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Dealing with unexpected shocks to the budget

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Author Info

  • Elena Gennari

    ()
    (Banca d'Italia)

  • Raffaela Giordano

    ()
    (Banca d'Italia)

  • Sandro Momigliano

    ()
    (Banca d'Italia)

Abstract

In this paper we assess the impact of unexpected shocks to real interest rates and GDP on government budgets for nine European Union countries. Shocks are estimated as onestep-ahead forecast errors arising from a recursive bivariate VAR model. To assess the impact on the budgets we use available information on budgetary sensitivities with respect to the business cycle and estimate the sensitivities to changes in interest rates on the basis of the maturity structure of public debts. Our analysis is relevant, in particular, to define what safety margins are needed to avoid the deficit exceeding the 3 per cent Maastricht threshold. The approach followed in this paper differs in two respects from standard analyses aiming at defining budgetary positions that satisfy the Stability and Growth Pact. First, whereas the latter examine only fluctuations in economic activity, we also consider fluctuations in interest rates. Second, whereas standard analyses focus on deviations from trends and define margins for the medium-term cyclically adjusted balance, we examine unexpected shocks and define margins for nominal balances. The results point to significant differences in the required margins across countries, depending on the amplitude of past shocks, the magnitude of automatic stabilizers and the size and maturity structure of the debt. In the case of Italy, the country with the highest debt/GDP ratio and the largest fraction of short-term debt, the impact of unexpected shocks to interest rates may be quite substantial. However, when shocks to interest rates and GDP are considered jointly, other countries (Belgium and Finland) seem to require larger margins.

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Bibliographic Info

Paper provided by Bank of Italy, Economic Research and International Relations Area in its series Temi di discussione (Economic working papers) with number 478.

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Date of creation: Jun 2003
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Handle: RePEc:bdi:wptemi:td_478_03

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Keywords: budgeting; Stability and Growth Pact; forecast errors;

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References

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  1. Missale, Alessandro, 1999. "Public Debt Management," OUP Catalogue, Oxford University Press, number 9780198290858.
  2. Canova, Fabio, 1993. "Detrending and Business Cycle Facts," CEPR Discussion Papers 782, C.E.P.R. Discussion Papers.
  3. Marín, José M., 2002. "Sustainability of public finances and automatic stabilisation under a rule of budgetary discipline," Working Paper Series 0193, European Central Bank.
  4. Ray Barrell & Ian Hurst & Álvaro Pina, 2002. "Fiscal Targets, Automatic Stabilisers and their Effects on Output," Working Papers Department of Economics 2002/05, ISEG - School of Economics and Management, Department of Economics, University of Lisbon.
  5. Michael Artis & Massimiliano Marcellino, 2001. "Fiscal forecasting: The track record of the IMF, OECD and EC," Econometrics Journal, Royal Economic Society, vol. 4(1), pages S20-S36.
  6. Bohn, Henning, 1990. "Tax Smoothing with Financial Instruments," American Economic Review, American Economic Association, vol. 80(5), pages 1217-30, December.
  7. Bouthevillain, C. & Van Den Dool, G. & Langenus, G. & Mohr, M. & Momigliano, S. & Tujula, M. & De Cos, P.H. & Cour-Thimann, Philippine, 2001. "Cyclically Adjusted Budget Balances: an Alternative Approach," Papers 77, Quebec a Montreal - Recherche en gestion.
  8. Buti, Marco & Franco, Daniele & Ongena, Hedwig, 1998. "Fiscal Discipline and Flexibility in EMU: The Implementation of the Stability and Growth Pact," Oxford Review of Economic Policy, Oxford University Press, vol. 14(3), pages 81-97, Autumn.
  9. Thomas Dalsgaard & Alain de Serres, 1999. "Estimating Prudent Budgetary Margins for 11 EU Countries: A Simulated SVAR Model Approach," OECD Economics Department Working Papers 216, OECD Publishing.
  10. M. Buti & D. Franco & H. Ongena, 1997. "Budgetary Policies during Recessions - Retrospective Application of the "Stability and Growth Pact" to the Post-War Period," European Economy - Economic Papers 121, Directorate General Economic and Monetary Affairs (DG ECFIN), European Commission.
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Cited by:
  1. Kempkes, Gerhard, 2012. "Cyclical adjustment in fiscal rules: Some evidence on real-time bias for EU-15 countries," Discussion Papers 15/2012, Deutsche Bundesbank, Research Centre.

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