changes in the labor market prevented any significant acceleration of wages. While wage pressures remained remarkably modest, inflation remained moderate.
Monetary policy remains important in the long-term projections, not so much in determining the level of output, but rather in determining the rate of inflation. With a steady-state rate of inflation in mind, it is assumed that the Federal Reserve will attempt to keep inflation contained over the projection period while providing adequate money growth to fuel economic expansion. The rate of inflation, as measured by the chain-weighted GDP price index, will grow at an average rate of 2.2 percent per year over the projection horizon.
Unemployment rate. During the recession of 2001, the unemployment rate rose from a 30-year low of 4.0 percent in 2000 to 4.7 percent in 2001 and jumped further to 5.8 percent in 2002. The unemployment rate reached an 8-year-high of 6.0 percent in 2003. However, the model assumes that long-term economic growth and job recovery will gradually push the unemployment rate down over the projection period. Keeping the labor force projections with steady inflation in mind, by the end of the projection interval, the economy is expected to make a transition towards "full employment." This underlies the expected unemployment rate of 5.2 percent in 2012. (A further discussion is presented later in the "Employment" section.)
Productivity growth. It is the economy's ability to increase supply in the face of increasing demand over the long run that determines its potential growth path. Growth in aggregate supply depends on the increase in the labor force, the growth of the capital stock, and improvements in productivity. In general, productivity is a cyclical variable that typically …
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Publication information: Article title: The U.S. Economy to 2012: Signs of Growth: Based on the Assumptions Used in Developing Economic Projections, Real GDP Is Expected to Grow during the Next Decade, While Productivity Remains Strong and Inflation Remains Stable. Contributors: Su, Betty W. - Author. Journal title: Monthly Labor Review. Volume: 127. Issue: 2 Publication date: February 2004. Page number: 23+. © 1999 U.S. Bureau of Labor Statistics. COPYRIGHT 2004 Gale Group.