By Robert W. Arnold (CBO)
As part of its mandate to provide nonpartisan analyses to assist economic and budgetary decisions by the Congress, CBO prepares an economic forecast twice per year. Those forecasts are used in the agency’s projections for the federal budget and cost estimates for proposed federal legislation. Forecasts of gross domestic product, inflation, interest rates, and income play a particularly significant role in the agency’s budgetary analysis; for example, projections of wages and salaries are used to forecast individual income tax receipts.
This paper describes the process used to produce CBO’s economic forecast. That process includes background analysis, the preparation of a series of preliminary forecasts, and several rounds of internal and external review. Central to the process is CBO’s large-scale macroeconometric model, which combines the forecasts of underlying inputs to produce forecasts of the macroeconomic variables of interest. That model focuses on the interaction between aggregate demand (which includes consumer spending, business investment, residential investment, government spending, and net exports) and aggregate supply (which includes the factors that determine CBO’s estimate of potential output) in the economy. The interaction of aggregate demand and aggregate supply determines the forecasts of the other variables in the model, including inflation, interest rates, the unemployment rate and incomes.
On March 5, 2018, CBO reposted this working paper with corrected text in Figure 2 (page 7).