Econ 240 C Lecture 13

2 Part I. CA Budget Crisis

3 CA Budget Crisis w What is Happening to UC? UC Budget from the state General Fund

4 UC Budget w Econ 240A Lab Four w New data for Fiscal Year w Governor’s Budget Summary released January

6 CA Budget Crisis w What is happening to the CA economy? CA personal income

Log Scale

11 CA Budget Crisis w How is UC faring relative to the CA economy?

13 CA Budget Crisis w What is happening to CA state Government? General Fund Expenditures?

15 CA Budget Crisis w How is CA state government General Fund expenditure faring relative to the CA economy?

17 Long Run Pattern Analysis w Make use of definitions: w UCBudget = (UCBudget/CA Gen Fnd Exp)*(CA Gen Fnd Exp/CA Pers Inc)* CA Pers Inc w UC Budget = UC Budget Share*Relative Size of CA Government*CA Pers Inc

18 What has happened to UC’s Share of CA General Fund Expenditures? w UC Budget Share = (UC Budget/CA Gen Fnd Exp)

22 UC Budget Crisis w UC’s Budget Share goes down about one tenth of one per cent per year will the legislature continue to lower UC’s share? Probably, since competing constituencies such as prisons, health and K-12 will continue to lobby the legislature.

23 What has happened to the size of California Government Expenditure Relative to Personal Income? w Relative Size of CA Government = (CA Gen Fnd Exp/CA Pers Inc)

25 California Political History w Proposition 13 approximately 2/3 of CA voters passed Prop. 13 on June 6, 1978 reducing property tax and shifting fiscal responsibility from the local to state level w Gann Inititiative (Prop 4) In November 1979, the Gann initiative was passed by the voters, limits real per capita government expenditures

26 CA Budget Crisis w Estimate of the relative size of the CA government: 6.00 %

27 CA Budget Crisis: Pattern Estimate of UC Budget w UC Budget = UC Budget Share*Relative Size of CA Government*CA Pers Inc w Political trends estimate w UC Budget = 0.035*.060* $B =$ 2.66 B estimate w Governor’s proposal in January: $ 2.67 B

28 Econometric Estimates of UCBUD w Linear trend w Exponential trend w Linear dependence on CAPY w Constant elasticity of CAPY

29 Econometric Estimates w Linear Trend Estimate w UCBUDB(t) = a + b*t +e(t) about 3.0 B Too optimistic

31 Econometric Estimates w Logarithmic (exponential trend) w lnUCBUDB = a + b*t +e(t) w simple exponential trend will over-estimate UC Budget by far

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34 Econometric Estimate w Dependence of UC Budget on CA Personal Income w UCBUDB(t) = a + b*CAPY(t) + e(t) w looks like a linear dependence on income will overestimate the UC Budget for

36 Econometric Estimates w How about a log-log relationship w lnUCBUDB(t) = a + b*lnCAPY(t) + e(t) w Estimated elasticity w autocorrelated residual w fitted lnUCBUDB( ) = $3.40 B w actual (Governor’s Proposal) = $2.67B

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41 Econometric Estimates w Try a distributed lag Model of lnUCBUDB(t) on lnCAPY(t) clearly lnUCBUDB(t) is trended (evolutionary) so difference to get fractional changes in UC Budget likewise, need to difference the log of personal income

42 Identify dlnucbudb

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45 Identify dlncapy

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48 Estimate ARONE Model for dlncapy

49 This is a satisfactory model

50 Estimate ARONE Model for dlncapy(t) w Orthogonalize dlncapy and save residual w need to do transform dlnucbudb w dlnucbudb(t) = h(Z)*dlncapy(y) + resid(t) w dlncapy(t) = 0.714*dlncapy(t-1) + N(t) w [ Z]*dlnucbudb(t) = h(Z)* [ Z]*dlncapy(t) + [ Z]*resid(t) w i.e. w(t) = h(Z)*N(t) + residw(t)

51 Distributed Lag Model w Having saved resid as res[N(t)] from ARONE model for dlncapy w and having correspondingly transformed dlnucbud to w w cross-correlate w and res

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53 Distributed lag model w There is contemporary correlation and maybe something at lag one w specify dlnucbud(t) = h 0 *dlncapy(t) + h 1 *dlncapy(t-1) + resid(t)

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57 Try an ARONE residual fo dlnucbudb

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61 w Try a dummy for , the last recession, this is the once and for all decline in UCBudget mentioned by Granfield w There is too much autocorrelation in the residual from the regression of lnucbud(t) = a + b*lncapy(t) + e(t) to see the problem w Look at the same regression in differences

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66 Distributed lag Model w dlnucbud(t) = h 0 *dlncapy(t) + h 1 *dlncapy(t-1) + dummy ( ) + resid(t) w

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69 Try an artwo residual instead of arone

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71 Note the fitted tends to be higher than the residual For the past three years suggesting UC is taking a bath

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73Correlogram of the residuals: try an ar(1) or an ma(1)

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76 Correlogram of the residuals

77Fitted fractional change in UC Budget is –0.025 (-2.5%)versus Governor’s proposal of (-8.6%)

78 Conclusions w Governors proposed cut in UC Budget of 8.6% is greater than expected from various Box-Jenkins models, controlling for income w The UC Budget growth path ratcheted down in the recession beginning July 1990 w The UC Budget growth path looks like it is ratcheting down again in the recession beginning March 2001

80 Try estimating the model in levels

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82 Correlogram of residuals: add an ARONE

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85 Correlogram of the residuals

86 dlucbud c dlncapy(-1) dummy for dummy2 for ma(7)

87 dlnucbud c dlncapy dummy for dummy2 for