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Explanations for the Great Moderation in GDP volatility have included improved management of inventory schedules, the good luck of smaller economic shocks, and better anti-inflation policy. This article provides direct evidence on the changes in production behavior underlying these explanations within a market model for consumer durable goods. Long-run price and sales elasticities are estimated using VECMs for 1959 through 1983 (period I) and 1984 through 2008 (period II). Significant and more effective adjustments to output growth in response to both market disequilibria and changes in demand occur in period II and contribute to the reduced volatility observed. During that time, 95 percent of market disequilibrium gaps were closed after four quarters, and current output adjusted to accommodate 90 percent of demand changes occurring during the preceding three quarters.

Using data from 1955 to 2005, the estimates presented imply a long-run equilibrium relation between U.S. federal government revenues and expenditures, but one that is consistent with a continuous expansion in the deficit. There is evidence of a structural break that led to deficit reduction and surpluses from 1996 to 2001, which coincides with several noteworthy economic and political outcomes including the only time when a Democratic administration and Republican Congress were in power simultaneously. The results support the view of a long-run deficit bias in federal budget decision-making. Absent behavior similar to that of the late 1990s, a change in budget rules may be needed to avoid the large deficits forecasted under current law.

A demand-based model of public sector spending is used to identify the economic determinants of the relative size of government in the United States for the period 1949 to 1998. The government's share of GDP is hypothesized to be a function of income growth (Wagner's Law), relative prices for public sector output (Baumol/Beck hypothesis), and several demographic, cyclical, and budget variables. Although nondefense, noninterest government spending as a share of GDP has not grown in recent decades, the results support both income and price explanations of increasing government size. It is shown that the income and price effects are sensitive to the degree of disaggregation used to define government spending shares. Higher relative prices outweigh economic growth as a factor behind increasing shares for government consumption. Economic growth dominates the relative price effect for investment purchases. The two effects are similar for transfer payments.

Capital stock data for the U.S. economy are used to develop a measure of sectoral shifts in productive resources. Within the context of the creative destruction process, this measure provides a direct indicator of sectoral shifts in resource demands independent of aggregate fluctuations. Years with greater reallocations of capital have higher unemployment, a result consistent with the traditional sectoral shifts hypothesis. However, fluctuations in unemployment appear to be more strongly influenced by aggregate rather than sectoral shocks. Significant variation exists across demographic groups in the responsiveness of unemployment to aggregate fluctuations and sectoral shifts. The adverse impact of sectoral shifts is greater for males and members of the nonwhite labor force.

The Office of Management and Budget (OMB) annually submits the President's budget for the U.S. government to the Congress. The economic forecasts and revenue and outlay proposals contained in the budget have been criticized as biased, especially during the 1980s. Tests for bias in one year ahead proposals for the 1963–89 period show no bias in economic forecasts and revenue estimates, but substantial bias in outlay proposals. Most outlay proposals are consistently less than actual outcomes, accounting for underprediction of the Federal deficit. OMB outlay proposals appear to be influenced by politics. Republican administrations show more significant proposal biases, with defense proposals higher and domestic outlay proposals lower than outcomes. The Office of Management and Budget consistently understates the deficits by resorting to the most optimistic economic assumptions it can credibly — and now sometimes even incredibly — employ. — Senator James SasserWall Street Journal, 25 January 1990