Measuring the cyclical sensitivity of federal receipts and expenditures: Simplified estimation procedures

Abstract

It is well known that the federal budget automatically responds to cyclical fluctuations in economic activity. For this reason, economists are often interested in removing these temporary cyclical changes in the budget to permit the analysis of fiscal trends and impacts. Cyclically adjusted budgets (e.g., the full-employment budget, the high-employment budget, etc.) emerge after removing the automatic cyclical responses and are frequently used in these fiscal studies. Further, forecasts of the cyclically adjusted budget often appear in policy discussions. This paper presents simple procedures to estimate automatic cyclical responses and the cyclically adjusted budget. The first section discusses some of the issues surrounding the measurement of automatic cyclical responses and the cyclically adjusted budget. The most controversial issue, the selection of trend GNP (e.g., potential GNP), is highlighted. The second section describes a relatively large structural model used by the Bureau of Economic Analysis to measure the cyclical responses and the cyclically adjusted budget. The third section presents several stochastic equations that approximate the results from the structural model. The final section uses the results from the stochastic equations to produce two equations - one for receipts, one for expenditures - that can be used to estimate the automatic cyclical responses and the cyclically adjusted budget. A comparison of the results from the two equations with those from the structural model and a post-sample analysis suggest that the two equations capture most of the variation in the estimates from the larger model, and can be used by forecasters to produce reasonable approximations of what ‘official’ cyclically adjusted budget estimates would be.