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Over-optimism in forecasts by official budget agencies and its implications

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  • Jeffrey Frankel

Abstract

The paper studies forecasts of real growth rates and budget balances made by official government agencies among 33 countries. In general, the forecasts are found: (i) to have a positive average bias, (ii) to be more biased in booms, and (iii) to be even more biased at the 3-year horizon than at shorter horizons. This over-optimism in official forecasts can help explain excessive budget deficits, especially the failure to run surpluses during periods of high output: if a boom is forecasted to last indefinitely, retrenchment is treated as unnecessary. Many believe that better fiscal policy can be obtained by means of rules such as ceilings for the deficit or, better yet, the structural deficit. But we also find: (iv) countries subject to a budget rule, in the form of euroland's Stability and Growth Pact (SGP), make official forecasts of growth and budget deficits that are even more biased and more correlated with booms than do other countries. This effect may help explain frequent violations of the SGP. The question becomes how to overcome governments' tendency to satisfy fiscal targets by wishful thinking rather than by action. Chile in 2000 created structural budget institutions that may have solved the problem. Independent expert panels, insulated from political pressures, are responsible for estimating the long-run trends that determine whether a given deficit is deemed structural or cyclical. The result is that Chile's official forecasts of growth and the budget have not been overly optimistic, even in booms. Unlike many countries in the North, Chile took advantage of the 2002--7 expansion to run budget surpluses, and so was able to ease in the 2008--9 recession. Copyright 2011, Oxford University Press.

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Bibliographic Info

Article provided by Oxford University Press in its journal Oxford Review of Economic Policy.

Volume (Year): 27 (2011)
Issue (Month): 4 ()
Pages: 536-562

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Handle: RePEc:oup:oxford:v:27:y:2011:i:4:p:536-562

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Citations

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Cited by:
  1. Jeffrey Frankel & Jesse Schreger, . "Over-optimistic official forecasts and fiscal rules in the eurozone," Working Paper 83166, Harvard University OpenScholar.
  2. Jeffrey A. Frankel & Carlos A. Végh & Guillermo Vuletin, 2011. "On Graduation from Fiscal Procyclicality," NBER Working Papers 17619, National Bureau of Economic Research, Inc.
  3. Douglas Sutherland & Peter Hoeller & Rossana Merola, 2012. "Fiscal Consolidation: Part 1. How Much is Needed and How to Reduce Debt to a Prudent Level?," OECD Economics Department Working Papers 932, OECD Publishing.
  4. Merola, Rossana & Pérez, Javier J., 2013. "Fiscal forecast errors: Governments versus independent agencies?," European Journal of Political Economy, Elsevier, vol. 32(C), pages 285-299.
  5. Simon Luechinger & Christoph Schaltegger, 2013. "Fiscal rules, budget deficits and budget projections," International Tax and Public Finance, Springer, vol. 20(5), pages 785-807, October.
  6. Frankel, Jeffrey A. & Schreger, Jesse, 2012. "Over-Optimistic Official Forecasts in the Eurozone and Fiscal Rules," Working Paper Series rwp12-041, Harvard University, John F. Kennedy School of Government.
  7. Ley, Eduardo & Misch, Florian, 2013. "Real-time macro monitoring and fiscal policy," Policy Research Working Paper Series 6303, The World Bank.
  8. Douglas Sutherland & Peter Hoeller & Rossana Merola, 2012. "Fiscal Consolidation: How Much, How Fast and by What Means?," OECD Economic Policy Papers 1, OECD Publishing.
  9. William Easterly, 2012. "The Role of Growth Slowdowns and Forecast Errors in Public Debt Crises," NBER Chapters, in: Fiscal Policy after the Financial Crisis, pages 151-173 National Bureau of Economic Research, Inc.
  10. World Bank, 2013. "World Development Report 2014 : Risk and Opportunity—Managing Risk for Development," World Bank Publications, The World Bank, number 16092, October.
  11. António Afonso & Ana Sofia Nunes, 2013. "Economic forecasts and sovereign yields," Working Papers Department of Economics 2013/02, ISEG - School of Economics and Management, Department of Economics, University of Lisbon.

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