College of Business
Western Carolina University
This paper describes the forecast of U.S. gross domestic product (GDP) from 1999 through 2003. Lagged government expenditure was chosen as the explanatory variable used to forecast future GDP. The forecast is based on the Keynesian aggregate expenditure model which relies on the accounting identity expressing that aggregate expenditure or GDP has the following components: consumption, investment, government expenditure, and net exports. The GDP forecast predicts a recession in the economy over the next five years. This conclusion is drawn from the fact that GDP drops by 9% between the first quarter of 1999 and the fourth quarter of 2003. The U.S. government and the Fed need to be concerned about the possibility of a recession occurring in the future so they can begin counteractive measures. If the Fed has some knowledge that a recession may occur then it could lessen the effects typically felt in a recessionary economy. (JEL: E120, H50)
Part 1. Introduction
This paperís intent is to forecast U.S. GDP for the years 1999 to 2003. The explanatory variable used to forecast GDP is real lagged government expenditure. The projection is based on the Keynesian aggregate expenditure model, which involves the marginal propensity to consume (MPC) and the marginal propensity to import (MPI). The Keynesian approach allows the forecaster to investigate the effect real government expenditures have on U.S. economic activity.
GDP is a measure of United States economic activity; thus it represents the strength of the U.S. economy. A growing GDP represents a strong economy. A decline in GDP results in a recession for the nation. The forecast period is five years into the future. The time period is short enough so that external conditions are minimal in impacting the forecast projection. The lengthier the forecast period, the worse the forecast serves as an estimation of future GDP levels.
The rest of this paper is arranged in the following order: Part 2. presents the data that was gathered to forecast GDP; Part 3. explains the economic theory on which the forecast is based; Part 4. presents the GDP forecast for 1999 through 2003; Part 5. indicates the importance GDP has on the U.S. economy; and Part 6. discusses the conclusions for the economic policy.
Part 2. Data
Both the government expenditure data and the GDP data were taken from the Federal Reserve Bank of St. Louis Federal Reserve Economic Data (FRED). The measures of government expenditure and GDP are FRED variables GCEC92 and GDPC92, respectively. They are both real variables and are reported in billions of chained 1992 dollars, which have been seasonally adjusted at annual rates (SAAR). Both variables are reported quarterly. The data used in this forecast was easy to access and a lot was available. The forecast period is five years into the future.
GDP is perhaps the most important measure of a nationís economic activity. The purpose of this forecast is to predict economic activity for future years with lagged government expenditure as the explanatory variable. Lagged government expenditure was chosen to forecast GDP because it is a component of GDP. It is conceivable that government expenditure should be a simple and reliable variable to forecast future GDP.
Part 3. Economic Theory: Forecasting with the Keynesian Model
This forecast assumes the interest rate will remain constant for the next five years. It also assumes that the interest rate will have no effect on government expenditure or GDP. Quarterly GDP will be calculated over the forecast period of five years. Government expenditure data was taken from the 1992.1 to 1998.4 time period.
The Keynesian aggregate expenditure model is appropriate for forecasting GDP because the model supports the idea that government expenditures influence the amount of GDP the United States produces in a given year. One problem with using government expenditure is that it is independent of GDP because the government sets the amount of expenditures for each year. This means that GDP has little or no effect on the amount of government expenditures, even though government expenditures directly influence GDP.
National consumption, investment, government expenditure, and net exports influence the level of GDP for a given year. These components actually drive the amount of GDP that is produced a year. The accounting identity that supports this theory is written as:
GDP = AE = C + I + G + X,
where AE is aggregate expenditure, C is consumption, I is investment, and X is net exports for the nation.
In the forecast, government expenditure was taken from the above equation and used in a regression with past GDP figures to calculate future GDP for the United States. The above equation is not actually used in the forecast; it merely supports the theory that government expenditures influence or drive future GDP.
It is the foundation on which the regression is based. There has to be a relationship between GDP and government expenditure in order for the forecast to be plausible. The Keynesian model provides that support.
Lagging the right-hand-side by five years, removing the other variables, and allowing intercept and error terms yields:
This is the equation which is estimated in part 4 and forms the basis of the forecast calculations.
Part 4. GDP Forecast for 1999 through 2003
Government expenditure and GDP are measured in billions of 1992 chained
dollars, which are seasonally adjusted at annual rates.
Regression Estimate of GDP Forecasting Equation 1: 1992.1-1998.4
|Explanatory Variable||Estimated Coefficient||t-ratio|
|G coefficient (b)||-10.1564||-1.30172|
|R Square = 0.220219||F (zero slopes) = 1.694472||Probability (F) = 0.240754|
Table 1 summarizes the regression that was run to forecast GDP. The intercept and the X variable were used in the regression equation to forecast GDP. The R-square is 0.220219, which means that approximately 22% of the variation in GDP is explained by variation in government expenditure. The t-statistic for the intercept is equal to 2.056649, and this indicates rejection of the null hypothesis that the intercept equals zero. The t-statistic for the coefficient on government spending and the F-statistic for zero slope (which is the square of the t-statistic when there is only one right-hand-side variable) fail to reject the null hypothesis that the slope is equal to zero.
The results of this forecast are very interesting. The first part of the projected five years of GDP is relatively stable and resembles the current GDP figures. However, toward the end of the five-year period, it appears as if there will be a recession in the economy. GDP drops near the end of the forecast period. The 1999 to 2003 GDP forecast is shown in table 2.
Forecasts of GDP 1999.1-2003.4
(Billions of Chained 1992 dollars, SAAR)
|Quarter||Forecast||Annualized % Growth|
This forecast predicts a protracted recession starting in 2001 because GDP activity decreases.
Part 5. The Bitter End
The forecast GDP is favorable in the beginning of the sample period, however, a recession is predicted near the end. If a recession were to actually occur then the Federal Reserve would have to implement some policies to counterattack the effects of the recession. Some measures that the Federal Reserve may introduce in recessionary periods are to shift the aggregate demand curve to the right and to lower unemployment. The Federal Reserve needs to be concerned with a possible recession in the future because it can have devastating effects on everyone in the economy. The past actual GDP and the forecast GDP are shown in graph 1 in order to demonstrate the predicted recession.
Part 6. Policy Conclusion
GDP is projected to decline by 9% over the next five years. GDP is predicted to decrease by .019% in 1999. In 2000, GDP is projected to increase by .002%. There is to be a decrease in GDP of .002% in 2001. GDP is predicted to decrease by .007% and .04% in 2002 and 2003, respectively. This was concluded based on government expenditure as the explanatory variable.
Industries may have to endure a slight decline in the economy over the next five years. According to the forecast data, it appears GDP is going to decline in the near future. This could have detrimental effects on U.S. industries. The industries will have to wait and see what policies the government will implement if a recession actually occurs.
The United States government needs to be concerned about any chance that a recession might occur in the near future. If a recession is predicted, the government needs to keep a careful track on any possibility that an actual recession may emerge. This will allow the government to have a headstart on controlling and lessening the effects of the recession. The Federal Reserve should also place emphasis on recognizing the emergence of a recession in the near future. If the Fed feels it necessary to do so they could start planning strategies that would best take advantage of a possible recession occurring. By being ready for a recession, the Fed could possibly reduce the negative effects associated with one.
Thomas, Lloyd B. Money, Banking, and Financial Markets. New York: McGraw-Hill Companies, Inc., 1997