Working Paper Series Congressional Budget Office Washington, D.C. Key Methods That CBO Used to Estimate the Effects of Pandemic-Related Legislation on Output John Seliski Aaron Betz Congressional Budget Office Congressional Budget Office [email protected] [email protected] Yiqun Gloria Chen U. Devrim Demirel Congressional Budget Office Congressional Budget Office [email protected] [email protected] Junghoon Lee Jaeger Nelson Congressional Budget Office Congressional Budget Office [email protected] [email protected] Working Paper 2020-07 October 2020 To enhance the transparency of the work of the Congressional Budget Office and to encourage external review of that work, CBO’s working paper series includes papers that provide technical descriptions of official CBO analyses as well as papers that represent independent research by CBO’s analysts. Papers in that series are available at http://go.usa.gov/ULE. For helpful comments and suggestions, the authors thank Christina Hawley Anthony, Robert Arnold, William Carrington, Mark Doms, Sebastien Gay, John Kitchen, Jeffrey Kling, John McClelland, Dan Ready, Chad Shirley, Phillip Swagel, and Jeffrey Werling. In addition, CBO consulted with many outside experts, including members of its Panel of Economic Advisers. Although those experts provided considerable assistance, they are not responsible for the contents of this paper. James Otterson created the tables, and Erin Deal fact-checked the paper. Christine Bogusz and Gabe Waggoner were the editors. www.cbo.gov/publication/56612 Abstract This paper describes key methods that the Congressional Budget Office used to estimate the effects on economic output of the laws enacted in response to the 2020 coronavirus pandemic. To quantify the short-term effects that those laws had on output by means of their influence on overall demand for goods and services, CBO used delayed and reduced estimates of the output multiplier to reflect the effects of social distancing. The agency combined estimates of the effects on overall demand with those on the supply of labor in the economy, when applicable, to examine the short-term effects of enhanced unemployment compensation, the Paycheck Protection Program and related provisions, the Federal Reserve’s emergency lending facilities, and other provisions. To estimate the longer-term effects of pandemic-related legislation on output, CBO used its Solow-type growth model to quantify the effect of higher federal deficits on national saving and private investment. Keywords: fiscal policy, pandemic, multiplier, labor supply, federal budget JEL Classification: E2, E32, E62, E63, H2, H3, H5, H6, J64 Notes Unless indicated otherwise, all years referred to in this paper are calendar years. Numbers in the text and tables may not add up to totals because of rounding. Contents Introduction ..................................................................................................................................... 2 Short-Term Effects.......................................................................................................................... 3 How Changes in Overall Demand for Goods and Services Affect Output................................. 3 How Enhanced Unemployment Compensation Affects Output ................................................. 9 How the Paycheck Protection Program and Related Provisions Affect Output ....................... 12 How the Federal Reserve’s Emergency Lending Facilities Affect Output ............................... 14 How Other Provisions Affect Output ....................................................................................... 15 Longer-Term Effects ..................................................................................................................... 17 How Increased Federal Borrowing Affects Output .................................................................. 18 The Transition Between the Short Term and the Longer Term ................................................ 19 Box 1. How CBO Estimates the Employment Effects of the Paycheck Protection Program ....... 20 Tables ............................................................................................................................................ 23 Table 1. The Effects of Pandemic-Related Legislation on Real GDP ...................................... 23 Table 2. Changes in Output From One Dollar of Direct Effects on Overall Demand When Output Is Well Below Potential and the Federal Reserve’s Responses Are Limited ............... 24 Table 3. Direct Effects on Overall Demand From One Dollar of Budgetary Cost Incurred in the Second Quarter of 2020 ...................................................................................................... 25 Introduction This paper describes key methods that the Congressional Budget Office used to estimate the effects on real (inflation-adjusted) output, or gross domestic product (GDP), of the laws enacted in response to the 2020 coronavirus pandemic.1 Taken together, that legislation substantially changed policies governing taxes and spending and provided significant financial support to households, businesses, and state and local governments through various channels. In CBO’s assessment, the changes in federal fiscal policies offset part of the deterioration in economic conditions brought about by the pandemic, boosting the level of real GDP by 4.7 percent in 2020 and 3.1 percent in 2021 (see Table 1).2 In the longer term, the agency estimates, higher federal budget deficits as a result of the legislation will reduce national saving, ultimately causing the level of real GDP to be about 0.4 percent lower in 2030 than it otherwise would have been. To analyze the short-term economic effects of pandemic-related legislation, CBO augmented its existing analytical methods with information from relevant research and developed new approaches to account for the circumstances surrounding the current economic environment.3 In particular, actions that governments, businesses, and households in the United States and around the world have taken to slow the spread of the coronavirus by limiting in-person interactions— collectively known as social distancing measures—are unique to the current recession.4 CBO expects that social distancing will delay and reduce fiscal policy’s effect on overall demand for goods and services. In addition, some key provisions of the legislation alter individuals’ labor supply choices in the economy, whereas others financially support businesses and help cushion the impact of the pandemic and social distancing on the economy’s productive capacity. CBO’s 1 Those estimates are presented in Congressional Budget Office, The Effects of Pandemic-Related Legislation on Output (September 2020), www.cbo.gov/publication/56537. The estimates presented in this paper do not include the effects of nonlegislative actions, such as those taken by the Federal Reserve (for example, lowering interest rates and purchasing mortgage-backed and Treasury securities) and the Administration (for example, delaying tax-filing deadlines). The estimates do account for the legislation’s funding of lending facilities established by the Federal Reserve to support the flow of credit to businesses, households, and state and local governments. CBO did not analyze the effects of any legislation that was enacted, executive orders that were made, or Federal Reserve actions that were taken after August 4, 2020. 2 Those effects were incorporated into the agency’s most recent economic forecast; see Congressional Budget Office, An Update to the Economic Outlook: 2020 to 2030 (July 2020), www.cbo.gov/publication/56442. The estimates in this report are presented in relation to an implied projection of real GDP that does not include the effects of the legislation—a projection computed by removing the estimated effects of the legislation from the July forecast. However, CBO did not construct a comprehensive projection of what the economy would have looked like without those legislative effects. 3 For a general discussion of the methods that CBO uses to analyze the economic effects of fiscal policy changes, see Congressional Budget Office, How CBO Analyzes the Effects of Changes in Federal Fiscal Policies on the Economy (November 2014), www.cbo.gov/publication/49494. 4 Social distancing measures include reducing social activities and travel, curtailing the activity of schools and businesses, prohibiting large gatherings, and working from home. CBO did not estimate effects of the pandemic- related legislation on the trajectory of the pandemic or on social distancing measures because the agency lacked the information to do so. 2 analytical framework incorporates those effects and other aspects of legislative actions taken in response to the pandemic. To estimate the longer-term effects of pandemic-related legislation on output, the agency used its Solow-type growth model. CBO expects that pandemic-related legislation will affect output in the longer term primarily by reducing national saving and private investment. Increased federal deficits and borrowing lower output in the longer term by reducing the amount of funds available for private investment, thereby causing the capital stock to be lower than it would be otherwise. CBO used a weighted average of the short-term and longer-term effects to estimate the effect on output over the period from 2020 to 2030. Short-Term Effects CBO assesses the short-term effects of changes in fiscal policies on